Information And Rationality

It’s hardly the most significant issues in normative neoclassical welfare economics, but there seems to me still quite a lot of confusion floating about relating to the role of the assumptions of perfect information and perfect rationality, which I suppose is only to be expected giving the confusing and idiosyncratic mix of the positive and the normative, fact and value, science and ethics associated with that theory. Let’s discuss that this week.

The main point I wish to establish is that the significance of the assumptions of perfect information and perfect rationality is entirely different in a normative context from in a positive context. In a positive, empirical, scientific context, perfect information and perfect rationality can be seen as simplifying assumptions that needn’t be true for the theory in which they are embedded to be highly evaluated on a scientific basis by its ability to predict. The use of such assumptions is just an analytical choice that may be useful in constructing predictive, scientific models without getting bogged down in complicating details that may add little to the predictive accuracy of the results.  Certainly, those particular assumptions make possible a great deal of mathematical model building that might otherwise be infeasible, although of course the scientific, empirical evaluation of the resulting models is another matter entirely.

In contrast, in a normative context, the “assumptions” of perfection information and rationality are more properly classified as “factual premises” that must be true if the conclusions are to be relevant to reality. The method for evaluating arguments or theories proper to ethical philosophy involves logic and precision. If one is evaluating an ethical proposition about what to do about other people eating apples that may be poisoned, and one knows ninety-nine out of every one hundred people know the apples are poisoned and one doesn’t, then that’s the correct factual premise that should appear in one’s ethical theory. The correct factual premise is not the approximation “everyone knows the apples are poisoned.” That’s a false factual premise. If one bases one’s ethical conclusions on that premise, one’s normative conclusions will not be applicable to the real world. One’s theory will not be highly evaluated according to the relevant criteria. That’s the way ethical philosophy works.

Nor can I can’t fix it by saying, look, I understand the problem. I dutifully call instances where the factual premise is false in realistic situations “theory failures,” and I try to address those theory failures by telling everyone I meet the apples are poisoned. My ethical theory would still be garbage, if not as a funny parlor game at least as a serious ethical theory, because the conclusions would be still inapplicable to the real world. The theory would remain garbage until I introduced true factual premises. 

It’s also important to realize that in normative neoclassical welfare economics, the factual premises of perfect information and perfect rationality are relevant to the evaluation of the fundamental ethical or normative proposition we should maximize total social utility. It’s a theoretical mistake to suppose those factual premises are only relevant in the context of specifying the conditions of a chimerical ideal market structure everyone understands is difficult or impossible to attain in a literal sense. It’s relevant to the entire normative program. It’s not the case that our theory can establish we reach pretty good normative outcomes even if we never attain those conditions exactly and hence arrive at ethical perfection. That’s not the way ethical philosophy works. My ethical theory of what I should do about people eating poisoned apples using the false factual premise everyone knows the apples are poisoned isn’t pretty good because the premise is approximately correct.

And if we’re thinking of perfect information and perfect rationality as hypothetical conditions rather than factual premises per se, then we not only need to identify them as such to avoid confusion with factual premises, but our normative or ethical theory needs to contain propositions about what we’re meant to do when those hypotheticals are not met; otherwise, again, it’s simply an example of a bad ethical theory, in that case because of incompleteness. In the context of the ethical or normative program of neoclassical welfare economics, are we still meant to accept the goal of maximizing total social utility when people don’t have perfect information and don’t exhibit perfect rationality, or are we meant to be interested in doing something else in that case? Because based on how we’ve defined “utility,” it sounds to me like that might be a bit controversial.

When one tries to address science and ethics, facts and values, the positive and the normative at the same time, confusion and conflict is the likely if not inevitable result. We should fix bad economics by taking the normative content out and allowing economics to become a real science.

The Ethics Of Markets 2: The Return Of the Onion

I thought recently of yet another way to describe or illustrate the distinctive, layered, onion-like structure of normative neoclassical welfare economics, and hence also of the bad economics based upon it, in which unrelated and inconsistent normative or ethical propositions enter into the theory in unexpected ways and places. Maybe I can talk about that this week.

The first step in developing this new perspective is to appreciate people have preferences not only with respect to goods and services exchanged in markets but also with respect to any number of other issues, such as the subjective distributional ethics they endorse and would prefer to live under. If one is interested in talking funny, like an economist, we can say people derive “utility” not just from fulfilling their preferences about goods and services and so on, but also from fulfilling their preferences about living in what they feel is an ethical society. (If you follow my blog at all, you’ll know I question the value of using the word “utility” when talking about the normative proposition we should allow other people to follow their preferences if there are no interpersonal conflicts involved to complicate the situation, which serves as one of the fundamental value inputs to neoclassical welfare economics. Saying it in plain English eliminates all or most of the conceptual nonsense and confusion associated with equivocating on the term “utility” as it is used in economic theory and other potential definitions of “utility” one finds in ethical philosophy.)

Preferences relating to living in societies expressing different forms of distributional ethics, and the “utility” associated with those preferences, if one insists upon talking that way, are explicitly set aside in normative neoclassical welfare economics as belonging to a class of so-called distributional issues considered exogenous to that theory. Even when the philosophical crazy quilt of “social welfare functions” are admitted as a legitimate feature of neoclassical welfare economics, those distributional issues remain exogenous to the theory because the distinctive weights that feature in social welfare functions are not part of that theory and because normative results or conclusions resting upon indifference to the weights would typically also be accepted as part of that theory. 

The ostensible reason distributional issues are explicitly set aside in neoclassical welfare economics is that they involve controversial ethical preferences or judgments or beliefs about how to resolve interpersonal conflicts of needs and desires, which again may involve not only goods and services but also the sort of society one prefers to live in, that cannot be resolved on the basis of ethical propositions about how to treat individuals expressing preferences when no such conflict exists or, again, if one insists on talking funny, because of the inability to make interpersonal comparisons of “utility.”

However, some preferences (and the “utility” associated with those preferences) are not similarly set aside but are taken up in the context of normative neoclassical welfare economics. Which ones? The preferences involving demand for goods and services expressed using economic power in markets. Why the differential treatment of preferences, or “utility” if one must? Because the fundamental normative propositions involved in, and required for the conclusions of, neoclassical welfare economics don’t just involve individual preferences or “utility” as defined in economics. Other normative or ethical or value inputs are involved. And those other normative propositions pertain to some preferences but not others.

What other normative propositions? Well, as I’ve discussed in previous posts, one normative or ethical or value input required for the normative argument presented in neoclassical welfare economics about the supposed optimality of perfectly competitive, Pareto optimal, economically efficient market outcomes is the implied ethical proposition we should resolve interpersonal conflicts on the basis of economic power in markets, which in turn implies or relies upon yet another ethical proposition that says we should respect, if not necessarily support as ethically optimal, some specification or definition of economic power in the form of legal specifications of property ownership to make such market resolutions possible.

The additional ethical proposition saying we should resolve interpersonal conflicts using economic power in markets, that is, resolve interpersonal disputes using the market mechanism, cannot be derived from the unrelated normative proposition about how to treat other people expressing their preferences when there are no interpersonal conflict involved, that is, from the ethical propositions about “utility” as defined in economic theory. It’s an entirely different, independent normative proposition. 

So under what conditions does the normative or ethical or value proposition required for the conclusions of neoclassical welfare economics suggest we resolve interpersonal conflicts on the basis of economic power in markets? Always? Sometimes? Under certain factual conditions? Under every possible set of factual conditions? 

This rather undeveloped, and indeed generally left entirely implicit, normative or ethical proposition is the one that causes problems when one tries to apply the conclusions of neoclassical welfare economics in certain difficult real world contexts involving things like future generations, the environment, animals, or even seemingly less complicated issues like education and medical care. It’s also what’s behind the controversial, if not downright dubious, ethical proposition we would create a more ethical society by increasing the extent of the market wherever and whenever possible, for example, if rather than resolving interpersonal conflicts involving preferences about social ethics including distributional ethics via one person one vote democracy, we instead instituted some sort of virtual market mechanism that could resolve those interpersonal conflicts on the basis of the economic power of those holding different beliefs or preferences.

To study the normative program of neoclassical welfare economics seriously, one must understand the normative content that enters at the stage of “utility,” that is, how to treat other people expressing their preferences in a no conflict case, at the stage of specifying or defining economic power, that is, so-called “property rights,” and at the stage of deciding which interpersonal conflicts to resolve on the basis of economic power in markets, that is, issues relating to the extent of the market. That’s the structure I’ve previously called the “onion” of bad economics to indicate the different layers or levels or stages at which controversial normative or ethical content enters normative neoclassical welfare economics. And don’t forget the all important and most pungent outer layer, which involves propositions that aren’t even really properly part of neoclassical welfare economics but often added on in practice to create the illusion pure neoclassical welfare economics is more relevant in realistic contexts than it really is, including the plethora of funny rhetorical stratagems associated with fake distributional indifference.

Interestingly, the various ways I’ve discussed this issue all seem to me to be different perspectives on what is essentially the same phenomenon.  One can use the same observations to illustrate the notion of neoclassical welfare economics as an insincere form of ethical “utilitarianism.” Normative neoclassical welfare economics has a small role for what it calls “utility,” but not much really, and certainly not only that.  One can also use the same observation to illustrate the notion of neoclassical welfare economics as an ethical half theory. Some relevant ethical issues are endogenous; some exogenous. Agenda control is so important in such cases, isn’t it? One can also use the same observation to illustrate the notion of normative neoclassical welfare economics as an ethical system that properly applies only to a sort of fairy land in which certain ethical issues relevant to the real world are explicitly banished, but can only be correctly applied to real world issues if those relevant ethical issues are reintroduced and addressed.

Unfortunately, economists typically aren’t very interested in serious discussions or explications of the normative program of neoclassical welfare economics. Economists typically prefer to express their personal ethical beliefs in policy prescriptions any old way they can, without worrying about clarity, consistency, evaluation, degree of controversy, or anything else. Basically, economists are bad ethical philosophers, which is why we should take the normative or ethical content out of economics and make it a true science.

Addendum

I’ve lately changed my mind about the middle layer of my onion of bad economics. In particular, I now believe it’s more sensible to present the choice to use economic power in markets to resolve interpersonal conflicts, and even the choice to support the legal conditions required to create or sustain markets, as exogenous to neoclassical welfare economics. It’s a point of interpretation, of what one believes reasonable to suppose neoclassical welfare economics is meant to say, but recently I’ve concluded it makes more sense to say neoclassical welfare economics says a good deal less than many people seem to suppose. For example, see the post Law Over Anarchy In Neoclassical Welfare Economics from June 2, 2021.

It’s Not Them, It’s You

I go on and on every week happily doing whatever I can to unravel the rhetorical mysteries of bad economics assuming always at least a few others must be as interested in the issue as I am myself, but every now and then I suspect most people may not even really see the issue or have any real notion what I’m talking about and that, consequently, I may be making my fascination observations mostly to myself. Nothing particularly wrong with that, of course. I’ve had some rather fascinating conservation with myself over the years. To be honest, much more interesting than the lion’s share of conversations I’ve had with other people. Nonetheless, this week I thought I’d step back, take a little breather, and try to provide some basic intellectual motivation for my agenda. What perceived puzzle, exactly, have I been laboring so strenuously to straighten out for everyone? Well, in a nutshell, neoclassical welfare economics is meant to avoid ethical controversy, that’s the ostensible rationale behind the way it defines “utility” and the Pareto concepts and so on, but practical policy recommendations ostensibly based on neoclassical welfare economics are quite often highly controversial ethically speaking. Isn’t that weird? How does that happen? Well, let me explain.

A common conceit among devotees of neoclassical welfare economics is that the normative or value or ethical inputs involved in that theory are so fundamental and non-controversial we needn’t think about them too much or, indeed, at all. That is incorrect. That’s one of the ways it happens. The ethical controversy associated with normative policy recommendations in realistic contexts is actually entirely consistent with that of the normative inputs, as one would expect in a logical or mathematical system, once one identifies and evaluates the normative inputs properly.

In particular, there is more ethical or normative controversy associated with the ethical proposition we should “maximize” total social “utility” as defined in economic theory, or in plain English, with the ethical proposition we should not interfere with other people expressing their preferences if there no interpersonal conflicts involved, than economists acknowledge. In addition, there are additional controversial normative or ethical inputs involving the assignment of economic power in the form of legal specifications of property ownership (so-called “property rights”) and when to resolve interpersonal conflicts on the basis of economic power in markets, that are unrelated to the proposition about “maximizing” total social “utility.”

The evaluation of these controversial normative or ethical inputs, both the commonly acknowledged and commonly unacknowledged ones, is complicated by the ubiquitous concomitant use of false factual premises, which are, of course, perfectly acceptable as simplifying assumption in positive, predictive, scientific theories, but are entirely inappropriate in normative or ethical theories that are meant to be relevant to the real world. The presence of false factual premises in the normative theory of neoclassical welfare economics serves to hide some of the controversy associated with the normative or ethical or value inputs.

To top it all off, there are certain controversial normative or ethical propositions that are commonly albeit informally and typically surreptitiously added on to neoclassical welfare economics in practice to make the theory appear more relevant in real world contexts than it really is in its pure non-augmented form. The typical example I’ve discussed in previous posts, and will no doubt discuss in future posts, is fake distributional indifference, in which additional normative or ethical propositions are slipped in to tip the metaphorical scales to certain preferred outcomes in situations in which the pure theory actually implies indifference.

Purveyors of bad economics shouldn’t flatter themselves that those opposed to the normative policy prescriptions they present, based ostensibly purely on neoclassical welfare economics, simply can’t comprehend the simple logic and math involved. That’s not the problem. The problem isn’t other people being unable to comprehend simple math and logic, it’s purveyors of bad economics being unable to comprehend, or unwilling to acknowledge, the ethical or normative content of neoclassical welfare economics and their own creative additions, and to evaluate them properly under realistic conditions by carefully analyzing potentially problematic cases and so on. The solution to the conflict and controversy caused by bad economics is not to dismiss the concerns of others, to smirk, pose, proselytize, make ostensibly witty mathematical comments, but to go back to the fundamentals: identify, understand, explain, and evaluate the normative or ethical or value inputs in both neoclassical welfare economics proper and those added on in practical applications. Bad economics creates conflict and confusion. We need to fix bad economics.

Pareto Improvements And The Fairy Land

I probably discussed it before but I thought I’d take another shot at explaining why instances of Pareto improvements, changes that make one person better off and no one worse off, are not ethically controversial when controversial distributional issues are set aside in what I’ve been calling the Fairy Land of Economic Theory, but are ethically controversial in real life where they come packaged with controversial distributional issues. Ready to take another trip to the mysterious Fairy Land of normative neoclassical welfare economics? Fine. Get out your pointy hat, old clay pipe, and trusty staff, and let’s take a quick look at the changeable normative status of Pareto improvements this week.

The reason we talk about Pareto improvements in the context of neoclassical welfare economics is that they’re meant to be normatively or ethically uncontroversial, and the laboriously created and maintained conceit that motivates neoclassical welfare economics is that it contains only simple, widely accepted, uncontroversial value judgments or ethical propositions. Well, actually I suppose it does when properly interpreted, so perhaps conceit is not the right word in the context of the theory itself, but in my experience hardly anyone properly interprets the real theory substituting instead what I call bad economics, which contains plenty of controversial ethical content, and in that context the claim in question clearly qualifies as a conceit.

The issue I’d like to think about this week is whether Pareto improvements are uncontroversial in real life, or only in the partially unspecified Fairy Land of Economic Theory in which certain relevant ethical issues have been set aside. In the words, whether the notion that Pareto improvements are ethically uncontroversial is yet another bit of mathematical formalism never correctly evaluated in a normative sense when applied to realistic situations.

Let’s try to imagine a Pareto improvement so we have something concrete to talk about. Let’s say hard working A makes $50 K per year. Layabout B makes $5 K per year, part time, and is perfectly happy. We drop $1 billion into B’s bank account. Would A find it ethically controversial? Is the only reason he or she would object to what just happened envy at B’s good fortune?

That’s what they call a trick question. You saw what I did there, right? I switched out the “utility” on which Pareto improvements in neoclassical welfare economics are meant to be based upon for money.  However, as I established in a previous post or probably several previous posts, “utility” in neoclassical welfare economics is not money; “utility” is meant to have different characteristics than money. What I just described is not a true Pareto improvement. Person A was made worse off in terms of relative economic power, buying power, which may translate into very real results in terms of the preferences he or she is able to express in the market, let’s say his or her preferences for the mysterious one-off gem everyone is so excited about that previously he or she could lay hands upon but no longer, so that’s not a true example of a Pareto improvement.

Let’s try to do it right. Let’s say layabout B gets a boost in his or her “utility” or ability to express his or her preferences using economic power in markets by a factor of one billion, whatever that means, and his or her moving up along his ranking of preferences by that factor has no effect on hardworking A, who still fulfills his or her preferences exactly as before. Is that a real thing or are we back to talking conceptual nonsense again? What happens if A wants the one-off gem but it also figures somewhere in the string of preferences B is moving up? That would be funny if the concept doesn’t even really make sense in realistic contexts, wouldn’t it? Shortest blog post ever! But I still have a point I wanted to make so let’s just get out the old broom and sweep that one under the rug this time, shall we? Let’s say B moves up his or her preference rankings by a factor of one billion but none of it has any effect on A, who still manages to fulfill exactly the same preferences as before or, if you’re a fan of funny talk, he or she has the same “utility” as formerly. Now that’s a Pareto improvement, right?

Let’s consider the same issue. Is the change in question ethically or normatively controversial or uncontroversial? Does A have any reason beyond envy to object? If not, then I suppose our Pareto improvement would be uncontroversial because I suppose rejecting ethical propositions based solely on envy would generally be considered uncontroversial. Well, if you’re asking me, I suspect hardworking A may be a little miffed for reasons that go beyond simple envy. I know I would be in his or her place. For example, A may believe the results of our little economy no longer comport with his or her distributional ethics, which let’s say propose the ability to meet one’s preferences, or “utility” if one insists, should be related in some way to individual merit or activity or behavior. Interestingly though, it would becomes uncontroversial were we to remove consideration of distributional ethics, and oddly enough that’s one of the distinctive characteristic of the ethical half-theory of neoclassical welfare economics.

So, yes, I suspect what’s going on here is that we’re looking at another artifact from the Fairy Land of Economic Theory, which is normatively evaluated one way in its proper context, the Fairy Land, but evaluated rather differently in real life. That is to say, it seems real instances of Pareto improvements are not really all they’re cracked up to be, similar to how real instances of Pareto optimality are not all they’re cracked up to be. Both are controversial in realistic settings because of the inevitable ethical and in particular distributional aspect or component. Concepts like Pareto improvements and Pareto optimality work just fine and as intended in the Fairy Land of Economic Theory, but don’t mistake the Fairy Land for reality. When one returns to reality and begins discussing real, defined, instances of Pareto improvements or Pareto optimums, one must confront the ethical or normative issues and controversies that were banished from the Fairy Land. The noncontroversial becomes controversial. Don’t end up forever wandering dark and twisted Fangorn Forest. Step into the light, behold reality, and adjust your ethical reasoning accordingly. 

All joking aside, I think the answer must be to remove the confused, complicated, misleading normative or ethical content from neoclassical welfare economics. We should make economics a science. When purveyors of bad economics, including alas many economists, try to do ethical philosophy, the results are just not very pretty. Comes out a bit of a mess, really. Economists should leave the ethical and normative issues involved in evaluating economic systems and outcomes to the people and democratic government to resolve.