Efficiency, Rights, and Public Goods in Philosophy, Politics, and Economics

Amartya Sen and the Impossibility of a Paretian Liberal

• Sen's Conception of Rights: Amartya Sen defines a person as having a right if they possess the authority to decide the social preference over at least one pair of alternatives $(x, y)$.
  • If the person chooses $x > y$, the social preference is $xPy$.
  • If the person chooses $y > x$, the social preference is $yPx$.
• The Conflict with the Pareto Principle: Sen demonstrates that if there are at least two persons, each with at least one right to determine the social order between two options, and all possible orderings are permissible, the outcome selected by rights can conflict with the Pareto principle.
  • The Pareto Principle: If for everyone $x > y$, then the social preference must be $xPy$.
• Intransitive Social Preferences: Accepting both individual rights and Paretian welfarism can lead to intransitive social orderings.
  • The Lewd and Prude Example: Concerning the reading of a book (e.g., Lady Chatterley's Lover), let the states be:
    • $a =$ Prude reads the book.
    • $b =$ Lewd reads the book.
    • $o =$ No one reads the book.
  • Both Lewd and Prude prefer that Prude reads the book over Lewd reading it ($a > b$), thus $aPb$ by the Pareto principle.
  • If Lewd has the right to read rather than letting the book go to waste, we get $b > o$, thus $bPo$ based on liberal rights.
  • If Prude has the right to decide if he reads it, and prefers not to ($o > a$), we get $oPa$ based on rights.
  • The resulting sequence is $bPoPaPb$, which is an intransitive social ordering.
• Implications for Liberalism: Sen viewed this proof as showing the unacceptability of the Pareto principle as a universal rule compatible with liberalism. He argues that a commitment to Pareto efficiency can sometimes lead us astray.
• Exclusion of Preferences: One response to this paradox is to exclude non-self-regarding preferences (preferences over the behavior of others). However, the text argues this is difficult because human welfare is naturally tied to social surroundings and how others behave.
• Welfarism vs. Rights: If non-self-regarding preferences are allowed and Pareto is accepted as the social criterion, a consistent system of individual rights cannot be maintained. Liberal rights are intended to manage these preferences, but Pareto evaluation does not rule them out.

Property Rights and Externalities

• Internalization of Externalities: Externalities involve inefficiencies in trade or production. Efficiency is achieved when parties are induced to "internalize" these externalities—paying the full cost or receiving the full benefit of their activities.
  • Betty's Social Marginal Benefit: Only if Betty internalizes all costs/benefits will she stop at the point where social marginal benefits equal social marginal costs.
  • Third-Party Effects: If Alf and Betty trade and there are negative externalities for Charlie, they may trade even when social marginal costs exceed benefits. If there are positive externalities, they may fail to trade even when social marginal benefits exceed costs.
• Function of Property Rights: Property rights are a mechanism to induce agents to internalize externalities. Well-allocated rights ensure agents pay full costs and receive full benefits.
• The Tragedy of the Commons: Fisheries are a primary example.
  • If Alf reduces his catch to secure future yield, he cannot guarantee he will receive those future benefits without clear rights.
  • If Betty and Charlie continue to fish, the stock depletes. They do not pay the full costs of overfishing because the costs of depletion are transferred to Alf.
  • In such cases, marginal social costs exceed marginal benefits. Institutionalizing property rights for fish is difficult because they swim between territories.
• Ubiquity of Externalities: If any preference over the behavior of others counts as an externality, they are everywhere.
  • Example: If Alf prefers that people shop at Target over Walmart, every transaction at Walmart becomes a negative externality due to the impact on Alf's utility function.

The Rights-Based Solution for Externalities

• John Stuart Mill's Perspective: Mill argued that a person should only be held accountable for imposing "costs" on others when they set back interests that ought to be considered as rights.
• Recognition of Social Costs: According to Mill, actions that involve falsehood, duplicity, or encroachment on rights are fit objects of moral reprobation and punishment. Simple dislike of an action by a neighbor does not constitute a social cost.
• Moralistic Conception of Efficiency: This view requires knowing which preferences are protected by rights before identifying externalities or efficient levels of activity.
  • If Prude finds Lewd's reading offensive, but has no right to prevent it, then no cost ($0$) is incurred and no externality exists.
• Critique of the Rights-Based View: Liberal political economists usually argue we should evaluate property rights based on their efficiency-promoting characteristics.
  • If efficiency depends on the prior assignment of rights, the argument becomes circular.
  • Example: If Alf wants to build a tavern and Betty objects, the "efficient" outcome depends entirely on who starts with the right (Alf to build or Betty to maintain property value).

The Coase Theorem

• Ronald Coase ($1910$–$2013$): Developed a theory on internalizing externalities and efficient compensation.
• Three Key Insights:
  1. Transaction Costs: Bargaining and contracting include costs that must be accounted for.
  2. Differential Valuation: Externalities are valued differently by different parties, creating room for exchange.
  3. Symmetry of Externalities: Without a background of rights, it is impossible to say who is imposing an externality on whom. Avoiding harm to $B$ often inflicts harm on $A$.
• The Theorem's Core Argument: In a world with zero transaction costs, any initial distribution of property rights will lead to a Pareto-efficient allocation of resources through negotiation and contracting.
  • The Loud Music Example: Alf enjoys loud music; Betty does not. Regardless of whether Alf has a right to play music or Betty has a right to silence, they will negotiate. If the joy Alf gets is higher than the cost to Betty, Alf will pay Betty to allow the music.
• Efficiency and the Global Level: Coase noted that the globally efficient level of externalities is not necessarily zero. If an activity provides a benefit, people will pay those affected for the right to continue it.
• Real-World Implications: In our world of non-zero transaction costs, the initial assignment of rights matters significantly.
  • The goal of property rights is to decide which interest is more important and should be protected (mimicking what a zero-cost bargain would have produced).
  • Rights tend to gravitate toward the highest-value producers unless transaction costs are too high.
• Legacy: Coase's work led to the fields of Law and Economics and Institutional Economics.

Taxonomy of Public Goods

• Two Defining Characteristics:
  1. Non-rival consumption: One person's consumption does not diminish the amount available for others (e.g., clean air).
  2. Non-excludability: It is impossible or very difficult to prevent non-payers from consuming the good.
• Table 4.3: Types of Goods:
  • Private Goods: Excludable and Rival (e.g., a carton of milk).
  • Club Goods: Excludable and Non-rival (e.g., a movie theater; one person's viewing doesn't stop another's, but the theater can exclude those without tickets).
  • Common Pool Resources: Non-excludable and Rival (e.g., fisheries; it is hard to stop people from fishing, but every fish caught is one less available for others). Investigated by Elinor Ostrom ($1933$–$2012$).
  • (Pure) Public Goods: Non-excludable and Non-rival (e.g., clean air, national defense).
• Standard Examples: Defense, law and order, air pollution regulation, highways, ports, and elementary education. Economists dispute the "publicness" of many items on this list.

The Free-Rider Problem

• The Lighthouse Example: Traditionally used by John Stuart Mill and Henry Sidgwick.
  • Mill argued that since ships cannot be made to pay a toll for a lighthouse, no private interest would build one without a compulsory levy from the state.
  • Sidgwick noted that benefits are enjoyed by ships on which no toll could be conveniently imposed.
• Strategic Incentive: If a good is non-excludable, individuals have an incentive to free-ride—hoping others pay for the good so they can enjoy it for free.

Efficiency and Non-Rivalry

• Inefficiency of Exclusion: Even if a technology exists to exclude non-payers (making a good an excludable club good), the outcome can still be inefficient.
  • If the marginal cost of providing the good to one more person is $0$, any price charged ($X$) that causes a person to decline the service results in a lost social gain at zero cost.
• Under-supply in Production: Suppose a public good $p$ is continuous (like picking up litter).
  • An individual $i$ will produce a unit $u$ only if her individual benefit $b_iu$ exceeds her cost $c_u$.
  • Because the good is non-rival, the actual social benefit is the sum of benefits for all $N$ persons: $\\sum b_nu$.
  • There will be a point where $b_iu < c_u$, and the individual stops producing, even though the social benefit $\\sum b_nu$ might still far exceed the cost $c_u$.

Public Goods and State Action

• The Collective-Action Problem: While everyone benefits from the good, individuals do better by letting others provide it.
• Necessity of Contribution: For state action to be Pareto-superior, everyone must prefer the state {providing the good and paying the share} over the state {no share paid and no good provided}.
• When Markets Do Supply Public Goods: If an individual's private benefit from a public good is so high that they would prefer to build it alone rather than have nothing (e.g., a fence between neighbors Alf and Betty), the good will be provided.
• Conditions for Market Failure: Undersupply typically occurs when:
  1. No single individual's utility makes it rational to buy the good at the efficient level.
  2. The number of people is large, increasing the temptation to free-ride.
  3. Formal agreements on contribution allocation are missing.
• Differential Pricing: Full efficiency for non-rival goods often requires differential pricing. However, the text notes that uniform pricing (e.g., for satellite TV) is often a practical necessity and not always a cause for concern.

Homo Economicus vs. Voluntary Cooperation

• The Homo Economicus Model: Assumes individuals only promote their own goals. This model is often insufficient for describing human action in public goods contexts.
• Ostrom's Findings: Groups often develop social norms and non-state institutions to manage collective goods. Government intervention can sometimes "crowd out" these social institutions.
• Experimental Evidence:
  • In public goods games, participants can pocket an endowment (e.g., $20 \, \text{dollars}$) or contribute to a pool. The experimenter typically increases the pool (e.g., by $0.5$) and redistributes it equally.
  • If Alf keeps his $20 \, \text{dollars}$ while nine others contribute, Alf might end up with $47 \, \text{dollars}$ ($20$ kept + $27$ share), creating a temptation to defection.
  • Most people initially contribute about half their endowment ($50\, \%$).
  • Contributions usually break down over time but can be sustained if punishment of free riders or exclusion of non-contributors is permitted.
• Cross-Cultural Study (Henrich and Smith):
  • Americans: About $25\, \%$ are fully cooperative (withdrawing nothing in the first round).
  • Machiguenga (Peruvian Amazon): Specifically prone to free-riding, withdrawing an average of $77\, \%$ of the pooled money in the first round. None were fully cooperative.
  • Conclusion: This suggests market societies (like the U.S.) may actually be less prone to act as pure "Homo economicus" in public goods contexts compared to some small-scale societies.

Discussion Questions and Summary

• Indeterminacy and Path Dependence: Pareto efficiency is limited by these factors.
• Sen's Impossibility Theorem: Highlights the potential conflict between efficiency and freedom/rights.
• Economics as "Conservative": A question of whether starting from the status quo distribution makes the science inherently conservative.
• Global Warming: A problematic case where voluntary action is often ineffective and state action faces significant hurdles in finding efficient solutions.