8.3 Utility and Pareto Optimality: The Orthodox Economic View of Social Welfare

Learning Objectives

By the end of this section, you will be able to:

  • Define Pareto optimality
  • Explain how orthodox determines the conditions for societal well-being to be maximized.
  • Analyze the ethical issues surrounding Pareto optimality.

For orthodox economists the ideal outcome for an economy is an outcome in which Pareto optimality is achieved.  The concept of Pareto optimality owes its origins to a 19th century Italian mathematician Vilfredo Pareto.  Stated simply, the Pareto criterion for determining whether an economy has produced the “best” or “ideal” outcome is fulfilled when economic outcomes are such that there is no way to make any one or many people better off without making any one person or many worse off.

On its own the Pareto criterion for social well-being is an attractive proposition.  After all if someone is harmed in order to improve the plight of someone else or many others, then it appears obvious that someone is being granted preferential treatment at the expense of someone else or many others.  The granting of preferential treatment hardly seems fair or equitable.  In this context, the utilization of the Pareto criterion eliminates the need to make those choices.

Additionally, the granting of preferential treatment opens the door to a long series of ethical questions that can be avoided by applying the Pareto criterion.  On what basis is the decision to harm or benefit being made?  How or when are interventions that inflict harm or bestow benefits decided? If an intervention does take place, who is making the decision to inflict harm or bestow benefits?  What is the degree of harm or benefit triggered by an intervention?  What is the ethical basis for intervening?  In many ways, whenever a government must make budgetary decisions, it is asking and answering these questions.  For example, perhaps government policymakers would like to expand the size of the military.  Expanding the size of the military requires that the government finance the expansion of the military.  Financing military expansion may require that other government spending programs be reduced.  Alternatively, perhaps taxes will be raised to pay for the military expansion.  Either way, whomever is responsible for financing the military expansion is directly paying for someone else to benefit.  In defense of expanding the military, policymakers may have to justify to the public why the public will, presumably, benefit from the expansion of the military.  The Pareto criterion appears to clearly answer these questions.  If a society knows when it is in a position of maximum benefit, then, on the basis of the Pareto criterion, no justification can be made to either harm or benefit anyone, causing all of the above questions become moot.

Something important has now been revealed.  The Pareto criterion only becomes applicable when there is a measure of what it means for someone, or many, to benefit and for someone, or many, to be harmed.  If some kind of metric exists, then, once measured, a society will know when no one person or many can be made better off without someone or many being harmed.  Therefore, what is essential to the Pareto criterion is the mechanism a theorist uses to measure and determine a society’s overall well being.  For orthodox economists, the measure of individual and social well-being is the amount of utility that individuals and society has derived.

Utility Maximization and Pareto Optimality: Ethical Implications

Given the nature of utility maximization, human social interaction is reduced to exchange between individuals.  Clearly the utility assumption generates a distinct depiction of human beings, human needs, and human society.  The utility maximizing assumption also generates a specific conception of what is an economically “just” society.  In other words, orthodox economics has a specific view of what it believes is the best way for society to be organized economically.

The orthodox worldview can be neatly summarized.  If people desire utility, then people can acquire utility by exchanging with others.  Once people exchange with others, the act of exchanging makes them better off.  Once all exchanges are complete, all people are as well off as they can become economically.  If everyone is as well off as they can become, then no one, or many, can be made better off without someone, or many, being made worse off.  As far as orthodox economics is concerned, society has reached its ideal, Pareto optimal, outcome because people were free to make choices within an economy that facilitates exchanges, namely a market based economy.

At this point it should be clear that utilitarianism provides the philosophical foundation supporting orthodox economics while Pareto optimality represents the final outcome of the orthodox social welfare theory.  If utility is the initial proposition on which orthodox theory is built, and Pareto optimality is the culmination of orthodox economic theory, then the utility and Pareto optimality must be intrinsically linked.

The dilemma for orthodox economics is that by accepting the utility theory of value and adopting the Pareto criterion as a social welfare measure, orthodox economics produces a very specific, and ethically limited, framework.  For example, by focusing exclusively on the point of exchange, orthodox economics tends to ignore situations in which people are in disagreement with one another, circumstances of conflict.  The reason why conflict is generally ignored is because the conditions of exchange are assumed in advance.  For orthodox economics, the institutions of exchange, such as markets, contract law, and contract enforcement, are assumed to be in place prior to economic agents exchanging.  Additionally, by assuming that initial endowments are given, orthodox economics assumes the existence of income on the part of trading parties, but generally fails to recognize where income originates.

The trouble for orthodox economics is that it is not hard to imagine a world in which one’s income is affected by discriminatory factors such as racism, sexism, sexual orientation or any other divisive perception. In fact, imagination is not necessary, as the real world is filled with examples of discrimination and exploitation.  Regardless of form, the outcome of discrimination is the same, some are able to exploit others by virtue of their power to discriminate.  Or, in another example, it is clear that conditions of inequality can empower some relative to others.  People that disproportionately benefit from economic outcomes are endowed with more income and have the power to acquire resources.  In instances in which the acquisition of resources becomes concentrated in the hands of a small number of people, those with great wealth and/or income may have the power to exploit their positions of power at the expense of others.  Of course, with exploitation, conditions of inequality may be worsened allowing unequal situations to become further entrenched.

Conscientious observers of a capitalist market system, including utilitarians, are aware that situations of exploitation are not only present, but virtually unavoidable.  Given the existence of conflict and inherent disparities of power, it is easy to imagine that someone might want to intervene in economic affairs in order to level the playing field.  For example, someone might advocate to pass laws to penalize discriminatory behavior so as to reduce its prevalence, or others might seek to impose taxes on some so as to redistribute income or wealth in the hopes of reducing inequality.  The interventions in questions would certainly be designed to make someone, or many, better off at the expense of someone else, or many others.  As a result, no matter how justified the interventionist actions may be, and they are certainly justifiable in the examples provided above, within the utilitarian and Pareto criterion context the interventionist actions cannot be supported!

If the significance of utilitarianism and the Pareto criterion remains obscure, then perhaps less abstract and much more obvious examples may be useful.  The following situations, using subjective measures of utility, are Pareto sub-optimal and cannot be justified:

  1. The defeat of Nazi Germany because Adolf Hitler was made worse off.
  2. The end of slavery in the American South because slave owners were made worse off.

Clearly, to any reasonable observer the defeat of Nazi Germany and the end of slavery in the American South are justifiable as they ended horrible chapters in human history.  However, by following the utilitarian belief and coupling it to the Pareto criterion, orthodox economics cannot really make any argument to defend the destruction of Nazi Germany and the conclusion of slavery in the American South.  Subjectively speaking, Hitler’s loss of utility may have more than offset the world’s gain in utility and thus made the world worse off.  Or, subjectively speaking, the loss of utility to slave owners in the South may have more than offset the gain in utility experienced by the former slaves.  After all, if no quantifiable measure is possible it is actually impossible to know whether or not total utility has become larger or smaller so there is no way for a utilitarian to justify an intervention in the above, albeit extreme, cases.  Additionally, any intervention in the above cases required someone or many being made worse off in order to make some or many better off.  The utilitarian tradition has no adequate way of applying anything more than some kind of hedonistic, happiness seeking, value judgment to human action.  Obviously, there are serious moral and ethical weaknesses associated with the acceptance of utilitarianism.

In summary, the significance and value-laden implications of accepting utility, appears to elude most orthodox economists.  In neoclassical theory price and utility are equalized, specifically price and marginal utility.  Therefore, price equals value and this concludes the story.  The neoclassical oversimplification of value theory, which treats value and price as synonyms, fails to recognize that by believing in utility, the orthodox economist is believing in a set of pre-ordained value judgments.  The importance of this point cannot be overstated.  Observe the significance of prices in a capitalist economy as described in this textbook.  Marveling at how fluidly consumers and producers respond to price changes in markets the textbook states:

“…adjustments in response to price changes happen all of the time in a market economy, often so smoothly and rapidly that we barely notice them…For both the U.S. economy and the world economy as a whole, markets – that is, demand and supply – are the primary social mechanism for answering the basic questions about what is produced, how it is produced, and for whom it is produced.”  (pg. 71)

Because prices send the signals that determine the allocation of resources in a market economy, and the allocation of resources has tremendous social ramifications, then the question of whether or not the allocation of resources is “socially just” must be addressed.  Because value theory provides the foundation for which the quantitative origin of prices, it is value theory then that also provides the basis for the normative criterion from which prices and the allocation of resources may be interpreted.  Clearly, the choice of value theory is extremely important.

Unfortunately, for orthodox economics, the normative implications of the utilitarian assumption generally lay dormant.

As non-orthodox economists are well aware, value theory acts as a cohesive, it is the glue that connects economic theory to a society’s moral and ethical norms.  Any complete theoretical depiction of economic interaction necessarily requires a theory of value.  As such, it is important to self- reflect on what values have been adopted by a theory and how those values impact how economic outcomes are interpreted.    Given the importance of value theory, the one dominant proposition presented throughout this paper is that it is absolutely necessary for any economic theorist to anchor their theoretical ideas to a theory of value.  Within this context, however, the utility theory of value presents orthodox economists with a dual horned dilemma.  To accept utility as the basis for their analysis means that orthodox economists are implicitly valuing any and all market driven economic outcomes, regardless of the negative impacts that those outcomes may have on large segments of the society.  To the contrary, to argue against any and all market outcomes as just, an economist, orthodox or otherwise, necessarily must begin their theorizing applying a different set of values outside of the value of endless hedonism that is central to utilitarian beliefs.

Glossary

Pareto optimality (the Pareto criterion)

when economic outcomes are such that there is no way to make any one or many people better off without making any one person or many worse off

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