Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
The man who chooses to work longer to gain an income
more than sufficient for his basic needs prefers some extra
goods or services to the leisure and activities he could
perform during the possible nonworking hours; whereas the
man who chooses not to work the extra time prefers the
leisure activities to the extra goods or services he could
acquire by working more.
Given this, if it would be illegitimate for a tax system to
seize some of a man’s leisure (forced labor) for the
purpose of serving the needy , how can it be legitimate
for a tax system to seize some of a man’s goods for that
purpose? Why should we treat the man whose happiness
requires certain material goods or services differently from
the man whose preferences and desires make such goods
unnecessary for his happiness? [Nozick, Robert (1974 /
2013-11-12). Anarchy, State, and Utopia (p. 170). Basic Books.
Kindle Edition.]
I.
Introduction: Welfare Economics as Social Philosophy
During the late nineteenth century the marginal revolution took place
in economics with a series of new analytical devices introduced that allowed
geometric and mathematical representations of individual markets and
market systems to be undertaken. Those devices include utility functions,
indifference curves, demand and supply curves, profit maximizing models
of a firm’s output decisions, and new price-driven theories of general
equilibrium. All these innovations where generalized and deepened during
the twentieth century. By mid century, a standard neoclassical “tool bag” of
geometric and mathematical models for microeconomics had been
assembled and was routinely taught at most universities.
The same might be said of the tools of Pigovian welfare economics.
More or less standard tools for analyzing the benefits and costs of public
1
policies were worked out, and modest generalizations of the utility
principle developed. Sedgewick and Pigou were a pioneers in efforts to join
the utilitarian “welfare” analysis to neoclassical economics. Their work was
extended by Bergson, Harasanyi, Samuelson, and Sen among many others.
Shortly after WWII, Buchanan, Coase, and Rawls showed how many of the
same tools could be used by contractarians as well as utilitarians.1
Contemporary welfare economics continues to have utilitarian and
contractarian foundations, although scholars do not often refer to its
philosophical roots. Nonetheless, there remains an overlap between the
work of economists and philosophers on issues of system choice and the
good society. Among the twentieth century philosophers, Rawls, Nozick,
and Skyrms, for example, are known for their efforts to use rational-choice
based analysis to support their reasoning and conclusions about the nature
of the good society.
Chapter 7 used elementary game theory and neoclassical tools to
illustrate how private codes of conduct can effect market equilibria. This
chapter illustrates how the neoclassical approach has been used by
utilitarians and contractarians to assess the merits of particular market
outcomes.
II.
The Neoclassical Debt to Utilitarian Analysis
Many of the leading utilitarians of the nineteenth century were also
highly regarded for their contributions to economics. Bentham, Mill, and
Sidgwick, for example, all made significant contributions to economics and
wrote principles of political economy books. Mill’s textbook was among
the most used in the English speaking world during the mid nineteenth
century. As a consequence, most economists trained in the nineteenth
century could be regarded as students of Mill.
The utility concept assumed a foundational role in the analytical tool
back of economics as the diminishing marginal utility concept was used to
The precision of the new geometric and mathematical analyses exaggerates their ability to shed light on economic and social activities, but may important insights were
developed using the neoclassical approach. Indeed, the precision associated with the new analysis caused the older more philosophical and historical approaches of
nineteenth century economics to gradually disappeared from mainstream economics.
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
explain the diamond-water paradox. The utility concept was also used to
illustrate the existence of gains to trade and to illustrate the thought process
that produces consumer demand.
Pigou, the founder of welfare economics was clearly influenced by
utilitarian thought as noted above. His discussion of economic welfare and
the national dividend both had utilitarian foundations. He used it
extensively in his normative analysis of the distribution of income.
Mathematical representations of aggregate utility allowed the effects of
economic development and public policy on aggregate utility to be
rigorously deduced from economic models.2
Insofar as neoclassical economics and utilitarianism emerged
simultaneously during the nineteenth century and was substantially the
product of the same minds, it is not surprising that utilitarian assessments
of economic activities lend themselves to illustration with neoclassical
geometry. The contractarian approach is less obviously associated with
neoclassical economics, in part because it had become moribund during the
nineteenth century.
Contractarian assessments of markets and institutions using
neoclassical tools arose later. During the 1950s and 1960s Rawls and
Buchanan routinely use neoclassical concepts and geometry to assess the
relative merits of alternative legal and political institutions. There was no
necessary conflict between the interests of an individual and pursuit of the
good society. It was not necessary to add up mental states to demonstrate
that everyone can benefit from institutions that address social dilemma or
promote voluntary exchange.
The various Pareto principles were often used to formalized this
non-utilitarian intuition. One state of the world (A) is better than (Pareto
2
superior to) another (B), if at least one person prefers A to B and no one
prefers B to A. Such is normally the consequence of any enterprise adopted
through contract or unanimous agreement. Utility-based, as opposed to
money based--representations of exchange clearly demonstrate that each
participant prefers the result after the exchange to that before the
exchange. If no one else is harmed by the transaction, the result can be
regarded as an improvement, a better society.
III.
Utility, Indifference Curves and Mutual Gains to Trade
Economists tend to take a materialistic view of utility rather than a
philosophical one. That is to say, they focus on how the consumption of
goods and services, rather than ethical dispositions, may contribute to
utility or happiness. Given this materialistic assessment of the interests of
most consumers and the assumptions that tastes are complete and
transitive, it is possible to characterize utility as a function from
combinations of goods and services into real numbers representing utility
levels, U= u(X, Y, Z, ...).
Such functions can be graphed in the same way that any other can.
Normally economists make assumptions about the manner in which utility
is generated by goods. For example, it is normally assumed that goods
exhibit diminishing marginal utility, that each successive unit of a good
generates less and less additional utility. This implies that marginal utility
curves are downward sloping. If the consumption of one good does not
affect the marginal utility of any others, this assumption is sufficient to
prove that and individual’s demand curves slope downward and that the
utility function itself is strictly concave, both important ideas in
economics.3
Subsequent generalizations of aggregate utility concept included non-linear functional representations of aggregate welfare to be employed as normative theories, but
were still grounded on Bentham’s utility principle. The mathematical generalization is arguably a retrogression from an ethical standard insofar as it allows the welfare of
different persons to have different weights. If so, persons would not necessarily be equal under the law, as with the aristocrats, commoners, and slaves of the medieval
system.
3
Some forms of interdependency among goods is also consistent with downward sloping demand curves and concavity of utility functions. If the consumption level of
one good increases the marginal utility of other goods, demand curves will also always slope downward. If it reduces the marginal utility of other goods ,there are cases in
which a demand curve may be upward sloping for some part of its range. Strict concavity is a useful mathematical property in maximization exercises. It implies that a
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
For many purposes, one and two dimensional choice settings are
sufficient to illustrate the main implications of the decisions made by utility
maximizing persons--what economists usually mean by rational persons.
A. Indifference Curves and Gains to Trade
For example, a function U = u(X,Z) can be represented in a two
dimensional diagram by graphing all the combinations of X and Z that
generate a particular utility level. Each such line or curve is called an
indifference curve. The “higher” an indifference curve a person can reach,
the higher is their utility and therefore their welfare or happiness. In 1881,
an economists named Francis Edgeworth realized that one could represent
gains to trade from such curves, and in 1906 Vilfredo Pareto realized that
one could form a box by representing two persons in a setting in which
given amounts of two goods are divided between two persons. The result
was called an Edgeworth box. The Edgeworth box can be used to illustrate
the idea of mutual gains to trade from both utilitarian and contractarian
perspectives.
Suppose that the two goods are initially distributed among Vilfredo
and Francis as at position 1, where both Francis and Vilfredo have positive
quantities of the goods. Although this would seem to place them in conflict
with each other, it turns out that at many points in the box both parties can
simultaneously be made better off, by shifting one resource (Z) from
Francis to Vilfredo while shifting some of the other resource (X) from
Vilfredo to Francis. Francis become better off (reaches higher indifference
curves and there for utility levels) as divisions of the good move to the
south west and Vilfredo become better off as divisions of the two goods
move to the northeast. Note that any point in the lens-shaped area labeled
“gains to trade” will simultaneously place both Vilfredo and Francis on a
higher indifference curve.
B. Normative Implications of Gains to Trade
Figure 10.1: Trading Goods X and Y
ZF
2
3
potential gains to trade
1
Vilfredo
Zv
Francis
The Edgeworth box demonstrates that there unrealized mutual gains
to trade that exist at a wide variety of initial allocations, as with ones similar
to division 1 and also for polar ones similar to division 2. Both persons
would benefit from terms of trade that would move them from 1 to 3. Self
interest is sufficient to induce trade in such cases, if one assumes that the
original division is protected in some way by norms or civil law, so that
theft does not pay. And, as argued by Bentham, any voluntary exchange
that takes place will increase social utility.
Note that the fact that higher indifference curves can be reached also
implies that aggregate utility is not maximized at all possible divisions of
resources. Utilitarians can thus could propose a wide variety of alternative
divisions of the resources that increase aggregate utility.
The Edgeworth box can also be used to demonstrates an important
difference between the contractarian and utilitarian norms. Gains to trade
are exhausted when divisions of goods reach any point on the wavy line
running from Francis’ corner to Vilfredo’s corner. At those points,
function can have at most one maximum. In geometric representations of utility functions with indifference curves, strict concavity of a utility function implies that its
associated indifference curves are “c-shaped” or “o-shaped,” as drawn in most intermediate microeconomic text books.
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
indifference curves of Francis and Vilfredo are tangent to one another.
Since there is no lens-shaped area of gains to trade associated with such
points, no further voluntary transactions will take place.
Individual utility levels vary along that line (the contract curve) and
thus it is likely that total utility does as well. Utilitarians are prepared to
force moves along the contract curve to a point where aggregate utility is
maximized. Such calculations usually require knowing utility levels for each
person for each of the divisions that are feasible. An exception is the case in
which Vilfredo and Francis have identical utility functions (a convenient,
but unrealistic assumption). In that case, the equal division that lies at the
exact center of the box will both be on the contract curve and maximize
aggregate utility. Except in that one case, precise measures of utility are
necessary to determine the best utilitarian allocation of the resources.
Although all voluntary exchanges increase aggregate utility, the end result
does not necessarily maximize it.
C. Gains to Trade and the Selection of Institutions
For a contractarian, the issue is not between allocations per se, but
between allocating systems, for example between voluntary exchange, some
central system of allocation, or some combination of the two. Alternatives
might include random divisions of the resources, equal divisions, or
combinations of one of these systems. It is clear that a composite system
that includes exchange would be preferred to a simple allocative rule from
behind a veil, because it can make all parties better off and cannot make
anyone worse off--ignoring cases of envy or malice, as usually done in such
illustrating exercises. Given any initial division of the two goods, any trade
that takes place necessarily benefits each.
A composite system under which resource shares are distributed,
perhaps equally, and then trade takes place would satisfy Rawls’ maximin
criteria (difference principle) in the circumstances of an Edgeworth box,
and would also be consistent with Buchanan’s veil of uncertainty when
initial allocations are not characterized by the status quo ante.4
However, if the distribution of goods (wealth) emerges from a long
series of exchange and power relationships, differences between Rawls and
Buchanan emerge. Buchanan takes the status quo seriously, whereas Rawls
does not. The allocation that emerges from historical processes is the point
of departure for both market exchange and constitutional exchange in
Buchanan’s work. Rawls is more interested in characterizing the best
society than in merely better ones.
Note, however, that the mutual benefits of exchange implies that
voters at a constitutional convention, whether taking place under Rawls’
veil of ignorance or Buchanan’s veil of uncertainty, will tend to favor
property systems in which exchange as possible. Given a choice between
systems in which most ownership rights are alienable and one in which
most ownership rights are not tradable, there would be unanimous
agreement to accept alienable ownership rights, because this allows
potential gains from trades to be realized by all parties.
Redistribution, in contrast, will tend to be vetoed by those with
initially larger endowments in the Buchanan setting, although they would
not be blocked in the Rawls or utilitarian setting. Some form of risk
pooling might, however, be acceptable to all.
D. Limitations of the Pareto Principles for Contractarians and
Utilitarians
The pure exchange model can be and has been generalized in a
number of ways. For example, generalized exchange models have been
used to prove the first fundamental theorem of welfare economics, that in
a market in which firms and consumers are both price takers and there are
no externalities, market equilibria are Pareto efficient.
However, the Edgeworth box illustration demonstrates that Pareto
optimality alone is not a sufficient condition for maximizing social utility
nor is ex post Pareto efficiency sufficient to assure Contractarian support
for the institutions that produce specific outcomes.
4
A similar rule might be adopted by utilitarians if the specific utility functions of the two individuals are known only probabilistically and cannot be assumed to be
identical. Harsanyi (195x, 1976). He also suggest that some persons may be dropped from a social welfare function, namely those with antisocial or illegitimate preferences.
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
Surprisingly, the Pareto criteria are not directly relevant to either
utilitarian or contractarian assessments of the relative merits of markets in
fixed resources environments. Issues in distributive justice are explored in
greater depth later in this chapter. Other feasibility issues are examined
below and in the next chapter.
IV.
Monetized Indicators of Welfare: The Geometry and Logic of
Net Benefit Analysis
One widely monetary representation for aggregate utility is concept
of the social net benefits. It is simply the total benefits in dollars less the
total cost associated with some outcome, often an output level or public
policy. Social benefits are simply the highest amount that a person is
willing to have quantity Q rather than 0 of the good or service of interest.
Total cost is simply the production cost of the good or service, which is an
indicator of the opportunity cost of production, although that is not
important for the calculation of social net benefits. In cases, in which all
persons are identical there will be a one to one correspondence between
social net benefits and aggregate Benthamite utility for given utility
functions. In other cases, as in that above, other assumptions are necessary
to assure an exact correspondence, although these are normally ignored for
reasons suggested by Pigou.
[T]he money which a person is prepared to offer for a thing
measures directly, not the satisfaction he will get from the
thing, but the intensity of his desire for it. This distinction,
obvious when stated, has been somewhat obscured for
English speaking students by the employment of the term
utility —which naturally carries an association with
satisfaction— to represent intensity of desire.
5
Thus, when one thing is desired by a person more keenly
than another, it is said to possess a greater utility to that
person. [Pigou (1920 / 2013-11-15). The Economics of
Welfare (KL 483-486).
It is a matter of great convenience for elementary welfare economics
that the social marginal benefits of consumption can be represented with
market demand curves and the marginal social cost of production with
market supply curves, under conditions that are not much stronger than
those required to derive them in the first place.
The areas between the demand and supply curves correspond to
social net benefits, as long as all the benefits from this product accrue to
consumers in this market and production costs are fully accounted for by
each firm’s own cost functions for this market. In that case, it can be easily
shown that competitive markets tend to produce output levels that
maximize social net benefits. Insofar as social net benefits are an indicator
of aggregate utility, this implies that each competive market tends to induce
production levels that maximize each product’s contribution to aggregate
utility. Market competition thus tends to maximize aggregate utility.5
A. Demand, Supply, and the Normative Merits of Competitive
Markets
In the absence of externalities, ordinary demand and supply curves
can be used to represent the consumers marginal benefits and industry’s
marginal production cost for various production levels.6 Market prices
adjust to equate the quantity demanded with the quantity supplied in both
the short run and long run.
Figure 10.2 illustrates a typical competitive market equilibrium.
Consumers realize consumer surplus equal to area 1 and firms earn long
The social net benefit approach neglects distributional issues, because it uses dollars rather than utils as the common indicator of happiness. A millionaire’s dollar is
treated just like a pauper’s.
6
The long run supply curve is assumed to represent a Ricaradian market in which suppliers produce essentially identical products but have different cost functions. In
this case, as opposed to the Marshallian case, most producers earn profits--e.g. net benefits from their production choices. In the long run MC=MR = P (in equilibrium) at
the output produced by each firm and MR>MC over the range below that output. Demand curves that represent marginal benefits of consumers can be derived either in
the Hicksian manner from utility functions, or perhaps better and more general for the purposes of this exercise from individual marginal benefit curves directly. In this
case MB = MC = P (in equilibrium) and MB>MC over most of the range of consumption and so consumer surplus is realized.
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
term profits equal to area 2. The total cost of production is area 3. In a
market without externalities, all the relevant costs and benefits for a single
market are characterized by the demand and supply curves. In that case the
demand and supply curves can be interpreted as social marginal benefit and
social marginal cost curves.7
Figure 10.2 Market Equilibrium
$/Q
S=MCi=SMC
1
P*
2
3
D=MBc=SMB
Q*=Q**
Q
Maximizing social net benefits requires an output level, Q**, where
SMB(Q**) equals SMC(Q**).8 Insofar as prices adjust to clear the market,
this is the output normally produced by competitive markets. Subject to
various caveats, Figure 10.3 thus demonstrates that markets tend to
maximize aggregate utility. This money-based analysis contrasts with the
more general Edgeworth box representation of exchange, where voluntary
7
exchange does not necessarily maximize the sum of the utilities for the
traders involved.9
Markets simultaneously the extent of production and the distribution
of social net benefits in a manner that approximately maximizes aggregate
utility, other things being equal. The market outcome divides the social net
benefits between firm owners and consumers based on price and the slopes
the relevant demand and supply curves.
In these widely used diagrams, it is essentially assumed that net
benefits are the same for each person or firm, and being denominated in
dollars, they can be simply added up. A dollar of net benefits is a dollar of
net benefits, and social net benefits are simply profits plus consumer
surplus. Such cost-benefit calculations clearly are in the spirit of utilitarian
analysis, and they make it possible to measure and add up net benefits
across individuals because dollars, prices, and outputs are observable
cardinal numbers, whereas “utils” are not.
Figure 10.2 illustrates why economists from Pigou forward have
been comfortable shifting from utility-based analysis to dollar-based
analysis. In many cases, money values for ouputs--as with GDP--and
money representations of net benefits--as with cost benefit analysis--allow
sharper conclusions to be reached using measurable monetary indicators of
welfare than can be deduced from abstract utilitarian analysis. Analysis of
net-benefits can be easily undertaken with the graphic tools of introductory
economics. Since both demand and supply curves can be estimated, so can
the net benefits associated with different markets.
I use Ricardian rather than Marshallian long run supply curves in the diagrams of this and the next chapter. These assume that firms producing the same products have
different cost curves, as in the oil, mining, and agricultural industries. In markets for consumer goods, production cost differences would emerge because of unique
features of economic organizations and managers and location, that long run competition does not completely eliminate, as in bakeries and repair shops.
8
For the standard neoclassical treatment, the demand curves should be of the Hicksian compensated demand variety. However, it is possible to directly derive demand
curves from individual consumer marginal benefit curves. In this case, it is simply demand curves that are used. The distribution of income typical of commercial societies
is more consistent with Ricardian than Marchallian representations of competitive supply.
9
The Pareto efficiency of competitive market outcomes is easier to demonstrate and requires far fewer assumptions. See Varian (xxxx) for a illustrating proof. Figure
10.3 can also be used to demonstrate the fundamental theorem of welfare economics. Net gains to trade exist for all units produced having a marginal benefit greater than
its marginal cost. Such potential gains exist for all units up to Q*, and for none afterwards. At the market equilibrium, all potential gains to trade are realized and no
changes in output or price are possible that would make one person better off without making another worse off.
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
This approach provides strong support for the “efficiency” of
markets as generator’s of aggregate utility in part because the approach
suppresses distributional concerns. It also can be used to analyzed
problems associated with monopoly power and externalities, as undertaken
in the next sections.
It bears noting that the informational assumptions of the partial
equilibrium mode of analysis are far less demanding than those required for
a truly global utilitarian analysis, which require a dynamic general
equilibrium perspective. No mind reading is required; nor is it necessary to
have a complete model of the economic and social universe in order to
understand the effects of one market at a time in an “other things being
equal” analysis. However, the partial equilibrium approach it cannot fully
address interdependencies among markets, nor intertemporal or
distributional issues.
Figure 10.2 can also be used to facilitate contractarian analysis. First,
the diagram implies that all gains to trade are realized when markets are
competitive. Voluntary exchange will not take one beyond the output
generated, because further production costs more than it brings in benefits
to consumers. Second, the fact that no further gains from trade exist at the
competitive equilibrium implies that no effort to regulate competitive
markets can generate additional net benefits for consumers and producers
beyond those generated by competitive markets. Third, movements away
from the market equilibrium generated by public policies are thus not
consistent with the interests of those As long as there is no change in either
a consumer’s marginal benefits or a firm’s marginal production costs, and
voluntary exchange is allowed to take place, market participants can do no
better than the market outcome.
Distributional issues, however, are more difficult to analyze.
Whether these are important or not depends on the contractarian
perspective adopted. From behind the veil of ignorance or veil of
uncertainty, risk neutral citizens would accept any system that maximizes
average utility. Such persons are indifferent about distributional matters
except insofar as average utility is increased. Institutions that produce
10
competitive markets would thus be supported insofar as average net
benefits and average benefits are correlated as argued by Pigou.
However, if citizens are risk averse as assumed in much of Rawls’
analysis, expected distributional outcomes are more important. In such
cases, the case for markets is less strong, as is evident in Rawls’ discussion.
Commerce would tend to be strongly supported, however, insofar as it
tends to maximize the material wealth that can be used to fund
redistributive and social insurance programs, other things being equal.10
Life satisfactions with a life spent largely in commerce would also be
relevant considerations.
B. The Utilitarian and Contractarian Cases Against Monopoly
The other extreme in the neoclassical spectrum of market types is a
pure monopoly. This is a firm that has market power in that it can set
prices and faces its own distinct demand curve. In the real world, these
conditions are met by a wide range of local retail stores, although with
internet shopping and efficient shipping, there are arguably fewer such
retail stores than there used to be. There are two forms of monopoly of
interest, first the standard text variety that sells all of its output at a single
price and second a price discriminating monopoly that sells its output at
different prices. Both can be analyzed with figure 10.3 below.
In the case in which a monopolist a monopolist sells all of its output
at a single price, it will take account of the effect that price has on revenues
and costs and select the profit maximizing output level. This is found
where marginal revenue (MR) equals its marginal cost (MCi). That point is
labeled Q* in the diagram. The area between the demand curve and the
monopoly’s marginal cost curve represents social net benefits.
Monopolistic markets tend to have outputs below those that set social
marginal costs to equal social marginal benefits (Q**). Note also that the
division of “social surplus” is less favorable to consumers than that of
competitive market. It is this last effect that attracted the most attention in
the periods before neoclassical welfare economics was worked out.
Rawls (xxxx) suggests that competitive markets are compatible with the principle of equal liberty, but not usually with the difference principle.
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
In cases in which competitive markets for the services are possible,
utilitarians would oppose the creation of monopolies. Social net benefits fall
and the distribution of net benefits tends to become less equal. Both effects
tend to reduce aggregate utility..
Figure 10.3 Monopoly Equilibrium
$/Q
P*
MCi=SMC
1
2
3
4
MR
Q* Q**
D=MBc=SMB
Q
Contractarians are not directly concerned about the magnitude of
social net benefits. From behind both veils of ignorance and veil of
uncertainty, the probability of being a monopolist would be far smaller than
that of being a consumer in a monopolized market. Since firm owners
realize increased profits that are smaller than the reduction in consumer
surplus, expected net benefits of from trade in this market fall. Thus,
contractarians would anticipate a consensus against the creation of
monopolists. Area 4 indicates the magnitude of the unrealized gains to
trade under monopoly that are recovered by elimination of monopoly
privilege.
C. Normative Cases for Polices with Respect to Monopoly
It bears noting that during the medieval period of Europe, it was
commonplace for national and regional governments to sell monopoly
privileges to otherwise competitive markets. Both contractarians and
utilitarians opposed such policies, although their reasoning differed from
that above. Their concern was the creation of privilege and inefficiency
associated with firms who do not face competitive pressures. For example,
both La Court (1662) and Smith (1776) makes a variety of critical
comments on monopoly.Support for free trade and markets does not
usually include support for monopoly.
[N]o members of those guilds, under what pretext
soever, can be countenanced or indulged in their
monopoly, or charter, but by the excluding of all other
inhabitants, and consequently to the hindrance of their
country’s prosperity. For how much soever those
members sell their pains or commodities dearer than if
that trade or occupation was open or free, all the other
better inhabitants that gain their subsistance
immediately, or by consequence by a foreign
consumption, must bear that loss. [Pieter de la Court
(1662) The True Interest and Political Maxims of the Republic of
Holland. Liberty Fund (p.78).]
People of the same trade seldom meet together, even
for merriment and diversion, but the conversation ends
in a conspiracy against the public, or in some
contrivance to raise prices. It is impossible indeed to
prevent such meetings, by any law which either could be
executed, or would be consistent with liberty and justice.
But though the law cannot hinder people of the same trade
from sometimes assembling together, it ought to do
nothing to facilitate such assemblies; much less to
render them necessary. [Smith, Adam (1776 / 2010-03-23).
Wealth of Nations: Full and Fine Text of 1776 Edition (p.
90). . Kindle Edition.]
Liberals of nearly all stripes have been opposed to policies that create or
encourage monopoly for many centuries.
When markets emerge from competitive pressures rather than
government regulation, both utilitarians and contractarians accept the
existence of such markets. If monopolies are the only sustainable market
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Moral Foundations of Capitalism: Chapter 10
Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
form because only a single efficient sized firm can be supported (e.g.
natural monopolies), eliminating monopoly would require eliminated such
markets. Utilitarians would not that consumers and firms benefit from
exchange in monopolized markets, so aggregate social utility rises with the
existence of such markets. Contractarians would note that persons
anticipating the gains from trade associated with such markets will conclude
that they are better off with such markets than without them. Trade, after
all, is a voluntary activity.
However, both utilitarians and contractarians would tend to favor
regulating the prices at which a monopolist’s output could be sold. For
utilitarians, such policies would, if properly designed and implemented,
increase social net benefits and reduce inequality in net benefits in this
market, which tend to increase aggregate utility. For contractarians, persons
behind the veil would anticipate greater average benefits from participating
in this market and also tend to favor such polices. Whether appropriate
regulatory prices are likely to emerge from government regulations or not is
a topic revisited in chapter 11.
The case in favor of breaking up monopolies that emerge via contract
(antitrust law) is similar, although it requires restrictions on core civil law
institutions. However, some limits on the use of property and contracts are
evidently permissible for both utilitarians and contractarians (as with rules
against selling oneself into slavery). Rules against cartel agreements are
fundamentally similar to the previous cases against monopoly insofar as
they attempt to promote competition because of its beneficial effects on the
the extent of commerce and relatively more even distribution of net
benefits. As in the other cases, support for antitrust polices is predicated on
the existence of an appropriately motivated government.
Overall, both the contractarian and utilitarian approaches to civil
ethics reach similar conclusion about monopolies. Governments should not
promote monopolies. When monopolies are unavoidable (and governments
appropriately motivated), some form of price regulation would be
11
appropriate. When they are not inevitable, but may emerge via contract,
they should be discouraged. Neoclassical analysis implies that such
practices tend to increase the size and scope of the commercial society.11
D. Are Perfectly Discrimination Monopolists and Exception?
In contrast to a monopolist that has to sell its output at a single price,
a perfectly price discriminating monopolist sells every successive unit of its
output for the highest price that consumers are willing to pay for them.
These prices follow the consumer marginal benefit curve, e.g. the market
demand curve of figure 10.3. In this case, the firm’s marginal revenue curve
is the same as the demand curve and output Q** will be produced.
This type of market is difficult to motivate for consumers, since they
realize no net benefits from their purchases; nonetheless, it represents the
limit of what price discrimination can achieve for monopolists. In that
limiting case, the social net benefit maximizing output is produced by the
monopolist and all the net benefits of trade are realized by monopolists.
The distributional effects of such price discrimination are worse for
consumers than a non-discriminating monopolist, although social net
benefits are maximized. The utilitarian case against this form of monopoly
rests entirely on its effect on the distribution of net benefits. The aggregate
utility maximizing output is produced, but the more unequal distribution of
net benefits for individuals relative to that of competitive markets implies
that competitive markets are better than that associated with a perfectly
discriminating monopolist. Again, utilitarians would tend to oppose
policies that promote or create monopolies, other things being equal.
Contractarian analysis is similar in this case. A risk neutral individual
operating behind either veil would anticipated the same expected net
benefits under both the perfect price discriminating monopoly and a
competitive market. However, any risk averse person would prefer the
greater certainty of expected net benefits in a competitive market to that of
the perfect price discriminator. For example if median rather than average
Analyses that go beyond the static partial equilibrium analysis would include consideration of the effects of monopoly profits on entry and inovationas well as
problems associated with inappropriate government interventions into specific markets. Analyzing those effects requires models beyond those provided by the postwar
neoclassical models.
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benefits are used for this calculation, the median benefit under a perfect
price discriminating monopolist is zero (e.g. that of a consumer) rather than
the positive consumer surplus realized in competitive markets.
E. Externality Problems
Figure 10.4 Market Equilibrium and Externalities
SMC= MCi+MCx
$/Q
S=MCi
P*
MCx
D=MBc=SMB
Q** Q*
Q
Another critical assumption of the neoclassical case in favor of
markets is that all relevant costs are included in producer accounts. This is
often not the case, because some inputs are not paid for or only partly paid
for. Examples include the cost of air, water, and transport, whether used as
inputs or to disperse unwanted (unmarketable) outputs. In some settings,
these additional factors of production are not scarce resources, in which
case their absence on company spreadsheets does not change the results of
the previous analyses. Roads may have substantial excess capacity or the air
and water circulation systems sufficient capacity to be used without
affecting others. However, in many cases, these resources are used in their
“congestion zones,” where additional use imposes costs on others, as with
highway congestion, unpleasant odors, and health risks imposed on others.
Such “external” costs have to be accounted for when calculating social
marginal cost. Such usage became more common with the advent of
12
capitalism in the nineteenth century because both urbanization and the
scale of production increased enormously.
Figure 10.4 illustrates the problem associated with external costs. In
this case the market supply curve no longer includes all production costs
and the external ones (MCx) have to be added to industry marginal costs
(MCi) to determine social marginal costs (SMC). The market equilibrium is
at the output level that equates the quantity supplied with the quantity
demanded, Q*. But the social net benefit outcome is somewhat less when
all costs are taken account of, Q**. The social net benefits of this product
are smaller than markets would lead one to believe..
Again, insofar as social net benefits correspond to aggregate utility,
utilitarians would intervene to improve the result generated by the market.
For example, they might support the possibility of law suits in civil law
(torts) to recover damages from such external costs. Or, in cases in which
court assignments of damages are unlikely to produce optimal results, they
might, as Pigou did, favor excise taxes on this product equal to marginal
spillover damages at Q**. Such steps can induce firms and consumers to
“internalize” the external costs generated by the demand and supply of this
product.12
Contractarian analysis tends to focus on grounding institutions rather
than regulation, which is a “post constitutional” matter, to be decided
through political and legal processes. At the level of grounding law, in
recognition of such damages they would also support a civil law code that
allows damages to be recovered by those damaged. Such a code might
allow for class action suits or punitive damage awards to account for the
difficulty of bring small cases to court. Other matters would be left to the
post-constitutional political system, which is analyzed in the next chapter.
V.
Critiques of the Market-Based Distribution of Income
Within a perfectly competitive market framework, wages reflect
marginal revenue products of the persons employed, and inequality in
Spillover benefits, in contrast, have no routine remedy in civil law. In those cases, Pigou would recommend appropriate subsidies.
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wages reflects inequality in marginal products. Some persons are stronger,
smarter, better educated, and entrepreneurial than others. Differences in the
distribution of wealth reflects inheritance (initial endowments), differences
in marginal product, differences in savings rates, and luck. Additional
inequalities tend to be induced by monopoly power. Inequality associated
with differences in marginal product or working conditions tend to increase
aggregate output. Those associated with inherited wealth and monopoly
power do not necessarily have a similar role, although relatively wealth
persons tend to save more which promotes capital formation.
As demonstrated below, both utilitarians and contractarians will favor
some inequality in settings in which resources are produced. Incentive
effects matter. In a world of equals, institutions that maximize per capita
GNP tend to maximize average utility. Insofar as commercial societies have
higher per capita GNPs than all societies, this provides macro-ethical
support for market systems as a whole. In a setting of equally productive
persons, the distribution of income simply reflects choices in the pursuit of
goals other than income.
Nonetheless, in settings in which productivity varies among persons
Figure 10.5 A Utilitarian Tax
and Transfer Scheme
u/%
SMC=N MUt
1
2
SMB=M MUs
t**
tax
in the society of interest, both utilitarian and contractarian logic can be used
13
to support large scale interventions in the distribution of income produced
by markets.
A. Utilitarian Efficiency and Distributional Tradeoffs
Support for a welfare state in combination with relatively open
markets is one possible contemporary utilitarian response the inequality
generated by markets. This line of argument stretches back through Pigou,
Sidgwick, to Mill, although the extent of the redistribution justified has
increased substantially through time. To illustrate the utilarian case for
redistribution, imagine a society with N high productivity persons and M
low productivity persons. Under a market based allocation, each persons is
paid according to their natural marginal product and so members of the
high marginal product group is paid more than the low marginal product
group, consumes more and so realized higher utility levels.
Now assume that a utilitarian redistribution is to be undertaken. A
proportional consumption tax imposed on the high productivity persons
and used to provide a proportional consumption subsidy for the low
productivity persons. As the tax increases, the high marginal product
person engage in more leisure, and their material consumption diminishes
because of the effects of reduced effort and higher taxes. On the other side
of the utilitarian balance sheet, utility accrues to low marginal product
persons, who may also work less but receive sufficient additional
consumption from the subsidy that their utility increases. Note that GNP
falls, because both groups tend to work less hard, but aggregate utility
increases.
Represented as an equation, aggregate utility is just W = NUh(t) +
MU (s(t)). Differentiating with respect to t and setting the result equal to
zero yields NUt = MUsst. The tax and transfer system should take place
until the marginal losses from the high productivity persons equals the
marginal gains in utility of the low productivity persons. Figure 10.5
illustrates the essential logic of the utilitarian case for such a redistributive
program.13
l
This result is based on the following simple model .The high productivity person makes a labor leisure decision that maximizes U = u(T-L, (1-t)ch(L)), where T is the
time available to distribute between labor and leisure, t is the tax rate, and ch is the high productivity persons production function. The low productivity persons maximizes
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Welfare Economics as Social Ethics: Neo-Utilitarian Support and Critiques of Market Outcomes
The net increase in aggregate utility is 1, which comes at a cost of
area 2 borne by the high marginal productivity group. Aggregate utility
increases because of diminishing marginal utility. The lost utility from
consumption by the high marginal product group is smaller than that
gained by the low marginal product group. .
The optimal tax varies with the group sizes and with the difference in
marginal utilities at the market equilibrium (without tax or subsidies). Note
also, that as in the case developed below for figure 10.6, that simply
dividing up the joint output between each group would have a much
different result than this tax and transfer program. The group choices are
analogous to those of choices 2 and 4 in figure 10.2, and the result after the
after tax and transfer result is analogous to that of outcome 3. A simple
share the output rule would generate a result similar to that of 1.
Insofar as market systems are regarded to maximize total
consumption, this tax and transfer system is fundamentally grounded in
markets, and may be regarded to support the commercial society, although
the government intervenes to redistribute income, given the properties of
the labor markets. The goal of most welfare-state utilitarians is not to
replace markets, but to modify them at the margin so that social utility is
increased. For many utilitarians, such tax-transfer systems are analogous to
Pigovian taxes.
B. Contractarian: From Maximin to Maximal
Contractarians differ in their concern for redistribution because of
differences in the presumed “initial position” and in the risk aversion of
those negotiating over fundamental institutions. Contemporary
contractarians use a methodology similar to that of the utilitarians, in that it
global and assumes rational individuals, but their goal is to establish
grounding rules for society rather than particular outcomes. To that end,
they have attempted to develop analytical devices that can identify points of
agreement among individuals.
In Buchanan’s case, the point of departure is a well understood
status quo from which a constitutional solution to some problem or set of
problems is to be devised. It could be the Hobbesian jungle or it could be
today’s American society. In either case the problem is the same, to
develop rules that advance common interests. If such rules can be agreed
to the result is an improvement. One can only be sure that society is better
off, through agreement. If the point of departure is a market with a
standard neoclassical equilibrium, with wages equal to marginal value
product, and not externalities, there is no prospect for a Pareto
improvement (recall the first theorem of welfare economics) and so no
redistributive agreement would occur--unless the persons in a community
were altruists.
A community of altruists might conceivably agree to redistribute
income from the most productive to the least, because their , who would
themselves be benefited by shifting income from the most productive to
the least productive. A community of pure altruists might, for example,
agree to the tax and transfer scheme developed above for utilitarians. Their
interest in redistribution, however, is not moral, but simply Smithian
fellow-feeling. They have internalized the benefits that the poor would
receive from their alms. In cases in which individuals were only self
interested and property secure, the Buchanan approach would not generate
an agreement to alter the distribution of income.
Rawls’ approach differs from that of Buchanan in that he s more
concerned with creating a just society from scratch than in improving an
existing one. His reliance on a veil of ignorance, in which one does not
know his or her place in the society that follows, but has complete
knowledge of how social systems operate, is likely to generate agreements
favoring shifts away from a competitive equilibrium. For example, suppose
that do know whether you will be a high productivity or low productivity
person in our illustrative two-type society. One might know the odds of
being a high productivity persons (N/[N+M]), in which case one would
want to maximize one’s expected utility in the society that will follow the
adoption of a competitive market system augmented with a tax and transfer
U=u(T-L, (1+s)cl(L)). The utilities at their solutions are U*=uh(T-L*, (1-t)c(L*)) and U*=ul(T-L*, (1-s)cL*)) for the high and low productivity persons respectively, which
can be written as U(t)) and U(s(t)) as above in the text, for a given T. The balanced budget constraint requires revenues to equal subsidies, t N ch(Lh*) = s M cl(Ll*).
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system. This calculation looks very similar to the utilitarian one above,
which implies universal agreement on something like the utilitarian
program.14
The minimax principle, suggests that rather than maximize the
average result one should focus all of one’s attention on the worst one and
attempt to make that as good as possible. Rawls uses this principle to block
possibilities of slavery and of assassinations for body parts, both of which
are conceptually consistent with utilitarianism. In many settings it will also
imply greater transfers or a higher safety net than the utilitarian calculus
does.
It bears noting that Rawls’ maximin principle is not a consequence of
the veil of interest but rather of the assumed inner sense of justice that
people bring to the veil. It is this which produces both the equil liberty
principle and the maximin principle. Rawls’ spends a good deal of the
revised version of A Theory of Justice defending it from various attacks in the
two decades after he introduced it, including the one that it represents an
extreme assumption about risk aversion. Harsanyi (1976), for example,
regards the minimax principle as a “highly irrational decision rule,” and
provides a defense of the maximize average utility idea.
C. Distributive Justice as a Consequence of Process rather than
Outcomes
Although the two main social normative theories used by economists
can be used to defend and challenge the moral properties of markets, other
less used theories can as well. Private ethical theories may not be able to--or
interested in--assessing the merits of social systems but they can be used to
evaluate market outcomes. The following quote from Nozick provides
much of the logic of the private ethics approach to judging market and
other outcomes.
The complete principle of distributive justice would say
simply that a distribution is just if everyone is entitled
to the holdings they possess under the distribution. A
14
distribution is just if it arises from another just distribution
by legitimate means. The legitimate means of moving
from one distribution to another are specified by the
principle of justice in transfer. [Nozick, Robert (1974 /
2013-11-12). Anarchy, State, and Utopia (p. 151). Basic
Books. Kindle Edition.]
In other words, if you have come by your income honestly and
without coercion, the result is surely just. What matters from this
perspective is not the global properties of a social system, but how it
emerged and evolves through time. Are the individual acts that generate the
system moral? If so then the system may be defended on moral grounds.
The difficulty of this approach is that it assumes that the various
social and market dilemmas analyzed in the past three chapters are ethically
irrelevant. The extent to which their relevance may be acknowledge is only
insofar as recognizing a dilemma may lead to a just solution: for example
one voluntarily adopted by those trapped in the dilemma. If not, it may be
argued that the dilemma does not really exist or that solutions are
infeasible.
With respect to distributive justice, many private normative theories
would accept Nozicks characterization of it as a property of the process
that generates the distribution of income (through moral acts or at least
ones that are not immoral), rather than the final outcome.
D. Distributional Mechanisms, Production, and Welfare
As one shifts from the Edgeworth environment in which goods and
services are exogenously determined to ones in which some or all of the
goods and services of interest are produced with scarce resources including
labor, consequence-based normative theories have to take account of the
incentive effects of alternative allocation mechanisms. The egalitarian
solution to the Edgeworth allocation problem was consistent with
utilitarian analysis for the case in which the extent of the resources available
are not affected by the manner in which they are distributed. If, however,
Harsanyi (1976) for this reason refers to this sort of calculation as a utilitarian, although much of his reasoning is otherwise similar to Rawls. He advocates a form of
utilitarian calculation that he refers to as rule utilitiarianism, in which strategies are chosen for all, rather than single acts.
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the size of the Edgeworth box is determined by the manner in which
resources are allocated, these effects also have to be taken into account.
NQ* units of output are produced, wages cannot exceed Q*/L*, the
average rate at which output is produced per hour by a typical laborer.
For example, suppose preferences are identical for leisure (L) and a
single produced output (C) that can be produced either alone or by teams.
Assume further that a subset of the necessary jobs on teams is unpleasant
and that every job on the team is less pleasant than that of solo production,
which in turn is less enjoyable than leisure over the full range of choice. In
the absence of an internalized work ethic or the like, no one in such
circumstances will work for the joy of working.
The work choice is voluntary and preferences are identical, so work
takes place only if it makes each person better off. Aggregate utility
consequently tends to be higher under such a universal flat wage system
than under an equally shared output system, although output in this case
could be said to be shared equally in this case as well, given our assumption
about identical individuals. This illustration demonstrates that allocative
rules have incentive effects that are relevant for utilitarians and
contractarian analysis.
Several allocative mechanisms can be analyzed in this relatively simple
production environment. Consider the following four possible rules for
distributing the output of a community or firm output among its members.
Two are egalitarian rules and the two others are non-egalatiarian rules First,
consider the case in which output is always equally shared among all N
persons in the community, a solution that satisfied utilitarian norms in the
Edgeworth case. In this setting, however, when each potential laborer can
independently choose whether to work or not, they will all free ride (shirk
rather than work) if the value of 1/N of a unit of the output is worth less
than the value of the leisure that has to be sacrificed to produce it.15 The
rewards to labor are minimal. In effect the sharing rule operates as a
(N-1)/N tax rate on one’s labor output.
(2) A second possibility is paying everyone the same hourly wage
regardless of where they work. In this case, a single flat hourly wage rate
would be paid for all work undertaken, whether on teams or alone. The
shirking problem is avoided in this case, because if one does not work, one
does not get paid. Work is rewarded, but not the difficulty of it. Given that
the displeasure of team production is greater than that of working alone (by
assumption), everyone would work alone. Output would be higher than
under the equal share of output rule and would vary with the wage rate,
insofar as different wage rates elicit different amounts of work and
therefore produce more or less goods. There is, of course, a feasibility
constraint on possibe wage rates. If NL* hours are worked in total and
15
(3) A third possibility is to allow wage rates to differ among firms,
although wages must be uniform at each firm. Suppose that a person is
either paid a wage that is equal to the marginal product of the last hour
worked alone or equal to the marginal product of the last hour worked at
the factory. Because of the assumed productivity differences, wage rates
will be higher at the factories than for solo production. All labor will be
attracted to the factories if the productivity advantage of team production
is sufficient to more than compensate persons for their less pleasant
working conditions. Factory employment dominates if the average
productivity of labor in the factory is relatively large or the working
conditions are only marginally less attractive than working at home alone.
Output again increases, and insofar as the employment choices are all
voluntary ones, aggregate utility rises as well.
(4) Now suppose that compensating differentials are paid within the
factory for more or less pleasant work there. In this case, a somewhat
better (more productive) allocation of persons to specialties within the
factory takes place and output rises again. It is clear that the result is
preferred by each worker to solo production option, because the place of
work is freely chosen. If there is no diminution of wage rates caused by this
compensation scheme relative to (3), the result again higher aggregate
utility, because of higher total output If some wages decrease but output
increases, average utility is still likely to rise, although this will depend on
the extent to which utility diminishes with income and the wage differences
Other equilibria are possible, although all involve relatively low levels of output in the absence of counterveiling private norms such as personal work ethics..
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within the factory. Insofar as total output increases and wage differentials
are small or diminishing marginal utility small, aggregate and average utility
is likely to increase.16 In such cases, the losses of persons bearing pay
reductions (in the more pleasant jobs) are more than offset by the persons
gaining higher wages (in the less pleasant jobs).
Figure 10.6 illustrates the average person’s choices and welfare under
these four regimes. Each allocation rule has associated with it a different
(average) production possibility frontier (PPF) reflecting how the
distributional rules affect the mode of production used. An average PPF is
created by dividing every point on the community’s PPFs by N, the number
of residents in the community. Along any single PPF, increases in the
consumption good require reduced increases in the hours worked. The
average PPFs allow the average person’s indifference curves to be used to
demonstrate the direction, although not the magnitude, of changes in
aggregate utility.17
Insofar as markets tend to produce allocations similar to that of 4 in
these circumstances, utilitarians would be indifferent between market
determination of wage rates and that by the identical choice of an imaginary
utilitarian social planner. Both would maximize aggregate utility given the 4
output sharing rules illustrated in the present circumstances. In effect, the
social planner would function as the Walrasian auctioneer in such cases. For
utilitarians, markets would simply be a method of inducing outcome 4, the
pattern of life that yields the highest feasible social utility for the rules
examined in this setting.
It is important to note that the egalitarian utilitarian solution to the
Edgeworth box allocation problem is only a special case. Whenever
incentive matters, utilitarian analysis takes them into account. The
distribution of income is equal among the first three cases, but unequal in
the fourth, because of differentials paid to compensate for the
unpleasantness of the various jointly productive factory jobs. Moreover,
16
because of incentive effects, egalitarian divisions of aggregate output are no
longer the best or “optimal” ones. Wages should vary among and within
firms. Note also, that the illustration represents a case in which the
magnitude of the observed commercial output (C) is positively correlated
with aggregate utility in this setting. Average utility rose in each case as the
PPF expanded and the output chosen increased.
The contractarian assessment of market wages in this case is similar
to the utilitarian one, but for contractarians, the focus of analysis is not the
outcome, per se, but on the institutions that induce particular outcomes to
emerge. The assumption that the individuals have identical tastes and
capacities makes it easy to anticipate the outcomes associated with each
rule (which in this case are unique) and so to rank alternative rules or
institutions for allocating aggregate output.
Insofar as markets realize allocations like 4, the persons in those
communities would unanimously prefer the institutions generating that
Figure 10.6 Incentive Effects of
Allocative Rules
L
1
4
2
3
PPF2
PPF3
PPF4
C
outcome to the others. In this case at least, institutions that assure
Because of team production problems, it is not necessarily the case that output is now maximized (Congleton 1991), only that output is higher than in the previous
case because of a more productive allocation of labor across tasks.
17
These comparisons could not be done with a social welfare function indifference curves because of changes in the distribution of income associated with the shift to
possibility 4. When defined over aggregate output, each social indifference curve series is based on a particular distribution of goods and services.
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Moral Foundations of Capitalism: Chapter 10
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competitive wages are preferred to equal sharing rules, uniform wage rates,
or uniform wage rates by firm or industry. Contractarians would in
principle reject the hiring of a utilitarian central planner even if such a
person could be identified and hired to manage this simple economy,
because the planner’ wages would reduce the incomes of all persons relative
to that available in the market. (The planner and his apparatus would need
to be funded through taxes or voluntary contributions, but would not
increase output over that produced by markets).
Insofar as market supporting ethics--such as the work ethic--generate
similar shifts in the various production possibility frontiers, such private
virtues would also be supported by utilitarian and contractarian analyses.
VI.
The Limits of Welfare Economics
Social, as opposed to civil and private ethics, attempt to make global
claims about society as a whole. Contemporary welfare economics attempts
the same types of calculations for economic aspects of society. However, it
also includes more modest efforts to evaluate and address specific problems
such as air pollution or highway congestion, which are more analogous to
the problems addressed by civil ethics. Global assessments are clearly more
challenging than the partial equilibrium based analysis of civic or private
ethics.
First, the informational requirements are enormous. Global
utility-based analysis requires knowledge of every single living persons’
utility function, and in some cases those of every person that might ever
live. To do so in as exact a manner as the mathematics suggests one might,
is clearly impossible unless people are identical and population can be
perfectly predicted. Beyond utility functions, one must know the various
production possibility frontiers that emerge under different social systems, a
matter that is much debated among economists and other social sciences.
The specific responses of individuals to the incentives and opportunities of
different social systems are empirical rather than matters that can be
determined via deduction.
There are methodological issues as well. It is one thing to suggest
that utility maximizing man and competitive markets are useful analytical
constructs that shed light on how well-developed markets operate, and
another to say that they represent exactly how such markets operate. Again
the mathematics associated with contemporary social normative theories
tends to exaggerate the precision with which conclusions can be teased out
of even rigorous normative theories. The consequences of alternative
grounding laws, collective choice methods, and policies can be
characterized in analytical models, but rarely conclusively compared.
Without precise information, social normative assessments of the
relative merits of alternative policies are at best approximations of the ideal.
This is not to say that approximations cannot be useful, but it is to say that
one should take most conclusions of utilitarian and contractarian analysis
with a grain of salt.
Applied welfare economics attempts to make the inferences of
analytical norms more useful by devising material measures that are
correlated with the aims of those theories. Global assessments of economic
systems as with per capita real gross national product and unemployment
rates provide measures that are likely to be correlated with aggregate utility.
Cost-benefit analysis similarly attempts to assess whether aggregate utility
rises or fall when a new policy is adopted. The latter cannot happen, of
course, unless markets fail to maximize aggregate utility along some its
margins. Various survey measures of contentment, optimism and the like
can also be employed as indicators of aggregate utility, which allow some of
the tools of welfare economics to be tested for their utilitarian validity. If
such measures typically improve during booms, when RGDP per capita is
increasing rapidly and unemployment is falling, the macro-economic norms
can be useful indicators of aggregate utility.
Similarly, if approval of markets and public policies increases provide
evidence of consensus, which in turn provides evidence of the extent to
which policies may be regarded as consistent with contractarian norms.
High degrees of support imply that a society’s core policies may be
regarded to be products of a hypothetical social contract. Procedural forms
of distributive justice are similarly affirmed by indices of corruption and
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crime rates. The higher are those indices, the fewer transactions satisfy
procedural norms.
In this manner, welfare economics can provide guidance to voters
and policy makers that are grounded in sophisticated social normative
theories. However, because they are imperfect correlates rather than
perfection ones, they cannot be used to characterized a utilitarian utopia or
utopian path, nor the perfect social contract or procedures for just
redistribution of existing resources. However, they can provide some useful
indications of the direction a society should move if its aim is to become
such societies. RGNP per capita, for example, is often increased by a well
functioning legal system and liberal economic policies.18
However, it cannot really be assumed that all voters are utilitarians or
contractarians, nor that those occupying elective and appointed offices are
motivated by such theories. Moreover, even if they were so motivated,
there would be points of disagreement about the relevance of individual
actions (act or rule utilitarians), grounding laws (standing rules or adaptive
policies), and just procedures for reform.
As examined in the next chapter, social, civil, and private ethical
theories may influence the votes cast by voters and therefore the policies
adopted by democratic governments. In this manner ethics may be said to
provide one of the foundations for public policy in a manner analogous to
the ones through which partly determine market outcomes. However, as in
the case of market relevant norms, only a subset of normative theories are
likely to lend support to policies that reinforce rather than undermine the
viability of a commercial society.
18
See for example: Feld and Voigt ( 2003), Blume and Voigt (2007), and Gwartney, Lawson, and Holcombe (1999).
page 17