"social" welfare: introductory dialogues

The concept of social welfare is hardly "social" at all. Once again the market takes center stage; and we are left wondering whether any social institutions could possibly exist in the bizarre world that Mankiw is painting for his readers. Yes, of course the model he sets up is meant to idealize in order to get to the core issues. But as we will see, Mankiw discusses the model in a way that leaves the student without any methodological framework for actually understanding those tools, except at a superficially wrong level.

We arrive at Chapter 7.

Mankiw motivates the study of welfare in perfectly competitive markets by asking whether the price of turkey at the supermarket is "fair". That is, he wants to know whether, by society's standard, the price of turkey is "just".

Behind this question is the following general idea: suppose we were to find some way of measuring the maximum amount of social welfare derived from an individual's consumption of a particular commodity. In equilibrium, the commodity will be sold at a stable price and with a stable quantity. Now, we know that when you consume more of a particular good, the additional satisfaction you get from consuming it diminishes. Thus, if you buy 5 apples at $1, that first apple was worth a lot to you, the second not so much, and so on. Mankiw wants to find some way of measuring exactly how much that first apple was worth to you, plus how much that second apple was worth to you, ... and so on. We know that the last apple, the 5th, is worth $1 to you because we assumed that to be the equilibrium price: you consume apples up to the point where the benefits of an additional apple equal the cost (or price) of an additional apple. So, what is the sum of all the positive values in between?

That is the concept of consumer surplus, or "CS" as we will call it for the remainder of the post.

...

Question: That seems easy enough to understand. But how does "society" fit in here? We were told by you in a previous post that society has no actual agency in the market, that it's really all about market mechanisms. But now you're telling us that Mankiw wants to judge whether the price of the good is "just" according to society. How does that leap take place?

Answer: The key lies in a concept that is not developed in Mankiw's presentation, thereby leading to the confusion. The key to clearing up your confusion is in coming up with a definition of "social welfare". That is, we need to define social welfare in an economy in order to say that markets maximize "social welfare"! The point is simple, and yet extremely crucial, at the same time.

Question: That seems like a simple problem to solve, though. We can measure the CS of any one individual by figuring out how much that individual values each apple. We just survey him or her (theoretically speaking) and come up with a number in money terms. Why don't we just do that for all consumers in the economy? Since everything is measured in money terms, we have a common unit of measurement. So we just add everything up! What's wrong with that?

Answer: There's nothing wrong with that, by any objective standard of right or wrong. But I do think that you need to realize what implicitly you are doing when you propose that measure of social welfare.

Recall first something that was mentioned at the beginning of this chapter of Mankiw: i.e. that we are now in the normative world of economics: what ought to be. Therefore, in your answer to me, you are implicitly saying that society ought to define social welfare as the equally weighted sum of all individually-summed CS's. That's a very big task you've taken on there!

First of all, you're arguing that your weighting scheme: " 1*(CS of consumer A) + 1*(CS of consumer B) + 1*(CS of consumer ...) + 1*(CS) + ... = SW" is not arrived at democratically or socially in any sane sense of the term. Rather, you're positing that that weighting mechanism is just how you think we should add things up to determine welfare.

Second of all, it's pretty arbitrary, don't you think? We've said that each person is unique in society. For example, some people are poor, and constrained much more by their budgets than other people. So, might there be a social welfare function that captures this fact more accurately? Think of person A and B: person A spends 90% of her income on food and other necessities (like turkey) while person B spends only 40%. How will a change in the price of turkey affect these two people? Most likely, it will affect them wildly differently.

Therefore, when you say "Competitive markets maximize social welfare" You are really saying "competitive markets maximize social welfare according to my definition of social welfare". That's not very "social".

Question: OK, let's step back here. Where does this leave Mankiw's original claim about society? All you're telling me is that society is arbitrary, or biased against people who are income-constrained. But "society" can't please everyone. Doesn't this at least give us a baseline?

Answer: No. In a text that purports to be scientific and based on measurement before theory, Mankiw 100% fails. There is nothing "scientific" about choosing an arbitrary weighting scheme and defining it as social welfare. There is also nothing "social" about it, since we are assigning this weighting scheme insulated from democratic processes which modern market economies are supposed to be all about.

We leave, for a separate post, the treatment of the social planner by Mankiw. To give the brief bottom line: it is a wild ride that involves a lot of intellectual thrashing about in the dark, making little sense and certainly not "enlightening" the student to anything regarding market processes or the significance of public policy in the real world.

turning the history of thought on its head, then reducing it to 3 pages not simply by summarizing but by ripping out the N-3 pages in between

Comments most welcome in what is to follow: the beginning of a multi-part series on the treatment of welfare economics in Mankiw's Principles of Economics. In his attempt to substantiate the claim that "society" is responsible for the distribution of income in an economy Mankiw fumbles the point, leaving us with a mess of confused statements and lines of thought. Anarchy ensues and the textbook abandons all hope to be perceived as an intellectual achievement (a political achievement, yes).

In a story that is still in the process of being uncovered, we have a startling discovery in the history of economics education in which the ideas and tools of welfare economics take early and center stage in the most popular principles of economics textbook currently around, by N. Gregory Mankiw.

Normally, welfare economics comes toward the end of any serious study of neoclassical economics. This is as it should, since many ideas and intuitions need to be developed before the student can even approach the idea of general equilibrium. The early placement of the subject of welfare economics (chapter 7 in his Principles text) is seen as an innovation by Mankiw: it allows students to see, early on, the applicability of the core ideas of mainstream economics to public policy.

But we think it's just a more convenient method of pushing the bourgeois ideology: the chapter is innaccurate according to any respectable take on the history of economic thought, full of conflicting and confusing statements, and yet confident throughout that it carries the stamp of approval of the "majority consensus" in economics. As such, Mankiw's act represents a significant turn in the history of economics education and of the bourgeois political project more generally: an exchange of scientific or "rigorous" dignity for, well, none at all.

Mankiw defends against the traditional ordering (i.e., the leaving of normative issues of consumer and producer surplus, social efficiency towards the end of the book, or by not including them at all) in classically bourgeois, non-rigorous fashion: early exposure to welfare economics 1. gives a better appreciation of supply and demand; 2. gives an "intuitive" grasp of market efficiency; 3. gives policy relevance (?) to the neoclassical model by using it as the baseline. As it is clear from these points, Mankiw does not place welfare economics early in the book because later concepts depend on it and build on it logically (cost of production does not build on welfare economics, methinks).

Mankiw sez that the former teacher of Ec 10 at Harvard, Martin Feldstein, originally came up with the idea of introducing welfare economics earlier because of his personal interests in public policy. Indeed, there is no reason, other than pure utility to the bourgeois economist, for putting welfare economics so early in the text. Up until chapter 7 (that is where welfare econ is first used), in fact, not much in the way of following the "scientific method" (which he purports to exploit throughout the text with the line 'observation, theory, observation') is invoked at all:

-The first chapters, as we have seen, are just Mankiw talking about how to think like an economist

-And then he spends a chapter talking just about a made up story, complete with dialog, where ranchers and farmers can trade and take a comparative advantage.

-After a drawn out chapter on supply and demand and the concept of elasticity, he brings government in by discussing how it can effect supply and demand through price floors.

-Then comes welfare.

It gets worse. The standard Marshallian method of calculating consumer and producer surplus (CS, PS heretofore) is flawed. While Hicks' reformulation saves the term in the end, it is not without significant qualifiers on Marshall's original formulation of the concept, so that any reference to the (albeit simpler) model of Marshall is incorrect. CS, for example, is not so easily the area under the market demand curve because that would a cardinal measure of utility (each person's utility in consuming a good can be compared with another person's utility in consuming the same good). If person A spends a large majority of his income on bread compared to person B, then an extra dollar might mean more to person A than it does to person B. Mankiw, of course, uses a rare Elvis Presley album as his example of consumer surplus (what various people are willing to pay for it) so he conveniently skirts the issue. But in fact, he never mentions the problem to begin with.

Remark:

The way that some early economists tried to get around this argument is just fascinating. Lerner (writing before Hicks' innovation), speaking more generally about the welfare properties of general equilibrium, tries to argue that we must accept that "the satisfactions experienced by different people are similar in the sense that they are the same thing" because otherwise, we "deny meaning even to the assertion that anyone other than myself is capable of feeling any kind of pain or pleasure" (25). It is by far the most confusing paragraph in the chapter. He attempts to deride "philosophers" who question how we can know that each person experiences utility from the same good equally but he gives no hard facts. All he says is "that the satisfactions experienced by different people are the same kind of thing is incapable of proof". Observation, Theory, Observation, indeed.

Others, including Marshall himself, simply assumed that each person spends similar (small) amounts on each commodity.

End Remark.

How ought welfare economics be taught, then? (We touch on the point briefly here, but it will certainly gain more attention in upcoming posts.) From the ground up. There's a lot of consumer choice and production theory to get through before we can even think about normative properties of our model. As observed earlier, the entire edifice of the welfare model is cracked and beaten and is probably built on a few fault lines too. We should just get rid of the fairy tale stories implicit in this old horse. But for now, it is important to get to the basics: see how the culture of bourgeois economics works in modern education: turning the history of economic thought on its head, stripping it down to a few pages, and ripping out everything else in between.

Some of the ideas of this post were taken from scholarly articles, including one by Miroslav Svoboda found here. The history of CS and PS is well-known but Svoboda has some interesting anecdotes in their account of the story. They will be elaborated upon in subsequent articles.

This post draws on Mankiw's remarks on "Teaching the Principles of Economics," which appeared in the Eastern Economic Journal, Vol. 24 No. 4, Fall 1998.

Closing the first of this multipart series with the observation that teaching the "right" form of welfare economics is both the right and terribly wrong answer to our troubles. "Right" because the lack of a coherent logic to the idea as presented in the text means that many students, who are not taught the importance of assumptions or even their accuracy, will accept the story. "Terribly wrong" because, even as taught correctly, it is still a horribly misguided understanding of how an economy works.

The contradictions, inaccuracies in this great story are still to be revealed...

new look

For those of you who don't stop by Imagining History daily and read through an RSS feed or Google Reader instead, I thought I would point out that the site has been revamped a bit, with A Cool New Background (yeeeah!), organization, and some additional blog pages on the right side with info about teaching and research. Any comments on these, how they can be cleaned up improved? Tough luck.

(Just kidding. Leave a comment and I'll see what I can fix.)

This was done partly because I was getting bored with the staid orange/white/black combo and also partly because I apparently just hit my 200th post the other day in a little over 2 years of blogging... wooooow!

But don't worry, it's a new look but same feel: you'll still get all the usual writings about videogames, random econ history papers that are actually Cool to Read, and assorted links... although I might be a bit more heavy on Anti-Mankiw for at least a little while...

addendum: stories?

Of course, the idea that NC econ is built on stories is not a new one; McCloskey made the point nicely in The Rhetoric of Economics over 20 years ago and Steve Cohn, professor at Knox and UMass Econ PhD, has argued in "Telling other Stories" that that's precisely what heterodox economists need to do: tell stories which are anti-Mankiw.

Look, you either stress the rhetoric or the "rigor", and you are either orthodox or heterodox.

-Orthodox rigor people are the "positive economics" people out there, people who just want orthodox economics on some "scientific" footing, whether that be more math, or better statistical analysis, or what have you.

-Heterodox rigor people are similar. They want to fight NC economists by "beating them at their own game" -- becoming better mathematicians or statisticians or historians than the orthodox economists, and answer heterodox/left-leaning questions in the process to jet them out.

-Orthodox rhetoric people are the welfare economists, the economists who quite consciously seek to propagate mainstream theory. Mankiw, for example. At the very very top of the ladder, these people often blur with the orthodox rigor people because they are just so good at everything. (Duflo, Acemoglu come to mind).

-Heterodox rhetoric people are the political activists, Marxists, anarchists out there who realize that there is a political battle to be won here and it won't just be won in the ivory tower. We need to raise awareness of fundamental wrongs in the economy and push for the smashing of capitalism and its institutions. At the very very top of the ladder, again, these people often blur with heterodox rigor people (Bowles... and not an economist but I would of course put some public intellectuals like Harvey or Chomsky or those guys at Wisconsin Soc/PolSci(?) in this group).

So in short, Cohn's view (mine as well) is that we need to come up with some good rhetorical strategies taking the form of anecdotes or stories which frame things from a workers' point of view. (McCloskey, on the other hand, believes we need to move in the 'scientific' direction in order to save NC econ.)

Cohn's list of stories is quite exhaustive, including Robinson Crusoe (apparently he owned a slave who was the other person on the island in the NC version of the story), Diamond/Water paradox, and "supermarket" analogies of an economic process rather than "workplace" analogies (even so-called "liberals" such as Brad DeLong are guilty of this fault, for example when he tries to analyze Polanyi's concept of a disembedded market *facepalm*). Needless to say, there is a lot of room for good ideas here.

We move next to a striking example of NC econ stories in action, one that has profoundly earth-shattering effects on Mankiw's text.

This article drew from Steve S. Cohn's "Telling other Stories: Heterodox Critiques of Neoclassical Micro Principles Texts", GDEI Working Paper 00-06, August 2000. Link here.

the culture of the bourgeois

Any culture produces stories, myths, and other traditions with the intent of reproducing itself in society. Economics is no different. Economics attempts to reproduce values that serve the interests of certain wealthy individuals in the capitalist economy (capitalists). This is not a new idea: capitalists itself would admit to it. But, like the creation myths of religions, we can question the truth of these stories with cultures and stories which are not so easily heard, precisely because they are against the status quo, with powerful results.

We shouldn't be surprised by all of the stories we find when we open up an introduction to economics textbook. All cultures have their own sets of stories which are meant to reproduce within any one culture the main ideas, customs, values of the society that maintains that culture. For religion, we have the creation stories and other parables. Ancient Greece had oral history and myth.

Therefore, it is very important to realize that when we see the proliferation of stories in economics -- whether it's "Vinny the vegetarian and Mark the meateater" who trade goods so as to equate their marginal utilities with the prices of the goods, or "Sam the farmer and Ralph the rancher" who specialize in their work in order to exploit comparative advantage -- it is very important to realize that there is a culture behind all these stories, attempting to reproduce itself throughout society. Just as religions spread themselves through introducing their texts and practices to new potential members, and just as any culture has its own set of traditions which, once known and practiced by an individual, signifies the individuals membership into a group, understanding in and believing in the central stories told in economics will lead you on the path towards being an economist (or at least, being accepted within their culture).

The problem is, of course, that the stories of economics are incongruent with reality, even when its practioners never cease to argue in favor for them.

Remark: Whenever I read these "stories" I am really amazed at how unbelievably untrue they are -- even while its author is arguing for them until he is blue in the face. For example, in Abba Lerner's The Economics of Control, he explains the classical model of general equilibrium (i.e. the allocation of goods and services in a competitive economy in the case where N=2). He explains, on page 20, that "[the optimal allocation of goods in a competitive economy] seems so obviously what happens in the existing free market economy that all the rigamarole about marginal substitutability and barter exchange would appear quite unnecessary. There are two reasons," he goes on to say, "why all this argument is not unnecessary."

That is, he gives two justifications for why we need the competitive model.

They are far from satisfactory based on any standard of logic or rigor.

The latter argument he provides is that such a model is necessary because it is the foundation upon which later results are built. Fair enough -- surely insane conclusions may derive from any number of laughable premises.

The former argument is more intriguing. "The first reason," Lerner begins, "is the horror that many socialists have of anything that reminds them of the existing capitalist world. This makes it necessary to show that the usefulness of money as a means of bringing about a good distribution of goods is not merely a bourgeois belief carried over uncritically from experience under capitalism but can be shown to bring about desirable ends by a consideration of fundamental principles" (21). But the Marxian critique of money as a basis for exchange is based on the fetishization of commodities and the principle differences between exchange value and use value of those commodities (particularly, labor). But nowhere in Lerner's discussion of a market economy does he address the Marxist critique of capitalist exchange.

My point is that, according to Lerner's discussion, the theory of the optimal allocation of goods in a market economy is not a substantive critique of socialist policy; rather, it is viewed by Lerner as an ideological attack on (or defense against) Marxism.

That changes the game considerably -- and it highlights the important point made above that these are stories which are told over and over in order to reproduce the ideology of traditional, bourgeois economics.

End Remark

For over a hundred years, since at least the time of the response to Marx's Labor Theory of Value, proponents of mainstream economics have actively recognized that their project is a political one. Thus, the bourgeois culture behind economics tells stories which aim to reproduce the system's core beliefs, even though those beliefs are far from universally true. And, in a surprising twist, most economists will not even admit that they are not being rigorous even though it is obviously true that they are not being rigorous.

why there is more to the organization of economic activity than incentives, tradeoffs, and prices: dilbert edition

Dilbert knows that applying economic incentives in the workplace is not always best, thus calling into question the idea that "markets are usually a good way of organizing activity". Most often -- as is the case with work -- there are probably other, more effective methods for getting Dilbert and his coworkers to perform well.

anti-mankiw: dialogues

The idea that "society" allocates goods and services in a market economy is incorrect: the true agent responsible for economic outcomes in such an economy is the market and market mechanisms. But market mechanisms are far from universal, far from the "usual way of organizing economic activity." In the home, with friends, or at work, decisions are made based on responsibility, need, trust, and love (in the case of the home and friends), or authority (in the case of work).

Question: Economists often attribute the resulting allocation and distribution of goods and services in an economy to SOCIETY, e.g., "SOCIETY allocates resources across the individuals in an economy." But what precisely do economists mean by the term "society decides..."?

Answer: Economists use the term "society decides..." or "society allocates..." in order to rid markets of any blame for problems with the current distribution of income in a society. When economists attribute the current distribution of income to society, economists really have in their minds a process which is not social, but which does rely heavily on markets and market mechanisms:

1. Individuals interact with each other according to a set of assumptions placed on how they behave (they are rational, they respond to tradeoffs, opportunity costs, and incentives).

2. They interact in a marketplace by trading at various prices until ...

3. everyone is satisfied given their budget constraints.

4. The point of this process is to reach the "social optimum": the amount of goods each person has received after individuals have traded in the market.

In short, it is not really "society" that allocates goods and services; it is individuals who interact through a market mechanism. By placing the "blame" on society, or calling it a "socially" determined income, economists make it seem like the market process is impersonal. According to them, the market does not discriminate against the sick and poor, when the sick and poor need medical services or food and cannot pay for them.

Question: But no one is discriminating against the sick and poor when they need medical services. It's just that, when you place everyone who needs, say, medical services, into a room with everyone who wants to sell medical services, the price naturally gravitates to a point where some are just too poor to afford them at the equilibrium price. So, who is there to blame, if not poor people, for letting themselves fall into bad health or not working hard enough to afford medical services at the current price?

Answer: The answer lies in who is truly to blame for the fact that the most needy cannot find the services necessary to survive. Economists say that "society decides the optimal division of goods and services in an economy." That is, society, which is composed of individuals freely making decisions, gives rise to the unfortunate situation of some people being rationed out of healthcare, or food or what have you.

But what we have found in the previous answer is that it's really about the market mechanism -- that is the agent responsible for some of the social problems you mentioned.

Question: So what you are saying is, we ought to blame the market for social problems? But Principle 6 of Mankiw's Principles textbook says that "markets are usually a good way to organize economic activity." Ought we try to enforce efficiency-enhancing solutions to our problems wherever possible, including organs, health care, and housing?

Answer: But markets are not a "usual" encounter in our society. When you go to work, markets are not how that economic activity is organized. Activity at work is organized by a boss or superintendent, who tells you what to do, and then you do it. Sure, you have the right to quit and look elsewhere for a job if you do not like your boss or think you're qualified for a better position, but that does not diminish the fact that for 8 to 9 hours a day you are working not according to a market mechanism, but rather according to the decisions of a central controller and his or her staff.

And when you go home, your mother or father will make dinner for you, not according to market prices or rationality, but because they love and care for you. They also recognize that you have certain needs in life, and try to provide a good life for you based on those needs.

In short, the majority of your day-to-day life, is decidedly not market-based.

-8 to 9 hours are spent at work or at school, under a boss or listening to a teacher

-7 to 8 hours are spent sleeping at home, under a roof provided for you by your parents

-1 to 2 hours are spent enjoying meals prepared for and provided to you by your family

-That leaves 4 or 5 hours left, which you might spend at a school, with your friends, or some other environment which is certainly not guided purely by market incentives

Furthermore, these traditions -- receiving orders in the workplace, or having your parents provide for you as a child -- have worked for thousands of years. So, is it so obvious that we should use the market to allocate healthcare, if there might be some other ways of doing it based on much more trusted and common ideas of responsibility, or need?

In conclusion, when economists say that society has allocated goods and services, it is really a market mechanism at work. Thus, the market is responsible for many existing social problems of the poor and sick. Since a large part of our time is spent outside of the market, either at home or at work, perhaps there are other ways of allocating the things we need. We should look into these before accepting as fundamental the ideas that "trade can make everyone better off", as Mankiw argues in Principle 5 of his textbook.