How to avoid comparing rich and poor

Reading Mark Blaug on Pareto efficiency was a lightbulb moment. As he says, Pareto's idea was a 'watershed moment' in arguments about utility. From a distance, the outcome can seem pretty meaningless but it's an important political fork in the road - and one that shines a light on how the abstractions of economic theory get tangled with power politics. There's a story about Pareto himself to be told, too - I'm not going into that. This is about where his idea went after that.

Benthamite utilitarianism hadn't been going badly. But it was premised on the idea that different people's well-being could be compared - after all, there's no other way of knowing if you're increasing or decreasing the general welfare.

This seemed intuitively straightforward at the time. But, perhaps as the study of utility as an economic concept developed, that began to change. Attempts to actually track down a scientific measurement of people's utility got underway. Folks got upset about the obvious problems in trying to define what utility really was.

Pareto offered a way out of this. I'd known the concept before but not understood its significance until reading Blaug. Pareto efficiency: you've reached an optimal state when it's not possible to make anyone better off without making someone else worse off. Sounds innocuous enough. But notice that it sidesteps comparability. As Blaug says:

"The beauty of Pareto’s definition of a welfare maximum was precisely that it defined the optimum as one which meets with unanimous approval because it does not involve conflicting welfare changes."

It rules out the possibility that one could -

" - evaluate changes in welfare that do make some people better off but also make other people worse off" (Blaug / economic theory in retrospect/ 1997 p.573-4).

So it can say absolutely nothing about inequality. Or rather, it implicitly says that it doesn't matter: you cannot, for example, assess whether taking money from one person and giving it to someone else will improve welfare overall. Bentham schmentham.

Pareto optimality, unsurprisingly, became very popular and is essential to most general equilibrium models. I don't understand those - I'm only familiar with Krugman's spatial GE stuff, which is not the same (they're driven by explicit utility differences across space). But I'm not surprised models that, by default, exclude inter-personal comparisons should form the inner sanctum of modern economics. A model that can, by design, exclude any discussion of redistribution was always going to thrive.

Which is not to say there aren't plenty of approaches that do analyse the differences between rich and poor. But... and I'm not on solid ground with this point at all... the kind of economics that sits in rooms with ruling elites don't generally use those.

I want to make two little points about this. The first comes from having actually used utility as a concept in my modelling work and found it extremely valuable. I spent far too long listening to the siren-calls of agent modellers telling me to go towards 'realism', then in the process of slowly solving my problems, realising I had ended up back at basic micro-economics.

So first: if you're going to use utility at all, you'd better accept it's a silly idea that lets you do useful things. People are not actually utility maximisers, but the concept is a superbly effective way of thinking about how people react to cost changes in certain situations. (This is all very Friedman [pdf].)

So all that pursuit of the actual foundations of utility in our meat-brains is, somewhat, beside the point. Given that, we should use the idea in ways that are useful. Ruling out utility comparisons is just a little bit too convenient a result, politically. There isn't really any reason to, and the angst about utility's epistemological status makes about as much sense as rejecting traffic models because they don't use gravity equations. (Er, at least I think they don't...)

Second, one of the most powerful ideas that utility gives us is diminishing returns. It's easy to forget how much of a puzzle this was - the whole water/diamond problem thing. It should be blatantly obvious to anyone who thinks for a few seconds that money itself has diminishing returns. Say a 7% drop in income forces your family to eat less well and you to have to skip meals sometimes. It shouldn't be beyond our economic theory to see this as more severe than having to compromise on the Land Rover you had your eye on by buying a Mondeo.

This is kind of paragraph that sets the flying monkeys off, though. Particularly since the 2008 crash, particularly in the UK - the story that's been slowly pushed through all media channels is solidifying into political reality: such talk is the politics of envy, rather than - as it actually is - a perfectly sensible way to think about wealth.

These days I generally end up thinking "it's all about the middle way". The same applies here - effective economic comparability could imply deep intrusion in people's lives, the state charged with measuring and judging what forms of spending were more worthy than others, creating a kind of state-sanctioned Maslow hierarchy. But it doesn't need to - if one is capable of accepting the basic premise that severe poverty makes people's valuation of money much higher than for richer folk, it just implies the need for policies that reduce inequality.

And there isn't necessarily anything wrong with Pareto efficiency. The problem here is what happens when powerful abstract ideas interact with powerful political forces. Things get warped to Wizard of Oz proportions. Other perfectly sensible ideas can't get their shoe in the door. But it's foolish to use Pareto efficiency to exclude distribution thinking, just as it would be idiotic to ban its use because it was too right-wing.

I wouldn't want to live in a world where political schools had their own paid-for economic theorists. I do still believe in the pursuit of actual social-scientific truths. But Pareto efficiency is one of those ideas that hammers home just how hard it is to pull economics and politics apart.

The point: as far as possible, your economic/mathematical models shouldn't rule out one particular political way of thinking. The choice of how we balance wealth in society - that's a political issue. There's no easy way to keep an unbreachable line between positive and normative - modelling methods will always interact with our political assumptions and power structures in sometimes very-hard-to-see ways. And I also believe in the power of quant modelling to help us understand which things may not work if pursuing certain political aims. But modelling distribution issues - and using utility to do this - no more makes you a communist than using Pareto efficiency makes you a fascist.

(p.s. googling Pareto inequality reminds me there's a mountain of stuff on this subject I don't know. But if I think like that all the time, I won't get a single blog entry written, let alone seventeen...!)

New year's earnestness 1/17



Things having diminishing returns can be explained perfectly well by the more natural view that a decent human life (or society) is made up of different components that are not tradable with each other. In other words, a holistic view.

There is nothing odd about the idea - for example, we need all of the vitamins, you can't drop vitamin A and make up for it with more vitamin D.

I can't see what possible advantage that utility theory could have over this when modelling or in any other instance, except to create a spurious circular ethical “justification” for the free market.

Hey Josie. Can you explain a

Hey Josie. Can you explain a bit more? I'm not quite getting your point. From my economicsy point of view, the thing you're describing looks like substitutability, not diminishing returns, though that might be cos I'm missing what you're saying.

Oop, apols, ended up writing quite a lot...

E.g. with the vitamins - yes, we need all of them and they're not substitutable. But each vitamin has, from the body's point of view, diminishing returns, doesn't it? I can take a certain amount of vitamins a day but the rest just get flushed out (or poison me). But the first portions are hugely valuable/essential to me.

A highly reductionist method for describing substitutability is central to the Krugman-style economics I used in the PhD, you'll be pleased to hear! The difference between substitutable and non-substitutable goods is reduced to a single parameter. It can be set so that e.g. if a model person has all of A but no B, or vice versa, their utility is zero. Or it can be set so that it's maximised when they have a perfect mix of both. Or anything in between. Or for any number of goods. Here's a Two good example: top graph, any mix of two goods for a given spend gives the same utility; bottom of the three, only the perfect mix of the two is maximal.

Can you say more about your last line as well? Seems like it's a more general point about the spurious ethics of utility and its relation to free market ideology. This is stuff I'm still trying to work out, input would be most welcome. I'm aware that my own use of the theory in the modelling work has probably coloured my entire world outlook. (Example: I seem to be happier to use plastic bags now there's a charge since I know I'm internalising their cost. Luckily, most people don't think like that, so the charge *has* led to a drop in plastic bag use, but perhaps it would have gone the other way if everyone thought like economists!)

That said, I am trying to situate what I do in some political context. I don't know if it's possible to extract economics from its relation to free market hegemony. Theoretically, that's not a problem. In practice? I always thought it was very telling in Krugman's reflections (PDF) on his most famous geography model. His whole aim was to get 'proper' economists to take geography seriously. There was no shortage of existing theory but Krugman knew he had to make a fully functioning general equilibrium model to be taken seriously:

In a crude sense, mainstream economics isn’t going away: like it or not, the White House has a Council of Economic Advisers, not a Council of Geographical Advisers, the World Bank hires lots of economists and not many geographers, and so on. So if insights from geography are going to have the influence they should, there has to be some kind of rapprochement.

So that certainly happens for people actually close to the economics/power nexus (and it would appear there certainly is one, as that quote makes clear!) For everyone else using bits of this body of work, as I am... well, it makes me think of the whole GM thing as well. My view is that the technology and the companies using it should be considered separately. GM could be useful and should be publically funded - without that public support, it remains in the control of companies like Monsanto. But one could take the opposite view: the two are inseparably tangled, massive corporate power and a particular form of tech and you can't support one while rejecting the other.

The same might be said of economic theory and free market ideology. Maybe they're not separable. I think that's wrong - some of the ideas are too useful to throw out. E.g. I've been using the CES function to try and work out what happens if fuel costs go up, to help figure a way through to post-carbon-land. And like I say in the Pareto stuff above, I think doing so is just as ideological as its opposite. But I'd like to hear more arguments on it.

On the post-carbon thing, I do wonder, for instance, if the Transition movement's focus on action and dense community economies (whether I agree with its economic analysis) is just so much better than sitting in a room with a CES function. Dunno. I'd like to think both had their place.

It's not clear that Pareto

It's not clear that Pareto Optimality is very useful. Perhaps a case of not getting carried away by the name. As wiki puts it, "Pareto efficiency is a minimal notion of efficiency and does not necessarily result in a socially desirable distribution of resources: it makes no statement about equality, or the overall well-being of a society". Their example of a monopolist is useful: "It is important to note, however, that a change from an inefficient allocation to an efficient one is not necessarily a Pareto improvement. Thus, in practice, ensuring that nobody is disadvantaged by a change aimed at achieving Pareto efficiency may require compensation of one or more parties. For instance, if a change in economic policy eliminates a monopoly and that market subsequently becomes competitive and efficient, the monopolist will be made worse off. However, the loss to the monopolist will be more than offset by the gain in efficiency, in the sense that the monopolist could hypothetically be compensated for its loss while still leaving a net gain for others in the economy, a Pareto improvement."

Cheers William. Not sure

Cheers William. Not sure about this line though: "It is important to note, however, that a change from an inefficient allocation to an efficient one is not necessarily a Pareto improvement." Doesn't that depend on how you're defining efficiency?

The wikipedia link's first reference is very interesting - I'd not seen it: the relevance of efficiency to different theories of society in 'Economics of the Welfare State' by Nicolas Barr. It's actually got a breakdown of meanings of efficiency for libertarian/socialist/utilitarian/Rawlsian. Which is actually a rather more effective way of showing that hegemonic economic ideas have political content...

> Doesn't that depend on how

> Doesn't that depend on how you're defining efficiency?

Yes. But I think that's why you have to be careful. Common-language use of the word "optimal" is very different from the technical meaning of "Pareto optimal", but its very easy to glide from one to the other.

The example wiki gives clarifies the situation: suppose someone has a monopoly. Getting rid of that will benefit all of society - except for one man. But if you're constraining yourself to Pareto optimisation, you can't do it.