In order to avoid measuring and comparing interpersonal utilities (i.e. trying to measure and compare the particulars of distributions of goods and services produced by an economic system), Pareto suggested that general states of personal welfare can be reported by members of the society. These reports of actual or potential personal or group utility across distributions then tell policy makers whether shifting from one pattern of distribution to another is theoretically to be preferred.
Get to know these three key terms:
I. Consider the following possible points of distribution of social
resources
. "A" (whose distributional share is measured
against the vertical axis of the graph) and "B" (whose distributional
share is measured against the horizontal axis of the graph) can represent
any person, group within a society, or groups or nation-states in the international
system. The point and key assumption is that reports of welfare from these
groups for their share of any distribution are credible.
Assume point 1 represents the current distribution of resources. Points 2-5 represent possible moves or shifts in distributions. Which of these moves are superior or inferior? are any optimal?
II. One way to graphically address that question is to take the
current distributional
point as the origin or starting point of a
new graph. If the dotted lines now represent a new graph for considering
shifts in distribution of resources, then any points that fall on these
lines or are encompassed by the area of the new graph (in short, any point
to the northeast of the current point), then those points represent superior
positions [at least one person or group is better off and no one is worse
off]. In this graph, possible superior points include 2 & 5.
All points outside that area are inferior points, being points where at least one party is worse off after the move. These points include 3 & 4, here.
Thus, policy makers can justify, for example, moving from point 1 to point 2 or 5, but not from point 1 to point 3 or 4.
III. The problem with this theoretical advice for policy makers is that the real world rarely presents us with moves that proffer such clear, no-loser possibilities. More frequently, perhaps in most all distributional struggles, some will gain but some will necessarily also lose. In brief, there are precious few Pareto superior moves in the real world.
In recognition of this theoretical and practical policy problem, two other economists suggested a modification of Pareto's criteria. This so-called Kaldor-Hicks criterion (named after the two economists who suggested the innovation) re-defines superiority in terms of Pareto potential. What they suggest is that when a move is potentially superior, the move is justified.
Consider the move from point 1 to point 4. As seen in this graph, B
would gain quite a bit (represented by the horizontal arrow) and A would
lose very little (represented by the vertical arrow) if such a move were
made. To put this somewhat more precisely, the Kaldor-Hicks criterion claims
that a move is justifiable when the party gaining from the move gains more
than the other party loses. Here, B could compensate A for A's losses
and still have something left over. (That is, if compensation were paid,
the move would actually be Pareto superior.)
The kicker is that compensation need not be paid, even in part. Rather, it is calculated that since society benefits overall from the move, the move is justified even though some party is disadvantaged and suffers some diminution of welfare after the move -- especially when compensation is not paid.
Specific examples and arguments concerning justification and effects of Pareto and Kaldor-Hicks policies will be discussed in class.