While cleaning up my hard drive I stumbled upon on old PDF of a paper, ‘The Foundations of Welfare Economics’, written by John Hicks in 1939.
‘Welfare economics’, the way Hicks uses the term, is economics directed towards questions of public policy, not just satisfying individual desires or maximising the profits of a particular firm. He contrasts it with ‘positive’ economists who want to see economics as an objective and rigorous science and who say welfare economics is about questions of subjective values, rather than facts.
The argument consists of two parts. The starting point is an idea known as ‘Pareto efficiency’, named for the Italian social scientist Vilfredo Pareto.
So to define it:
An economic arrangement is ‘Pareto efficient’ if no one can be made better off without making someone else worse off. It helps to think of a ‘Pareto inefficient’ state of affairs, which by extension means a scenario where someone can be made better off without making anyone else worse off.
The key reason this idea is said to be value-neutral is that whatever your system of values might be it seems undeniably preferable that someone should be made better off if doing so involves no cost at all.
It is very important to note at this point that ‘Pareto efficiency’ says absolutely nothing about whether the scenario is desirable in any other sense. It simply says that if we are at a Pareto inefficient state, we may as well move towards a Pareto efficient one.
However in real life any policy change is going to make some people economically worse off and so this idea of Paretian efficiency on its own cannot help us.
Hicks’ solution, and the real core of the paper, is to think about whether or not someone could be hypothetically compensated for the damages they receive under some policy change.
The compensation doesn’t actually have to be paid, mind you. That remains a question of the just distribution of resources and is not in the domain, strictly speaking, of economic science. But if it could be paid and the system still produce a Paretian improvement, well, that is good information for evaluating whether or not to implement the policy.
With this move – of thinking in term of compensation – Hicks’ hope is to separate the objective question of economic efficiency from the subjective question of the distribution of society’s resources. And by so doing allow economic science to say something useful in the evaluation of economic policy.
Reading this paper has rekindled my interest in welfare economics, and given me several things to read next. In particular, this paper of Hicks’ is cited along with another paper released the same year by Kaldor which I need to read. And this is also part of a tradition that lead to the Coase Theorem that comes from Coase’s 1960 paper ‘The Problem of Social Cost’.