It's a matter of trade-offs.

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Balancing Fairness and Efficiency

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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One common criticism of economics is that it focuses too much on efficiency, and not enough on things like equality, fairness and the welfare of future generations. In the extreme version of the criticism, the focus on efficiency is a deliberate plot to keep resources in the hands of the wealthy.

The economic definition of efficiency -- also called Pareto efficiency, after the Italian economist Vilfredo Pareto -- is easy to understand. Basically, it’s just the same thing as gross domestic product. The more things we produce -- including goods like TVs and cars, but also services like insurance and back massages -- the fewer resources we are wasting. Perfect efficiency -- called Pareto optimality -- is a situation in which the economy is so efficient that it’s impossible to give one person more without taking something away from someone else. In other words, perfect efficiency is a world where there really is no free lunch.

Economists focus on efficiency for several reasons. The first is probably historical. As historian Adam Tooze notes in his book “The Deluge,” government attention to economic statistics increased dramatically after World War 1. The U.S., with its massive economic output, had tipped the scales decisively in favor of the Allies, so total output was believed to be an indication of warfighting strength. That logic seemed to repeat itself in World War II, and again in the Cold War, in which the U.S. is widely believed to have outspent the Soviet Union. Greater economic efficiency probably means a more militarily powerful nation.

The second reason economists focus on efficiency is that it’s clear and unambiguous. Human welfare, on the other hand, is tricky to define. Should we care about people’s ability to fulfill their desires, or their emotional happiness? Should we value each member of society equally, or should we place more emphasis on the poorest and most disadvantaged? What is “fairness,” and how should it factor into our economic calculus? Economists usually shy away from taking a stand on these difficult philosophical questions, and stick to thinking about what will boost GDP.

The critics, however, make some good points. The most obvious flaw in the efficiency concept is the question of time -- by producing more today, we leave fewer resources for our descendants. A policy that is Pareto optimal today may be robbing from our unborn grandchildren. Thus, static efficiency, or efficiency in the present, isn’t always the same as dynamic efficiency. Economists must take a stand on which one they care about when the two are in conflict.

I also believe that economists are dodging responsibility when they ignore the hard philosophical questions of human welfare. After all, a world in which one person owns all the output, and everyone else starves to death, is technically Pareto optimal, since saving the masses from starvation would require making the monopolist worse off. That’s not the kind of world any of us want to live in. As inequality becomes a more important issue in the U.S. and other rich countries, economists can no longer afford to ignore the trade-off between efficiency and equality.

But the critics of efficiency tend to overreach. First, economic growth usually does enrich the poor as well as the rich. Even the last few decades of global growth, which have seen inequality increase in rich nations, have produced huge gains for most of the world’s poor, and reduced global inequality in the bargain.

Second, efficiency really does capture how many economic arrangements are simply suboptimal. New policies and institutions really can make things better for everybody.

For example, consider property rights. Matt Bruenig, a writer at the website Demos, claims that property rights represent a form of theft. But imagine a world with no property rights, where everyone always has to be afraid of someone taking the food that they hope to eat tomorrow. By establishing and enforcing rules saying that some of the food is “mine” and some is “yours,” we can allow everyone to sleep better at night, secure in the knowledge that they will be able to eat tomorrow. I call that an unambiguous win for society.

The real strength of the efficiency concept is that it focuses on gradual improvement. Instead of trying to radically reorganize society from the ground up, efficiency focuses on finding institutional or policy tweaks that make everyone just a little better off. So far, I think that history has shown that gradual reform is the best way to improve the world. So no, the efficiency concept isn’t perfect, and economists should also think deeply about things like fairness and welfare. But we shouldn’t give up on our quest for a more efficient world.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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