Monday, May 18, 2015

Pareto Efficiency and Social Policy

Here is a term bandied about by economists: Pareto efficiency

The term is named after Vilfredo Pareto an Italian engineer, economist, and social scientist. Pareto was born in 1848 as the Italian revolution got underway in typical Italian fashion (people stopped smoking and playing the lottery!) and he died in 1923 right after Benito Mussolini assumed power in Italy. 

A pareto improvement is when a change in allocation makes at least one individual better off without making any other individual worse off. An allocation is defined as "Pareto efficient" or "Pareto optimal" when no further Pareto improvements can be made, i.e. you can't improve anyone's position without making at least some person worse off.  

The term is most usefully applied in the production of goods, as in "guns vs. butter."  Same amount of butter and more guns is a Pareto improvement; so is same amount of guns and more butter; so is more guns and more butter. Trading off guns for butter (fewer guns in order to make more butter) is not a Pareto improvement.

The concept, of course, has nothing to do with a just or sensible distribution of resources and goods. An economy can be run in a way so there is more and more inequality without making anyone at the bottom worse off. As productivity increases we have Pareto improvements, we don't have an increase in justice or an equitable or sensible distribution of wealth.

And here is where Brad DeLong comes in with two very Brad DeLong sentences from this morning: 
I have often wondered and never manage to get completely straight in my mind how economics lost its utilitarian roots–how it went from saying “this is a good policy because it advances the greater good of the greater number” to “competitive free-market allocations are good because they are Pareto-optimal, and we do not prefer any particular Pareto-optimal allocation because that would be a question not of science but of values and politics, and non-Pareto-optimal allocations are bad.” It has puzzled me particularly because the claim that we cannot say X is better than Y because they are not Pareto-ranked is not, in general, raised when the policy at issue is a GDP-increasing and either distributionally-neutral or inequality-increasing policy like tariff reductions or cuts in capital taxation…
And, by all means, read John Quiggin's The Political is Personal too.  

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