The Economics of Social Welfare
Welfare Economics is the branch of economics that evaluates the effects of economic policies, processes, and outcomes. Neoclassical economics uses a welfare function, where social welfare is based on the well being of all the individuals, according to their values. The problem with that is that individual utility can’t be added up, and even if we do add it up, we should not include all the preferences that people have, such as the preference of a thief to steal goods or the preference of a fanatic to murder those people he disagrees with.
by Fred E. Foldvary, Senior Editor
The benefit individuals get from consuming things is called the consumer surplus. Nobody knows that surplus except the individual. If we trust him to tell the truth, we can ask a person what is the most he would pay for something, and compare that to how much he actually pays, and take the difference to get the consumer surplus. But it is not practical to do that for all goods, and if we try, people can lie, and even if they can estimate it and tell the truth, their preferences are subject to change.
Neoclassical economic welfare economics also uses the concept that a situation is optimal if there is no way to improve the position of one person without reducing the well being of someone else. But almost all outcomes are optimal in this sense. Removing the import quota on sugar imported into the USA would benefit consumers but would eliminate the profit of the protected growers. So this criterion is useless for policy.
Neoclassical economic theory has a “first fundamental theorem of welfare economics” which says that if there is atomistic competition in production and consumption, with thousands of producers and consumers of one uniform good, the outcome is efficient because the price of the good equals its marginal cost, the cost of producing one more good. But in fact, many industries produce goods where there is product variety, where that theorem does not apply, yet it would be silly to call product variety inefficient, because folks prefer to have the choice.
In contrast, a market-process concept of social welfare would not try to measure outcomes or individual utilities, but rather judge how well individuals are able to pursue their goals and correct past errors. Because preferences are subjective and the knowledge of how to best produce goods is dispersed, there is no way government can improve on the preferences and actions of individuals.
This implies that folks not interfere with the actions of others, so that only peaceful and honest action is free of restriction. The joy of theft does not count for social welfare. Social welfare is therefore a moral concept.
To determine the social welfare function, we first need a moral standard, and it has to be a morality for all humanity, independent of subjective whims and of arbitrary cultural standards. This is the universal ethic by which acts are good if they are welcomed benefits, and evil if the acts coercively harm others, even if they happen to offend some folks. The taxation of peaceful and honest human action coercively harms the actor because by making the goal more costly, the tax restricts it.
Governance which applies the natural law of the universal ethic will also provide the greatest social welfare. An economy governed by natural moral law maximizes the four surpluses. The consumer surplus is maximized because consumers are free to buy the products they most desire, with no arbitrary restrictions nor any added costs such as taxes.
Neoclassical economics has the concept of a “producer surplus,” the difference between the price of a good and the cost of producing that good. But any gain from production is not a surplus, but rather a return on exertion. Any surplus therefore comes from non-production, such as the rent from land which no human produced. This non-producer surplus is maximized by the universal ethic, because there is no added cost to production by taxation or restriction. The non-producer surplus can be used to finance public goods without any excess burden.
The worker surplus is the difference between a worker’s wage and the least he would accept as payment. The worker surplus is maximized by avoiding taxes on wages.
The fourth surplus is the taxpayer surplus, the difference between the benefit of a government service and the tax price paid by the taxpayer. Often, this surplus is negative. The taxpayer surplus has to take into account all lost opportunities caused by the tax. The civic revenues that maximizes the taxpayer surplus are payments for causing damage, such as pollution, and payments that have no opportunity costs, such as tapping site rentals, as land has no opportunity cost. Nothing was given up to obtain land, nor will anything be given up to produce more land, since no more can be produced.
Real welfare economics is therefore based on implementing a market ethic that has no restriction or tax on peaceful and honest human action. The policy of fining negative acts and tapping economic rent for civic revenues maximizes the surpluses of the consumer, the non-producer, the worker, and the resident paying for civic services. Maximizing these surpluses maximizes social well being by letting each peaceful person determine his own benefits free of any interference. There is no need to add up individual benefits or judge particular outcomes. Just let people be free, and social welfare will follow.
-- Fred Foldvary
Copyright 2006 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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