Chapter 8
Welfare Economics and the Gains from Trade
Author Commentary

Author Commentary 1. Read about the conflict between the Pareto criterion and individual freedom.
Is Everybody Happy?
The cost-benefit analysis of making folks smile.

Here's the least controversial principle in all statecraft:
Never pass up an opportunity to make everyone happier at the
same time. Admittedly, opportunities like that are vanishingly
rare--almost anything you propose is likely to make someone
unhappy--so the principle is as useless in practice as it is
compelling in theory. But if you want to talk about the difference
between good and bad policy, it helps to have an
uncontroversial starting point.

This particular starting point has proved useful enough to
earn a proper name. Economists call it the Pareto Principle, in
honor of the 19th-century economist Vilfredo Pareto. The party
line among economists is that although we disagree about a
myriad of issues, at least we’re all good Paretians: If you can
think of a way to make everyone happier, we’re behind you all
the way.

How disturbing, then, to realize that the Pareto Principle
conflicts with another value that some of us hold at least
equally dear--the right of individuals to make free choices.
Here's a stylized example: Suppose some people (call them
the "prudes") cherish their freedom of religion, but not half
so much as they would cherish a general ban on
pornography. Others (call them the "lewds") cherish their
right to read Lady Chatterley's Lover but not half so much
as they would cherish a general ban on religion. Then if you
outlawed both pornography and religion, you'd make
everyone happier, while simultaneously making everyone
less free.

The Pareto Principle demands that we embrace such a
law while the fundamental precepts of liberalism demand
that we recoil from it. As Nobel laureate Amartya Sen
pointed out 30 years ago, there's no such thing as a Paretian
liberal. When some people get pleasure from controlling
other people, the Paretians and the liberals must part ways.

That's no problem in practice, because in practice there will
always be liberals who are offended by
book-banning--and the very existence of those liberals leads
the Paretian to withdraw his endorsement of the ban.
(Remember, the Pareto Principle endorses only changes that
make everyone happier, including the liberals.) But in practice,
nobody is guided solely by the Pareto Principle anyway.
Instead, we're guided by more flexible criteria such as the
cost-benefit principle: A policy is good when its benefits
exceed its costs, with benefits (or costs) measured by what the
proponents (or opponents) would be willing to pay to see the
policy enacted (or defeated).

Under quite general circumstances, it can be proved
(though not in the space of a single magazine column) that free
markets yield exactly those outcomes the cost-benefit principle
recommends. That makes it easy to reconcile a taste for
economic welfare with a taste for individual liberty: Usually,
markets deliver both at once.

Usually, but not always. With just a slight modification,
the paradox of the Paretian liberal reasserts itself in the
cost-benefit context. Suppose I'm willing to pay $20 to read
the subversive works of Paul Krugman and you're willing to
pay $40 to stop me. A strict cost-benefit analysis suggests that
Krugman's writing should be banned.

(There's no need for a ban if you can locate me and offer
me, say, $30 to change my reading habits--and if you can be
assured that I won't just take the money and run. But let's
suppose the impracticality of such arrangements leaves
book-banning as the only realistic alternative.)

That's a conclusion we liberals find repugnant, and it would be
nice to avoid it. One way out is simply to declare that
"psychic costs don't count." If you don't like getting your nose
punched, your aversion goes into the cost-benefit calculus and
inspires us to write laws that discourage nose-punching. But if you
don't like knowing I read Krugman, that's your own problem.

Appealing as that position might sound, it's also suspiciously
incoherent. If my habit of reading Krugman and my habit of
punching your nose are equally painful to you, why should public
policy discourage one and not the other?

One answer is that psychic costs shouldn't count because
they're too easy to exaggerate. Anyone can claim to have
suffered $1 million worth of emotional distress, but we have
no way of knowing which claims are simply fabricated.
Amazingly, though, this seemingly insurmountable problem can
be surmounted. A sufficiently clever system of taxes and
subsidies can induce people to make accurate reports of their
own emotional distress. (I look forward to explaining how
such systems work in a forthcoming column.)

The second argument against counting psychic harm is
that once you start counting it, people train themselves to start
feeling it. That one, I suspect, is harder to refute.

The mirror image of a psychic cost is a psychic benefit.
The New York Times reports that economists with the Army
Corps of Engineers, charged with executing a cost-benefit
analysis of un-damming the Snake River in eastern
Washington, plan to factor in something they call "existence
value"--the value of the psychic benefit people get from
knowing the river is running wild.

In principle, existence value makes perfect sense. If your Aunt
Agnes just can't stand the idea of people damming the Snake
River, her anguish is a real cost of maintaining the dam. Of
course, it's also true that if your Aunt Agnes just can't stand the
idea of people reading the New York Times, her anguish is a real
cost of allowing freedom of the press. If we're intellectually
consistent, we'll cater either to both those preferences or to
neither.

Not that everyone values intellectual consistency. Professor
Tom Stevens of the University of Massachusetts is identified in
the Times as an environmentalist who is skeptical of the concept
of existence value. The source of his skepticism: "What if you add
up all these numbers and they don't come out in our favor?" So
much for statecraft as a dispassionate attempt to balance
competing interests. If the goal is simply to make the numbers
come out the way you want them to, you're not a policy analyst;
you're just a bully.

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