Usher Political Economy (Blackwell, 2003)

randomly determined outcomes, “very successful,” “moderately successful” and “not successful” become persons 1, 2, and 3 whose incomes a person behind the veil of ignorance might eventually acquire. The choice between two gambles – on professions with uncertain incomes, and on policies behind the veil of ignorance – is the same.

On the strength of this comparison, your utility function, u(Y) derived to reflect your deportment toward risk, becomes the basis of your social welfare function. Just as you can be said to maximize expected utility in choosing among risky options, so too, behind the veil of ignorance, can you be said to maximize expected utility for the community as a whole, where incomes of different people replace incomes of the same person in different situations. You choose between the policies to maximize expected utility, or, equivalently, to maximize the sum of the utilities of every person in society. You maximize social welfare, or the common good, which on the assumptions we are making, can be represented as the sum, W, of the utilities of income of each and every person in society. With only three people, equation (3) becomes

where Y1, Y2, and Y3 are their incomes, and where the derivation of the utility of income function, u(Y), is as explained in chapter 5. If you are a risk-neutral person, the common good is promoted – that is, the value of W in equation (4) is made as large as possible – by choosing private medical care with the larger average income. If you are very risk-averse, the common good is promoted by choosing public medical care with the smaller dispersion of income. If your observed utility of income function just happens to conform to the postulated utility of income function in equation (25) of chapter 5 (u = AYα + B where α is a parameter signifying your degree of risk aversion), the common good is promoted by public provision when your value of α is close to 1 and by private medical care when your value of α is close to 0.

Regardless of the assumed form of the individual utility function, the doctrine that the common good is the sum of the utilities of every person in society is called utilitarianism. With a population of N, the doctrine is that

Philosophers have attached the veil of ignorance test to the maximization of the income of the worst-off person in the community. On this criterion, a program, policy, or institution promotes the common good if and only if the worst-off person when this program, policy or institution is adopted is better off than the worst-off person under any alternative. That is just plain wrong. One would never opt for such a rule

behind the veil of ignorance. Consider a society of four people whose incomes would be $19,900, $100,000, $100,000, and $100,000 under private medical care and $20,000, $20,000, $20,000, and $20,000 under public medical care. Ask yourself which option you would choose behind the veil of ignorance with equal chances of becoming any of the four people in whichever option you choose. You would have to be absurdly and pathologically risk averse to choose the second option (forgoing a 75 percent chance of an $80,000 gain to avoid a 25 percent chance of a $100 loss), but that is what the maximization of the income of the worst-off person would lead you to do. Behind the veil of ignorance and with these consequences of the two systems of medical care, any reasonable person would choose private provision.

Several objections can be raised to the identification of the social welfare with the welfare of the individual behind the veil of ignorance. The test is corrupted to some extent by differences in taste. Even behind the veil of ignorance, people may differ in their ranking of societies according to their weighting of average income and variance of income, but people’s tastes may differ in other respects as well. One person’s vision of a good life is a big house in the fashionable part of town and foreign vacations on his private yacht. Another’s vision of the good life is a snug cell in a monastery with plenty of time for private contemplation. Their rankings of methods of providing medical care need not be the same. The veil of ignorance test cannot be relied upon to supply a unique vantage point for the evaluation of public policy because, even with equal chances of filling the shoes of every person in society, people’s conceptions of the common good differ in accordance with their visions of the good life. On the other hand, the veil of ignorance does successfully abstract from differences in income which may, in practice, be the largest source of disagreement over public policy. To account for other differences among people’s tastes, it would have to be imagined that tastes as well as material advantages are randomly assigned.

One might also object to the alleged identity in the veil of ignorance test between one’s concern for other people and one’s willingness to bear risk oneself. Strictly speaking, a risk-neutral person would prefer private over public medical care because his sense of the common good takes account of average income exclusively, and no weight whatsoever is placed upon the dispersion of income in his community. That may not be true. A person willing to take large gambles in his own life may nonetheless favour public medical care over private medical care. He may adhere to a conception of social welfare that takes account of the variance of income as well as average income, and he may favor substantial redistribution of income to the poor. Though inconsistent with the assumptions in the veil of ignorance test, and perhaps unlikely, such behavior is by no means impossible. It is even arguable that the juxtaposition of risk aversion and altruism is just coincidental, and that risk aversion plays no necessary role to ensure a place for equality, in addition to efficiency, as part of people’s conception of the common good.

One might assert instead that the common good is independent of computations of gain and loss. I might simply “know” that public medical care is right, or wrong as the case may be, almost regardless of its consequences. I might know that through direct intuition or because it is decreed in the holy book. You cannot prove that I do not have such knowledge and you cannot budge me from views by vulgar calculation. On the other hand, if recognition of the common good falls upon our consciousness like

manna from heaven, what possible counter-argument can one put forward against the fundamentalist who sees a mandate in his holy book for inherited privilege, slavery, capital punishment, the cutting off of the hands of a thief, the stoning of women taken in adultery, or the destruction of infidels? A common understanding of the common good is always difficult to acquire. It is virtually impossible to acquire unless the common good is understood as an aggregate of utilities or unless conformity is imposed by a priestly class empowered to punish heresy. The gods may well be utilitarians, concerned about the consequences for humankind of policies, programs, and institutions. Even so, decrees transcribed yesterday may no longer be appropriate today. Disagreeing, we may have no recourse short of violence to determine whose god is the stronger or whose intuition is right.

The notion of the common good may be dismissed as superfluous or illusory because political disputes are resolved and society is preserved by people’s self-interested support for the rules of society. On this view, I do not try to persuade you that my preferred system of medical care is best for society as a whole. I try to persuade you that it is best for you. Once democratic institutions are established, we are content to resolve disputes by voting because we fear the consequences to ourselves if the outcome of the vote is overturned by violence or trickery. Enough people reasoning that way can compel others to abide by the rules too. The whole process takes place without anybody behaving in a way that, all things considered, is not best for himself. In fact, voting is examined in the next chapter on precisely this view of the world.

On the other hand, political arguments are framed with reference to what is best for society as a whole, and it is hard to believe that such talk is entirely hypocritical. There would be no such talk unless somebody, speaker or audience, believed there to be a common good and was prepared to temper self-interest accordingly. Concern for one’s children, one’s relatives, one’s friends and so on, with diminishing weight for an ever-widening circle of people, transforms one’s individual utility function into something more and more like a social welfare function. Seen in this light, people’s social welfare functions differ, but differences among social welfare functions are less pronounced than differences in ordinary utility functions.

It is doubtful whether society could get on without some residue of concern for the common good. At a minimum, a significant portion of the population must be willing to vote even though voting is never advantageous from a purely selfish point of view. The private benefit of voting is always less than the private cost. The cost of voting is the time and trouble required to inform oneself about the candidates and to cast one’s ballot. The expected benefit of voting is the gain to oneself from having one’s preferred candidate win the election weighted by the probability that one’s vote will swing the election. That probability is minute. Consider an election with two candidates and a million and one voters. The only way for any particular voter’s participation to affect the outcome of the election is for all other voters to split evenly between the two candidates, with 500,000 votes for each. It is all but impossible for an election to be that close. A decision to vote voluntarily is like a decision not to smoke voluntarily in the smoke-and-smoking example in chapter 5. There, my smoking was assumed to be beneficial to me despite the fact that everybody would be better off if nobody smoked. Each person’s gain from a smoke-free room was assumed to outweigh his loss from not smoking himself. Here, my decision not to vote is beneficial to me despite the fact that

everybody is better off when everybody (or a significant proportion of the population) chooses to vote, for the continuance of democratic government is at stake. In both cases, there are externalities associated with individually costly actions, externalities large enough that everybody is better off when everybody bears the private cost than when nobody does, though it is in no person’s interest to do so when all other people’s actions are what they are independently of one’s own. People vote because they enjoy participation in elections or because they feel a duty to do so. D. H. Robinson’s answer to the question posed in the quotation at the beginning of this chapter was that economists economize love. By love, he meant altruism, a willingness to forgo one’s own personal advantage for the common good. Love is a scarce commodity. Economists postulate a society where everybody is entirely self-interested not because “greed is good,” but in the hope of transacting as large a share as possible of the world’s business by means of greed, to avoid squandering love unnecessarily and to preserve that scarce and precious commodity for domains of life where love, and love alone, will suffice.

The real problem, in my opinion, in the evaluation of alternatives for public policy is not so much that people differ in their assessments of the common good, but that they, naturally enough, favor policies likely to benefit themselves, regardless of the effects on other people. There are many considerations in the choice between public and private provision of medical care. With private provision, the best physicians command the highest fees to allocate their services to those who value them most. With public provision, it is difficult not to pay all physicians in accordance with their formal qualifications and with the number of patient visits. Public provision may induce especially capable doctors to emigrate to countries where medical care is still private and remuneration is more in accordance with the physicians’ diligence ability. Resources may be wasted in rent seeking. If some physicians are better than others and if physicians are assigned to patients by the state, then, one way or another, people pressure the state to supply them with the best physicians and the best medical services. Workers in unions may have the edge in this process over unorganized workers. Rent seeking is costly to supplicants, to the administration which must cope with competing claims to the services at its disposal, and in the temptation to corruption when what should be allocated evenly is, in practice, sold. Politics may be destabilized to some extent as the party in office is tempted to direct the best medical care to its supporters. Health or life itself may be at stake if failure to support the party in power comes to mean that fewer hospitals and less competent doctors are provided for one’s region or social class. On the other hand, private medical care requires insurance which is by no means problemfree. Without insurance, each person’s anticipated cost of medical care is like a gamble in which some people are bankrupted and others get away free. Insurance imposes a considerable administrative cost in deciding whether any given medical procedure is warranted in the case at hand and it places people at the mercy of insurance companies with an incentive to reject clients who are especially likely to become ill and to terminate very ill people with large medical bills. Beyond these considerations are others based on wealth. The rich can be expected to favor private provision of medical care because with progressive income taxation (anything more progressive than a head tax) the cost of public provision of medical care is borne disproportionately by the rich and because private medical care enables the rich to purchase the services of the better doctors.

The poor can be expected to favor public medical care for much the same reasons and because many poor people, unable to afford the cost of medical care or medical insurance, are obliged to rely on charity or are denied medical care altogether.

To take a different example, consider the death penalty when one’s probability of being executed for murder is correlated, as seems to be the case in most societies where the death penalty is imposed, with one’s income or one’s class in society. If I am rich or a member of the upper classes, I may favor the death penalty, secure in the knowledge that I am very unlikely to be executed because the rich need not commit murder or because they can usually manipulate the legal system to impose a lesser penalty. If I am poor or a member of the lower classes, I may oppose the death penalty, being only too well aware that I stand a substantially higher than average chance of being executed because the poor commit more than their share of murders or because they cannot afford the expertise to manipulate the legal system to impose a lesser penalty. Behind the veil, these considerations balance out because I am assumed not to know who I shall become when the veil is lifted. In actual judgments, that information may be difficult to conceal.

Finally, it is worth mentioning that this discussion of the common good has not crossed the barrier between is and ought. The purpose of this chapter has not been to impose a notion of the common good upon the reader, but to analyze his sense of the common good and to show what his premises must be in favoring this or that policy, program, or institution. Much, though by no means all, of economic analysis is what might be called conditional prescription: “If this is your objective and these are your options, then this is what you ought to do.” The role of economics in this context is to facilitate reasoning by spelling out the consequences of any given set of premises.

SOCIAL WELFARE IN PRACTICE

The social welfare function ranks alternative institutions, policies, or programs such as public vs. private medical care and the infinite gradations in between. To do so, it must be translated from a summation of every person’s utility into a weighting of broadly defined objectives of public policy. We cannot rank private and public medical care by subtracting Bill’s loss of utility from Carol’s gain. The best we can do is to reformulate social welfare as dependent on the size of the national income, the degree of inequality in the distribution of income, average life expectancy, the dispersion of life expectancy between rich and poor and between other groups in society, leisure, political freedom and so on, including, but not restricted to, the entire range of considerations discussed in chapter 1.

For purposes of exposition, utility, u, has been defined as a function of money income, Y, as though nothing else mattered. There are circumstances where that formulation is useful and where a more realistic representation of the components of a person’s well-being would be counter-productive by diverting attention from the essence of the problem at hand. The simple formulation might be best for identifying the appropriate degree of progressivity in the income tax, progressivity being the gap between the rate of income tax levied on the rich and the rate of income tax levied on the poor. In other circumstances, that interpretation of u would be ridiculous. The

choice between private and public provision of medical care has more to do with life expectancy and health than with income per se.

The term Y in the utility function may be stretched to cover many aspects of life. It may incorporate non-monetary aspects of well-being such as leisure, longevity, and health. It may allow for the impact tomorrow of public policy today. Most of the analysis in this book is static, as though the world we see today were to replicate itself in every detail forever. For many purposes, this simplification is convenient. Sometimes it is too far from the truth to be useful, as when preventive medicine today improves our lives tomorrow or when roads built today remain in use for a long time to come. The term Y may be reinterpreted as wealth rather than money income. Non-monetary considerations may be combined with ordinary goods and services in an enlargement of the measure of real income discussed at the end of chapter 5, or income may be reconstructed as a vector with income (as ordinarily defined) and non-monetary considerations as components.

Social welfare function may be adequately represented in some contexts by the national income, more or less as measured in the time series in table 1.8. As will be discussed in greater detail in the next two chapters, national income may be the best available surrogate for social welfare for use by the Ministry of Transport in deciding which roads to build and which roads to desist from building. All roads are of some benefit to everybody but each road is especially beneficial to identifiable sub-groups of the population. A rule is required to defend society from costly bickering over who is to be favored and at whose expense. A prior agreement to choose among roads so as to make the national income as large as possible has the double virtue that, with the usual uncertainty about what the future may bring, nobody may know at the time the rule is adopted who the ultimate beneficiaries of the rule will be and that everybody’s expected net gain – the difference between one’s benefits from all roads together and one’s taxes to pay for them – is larger than it would be under any other rule. The common name for that rule is cost-benefit analysis.

Generalizing somewhat, public policy can be designed for efficiency, defined in economics as “the absence of waste.” Three levels of efficiency might be identified: productive, allocative and distributive. These are most easily distinguished with reference to the bread-and-cheese economy in chapters 3 and 4. An economy is productively efficient when outputs of bread and cheese lie on, rather than below, the production possibility curve. An economy is productively efficient when it cannot be reorganized to yield more of some goods without yielding less of others. As a first approximation, an economy is productively efficient when the national income is as large as possible. An economy is allocatively efficient when the utility-maximizing combination of bread and cheese is chosen from among all possible combinations on the production possibility curve or among all attainable combinations. Consider a many-person economy where everybody is identical in every respect. For such an economy, there is one, unique, combination of bread and cheese – from among the set of combinations along the production possibility curve – at which everybody is better off than he would be with any other feasible combination. Output corresponding to any other mix of bread and cheese would be allocatively inefficient. This notion of efficiency is useful in the analysis of taxation. Allocative inefficiency may arise when some goods are heavily taxed and other goods are lightly taxed or untaxed altogether. An economy is

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distributionally efficient when the available bread and cheese cannot be reapportioned to make everybody better off simultaneously. In a society of two people who like to eat cheese sandwiches, an apportionment where one person consumes all the bread and another consumes all the cheese is distributionally inefficient in this sense. Distributional efficiency is entirely distinct from equality in the distribution of income. The apportionment of bread and cheese may be efficient even though some people are very well off and others are very badly off. Distributional efficiency requires that no trade can make all parties better off simultaneously. Full efficiency is a combination of productive, allocative, and distributive efficiency. The absence of waste means more than that the consumption of some goods is less than it might be. It also means that potential utility is not forgone through production of the wrong mix of goods or through the misapportionment of goods among people such that everybody could gain from trade. Public policy is efficient when nobody could be made better off without at the same time making somebody else worse off.

Desirable as it is, efficiency cannot be the only criterion for public policy, programs, or institutions because efficiency is not unique and because a somewhat wasteful policy may be preferred to a less wasteful policy with a significantly less equal distribution of income. Recall, for example, the distribution of 100 loaves of bread and 50 pounds of cheese between Mary and Norman as described in figure 3.7. Many possible distributions are not efficient, but there is a wide range of efficient distributions along the “efficiency locus,” from the assignment of everything to Mary at one extreme to the assignment of everything to Norman at the other. Something beyond efficiency is required for choosing among points on the efficiency locus.

The significance of distribution as a component of social welfare is illustrated in a standard utilitarian argument not just for a degree of redistribution of income, but for full and complete equality. The argument presupposes a given national income, a utilitarian social welfare function (consistent with the veil of ignorance test) and concavity of the common utility of income function. A concave utility of income function bends forward so that each additional dollar of income yields progressively less utility. Concavity of the utility of income function was introduced in chapter 5 as an indicator of risk aversion, but, as shown in the discussion surrounding table 8.1, can be extended to the weighting of the incomes of different people, some prosperous, others not, in assessing the costs and benefits of public projects. Consider an economy with just two people, one rich and the other poor, whose incomes prior to redistribution are YR and YP (where of course YR > YP) and whose utilities are u(YR ) and u(YP) for some common utility function u(Y) as illustrated in figure 8.1. A transfer of income,

Y, from the rich person to the poor person reduces the income of the rich person

It follows at once from the concavity of the utility function in figure 8.1 – and is immediately evident from inspection of the figure – that uP > uR . Though total income remains unchanged, the gain of utility to the poor exceeds the loss of utility

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narrowing of the distribution of income. Or, to express the point in the language we have developed, a partial redistribution of income may increase social welfare even at the cost of reducing the sum of the incomes of all citizens and despite the fact that a massive redistribution of income could be expected to reduce social welfare.

The basic idea is that the pie shrinks as you share it. Knowing income is to be redistributed, people work less, save less and devote more of their resources to the hiding of their incomes from the tax collector, so that the national income becomes less than it might otherwise be. A useful way to think about this is to suppose that, one way or another, a transfer of income that increases the net income of the poor by T would decrease the net income of the rich by θT where θ is greater than 1 and where the value of θ typically increases with T. For example if θ were 2, the income of the rich would have to be decreased by $2,000 to bring about an increase of $1,000 in the income of the poor. Social welfare, W, is maximized when the increase, uP, in the utility of the poor from the last dollar of transfer from the rich is just equal to the decrease, uR , in the utility of the rich caused by whatever reduction in income is necessary to procure that extra dollar for the poor. Specifically, redistribution has gone far enough when an additional transfer of income yielding $1 to the poor affects the utilities of the rich and the poor so that

When uP = uR , no feasible redistribution can increase one party’s utility without decreasing the other’s utility just as much, which is another way of saying that the sum of their utilities is as large as possible. Properly interpreted, the utilitarian social welfare function typically warrants some redistribution but never, in realistic conditions, as much as 100 percent. How to determine the value of θ will be discussed in chapters 9 and 10.

An economy with huge disparities between rich and poor may be efficient. As will be discussed in the next two chapters, an economy with substantial redistribution of income is typically somewhat inefficient (in the sense that an omnipotent planner could rearrange the economy to make everybody better off ), but this may be considered a fair price to pay for the greater equality in the distribution of income. The story in chapter 3 is that a competitive economy is efficient in all three senses of the term. The utilitarian criterion interpretation of social welfare boils down in practice to the amalgamation of efficiency and equality into one higher criterion to provide “the greatest good for the greatest number,” where the trade-off between these two “greats” is a reflection of the specification of welfare and of the utility of income function in equation (3).

PROPERTY, EQUALITY AND THE COMMON GOOD

One can think of social welfare as a person’s ranking of entire distributions of income for society as a whole. Just as one is presumed able to rank alternative bundles of bread and cheese as better, worse or equal in the construction of indifference curves, so too is one presumed able to rank bundles of incomes of different people as better, worse,

or equal in one’s assessment of the common good of the community, though, to do so, one must somehow abstract both from his own place in the income distribution and from the identities of the occupants of each and every slot. As mentioned above, we normally think of social welfare as anonymous, so that an income of $100,000 a year to Charlie and an income of $50,000 a year to Joe is deemed neither better nor worse than an income of $100,000 a year to Joe and an income of $50,000 a year to Charlie.

To reason this way is to sweep an important question under the rug. If one person is to have an income of $100,000 and the other person is to have an income of $50,000, why does Charlie get to enjoy the higher income and not the other way round? Why in the example in chapter 3 does person A consume twice as much bread and cheese as person B? Why might the head of a major corporation earn, literally, thousands of times the income of the lowest paid worker? At one level the question is easily answered. People’s incomes are a reflection of their resources in land, shares of companies, skills, and situations in society. The answer is true but unsatisfactory, for the real question is why resources, broadly defined, are allocated unevenly. Why, referring again to the example in chapter 3, does person A get plot A and person B get plot B, rather than some more even distribution of land between them? No explanation was provided. An allocation of resources to people was simply assumed.

We speak of people “earning” incomes, but earnings themselves are the outcomes of social conventions that might have been other than they are, and not all routes to high incomes are admirable or advantageous to society as a whole. Fortunes are often acquired by invention and industry, but not always so. Much wealth is acquired by chicanery, political influence, speculation (where the gain to the speculator is at the expense of the rest of society), or outright theft that somehow escapes the law. Ownership may be the loot of a thief made secure by a conspiracy of thieves. North America was stolen by the Europeans from the native people. Land occupied by tribes of native people at the time of the European conquest had been stolen by their ancestors from other tribes whose members rarely survived to claim their historic rights. The respectable landed fortunes of England originate in the banditry of William the Conqueror. Trace back the origins of “old wealth” today, and you will often find evidence of plunder. The claim that “property is theft” is at least partially true. If that be so, why should people tolerate the gross disparities of income that are to be found in almost any capitalist society with a degree of private ownership of the means of production?

The question is sometimes answered by an appeal to a “right of property.” “Life, liberty and property” are seen as inalienable rights that no government may abrogate. In the late nineteenth century, an assumed right of property led the American Supreme Court to ban income tax as unconstitutional. A constitutional amendment was required before income tax could be reinstated. Some people see property rights as god given, or profess to find warrant for property rights in the Bible. Others see property rights as derived from a right to one’s own labor or from a principle of “first possession,” exemplified by the settler who gets to own the plot of land he clears from the wilderness.

This line of argument is not wrong, but back to front. Society upholds property rights not for their own sake, but because property rights are a requirement for other things we value, for general prosperity and, as we shall argue in the remaining chapters