Someone got me going the other day on the supposed “efficiency” of markets, which made me realize I haven’t actually done a storm on that yet this cycle, so how about that this week? “Economic efficiency” in models of perfectly competitive markets and in reality?
“Efficiency” in economic contexts relating to the supposed advantages of markets generally means so-called “economic efficiency,” that is, “Pareto efficiency,” defined with respect to individual preference ranks (or “utility,” as uniquely and rather oddly defined in neoclassical economic theory). Don’t know what any of that means? Never heard of old Italian fascist Mr. Pareto? You just suppose “free markets” are good because they’re “efficient?” That’s funny. Maybe don’t ape the language of economic theory without knowing what it actually means? For the rest of us, let’s get into it a bit.
“Economic efficiency” or “Pareto efficiency” is about a situation where one cannot move one person up his or her individual preference ranking without moving someone else down their own preference ranking. The kernel of truth is it seems a nice thing to have, unless other issues. Why not? That’s not the tricky bit, although someone was recently arguing to me against placing normative significance on economic efficiency, an argument I’m not really familiar with and won’t be going into today. No, for me the tricky bit is how the concept is used or let’s say misused in real situations.
Economic efficiency has great significance within the confines of the ethical half-theory of neoclassical welfare economics because interpersonal ethics are purposefully excluded, so the only issue left is individuals and their preferences. In reality, the significance is rather different. The typical context this is discussed in the Fairy Land, as I call it, is to compare some random market outcome which is not Pareto efficient to one that is and, as one has no other normative basis to distinguish the two outcomes, to declare the Pareto efficient outcome “socially optimal.” Another typical context in the Fairy Land is to consider two Pareto efficient outcomes, wonder which to choose, remember there is no basis in that ethical half-theory to choose because all relevant interpersonal ethics issues are exogenous, and to be indifferent, say either will do just fine.
The significance of Pareto optimality is quite different in reality, of course. In real contexts, people may have ideas relating to interpersonal ethics, equity, fairness, justice, welfare, and so on, and those may well take precedence over considerations of Pareto or economic efficiency. When interpersonal ethics, so-called equity issues involving issues like fairness, justice, welfare variously defined, that sort, are added back in, one may prefer not only one Pareto efficient outcome to another, but one may prefer some non-Pareto efficient outcome to some Pareto efficient one. For example, given existing arrangements, Pareto optimality may mean ensuring the Tsar can buy a jeweled Easter egg, which he prefers to a jeweled cigarette case. However, in the presence of interpersonal ethics, one may not really care very much, at least until certain other issues are addressed.
In the context of bad economics in the conservative style, this calls forth various misleading rhetorical arguments to get around the obvious ethical limitations of real neoclassical welfare economics when applied in reality, typically involving fake indifference or what I call roadblocks. I discuss those often enough, and if I did again now I’d probably go over, so this time let me just observe there is nothing in real neoclassical welfare economics that justifies economists qua economists telling other people they should not distort or interfere with markets. That’s bad economics.
More generally? Surely “efficiency” doesn’t always mean “economic efficiency” or “Pareto efficiency?” No, indeed. Just keep in mind nothing is efficient for every possible goal or objective. Things are efficient for one thing, not another. Ask always, efficient with respect to what? A joke I like to tell about efficiency is to answer the question of what’s the most efficient way to the bottom of the cliff by saying jump off it. Oh ... you mean while remaining alive? That’s a different issue. You didn’t say that the first time. Different answer, of course. When you hear something like “markets are efficient,” and you don't think you’re talking about “economic efficiency” or “Pareto efficiency,” ask yourself, efficient for what? Maximizing human welfare? Addressing material want? Generating human happiness? Maximizing production? Making a just society?
