Hahnel ABCs of Political Economy Modern Primer

36 The ABCs of Political Economy

people in the future were large compared to the cost of reducing emissions to people in the present. I was willing to compare how large a gain was for one person compared to how small a loss was for a different person. If one refuses to compare the size of benefits and costs to different people, the efficiency criterion cannot be used. Unlike the narrow Pareto principle, the efficiency criterion requires comparing the magnitudes of costs and benefits to different people and deciding how much importance to attach to the well being of different people.

In other words, the efficiency criterion requires value judgments beyond what are required by the Pareto principle. So when mainstream economists pretend they have imposed no value judgments, and have separated efficiency from equity issues when they apply cost benefit analysis and recommend policy based on the efficiency criterion they misrepresent themselves. While a Pareto improvement makes some better off at the expense of none – and therefore does not require comparing the sizes of gains and losses to different people or weighing the importance of well being to different people – policies that satisfy the efficiency criterion generally make some better off precisely at the expense of others, which necessarily requires comparing the magnitudes of costs and benefits to different people and making a value judgment regarding how important the interests of the “winners” are compared to the interests of the “losers.” Mainstream economists like to point out that if a policy passes the efficiency criterion that means the magnitude of benefits enjoyed by the winners is necessarily larger than the magnitude of costs suffered by the losers, which means it would be theoretically possible for the winners to fully compensate the losers and still be better off themselves. But first, this requires a comparison of the magnitude of gains to some compared to the magnitude of losses to others – already a large step beyond the narrow conceptualization of efficiency enshrined in the Pareto principle that does not permit comparing different people’s satisfactions. Secondly, either compensation is paid, or it is not paid. If a policy requires winners to fully compensate losers then it is a Pareto improvement and we do not need the broader efficiency criterion to recommend it. If, on the other hand, a policy does not require that losers be fully compensated from the gains to winners, then it requires a value judgment that those who win deserve to do so, and those who lose deserve to do so, before it can be recommended – however much economists who claim to forswear “value judgments”

What Should We Demand from Our Economy? 37

may wish otherwise. In the end, the only reason we need the efficiency criterion in the first place is precisely because so many important choices fall outside the purview of the Pareto principle, i.e. cannot be reduced to efficiency defined narrowly.

Seven deadly sins of inefficiency

How might an economy be wasteful in the sense that it fails to achieve a Pareto optimal outcome? It turns out there are seven different ways that any economy might be inefficient. I facetiously call them the seven “deadly sins” of inefficiency.

The production sector of an economy will be inefficient if:

1.It leaves productive resources idle. (Example: unemployed workers, or idle crop land.)

2.It uses inefficient technologies, that is, uses more of some input than necessary to get a given amount of output. (Example: The same number of shoes can be made with less leather by more careful cutting.)

3.It misallocates productive resources so that swapping inputs between two different production units would lead to increases in output in both. (Example: Assigning carpenters to a farm and agronomists to the construction industry.)

The consumption sector will be inefficient if:

4.There are undistributed, or idle consumption goods. (Example: Wheat rotting in silos while people go hungry.)

5.Final goods are misdistributed so that two or more consumers could exchange goods and both be better off than under the original distribution. (Examples: Apples are distributed to orange lovers while oranges are distributed to apple lovers.)

And the production and consumption sectors will be inefficiently integrated if:

6.Goods are misallocated between consumers and producers so it is possible for a producer and consumer to swap goods and have the output of the producer rise and the satisfaction of the consumer increase as well. (Example: Personal computers are distributed to households that suffer for lack of heat while

38 The ABCs of Political Economy

employees at accounting firms are unproductive in overheated offices without personal computers to work with.)

7.Resources are misallocated to different industries so it is possible to shift productive resources from one industry to another to produce a different mixture of outputs more to consumers’ tastes. (Example: Most land suitable for orchards is planted in pear trees even though most consumers prefer apples to pears.)

The seven deadly sins of inefficiency provide an orderly, and not overly intimidating, procedure for checking to see if an economy will be inefficient in the narrow sense of the Pareto principle. All we need to do is check if the economy is prone to “sinning” in any of these seven ways. If not, we can conclude the economy is efficient, or will achieve Pareto optimality, whatever other desirable or undesirable qualities it may posess. Moreover, if the economy is prone to inefficiency we will know what kind of inefficiency it suffers from.

Endogenous preferences

There is an important issue traditional treatments ignore which complicates how we should think about efficiency. When people make choices in light of their present preferences, the actions they take not only fulfill their present preferences (to a greater or lesser degree), they also change people’s human characteristics to some extent, and thereby change their future needs and desires. In chapter 1 we saw this is what it means to say people have “consciousness” and are “self-creative.” While traditional treatments of efficiency take account of the first effect of people’s choices – the “preference fulfillment effect” – the second effect – the “preference development effect” – is usually ignored even though evaluating the effect of economic choices and institutions on people’s human development patterns may be as important as evaluating how well those choices and institutions succeed in fulfilling their present preferences. However, when economic choices have human development effects that means they also change people’s preferences, creating the following dilemma: How are we to judge the efficiency of economic institutions using people’s preferences as our yardstick if those preferences are in part a product of those same economic institutions in the first place? While this may appear to be a vicious circle giving rise to a philosophical conundrum that cannot be resolved, it turns out there are some conclusions we can draw about economic efficiency even when we recognize that people’s preferences are

What Should We Demand from Our Economy? 39

influenced by the economic institutions that purport to satisfy those preferences.

The view that people are self-conscious agents whose characteristics and therefore preferences develop can be summarized in a model of “endogenous preferences.” Using such a model it is possible to demonstrate that if an economy is biased against a certain kind of activity – that is, if people must pay more than the true cost to society to engage in the activity:

1.The degree of inefficiency in the economy will be greater than recognized by traditional theory that fails to treat preferences as endogenous, and the inefficiency will increase, or “snowball” over time.

2.Individual human development patterns will be “warped” in the sense that they will not develop in ways that would generate the most fulfillment people could enjoy, and the warping will increase or “snowball” over time.

3.These detrimental, non-traditional effects of the bias in the economy will be disguised to participants who adjust unconsciously, or forget they have adjusted after the fact.

The intuition behind these political economy welfare theorems13 is that to the extent people recognize the “preference development” as well as the “preference fulfillment” effects of their choices, it is sensible for them to take both effects into account when making decisions. If an economic institution is biased against some activity

– charging people more than the true social cost of their engaging in the activity – then rational people will choose activities in part to develop a lower preference for that activity than if they were only charged the true social cost for engaging in it. It follows that the demand for the activity in the future will be less than had people not adjusted their preferences. But this reduced demand implies that even fewer resources will be allocated to supplying the activity than had people not adjusted their preferences. The more time people have to make these individually rational adjustments, the lower demand, and therefore supply of the activity will be, leading to ever greater misallocations of productive resources as time goes on, and

13.For a rigorous derivation of these results see chapter 6 in Robin Hahnel and Michael Albert, Quiet Revolution in Welfare Economics (Princeton University Press, 1990).

40 The ABCs of Political Economy

ever greater deviations of people’s human development trajectories from those that would have maximized their well being under a system of unbiased prices. If after the fact people forget that they adjusted their preferences in response to the bias, they will only see themselves as getting what they want.

In other words, if an economic institution introduces a bias in the terms of availability of an activity, the consequence will be a “snowballing” divergence from efficient allocations. This implies that a major criterion for judging economic institutions should be determining whether they exert any systematic biases on individual choice, because to the extent that people’s preferences are endogenous, any biases will be more detrimental than traditionally recognized.

While traditional economists limit their evaluations of economies to efficiency (without considering the complication of endogenous preferences) and equity (about which they have little to say), political economists have good reason to take other criteria into account as well. Specifically, how and by whom decisions are made, and the social effects of economic activities are important to evaluate and take into account.

SELF-MANAGEMENT

I define self-management as decision making input in proportion to the degree one is affected, and believe more self-management is desirable, all other things being equal, or as economists like to say, ceteris paribus.

The first thing to notice is that defined in this way selfmanagement is seldom equivalent either to individual freedom or majority rule. Only if a single individual were the only person affected by a decision would self-management be the same as individual freedom, i.e. the right of a single individual to decide whatever she pleases. And only if all were equally affected by a decision would self-management be the same as majority rule, i.e. one person one vote. Since most economic decisions affect more than one person, but affect people to different degrees, selfmanagement as I have defined it usually requires that some people have more decision making power while others have less regarding any particular economic decision.

But why is more self-management a good thing? Throughout history most humans have lived in circumstances with few opportunities for economic self-management. So admittedly, most people

What Should We Demand from Our Economy? 41

don’t die without it. Political economists contend that just as denial of material means of subsistence conflicts with human “natural” needs for food, shelter, and clothing, denial of self-management opportunities is in conflict with our “species nature.” The capacity to analyze and evaluate the consequences of our actions, and choose among alternatives based on our assessments, in conjunction with the need to employ this capacity, is what we called “consciousness.” Development of the capacity and desire for self-management is nothing more than development of the capacity to garner satisfaction from this innate human potential. For that reason, economic institutions that satisfy this need and develop this capacity are preferable to economic institutions that stifle self-management. In brief, we human beings have the ability to analyze and evaluate the consequences of our economic actions and choose accordingly, and we garner considerable satisfaction from doing so!

SOLIDARITY

By solidarity I simply mean concern for the well being of others, and granting others the same consideration in their endeavors as we ask for ourselves. Empathy and respect for others has been formulated as a “golden rule” and “categorical imperative,” and outside the economics profession solidarity is widely held to be a powerful creator of well being. Solidarity among family members, between members of the same tribe, or within an ethnic group, frequently generate well being far in excess of what would be possible based on material resources alone. But in mainstream economics concern for others is defined as an “interpersonal externality” – a nasty sounding habit – and justification is demanded for why it is necessarily a good thing.

Besides consciousness, sociability is an important part of human nature. Our desires develop in interaction with others. One of the strongest human drives is the never ending search for respect and esteem from others. All this is a consequence of our innate sociability. Because our lives are to a great extent joint endeavors, it makes sense that we would seek the approval of others for our part in group efforts. Since many of our needs are best filled by what others do for/with us, it makes sense to want to be well regarded by others.

Now compare two different ways in which an individual can gain the esteem and respect of others. One way grants an individual status by elevating her above others, by positioning the person in a status hierarchy that is nothing more than a pyramidal system of relative

42 The ABCs of Political Economy

rankings according to established criteria – whatever they may be. For one individual to gain esteem in this way it is necessary that at least one other – and usually many others – lose esteem. We have at best a zero-sum game, and most often a negative-sum game since losers in pyramidal hierarchies far outnumber winners. The second way grants individuals respect and guarantees that others are concerned for their well being out of group solidarity. Solidarity establishes a predisposition to consider others’ needs as if they were one’s own, and to recognize the value of others’ diverse contributions to the group’s social endeavors. Solidarity is a positive-sum game. Any group characteristic that enhances the overall well being that members can obtain from a given set of scarce material resources is obviously advantageous. Solidarity is one such group characteristic. So political economists consider economic institutions that enhance feelings of solidarity preferable to economic institutions that undermine solidarity among participants.

VARIETY

I define economic variety as achieving a diversity of economic lifestyles and outcomes, and believe it is desirable ceteris paribus. The argument for variety as an economic goal is based on the breadth of human potentials, the multiplicity of human natural and species needs and powers, and the fact that people are neither omniscient nor immortal.

First of all, people are very different. The fact that we are all human means we have genetic traits in common, but this does not mean there are not differences between people’s genetic endowments. So the best life for one is not necessarily the best life for another. Second, we are each individually too complex to achieve our greatest fulfillment through relatively few activities. Even if every individual were a genetic carbon copy of every other, the complexity of this single human entity, their multiplicity of potential needs and capacities, would require a great variety of different human activities to achieve maximum fulfillment. To generate this variety of activities would in turn require a rich variety of social roles even in a society of genetic clones. And with a variety of social roles we would discover that even genetic clones would develop quite different derived human characteristics and needs.

While the above two arguments for the desirability of a variety of outcomes are “positive,” there are “negative” reasons that make variety preferable to conformity as well. Since we are not omniscient

What Should We Demand from Our Economy? 43

nobody can know for sure which development path will be most suitable for her, nor can any group be certain what path is best. John Stuart Mill astutely pointed out long ago in On Liberty that this implies the majority should be thankful, rather than resentful, to have minorities testing out different lifestyles – because every once in a while every majority is wrong. Therefore, it is in the majority’s interest to have minorities testing their dissident notions of “the good life” in case one of them turns out to be a better idea. Finally, since we are not immortal, each of us can only live one life trajectory. Only if others are living differently can each of us vicariously enjoy more than one kind of life.

SUSTAINABILITY

It took a massive movement to raise the issue of whether or not modern economies were “environmentally sustainable,” or instead, on course to destroy the natural environment upon which they depend. But it sometimes seems there are as many different definitions of “sustainability” and “sustainable development” as people who use the words. There are even some in the environmental movement who, with good reason, have suggested that “sustainable development” has become the enemy, rather than the friend, of the environment. It is also not clear that if we leave aside the political question of how to popularize important ideas, there is anything in the notion of “sustainability” that is not already implicit in the values of efficiency, equity, and variety. If an economy uses up natural resources too quickly, leaving too little or none for later, it has violated the efficiency criterion. If an economy sacrifices the basic needs of future generations to fulfill desires for luxuries of some in the present generation, it has failed to achieve intergenerational equity. If we chop down tropical forests with all their biodiversity and replace them with single species tree plantations, we have destroyed, rather than promoted variety.

Be this as it may, perhaps it is wise to adopt a principle the environmental movement has made popular: the precautionary principle. According to the precautionary principle when there is fundamental uncertainty with very large downside potential, it is best to take proactive action. In this case, it is by no means clear that the concepts of efficiency, equity and variety include everything we need to consider regarding relations between the human economy and the natural environment. Since it is riskier to leave out the criterion

44 The ABCs of Political Economy

of environmental sustainability than include it, let us include the goal of sustainability, while recognizing that it can be defined in different ways. (1) Weak sustainability requires only leaving future generations a stock of natural and produced capital that is as valuable, in sum total, as that we enjoy today. (2) Strong sustainability requires leaving future generations a stock of natural capital that is as valuable as that we enjoy. (3) Environmental sustainability requires leaving stocks of each different kind of natural capital that are as large as those we enjoy. Obviously these are different notions of sustainability. The first allows for complete substitution between produced and natural capital. The second allows for substitution between different kinds of natural capital, but not between natural and produced capital. The third does not even permit substitution between different kinds of natural capital.

CONCLUSION

So the criteria political economists should consider when evaluating the performance of an economy, or evaluating the consequences of different economic policies, or comparing the desirability of different kinds of economies are: (1) equity, defined as reward according to sacrifice; (2) efficiency, defined narrowly as Pareto optimality, and more broadly as the efficiency criterion, but with the preference development effect accounted for rather than ignored; (3) selfmanagement, defined as decision making power in proportion to the degree one is affected; (4) solidarity, defined as concern for the well being of others; (5) variety, defined as achieving a variety of economic life styles and outcomes; and (6) sustainability which can be defined in a number of ways.