The next stage in development of Welfare Economics after Leon Walras was taken by Vilfredo Pareto, who also succeeded Walras in his professorship. This is all good technical economics that feeds our understanding of market successes and failures, and what to do about them. Unfortunately Pareto’s ideas have been perverted in the usual ways by the usual suspects, including Mussolini’s Fascists.
Vilfredo Pareto
He introduced the concept of Pareto efficiency and helped develop the field of microeconomics. He was also the first to discover that income follows a Pareto distribution, which is a power law probability distribution. The Pareto principle was named after him, and it was built on his observations that 80% of the wealth in Italy belonged to about 20% of the population. He also contributed to the fields of sociology and mathematics.
Pareto efficiency or Pareto optimality
The following three concepts are closely related:
- Given an initial situation, a Pareto improvement is a new situation where some agents will gain, and no agents will lose.
- A situation is called Pareto-dominated if there exists a possible Pareto improvement.
- A situation is called Pareto-optimal or Pareto-efficient if no change could lead to improved satisfaction for some agent without some other agent losing or, equivalently, if there is no scope for further Pareto improvement (in other words, the situation is not Pareto-dominated).
The Pareto front (also called Pareto frontier or Pareto set) is the set of all Pareto-efficient situations.[2]
Under the assumptions of the first welfare theorem, a competitive market leads to a Pareto-efficient outcome. This result was first demonstrated mathematically by economists Kenneth Arrow and Gérard Debreu.[8] However, the result only holds under the assumptions of the theorem: markets exist for all possible goods, there are no externalities, markets are perfectly competitive, and market participants have perfect information.
In the absence of perfect information or complete markets, outcomes will generally be Pareto-inefficient, per the Greenwald–Stiglitz theorem.[9]
The second welfare theorem is essentially the reverse of the first welfare theorem. It states that under similar, ideal assumptions, any Pareto optimum can be obtained by some competitive equilibrium, or free market system, although it may also require a lump-sum transfer of wealth.[7]
Ophelimity from greek "Ophelimos" "useful" is an economic concept introduced by Vilfredo Pareto as a measure of purely economic satisfaction, so he could use the already well-established term utility as a measure of a more broadly based satisfaction encompassing other dimensions as well, such as the ethical, moral, religious, and political.[1] As such, it corresponds to the sense in which utility is often used in economic calculations. Irving Fisher proposed replacing ophelimity (and thus utility as it is commonly construed) with the term wantability.[2]
Pareto Optimality in the work of Pareto
Pareto supplied his first version of Paretian optimality in the article Il massimo di utilità dato dalla libera concorrenza (1894b)
In his subsequent Cours d’Économie politique (1964 [1896-1897], §3852, §7212), Pareto proposed a new, and clearer, version of the demonstration.
In his Manuel d’Économie politique (1966 [1906]) Pareto envisages the maximum of ophelimity for the society as a property of the general economic equilibrium and he defines it as the position from which any small variation increases the ophelimity of some and reduces the ophelimity of others (ibid., chapter VI, §32-33).
The Idea and Its Perversion
OK, so a well-functioning market will produce a Pareto optimum in the distribution of goods and services. So, if it’s an optimum, our work here is done, right? Not so fast, Buster. We said that we can reach any Pareto optimum from some initial conditions. How do we choose among them? Worse still, what if the definition of a Pareto optimum is wrong?
Consider a simple case, in which one person owns all of the bread in a community, and others have nothing. This is the ultimate Smithian dystopia.
Everything for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.
Wealth of Nations
At first, it may seem that we have to make the breadholder worse off in order to feed anyone else. But what if the breadholder cannot eat all of this bread, and needs workers to grow and grind grain, and work in his bakery, and deliver bread to other customers, and produce butter and eggs and milk and other foods, and clothing and everything else necessary? And, in fact, to buy bread? You cannot live on numeric prosperity. You need a whole economy.
Therefore we can tax the rich and invest the proceeds in an economy for all of us, even the rich, who will wind up better off with fewer numeric tokens of wealth and more goods and services that they need, including government services.
Nevertheless, Market Fundamentalists hold that markets are pure and produce perfect results, evidence be damned, and anything else is Stalinism.
I will not again draw the straight line away from Friedmanite, Lafferite, Voodoo Reaganomics and Starve the Beast politics to Bidenomics. I will just say, damn, 4.9% GDP growth! Who saw that coming?
Works
- The Mind and Society, New York: Harcourt, Brace and Company, 1935 (translation ofTrattato di sociologia generale). (Vol. I, Vol. II, Vol. III, Vol. IV)
- Compendium of General Sociology, University of Minnesota Press, 1980 (abridgement of The Mind and Society; translation of Compendio di sociologia generale).
- Sociological Writings, Praeger, 1966 (translations of excerpts from major works).
- Manual of Political Economy, Augustus M. Kelley, 1971 (translation of 1927 French edition of Manuale di economia politica con una introduzione alla scienza sociale).
- The Transformation of Democracy, Transaction Books, 1984 (translation of Trasformazione della democrazia).
- The Rise and Fall of Elites: An Application of Theoretical Sociology, Transaction Publishers, 1991 (translation of essay Un applicazione di teorie sociologiche).