Efficiency, like most terms in economics, is loaded. Used in context as if it makes reference to objective properties of the world, efficiency is a value-laden concept.
Pareto efficiency is the idea that a group of agents can be moved to a steady state such that no one could be made better off without anyone being made worse off. In other words, everyone is doing as well as they can given that no one could be made any better off without making at least one other person worse off (and perhaps inviting retaliation).
Pareto efficiency and any other sorts of Benthamite-esque calculi may fail in the complex realities of the harsh world we live in because of the difficulties in making interpersonal comparisons of utility, or achieving permanence with imperfect information, or random dislocations, &tc. Furthermore individuals face shifting frames of reference, which is hard to account for in even fairly robust microeconomic models. But it is no longer bleeding heart liberals who seek to use the mystification of mathematical rigor to justify their value-laden assertions about economic policy.
In "When Value Judgments Masquerade as Science," Uwe Reinhardt states that a distinction must be made between
changes in public policies (reallocations of economic welfare) that make some people feel better off and none feel worse off and those that make some people feel better off but others feel worse off. The first type of policy can unambiguously be said to enhance social welfare. But no such claim can be made for the second, which nonetheless is typical of virtually all major public policies.
When people are in a situation where everyone is doing as well as they can as a group, even if each is not doing as well as they could as an individual, they are said to be on a Pareto frontier. That is actually a very inexact formulation of Pareto dominance, but for our purposes it will have to do. Pareto frontiers can occur from sets of strategic choices where some people feel better off while leaving no one else worse off. In other words, they involve painless gains.
When you hear commentators talk about economic policy, you would think that economic policy involved all sorts of painless gains—for example clearly everyone in society would be better off if we lowered the corporate tax rate. Hell, we should do away with the corporate taxes altogether, even dispensing the mere idea of the concept of taxing corporations from our minds. That would make some people better off and none worse off. No one actually benefits from the spending that government does with revenues they receive from taxing corporations. Well, okay, yes some people do but those same people would be at least as well off if the corporations kept that money and were allowed to spend it creating jobs, which they will certainly do rather than spend it on plant and equipment capital expenditures, investments in external securities, buying back shares, giving dividends to shareholders, or paying compensation to executives. That tortured logic is actually on display in America and the American people, who are pillars of sophistication, are apparently largely persuaded.
The inconvenient truth is, while trade can be a non-zero-sum game, as illustrated in the case of trade by David Ricardo, economic interactions are often zero sum, especially trade (economists, when pressed, admit that only about 1/3 of international trade is explained by comparative advantage). Economic public policy is to some degree about how much the government takes from the rich, in the form of taxes, and distributes to the non-rich in the form of government spending, though much of government spending benefits the rich such as our new industrial policy of bailing out large banks and corporations when they get into trouble with solvency or sometimes just when they become illiquid. To say that the rich are entitled to the fruits of their hard work is every bit as much of a value judgment as to say that the poor deserve for some of it to be redistributed to them in order to provide a social safety net. In addition, if we take $1 away from a rich person and give it to a poor person, the net gain/loss to society is $0, so isn’t the policy welfare neutral as far as society is concerned? And society is as far as we’re concerned, after all we are economists and not advocates for any sort of class interests, this is objective science is the strictest sense of strict constructionism.
Some modern western economists (especially those who can make it on the Kudlow Report) would have you believe that economists has uncovered a law of nature where if you increase the amount of taxes on the wealthy, the class of job creators, then they will either shift those costs onto the non-rich by firing them or not hiring them, or they will simply produce less because there is less incentive for them to produce more when the government is just going to take it away from them.
Let’s try a thought experiment, let’s say you are a billionaire and you have to allocate those billion dollars in spending among a basket of goods across your lifetime such that it maximizes your utility. How in the world are you going to do US$1 billion in consumption in a single human lifetime? How many cars and homes and yachts and jets do you need to be satisfied? Let’s say the government increases your taxes and now instead of being able to 20 luxury cars, 5 homes and a vacation condo in St. Barts, 4 yachts, 2 jets, and a private island, you now can only consume 15 luxury cars, 5 homes and a vacation condo in St. Barts, 4 yachts, 2 jets, and a private island. According to economists, now since you cannot have all 20 of those luxury cars, you are not going to be willing to work as hard so you end up with only 10 luxury cars, 4 homes and a vacation condo in St. Barts, 3 yachts, 2 jets, and a private island.
The government’s confiscatory ways have discouraged you and made you lazy. You may be one of the richest people in the world, but Uncle Sam can really do a number on your work ethic. Sure, the set of feasible capital projects that you can invest in (some of which involve hiring additional laborers) still have the same internal rates of return they did before, but the fact that the government will take an additional 4.5 cents per dollar earned and returned as personal income makes you not want to see them all through.
If you read biographies of rich people, for example Warren Buffet’s The Snowball, you will see that the rich use wealth to keep score, not consume. It’s about status, not about consumption. If you raise the corporate tax rate on all wealthy people in equivalent amount, simultaneously, and without any loopholes, then you have changed the scoreboard but you have not changed the pecking order.
Furthermore, what about the fact that rich people have a higher marginal propensity to save and thus an additional dollar in the hands of a rich person means some smaller amount of change will find its way back into the flow of the economy than if the same additional dollar were given to a poor person? The economic truth is that the rich are simply more skilled users of funds than the poor, that’s the reason why they are rich. We want to play statements like that down because we don’t want the non-rich to feel insecure and jealous of the rich, we want them to keep idolizing and identifying with the wealthy. But that’s just the hard truth. The rich people will save that money and wisely invest it, building up the nation’s capital base in the most efficient way possible.
The problem is, the nation’s capital base has been so thoroughly built up that rates of return by domestic companies are going to tend to be lower than that in developing economies that are structurally capital scarce. Wealthy investors know that and that is why larger portions of investment portfolios are going into emerging market funds.
I have yet to year an economist make the argument that the rich people need to keep their money rather than be taxed so they can fund the development of the rest of the world. I’m sure it’s coming. Economists will continue to make value-laden arguments in favor of policies the further enrich the rich, all the while masquerading as disinterested social scientists in white lab coats. Employing economic analysis, we can see why. It is perfectly rational for an economist to serve as a propagandist for the wealthy; it is the wealthy and their business interests that help finance economic departments, research, and careers.
Philosopher Chin-tai Kim is quoted in "When Value Judgments Masquerade as Science," saying
economics is not a science that only describes, measures, explains and predicts human interests, values and policies — it also evaluates, promotes, endorses or rejects them. The predicament of economics and all other social sciences consists in their failure to acknowledge honestly their value orientation in their pathetic and inauthentic pretension to emulate the natural sciences they presume to be value free.