Philosophy, Politics, and Economics: Efficiency, Property Rights, and Public Goods

Liberalism and the Pareto Principle

• Amartya Sen conceives of an individual having a right as having the authority to decide the social preference over at least one pair of alternatives $(x, y)$.

• Under this conception, if a person chooses x > y, that choice constitutes the social preference (denoted as $xPy$); conversely, if the person chooses y > x, the social preference is $yPx$.

• Sen's Impossibility Theorem demonstrates that if there are at least two persons, each with at least one right to determine the social order between two options, and assuming all possible orderings of social states are permissible, the social outcome selected by these rights can conflict with the Pareto principle.

• The Pareto principle (specifically the weak version) states that if for every individual x > y, then the social preference must be $xPy$. This is based on the intuition that if everyone prefers $x$ to $y$, society should surely prefer $x$ to $y$.

• Accepting both individual rights and Paretian welfarism can result in intransitive social preferences.

• The Case of Lewd and Prude (Lady Chatterley's Lover):

  • There are three social states: $a$ (Prude reads the book), $b$ (Lewd reads the book), and $o$ (No one reads the book).

  • Prude's ordering: o > a > b (Prude prefers no one reads it, but would rather read it himself than let Lewd have it).

  • Lewd's ordering: a > b > o (Lewd prefers Prude reads it for the shock value, but would rather read it himself than have it go to waste).

  • Pareto preference: Both Lewd and Prude prefer a > b, so $aPb$ (Paretian welfarism).

  • Lewd's Right: Lewd has the right to choose between reading the book ($b$) or let it go to waste ($o$). He chooses b > o, so $bPo$.

  • Prude's Right: Prude has the right to choose between reading the book ($a$) or let it go to waste ($o$). He chooses o > a, so $oPa$.

  • Combined social ranking: $bPoPaPb$. This is an intransitive ordering where $b$ is preferred to $o$, $o$ to $a$, and $a$ to $b$.

• Sen interpreted this proof as showing the unacceptability of the Pareto principle as a universal rule compatible with liberalism.

• One response is to restrict Paretian welfarism to "self-regarding preferences" (preferences over one's own life) and ignore preferences regarding others' behaviors. However, the authors argue it is difficult to restrict human welfare this way, as people have legitimate interests in their social surroundings.

• Liberal rights are intended to manage these preferences to prevent problems, but Paretianism provides no inherent way to rule out invasive preferences without begging questions about rights and freedom.

Property Rights and Internalizing Externalities

• Externalities occur when there is inefficiency in the trade or production of a good, often because certain costs/benefits are not borne by the parties involved.

• To minimize externalities, parties must "internalize" them, meaning they directly pay the cost or receive the benefit of the externality rather than imposing it on third parties.

• Economic Conditions for Efficiency:

  • An agent proceeds to the optimal point only if they internalize all costs and benefits, stopping where social marginal benefits ($SMB$) equal social marginal costs ($SMC$).

  • A trade is only guaranteed to be Pareto-superior if Alf and Betty fully internalize costs/benefits. Negative externalities (third-party costs to Charlie) may lead to trades where SMC > SMB.

  • Positive externalities (third-party benefits) may result in parties failing to trade even when SMB > SMC.

• The Tragedy of the Commons (Fisheries):

  • Many fisheries are overfished because rights are not clearly allocated.

  • If Alf reduces his catch this year to secure yield next year, he cannot be confident he will reap the future benefit if Betty and Charlie continue to fish.

  • Alf pays the cost of restraint but lacks the benefit; Betty and Charlie reap benefits of overfishing but transfer the depletion costs to Alf.

  • This results in a state where marginal social costs exceed marginal benefits.

• Effectively allocated property rights solve this by according agents full benefits and forcing them to pay full costs. However, institutionalizing rights over resources like ocean fish is difficult because they are mobile.

The Rights-Based Solution to Externalities

• This solution posits that an action has a negative externality if and only if it violates a right. This suggests rights protect a specific set of preferences, and only impingement on these counts as "harm."

• John Stuart Mill (1806–1873):

  • Mill was concerned people would be held accountable for every "cost" (such as actions neighbors simply dislike).

  • He argued that costs should only be recognized when they set back certain interests that ought to be considered rights.

  • Mill listed fit objects of moral reprobation/retribution: encroachment on rights; infliction of loss/damage not justified by one's own rights; falsehood; duplicity; unfair use of advantages; and selfish abstinence from defending others against injury.

• Identifying a social cost (rights infringement) does not automatically mandate prohibition, as social benefits might still outweigh costs.

• Moralistic Conception of Efficiency: This view requires knowing which preferences are protected by rights before defining an externality or an efficient level of activity.

• Criticisms of the Rights-Based View:

  • Liberal political economists usually want to evaluate property rights systems based on their ability to promote efficiency.

  • If efficiency depends on the prior definition of rights, one cannot use efficiency to justify the rights without circularity.

  • Example: If Alf wants to build a tavern and Betty objects due to property values, one must know who has the right (Alf to build or Betty to maintain value) to know which outcome is "efficient."

The Coase Theorem and Transaction Costs

• Ronald Coase (1910–2013) developed an alternative theory on how to internalize externalities and compensate those made worse off.

• Key Insights of the Coase Theorem:

  1. Transaction Costs: Bargaining, exchanging, and contracting are not costless; these costs must be accounted for in any exchange.

  2. Differential Valuation: Externalities are valued differently by different people; if a person benefits from imposing an externality more than it costs the victim to bear it, there is a possibility for a mutually beneficial exchange.

  3. Symmetry of Externalities: Without background rights, we cannot objectively say who is imposing an externality on whom. Avoiding harm to B (prohibiting A's music) inflicts harm on A.

• The Theorem: In a world with zero transaction and bargaining costs, any distribution of rights to impose externalities will result in an efficient outcome because parties will contract to compensate each other at the efficient level.

• Implications for Reality:

  • Coase knew transaction costs are often high, creating barriers to trade.

  • The goal of property rights in this framework is to decide which interest is more important/valuable.

  • Society should place the property right with the person engaging in the more valuable activity, essentially "guessing" what the bargain would be under zero transaction costs.

• Value Attraction: In the absence of transaction friction, rights will naturally move toward the highest-valued users. If rights aren't held by the highest-value producer, it is likely because transaction costs are too high to allow exchange.

• This theory led to the "law and economics" movement and modern cost-benefit analysis.

Public Goods: Definition and Classification

• Public goods are defined by two primary characteristics:

  1. Non-rival Consumption: One person's consumption does not diminish the amount available for others (e.g., clean air or a lighthouse signal).

  2. Non-excludability: It is impossible (or prohibitively expensive) to exclude those who have not paid from enjoying the benefits.

• Taxonomy of Goods:

  • Private Goods: Rival and Excludable (e.g., a carton of milk).

  • Club Goods: Non-rival but Excludable (e.g., a movie theater; one person's viewing doesn't stop others, but the theater can limit entry).

  • Common Pool Resources: Rival but Non-excludable (e.g., fisheries; one person's catch reduces the total pool, but it is hard to prevent people from fishing).

  • (Pure) Public Goods: Non-rival and Non-excludable (e.g., clean air, national defense).

• Pure public goods are rare; most goods cited (highways, ports, education) have disputed levels of "publicness."

Problems of Non-Excludability and Non-Rivalry

• Non-Excludability and the Free-Rider Problem:

  • John Stuart Mill: Argued the state must maintain lighthouses because ships cannot be made to pay a toll at sea; therefore, no private interest would build them without a compulsory state levy.

  • Henry Sidgwick (1901): Noted that benefits of a well-placed lighthouse are enjoyed by ships on which no toll can be "conveniently imposed."

  • Because users can gain the benefit for free, they have incentives to "free-ride"—hoping others pay while withholding their own contribution.

• Non-Rival Consumption and Efficiency:

  • Even if exclusion is possible (a "club good" lighthouse using signal decoders), provision may still be inefficient.

  • Since the marginal cost ($MC$) of supplying an additional user is zero ($MC = 0$), any price above zero that causes a user to decline the service results in a lost social gain at zero cost.

• Undersupply and Positive Externalities:

  • Suppose unit $u$ of public good $p$ is produced. An individual $i$ will produce $u$ if their individual benefit $b_iu$ exceeds their cost $c_u$ (b_iu > c_u).

  • Because $p$ is non-rival, the actual social benefit is the sum of all individual benefits: $\sum_{i=1}^{N} b_iu$.

  • Even if individual rationality dictates stopping production, the social benefit ($\sum b_iu$) may still far exceed the cost ($c_u$), leading to significant undersupply.

State Action, Collective Action, and Public Goods

• Public goods create "collective-action problems" where individual rationality and social efficiency diverge.

• Nuances to the Argument for State Action:

  1. Preference Necessity: For state action to be Pareto-superior, individuals must prefer {having the good and paying for it} over {not having the good and not paying}.

  2. Voluntary Provision (The Fence Example): Public goods are sometimes provided privately. If Alf and Betty both benefit from a fence more than its total cost, even if they'd prefer the other to pay, one may eventually pay the full cost because it is better than no fence.

  3. Large vs. Small Groups: In small groups, provision is more likely. As number ($N$) increases, the temptation to free-ride grows, necessitating formal agreements or state intervention.

  4. The Utility of Inefficiency: Inefficiency is not always a major concern. For goods like satellite television, uniform pricing is used to incentivize entrepreneurs even if the marginal cost for additional users is near zero. While not perfectly Pareto-efficient, it is often acceptable.

Homo Economicus or Voluntary Cooperation?

• The traditional model assumes humans act as Homo economicus (maximizing self-interest).

• Elinor Ostrom's Findings:

  • Individuals often develop non-state social institutions and norms to manage collective goods.

  • Government policies can sometimes "crowd out" these social norms, making cooperation less likely.

• Experimental Public Goods Games:

  • Participants are given an endowment (e.g., $\$20$).

  • Contributions to a common pool are multiplied (e.g., by $0.5$) and distributed equally.

  • Logic: If all contribute $\$20$, they each get $\$30$. If one defects while 9 contribute, the defector gets their original $\$20$ plus a $\$27$ share, totaling $\$47$.

  • Results: People typically contribute about half their endowment initially. Contributions decline over time as people observe others defecting.

  • Stabilization: Cooperation remains robust if participants are allowed to punish free-riders or exclude non-contributors.

• Cross-Cultural Study (Henrich and Smith):

  • Americans: Approx. $25\%$ are fully cooperative (withdrawing nothing from pool), even in first rounds.

  • Machiguenga (Amazon/Chile): Prone to free-riding, withdrawing an average of $77\%$ in the first round; zero full cooperators found in the sample.

  • Paradoxical Hypothesis: Market societies (like the U.S.) may actually be less prone to the selfish behavior predicted by economists compared to small-scale non-market societies.

Questions & Discussion

• Question 1: Does indifference curve analysis require self-interest? If Alf and Betty are altruists (Alf cares for Betty's pizza, Betty for Alf's wings), they can still have an Edgeworth box, though the preferences represent the other's well-being.

• Question 2: If Alf has moral commitments (Charity vs. Philosophy), can he have a cardinal utility function? Yes, provided the commitments meet axioms like transitivity and completeness; Homo economicus is not strictly required for the utility map.

• Question 3: Is economics a "conservative science" because Pareto efficiency starts from the status quo? This is a point of debate, as the status quo determines the starting point for Pareto-superior moves.

• Question 4: Can you have a liberal and efficient state if rights and Pareto conflict? Sen's theorem suggests a fundamental tension between minimal liberalism and the Pareto criterion.

• Question 5: Identifying goods:

  • Club Good: Netflix (Non-state) vs. A state-run toll park (State).

  • Common Pool Resource: A local trout stream (Non-state/Club regulated) vs. The high seas (State/International Law).

  • Public Good: Open-source software (Non-state) vs. National defense (State).

• Question 6: Global Warming: This is a global public good problem. Voluntary action is often ineffective due to the high incentive to free-ride (nations benefit from others' carbon cuts without paying). State (or international) action faces the problem of lack of a central enforcement authority.