A reader asked whether in
economics we should always strive for Pareto improvements. For those unfamiliar
with the term, a Pareto improvement is any action that makes at least one
person better off and makes nobody worse off. That is not the same as saying
that society enjoys a net benefit, because that can happen while still seeing
some people being made worse off.
A new village pub could
make 90% of the villagers better off while still making 10% of them worse off.
The only way to turn that into a Pareto improvement would be to compensate the 10%. Besides, Pareto optimality
isn't much of a measure of a society anyway - a society can have numerous Pareto
efficiencies and still be a pretty fraught place to live.
Pareto efficiencies are
relatively rare in society because life is a series of trade offs, and it is
difficult to do anything in society without making someone else worse off. The
prospect of people feeling like they've been made worse off often leads to a
stalemate.
For example, suppose your
23 year old son Jack is performing his first piano concert at the local school
hall, but you and your wife get a one-off offer of a holiday to stay in a
luxury apartment overlooking Central Park courtesy of your best friends Jim and
Sue who've won a New York
The holiday clashes with
the piano concert - and what usually would happen is that someone is going to
be disappointed, and it must be weighed up with the question of who should be
the one disappointed? Personally I think the son should be disappointed.
When there is a stalemate,
the economists Nicholas Kaldor and John Hicks came up with a watered down
version of the Pareto criterion, called the Kaldor–Hicks criterion, which is a
measure of economic efficiency that runs alongside the Pareto-efficiency, but
makes less of a demand on the outcome. The Kaldor-Hicks criterion states that a
decision can be seen as efficient as long as in theory everyone can be
compensated to offset any potential costs.
So in the above case,
Jack's parents are made better off by the holiday, whereas Jack is made worse
off because his parents won't be there for his big concert performance, so they
would need to find significant financial restitution or compensatory action to
make things beneficial for all concerned. As long as this can be done in
theory, the Kaldor-Hicks criterion is satisfied - and this is a good basis on
which to assess cost-benefit analyses.
