Bad Economics And The Spirit Of Neoclassical Economics

Here’s a question for you, do you think economists should serve as ethical arbiters of society? That is to say, should economists resolve controversial normative or ethical issues and tell people what economic arrangements are ethically optimal, or go around them to policymakers if the people are too dense to understand or simply disagree?

Just curious because it seems a common enough view. I’ve had people, economists I suspect but haven’t confirmed, tell me the people themselves are not fit to entertain such weighty matters. I’ve had people tell me someone must decide what’s optimal and wonder if not economists, then who? I infer from such commentary some people do, indeed, feel economists should serve as ethical arbiters of society.

It’s interesting to me because neoclassical welfare economics was specifically designed to avoid controversial ethical issues and prevent economists becoming the ethical arbiters of society. That’s the reason it’s structured the way it is, the reason “utility” is defined the way it is. Well, I suppose I should clarify that. That’s the explicit intent. Given the proven ability of neoclassical welfare economics to support error, misinterpretation, bad economics, one can only ponder the implicit intent.

The perspective on what economists should be doing consistent with the explicit, ostensible motivating spirit of neoclassical welfare economics is for economists to avoid controversial ethical judgments and defer to the changeable views of the people and democratic government. What is “optimal” as far as real instances of economic systems and economics outcomes, distributional ethics, the extent of the market, what to do about expressions of preferences under conditions of ignorance and irrationality, the resolution of interpersonal conflicts of preferences, the allocation of scarce resources, is not an objective fact, not some unchanging facet of nature we must discover. It’s a social decision based on changing and evolving ethical beliefs that must be determined democratically over and over again.

Some people profess to understand and support neoclassical welfare economics, but they ignore its true ethos in favor of personal power, using neoclassical economics inappropriately to promulgate particular subjective ethics, typically their own, but sometimes those of some patron or esteemed other, in rhetorical, underhanded ways. Good economics uses neoclassical welfare economics correctly. It elucidates the role of controversial normative or ethical values in evaluating economic systems and outcomes and highlights the need for popular input from democratic government. Bad economics uses neoclassical welfare economics incorrectly. It fails to accurately identify and evaluate the value inputs in the theory, it adds exogenous values in practice, it attempts to wrest control of normative economic decisions away from democratic government.

We should all fight bad economics and support good economics. Economists above all others have a social responsibility to do so, but if they fail in that important task, and just for the record I believe a great many economists fail in that important task, others must be ready to take up the fight. It’s important. Bad economics is anti-democratic, toxic, cancerous. It’s not something we should be complacent about.

Socialism And Distributional Ethics

A common notion from the world of bad economics and folk economics so prevalent here in the USA is that discussing distributional ethics, or really I suppose even thinking about distributional ethics, represents incipient “socialism.” It’s not a very serious idea, of course, and I’m not entirely sure it’s something suitable to address in a blog post, not in one of my blog posts, anyway, but I do feel I’ve been getting quite serious lately, perhaps a bit too serious, so maybe something on the lighter side wouldn’t go amiss.

Let’s start at the very beginning. All economic systems express or imply a system of distributional ethics, whether one chooses to talk about it or not. And everyone, I suppose, holds ethical beliefs relating to the proper distribution of economic power and hence distribution or allocation of any scarce resources allocated on the basis of economic power in markets. Even real anarchism, the complete absence of law and government, which under conventional language must surely represent the antithesis of “socialism,” variously defined, necessarily involves resources ending up some old place, as opposed to some other old place, and hence distributional ethics. One may suppose under anarchy resources will end up distributed by violence and guile, or perhaps some fantastical and lovely spontaneous mechanism, or perhaps even entirely by chance, but if one supports anarchism, whatever mechanism one supposes it involves will represent one’s explicit or implicit distributional ethics. That’s the funny thing about ethics. It’s completely understandable people want to avoid awkward issues. Sweep things under the rug. Pretend they’re not involved. Unfortunately, things happen. And when they do, one accepts them or does not, one tries to do something or does not. No way to avoid becoming involved really, not outside the ethically attenuated Fairy Land of Economic Theory, anyway.

Now let’s think specifically about distributional ethics in the context of markets. Markets are a venue for expressing preferences using economic power, thus supporting using markets to resolve interpersonal conflicts of preferences over scarce resources, for example, involves ethics relating to the distribution of economic power. No real instance of a market is “best” for “everyone.” The guy living in the forest may quite possibly do better under another system. Same for the gal living under the bridge. And the kid living behind the old convenience store. They’re not all doing as well as they might. If one finds the results of any real instance of a market ethically optimal, one isn’t really talking about what’s best for everyone, one is making a statement about distributional  ethics. One is saying one believes everyone has what they should rightfully have, no matter how much or how little that may be.

The ethics relevant to evaluating real markets are to a small degree about how we should treat individuals expressing preferences, if there is no interpersonal conflict of preferences, and under favorable conditions like perfect information, rationality, etc. Those are the normative or ethical issues capable of being addressed using the type of “utility” we use in neoclassical welfare economics. In contrast, the ethics relevant to evaluating real markets are much more about how to resolve interpersonal conflicts of preferences, how to allocate scarce resources, even how to treat individuals expressing preferences under rather more realistic conditions, such as ignorance and incomplete rationality. All the important and controversial ethical questions associated with real markets, the significance of human welfare, “rights,” different conceptions of merit, etc., are exogenous to neoclassical welfare economics and its idiosyncratic and misleading “utility.”

Bad economics riffs off neoclassical welfare economics to talk about “social optimums,” “social welfare losses,” “deadweight losses” and so on, in real world contexts, but it’s really about the promotion and defense of opaque, obscure, implicit, exogenous, often controversial ethics. Cynics may suppose the facilitation of bad economics is the original and only real purpose of neoclassical welfare economics, but there may be a modicum of content, if one digs for it, and anyway many people enjoy parlor games, especially academic economists. The comedy inherent in our popular discourse about economic issues appears when purveyors of bad economics portray the trivial normative content of neoclassical welfare economics as all that really matters in controversial real world contexts. It’s the mouse that roared. Whatever sells in the “marketplace of ideas?” That’s some shoddy workmanship, right there. Bad economics and related folk economics is to a large extent, perhaps entirely, an empty, insincere, misleading, rhetorical, confidence game. It’s not designed to explain anything, to elucidate any real issue. Indeed, just the opposite.

Yes, in what passes for our social conversation about economic issues here in the USA it’s the battle of neoclassical welfare economics, with its trivial half-ethics and misleading pseudo-socialistic “social optimums” and “social welfare” supporting bad economics and its implied, opaque, exogenous, controversial distributional ethics versus the ostensible incipient “socialism” of anyone who wants to talk plainly and honestly about distributional ethics, real economics, resolving interpersonal conflicts of preferences, the allocation of scarce resources, hunger and castles on Mars. It’s comical, but not in a good way. Our time is short, my friends. Don’t spend it talking rot and acting the fool. The small window we have to help this struggling world of ours, the young, future generations, will close on all of us soon enough, perhaps forever. Be real. Respect philosophy. Fight bad economics.

The Theory of Economic Relativity

I had a fun idea the other day. Given the tendency of purveyors of bad economics to pose as scientists, I wonder if explaining distributional indifference in neoclassical welfare economics in terms of a Theory of Economic Relativity might help. Couldn’t hurt, right? Have I done this one before? Can’t even remember, but it doesn’t really matter, let’s just do it again or maybe for the first time.

What’s the Theory of Economic Relativity? It’s the idea that “social welfare losses” and “deadweight losses,” defined in terms of utility, are relative to a given distribution of economic power and hence pattern of demand and supply, among other things. Let’s talk it through. Imagine first two “economically efficient,” Pareto optimal outcomes: E1 and E2. They have different distributions of economic power and hence different patterns of demand and supply, different resolutions of interpersonal conflicts of preferences, different allocations of scarce resources, etc. If one looks at economically efficient outcome E2, but analyzes it under the distribution of economic power that generates economically efficient outcome E1, one will be able to calculate a social welfare loss from the incongruity of that outcome with that distribution of economic power. However, although one can calculate that apparent social welfare loss easily enough, it has no significance in neoclassical welfare economics. One cannot compare outcomes E1 and E2 on the basis of “utility,” as defined in that theory. Indeed, one could just as easily flip it around and look at economically efficient outcome E1 under the distribution of economic power that generates economically efficient outcome E2 and calculate that social welfare loss. So which one is meaningful? Which has normative significance? That’s an easy one: neither. The so-called “social welfare loss” or “deadweight loss” is defined relative to a particular distribution of economic power. We don’t know what happens to utility when we change the distribution of economic power. That’s what distributional indifference in neoclassical welfare economics is all about.

Again, I understand some economists are now involved with general “welfare analysis” rather that neoclassical welfare economics, per se, and use variable and idiosyncratic definitions of “utility” to make interpersonal utility comparisons all over the place. That’s not what I’m talking about. General “welfare analysis,” where one uses any definition of utility one likes and changes it willy nilly, is not really a “theory,” per se. It has no defined conclusions. One could think of it as a sort of confusing, opaque “bad economics,” but it’s not the sort I’m discussing here. The “bad economics” I have in mind relates to misapplications or misinterpretations of the theory of neoclassical welfare economics and what that theory says about Pareto optimal, economically efficient, “perfectly competitive” market outcomes using a particular definition of utility with defined qualities. In the orthodox, traditional theory of neoclassical welfare economics, one cannot make interpersonal utility comparisons, and for that reason economic relativity of social costs defined in terms of utility must hold, as a matter of logic.

Next, imagine an economically inefficient outcome N. Let’s say one can get from N to E2 using Pareto improvements (E2 Pareto dominates N), but one cannot get from N to E1 using Pareto improvements (E1 does not Pareto dominate N). Again, one can calculate a “social welfare” loss from a “re-distributional” policy that moves one from economically efficient outcome E1 to economically inefficient outcome N, but that calculation has no significance in neoclassical welfare economics. As I’m always so keen to point out, there is no normatively significant “efficiency equity tradeoff” in neoclassical welfare economics.

Finally, consider an issue relating to whether to use economic power in markets to resolve interpersonal conflicts of preferences, the issue I call “extent of the market.” Let’s consider vaccines distributed by medical need rather than economic power in markets. Again, one can calculate an apparent social welfare loss based on the incongruity of the allocation of a vaccine by medical need to the economically efficient allocation that would result from using economic power in markets. However, that calculation has no normative or ethical significance in neoclassical welfare economics. “Utility,” as defined in neoclassical welfare economics, cannot be used to resolve interpersonal conflicts of preferences, desires, needs. Here, the social welfare loss is relative to an exogenous ethical decision to resolve interpersonal conflicts over access to vaccines using economic power in markets. So that’s a second layer of relativity.

We have relativity of social welfare losses to exogenous distributions of economic power, and hence ethical decisions about distributions of economic power, and to exogenous ethical decisions to use economic power in markets to resolve interpersonal conflicts. Other sources seem possible. You know what that means, right? If one leaves the real world for the Fairy Land and stays for forty years, one will return to Earth a virtual infant, as far as one’s ethical thinking. Weird. No, not really. I made that up. But certainly seems the case, sometimes.

If you hear a purveyor of bad economics blabbing on about the “efficiency equity” tradeoff and trying to “ethics block” others, tell them their real world application of their positive analysis of normative economics appears to be more in the order of pseudoscience than actual science. Why? Because they neglect to account for the Theory of Economic Relativity. Stepping back a level, what I’m talking about here is the danger of uncritical, unthinking mathematical formalism, in this case rushing about calculating things because one can, without understanding the conceptual significance, or lack thereof. Setting aside our scientific aspirations for just a moment, if one is doing ethics for the partially unspecified, ethically  attenuated, arbitrary, unreal Fairy Land, say so. If one is doing ethics for the fully specified, ethically complete, real world, say so. Don’t get them twisted. That creates confusion and conflict.

Initial Endowments and Fake Distributional Indifference

I had a fun conversation with another economist the other day, which helped me suspect there may be yet another pathway of fake distributional indifference in bad economics I haven’t really discussed before, in this case centered on the theoretical concept of “initial endowments.”

Recall “fake distributional indifference” is just my term for the great assortment of errors and rhetorical tricks by which purveyors of bad economics seek to portray neoclassical welfare economics as saying more about distributional issues and ethics in the real world than it really does. The initial endowment variant of fake distributional indifference runs something like the following: “In economic theory, we can theoretically get to any Pareto optimal, economically efficient outcome corresponding to any distributional ethics by changing the initial endowment. However, in real life we can’t do that. In real life, we must consider the cost of changing the distribution of economic power in terms of lost “efficiency,” the deadweight loss of “utility” that accompanies any tax, for example, which must be balanced against any purported benefit based on distributional ethics, in other words, the famous “efficiency versus equity” tradeoff I’ve discussed in past posts. To avoid this loss of utility, we must accept the status quo Pareto optimal, economically efficient outcome, or if we’re not already at one, whatever particular instance results from policies designed to foster one from any given starting point. Whether or not to accept the loss of utility associated with “re-distribution” is exogenous to economic theory. Other people may decide the utility loss is worthwhile, including economists talking as regular people, but the job of economists qua economists is simply to point out the utility loss.” That’s basically just repeating back what this fellow was telling me, except he wasn’t very clear on the last bit, so when he informed me he would be willing to “tolerate” the utility losses if the taxes generating the “deadweight loss” of utility were used for certain purposes, I couldn’t really tell if he was still talking as an economist or just a random person with ethical beliefs, but I’m giving him the benefit of the doubt on that one.

Oh boy, here we go again, right? Bad economics rears its ugly head. Distributional indifference in neoclassical welfare economics holds even in the real world, when initial endowments are off the table. It holds even between Pareto optimal, economically efficient outcomes and any non-Pareto optimal, non-economically efficient outcomes (economically inefficient outcomes?) not Pareto dominated by them. That is to say, it holds between any two outcomes related in such a way that one cannot get from the one to the other via Pareto improvements. (That’s sufficient for my purposes, although honestly there are issues even if one can, relating to the fact particular real world instances of apparent Pareto improvements inevitably correspond to some subject’s distributional ethics but not others, which means they may themselves generate utility losses for some people, and hence are not real Pareto improvements. In other words, Pareto improvements are denizens of the Fairy Land, not the real world, a point I’ve discussed previously and will surely discuss again.) One doesn’t “lose” utility when moving from a particular real instance of a Pareto optimal, economically efficient outcome to a non-Pareto optimal, non-economically efficient outcome not Pareto dominated by it. One simply cannot compare the utility of the two outcomes. It’s that discontinuity, that incommensurable quality of outcomes differing along the distributional dimension, masked by things like “welfare losses” and “deadweight losses” defined relative to one distribution, that leads so many down the merry path to bad economics. 

Put another way, there is no normative or ethical proposition in neoclassical welfare economics restricting distributional indifference to changing initial endowments, thus rendering it irrelevant in the real world where changing initial endowments is not as option. The idea true distributional indifference is restricted to changes in initial endowments because other ways of addressing distributional issues involve an “efficiency equity” tradeoff involves a form of fake distributional indifference I’ve discussed many times. “Economic efficiency,” defined using “utility,” cannot correctly be used as an independent criterion from utility. One can’t use economic efficiency to break distributional indifference by saying the latter only concerns utility, but we must also consider economic efficiency. I wrote a blog post or two on that, which I may have mentioned once or a million times. (See The Equity Efficiency Tradeoff and Fake Distributional Indifferences, July 22, 2020, or The Equity Equity Tradeoff, September 9, 2020.)

This issue is linked directly to the attenuated nature of “utility” in neoclassical welfare economics, the ethical half-theory structure of neoclassical welfare economics with some relevant normative issues in and some out, and the resulting split between the ethics of the Fairy Land of the Economic Theory and the ethics of reality. In the ethically attenuated, partially unspecified, unreal Fairy Land, one can make normative propositions about Pareto optimal, economically efficient outcomes as a general class, about collections, frontiers, boxes of equivalent outcomes, and one can flit easily between them at the stroke of the pan, by changing initial endowments or making market structure preserving transfers. In the real world, one is inevitably dealing with one particular instance of a Pareto optimal, economically efficient outcome at a time, in a fully specified world in which variable, subjective, full ethics apply. One. Not all of them. One. That’s it. And that one will appeal to some people, some subjects, but not others. The relevant real world comparisons, discussions, propositions must relate to particular, fully specified instances of economically efficient outcomes and other potential outcomes under realistic conditions. And forget flitting. If society prefers something different in the real world, it must do something, change something. Initial endowments are obviously out, and I’ve discussed the related problematic idea of market structure preserving transfers in previous posts. (See Appeals to Nonexistent Mechanisms for Addressing Distributional Concerns, June 10, 2020.) Labor and capital markets, even perfectly competitive ones, are part of a system for distributing economic power. People may have ethical opinions about them that are exogenous to neoclassical welfare economics. Distributional indifference applies to those distributional mechanisms just as much as to initial endowments modified by them.

Normative or ethical thinking about economic issues in the Fairy Land is different from normative or ethical thinking about economic issues in real life in that respect, and also with respect to the false factual premises that arguably apply in the Fairy Land. Normative or ethical arguments developed in the Fairy Land may be perfectly sensible when applied to the Fairy Land, but they can create all manner of confusion and conflict when inappropriately applied to the real world. It’s a misuse of economics. It’s bad economics.

Neoclassical welfare economics cannot properly be used to thwart other people’s efforts to revise economic systems, including perfectly competitive, Pareto optimal, economically efficient systems, to accommodate their distributional ethics or really other ethics. Ethical decisions about the distribution of economic power; whether to resolve particular or all interpersonal conflicts of preferences, needs, desires by using economic power in markets (extent of the market); even how to treat others expressing preferences that don’t conflict with the preferences of anyone else, under realistic conditions, are exogenous. Using neoclassical welfare economics to argue explicitly or implicitly for particular methods of resolving interpersonal conflicts of preferences or particular distribution or allocation systems or ethics, such as those expressed in perfectly competitive labor and capital markets and product markets, is bad economics.

Bad economics creates confusion and conflict. We can fix bad economics in the short run by accurately describing what neoclassical welfare economics really says, the normative inputs, the limits of the ethical half-theory structure. We can fix bad economics by accurately portraying the important role of activist democratic government in economic systems, including market systems, in terms of addressing the subjective, normative issues exogenous to neoclassical welfare economics, based on the subjective ethical views of the voters. We can fix bad economics by exerting some pressure on the typically complacent, self-satisfied, self-congratulatory residents of the Villa of Academic Economics to finally review their pedagogy and enforce some standards of professional behavior. In the long run, we can fix bad economics by revising the confusing bits of neoclassical welfare economics that generate bad economics, formalizing the role of democratic government in market systems, and hopefully removing the normative content entirely. Resolving the normative or ethical issues associated with evaluating economic systems and outcomes shouldn’t be an intellectual football contested by teams of clueless, insular, defensive, clannish, technocrats speaking in arcane, inaccessible terms as though they belonged to some all powerful ancient priesthood. It should be open, honest, public, forthright, in plain language, a matter for the people and democratic government. Resolving those issues will necessarily be an ongoing process, as some people die and others are born, and the living revise their ethical positions in response to the arguments of philosophers and others, events, experience, knowledge, science, technology, etc. There is no final resolution, only temporary agreement.