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Lecture notes, cheat sheets
History of economic thought. Economic theories of welfare (lecture notes)
Directory / Lecture notes, cheat sheets Table of contents (expand) LECTURE 11. WELFARE ECONOMIC THEORIES 1. The evolution of views on welfare issues Humanity, like the individual, has always sought to achieve prosperity. Already in the ideas of early utopian socialism, the destruction of private property, egalitarian distribution and the complete regulation of public life were considered as a condition for achieving universal happiness. According to the representatives of this doctrine, a person is unhappy because he is envious of a more fortunate neighbor. And there is only one way to destroy envy - to make everyone the same. The ideologists of capitalist production with their philosophy of selfishness and individualism (see the views of A. Smith - author's note) in the theory of welfare focused on production, viewing welfare as a synonym for wealth, where wealth was understood as products of material production. Within the framework of these ideas, the basis and source of well-being is the accumulation of national capital, and the indicator of the level of well-being is the growth in the amount of goods per capita or the net income of the nation, which functionally depends on the resources of capital, land and labor. Consequently, the factors of economic growth, the most important of which were the accumulation of capital and the division of labor, automatically became factors in the growth of well-being. The classics unanimously considered the system of “natural freedom” to be a prerequisite for the growth of national wealth. The origins of modern theories of welfare should be sought in utilitarianism - an ethical theory that recognizes the usefulness of an action as a criterion of its morality. The founder of this theory was the English philosopher I. Bentham (1748-1832), who believed that philosophy has no more worthy occupation than supporting the economy of everyday life. Bentham proclaimed well-being as the goal of every human action. Consequently, according to Bentham, the only universal social science should be “eudaimonics” - the science of achieving well-being. Bentham proposed to measure well-being itself by subtracting the amount of suffering from the amount of pleasure for a given period of time. In his theory, he proceeds from the fact that every person is able to perform those arithmetic operations that are needed to obtain maximum happiness. It should be noted that in Bentham's concept man is exclusively a consumer; the sphere of production interests him very little. Moreover, it is aimed at immediate consumption - future pleasures, according to the “arithmetic of happiness,” are included in consideration with less weight than present ones. This person (Bentham's universal consumer) is well recognized; it is he who becomes the central figure of marginal analysis. And the same G. Gossen, who was the first to formulate the law of diminishing marginal utility (see Gossen's laws - author's note) took from traditional economic science the philosophy of utilitarianism with its principles of reasonable egoism, subjective comparison of benefits and sacrifices, pleasure and suffering. He even proposed renaming political economy Genusslehre, that is, the doctrine of satisfaction (or pleasure), where maximizing pleasure (utility) becomes the most important principle of social management. In Bentham, as in the marginalists, we see the reduction of all motives of human behavior to the achievement of pleasure; They view wealth as a special case of pleasure. And this is the first difference between the views of Bentham and Smith. Another difference is that Bentham did not trust the coordination of individual aspirations for well-being to the market and competition, considering this the prerogative of legislation, where the ideal set of laws should be built on the principle of “maximum happiness for all.” It is worth noting that Bentham’s views influenced not only representatives of the marginalist trend in economic science, but also Sismondi, who believed that the science of management should set as its goal the happiness of people united in society. In his words, “...it seeks means to secure for men the highest welfare consistent with their nature.” 2. A look at the economic theory of welfare by V. Pareto. "Pareto optimum" Until now, our focus has been on the behavior of economic entities (consumers and firms), the study of the conditions for optimizing their behavior, which boils down to maximizing utility. This predetermined our interest in the problems of formation of prices for factors of production, which are also the income of the owners of these factors, and prices for the products of firms. However, the question remains open: does optimizing the behavior of individuals mean maximizing social welfare as a whole? The answer to this question, among other things, will help answer the question of whether the existence of monopolies prevents the achievement of this state. I. Bentham proclaimed as the sole goal of any government “to ensure the greatest happiness to the greatest number of people.” But how? A fundamentally different answer to this question is given by the authors of the two most famous theories of economic well-being - the Italian economist V. Pareto and the English economist A. Pigou. According to his economic views, V. Pareto (1848-1923) can be classified as a representative of the Lausanne School of Economics. Like Walras, Pareto considered political economy to be a kind of mechanics that reveals the processes of economic interactions based on the theory of equilibrium. In his opinion, this science should explore the mechanism that establishes a balance between the needs of people and the limited means of satisfying them. V. Pareto made a significant contribution to the development of the theory of consumer behavior, introducing ordinal ones instead of the quantitative concept of subjective utility, which meant a transition from the cardinalist to the ordinalist version of the theory of marginal utility. Further, instead of comparing the ordinal utility of individual goods, Pareto proposed a comparison of their sets, where equally preferable sets were described by indifference curves. According to Pareto, there is always a combination of values in which the consumer does not care in what proportion he receives them, as long as the sum of these values does not change and brings maximum satisfaction. These provisions of V. Pareto formed the basis of the modern theory of consumer behavior. But Pareto is best known for his principle of optimality, which was called the "Pareto optimum", which formed the basis of the so-called new welfare economics. The Pareto optimum states that the welfare of society reaches its maximum, and the distribution of resources becomes optimal if any change in this distribution worsens the welfare of at least one subject of the economic system. In a Pareto optimal situation, it is impossible to improve the position of any participant in the economic process without simultaneously reducing the well-being of at least one of the others. This state of the market is called the Pareto-optimal state. According to the Pareto criterion (criterion for the growth of social welfare), movement towards the optimum is possible only with such a distribution of resources that increases the welfare of at least one person, without harming anyone else. The initial premise of the Pareto theorem was the views of Bentham and other early representatives of utilitarianism among economists that the happiness (considered as pleasure or utility) of different people is comparable and additive, that is, they can be summed up in some common happiness of all. And, according to Pareto, the criterion of optimality is not the general maximization of utility, but its maximization for each individual within the limits of owning a certain initial supply of goods. Based on the premise of the rational behavior of the individual, we assume that the firm in the production of products uses such a set of production possibilities that will provide it with the maximum discrepancy between gross revenue and costs. The consumer, in turn, acquires such a set of goods that will provide him with the maximization of utility. The equilibrium state of the system involves the optimization of objective functions (for the consumer - utility maximization, for the entrepreneur - profit maximization). This is the Pareto optimal state of the market. It means that when all market participants, each striving for their own benefit, reach a mutual balance of interests and benefits, the total satisfaction (general utility function) reaches its maximum. And this is almost what A. Smith spoke about in his famous passage about the "invisible hand" (though not in terms of utility, but in terms of wealth). Subsequently, the theorem was indeed proved that the general market equilibrium is the Pareto-optimal state of the market. So, the essence of Pareto's views can be reduced to two statements: ▪ any competitive equilibrium is optimal (direct theorem); ▪ the optimum can be achieved by competitive equilibrium, which means that the optimum selected based on certain criteria is best achieved through the market mechanism (inverse theorem). In other words, the state of the optimum of objective functions ensures balance in all markets. Optimization of objective functions, according to Pareto, means choosing the best alternative from all possible by all participants in the economic process. However, it should be noted that the choice of each individual depends on prices and the initial amount of goods that he has, and by varying the initial distribution of goods, we change both the equilibrium distribution and prices. It follows that the market equilibrium is the best position within the framework of an already formed distribution system and the Pareto model assumes that society is immune to inequality. This approach will become more understandable if we take into account the "Pareto law", or the law of distribution of income. Based on a study of the statistics of a number of countries in various historical epochs, Pareto found that the distribution of income above a certain value retains significant stability, and this, in his opinion, indicates an uneven distribution of natural human abilities, and not an imperfect social conditions. From this followed the extremely skeptical attitude of Pareto to the questions of the social reorganization of society. However, it is difficult to dispute the position that the optimal, according to Pareto, is very often socially unacceptable. Therefore, even in line with the neoclassical direction of political economy, other welfare theories are being formed. 3. A. Pigou’s theory of economic welfare According to Pareto's views, perfect competition will ensure the maximization of the utility function throughout society. However, at the beginning of the twentieth century, certain doubts arose about the truth of this position. In this regard, it is worth mentioning the views of the English economist G. Sidgwick (1838-1900), who for the first time began to consider such concepts as wealth and well-being both from the position of society and from the position of the individual, emphasizing that the same concepts have different meanings depending on whether we look at them from a social or an individual point of view. Therefore, for Sidgwick, the accumulated stock of material resources (which was synonymous with wealth among the classics) and the wealth of society, its real income, are by no means the same value. As is known, within the framework of the classical school of political economy, A. Smith’s position was an axiom that each person, pursuing his own benefit, simultaneously serves the interests of society (this is the essence of the principle of the “invisible hand” - author’s note). Sidgwick cites simple, now textbook examples of the discrepancy between private and public benefits and concludes that to effectively solve many types of production problems, government intervention in one form or another is required. According to Sidgwick, the shortcomings of the system of “natural freedom” are manifested in an even more prominent form in the distribution system and excessive income inequality. Anticipating twentieth-century economists, he writes that a more equal distribution of created wealth increases overall levels of well-being. The work of another prominent English economist, a representative of the Cambridge school A. Pigou (1877-1959), whose book “The Economic Theory of Welfare” was published in 1924, was devoted to the problems of welfare research. Pigou set the goal of his research to develop practical tools for ensuring well-being based on the premises of neoclassical theory: the theory of diminishing marginal utility, the subjective-psychological approach to valuing goods, and the principle of utilitarianism. It can rightly be said that Pigou completed the creation of the neoclassical theory of welfare. At the center of Pigou's theory is the concept of a national dividend, or national income, considered as a net product of society, as a set of material goods and services bought with money. And Pigou considers this indicator not only a measure of production efficiency, but also a measure of social welfare. As we can see, Pigou's approach to the problem of well-being assumes a view from the position of the whole society, and not the individual. But, curiously, this approach is applied using concepts such as individual satisfaction function, private benefit from production, etc. As part of his concept, Pigou drew attention to the fact that the concept of individual well-being is broader than its purely economic aspects. In addition to the maximum utility from consumption, it also includes such components as the nature of work, environmental conditions, relationships with other people, position in society, living conditions, public order and safety. In each of these aspects, a person can feel satisfied to a greater or lesser extent. Today, these characteristics are combined into the concept of “quality of life.” However, defining quality of life faces significant difficulties due to the inability to measure utility. Pigou repeatedly emphasizes that the size of the national dividend does not accurately reflect the level of general well-being, since many elements of the quality of life that do not have a monetary value are nevertheless real factors of well-being. Therefore, situations of growth in the level of general well-being are possible while the level of economic well-being remains unchanged. Nevertheless, in the general case, Pigou concludes, “...qualitative conclusions about the influence of economic factors on economic well-being are also valid in relation to general well-being.” But for Pigou, the overall level of well-being is influenced not only by the size of the national dividend, but also by the principles of its distribution. Based on the law of diminishing marginal utility, he puts forward the thesis that the transfer of part of the income from the rich to the poor increases the amount of general welfare. On the basis of these assumptions, Pigou developed his theory of taxation and subsidies, where the main principle of taxation is the principle of the least cumulative victim, that is, the equality of the marginal victims for all members of society, which corresponds to the system of progressive taxation. It should be noted that in substantiating progressive taxation, that is, advocating the equalization of disposable income through taxes, Pigou consciously or unconsciously proceeded from the hypothesis of the sameness of individual utility functions from income. It follows from this hypothesis that a higher tax rate on high incomes means about the same loss of utility for high-income groups as a lower tax rate for low-income groups. Pigou's reasoning is based on Gossen's second law, according to which the maximum utility is achieved under the condition that the marginal utilities are equal per the last monetary unit spent, in this case, per unit of disposable income. In the aspect of distribution problems, Pigou also considers the question of the relationship between the economic interests of society and the individual. G. drew attention to a certain conflict between private and public interests. Sidgwick. Developing his views, Pigou set the task of finding the theoretical foundations for resolving such conflicts. As already noted, for Pigou, the size of the gross national product does not accurately reflect the level of general well-being, since the state of the environment, the nature of work, and forms of leisure, etc. are real factors of well-being and therefore a change in the level of general well-being with a constant level of economic well-being is possible. In this regard, Pigou analyzes in particular detail situations where the activities of the enterprise and the consumer have so-called "external effects" that do not have a monetary measure, but, nevertheless, they really affect well-being. As a textbook example of negative "externalities" we can cite environmental pollution as a result of the industrial activities of enterprises. Pigou notes that, depending on the sign of externalities, public costs and results can be either greater or less than private ones. The key concept of Pigou's concept is precisely the divergence (gap) between the private benefits and costs resulting from the economic decisions of individuals, on the one hand, and the social benefits and costs that fall to the lot of everyone, on the other. The object of Pigou's closest attention was situations where the social costs of producing a good were greater than the private costs of its producer. As a result, private supply, subject to profit motives, turned out to be inadequate to the optimal, from the point of view of the whole society, distribution of resources among various branches of production. According to Pigou, for each good produced, it is necessary to satisfy the condition that the marginal social benefit, which reflects the amount that all people would be willing to pay for all the benefits from using an additional unit of goods, is equal to the marginal social cost, that is, the amount that people would be willing to pay for alternative use of resources. In cases where the marginal social benefit exceeds the marginal private benefit, the government must subsidize the production of the good. When the marginal social cost exceeds the marginal private cost, the government should tax the economic activities associated with additional social costs (for example, the emission of smoke from industrial activities) so that the private costs and the price of the goods then reflect these costs. As we can see, the maximization of social welfare, according to Pigue, involves not only a system of progressive taxation of income, but also the measurement of so-called "external effects" and the organization of the redistribution of funds through the mechanism of the state budget. Interesting in Pigou's welfare theory is the conclusion that he draws from the recognition of the theory of interest developed by the representative of the Austrian school Böhm-Bawerk. As you remember, in this theory, interest is considered as a reward for waiting in the conditions of preferring current goods to future ones. Recognizing that our gift of foresight is imperfect and we estimate future blessings on a decreasing scale (except for periods of revolutionary enthusiasm), Pigou concludes that it is difficult to implement large-scale investment projects with a long payback period (including investment in education) and wastefulness in the use of natural resources. This proves that the "free market" system generates conflicts not only between private and public interests, but also conflicts within the public interest: between the benefit of the present moment and the interests of future generations. This leads to a quite logical conclusion that the state should not only ensure the maximization of social welfare through the mechanism of redistribution of income and taking into account "external effects", but also ensure the development of fundamental science, education, and implement environmental projects, protecting the "interests of the future". But the strongest arguments in favor of strengthening the economic role of the state were put forward by J. Keynes. Author: Agapova I. I. << Back: Theories of monopoly and monopolistic pricing (Analysis of the process of monopolization of the economy by representatives of the historical school and Marxism. The theory of monopolistic competition by E. Chamberlain. The theory of imperfect competition by J. Robinson) >> Forward: Economic views of John Keynes (Theory of effective demand. Price and inflation in the theory of J. Keynes. Economic program of J. Keynes)
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