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.
