Reasonable Homunculi Can Disagree: The Impossibility of Welfare Economics

I’ve just uploaded a new working paper, which is a slightly edited version of a chapter from my thesis, to SSRN. Here’s the abstract:

This paper draws on the “preference reversal” literature in psychology and behavioural economics to argue for the impossibility of welfare economics. The effect of normatively-irrelevant contextual factors shows that humans do not have a coherent preference function which pre-exists and informs choice. Every choice is a constructive act which forces us to choose among incommensurable values: choice creates preference. This rules out the possibility of a value-free welfare economics and forces social scientists wishing to make normative conclusions to engage in indeterminate moral reasoning.

Quote of the Day: Mises Edition

Another from the “I want to make a note of this for future reference and a blog post seems like the easiest way to do it” files. From Theory and History, chapter 7:

In the world of reality, life, and human action there is no such thing as interests independent of ideas, preceding them temporally and logically. What a man considers his interest is the result of his ideas.

If there is any sense in the proposition that the interests of the proletarians would be best served by socialism, it is this: the ends which the individual proletarians are aiming at will be best achieved by socialism. Such a proposition requires proof. It is vain to substitute for such a proof the recourse to an arbitrarily contrived system of philosophy of history.

All this could never occur to Marx because he was engrossed by the idea that human interests are uniquely and entirely determined by the biological nature of the human body. Man, as he saw it, is exclusively interested in the procurement of the largest quantity of tangible goods. There is no qualitative, only a quantitative, problem in the supply of goods and services. Wants do not depend on ideas but solely on physiological conditions. Blinded by this preconception, Marx ignored the fact that one of the problems of production is to decide what kind of goods are to be produced.

With animals and with primitive men on the verge of starvation it is certainly true that nothing counts but the quantity of edible things they can secure. There is no need to point out that conditions are entirely different for men, even for those in the earliest stages of civilization. Civilized man is faced with the problem of choosing among the satisfactions of various needs and among various modes of satisfying the same need. His interests are diversified and are determined by the ideas that influence his choosing. One does not serve the interests of a man who wants a new coat by giving him a pair of shoes or those of a man who wants to hear a Beethoven symphony by giving him admission to a boxing match. It is ideas that are responsible for the fact that the interests of people are disparate.

Incidentally it may be mentioned that this misconstruing of human wants and interests prevented Marx and other socialists from comprehending the distinction between freedom and slavery, between the condition of a man who himself decides how to spend his income and that of a man whom a paternal authority supplies with those things which, as the authority thinks, he needs. In the market economy the consumers choose and thereby determine the quantity and the quality of the goods produced. Under socialism the authority takes care of these matters. In the eyes of Marx and the Marxians there is no substantial difference between these two methods of want satisfaction; it is of no consequence who chooses, the “paltry” individual for himself or the authority for all its subjects. They fail to realize that the authority does not give its wards what they want to get but what, according to the opinion, of the authority; they ought to get. If a man who wants to get the Bible gets the Koran instead, he is no longer free.

That’s about the best summation of the subjectivist position I’ve come across.

Where my Georgists at?

Many libertarians accept that government, and therefore taxation, is necessary. If taxation is unavoidable, the economically literate libertarian should prefer a tax system with minimal distortionary effect and injustice. I think the Georgist idea of a single tax on the unimproved value of land is clearly the best tax on both counts, but is seldom discussed by economists or policy wonks.

Taxation distorts economic activity by discouraging the taxed activity. If we tax income, people will work less. That’s bad. Given that (almost) all the land there’s ever going to be is already in existence and can’t be destroyed, a tax on the unimproved value of land wouldn’t have these distortionary effects. Of course, there’s really no such thing as the unimproved value of land: the value of a particular piece of land depends on improvements made in neighbouring areas. Still, such a tax would surely be less distortionary than other forms of taxation.

Many libertarians will object that efficient theft is still theft, and therefore wrong. I’ve never completely bought in to the taxation is theft line, since I think property rights are themselves morally problematic. I really like property rights, and I think it’s pretty indisputable that we’d all be poor and miserable in a world without them.

I don’t like the quasi-mystical overtones of the “mixing one’s labour” metaphor, but I think some version of homesteading principle is the only way to think about just and reasonable acquisition. The Lockean proviso that we leave enough and as good for others, though, is never completely met in reality. Even if there’s an abundance of unclaimed land, location remains important. If I claim exclusive right to a piece of land, I am reducing the options available to everyone else.

I don’t like Nozick’s move of interpreting the Lockean proviso as being met if everybody is better off in a system of private property rights than the alternative. This neglects the intermediate possibility of attenuated property rights. It seems fairly plausible that everyone would prefer a system in which people could claim private ownership of land, but only on the condition that they compensate others – in Georgist terms, paying rent to the community. There are some problems in terms of justice, but, to me, there much less serious than the problems of current tax systems.

Milton Friedman once called it “the least-bad tax” (but to my knowledge never discussed the possibility in any depth). I’d go further and say it could be a positively good tax. If we could design a government and ensured it remained within predefined bounds, a nightwatchman state funded by a single land tax could be preferable (in expected value terms) to anarchism. (Constraining government in this way is impossible, though, which is why I’m an anarchist. Still, the “imagine a perfect government; wish really hard” approach is the dominant one in political discourse.)

Why, then, is the idea largely confined the certain portions of the left-libertarian fringe? With few exceptions, free market economists have neglected the possibility of replacing income or consumption taxes with land taxes. Fred Foldvary has done some great work, but that’s about it.

I don’t get it. Any ideas?

Holcombe on the Foundations of Welfare Economics

I haven’t yet read it, but this paper by Randall Holcombe in the latest Review of Austrian Economics, “A reformulation of the foundations of welfare economics“ looks like a very important contribution. The abstract:

Neoclassical welfare economics takes an outcome-oriented approach that uses Pareto optimality as its benchmark for welfare maximization. When one looks at the remarkable improvements in economic welfare that have characterized market economies, most of those improvements in welfare have been due to economic progress that has introduced new and improved goods and services into the economy, and innovations in production methods that have brought costs down, leading to higher real incomes. Pareto optimality is only peripherally related to actual economic welfare, and no economist would argue that people are materially better off today than a century ago because the economy is closer to Pareto optimality. After analyzing the actual factors that lead to improvements in welfare, this paper suggests a reformulation of the foundations of welfare economics to replace the almost irrelevant outcome-oriented concept of Pareto optimality as the benchmark for evaluating welfare with a process-oriented benchmark based on factors that generate economic progress. The paper then explores some implications of this reformulation.

Smoking Bans and Norms

Henry Farrell has an excellent post at Crooked Timber on smoking bans and public norms:

I haven’t seen any research on this (if someone knows of any, let me know in comments), but my best guess in the absence of good evidence would be that the success of the ban reflected instabilities in previously existing informal norms about where people could or could not smoke. Laws that work against prevailing social norms face an uphill battle in implementation – unless people come to a general belief that non-compliers are highly likely to be sanctioned by the public authorities, they are likely to carry on doing what they always do. Hence, for example, the continued failure of the RIAA etc to stop file-sharing – file-sharers who both (a) think that there is nothing wrong with swapping music and movies, and (b) that the chance that they are going to be punished is low, are going to go on sharing files (current US law tries to counterbalance this problem by applying relatively draconian penalties to the few file sharers who are caught, but this strategy carries its own problems). Laws that broadly fit with prevailing informal norms, will, obviously, have few implementation problems.

But what we may have seen (if my guess is right) with smoking bans is an unusual case in which prevailing norms (that Irish people can smoke in pubs to their hearts’ content, and that others will just have to put up with it) were much more fragile than they appeared to be, and that the change in law made it easier for those disadvantaged by the prevailing norms to challenge smokers and to shame them into stopping smoking in certain places, hence creating a new set of robust norms.

I think that’s about right. Jonathan Adler, Stephen Bainbridge, and Patri Friedman also have interesting posts on norms and smoking bans.

For the record: I smoke, but hate the smell of stale smoke and generally have a preference for it being done outdoors (below-freezing Christchurch nights excepted). New Zealand banned smoking in all indoor workplaces a few years ago. I think this was very bad policy – I oppose coercive solutions to minor or nonexistent problems – but don’t feel particularly put out myself.

It seems pretty obvious that the optimal market outcome would involve some smoking and some non-smoking bars. This is what the market was moving towards, with a small but growing number of smokefree bars here in New Zealand before the ban. Due to the stickiness of social norms, though, this movement might have been slower than we might prefer. I have no idea what the optimal mix would be, but I’m fairly comfortable saying there were too few non-smoking bars in New Zealand before the ban.

I’ll put on my vulgar utilitarian hat for a second and offer some thoughts. My feeling is that the situation in which all bars ban smoking would be preferable to the situation in which all bars allow it. I can even buy the idea that the new blanket ban increases welfare relative to the old situation with few non-smoking bars. To simplify things horrendously, I suspect there’s a relationship between utility and the proportion of non-smoking bars which looks something like this:

Before the ban, we were somewhere near the far left of the curve. With the ban, we were pushed to the extreme right. This is welfare improving in the short run, but if we think we were slowly moving towards the centre anyway – which seems undeniable – the ban precludes the optimal long-run equilibrium. Whether the ban is welfare-improving depends on the relative magnitudes of the short-term and long-term welfare effects, as well as the appropriate discount rate. As a vulgar utilitarian, I have no way of knowing which dominates without some sort of revealed preference mechanism. The aggregate welfare implications of the ban are not obvious. What is obvious, though, is that a removal of the ban would improve things, as Jonathan Adler argues:

What would happen were such bans to be repealed? My best guess is that relatively little would change. When I think about my favorite local restaurants, I cannot see any of them allowing patrons to smoke even if the law were changed. There are one or two local bars, however, that I suspect might allow smoking on the premises, but they would be the exception. So whereas before the smoking ban here in Ohio, most restaurants and bars allowed smoking in a separate room or at the bar, were the ban repealed today I would be willing to bet that most restaurants and bars would remain entirely smoke-free.

What does this all mean? On the one hand, if most restaurants and bars would remain smoke-free, it seems to me the argument for allowing some establishments to adopt different rules is that much stronger. Remove the bans and us libertarian-types can still toast to the free market system in a smoke-free pub. But it is important to acknowledge that this state of affairs exists today because of the initial government intervention. The smoking ban appears to have helped solve a collective action problem that had kept a suboptimal norm in place. So even if a ban limited the ability of business owners to set the rules for their own businesses, it may have also helped them shift toward preferable business practices. Non-governmental efforts may have produced the same result eventually, but it would almost certainly have taken longer. So smoking bans have been beneficial, but it may also be the case that the maintenance of such bans is unnecessary to retain most of their benefits.

The initial ban shifted us to the extreme right of the graph, which was preferable to the old situation. A removal of the ban would allow us to move towards the centre as some bars would allow smoking, presumably right up until the optimal point. This would be the best of all possible worlds. Unfortunately, I can’t see the New Zealand smoking ban being repealed anytime soon. The normally-dominant angry libertarian in me still thinks the anti-smoking movement is all bigotry, by the way. At worst, I think smoking in bars bothering others is a small problem. Social norms are only going to stop people voting with their feet for smoke-free bars when they are pretty close to indifference.

Quote of the Day: Bigotry and Utilitarianism Edition

There are many who consider as an injury to themselves any conduct which they have a distaste for, and resent it as an outrage to their feelings; as a religious bigot when charged with disregarding the religious feelings of others, has been known to retort that they disregard his feelings, by persisting in their abominable worship or creed. But there is no parity between the feeling of a person for his own opinion, and the feeling of another who is offended at his holding it; no more than between the desire of a thief to take a purse, and the desire of the right owner to keep it. And a person’s taste is as much his own peculiar concern as his opinion or his purse.

John Stuart Mill, On Liberty, Ch. 4, paragraph 12.

Liberals and libertarians need to think very carefully about the kinds of preferences/harms should be considered valid policy concerns. The are obvious cases: I wrong you when kick you in the shin, but not when I wear clothes you find distasteful. It seems that this is so even when you have a very high tolerance for shin pain and a low tolerance for fashion crimes, and the harm/disutility is equal in each case. Most people find it reasonable that people have a presumptive right not to be physically attacked, but no such right not to be visually offended by poor taste. There is a large grey area in between these two cases.  Utilitarianism as a moral theory is incapable of considering this question, or even admitting that it is a problem. This, more than anything else, is why I am not a utilitarian. The Mill of On Liberty was not a utilitarian in this respect either. On some readings, not even the Mill of Utilitarianism was really a utilitarian.

Update: Eric disagrees. Update 2: Not really. See the comments on Eric’s post.

Pluralism, Subjectivism, and Welfare Economics

Some recent posts by Rauparaha at The Visible Hand in Economics have got me thinking about the problems of subjectivism and value pluralism in welfare economics. Rauparaha is using widely-accepted methodology and taking the conventional view on this, so my criticisms are not directed at him particularly, but at the general approach taken by most welfare economists.  He says, for example:

It’s great to see the government taking economic incentives seriously. Their latest initiative considers imposing a 5c/bag tariff on plastic bags in supermarkets. The idea is that the market price for the bags doesn’t take into account the full environmental cost of non-biodegradable bags. By taxing the bags the government can adjust the market price of the bags to match their social cost.

It seems to me that the idea that government can use Pigouvian taxes and subsidies to internalise externalities stems from a combination of technocratic hubris and a fundamental misunderstanding of the concept of welfare.

First off, and least interestingly, I don’t think the messy workings of government are particularly likely to produce those policies welfare economists would find optimal. Public Choice Theory tells us to treat markets and governments on equal terms: neither businessmen nor politicians are angels and both markets and governments fail. The benevolent despot model of government implicit in much of economics is unjustified, since government is neither entirely benevolent nor under the control of a single decision-maker: it is neither benevolent nor a despot. This, by itself, doesn’t make conventional welfare economics utterly worthless, since there may be some value in specifying what it would be good to do, even if we recognise that it’s not likely to happen that way in practice.

A more fundamental problem with the idea that government can provide incentives through taxes and subsidies to induce efficient levels of consumption of some good is in the very idea that there exists a definite amount of utility, either within or across individuals, which the government can attempt to maximise.  

We value many things and these are not easily commensurable. Everyone has surely experienced the difficulty of trading off different preferences against each other: higher pay or more job satisfaction, night of pure hedonism or productive morning, new TV or new computer. Of course, we do manage to trade these things off and on average our decisions can reasonably be said to make us better off. It is only through facing the trade-offs and thus being forced to weigh them, however, that we discover what we really value. As Mises puts it:

Economic action is always in accord only with the importance that acting man attaches to the limited quantities among which he must directly choose. It does not refer to the importance that the total supply at his disposal has for him nor to the altogether impractical judgment of the social philosopher concerning the importance for humanity of the total supply that men can obtain.

I see no reason to suppose that there is something analogous to a substance that we are maximising here. When I make myself richer but have less fun in the process, I am improving my life in one sense and worsening it in another. I have demonstrated through action my preference, but why should there be any basis for supposing that I have increased the quantity of some common thing within myself called ‘utility’ to which both short-term fun and wealth can be reduced? I like Sen’s idea of utility as a vector, but I don’t think it goes far enough. It is only through trade or other decision-making that we come can come to say that good X is more valuable than good Y to agent A at time t. We cannot come to know this by simply asking them, since this does not approximate a real decision and will not put them in a genuine trading-off frame of mind. I suspect that expressive preferences are likely to dominate in such situations.

I’m tempted to say that there is no fact of the matter whether A prefers X over Y until he actually faces the choice. I have no idea whether I’d prefer world peace to a twenty percent increase in global economic growth, because this is not a decision I have ever had to make. I can make a number of arguments either way, but these are biased by how I would like to see myself. If I ever were in the position to push the button, I’m sure my decision-making would become less biased and more consequentialist. If I cannot predict in advance what I would prefer given the choice, can I really be said to have a true preference? Rather than maximising utility from some pre-defined function, human action itself in some sense defines our preferences: exchange is performative.  

All of this becomes far more problematic once we begin to consider interpersonal utility comparisons. We clearly can’t aggregate something we can’t quantify, and there is no neutral way to make tradeoffs between the preferences of different individuals. How do we trade off satisfying the preferences of many people versus leaving a few utterly miserable? How do we weigh the value of poetry and pushpin? Without individual decision-making in the real world, it’s hard to see how this is even possible in principle.

Bringing this back to taxing plastic bags: it seems likely that discarded plastic bags cause people some displeasure, and they may hypothetically be willing to give up some other resources to avoid this displeasure. What they are willing to give up, however, is fundamentally unknowable unless we create some sort of market for bag-reduction or observe the compensating differentials in bag versus non-bag areas: i.e. for practical purposes, we can’t. It is not just that we don’t know the precise value of the disutility caused by discarded plastic bags, if this were the case it might be reasonable to set a conservative Pigouvian tax and feel confident that we are improving things somewhat while not making things perfect. The real issue is that we have absolutely no idea of how people are affected, or even if they would be willing to give up anything at all to see less plastic bags, and have no reliable and realistic way of finding out.