19 July 2008

The Ethics of Efficiency

Mainstream economics often assumes that the "optimal outcome" is one that maximizes total utility (welfare or happiness). It is common to make a connection between consumption (or resource use) and utility, e.g., as if a larger GDP means that society is better off because the sum total of utility is higher.

In this paper [PDF], Staveren takes these assumptions apart:
The choice of individual utility as the unit of measurement of Pareto efficiency, however, implies that it is not resource-use that is measured for the evaluation of efficiency. Rather, the assumption is that when total utility is maximized, this can only mean that resources must have been used to their maximum efficiency. This assumption, however, is incorrect.

Modern economics has recognized that preferences may include psychological desires, relying on feelings of jealousy, status, affection, etc. So, it is not resource-use that is the space in which Pareto efficiency is measured, but desire fulfillment, including desires that are unrelated to resources as well as desires that are highly resource-intensive or that are harmful for oneself but indulged in because of myopia, limited information or weakness of will. In addition, the satisfaction of some preferences generates externalities, affecting other agents' desire fulfillment.

Hence, from a resource perspective, utility maximization does not necessarily result in the most efficient use of a society's resources: various preferences actually rely on or lead to a waste of resources. So, what is actually measured by Pareto efficiency is sub-optimal total utility, not minimum resource use.
Put plainly, we are not necessarily using our resources to create the greatest good for the greatest number. We may fail to do so because property rights are not clear and/or prices do not reflect the value of the resources.

[Staveren goes on to argue that redistribution of resources (equity) can do wonders for both efficiency and/or utility maximization. Although I acknowledge the problems of resource distribution today, I do not fully agree with this heterodox perspective. Anyone interested in these issues should read the paper.]

Bottom Line: Institutions for managing resources need to reflect their full value. If not, we will not maximize their value.

3 comments:

Bob Murphy said...

I have to read the paper, but I wanted to clarify a common misconception for your readers who were fortunate enough not to waste five or more years of their lives getting a PhD in economics:

Strictly speaking, talking about "total utility" or the "sum" of utility is nonsense. Standard theory does not assume that there is even such a thing as a unit of utility; this is just a convenient language we use to allow calculus when solving optimization problems.

If someone has a utility function on gallons (or liters, for everyone else in the world) of water according to U=w^(1/2), i.e. where you take the square root of how many units of water you consume, and that's how many "utils" you have. Note it is increasing in water, but declining marginal utility. E.g. the 100th unit of water gives you a smaller increment in utility than the 10th unit of water.

But even here, it doesn't really make sense to think that we economists are "measuring" utility. You could replicate the same behavior of the person by using a utility function of U=2*w^(1/2), i.e. you just double all the utility numbers assigned by the previous function. The agent's actions (for given prices, income, etc.) would be the same.

Finally, Pareto efficiency does NOT mean "maximize social welfare." You can't maximize something whose components you can't add up. Pareto efficiency rather means, "There is no technologically feasible rearrangement of goods such that at least one person is better off, and no one is worse off."

Bob Murphy said...

BTW I should also say that David is talking like other economists talk. I'm just saying, utility theory is an area where economists speak one way, but rely on a theoretical edifice that actually doesn't match up with the English description. So outsiders get very confused.

David Zetland said...

Bob -- I agree with your second comment and your general point that utility is a weird item.

BTW, IMO, controversy (!) over the shape of the utility fn is not as damning as the problem of interpersonal comparison of utility, which comes up if you want to Max U across all i.

The thing I like about this paper is the way that it discusses WHAT is included in the utility fn. It's an important point.