 Let me begin by issuing a disclaimer. This talk is not about the economics of welfare. So we're not going to discuss like government welfare programs. That's not what this is about. I mean, you've gone through enough of this already that you know that that's like shooting fish in a barrel anyway, right? And it's sort of obvious as to what the problems are involved in government transfer programs. Now this talk is on a somewhat arcane field in economics called welfare economics. Now I say it's somewhat arcane just because it's been kind of pushed sort of into the background for various reasons that we'll talk about or at least mention as we go through the discussion of this. But then on the other hand it addresses a very important issue in economics and so even though welfare economics may not be like a prominent part of curriculum in an economic program in your undergrad department, the issues involved are of course discussed and are prominent. And the basic issue of welfare economics is can we as economists construct a scientific analysis of social well-being? So is there a economic theory of the well-being of people in society? Is it possible to make such a theory? Or we could say this in a slightly different way. Is there a justification just purely from the economic scientific viewpoint for public policy? What kind of a justification can be actually given within the confines of economic theory? For government policy. Now before we launch into the different approaches that economists have taken to answering this question, let me just remind you about the value-free character of economic theory. This is something that's not really very controversial among economists, mainstream colleagues tend to agree with us that economic theory is scientific. They have a different conception of what it is as you've learned about this week, but they don't really contest this claim. So let's just start with a simple illustration of this and then again, you'll see that this constraint, if you will, on economic reasoning provides certain problems for advocating public policy. Okay, so let's just take a simple illustration of how we would think about the value-free character of public policy, we say. You know, if the government erects a minimum wage above the market clearing wage, then this will result in, you know, we can show through economic logic that this results in unemployment. And this conclusion is entirely value-free in the sense that all we do is start with our beginning axioms and we spin out the logic of demand and supply and market clearing prices, and then we make an application to this particular case and we haven't interjected any ethical propositions in our reasoning process. This is what we mean by value-free. We're just like doctors doing scientific medicine. But then the question comes, how do we apply our knowledge? What happens when we apply our knowledge? Can we be value-free then? Okay, well, perhaps you can see again the problem. We can be value-free till the cows come home in doing our analysis, but when we want to make an application to some particular case, it isn't obvious that we can retain our value-free status, right? It would seem in my case of the minimum wage, we would have to say something like economic theory says we should not, the government should not erect a minimum wage, because if they do it will cause unemployment, and so we're making an ethical judgment that unemployment is bad, but there might be some people who think unemployment is good or more likely, you know, they're labor unions who think that income transfers to them are good and, you know, the unemployment of other people. Well, that's that's a unfortunate side effect of the benefit that we're getting, you know, too bad for you guys, but we still think this is good public policy. So you can see the you can see the difficulty, right, the interface between the ethical dimension of advocating policy or justifying policy and the value-free character of economics. Okay, so let's start then with the different approaches to welfare economics. We'll take these six these are the, for our purposes, the prominent ones. So Mises has his own conception about how you might undertake a justification of public policy. The classical economics had had a conception of how we might proceed to answer this question. There was a school in welfare economics called the old welfare economics that came about through the right at the beginning of the Marginalist Revolution and then the new welfare economics that was based upon the emerging neoclassical synthesis of the 1930s. Then Rothbard famously posed his welfare economics in in the 1950s and the most recent mainstream treatment of welfare economics is sometimes called the compensation principle. So we'll talk about these in turn. So let's begin with Mises. Mises takes its value-free framework. He says, look economics is economic theory is always within the ends means framework. As economists what we're doing is seeing what the causal relationships are between the means and the ends and so we can do this in a value-free manner just as scientific medicine finds out what you know causal factors create cancer or what have you and then and this is all just pure science and value-free. So the economists can tell us what means are suitable to attain particular ends and then Mises says you know for any particular end that someone would select then the role of economists would be would be to say look these are the suitable means by which that end could be attained that that would be the role of the economists quo economists. Okay, so how do you how do you get from that claim again, which is kind of a standard claim in economic theory to Mises's justification for laissez-faire. How does he do this? Well, he makes he makes one ethical claim right he says everyone shares the end of material well-being. Everyone right wants to have material goods better and more plentiful material goods. So that's his starting point. That's his end right. He says look in society. This is what we want everybody wants this and from that claim it's not too difficult to show that the means suitable to the attainment of the material well-being of everyone is the market economy. So he gives his famous demonstration of the you know impossibility of economic calculation and socialism. So he shows that central planning can't provide us with a division of labor system by which material progress is forthcoming. And then of course he has to deal with the case of intervention. I've summarized it here that interventionism impedes material prosperity. But Mises's argument you may recall is that any act of intervention on the part of the government is either counterproductive to the ends at least the ostensible ends to which it is being put. Like again he gives an example of the milk market. He says I suppose we have government officials and they say we want to make milk cheap and available to the consumer. So we place price controls on milk and economic theory can show that actually that makes the milk more scarce. So it's counterproductive to the ostensible ends. And he says look any reasonable person then we'll just conclude that we shouldn't have price controls right. If our end is to have more plentiful milk and price controls give us less plentiful milk well okay so that's not a good public policy we reject that. Then he says there are other interventions that are cumulative they may not be counterproductive in and of themselves but they accumulate in a way that the sponsors of the of these interventions again say wait a minute I you know I didn't want that right. I can see now that this isn't a suitable means to attain my ends because of all these secondary effects. So the minimum wage again is classic illustration of this. We have minimum wage causes unemployment. You know it does raise the wages of a certain group right but by excluding competition the lower marginal revenue product workers they become unemployed. Ooh that's a problem we don't we don't want unemployment right. And so now we have to do something about that right we have to intervene again we have to come up with transfer programs for the unemployed. This thing creates other problems it takes capital from the producers and so it you know gives it to the non-producers so it lowers the capital accumulation process and makes us less wealthy or at least not as wealthy as we would have been and so on. And so again he just says look a reasonable person who says the end of the of having a minimum wage is to raise the income of you know the working poor if that's your end. You can see that you know while it might appear that it does that initially the secondary effects wash away this effect right I think accumulate and therefore we don't really get what we want in the end. So this is a Mises' approach again this is a this is a adequate logical approach but right I mean it's a perfectly fine argument that he makes but remember it does contain an ethical claim right the the weakness in this argument with respect to can we have a purely scientific analysis of the state from economic theory is that we've made one one value judgment at the beginning we've said everyone shares the the end of having more material progress well that may not be the case right that's just a that's just an assumption an ethical claim okay now the classical economic classical economist did something different they had a different approach to this entire question and what their argument was is that what we ought to do to you know create the greatest social welfare is maximize physical output again there's a certain superficial plausibility about this right we want more and better material goods better consumer goods and and more of them and the way to do this is as they argued right Adam Smith famously argued the way to increase production in society is to extend the division of labor on the one hand because when we extend the division of labor we get the greater productivity of bringing into production you know relatively more efficient producers right so so that would be a good idea extend the division of labor and the other is capital accumulation let's just right we will build more factories and and equipment and so on and so forth so this was there you know again there's nothing in economic theory that contradicts this is correct a theory to think that our production increases in our material prosperity is greater if we extend the division of labor and and we accumulate capital it was the policy end of this that well we might debate okay so again it's one thing to say as the classical economists did that we ought to have free trade free international trade right no trade barriers no tariffs and import quotas and so on let's get rid of all that that's again fine most economists would go along with this Austrian certainly would to say that regime of free trade will extend the division of labor will bring you know all those workers in China and India and every place in the world into the world economy and everyone will well the society as a whole in terms of the material goods produced will be richer and so this is a good thing this is you know an adequate policy now part of the problem though with the with the a classical conception of this is since they didn't base this upon subjective value so they they just base it upon the physical the physical production of goods you could also have a policy justified something like you know gunboat policy right you could open up markets at gunpoint this too would seem to be at least possible under this under this view you could just have a policy where England let's say you know threatens Germany some German state right with with war if they don't open up their markets if they don't drop their tariffs and so on and so forth now I'm not saying that all classical economists held this view I'm just saying if you say that it's maximizing physical output that you know is the goal of welfare analysis then you can in fact get these policies that seem at least to us as Austrians questionable now to go from the hypothetical this free trade claim to the actual technological advance and capital accumulation were actual cases where the classical economists advocated policies that went against the underlying private property system in in the economy and advocated you know capital accumulation say in Adam Smith by invoking government policies let's say credit expansion monetary inflation or other sets policies let's say taking income from people who have higher time preference and giving it to people who have lower time preference so the saving investing would be stimulated by this that those policies are also justified because because the goal of having a policy is just to increase physical output is just to produce more and more stuff and the same with technological advance so the classical economists tended to be in favor of patents and copyrights and because they thought now again here you know Stefan Cancelo's made clear there's a question of the economic analysis of the logical analysis of whether or not having a patent regime gives you more and better technology than a than an open system with no patents and so on that will set that question aside I mean we could do the analysis right and probably come down on the side of no IP but but you can see the classical economists just just thought look if we if we have patents then we'll subsidize the it's perfectly okay to for the government to subsidize the development of certain lines of technological improvement precisely because they thought public policy can be justified if it maximizes physical output but okay so so that was the class now by the way I should mention that the this classical notion that we have some sort of some sort of object that we're going to maximize as the goal of policy that lies outside the realm of subjective concerns of welfare itself right of human well-being itself the classical economists are not the only group of economists who hold this as we'll see the the advocates of the compensation principle do the same thing they don't they don't argue for maximizing physical output they argue for maximizing the monetary value of assets and this is just an objective criterion like the classical economists is not necessarily connected to subjective value you have to assume a whole bunch of other things in order to have monetary values connected to subjective values we'll we'll see how they grapple with this and when we get to them okay now let's take the old well welfare economics old welfare economics as I said came about in the wake of the marginalist revolution so economists could no longer ignore subjective value I mean if you're going to do welfare economics in fact about well-being it would seem that the value that people place upon different goods would somehow enter into the analysis again this is sort of assumed when you talk about maximizing physical output right the classical economists were not just talking about building pyramids or you know having physical stuff they sort of took for granted or implicitly assumed that this stuff would be valuable to people so the old welfare economists made this explicit these are guys like edward and pagoo and they they're a goal then for public policy was to maximize social utility where they conceived as social utility as a as the sum of individual utility you could add it up you could have cardinal expressions of utility or if you didn't have cardinal expressions of utility you could have monetary proxies for utility which were addable summable and therefore you could you could tell when utility social utility as the sum of individual utility was rising or falling their classic public policy was income redistribution they said look there's diminishing marginal utility of money or money assets and so a poor person has a higher marginal utility of of money than a rich person the rich person has much more money or more money assets and so the sum the aggregate sum of their of their utilities would rise if we just take income from the rich guy and give it to the poor guy and that was that was one of their prominent policies right so here's a you're justifying this particular public policy on the grounds that it maximizes or brings about greater social utility now again the problems with this are fairly obvious and we won't belabor them the economic theoretical problem is of course that if you if you initiate this kind of mass transfer from the rich to the poor you'll destroy the whole the whole market process of production right again you decapitalize the productive people and you subsidize the unproductive people and therefore the productivity of society overall would collapse and this this wouldn't lead to greater social utility right it's it's the dynamic process of that's set in motion by this kind of massive intervention would would not lead us to desirable consequences but the thing that that particular argument was not the determining factor in overthrowing this view what overthrew this view was the demonstration by Pareto and Robbins that in scientific economic theorizing we we cannot make interpersonal utility comparisons it's it's certainly true that everybody has diminishing marginal utility of money but but that that's not the same thing as claiming claiming that the marginal utility for let's say an additional thousand dollars to a poor person is greater than the marginal utility of an additional thousand dollars to a rich person we know we know only what's going on marginal utility only tells us what's going on in the mind of any particular person but the subjectivity of value does not permit us to interpersonally compare utility so all economists then accepted well mainstream economists accepted this view and the old welfare theory went out went out the window it was just abandoned and in its place we got a new welfare economics and new welfare economics adopted the Pareto rule and they took a particular variation of the Pareto rule that in the literature is called Pareto optimality and we'll go through the conditions of Pareto optimality one by one just to see just to show you that this is uh oh that's a dependent you dependent upon the conception of modeling that the neoclassical economists have but but anyway there are some affinities here between the the new welfare economics and rompards approach so we don't want to miss those as well so the Pareto rule says this that if an interaction in society any social interaction makes one person worse off then any judgment concerning the social welfare consequences requires an ethical rule requires that we interpersonally compare utility we say this guy's utility is more important than that guy's that was the source of the Pareto rule so notice for a social interaction to increase social welfare so to speak it has to make at least one person better off and no one worse off now again it's admitted by the by the new welfare economists that all voluntary exchange does this right so the market does this right a normal process of the market so the voluntary exchange the two parties benefit or if there you know multiple parties to the trade they all benefit and none of them is none of them is you know made worse off because because otherwise they would withdraw right so there's this voluntary character of of exchange now uh so i'm just using that as an example and again there's an affinity between that kind of claim the claim that uh Rothbardians make in uh in Rothbard's version of uh Rothbard's version also uses the Pareto rule okay but let so let's go on now to their conception of how you get um how you apply value free economic theorizing here and then as a conclusion from your analysis you you're able to say good public policy you know proper public policy the government should do x this is this is good public policy it's justified by our economic value free analysis okay so this is in the perfectly competitive general equilibrium and so for those of you who haven't you know studied economics i'm going to sort of acquire you to at least see this one time this is what you would be taught in a mainstream program this is how economics is done in the mainstream so first we start with certain remember this is a model okay so so the standard approach by mainstream economists is to say you know the real world is too messy for us to really analyze empirically with just sort of straightforward complexity of reality so what we have to do is construct simplified models and then and then and then the model will spin out uh empirically testable hypotheses that we can then use empirical data to uh falsify and if we falsify then we can adjust our model accordingly and then you know get closer and closer to having it describe or predict um a reality okay so the model first includes economic agents not human beings but economic agents and these economic agents have well we make certain assumptions about their motivations and about their abilities as as actors so the motivational assumptions are first of all all of the all of the agents in the model as consumers are able to maximize their utility subject to market constraints so they have a utility function um and they have uh you know prices of goods that are given and income that they possess and those of you studying economics have seen this right it's in difference curve analysis so here we get utility maximization uh where as we say the marginal rate of substitution is equal to the price the price ratio for each consumer the entrepreneurs maximize profit they do this in the iso quant iso cost arena for use of the factors of production they decide on how much labor and capital to use in combination to produce a good again based upon the uh production relationship you know they maximize production for a given constraint that they face the prices of the uh inputs and the amount of uh income that they have to spend and uh and then they maximize they also have the consideration of maximizing profit means producing efficiently and then producing what people want so they have right so there's a second condition where they have to produce this is the marginal rate of transformation is equal to marginal rate of substitution i'll get to the technical part of this in a minute where those have to be equal they have to produce exactly the right amount of stuff of each good right amount of each good uh that is being demanded by the consumers okay and then producers people as producers or the agents as producers maximize income so they're subject to this process too right they allocate their income according to where their monetary income or monetary compensation would be the greatest so they're those motivational assumptions right we have agents and they're you know capable of doing the maximizing calculus and uh they're motivated in strictly in these uh in these ways uh then there are certain market conditions that are assumed this again is in order to have a nice uh tractable model certain assumptions are made about the market uh these are the perfectly competitive assumptions maybe you've heard this list but they're things like in every market there are many uh buyers and sellers many small buyers and sellers so you know one of them can set price they're just price takers uh the goods are all homogeneous all sellers sell homogeneous goods no product differentiation right every everyone's just selling uh you know uh exactly identical or at least interchangeably useful uh units of goods resource mobility is costless so it's possible to move for the producers to move resources without cost uh they have perfect information so they're not in the dark about demands and market conditions and so on now uh given these conditions as background and and there are also some conditions about production relationships and the concavity conditions of utility function right so there's a whole bunch of technical stuff I won't go into uh but given these uh assumptions then uh the model we're able to construct a formal model with mathematical equations that we can solve for its general equilibrium uh outcome right we can simultaneously solve all the equations all the labor and capital uses in the production of every good all the different amounts of every good produced all the different trade that would take place uh the prices at which every all of this would occur and so on so everything could fall out from general equilibrium now here's where we're starting to get now to the technical part that I put up on the slide in order for there to be and again I'm doing this I want to run through this as I said before in part because there's some affinities here with the way that Austrians think about about social interaction as well so we shouldn't lose those we shouldn't just think oh you know the model is just just a heap of trash and these guys are just all wet I mean they are wet but they're not all wet right they got something going on here that Austrians would also consent to right incorporate in their own analysis and again you've heard this principle before during the week this is the idea that if they're if they're unequal values people in their heads hold valuations for different goods that are unequal significantly unequal they can engage in exchange and as they engage in exchange since they have diminishing marginal utility for the two goods they're trading their marginal utilities come together right and they come together to the point where they stop trading they're at a plain state of rest so that that really is true right we really do have these arbitrage processes in the real world where you know the price of oil a spot price of oil today and trading in London is 150 dollars a barrel and then New York is a hundred well then it really is true that the traders would jump in right and arbitrage away this difference they would you know buy the oil cheaply in New York and then resell it immediately in London where its price was high and by doing so they would bring it would eliminate the differences in prices eliminate the differences in marginal utilities so there is this process that's that's being undertaken in markets all the time uh what what's wrong with the modeling of this of course is that what we've done is this kind of functional analysis where we not only have this process of arbitrage moving goods from lesser value to higher value users and then eliminating the price difference but we get we have to get to solve the model a single solution where we get equality of all these things right where everything is equalized there can't be any any differential between utility values or or technically speaking marginal rates of substitution uh or price uh prices that exist in different markets or profitability opportunities and so on and so forth we have to squeeze out every possible value differential that might exist among the agents and among the producers and so on in the market in order to get a solution uh attractable solution in the model so the marginal rate of substitution has to be equal for all consumers marginal rate of substitution is the amount of why that a person is willing to give up in order to obtain another unit of x it's the rate of which they're willing to exchange the physical amounts of goods uh in in the marginal rate of technical substitution the next line down has to be equal in the production for all goods this is labor and capital so every entrepreneur who's using a certain type of labor and a certain type of capital and production has to bring the trade trade off the rate at which they're trading off capital for labor in the production process into equality with the rate that's being traded off in every other production process so the marginal rate of technical substitution again is how much capital can be surrendered in a production process uh per unit of labor leaving the production no intact so it'd be something like a home construction company uh getting rid of a backhoe and replacing the backhoe with six workers to dig ditches right that would be the marginal rate of technical substitution one one backhoe for six units of labor all those ratios have to be equal everywhere in all production processes that use the same the same output the same i mean inputs to produce whatever output it is they're producing okay and then the marginal rate of transformation the bottom the third point there the marginal rate of transformation equal to the marginal rate of substitution that's the principle that brings production in line with with consumption or with demand so the marginal rate of substitution again is is consumer utility and the marginal rate of transformation is the production relationships by which y can be traded for x the two goods can be traded for each other right we can we can take labor and capital and transfer them into uh more production of y but only by suffering a reduced production of x so that's the marginal rate of transformation and only when those two things are equal will we have you know squeezed out all possible beneficial arbitrage opportunities if we value x relative to y as consumers more highly than the physical processes more highly than the ratio of the physical processes of production then then we can make further substitutions of production in certain goods in order to get a greater greater utility we can we can move to higher indifference curves by moving from one point to another on the production possibilities frontier for those of you you know know about the technical aspects of this right until the marginal rate of transformation the slope of the production possibilities frontier is equal to the marginal rate of substitution the slope of our indifference curve well for every consumer right so that's the conception that's going on here now why what happens in the market how so that's just the notion of what would happen in the model right when we solve the model but now the question is what what about the market does the market bring about this general equilibrium so that that's the next question right there's an unimpeded market the unampered market bring about general equilibrium and the answer is yes according to the assumptions that we made undergirding this model the market would in fact bring about a general equilibrium why is this true because every go back on the slide every consumer maximizes his or her utility by equating the marginal rate of substitution the rate at which they're willing to trade goods y for x they equate that to the price ratio but the price ratio in perfectly competitive markets will be the same for all consumers right well there won't be any divergence between the price of x that all the that each consumer is paying in the price of y that each consumer is paying and so on so this gives us okay the market's good here it's efficient uh same condition would exist for technical production all the entrepreneurs are saying paying the same price ratio for labor and capital and so they'll bring their production relationships into line with this they'll adjust their methods of production so that the rate at which they're trading off capital for labor will be exactly equal to the rate at which it can be bought and sold in the market they'll all do this so they all equate their marginal rates of technical substitution with all the other producers and then the same thing for the marginal rate of transformation marginal rate of substitution these two things will be equalized in the market because profit maximization requires that the price of each good be equal to its marginal cost again this is a technical condition we will go into the details of it but if that's true then the marginal rate of transformation which is the marginal cost of x over the marginal cost of y just the ratio of marginal costs will be equal to the ratio of prices p sub x divided by p sub y so that would have to be true too in the market right because all profit maximizing entrepreneurs will bring price of x and marginal cost of x into equality when they do this then obviously for every good that when we do ratios the price of x over the price of y would be equal to marginal cost of x over the marginal cost of y right and so on and so forth so so this is this is great right we the model has shown that so far that we can have we can have laissez faire or that market produces these these results okay so what room does this leave for public policy in the in the general equilibrium conception and surprisingly given this demonstration surprisingly the answer is quite a bit quite a bit of room for one thing again let me rely on some of the technical apparatus that those of you studying economics already know there can be this perfectly competitive general equilibrium point will exist for every for every single point on the production possibilities frontier every point is or contains the conditions of a perfectly competitive general equilibrium so so somebody has to choose which point we wind up on but i mean that's a choice variable as far as the mainstream economists are concerned now notice they don't want to say though let's erect the social welfare function by which we can decide right by which the government or government officials could decide you know let you know whether we should produce more of x or more of y which gives which would shift utility from one group to another right because then they're making interpersonal utility comparisons so they don't want to say that what they do say this is their attempt at being clever to get around the problem of interpersonal utility comparisons they say the government can establish you know on the basis of value-free scientific economics they can establish initial endowments of income so we're back to income redistribution they think that you know if the government just redistributes income that this does not involve interpersonal utility comparisons again i say that's perhaps debatable let's say okay but more importantly for public policy what the advocates of this kind of modeling approach a suggest is that there can be market failures and so again those of you studying economics you know that market failure literature is a cottage industry right and he says everything is a market failure you can you can construct i've constructed kind of a perfect model sort of a basic simple model right but you can you can reconstruct the models in order to just create market failures of various types and and so on and then and then say oh look the government can intervene to correct the market failure that's not that that's just purely scientific value free economics we're not making any value judgments just saying look there's this there's an inefficiency here and the government can just it's always proper policy for the government to step in and correct it so you get things like uh well the absence of perfect competition that is a classic case of this right what if we have some monopoly power by certain firms well then then they'll set their profit maximizing point where price is greater than marginal cost this means that there's a certain amount of production that would be efficient to produce it would satisfy higher valued consumer demands but the monopolist won't produce it and therefore the government's justified in breaking up the monopoly or regulating it or okay you get this kind of a claim uh product differentiation would do this lack of perfect information would leave you know a value gaps between i don't know about you but you have a good that if i didn't know about you you know you could have mutual trade with your goods and my goods but we don't know the existence of each other or that these uh possibilities exist so the government is supposed to be justified in somehow providing us with this information right and then so that we can improve our trades uh transaction costs huge literature on transaction costs right how they the government can manage transaction costs because transaction costs again create price gaps right if they're transaction costs in shipping oil let's say between two points the price differential between these two points can be maintained and so allegedly the government can step in and magically you know reduce these transaction costs somehow and lead to more trade and greater benefit and and so on uh there are externalities you've heard about in other lectures this week uh benefits are costs that are generated by the private parties involved in uh production and exchange that are the crew to third parties that aren't included in the in the production decisions right of the people generating these externalities and therefore social welfare can be improved if somehow the government steps in and you know forces people to take into account these benefits and costs so uh you know somebody has a garden my wife has a garden flower garden and it's really spectacular and everybody who drives by the house gets this external benefit and so in order to have a efficient production of the of the of the garden the these people who are passing by who value the garden would have to be forced to pay my wife to produce more of the good right that because because we we have an inefficiency here according to the model and external costs will be the opposite right external costs the government would have to step in and force the person creating the external costs to bear the cost and therefore reduce production to get the efficient amount we get public goods another famous case right that are non rival and non exclusive in in consumption and so here the government has a role to produce the public good because private enterprise won't do this it lies outside of this profit maximizing calculus now the the perhaps criticisms of this approach are fairly apparent but let me just run down some of the main ones first this whole notion of functional analysis we've criticized before right at mises makes a great point against this by saying that in human action there are no constants and therefore anytime we attempt to do functional analysis we were stymied right because to write a function or at least a function where we can solve for actual empirical results we have to have constants and variables functions always have constants and variable like the consumption function right a plus b times y it's this constants the a and the b and variables the y and the c well okay if if if there aren't any constants in human action you can't write functions and you can't do functional analysis you can't solve models and so on and so forth right herald demset the the famous ucla economist pointed out that this whole this whole project of saying let's erect a model and then if the real world deviates from the model we'll call that a market failure and justify the government you know intervening to correct to correct this failure he called this the nirvana fallacy very famously and so this is certainly correct right this is this whole approach suffers from some kind of strange illogical disconnect you know so what if the model has these features how does that justify public policy in the real world and but the one that i want to mention before we go on to the austrian Rothbard's conception is that this whole way of approaching welfare economics is what we might call in-state analysis right this is pareto optimality we reached the in-state the general equilibrium in-state and we say that is a perfectly adjusted you know perfectly efficient situation and if the real world deviates at all from this in-state this optimal situation that's created by the general equilibrium process then the government can intervene to move the real world toward that in-state and we'll see this is not the only way of conceiving of the pareto rule okay so now let's turn to a Rothbard Rothbard as i suggested has a different notion of the pareto rule and we might call this dynamic or again to keep in sync with the terminology of this literature we would call this pareto superiority as opposed to pareto optimality but pareto superiority just says that in each social interaction we can judge on the basis of the pareto rule whether or not this social interaction increases social welfare we can so and so we can just proceed step by step each action at a time right saying yes this action would increase social welfare according to the pareto rule this one would not and so on and so forth so we can just have a dynamic application of the pareto rule and again we call this a pareto superior superiority okay so how does Rothbard proceed you'll find this in his famous article he wrote in the 1950s toward a reconstruction of utility and welfare economics and then professor Hoppe has also done work on this conception of welfare economics okay so we start with self-owned labor each person right is in fact an owner of their body their mind and body so from that beginning point which again is not an ethical claim but a just a claim but you know just a claim about the world as it is a descriptive claim we just apply the pareto rule to every action that people would take as they you know begin to live their lives so we have this person and this person is that starts with self-owned labor in order to you know sustain himself he would then appropriate a property out of nature you appropriate natural resources property acquisition as I called it on the slide every time as Hoppe puts it every time a person takes his labor which he owns and he acquires a natural resource with it he's demonstrating his his utility right so he's made better off no one else is demonstrably worse off because everybody else is doing something else everybody else is demonstrating their preference for doing something else they're not preempting this guy right by by by getting to this natural resource first and homesteading it for themselves and so no one is made worse off no one is made demonstrably worse off in any act of property act any voluntary act of property acquisition the same then would follow with production so let me give you a concrete hypothetical case let's suppose in 1700 we have a guy in his family you live in uh I don't know on the east coast in Philadelphia or wherever and they decided to heck with this we're going to move west and you know establish our own or we're going to live on our own right so our own little community and so they trek west and they come all the way let's say to Illinois and they find the you know those virgin territory no Indians no white no Frenchman no right they're just by themselves and so they you know cut down the trees and they build a log cabin right they go through this process of homesteading they bring the land into production they plow it and and so on and so forth the Austrian conceptual welfare they would say well look you know these guys are made better off by these actions no one else is demonstrably worse off right no one no one no one's worse off that they're doing this because in order to demonstrate that they'd be worse off the person who claims to be worse worse off would have to preempt this homesteader would have to have gotten there first right and said no I want this land and you know I'm going to homestead it before you that would be a demonstration of their greater utility but what are they actually doing well they're actually you know sitting in counting houses in Philadelphia or you know they're being a blacksmith in some little town in Massachusetts or whatever okay then then so once once the person has natural resources he engages in acts of production same the same logic right so we have our homesteading family they create a corn crop and the corn crop they produce right by the application of their labor with natural resources and this demonstrably increases their utility without demonstrably any decreasing utility of anybody else right because everybody else was doing something that they valued more they weren't they weren't right interfering somehow to show that they value not a corn crop but a wheat crop more than the corn crop or whatever and so on then once he once the guy has the corn he can trade it with someone else when he engages in a trade with someone else both parties benefit no one is demonstrably worse off because again they're choosing to do something else they're they're demonstrating their preference to do something else right so they're they're better off by their actions doing something else as opposed to attempting to preempt this exchange so and so on so we see that every act of acquisition production transfer voluntary acts are parade of superior every act on the unhampered market then is parade of superior it's just a dynamic process where step by step social welfare is going up little by little right every time people engage in these actions now if we think about the state every time the state intervenes we've got aggression we've got an act of aggression against a person or property and an act of aggression then fails the Pareto rule it doesn't pass the Pareto test right because one party's made better off but another party's made worse off and since someone's made worse off we can't say that social welfare has improved we're scientifically speaking we're lost to say so so we can just say well look no act of government is Pareto superior no act of government can increase social welfare right every act on the unhampered market increases social welfare and no act of the state can increase social welfare this is how the argument runs okay so that's the Rothbardian theory so this is a justification right of pure laissez-faire no no government act could be justified on the grounds of this of this kind of approach now let's do the compensation principle the last again you'll see some affinities as we move back and forth between these things so the compensation principle as I mentioned before takes as its goal to of you know maximize or of creating social welfare is to maximize monetary wealth to maximize the monetary value of assets that as opposed to the classical economist which said let's maximize physical output the amount of goods or the quality of the goods that we have the compensation principle says let's just maximize monetary income or again monet technically monetary wealth and they do this while their rule is not the Pareto rule remember the Pareto rule says that any interaction between parties that makes one party worse off cannot increase social welfare we just we can't tell because we have to make an interpersonal utility comparison to be able to tell a social welfare so to speak has gone up and so the compensation principle tries to get around this try to get around this restriction of the Pareto rule by saying well the calder a formula for this is to say if an if an interaction what if we have an interaction where those who it's true that one party gains and another loses but what if we could demonstrate that the party that gains could make a monetary compensation to the party that loses and the party that loses would still be better off after the after the compensation then wouldn't it be okay wouldn't that satisfy the the the underlying notion behind the Pareto rule now you'll notice a key key element of this calder criterion is that the compensation isn't actually paid the idea the claim is that if the winners could compensate the losers then the action increases social welfare just if they could potentially compensate them then it would be okay notice it if if the compensation were actually paid this would just this would just revert to the Pareto rule right everybody would be a winner and we we just have the same thing as a Pareto rule so so the calder Hicks criteria is an attempt to again get around the restriction of the Pareto rule by trying to find instances where when they're winners and losers the winners would be able with their greater monetary wealth from winning to compensate the losers who whose monetary wealth is reduced okay the Hicks criteria you might imagine that there's one of the problems involved in this is that since income is being redistributed in the winner-loser interaction you you don't you you don't get a reversible process necessarily right the process isn't you can't back it out the other way because income has been redistributed once you do the you know once you go through the process where someone loses and another guy wins now the winner has more income and the loser lasts and if you tried to reverse the process to show that you had it like a logically transitive action here you well sometimes it would work and sometimes it wouldn't and so that's why you get the Hicks part of this the Hicks rule says that the absence of an interaction would improve social welfare if those who lose could compensate those who gain and still be better off so you're not going to do those things where the the person who would lose is able to compensate the person who wins and still be and the both parties would still then be better off so if you can if you can have both the calder and the Hicks condition met at the same time then you avoid at least some of these logical difficulties okay well what does all this have to do with policy well the policy then would be to have just cost-benefit analysis this is where you get cost-benefit analysis right you just have government officials and they they decide oh this is the monetary benefit of policy x and this is the monetary cost these are the guys who are going to lose and these are the guys who will win and the monetary gain by the winners is greater than the monetary loss by the by the losers now perhaps you can see the the problems involved in this the first problem we might mention is that you can't even apply the calder Hicks rule to actual social interactions and the reason is you have no demonstration of the you know willingness to be compensated by the losers you have no idea in other words whatsoever how much the losers would have to be compensated in order for them to say yes yes go ahead and do this there's no no demonstration whatsoever of right of what these what the monetary value what their willingness to pay would be to absorb this loss secondly the bureaucrats of course of the government can't compare all the different policy options again if we think about their situation with respect to let's say market entrepreneurs entrepreneurs in the market have economic calculation they can then engage in appraisement right and they can know then or you know have reasonable expectations about what sort of course of action they should take you know I should produce this good to the exclusion of that one because it'll generate more social benefit than if I produce the second good but the bureaucrats have no idea whatsoever right they have no guide uh to what uh what should or should not be produced so they lack uh economic the apparatus of economic calculation they have prices and so on but they lack what the entrepreneur has right in uh engaging in in the appraisement process of economic calculation monetary values themselves are just empty the entrepreneurs putting his own wealth at risk in this process and bringing forth right through his own his own effort you know this one line of production as opposed to this one where some bureaucrats just sitting back and saying yeah yeah you know if we let the the forest be assigned to the developers they'll cut the trees and that'll be worth more than you know these environmentalists wackos just wandering around on the trails so well let's go for that that's that sounds good to me right that's totally different it's not there's nothing scientific about this and then finally let me mention that the is a great point that Rothbard made uh the calder-hicks rule actually uh makes an implicit value judgment in favor of the status quo for example what if we had slavery a system of slavery already in place and we asked the you know the the hicks uh criterion or the calder criteria well okay uh no we probably wouldn't be able to get rid of it right it would probably pass the calder-hicks rule uh Ed Stringham gives this example he says uh what if you have a rich person a really rich person a really poor person doesn't have any money at all wouldn't it be possible under calder-hicks for the rich guy just to kill the poor guy i mean if he gets some value from doing it right because the poor guy doesn't have any money to right to make the compensate there's no he's not able to okay he's doomed so so this shows you what we what i pointed out at the very beginning when we talked about the classical school this this calder-hicks this compensation principle is not actually connected to the private property structure of real life right it's just it's just like the you know producing whatever you want right let's maximize the production of physical things let's just predict you know produce uh uh bricks or or pyramids or something of the sort and that's supposed to pass the social welfare test so we have a similar kind of problem here okay sorry i went a little over but