Gabriel Mihalache (who I am told I give too much credit to) on the second theorem of welfare economics and free trade - Forget the 2nd WT Defense of Trade. It starts as follows:
My belief is that while there are potential pareto improvements, in reality there is no such thing as a Pareto improvement. Ever. If you're evaluating an economic change and can't find the loser, you're not looking hard enough.
About 8 years ago I took a Public Finance course from the great Robin Boadway and one of the midterm questions had to do with Pareto improvements. The scenario had to do with snow removal on sidewalks of a downtown shopping area. Would it be Pareto improving for the city to have a by-law forcing store owners to remove the snow on the sidewalk in front of their stores? Given the parameters in the question, the "correct" answer was yes - it would be.
My answer, which was too clever by half, was "no, it wouldn't be". If the downtown stores had better sidewalks, more people would shop there, which would mean in the short run, they'd be shopping less somewhere else, such as at the surburban mall. So there was an identifiable loser - shops in the mall.
But the points remain:
The biggest mistake of international freedom of association defenders (a.k.a. free traders) was the 2nd Welfare Theorem concession. A very stylized version of the history follows…Tim Worstall's response to the argument shows why he's one of the more brilliant economic commentators alive:
Protectionists: Oh, oh. Trade has both “winners” and “losers”.
Free Traders: True, but winners win more (in numeraire) than losers. So why don’t we consider the fact that we’re better off, in the aggregate, in the spirit — if not the letter — of the 2nd Welfare Theorem.
Protectionists: Fine.
Free Traders: Let’s Trade!
Protectionists: Not so fast! No trade for you until you set up, ex ante, those institutions that will enable those (lump-sum?) transfers.
Doh! Homer Simpson moment.
“Protectionists: Not so fast! No trade for you until you set up, ex ante, those institutions that will enable those (lump-sum?) transfers.”A question: Has there ever been a government policy that has been pareto improving? Ever? That is, has there ever been a policy that has made some better off while no one was made worse off? I cannot think of one. If that's the case, saying "policy X has some losers" probably isn't pretty insightful.
My favoured answer here is this:
So, we agree that the current restrictions upon my freedom to trade benefit you at a cost to me then?
Excellent, where is the lump sum transfer you are currently making to me to compensate me?
You’re not doing so? So why should the opposite be necessary?
My belief is that while there are potential pareto improvements, in reality there is no such thing as a Pareto improvement. Ever. If you're evaluating an economic change and can't find the loser, you're not looking hard enough.
About 8 years ago I took a Public Finance course from the great Robin Boadway and one of the midterm questions had to do with Pareto improvements. The scenario had to do with snow removal on sidewalks of a downtown shopping area. Would it be Pareto improving for the city to have a by-law forcing store owners to remove the snow on the sidewalk in front of their stores? Given the parameters in the question, the "correct" answer was yes - it would be.
My answer, which was too clever by half, was "no, it wouldn't be". If the downtown stores had better sidewalks, more people would shop there, which would mean in the short run, they'd be shopping less somewhere else, such as at the surburban mall. So there was an identifiable loser - shops in the mall.
But the points remain:
- If you can't find the loser from a policy change, you're not looking hard enough.
- Because all policy changes have losers, saying that some person (or group) loses from a policy change is, in itself, not particularly useful.
Comments
Even in a neat, Econ 101 world, there are pecuniary externalities everywhere.
So, it boils down to, legally speaking, who’s entitled to what.
P.S. Thanks for the exposure!
It shocks me that most economists can’t seem to realize this. I remember one time one of my professors called the legalization of gay marriage a Pareto optimal improvement. I just blinked and said sarcastically, “Yeah, you’d be making angry that I’d be picketing in the streets.” He didn’t seem to believe me.
Incidentally, it seems to me that the theory that monopolies will restrict output is based on a flat, static demand curve. Does this hold true empirically? The elasticity of demand doesn’t have to keep declining. So can certain monopolies have an incentive to produce and cut prices like the free market could? Or am I just completely off? The economics department at my school is not really so hot, especially when it comes to explaining things. Economics here (and probably elsewhere) is almost entirely theory without empirical evidence.
“Kto Kogo” as someone would say
Because all policy changes have losers, saying that some person (or group) loses from a policy change is, in itself, not particularly useful.
Well then it all depends on who looses, on their ability to take the hit (you know loosing half of one’s income potential can mean starvation or no yacht), and the social benefit for all at the end.
and all that matters in this case, doesn’t it ?
This all seems to come down to the more general principle of deciding policy on the basis of Kaldor-Hicks improvements, which I support as a rule of thumb, but not a hard and fast rule. It seems that there are two basic cases for overturning Kaldor-Hicks efficiency as a policy guide. The first is the social welfare argument that Nu seems to be using. That argument is predicated on the idea that unless one uses a Benthamite/Utilitarian social welfare function, improvements to social welfare will not be identical to Kaldor-Hicks improvements in all cases. I’ll buy that logic, but I think it only applies to the free trade case in the short run. Of course, the short run can last quite a while, particularly in cases when human capital needs to adjust.
The second argument is one of pragmatism. Ideal free trade may not be a political possibility in the near future. Free trade can’t be the best option if it isn’t really an option to start with. So we may end up choosing between trade barriers and free trade with transfers. I seem to me seeing more and more discussion of that tradeoff, which I see as a potentially vast improvement over the generations of trade debates that have left us with so many terrible policies.
“one of the more brilliant economic commentators alive”
Most kind, if grossly, wildly, overstated.
“Most kind, if grossly, wildly, overstated.”
Is it? Oh, maybe I was confusing you with someone else? (j/k)