Equity Issues and Market Failure

I read someone talking about the ubiquity in reality of what are called “market failures” in neoclassical welfare economics, which is true enough, but it reminded me of the confusion the ethical half-theory of neoclassical welfare economics may produce. Let’s discuss.

In the world of the artificially defined and constrained ethical half-theory of neoclassical welfare economics, a “market failure” refers to some feature of a market that prevents it from corresponding entirely to the “perfectly competitive market” model defined in that theory. Just FYI, no real market corresponds to the “perfectly competitive” market model of normative neoclassical welfare economics, which is a theoretical construct that includes false factual premises such as perfect information, perfect rationality. In that area, confusion between normative and positive economics is rife, with many seemingly not understanding the normative significance of false factual premises in ethical theory, trying to relate it back instead to positive issues of usefulness, predictability. I discuss those issues often enough and anyway don’t want to discuss the definition and significance of so-called “market failures” in real markets as much as to compare and contrast that category of normative issues with the vastly more significant one of equity issues.

“Market failures” involve normative considerations endogenous to the ethical theory presented in neoclassical welfare economics. “Equity issues” involve normative considerations recognized and acknowledged in neoclassical welfare economics but not discussed there, exogenous in that sense. I commented before on possible equivocation on the term “exogenous” as meaning not recognized or acknowledged, rejected, versus “exogenous” as meaning recognized, acknowledged as having standing, accepted, but not discussed, so I won’t belabor the point here, as long as we know what we mean.

Rather than talking it all out in an abstract, theoretical way, let’s discuss the relevant issues using the concrete example of a policy of allocating scarce vaccine by medical need, a policy used without significant normative controversy during the recent covid epidemic. The policy of allocating the scarce resources of a vaccine by medical need conflicts with allocating that resource using economic power plus personal preferences in markets. It leads to results that differ from what one would find if vaccines were allocated by a “perfectly competitive market.” Such a policy exhibits the same problem as a so-called “market failure” and could thus be seen as a type of self-inflicted “market failure,” although because of the more direct government involvement, as opposed to creating or defining real markets, some may want to call it a “government failure.” So why were so few concerned about this self-inflicted “market failure” given the supposedly minimal and uncontroversial normative content in neoclassical welfare economics? Interesting question. If you can follow along here, you may be in a good position to reject bad economics entirely.

The “failure” here is relative to the normative issues taken up, discussed in, endogenous to neoclassical welfare economics, so about individual preference ranks only. The reason the policy was not seen by many, if any, as a “failure” needing fixing is due to “equity issues,” interpersonal ethics. Apparently, most thought the ethics of allocating the scarce vaccine to those who need it more compelling than allocating it to those with sufficient economic power and preferences to claim it, unnecessarily and possibly only on the slightest of whims. It’s fine. It’s one reason we have democracy. The point is accepted in good economics, real neoclassical welfare economics, where equity issues are acknowledged as having standing, albeit not discussed, so voters weighing in on such issues may override any endogenous findings based on individual preferences alone. In real neoclassical welfare economics, no endogenous normative judgment may be made relating to real outcomes or solutions that differ on the basis of interpersonal results, who gets what, regardless of how closely they correspond to perfectly competitive market model results. That’s why issues that occur in reality like evaluating the distribution of economic power, mechanisms for distributing economic power, various market outcomes, choosing market or non-market allocation methods (extent of the market), cannot be resolved within neoclassical welfare economics.

However, what happens if one does not understand the ethical half-theory structure of neoclassical welfare economies, does not understand the role of equity issues, interpersonal ethics, voters, democracy, is one may simplistically glom onto “market failure,” try to fix it. That’s what makes the language of “market failure,” and its fix of pursuing perfectly competitive market arrangements and expanding the extent of the market to cover every allocation of every scarce resources, so rhetorically useful to those who wish to suppress consideration of equity issues.  The point is to not get confused by the contradictory policy recommendations if one looks only at the normative issues involving individual preferences discussed within neoclassical welfare economic theory versus if one looks at the interpersonal ethics that have standing but are not discussed. If voters agree no equity issues, no disagreements, controversies relating to interpersonal ethics, fairness, justness, objective human welfare, what have you, then sure, concentrate on “market failure.” If there are equity issues, concentrate on and address those, not “market failure.”

Efficiency As Equity II

I thought I’d say a few more syllables this week about that efficiency as equity post I did last time, including the possibly cryptic bit at the end that called out a potential level issue relating to equity in neoclassical welfare economics. Good times.

I’m a bit concerned that rather than appreciating the point about an equity proposition underlying Pareto optimality and hence (economic) “efficiency,” readers might suppose the issue was about evaluating the equity proposition in question. I’ll address that in a moment, but no, it wasn’t. The point was equity propositions that can resolve interpersonal conflicts of preferences by going beyond individual preferences ranks as “utility” are meant to be exogenous to neoclassical welfare economics. They’re qualitatively different from the endogenous normative propositions. But the equity proposition that underlies Pareto optimality and hence (economic) efficiency isn’t exogenous; it’s right there at the heart of the argument about the supposed social optimality of markets. It’s a biggie, as people once said. It’s also weird. Awkward combination for any theory.

Turning now to the issue of the evaluation of that proposition leads me to a possibly cryptic statement I made previously about equity arriving at different levels of theory. Recall for me a level issue is when the same term, concept, idea applies at different points in an argument or theory. Level issues are an important rhetorical device or stumbling block, depending on one’s perspective, because they provide a hook beyond simple terms or concepts on which one may hang equivocation, that is, switching between issues in an unconscious or more typically sly, artfully deceitful way.

One level issue here relates to context. An interesting aspect of the ethical half-theory of neoclassical welfare economics is it’s not developed in, nor evaluated in, realistic contexts, but in an artificial, artfully contrived, theoretical context I call the Fairy Land of Economic Theory. It’s a very atypical sort of ethical philosophy and can lead to problems associated with properly evaluating ethical propositions under the conditions that apply in the Fairy Land then incorrectly supposing that evaluation also holds in the very different context of reality. One useful way to think about what’s going is only part of the ethical content of neoclassical welfare economics arrives as explicit normative propositions, another part arrives as artful manipulation of the theoretical context, the introduction of false factual premises affecting evaluation. Need a non-economic example? Suppose I proposed to discuss the ethics of murder in an artfully constructed unreal world is which no one ever intends to kill anyone else. Then suppose I took propositions developed in that world, sensible in that world, and applied them to reality. Awkward, right?

Let’s consider context specifically in the context of equity. When one evaluates the equity proposition associated with Pareto Optimality / “economic efficiency” in the Fairy Land, it may seem entirely unobjectionable; however, I would suggest much of that is due to the theoretical context. There is simply not enough detail typically provided in theoretical contexts for that equity proposition to seem notable at all, indeed possibly not even enough to recognize it as an equity proposition. However, consider the same proposition in reality and the equity element becomes more obvious. Let’s say in reality A just hit B over the head with a rock and stole her wallet. B’s preference is to get it back. A’s preference is to keep it. The Pareto Optimal / “economically efficient” outcome is for A to keep it as we’re not meant to consider moving anyone down his or her preference rank. That’s clearly an equity judgment. We looked at an interpersonal conflict of preferences between A and B and resolved it in favor of A. That cannot be done solely on the basis of individual preference ranks. It’s an equity proposition like any other equity proposition. So one level issue concerns context. Equity issues in realistic contexts typically involve details some may find relevant to some theory of interpersonal ethics. However, we may also have equity issues in theoretical contexts in which such details are missing. They have the same status. 

That observation leads to another potentially relevant level issue to consider, which I’ve discussed before but might as well do here again, not so much involving what constitutes an equity proposition, but moving on to what it means to be indifferent to an equity proposition or to equity issues. At one level, one is indifferent to typical real equity propositions or issues in the case of the stolen wallet because one’s judgment of optimality doesn’t hinge on how the fellow came to have the wallet, so one is indifferent to any equity arguments others find appropriate to apply to that issue. However, at another more theoretical level of equity issues, one is not indifferent to how the relevant interpersonal conflict of preferences is resolved, the issue that cannot be addressed via “utility” as individual preference ranks, one calls as optimal one resolution, not the other. 

On may say, well, Pareto optimality and “economic efficiency” are only meant to be dispositive in the ethical half-theory of neoclassical welfare economics until other exogenous equity concerns, propositions are introduced. That’s fine. But they’re also equity propositions. Another way of saying it is one may find Pareto optimality and “economic efficiency” normatively significant if one agrees the underlying equity proposition relating to the ethical significance of the status quo, if one agrees preserving status quo relations, equity at both levels.