Paretianism And The Fundamental Theorem Of Welfare Economics

Have I told you before I love reading? Through my reading I have been exposed to many different ideas. I looked at the list of books that Paul Sohn wants to read, mentioned in his blog, and I was challenged and encouraged by his breadth of interest. Those who grew up in the 60’s had many different sayings, one of which involved mind expansion. There were those that believed drugs were the tool of expansion. I think we were incorrect in that assumption. However, reading is the one thing that can truly expand our minds.

I have recently been exposed to two congruent ideas proposed by Alfredo Pareto (1848-1923).  We usually think of Pareto when we use bar charts displaying data used to make business decisions. But Pareto’s ideas were much greater and deeper than aligning data. Two of which I’d like to discuss this morning: Pareto Optimality and the fundamental theorem of welfare economics.

As I have stated before Adam Smith has aligned free enterprise with political freedom. However, “Smith’s defense of markets did not rest on their purported allocative efficiency, but rather on their connection to social relations based on freedom and equality.” In other words, free enterprise based on direction from the invisible hand, leads to product distribution efficiency, but not an egalitarian income distribution. The innovative, creative drivers who are willing to take greater risks earn greater rewards.

The role then of government is to assure the free expression of choice within the market. As Amartya Sen argues, “Rather than evaluating a market solely in terms of its ability to satisfy a person’s subjective preferences, [one must evaluate the market’s] effects on a person’s actual capabilities, the person’s ability to do and achieve.” In a free system, people should be nourished, literate, and have the “ability to appear in public without shame.” This is rich with meaning.

Free enterprise means we have the ability to chose what we wish to sell and buy. A free political system means we have a choice to choose our political leaders without fear of retribution. There are certain unalienable rights that we as free citizens have that are endowed on us by our creator, thus government is put in place by our God, to ensure these human rights are protected.

The tension between strong centralized government and a free market that we are currently experiencing has been masked by economic advancement. This tension is usually experienced any time we go into a recession. However, it is only when the recession is prolonged, like a depression, that we feel we need to deal with the dissonance.  FDR felt so strongly about this he created a second bill of rights, while several wealthy families were so strongly opposed to redistribution that they attempted to hire a general to overthrough the government of the United States. Cities that have made huge financial promises to its employees are finding they cannot meet their obligations. The Federal government has spent to a level that we will need to pay the piper. These are the moments when we argue over money, and the purpose of government.

The fundamental theorems of welfare economics reflect what we are arguing about. The first theorem argues that free markets move to points of price equilibrium leading to an efficient allocation of resources. This is called Pareto Efficiency. It is not an egalitarian distribution of wealth, but the market distributing goods according to demand. The second theorem is very interesting. “The second theorem states that out of all possible Pareto-efficient outcomes, one can achieve any particular one by enacting a lump-sum wealth distribution and then letting the market take over.” This could argue for a government intervention to redistribute wealth and then let the market do its work. This sounds like to Biblical “year of jubilee,” when the economy was reset.

I am convinced there is nothing new under the sun. We just continue to reinvent the wheel. I’ll tell you, this is why I like to read.

And that is my thought for the day!

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