The most misleading definition in economics (draft excerpt from Economics in Two Lessons)

by John Quiggin on May 19, 2015

After a couple of preliminary posts, here goes with my first draft excerpt from my planned book on Economics in Two Lessons. They won’t be in any particular order, just tossed up for comment when I think I have something that might interest readers here. To remind you, the core idea of the book is that of discussing all of economic policy in terms of “opportunity cost”. I’ll update as I go, in response to comments and criticism; this may create some difficulties reading the comments thread, but hopefully the improvement in the final product will be worth it.

My first snippet is about

Pareto optimality

The situation where there is no way to make some people better off without making anyone worse off is often referred to as “Pareto optimal” after the Italian economist and political theorist Vilfredo Pareto, who developed the underlying concept. “Pareto optimal” is arguably, the most misleading term in economics (and there are plenty of contenders). Before explaining this, it’s important to understand Pareto’s broader body of thought, one which led him in the end to embrace fascism.

Pareto and the “libertarian” path to dictatorship

Pareto sought to undermine the version of liberalism that dominated 19th century economics, according to which the optimal (most desirable) economic outcome was the one that contributed most to human happiness[^1], often (if somewhat loosely( summed up as ‘the greatest good of the greatest number’. Particularly as developed by the great philosopher and economist John Stuart Mill, this is a naturally egalitarian doctrine.

The egalitarian implications of the classical framework reflect the fact that the needs of poor people are more urgent than those of the better off. So, the happiness of the community as a whole all be increased by policies that benefit the poorest members of the community, even if these benefits come at the expense of those who are better off. It follows that a substantial degree of income redistribution will be social desirable and that large accumulations of individual wealth, which contribute only marginally to the happiness of a small number of people are undesirable in themselves, though they may in some circumstances be a by-product of desirable policies.

Pareto’s big achievement, further developed by a large number 20th century economists, was to show that much of economic analysis could be undertaken without invoking the concept of utility. Hence, interpersonal comparisons of utility, which invariably lead to the conclusion that redistributing wealth more equally is beneficial, could be dismissed as ‘unscientific’.

Pareto didn’t stop with an attack on the economic implications of Mill’s approach. Mill’s philosophical framework implied support for political democracy, including the enfranchisement of women. Since everyone’s welfare counts equally in the classical calculus, the political process should, as far as possible, give everyone equal weight.

Pareto reversed this reasoning, arguing that a highly unequal distribution of income was both inevitable and desirable; he proposed what he called a power law, described by a statistical distribution which also bears his name. Pareto’s “Law” may be summed up the 80-20 proposition, that 20 per cent of the population have 80 per cent of the wealth.

The supposed constancy of income distribution implies that any attempt at redistribution must be essentially futile. Even the aim is to benefit the poor at the expense of the rich, the effect will simply be to make some people newly rich at the expense of those who are currently rich. Pareto called this process ‘the circulation of elites’. (Footnote: In his dystopian classic 1984, Orwell has the Trotsky-like character Emmanuel Goldstein present the same idea as the starting point of The Theory of Oligarchical Collectivism. Orwell almost certainly derived the idea from James Burnham, an admirer of Pareto whose work Orwell saw as the embodiment of ‘power worship))

All of this led Pareto to become one of the first advocates of a political position combining an extreme free-market position on economic issues with hostility to political liberalism and democracy. Pareto welcomed the rise of Mussolini’s fascist regime, and accepted and accepted a “royal” nomination to the Italian senate from Mussolini.

Pareto was not really a fascist however. Rather, he developed a version of liberalism similar to that of his more famous successors, Hayek and Mises, both of whom embraced and worked for murderous regimes that had come to power by suppressing democratic socialist parties. Like Pareto, neither Hayek nor Mises can properly be described as fascists – they weren’t interested in nationalism or in the display of power for its own sake. Rather, their brand of liberalism was hostile to democracy and indifferent to political liberty, making them natural allies of any authoritarian regime which adheres to free market orthodoxy in economics. (Fn Supporters of Hayek and Mises commonly describe themselves as “libertarians”, but their alliance with brutal dictators makes a travesty of the term – they have been derisively described as “shmibertarian”).

Pareto optimality

Now back to “Pareto optimality”, and why it is such a misleading term. In ordinary language, describing a situation as “optimal” implies that it is the unique best outcome. As we shall see this is not the case. Pareto, and followers like Hazlitt, seek to claim unique social desirability for market outcomes by definition rather than demonstration.

If that were true, then only the market outcome associated with the existing distribution of property rights would be Pareto optimal. Hazlitt, like many subsequent free market advocates, implicitly assumes that this is the case. In reality, though there are infinitely many possible allocations of property rights, and infinitely many allocations of goods and services that meet the definition of “Pareto optimality”. A highly egalitarian allocation can be Pareto optimal. So can any allocation where one person has all the wealth and everyone else is reduced to a bare subsistence.

Recognising the inappropriateness of describing radically unfair allocations as “optimal”, some economists have used the description “Pareto efficient” instead, but this is not much better. It corresponds neither to the ordinary meaning of “efficient” nor to the meaning with which the term is commonly used in economics, which is also misleading, but in a different way.

The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs. Conversely, if there is a positive opportunity cost for any benefit, then we can’t make anyone better off without making someone else worse off. So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.

[^1]:This approach is often described as “utilitarianism”, and, until relatively recently, economists have mostly talked about “utility” rather than “happiness”. This terminology has been the subject of heated, but not enlightening, debate, with the result that it is best avoided.

{ 75 comments }

1

Harald K 05.19.15 at 8:08 am

I’d like to plug Steve Randy Waldman (Interfluidity)’s admirably accessible series on introduction to welfare economics. He explains very well both the problems with Pareto optimality, and the problems with some of the various concepts trying to replace it with something better.

2

david 05.19.15 at 8:54 am

Badly written. If you understand the problem with Pareto optimality (which is readily and graphically illustrated by raising the observation that slavery is easily sketched to be Pareto optimal; it is even Kaldor-Hicks optimal), then these 1000 odd words here don’t add any insight. It’s too shallow to even really dig into the philosophical the-political-is-personal idea you raised in your previous blog post.

But if you don’t already understand it, then this doesn’t give any context either, and if anything further muddles the idea: “some economists”? If Pareto was “one of the first”, who are the others? Could one have at least a sketch of their ideological positions, their timing and influence? Is your side remark on Orwell personal speculation, or is it intended as your academic assertion of a consensus amongst literary historians, and does it impact your thesis either way? Who the heck is Cirillo? Or Dollfuss? Or (because one shouldn’t really overestimate lay readers) Pinochet? Why on earth am I expected to know of Austria during the First Republic if I need to have JS Mill patiently introduced for me?

The unclinical tone also doesn’t work in a way that improves engagement here, IMO. Let’s say I’m an undergraduate wandering the pop econ shelf. I’ve heard of Mill, he’s the first assigned text for philosophy 10. Is he really straightforwardly “naturally egalitarian”? This seems confidently glib. I’ve also heard of “utility” (because I am, after all, reading pop econ). A lot of left-wing writers don’t like it. Am I reading something trying to sell something to me as some “naturally egalitarian” concept opposed to “scientific” Nazis? Too many weird smells, I’d just put down the book.

3

david 05.19.15 at 9:13 am

Less negatively – if your intention is to site Pareto as an early fascist in intellectual/historical context, I’d consider a tree diagram instead of trying to sketch it out in words. Something like this figure from Lavoie’s text on post-Keynesianism, perhaps, with the timeline running alongside – except with assorted fascists or antifascists. You could identity associated regimes (as opposed to writers) with a key, that sort of thing.

4

reason 05.19.15 at 9:25 am

Harald K. @1
second that.

5

reason 05.19.15 at 9:36 am

“The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs. Conversely, if there is a positive opportunity cost for any benefit, then we can’t make anyone better off without making someone else worse off. So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.”

I’m not sure that this really works here (see Interfluidities work on welfare economics again). The problem is with the specific nature of cost evaluation. You can say that “Pareto efficient” means that there are no possible gains from exchanges that are not taken. But that we giving the game away – wouldn’t it. (i.e. that the claim that the unrestricted market results in “Pareto Optimum” allocation is simply a tautology.)

6

david 05.19.15 at 9:45 am

Whilst Interfluidity’s series is very good, it is both really meant for a reader with more than a passing familiarity with the concepts at hand, and also not formulating an intuitive attack on the Hazlitt/Bastiat emphasis on hidden costs of policy.

Waldman is putting forth a subtle vision, by sketching the historical path which the Cowles Commission pursued and eventually stalled, and nonetheless defending it as deeply flawed and yet conditionally appealing. Quiggin said that he wanted to make the relatively pedestrian point of conceptualizing claims on social security or claims on income taxes as endowment claims in themselves. These aren’t just different goals, they’re actively conflicting ideas.

7

Lee A. Arnold 05.19.15 at 10:54 am

John is your book going to deal with the NEXT transaction, the one that comes after the first which is judged to be Pareto-optimal, or opportunity-cost-neutral? For if someone has a gain which is Pareto-optimal, he/she might be better positioned to buy more property in the NEXT transaction. So, the Pareto-optimal transaction keeps things at 80-20, i.e. no one is worse off. But is this really so? In the next transaction, the one who became better-off in the last transaction can now outbid another in a property market, which changes the wealth to 81-19. You can always say, “Well, attrition, deaths, and the vagaries of life will knock it back down to 80-20” (i.e., one of the responses to Piketty’s theory, though it doesn’t explain Piketty’s data). I am always confused as to how and why economists draw lines at the single, first transaction (as well as draw lines at the standing distribution, as you mention in this piece).

8

bianca steele 05.19.15 at 12:10 pm

John:

Isn’t Goldstein’s work ultimately revealed to be a forgery by O’Brian?

9

reason 05.19.15 at 12:26 pm

Bianca, @9
so we are dealing with a fictional fictional character? Is that substantially different in this case?

10

JimV 05.19.15 at 12:37 pm

Typo alert: “and accepted and accepted” (Pareto’s senate nomination). I do that sort of thing all the time, so I find its rare occurrence from good writers reassuring.

As a very lay reader, I did not find any of the points or references obscure, but expect that in a book they would have footnotes or endnotes to give sources.

11

Mdc 05.19.15 at 1:18 pm

“interpersonal comparisons of utility, which invariably lead to the conclusion that redistributing wealth more equally is beneficial”

This could use some more explanation- it’s at least not obvious. Plenty of simple, intuitive scenarios spring to mind, in which equality might be sacrificed for “the greater good.”

12

reason 05.19.15 at 1:27 pm

Mdc @11
isn’t “The egalitarian implications of utilitarianism reflect the fact that the needs of poor people are more urgent than those of the better off. ” sufficient? Is a dollar worth the same to Bill Gates as to someone who earns that much in a day? I would have thought the answer was obvious.

13

MPAVictoria 05.19.15 at 1:40 pm

“Typo alert: “and accepted and accepted” (Pareto’s senate nomination). I do that sort of thing all the time, so I find its rare occurrence from good writers reassuring.”

Yep. It is nice to not be the only one who has typos…

14

reason 05.19.15 at 1:41 pm

” If such possibilities exist, then there are potential benefits that have no opportunity costs. “

Surely, the biggest issue here, and you don’t seem to have addressed it, is uncertainty. The ex-ante, ex-post issue is being swept under the carpet here.

15

reason 05.19.15 at 1:45 pm

me @14,
the “great risk shift” comes to mind here. It seems to me that “market efficient” outcomes are fundamentally fragile, because the market doesn’t value resilience, unless it is fully insured (which for a number of reasons is impossible).

16

reason 05.19.15 at 1:52 pm

MPAVictoria @13
“Yep. It is nice to not be the only one who has typos…”

So Schadenfreude ist der schönste Freude?

I would have thought in the interests of clear communication, it would be better if nobody else (including – blushes – me) made typos.

17

MPAVictoria 05.19.15 at 2:07 pm

“the “great risk shift” comes to mind here. It seems to me that “market efficient” outcomes are fundamentally fragile, because the market doesn’t value resilience, unless it is fully insured (which for a number of reasons is impossible).”

Yep. Which is why “just in time” manufacturing is not always the fantastic innovation it has been portrayed as. Take a look for example at the increase in the occurrence of “drug shortages” in recent years.

“I would have thought in the interests of clear communication, it would be better if nobody else (including – blushes – me) made typos.”

Well sure, but since we are human, and thus fallible, it is nice not to make all our mistakes alone.

18

In the sky 05.19.15 at 2:21 pm

1. The text needs editing, e.g. “It follows that a substantial degree of income redistribution will be social[LY] desirable”, “Pareto welcomed the rise of Mussolini’s fascist regime, and accepted and accepted a “royal” nomination”.

2. “often summed up as ‘the greatest good of the greatest number’.”
It is true that utilitarianism is often expressed thus, but it is a misrepresentation of utilitarianism. As von Neumann wrote of that phrase, “A guiding principle cannot be formulated by the requirement of maximizing two (or more) functions at once. Such a principle, taken literally, is self-contradictory. (In general one function will have no maximum where the other function has one.) It is no better than saying, e.g., that a firm should obtain maximum prices at maximum turnover, or a maximum revenue at minimum outlay.”

3. Pedantic point: afaik Orwell’s book was not called “1984”.

4. The opening salvo mentions how misleading the term “Pareto optimality” is. Ironic, then, to title a chapter “Pareto’s path to fascism” when the last paragraph openly admits that “Pareto was not really a fascist however.” Come on, you’re asking for cynical responses here.

5. “Describing a situation as “optimal” implies that it is the unique best outcome.” I appreciate this entire endeavour is intentionally provocative, but this statement is too strong. It’s taking a stand on semantics and claiming you’re unambiguously in the right. Guess the roll a die and I think it’s fair to say “Any number 1-6 is optimal”, at least in the sense that 7 is clearly suboptimal.

6. More generally, Pareto optimality in the context of an Edgeworth Box (often taught in introductory micro as an example of GE) sheds light on what Pareto optimality actually means.

7. “So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.”
This is mis-stated, surely? Pareto suboptimal allocations also have positive (and large) opportunity costs.

8. The argument that Pareto optimality gives undue weight to previous distributions of property is well made in Atkinson and Stiglitz’s graduate textbook. You might cite.

19

Cosma Shalizi 05.19.15 at 2:30 pm

“Describing a situation as “optimal” implies that it is the unique best outcome”: I may be over-trained in the dialect of my field, but the word really doesn’t carry an implication of uniqueness for me.

20

reason 05.19.15 at 2:38 pm

In the Sky @18
3 (That “nineteen eighty four” is different from “1984” is REALLY pedantic).
7. “So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.”
This is mis-stated, surely? Pareto suboptimal allocations also have positive (and large) opportunity costs. (BUT suboptimal allocations will have SOME negative opportunity costs).

21

Lee A. Arnold 05.19.15 at 2:54 pm

Now I’m confused. Please tell me where I go wrong. A positive cost is where you pay more. A negative cost is where you pay less. The opportunity cost is the value of your other possible choice or alternative. So a positive opportunity cost would make that alternative more expensive.

In a Pareto-optimal improvement, one person gets more in results, while none are penalized. So for the one who gets more results, the value of the alternatives has diminished relatively. So that person’s opportunity costs have moved in the negative direction. For all the rest of the people, nothing has changed; their opportunity costs are neutral.

Is this right?

22

Barry 05.19.15 at 2:55 pm

Or, as Daniel Davies once put it here, an economy where one person owns everything and the rest own nothing is pareto-optimal.

23

bianca steele 05.19.15 at 3:00 pm

Count me with Cosma (I think). The simple definition doesn’t rule out the existence of multiple local optimums. Admittedly, in many cases you can’t get there from here (assuming the possibility space is the same as the space of possible moves).

24

adam.smtih 05.19.15 at 3:12 pm

Lee — you’re exactly right, but you’re describing a pareto improvable situation, in which, exactly as you say, at least one person’s opportunity costs are negative.
And directly from that follows that in a pareto unimprovable (aka “optimal”) situation, there is no person with negative opportunity costs, which is what JQ writes.
I’m not convinced that’s a pedagogically particularly helpful way of thinking about this, but I’m open to being convinced otherwise.

25

Marshall 05.19.15 at 3:17 pm

The simple English dictionary definition of “optimal” is [the] “best”. Personally as a poorly educated layman I am frequently confused when technical vocabulary looses touch with the ordinary meaning of things; perhaps here such confusion is an important rhetorical intention in that the subject term tends to falsely justify the existing wealth distribution. Which I take to be John’s point.

26

david 05.19.15 at 3:21 pm

If you’re the sort of thinker where the set of optima is just another uninteresting set unless first proven nonempty – if you are the sort to think about surfaces and points to begin with – then perhaps an essay on the inadequacies of Hazlittian intuitionistic handwaving, labouriously expressed in words, is not for you. Perhaps Mas-Colell et al might be more appropriate?

I dunno. I fear that any book that fully comports with the intuitions of the Cosma Shalizis of the world is not a thing that would be reasonably described as one lesson, or two lessons, or any countable number of lessons, really.

27

VeeLow 05.19.15 at 3:58 pm

Using the terms “positive” and “negative” to modify “costs” is what will get the lay person confused….why not simply talk about the presence/absence of opportunity costs in a given Pareto test case: do all benefits have opportunity costs, or do they not?

28

Plume 05.19.15 at 4:17 pm

John,

If Pareto thought the richest 20% holding 80% of all wealth was “optimal,” what would he have to say about the richest 1% holding 99% of it?

That will be the case as of 2016, with the trend accelerating from there.

International Business Times on the Oxfam study

Right now, the richest 80 human beings hold as much wealth as the bottom half of the world’s population (3.5 billion), and the trend is for greater and greater accumulation of total wealth, income and resources at the top to continue.

I think lost in the argument among all too many economists is that past oligarchical dreams seem rather quaint by today’s standards. Even the 18th century denizens of Versailles would blush at the levels of inequality in 2015 — and beyond.

29

In the sky 05.19.15 at 4:36 pm

“Pareto reversed this reasoning, arguing that a highly unequal distribution of income was both inevitable and desirable; he proposed what he called a power law, described by a statistical distribution which also bears his name. Pareto’s “Law” may be summed up the 80-20 proposition, that 20 per cent of the population have 80 per cent of the wealth.”

Income vs wealth.

30

Plume 05.19.15 at 4:45 pm

Another thing missing from the discussion — at least in the very narrow confines of American politics: Pretty much all “redistribution” downward ends up going back upward again. Capitalism itself is the most aggressive machine in history when it comes to upward redistribution of wealth, income and resources . . . and even when the government does its token share of downward re-redistribution, that money ends up in the hands of the rich. From food stamps to direct monetary assistance, the ultimate beneficiaries of that government largesse have always been the rich. They win regardless . . . Basically, all government programs, either immediately or long term, benefit the wealthy, directly and indirectly. But too much of our political talk is stuck on the supposed “injustice” to the rich when it comes to said “redistribution.”

Cry me a river.

31

adam.smith 05.19.15 at 5:05 pm

In the sky @29 — yeah, Pareto seems a bit confused on that, too. Today, obviously, wealth inequality is much higher than income inequality. Was that perhaps not the case, historically? (The original 80/20 was about land ownership in Italy, FWIW).

32

Stephen 05.19.15 at 5:44 pm

“wealth inequality is much higher than income inequality”. Is this not necessarily true?

I have a large income: some of that can go into increasing my wealth. I have a no more than adequate income: I can keep going but my wealth will not increase.

Is that not so?

33

Plume 05.19.15 at 5:53 pm

Stephen,

“Wealth” is generally thought of as net assets. What we have after debt is factored in. So, yes, one could make a ton of money each year in income, but have enough debt to fall further and further behind from a “wealth” aspect. But then that leads into the ability of “debt” to be postponed, and postponed more successfully (ironically) when it has plenty of zeroes after it. As in, some people can live incredibly well with massive debt hanging over their heads — better than someone else who has little to no debt, but a relatively low salary. Lots of complications come into play at that point. Like, what does that debt actually buy? It can often buy a luxurious standard of living . . . . so perhaps “wealth” should factor that in as well.

As far as I know, the official definition leaves that out.

34

Mike Isaacson 05.19.15 at 10:31 pm

I would submit that Chile was not appropriately fascist since its economic system did not rely on corporatism in any sense.

35

marcel proust 05.20.15 at 2:38 am

… the utilitarian version of liberalism that dominated 19th century economics, according to which the optimal (most desirable) economic outcome was the one that contributed most to human happiness, often summed up as ‘the greatest good of the greatest number’. Utilitarianism, particularly as developed by the great liberal philosopher and economist John Stuart Mill, is a naturally egalitarian doctrine.

The egalitarian implications of utilitarianism reflect the fact that the needs of poor people are more urgent than those of the better off. So, aggregate utility all be increased by policies that benefit the poorest members of the community, even if these benefits come at the expense of those who are better off. It follows that a substantial degree of income redistribution will be social desirable and that large accumulations of individual wealth, which contribute only marginally to the happiness of a small number of people are undesirable in themselves, though they may in some circumstances be a by-product of desirable policies.

Not necessarily. About 25 years ago I read something by an author whose name has long eluded me.[1] It was (clearly autobiographical) fiction about growing up as a middle class Jew in England in the 50s and 60s, facing the mild anti-semitism of then widespread in polite society.[2] In one of his chapters he imagined a situation in which God proposed the following deal with humans. Allow God to dispose of a small, clearly identified group of troublesome people and everyone else will live in peace and comfort forever and ever. From what I remember, he asserted that Bertrand Russell’s morality, yea the morality of any reasonable person (reasonable according to conventional standards) would be quite comfortable accepting the bargain. The rest of the chapter argued that this was decidedly not moral despite the permanent (and thus infinite because temporally infinite) benefit that would accrue to the vast majority. My recollection of the rest of the chapter is that the author’s tone was mildly indignant that anyone would think otherwise (which he took for granted).

Anyway, you have to sneak in some other assumptions about marginal utility and the infinite disutility of death to be so confident that it tends toward egalitarian outcomes.

[1] I went searching among my papers to see if I could find the few pages that I had xeroxed to keep, but I think I tossed them during one of my moves. If anyone recognizes this, I’d be happy to learn the author’s name.

[2]The line that has stuck with me all these years: “I’m not a Jew… just Jewish.” And yes, Seth Meyers sort of covered this issue last spring.

36

js. 05.20.15 at 3:27 am

Utilitarianism, particularly as developed by the great liberal philosopher and economist John Stuart Mill, is a naturally egalitarian doctrine.

Oof! I’m not exactly sure who the audience for the book is supposed/going to be, but handwaving at JS Mill (who was indeed an egalitarian, if only partially), and slipping in “utilitarianism … is naturally egalitarian” is a little weak. Especially as I’m sure you know that there’s been plenty of debate about this. Sen’s “Equality of What?” is the most obvious reference that comes to mind, but there’s plenty more in that vein (and I’d imagine your co-blogger Ingrid Robeyns could supply with lots of references).

Look, I get that this might be tangential to your main purposes, but something like that coming not from you, JQ, but say from someone I didn’t already know of and respect and trust would immediately make me very wary.

37

John Quiggin 05.20.15 at 6:05 am

@36 I don’t think the common allergic reaction to utilitarianism is justified and in particular find Rawls’s attempt at an alternative less and less convincing the more I look at it. In particular, even if, like Sen, you don’t think utilitarianism leads to “the right kind” of egalitarianism, that doesn’t mean it isn’t egalitarian.

But I’m looking for reader reactions here, and I take your point. I’ll just have to make the point about the egalitarian implications of classical economics without mentioning utility.

38

Chris Bertram 05.20.15 at 6:51 am

@John Quiggin apparently, among Rawls’s drafts, there’s a utilitarian version of ToJ.

39

John Quiggin 05.20.15 at 6:57 am

@19 Cosma, I think you are overtrained, but even within the context of mathematical usage, “Pareto optimality” is unusual. Sure, a function can have multiple optima, but the case here is that infinitely many points are regarded as optimal, even though there is no function that all of them maximize.

Rather, any point on the boundary of a convex set is being called “optimal”, in the sense (guaranteed by the separating hyperplane theorem) that it must maximize some function.

40

reason 05.20.15 at 7:12 am

marcel proust, @35

Now let the group in question be the Nazi leadership.

41

reason 05.20.15 at 7:52 am

marcel proust @35
btw There is such a concept as CONSTRAINED optimization. Nobody said that utilitarianism had to be unpolluted by basic rights concepts.

42

david 05.20.15 at 8:00 am

Quiggin @39 – vector optimization and defining a partial ordering of a set are pretty common concepts; economists don’t have a monopoly on linear algebra or overloading the “greater than or equal to” operator.

If anything, fields which are actually interested in computationally obtaining these optima (rather than merely being satisfied with existence and uniqueness theorems) develop them with far more attention.

43

John Quiggin 05.20.15 at 9:02 am

@42 I’m not clear how this relates to the point I made.

In particular, I’m not clear if you’re talking about computable general equilibrium models which have, at least as long as I can remember (40 years or so) , been of more interest to economists than existence and uniqueness proofs. The construction of these models normally guarantees uniqueness, but of course, that’s conditional on initial endowments as I said in the OP. Obviously economists aren’t the only ones interested in computing equilibria/optima, but how is that relevant?

44

david 05.20.15 at 10:36 am

Sorry – I was unclear. I was referring to your claim that, in the context of mathematical usage, labeling the concept of an element of a set that is “≿” all elements of the set as ‘optimal’ or somesuch usage is unusual or presumably therefore
deceptive in some way

This is not the case, as the set of Pareto optima is straightforwardly the set of points which are not subject to an incomplete binary relation of Pareto improvement, i.e., it is the set of maximal elements. The language choice serves to generalize the intuition of a “largest” element in some way, in situations where (unfortunately) the concept of being the largest develops some complexity.

I don’t have CGE in mind at all, the entire academic project seems moribund. Non-economists do have uses for optimization theory, though – in engineering, data processing, etc. The Bellman Equation that stalks the minds of undergraduates studying intertemporal choice stems from optimal control theory developed in the historical context of manned flight and missiles, not consumer choice – in the context of wanting to do something rather than modelling how someone else does something, so to speak. In these cases they nonetheless call it optimization theory.

45

bianca steele 05.20.15 at 4:17 pm

@22

In fact, if I understand this correctly, any complete distribution where there are no goods left undistributed is Pareto-optimal. I’m the first to admit I don’t understand economics, but I’m unclear about the usefulness of such a concept, much less how it could be said to determine policy questions. (The situation where IBM makes PCs and Dell doesn’t is Pareto-optimal, by comparison with the situation where Dell takes away increasing numbers of sales from IBM, but it would be a peculiar sort even of corporatism that likened Dell to a kind of taxing body, or something. Or if Bruce owns a sandwich shop, his landlord won’t let a second sandwich shop open in the same shopping center, but it’s unclear that the municipality shouldn’t let a second shop open in the same town.) If Pareto-optimality is a useful theoretical construct, while Pareto’s own writings are not especially useful for understanding the implications of that construct, that seems reasonable as far as I’m concerned.

46

Matt 05.20.15 at 5:06 pm

John, I’d meant to ask earlier on (but was too busy) if you’d seen Joseph Heath’s book _Filthy Lucre: Economics for People who Hate Capitalism_ (called, in the US, _Economics Without Illusions_, supposedly for fear that not enough people in the US know what lucre is.) Heath is a philosophy (at the University of Toronto) but I ask because he explicitly sets his book out as a sort of response to Hazlitt. I would be pretty surprised if you agreed with all of it, but thought you might want to look at it, given the similarity of the projects. (I have used parts of the book in teaching business ethics to udergrads at Wharton, and found it useful, especially parts on the non-naturalness of markets, and on the possibility of non-efficent, but stable, equalibria.)

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In the sky 05.20.15 at 5:36 pm

@bianca steele

In fact, if I understand this correctly, any complete distribution where there are no goods left undistributed is Pareto-optimal.

This is incorrect.

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adam.smith 05.20.15 at 5:45 pm

@bianca — for a simple example:
If you prefer BB King and I prefer Buddy Guy, and you own a Buddy Guy LP and I own a BB King LP, all goods are distributed, but not in a pareto optimal way: by just swapping the two LPs we could both be better of.

A typical example of Pareto improvements used by economists is a super stylized model of free trade: If we accept all the assumptions of Ricardian trade and make redistribution both politically feasible and costless, then allowing trade (or reducing tariffs) and compensating losers is a Pareto improvement.

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Plume 05.20.15 at 5:47 pm

From Wikipedia:

Given an initial allocation of goods among a set of individuals, a change to a different allocation that makes at least one individual better off without making any other individual worse off is called a Pareto improvement. An allocation is defined as “Pareto efficient” or “Pareto optimal” when no further Pareto improvements can be made.

Pareto optimality seems like a great argument for preserving the status quo. If, say, the richest man in town holds 80% of all wealth, and the town decides that it needs to alter this percentage, then at least one person — the rich guy, obviously — will be worse off as individuals on the bottom receive a bit of an upward bump.

Or, when it comes to income distribution. A company has a max payroll. Joe CEO makes 10 million. The rank and file average 50K. If Joe takes a reduction of a million in order to increase salaries for the rank and file, this kills the Pareto optimal scenario right off the bat. And since the overall economy works this way under capitalism, any attempt to improve salaries at the bottom or the middle will result is losses for those at the top. Any attempt to give consumers a better deal on their individual transactions will do the same. Any attempt to establish “fair trade” will do the same. If Walmart pays downstream suppliers fairer compensation for their goods, Pareto is broken, etc. If they stop ripping off coffee growers in Africa and South America, or chocolate farmers in Africa, etc. etc. . . . Pareto is broken.

It’s really just a fancy way of saying we can’t improve the lot of the “lower orders” or the middle.

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Plume 05.20.15 at 5:54 pm

adam.smith @48,

Not getting that at all. Any form of redistribution would entail individual loss. If it’s redistribution upward — capitalism and the vast majority of governmental supports for capitalism — those at the bottom and the middle lose. If it’s downward redistribution, individuals at the top lose. Wealth, income, access, etc. etc. are finite things. Add them for individuals/or one side of any transaction, and you have to subtract them from other individuals or the other side of that transaction. How can that be seen as a Pareto Improvement?

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bianca steele 05.20.15 at 6:09 pm

adam:

I suppose this is what I don’t understand: Say what’s at issue is distribution, right now. This seems to be what’s necessary to make the argument that taxation messes with Pareto-optimality and is therefore wrong. It also seems to be what’s behind dsquared’s witticism as conveyed by Barry. Then–if changes that destroy Pareto-optimality are immoral–any change in distribution, unless new goods are found from somewhere, is impermissible. But if those changes are allowed, then why not taxation?

Or else, say, possibly what’s at issue is something more complicated, taking time into account, and processes, and such. In this case the end result could be “growing the pie” and every single person being better off (with or without regard to positional goods). But are there intermediate states that are declines from higher states of Pareto-optimality, or not? If there are, then it seems there’s no reason to oppose taxation and other forms of regulation, or any system/process that results in (temporary) transfers of goods from one person to another. If there aren’t and can’t be, then it seems we can’t get to a situation where the pie is bigger, because we’d have to implement impermissible transfers to get to that state.

The concept sounded useful to me, I admit, before I heard the CT commentariat using it. I naturally assumed that it was meant to describe a system in which there was inequality but where everyone was better off than they’d have been in conditions of equality. But instead I hear it used to describe a system in which there’s inequality that can’t be justified except by saying that goods can’t be taken away from those who have them.

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adam.smith 05.20.15 at 7:09 pm

Right, there seems to be some confusion, and it’s exactly the type of confusion that JQ thinks (correctly, imo) the terminology is causing. What follows is intended in purely technical terms, without engaging in the normative part.

Both Plume and Bianca seem to be suggesting that there is something about a Pareto optimal distribution that means it shouldn’t be changed. While I’m sure you’ll be able to find some hacks who insinuate that, it’s incorrect. If, to take Plume’s example, you have someone who owns 80% of all assets and you take away all of her money and distribute it equally among the entire population, you’re moving from one Pareto efficient state to another Pareto efficient state. Welfare economics may have something to say about which is more desirable; Pareto efficiency doesn’t.
The argument that “taxation messes with Pareto efficiency and is therefore wrong” is bogus. I’ve never seen that made by an economist, either.

The question about results along the way is actually quite helpful to think about this. Think about a country with two equal sized groups, Winners (W) and Losers (L). Before “free trade” both own 50 gold. With free trade, winners gain 20, and losers lose 10 gold. Then, the king takes half of the winners’ gains and gives them to the losers. So we have three states:
1) W=50, L=50
2) W=70, L=40
3)W=60, L=50

The only thing that Pareto efficiency tells us is that 3) is an improvement over 1). It has nothing to say on whether 2) is better than 1) or vice versa or whether 3) is better than 2) or vice versa.

Hopefully that clarifies the technical part. I can’t think of any real world policy debate in which Pareto efficiency (even renamed) would be a particularly useful concept, so in addition to what JQ says, it may be worth considering relegating it to a much less prominent place in economics education.

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Plume 05.20.15 at 7:25 pm

adam.smith @52,

I’m still confused. It just seems to go against math and common sense.

Given an initial allocation of goods among a set of individuals, a change to a different allocation that makes at least one individual better off without making any other individual worse off is called a Pareto improvement. An allocation is defined as “Pareto efficient” or “Pareto optimal” when no further Pareto improvements can be made.

I’m not seeing how you can ever achieve a Pareto improvement, given the math.

If Johnny has five marbles, and Janey has three, and Johnny gives Janey one marble, he’s worse off; she’s better off. No Pareto improvement. In reality, it would seem that no matter what the initial distribution might be, no Pareto improvement is possible, ever — unless it allows for additions from outside a closed system . . . . which, in reality, would have to be paid back somehow anyway . . . thus negating the effects, at least eventually. That means we’re always in a (perverse) kind of “optimal” scenario.

Most likely, I’m misunderstanding the entire concept, cuz it just seems absurd to me. It’s not that far from a tautology of an odd sort. A kind of locked in justification for any existing distribution regime. It’s always going to be “optimal,” because to alter that distribution, someone or some part of the transaction dynamic is hurt. Only in alchemy (and the Fed’s printing press) could you actually “create wealth” beyond what already exists. A dollar doesn’t multiply itself. It just relocates. Can’t be in two places at the same time, like a marble. One person’s gain is another’s loss, etc.

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adam.smith 05.20.15 at 7:42 pm

There’s basically two ways you can get a pareto improvement:
a) You’re not dealing with money, but with “utility.” If, as in my first example, people value goods differently (derive different utility from them in econ-speak), then that’s easily acheived by just swapping them. Often, one of those will be money: If you buy a baseball card from me for $10, than that’s a Pareto improvement: As per “revealed preferences,” you value the baseball card at $10 or more (else you wouldn’t buy it) and I value the baseball at $10 or less (else I wouldn’t sell it), so we’re both at least as well of after the transaction as before.

b) If we’re increasing the pie. The idea that that’s somehow impossible except for alchemy is quite obviously untrue, both empirically (there’s quite obviously a lot more wealth around per person now than there was 100 years ago) and logically. Ricardo’s comparative advantage example is rightfully famous because it’s such an elegant way of showing that, no matter how much it has been abused since.

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Plume 05.20.15 at 8:01 pm

adam.smith @54,

It doesn’t make your case to say there is more “wealth” now than in the past, for a host of reasons. It only matters within the context of the present, and for people living in the present compared with others living in the present. What other people had in the past is irrelevant. It has no bearing on any useful comparisons/analyses in the here and now. “Growing the pie” is also another cynical ploy to legitimate massive inequality. It still involves finite resources, incomes, access, etc. etc. Those finite amounts must still be divided by actually existing human beings, and as the pie grows, so does the number of people vying for those things. As long as the folks at the top take a massively disproportionate amount of the finite totals, the vast majority is not better off in any way, shape or form. And a larger GDP doesn’t necessarily (and rarely if ever does) mean an individual company’s payroll totals have increased, and that’s what matters to individual workers. Their share of the pie is what matters, not its total size. The overall size of the pie could in fact shrink, and workers’ share could increase. Easily.

One could go the nonsensical (Heritage Foundation) route and say someone in 2015 is better off than they were in 1815, but even there, it would all depend. What is their current socio-economic strata? What is their environment? Their levels of safety, health, etc. etc.? Can they afford basic things like health care, eduction, transportation, housing, etc. etc.? Having a smartphone, while being locked out of college isn’t really an improvement in “wealth.” And, again, it’s just not relevant that they have more of X, Y or Z now than totally different souls had in the past. Aside from the fact that others in the past had benefits we have since lost, it’s just not useful to compare completely separate persons, and these comparisons are all too often used to get the rank and file to shut up and clap louder for what they do have.

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Plume 05.20.15 at 8:10 pm

“completely separate persons from different eras,” I should have said.

But, back to the idea of alchemy and increased pies, etc. etc. Massive population growth, technological change, greater and greater divisions of labor. More “efficiency” for our economic system, in the sense that more wealth and power can be collected by those at the top . . . . but inequality has never been greater.

It’s simply not legitimate, in my view, to compare someone today with someone in 1815 — at least for the purposes of crafting policy today. What is legitimate and especially useful is to compare strata in 2015 with each other. The steepness of the pyramid is accelerating, rapidly and radically. By next year, the richest 1% will hold 99% of all wealth. So it makes sense to compare the 1% with everyone else, or the top 10% with the bottom 50%, etc. etc. It makes zero sense to compare the average Joe and Jane of today with yesteryear, unless the object is to get them to forget about the vertiginous differences in current wealth, income, access and power arrangements. Unless the object is just to shut them up.

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bianca steele 05.20.15 at 11:38 pm

Adam,

That’s helpful, thanks, though my reaction is to feel some sympathy to people who get restless when I try to impress on them that their idea of how to use technical terms is just wrong even if they’re not getting why. So if there are positive-sum exchanges, things are different. I’m still inclined to think that my growing inclination to respond to CT threads that discuss things like Pareto optimality by avoiding them, rather than trying to figure out what people are trying to say, is probably reasonable. It’s good to know that real economists aren’t arguing that anything that shifts the members of the top few percent around is wrong or pointless at best. I may very well put Quiggin next to my inherited, yellowing copy of Hazlitt.

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Bernard Yomtov 05.21.15 at 12:15 am

Plume,

Most likely, I’m misunderstanding the entire concept, cuz it just seems absurd to me.

I think the concept you are misunderstanding is differing preferences, which is what allows for gains from trade.

If Johnny has five marbles, and Janey has three, and Johnny gives Janey one marble, he’s worse off; she’s better off.

This misses the point because it deals with a case where, presumably, Johnny and Janey value marbles equally. But suppose Johnny, whose marbles are all red, likes green ones better. So he trades Janey, who is indifferent as to the color, two of his red marbles for one green one.

Now he has three reds and one green, but prefers that to five reds. Janey, in turn, prefers four marbles of whatever color to three. Presto. A Pareto improvement.

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Chris Warren 05.21.15 at 1:41 am

Bernard Yomtov

This is wrong. If there ever was a distribution of marbles like this – there is no equilibrium.

Pareto optimums only make sense at equlibrium.

You can always find a better outcome if the economy is not in equilibrium. This has nothing to do with Pareto.

Between equilibriums all trades appear without involving Pareto constructs.

Pareto efficiency is an ideological construct forced down undergraduate throats as a justification of market capitalism.

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Kurt Schuler 05.21.15 at 2:51 am

1.A blog is a good place to test what might work in a book. As the comments suggest, your treatment needs revising.
2. Utilitarianism need not be egalitarian. What if some people are capable of much greater enjoyment than others? Then utilitarian reasoning may lead to a system where most people have certain basics–living in shabby apartments, taking the bus to work, and standing in line for hours to buy potatoes–while the nomenklatura enjoy dachas, cars, and caviar. I’m sure you can think of countries that have had such a system.
3. Among U.S. economists there is a joke that the only truly Pareto-optimal government policy ever devised is turning right on a red light if there are no pedestrians in your path, rather than waiting for the light to turn green. (For Australians, that would be left turn on red.) There are other examples, but they are scarce, and in my 25 or so years of observing economic policy being made I never recall anyone using Pareto optimality as a criterion.
4. You bring in thinkers not necessary for your argument and make inaccurate statements about them. For example, from what you have written elsewhere I assume that the “murderous regime” that Hayek “worked” for was the Pinochet government. As explained in Bruce Caldwell and Leonidas Montes’s paper “Friedrich Hayek and His Visits to Chile,” Hayek’s visits were not funded by the government; did not focus on meeting government officials (though he did meet some, including Pinochet briefly); and did not seem to have influenced Chile’s 1980 constitution. Whatever the unwisdom of Hayek’s statements about Chile, there is no sense in which he worked for the Pinochet government.

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Bernard Yomtov 05.21.15 at 3:30 am

Chris Warren,

I don’t get why it’s wrong. Here is the passage Plume quotes:

Given an initial allocation of goods among a set of individuals, a change to a different allocation that makes at least one individual better off without making any other individual worse off is called a Pareto improvement. An allocation is defined as “Pareto efficient” or “Pareto optimal” when no further Pareto improvements can be made.

Note that the initial allocation need not be Pareto-efficient.

You can always find a better outcome if the economy is not in equilibrium. This has nothing to do with Pareto.

Yes. You can. And if that outcome makes no one worse off it is a Pareto improvement.

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js. 05.21.15 at 4:54 am

If you (a) completely reject the idea that wealth can be created, and (b) don’t understand that (at least in the original version) Pareto calculations range over subjective—indeed affective—mental states (“preferences”), then yes, the idea of a Pareto improvement isn’t going to make much sense to you.

For what it’s worth though, I do think this the focus on affective states is a disaster for both the Pareto framework and utilitarianism—and in the latter case, the move from the original hedonistic picture to one based on “desire/preference-satisfaction” isn’t much of an improvement. I partly make this point because I appreciate JQ’s point @37. But honestly, while I have gone on at length about Rawls’ criticisms of utilitarianism on CT threads past, they’re actually not what turn me off utilitarianism at the deepest level. Part of it is this focus on affective states that I’ve found dumb since before I ever studied Rawls. (The rest of it is the classic Williams arguments—also in my life dating back from before I ever really studied Rawls). This is mostly irrelevant, but I wanted to clarify that my objections to utilitarianism aren’t in the first instance Rawls-inspired.

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John Quiggin 05.21.15 at 5:01 am

@62 Do you have any suggestions for an operational alternative that isn’t open to equally serious objections? I had a go at developing a working version of Sen’s capability approach in a paper with Han Bleichrodt, tying it to the QALY approach in medical decision making, but no one seemed interested, either here or in the academic journals.

http://crookedtimber.org/2014/03/08/capabilities-as-menus-a-non-welfarist-basis-for-qaly-evaluation/

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js. 05.21.15 at 5:12 am

JQ: short version—admittedly not! But I will try to have a more substantive response tomorrow (I need to be off to bed!).

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js. 05.21.15 at 5:17 am

Ok, one quick thing. Having done a dissertation on Kant and all, I’m probably way more comfortable with what’ll seem like a pretty metaphysically heavy picture of the “mental”. So that creates a certain sort of problem. (But again, I’ll try to spell this out in non-insane terms that can fit in a blog comment.)

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ZM 05.21.15 at 6:21 am

From the linked 2014 post:

“As has already been mentioned, most of the discussion of capabilities has concerned poor/developing countries. Moreover, most of it has been qualitative rather than quantitative. One consequence is that, although the idea of capabilities has been around for a while now, its impact on the policy process in developed countries has been modest at best.”

The September UN conference on post-2015 sustainability goals is going to apply to both developing and developed countries, unlike the previous Millenium Develooment Goals – so that might create space to apply a capabilities approach in developed countries as they work out how to be more sustainable.

I was reading a chapter of Ethical Adaptation to Clinate Change: Human Virtues of the Future called Environment as Meta-Capability which tries to integrate the environment into a capabilities approach.

In terms of Australia – a capabilities approach might help with the NDIS , I have family involved in one of the trials and there are some problems at the moment. Other things I’ve heard or read make me think it is going to be difficult to work out how the NDIS can both enable more choice but also provide coverage to a broad segment of people with a disability.

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david 05.21.15 at 6:33 am

Material inequality or disparities amongst social identities are concepts that are subordinate to the imagined community and data-gathering state bureaucracy at hand, so I operationally think it’s acceptable to give the social planner’s objective function weights of assorted measured aggregates, rather than attempting some kind of individualist additive/maximin measure. Weights can be calibrated non-rigorously (perhaps by survey), with an eye towards robustness even with somewhat incorrect weights.

This obviously sidesteps the philosophical issues at hand, but you did ask for operational approaches.

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John Quiggin 05.21.15 at 9:03 am

What kind of aggregates d0 you have in mind? And what kind of weights?

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ZM 05.21.15 at 10:42 pm

Slightly off topic – relating to the earlier post that defined property rights broadly to include welfare benefits , I said I thought that the Howard Government “mutual obligation” idea was more suitable. Now I have been to the talk by the Chief Justice, before I forget I will mention now I think that the legal concept of a trust would be correct – as trusts include duties and obligations, whereas I am not sure the legal concept of property does (although property was not part of the talk) .

Trusts being of the conscience law part of the common law, rather than the common law part of the common law, interact with statutory laws – so you might say the duty to provide for the welfare of the commonwealth was a trust – but then the government enacts statutory laws about how this is to be done and implemented to meet its trust obligation. And then you can look at the history of this to see good and bad examples.

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david 05.22.15 at 3:43 am

I don’t know. Everyone talks about Thurow 1971 but nobody seems to want to do the legwork.

Looking up for citations of Thurow, I did find a fairly dry UK OFT-commissioned literature review, but it’s likewise just pure theory.

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John Quiggin 05.22.15 at 4:25 am

I’ll see if I can dig out the Thurow paper. The piece you link to is classic C19 utilitarianism, with more up-to-date math, which is fine by me.

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david 05.22.15 at 4:36 am

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david 05.22.15 at 4:52 am

re: the OFT piece. It strikes me that there are easier ways to handwave an answer to the question “how much do people really care about inequality? No, really? As distinguished from risk aversion? With permanent income or without?”

nonetheless Gscholar suggests that is a whole hive of busy graduate-student bees hacking away at distinguishing risk aversion from inequality aversion

microfinancy, liquidity-related-market-failure stuff, I expect

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C 05.22.15 at 9:15 am

Utilitarianism is egalitarian in the abstract sense that everyone’s wellbeing counts the same (including non human animals! There is no escaping that, which meat gulping economists often fail to realize or own up to! That failure, BTW, and the harm that has come from it is arguably magnitudes larger than any other failure of economists… ). But utilitarianism only contingently tend toward more equal distributions of material resources and even then only due to the psychological fact of diminishing marginal wellbeing production for each extra unit of material stuff. ( U is vulnerable to the utility monster thought experiment objection since rust monster supposedly lack that psychological feature ). In contrast, egalitarian and prioritarian versions of wellbeing consequentialism put some principled weight on distribution for those at lower levels of wellbeing.

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Seamus Hogan 05.24.15 at 10:52 pm

John. I agree in part with your view, but not entirely. My comments grew too large so I turned it into a blog post: http://offsettingbehaviour.blogspot.co.nz/2015/05/is-pareto-optimality-most-misleading.html.

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