This is just an outstanding quotation, from a New York Times article:
"Often introducing money into the exchange — putting it into the marketplace — is what people find repugnant. Mr. Bloom asserted that money is a relatively new invention in human existence and therefore "unnatural."
Economists are asking the wrong question, Mr. Bloom said at the panel. They assume that "everything is subject to market pricing unless proven otherwise."
"The problem is not that economists are unreasonable people, it’s that they’re evil people," he said. "They work in a different moral universe. The burden of proof is on someone who wants to include" a transaction in the marketplace. (Mr. Roth, who acknowledges that "economists see very few tradeoffs as completely taboo," did not take the criticism personally.)"
Sadly, it seems that Bloom was kidding. Isn't it nice that "economists are evil" is a statement that can be mistaken for seriousness, but "psychologists are evil" is so clearly ridiculous?
How can economists plausibly evil, but psychologists cannot? I think the idea that economists "assume that “everything is subject to market pricing unless proven otherwise.”" is wrong. It's a common criticism: economists reduce everything to dollars and cents, trying to measure the value of stuff that's invaluable (the article is talking about how "repugnance" affects trade, using the example of selling organs).
As the social science of the allocation of scarce resources, how could economics operate without trying to figure out some concept of the value of something to someone? I think environmentalists have long despised economists for this reason. Say we're talking about a scarce natural resource, a rain forest for example. Again, positive economic science cannot possibly hope to tell us what the "best" use of this resource is, but it can hope to tell us the consequences of each use. Unfortunately, it's clearly easier to measure, say, the value of this resource to the logger and grazer who seek to use it today than it is to measure the value to humanity of preserving the forest.
Similarly, it's easier to measure the willingness to pay for an organ by a terminally ill individual, and to measure the willingness of another individual to give up an organ, than it is to measure the potential consequences of allowing the sale of organs. The question at hand is: do we do what we can, even given this imbalance, or does the imbalance justify making no valuation, even the ones that are possible? Is attempting to value anything an assumption that "everything is subject to market pricing"?
Trying to understand more about the consequences of a particular allocation of resources is not the same as either propagandizing for that allocation or method of allocation, that is, markets. Even in jest, the charge that we "operate in a different moral universe" is a serious one. It actually makes me very sad, because I'm very familiar with the particular problem of introducing myself as an economist: it alienates a decent percentage of people you meet. ("I'm an economist, but I'm not evil, honest".) Economists are evil, or at least morally bankrupt, to some people. I wish that wasn't the case.
It's understandable. Let's take the ideal world where all positive economics is done scientifically and without normative judgment. Is it surprising that value-neutral economic science seems evil, while value-neutral physics, or chemistry, or psychology, seems like the noble pursuit of knowledge? The Methodology of Positive Economics by Friedman is, again, eloquent on this subject:
"The subject matter of economics is regarded by almost everyone as vitally important to himself and within the range of his own experience and competence; it is the source of continuous and extensive controversy and the occasion for frequent legislation. Self-proclaimed "experts" speak with many voices and can hardly all be regarded as disinterested; in any event, on questions that matter so much, “expert” opinion could hardly be accepted solely on faith even if the "experts" were nearly unanimous and clearly disinterested. The conclusions of positive economics seem to be, and are, immediately relevant to important normative problems, to questions of what ought to be done and how any given goal can be attained. Laymen and experts alike are inevitably tempted to shape positive conclusions to fit strongly held normative preconceptions and to reject positive conclusions if their normative implications - or what are said to be their normative implications - are unpalatable."
It's not just confusion between positive and normative economics, between the practice of the science and its interpretation, it's the very attempt to be value-neutral, to be agnostic, that makes economics seem evil. This is all the more true if, as Friedman is arguing, that there's temptation to attach value judgment to positive economics. If there's any hope of us shedding the "evil" tag, this is a temptation that all economists must resist and fight.
Sunday, February 3, 2008
Saturday, February 2, 2008
Getting what you want: when should politics invoke economics?
The health policy exchange during the Democratic debate on Thursday shows exactly where economics should fit into policy, and politics. I'm not in the business of policy analysis, so instead let's ask how an economist could help Senator Clinton achieve the goal she stated in the debate:
"But if you don't start by saying you're going to achieve universal health care, you will be nibbled to death."
As I said before, I think there are two places for positive economics in the formulation of policy. One is when we ask "what will happen if we do this?", and the second is when we ask the question Hillary's statement invites: "how can I achieve that?". America is no technocracy, so there's no way positive economics can tell us what to do; that question is for every person and every candidate to decide.
This doesn't just apply to questions within the rules of the game. If we take the biggest possible economic question, "how should our resources be allocated?", it's still the case that positive economic science cannot tell us, for example, which of capitalist markets, socialist planning, or making decisions by rolling dice is "best". It's not even difficult - it's impossible. The furthest positive economics can go is to say that if you want to achieve some particular objective then one of the systems might be the most successful, but that obviously relies on the purely subjective notion of what you want.
Even when our questions get more specific - for example, not "how should our resources be allocated?" but "what should we do about health care?" - exactly the same principle applies. So, with that in mind, Senator Clinton has taken the subjective position in support of "universal health care". Let's take a look at the second part of the quotation from the debate:
"But if you don't start by saying you're going to achieve universal health care, you will be nibbled to death."
The argument there is that if you don't define your normative goal well enough, even getting close to it becomes more difficult, which is probably true. Even more fundamentally, it's impossible for a politician to be "wrong" when taking a normative position. Like I said, I won't try a policy analysis asking whether Clinton's policies will really achieve her goal, and I make no judgment on that question.
With that in mind: unfortunately, actual policy has to be made to try to achieve the normative goal. If there's significant doubt that the policy will lead to the outcome stated in the goal, then the politician is misguided or, worse, lying. Political campaigns sometimes seem to promote either depressive pronouncements of how we're all going down in flames, or their ideological counterpart, the Utopian "I can make it all better", neither of which have much in common with the real goals of the candidate. Realism doesn't often sell well, but noble aims without realism run dangerously close to fraud.
To put this in a real context, even if I don't care about your immigration policy, I care about whether or not you are honest in presenting it. Again, positive economics can't say whether you should close the borders; it can (perhaps) describe some of the likely consequences of doing so, and to convince me that your plan to close the borders is sensible you must convince me that, on balance, the many dimensions (moral, financial, political) of the problem favor your plan. If, in doing so, you fail to acknowledge or deny the consequences your argument is immediately bankrupt. That doesn't only apply to whatever consequences economic science can help us figure out - it applies to everything.
Even though I believe that economics can be a tool for analyzing more than just financial consequences, it would be wrong to claim that economic science can tell us everything we need to do. If it could, we might as well just cede to a technocracy. What we can do is help set out the means to your chosen end (as in the example of achieving universal health care), or describe the consequences of your policy (as in the example of closing the borders). To argue that other things matter more than what economic science tells us is defensible; to lie about what economic science tells us is wrong.
"But if you don't start by saying you're going to achieve universal health care, you will be nibbled to death."
As I said before, I think there are two places for positive economics in the formulation of policy. One is when we ask "what will happen if we do this?", and the second is when we ask the question Hillary's statement invites: "how can I achieve that?". America is no technocracy, so there's no way positive economics can tell us what to do; that question is for every person and every candidate to decide.
This doesn't just apply to questions within the rules of the game. If we take the biggest possible economic question, "how should our resources be allocated?", it's still the case that positive economic science cannot tell us, for example, which of capitalist markets, socialist planning, or making decisions by rolling dice is "best". It's not even difficult - it's impossible. The furthest positive economics can go is to say that if you want to achieve some particular objective then one of the systems might be the most successful, but that obviously relies on the purely subjective notion of what you want.
Even when our questions get more specific - for example, not "how should our resources be allocated?" but "what should we do about health care?" - exactly the same principle applies. So, with that in mind, Senator Clinton has taken the subjective position in support of "universal health care". Let's take a look at the second part of the quotation from the debate:
"But if you don't start by saying you're going to achieve universal health care, you will be nibbled to death."
The argument there is that if you don't define your normative goal well enough, even getting close to it becomes more difficult, which is probably true. Even more fundamentally, it's impossible for a politician to be "wrong" when taking a normative position. Like I said, I won't try a policy analysis asking whether Clinton's policies will really achieve her goal, and I make no judgment on that question.
With that in mind: unfortunately, actual policy has to be made to try to achieve the normative goal. If there's significant doubt that the policy will lead to the outcome stated in the goal, then the politician is misguided or, worse, lying. Political campaigns sometimes seem to promote either depressive pronouncements of how we're all going down in flames, or their ideological counterpart, the Utopian "I can make it all better", neither of which have much in common with the real goals of the candidate. Realism doesn't often sell well, but noble aims without realism run dangerously close to fraud.
To put this in a real context, even if I don't care about your immigration policy, I care about whether or not you are honest in presenting it. Again, positive economics can't say whether you should close the borders; it can (perhaps) describe some of the likely consequences of doing so, and to convince me that your plan to close the borders is sensible you must convince me that, on balance, the many dimensions (moral, financial, political) of the problem favor your plan. If, in doing so, you fail to acknowledge or deny the consequences your argument is immediately bankrupt. That doesn't only apply to whatever consequences economic science can help us figure out - it applies to everything.
Even though I believe that economics can be a tool for analyzing more than just financial consequences, it would be wrong to claim that economic science can tell us everything we need to do. If it could, we might as well just cede to a technocracy. What we can do is help set out the means to your chosen end (as in the example of achieving universal health care), or describe the consequences of your policy (as in the example of closing the borders). To argue that other things matter more than what economic science tells us is defensible; to lie about what economic science tells us is wrong.
Friday, February 1, 2008
Too complicated?
One of the principles of writing economic theory is to create a simplified abstraction of reality. If the theory convincingly isolates an idea, it cannot be too simple; hopefully, the narrower the question, the simpler the theory can be written.
Economists therefore appeal to the "all else equal" assumption a lot. The oft-perceived superiority complex of economists is traceable to our willingness to use the "all else equal" clause to make our questions answerable, theoretically and empirically. If we want to write relevant economic models that investigate the link between A and B, we hold C equal; whether or not C would really be equal or relevant in reality, we can't isolate the effect we're interested in if we don't figure out a way stop it from contaminating the abstraction.
It's the same principle that underlies the ideal of "controlled experiments" in all science; empirically, if we want to figure out how A and B are related, I need to be careful to avoid finding an effect because a third factor C is involved. For example, there's an important difference between "people who exercise more have a longer lifespan" and "people who exercise more also eat well, and people who eat well have a longer lifespan". That's well understood in statistics and empirics generally; there's no reason why the same principle is not also needed when we use the theoretical standard of proof rather than the empirical standard of proof.
Why, then, is "economic theory" so amazingly bewildering? With very little exaggeration, we can claim that no great development in the science of economics has used very complicated techniques, even when math was involved, yet even to the technically competent a lot of economics research is very difficult to understand. Of course, if an economist could all find ground-breaking theory that can be represented in two lines, I'm sure she'd write it. Is the reason for the complexity an attempt to make average ideas look better?
Let's be charitable and assume that's not the case. I think that once we exclude the "obfuscation motive", there are two possible reasons why economic theory is technically complex. One might be that the relationships being investigated are broader, that less is held equal, that we're looking to more nuanced explanations. Another possible reason is, paradoxically, that theory gets more complex as the questions get narrower - the more we assume, the higher the complexity.
Why? Imagine I want to figure out the relationship between a person's income and the number of hours that person does voluntary work. This is a question that asks about how people allocate a scarce resource, time. I might make an abstraction that says "if all people like both money and helping others, then people with higher incomes will spend more time helping others, while people with lower incomes will spend more time trying to earn extra money." I might make an abstraction that says "people with more income work more so have less time to volunteer". What assumptions lead to the first conclusion, and what to the second?
If I wanted to broaden my question, I might start including in my theory labor market conditions, the availability of volunteering opportunities, the peer pressure to volunteer, the social pressure to earn more money to buy a big car, and so on and so forth. That would certainly make my theory more complicated; whether or not it makes it a better theory than the one that kept all that stuff equal and abstracted from it is a matter of preference, but I'm sure it would be more difficult to understand.
The second way to make the theory more "complicated", at least superficially, might be to keep all the same stuff equal, but to say "imagine the person cares this much about money and this much about volunteering; then someone with this income will volunteer this much". The abstraction is getting more abstract; we are getting more and more specific about the conditions of our model, and we must use more specific techniques to, in particular, quantify the result.
What do we gain from this quantification, and what do we lose? Perhaps we can look at actual evidence on the link between income and volunteering, and compare it to the quantified prediction, but that only works if all else is equal in our evidence, too. A better justification is that we can get a theoretical idea of how big our effect is. However, as we get more specific we get more abstract; in this example, we're getting more abstract about preferences, which are themselves unobservable. We've gone from "a person cares about money and volunteering" to attaching magnitudes to those cares.
The link between simplicity and usefulness is not just in the realism of the abstraction; it's also in the procedure itself. Economic theory should be neither too broad or too narrow, but "just right", whatever that means. Assume too little and we can't figure out what's really causing what; assume too much and you rest an entire argument on a special case. What's the simplest model that explores the relationship I care about, and what's the simplest model that shows what I want to show about that relationship?
Oh, and a practical suggestion: I'd love it if we all stopped writing ceteris paribus and used "all else equal". What's with the Latin?
Economists therefore appeal to the "all else equal" assumption a lot. The oft-perceived superiority complex of economists is traceable to our willingness to use the "all else equal" clause to make our questions answerable, theoretically and empirically. If we want to write relevant economic models that investigate the link between A and B, we hold C equal; whether or not C would really be equal or relevant in reality, we can't isolate the effect we're interested in if we don't figure out a way stop it from contaminating the abstraction.
It's the same principle that underlies the ideal of "controlled experiments" in all science; empirically, if we want to figure out how A and B are related, I need to be careful to avoid finding an effect because a third factor C is involved. For example, there's an important difference between "people who exercise more have a longer lifespan" and "people who exercise more also eat well, and people who eat well have a longer lifespan". That's well understood in statistics and empirics generally; there's no reason why the same principle is not also needed when we use the theoretical standard of proof rather than the empirical standard of proof.
Why, then, is "economic theory" so amazingly bewildering? With very little exaggeration, we can claim that no great development in the science of economics has used very complicated techniques, even when math was involved, yet even to the technically competent a lot of economics research is very difficult to understand. Of course, if an economist could all find ground-breaking theory that can be represented in two lines, I'm sure she'd write it. Is the reason for the complexity an attempt to make average ideas look better?
Let's be charitable and assume that's not the case. I think that once we exclude the "obfuscation motive", there are two possible reasons why economic theory is technically complex. One might be that the relationships being investigated are broader, that less is held equal, that we're looking to more nuanced explanations. Another possible reason is, paradoxically, that theory gets more complex as the questions get narrower - the more we assume, the higher the complexity.
Why? Imagine I want to figure out the relationship between a person's income and the number of hours that person does voluntary work. This is a question that asks about how people allocate a scarce resource, time. I might make an abstraction that says "if all people like both money and helping others, then people with higher incomes will spend more time helping others, while people with lower incomes will spend more time trying to earn extra money." I might make an abstraction that says "people with more income work more so have less time to volunteer". What assumptions lead to the first conclusion, and what to the second?
If I wanted to broaden my question, I might start including in my theory labor market conditions, the availability of volunteering opportunities, the peer pressure to volunteer, the social pressure to earn more money to buy a big car, and so on and so forth. That would certainly make my theory more complicated; whether or not it makes it a better theory than the one that kept all that stuff equal and abstracted from it is a matter of preference, but I'm sure it would be more difficult to understand.
The second way to make the theory more "complicated", at least superficially, might be to keep all the same stuff equal, but to say "imagine the person cares this much about money and this much about volunteering; then someone with this income will volunteer this much". The abstraction is getting more abstract; we are getting more and more specific about the conditions of our model, and we must use more specific techniques to, in particular, quantify the result.
What do we gain from this quantification, and what do we lose? Perhaps we can look at actual evidence on the link between income and volunteering, and compare it to the quantified prediction, but that only works if all else is equal in our evidence, too. A better justification is that we can get a theoretical idea of how big our effect is. However, as we get more specific we get more abstract; in this example, we're getting more abstract about preferences, which are themselves unobservable. We've gone from "a person cares about money and volunteering" to attaching magnitudes to those cares.
The link between simplicity and usefulness is not just in the realism of the abstraction; it's also in the procedure itself. Economic theory should be neither too broad or too narrow, but "just right", whatever that means. Assume too little and we can't figure out what's really causing what; assume too much and you rest an entire argument on a special case. What's the simplest model that explores the relationship I care about, and what's the simplest model that shows what I want to show about that relationship?
Oh, and a practical suggestion: I'd love it if we all stopped writing ceteris paribus and used "all else equal". What's with the Latin?
Thursday, January 31, 2008
Arguing in economics: the gray area
Despite being interested in figuring out exactly what economics is, really, I have to confess that I don't really care about the common question "is economics a science?". Trying to answer it seems to tie people in knots, and I don't think the question by itself is very important. However, I just found a nice article on the subject which set me thinking.
My economics education was very essay-centric, and, perhaps paradoxically, I think was a good means to understanding what it takes to be "scientific" in a social science. A good essay has to contain more than raw emotion, but similarly should not avoid interpretation. It's equally difficult to argue using facts alone as it is to argue without them.
Is "good economics" the same? A theorem or result is, by nature, empty in itself - it's just a logical chain from start to finish. With the right starting point, you can "prove" anything; with an unproveable starting point, you're really in business. However, for the result to matter, it has to be put in context. What does it mean? Maybe it's semantics, but the search for meaning - the interpretation - is the birth of a normative judgment, still value-free but certainly pushing that label as far as it can go, before the true normative judgments of what we want are made.
The separation of the "scientific method" of economics and the use of its results must be sacred. The former, done from a position of honesty, can never be "wrong", since it's just logic. Why, then, must we introduce interpretation at all? The best reason to do so is the problem of "underdetermination", the idea, captured in the Friedman quotation I mentioned in a previous post, that if there exists another theory at least as consistent with the evidence, our theory is "underdetermined": all, perhaps, related to the problem of the unproveable starting point.
The underdetermination issue is, I think, especially relevant to theories which rely on behavioral assumptions, given that we know that humans are (sometimes) capable of being pretty nuanced in their behavior. Whether or not any scientific theory can be airtight is up for debate; in economics, I am convinced that no theory can be airtight. That's not to say we can't be nice empiricists and check predictions against evidence like scientists do, but it is to say that the alternative, consistent theories must be addressed before we can cross the line from positive science to normative policy. I have to show that my theory can be right, but also argue that mine is the most right, especially if I want to take my theory from the sterile, all else equal, scientific vacuum into inference about the real world.
Just like a debater or an essay writer, any position I occupy can be attacked, and defense is the only response that will preserve that positive, scientific position. If we can prove anything, if any hypothesis is underdetermined, then whether or not economics can be called a science, the scientific method alone won't be enough. Somewhere between that scientific method and the politicking of normative selection lies that subtle gray area which all of our correct, consistent theories must cross. There we must decide what we want to use them for, and how they should be received; the "useful" ones must be the only ones allowed to survive.
My economics education was very essay-centric, and, perhaps paradoxically, I think was a good means to understanding what it takes to be "scientific" in a social science. A good essay has to contain more than raw emotion, but similarly should not avoid interpretation. It's equally difficult to argue using facts alone as it is to argue without them.
Is "good economics" the same? A theorem or result is, by nature, empty in itself - it's just a logical chain from start to finish. With the right starting point, you can "prove" anything; with an unproveable starting point, you're really in business. However, for the result to matter, it has to be put in context. What does it mean? Maybe it's semantics, but the search for meaning - the interpretation - is the birth of a normative judgment, still value-free but certainly pushing that label as far as it can go, before the true normative judgments of what we want are made.
The separation of the "scientific method" of economics and the use of its results must be sacred. The former, done from a position of honesty, can never be "wrong", since it's just logic. Why, then, must we introduce interpretation at all? The best reason to do so is the problem of "underdetermination", the idea, captured in the Friedman quotation I mentioned in a previous post, that if there exists another theory at least as consistent with the evidence, our theory is "underdetermined": all, perhaps, related to the problem of the unproveable starting point.
The underdetermination issue is, I think, especially relevant to theories which rely on behavioral assumptions, given that we know that humans are (sometimes) capable of being pretty nuanced in their behavior. Whether or not any scientific theory can be airtight is up for debate; in economics, I am convinced that no theory can be airtight. That's not to say we can't be nice empiricists and check predictions against evidence like scientists do, but it is to say that the alternative, consistent theories must be addressed before we can cross the line from positive science to normative policy. I have to show that my theory can be right, but also argue that mine is the most right, especially if I want to take my theory from the sterile, all else equal, scientific vacuum into inference about the real world.
Just like a debater or an essay writer, any position I occupy can be attacked, and defense is the only response that will preserve that positive, scientific position. If we can prove anything, if any hypothesis is underdetermined, then whether or not economics can be called a science, the scientific method alone won't be enough. Somewhere between that scientific method and the politicking of normative selection lies that subtle gray area which all of our correct, consistent theories must cross. There we must decide what we want to use them for, and how they should be received; the "useful" ones must be the only ones allowed to survive.
Wednesday, January 30, 2008
Can you test rationality?
Is it possible to test if people are rational? I think the answer, practically, is a very short no: if a rational person tries to achieve his most preferred outcome of the ones that are available, we can't distinguish the rationality or irrationality of his choice from his preferences. That is, if I don't know what you like, I can't tell if you did something because you liked it or because you're "irrational".
Yet rivers of ink have been spilled trying to "prove" or "disprove" models of rational choice. The most famous study of the type is the "Allais paradox", discussed here. It says that when you pose different choices to people, their responses to pairs of choices are "inconsistent" with each other because the two choices really represented the same cash outcomes.
Whether you look at the question being asked by this type of work "are people rational?", or "what do people care about?", it's pretty clear that any observation cannot answer either of these without knowledge of the other. In "The Methodology of Positive Economics" (pdf) Milton Friedman made the valid, general point that
"If there is one hypothesis that is consistent with the available evidence, there are always an infinite number that are."
It just so happens that if we interpret some piece of evidence as being consistent with "people are irrational", one of the "infinite number" towers above all others: "you guessed the preferences wrong". There's nothing wrong with trying to figure out how to better model the decisions of people, but claiming to have proved irrationality is nonsensical.
Yet rivers of ink have been spilled trying to "prove" or "disprove" models of rational choice. The most famous study of the type is the "Allais paradox", discussed here. It says that when you pose different choices to people, their responses to pairs of choices are "inconsistent" with each other because the two choices really represented the same cash outcomes.
Whether you look at the question being asked by this type of work "are people rational?", or "what do people care about?", it's pretty clear that any observation cannot answer either of these without knowledge of the other. In "The Methodology of Positive Economics" (pdf) Milton Friedman made the valid, general point that
"If there is one hypothesis that is consistent with the available evidence, there are always an infinite number that are."
It just so happens that if we interpret some piece of evidence as being consistent with "people are irrational", one of the "infinite number" towers above all others: "you guessed the preferences wrong". There's nothing wrong with trying to figure out how to better model the decisions of people, but claiming to have proved irrationality is nonsensical.
Tuesday, January 29, 2008
Who was Pareto anyway?
Students of economics will hear about "Pareto efficiency" very early in Econ 101. It's a tool to compare outcomes. Sadly, poor Pareto now has his name attached to a disastrously misunderstood concept - Pareto efficiency is everywhere used and frequently abused.
From a biography of the man himself, Vilfredo Pareto:
"Like Irving Fisher (1892), Pareto stumbled on the idea that cardinal utility could be dispensed with. Preferences were the primitive datum, and utility a mere representation of preference-ordering. With this, Pareto not only inaugurated modern microeconomics, but he also demolished the "unholy alliance" of economics and utilitarianism. In its stead, he introduced the notion of Pareto-optimality, the idea that a society is enjoying maximum ophelimity when no one can be made better off without making someone else worse off."
Two reasons to be cheerful: apart from featuring the excellent word "ophelimity" (n., economic satisfaction), this could not be clearer on the definition of Pareto optimality (now synonymous with Pareto efficiency). A situation is Pareto optimal if no one can be made better off without making someone else worse off.
Why, then, is this type of statement easily the most common mistake in economics (not intended to pick on the source, which is certainly not unique):
"There is no connection between Pareto efficiency and equity! In particular, a Pareto efficient outcome may be very inequitable. For example, the outcome in which I have all the goods in the world is Pareto efficient (since there is no way to make someone better off without making me worse off)." [Emphasis mine]
To get the cheapest criticism out of the way first, saying "there is no connection between Pareto efficiency and equity" is a bit like saying "there is no connection between Pareto efficiency and the color of my shoes"; why should there be? It's just a definition. It is, or it isn't. The criticism that's actually important is that the bit in bold is a logical falsehood.
The true statement would be "the outcome in which I have all the goods in the world can be Pareto efficient". In fact, equally true: "outcome _____ can be Pareto efficient". Why? The missing link is that Pareto efficient is, inherently, a concept built on utility. The "better off" part implies that our test of Pareto efficiency centers on the relative satisfaction enjoyed under alternative outcomes. This is, again, not the same as the relative levels of income, consumption or stuff enjoyed under alternative outcomes.
A simple proof by contradiction: I have all the goods in the world. I am also ascetic and thus get more satisfaction from having less goods. You always like more goods. The outcome in which I have all the goods in the world is Pareto inefficient.
Simple, no? Again, it's a case of confusing utility with goods or money, a case that would probably have irritated Pareto himself. The hidden assumption in the mistake quotation is the assumption on what the preferences of the person with all the goods are. We can imagine many ways in which that person's preferences would result in the falsehood of the assertion of Pareto optimality, yet we are anyway confronted with this manifestation of the prejudice that the concepts used by economists to compare outcomes are evil manifestations of an imagined money-centric, capitalist doctrine.
So is Pareto efficiency a normatively loaded term? Is the concept of Pareto efficiency part of positive economics or normative economics? Those who would argue that the boundary between the two is fuzzy frequently point to the Pareto efficiency tool as evidence. It's a concept that is, however, firmly positive, at least up to the scale of the interpretation of language. It either is raining, or it isn't. An outcome either is Pareto efficient, or it isn't. This cannot be a normative statement.
Perhaps the problem arises because, like all concepts that rely on assessing utility or satisfaction, Pareto efficiency might be inherently untestable. Unless it's actually possible to know or deduce preferences, we can't make physically true statements about Pareto efficiency or the like; the best we can do is to say "if these people have these preferences, this outcome is or is not Pareto efficient". To do better than conditional truth we somehow have to know preferences, and whether that's possible is, to me, a huge open question. Pareto efficiency might then seem normatively loaded because the assumption on what preferences people hold is folded into the statement of Pareto efficiency, as in the mistake above that omitted "if people only care about their own material possessions".
The irony is that Pareto, the man, for whom "Preferences were the primitive datum, and utility a mere representation of preference-ordering", might perhaps be the first to object to the misuse of his most famous concept.
From a biography of the man himself, Vilfredo Pareto:
"Like Irving Fisher (1892), Pareto stumbled on the idea that cardinal utility could be dispensed with. Preferences were the primitive datum, and utility a mere representation of preference-ordering. With this, Pareto not only inaugurated modern microeconomics, but he also demolished the "unholy alliance" of economics and utilitarianism. In its stead, he introduced the notion of Pareto-optimality, the idea that a society is enjoying maximum ophelimity when no one can be made better off without making someone else worse off."
Two reasons to be cheerful: apart from featuring the excellent word "ophelimity" (n., economic satisfaction), this could not be clearer on the definition of Pareto optimality (now synonymous with Pareto efficiency). A situation is Pareto optimal if no one can be made better off without making someone else worse off.
Why, then, is this type of statement easily the most common mistake in economics (not intended to pick on the source, which is certainly not unique):
"There is no connection between Pareto efficiency and equity! In particular, a Pareto efficient outcome may be very inequitable. For example, the outcome in which I have all the goods in the world is Pareto efficient (since there is no way to make someone better off without making me worse off)." [Emphasis mine]
To get the cheapest criticism out of the way first, saying "there is no connection between Pareto efficiency and equity" is a bit like saying "there is no connection between Pareto efficiency and the color of my shoes"; why should there be? It's just a definition. It is, or it isn't. The criticism that's actually important is that the bit in bold is a logical falsehood.
The true statement would be "the outcome in which I have all the goods in the world can be Pareto efficient". In fact, equally true: "outcome _____ can be Pareto efficient". Why? The missing link is that Pareto efficient is, inherently, a concept built on utility. The "better off" part implies that our test of Pareto efficiency centers on the relative satisfaction enjoyed under alternative outcomes. This is, again, not the same as the relative levels of income, consumption or stuff enjoyed under alternative outcomes.
A simple proof by contradiction: I have all the goods in the world. I am also ascetic and thus get more satisfaction from having less goods. You always like more goods. The outcome in which I have all the goods in the world is Pareto inefficient.
Simple, no? Again, it's a case of confusing utility with goods or money, a case that would probably have irritated Pareto himself. The hidden assumption in the mistake quotation is the assumption on what the preferences of the person with all the goods are. We can imagine many ways in which that person's preferences would result in the falsehood of the assertion of Pareto optimality, yet we are anyway confronted with this manifestation of the prejudice that the concepts used by economists to compare outcomes are evil manifestations of an imagined money-centric, capitalist doctrine.
So is Pareto efficiency a normatively loaded term? Is the concept of Pareto efficiency part of positive economics or normative economics? Those who would argue that the boundary between the two is fuzzy frequently point to the Pareto efficiency tool as evidence. It's a concept that is, however, firmly positive, at least up to the scale of the interpretation of language. It either is raining, or it isn't. An outcome either is Pareto efficient, or it isn't. This cannot be a normative statement.
Perhaps the problem arises because, like all concepts that rely on assessing utility or satisfaction, Pareto efficiency might be inherently untestable. Unless it's actually possible to know or deduce preferences, we can't make physically true statements about Pareto efficiency or the like; the best we can do is to say "if these people have these preferences, this outcome is or is not Pareto efficient". To do better than conditional truth we somehow have to know preferences, and whether that's possible is, to me, a huge open question. Pareto efficiency might then seem normatively loaded because the assumption on what preferences people hold is folded into the statement of Pareto efficiency, as in the mistake above that omitted "if people only care about their own material possessions".
The irony is that Pareto, the man, for whom "Preferences were the primitive datum, and utility a mere representation of preference-ordering", might perhaps be the first to object to the misuse of his most famous concept.
Monday, January 28, 2008
The Philosophy of Economics
If we accept that there is a disconnect between the prior beliefs of economics students on what economics is and the real basis of the discipline, I think the quickest way to make a change would be to make a course in the philosophy of economics compulsory.
This is a pretty long piece (from an encyclopedia of philosophy no less), but it's just an excellent overview of some of the things a course like that would cover. It's certainly not uncontroversial though. I hope I can talk about some of these things soon.
This is a pretty long piece (from an encyclopedia of philosophy no less), but it's just an excellent overview of some of the things a course like that would cover. It's certainly not uncontroversial though. I hope I can talk about some of these things soon.
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