Would a good society seek to maximize a social welfare function?

 This article is about my personal experience in attempting to understand social welfare, the concept of a good society, and my role as an economist involved in the processes of social choice. I decided to write about this topic after writing an article for Savvy Street on the related topic, “Can social planning enhance individual flourishing?”

When economists talk about maximizing social welfare, they are referring to a concept that appears to have something to do with the well-being of people. However, the concept is best viewed as a signaling device to suggest that the social planner claims to have obtained insights about society from studying an abstract mathematical model. Such signaling is not helpful to consideration of the merits of policy proposals.

Maximizing social welfare can encompass policies that would enlarge the economic pie (national product) so that there is potential for everyone to be given a larger slice. In that case, it might be reasonable to argue that the policy would receive widespread support among citizens. A good society - one that is good for the people who live in it – could be expected to adopt such policies. However, claims about pursuing social welfare objectives make such policies no more attractive than if they are advocated to simply expand opportunities for individual flourishing.

Maximizing social welfare can also encompass policies to redistribute the economic pie in a manner that advocates believe will somehow enhance the collective well-being of citizens.  When maximizing social welfare is said to require redistribution of the cake, some citizens will be advantaged at the expense of others. It is possible for some policies of this nature to receive widespread support (e.g. provision of a basic social safety net) but that is less likely when extensive redistribution is proposed to equalize the utility that different individuals obtain at the margin from additional income.

Whose welfare function should we maximize?

The idea of social welfare maximization implies the existence of a social welfare function reflecting insights about determinants of collective well-being and expressing the “general will’ of the people. It was over 50 years ago that I began to realize that this idea is highly problematic. My libertarian friends might find this hard to believe, but it happened while I was studying welfare economics.

An article by Francis M Bator influenced me greatly, although perhaps not in the way the author intended. As I was reading Bator’s article - ‘The Simple Analytics of Welfare Maximization, The American Economic Review, 17(1) March 1957 - I remember feeling that this was an object of great beauty. I suppose the article seemed beautiful for the same reasons that abstract art can seem beautiful. Bator provides a geometric presentation of the derivation of a production possibilities curve, then proceeds to derivation of the utility possibility frontier, which he then crowns with a social welfare function, as shown in the diagram above.

Bator’s description of that diagram left a lasting impression on me. He tells us that BB represents the grand utility possibilities frontier, showing at each point the maximum utility for person X given any feasible level of utility for person Y, and vice versa. He then proceeds to explain the “bliss point”, Ω, in the following words:

“To designate a single best configuration we must be given a Bergson-Samuelson social welfare function that denotes the ethic that is to “count” or whose implications we wish to study. Such a function – it could be yours, or mine, or Mossadegh’s, though his is likely to be non-transitive – is intrinsically ascientific.”

What Bator meant by ascientific is that the function involves ethical valuations. However, the point that has stuck in my mind is that despite the heroic assumptions Bator was making in constructing his beautiful geometric edifice, he did not try to pretend that it could be crowned with a social welfare function aggregating the preferences of all citizens. The function depicted “could be yours, or mine, of Mossadegh’s”. (Mohammad Mosaddegh was an Iranian prime minister who held office from 1951 until 1953, when his government was overthrown - apparently in a coup orchestrated by M16 and the CIA.)

Is it possible to make sense of the diagram? 

As I look at the diagram now, the idea of choosing between the utility levels of different people seems problematic. It would also be problematic to some modern utilitarians whose social welfare function is defined simply in terms of maximizing average life satisfaction (making the implicit ethical judgement that everyone deserves to have the same life satisfaction). In that case, if the axes measure the life satisfaction of X and Y, the bliss point would be defined by the intersection of the possibility frontier and a 45⁰ line drawn from the origin. The 45⁰ line would represent all points where X and Y have equal life satisfaction – X and Y would each have maximum life satisfaction at the bliss point.

However, I reject that modern utilitarian view. It seems to me to reflect an inadequate understanding of the determinants of individual flourishing. As argued in Freedom, Progress, and Human Flourishing, even though average life satisfaction may be a reasonable indicator of the average psychological well-being of large groups of people, psychological well-being is just one of the basic goods of a flourishing human. In my experience, when people are encouraged to offer more than perfunctory responses to questions about how they are faring, they tend to talk about a combination of different things such as their aspirations and the choices they have made, their health, and their personal relationships. Satisfaction is relevant, but does not encompass all relevant aspects of human flourishing.

To make sense of the choices represented in the social welfare function depicted, I would need to replace “utility” with “opportunity to flourish”. Even then, I would need good reasons to make an ethical judgement about whether X and Y deserve to have their opportunity to flourish enhanced or restricted.

What are the implications for social choice?

While Bator’s description of the social welfare function let the cat out of the bag for me, I remember reading about Kenneth Arrow’s impossibility theorem at about the same time. I think the main lesson I took away was that the processes of government must inevitably be somewhat dictatorial. That makes it important to have constitutions that protect liberty and electoral processes that are capable of kicking tyrants out of office.

While studying welfare economics, I also took a course in public choice in which I had my first exposure to The Calculus of Consent, by James M Buchanan and Gordon Tulloch. That book and other writings by Buchanan have had a profound impact on my views about the good society and the role of economists.

Buchanan and Tulloch noted that when individuals are considering constitutional rules that they expect to be in place for a long time, they are uncertain as to what their own interests will be in any of the whole chain of later collective choices made according to those rules. Such uncertainty may enable people to set aside their current economic interests in making constitutional choices. One implication is that individuals will tend to choose somewhat more restrictive rules for social choice-making for areas of potential political activity that could involve violation of liberty.

Buchanan and Tulloch link liberty directly to the concept of a good society:

“The acceptance of the right of the individual to do as he desires so long as his action does not infringe on the freedom of other individuals to do likewise must be a characteristic trait in any “good” society. The precept “Love thy neighbor, but also let him alone when he desires to be let alone” may, in one sense, be said to be the overriding ethical principle for Western liberal society.” (p 217).

 Buchanan later warned that the norms that underlie democratic institutions are under threat when politics is allowed to become little more than a ‘commons’ through which competing coalitions seek mutual exploitation.  (For further discussion of this please see Chapter 6 of Freedom, Progress, and HumanFlourishing).

What should economists do?

Economists who advise on public policy often view themselves as social planners who are advising benevolent despots. They are frequently disappointed to find that those whom they advise give higher priority to political and personal goals than to publicly stated economic objectives, or lack the political power to implement recommendations.  

James Buchanan suggested that economists should adopt a contractarian approach, with a focus on the consequences of rules and, in particular, on the question of what rules of the game individuals might accept voluntarily as participants in an authentic constitutional convention. In providing an example of this approach, Buchanan suggested that such a convention would be unlikely to endorse rules of the game which allow majorities in a single generation to impose public debt burdens on subsequent generations of taxpayers. (Nobel prize lecture).

My career

The focus of my career in public policy advice was partly contractarian. For most of my public service career I had the good fortune to work in agencies of the Australian government (predecessors of the Productivity Commission) which undertook research and published reports on the economic implications of changing the rules of the game for economic development. The focus of much of this work was assessing effects of barriers to international trade and other forms of industry assistance.

I note that my career was only partially contractarian because the agencies were required to make recommendations to the government according to specific terms of reference for individual inquiries and more general guidelines. The specific terms of reference were sometimes designed to ensure that governments received politically palatable recommendations, but the research and policy analysis published in inquiry reports, and in annual reports, informed policy-making processes in ways that led eventually to adoption of rules of the game more favourable to free trade.

The advisory agencies were given general guidelines including having “to have regard to the desire of the Australian Government …  to improve and promote the well-being of the people” and to “improve the efficiency with which the community’s productive resources are used”. I do not believe that the collectivism reflected in the reference to people and privately owned capital as “the community’s productive resources” had one iota of influence on the research and policy analyses conducted by the agencies.

I have endeavored to maintain a focus on the implications of different “rules of the game” in the public policy aspects of my subsequent consulting career and my writing on freedom and flourishing on this blog and in my books. There have been some lapses, but I hereby forgive myself 😄 . It has not always been easy to avoid falling into the trap of viewing oneself as a social planner advising a benevolent despot. 

How useful is the WELLBY concept in assessing the benefits and costs of alternative policies?

 

There are good reasons why public policy discussions often revolve around the benefits and costs of alternative policies. Discussions that begin with the consideration of rights often require participants to acknowledge conflicting rights and to weigh up consequences in a search for the principles that can most appropriately be applied.

For example, consider what followed when I suggested recently in a discussion of the merits of lockdowns to counter the spread of COVID19 that such policies should be assessed against the principle that individuals have a right to direct their own flourishing, provided they do not interfere with the similar rights of other people. The latter part of that assertion implies a willingness to consider whether infected people who spread disease are interfering with the rights of others. At an early stage of the discussion, I acknowledged that it would be a step too far to insist that everyone has the right to recklessly endanger the lives of others. I argued that there should nevertheless be a presumption in favour of freedom, and that those who advocate restriction of freedom should be required to demonstrate that the benefits clearly exceed the costs.

That illustrates how the discussion of benefits and costs tends to rule the roost in civilized discussions of public policy. An exchange of different views about rights can be enlightening, but endless repetition of conflicting assertions about rights does not qualify as civilized discussion in my view.

A WELLBY (or Wellbeing Year) is equal to a one-point increment on a 10-point life satisfaction scale. If you assessed your level of life satisfaction as 8/10 in 2019 and 7/10 in 2020, that would be a decline of one WELLBY.

I began thinking about the WELLBY concept while considering how it is possible to measure the costs and benefits of lockdowns, but in this article, I will focus on the usefulness of that concept rather than on the question of whether benefits of lockdowns could ever exceed the associated costs.

Assessing the psychological cost of lockdowns

Indicators of subjective well-being are obviously relevant in assessing the psychological costs associated with policies that require people to stay at home. Available evidence suggests that lockdowns caused a decline in average life satisfaction of about half a point in the UK and similar countries in the
period to March 2021. On that basis, Paul Frijters, Gigi Foster, and Michael Baker estimate that lockdowns cause loss of life satisfaction to the general public in the U.K. of 41,667 WELLBYs per million citizens for each month of lockdown. This estimate is in Chapter 5 of their book, The Great Covid Panic, 2021.

I think that is an appropriate use of the WELLBY concept. If anyone knows of a better way to assess the psychological costs of lockdowns, I would be interested to know what it is.

Frijters, Foster, and Baker incorporate several other items in their assessment of the costs of lockdowns. I will consider one of those later, but I want to turn now to use of the WELLBY concept in the assessment of the main hypothetical benefit of lockdowns, namely lives potentially saved.

Assessing the value of a life saved

Richard Layard and Ekaterina Oparina have published a provocative article using a WELLBY approach to assess the monetary value of preventing the loss of one year of human life (Chapter 8 of World Happiness Report, 2021).

Layard and Oparina begin their discussion by observing that the average WELLBY is 7.5 in advanced countries. On that basis, they claim that preventing the loss of one year of the life of one person saves 7.5 WELLBYs.

The authors draw upon information on the relationship between income and life satisfaction in order to assess the monetary value of that loss. After some discussion of relevant research, they suggest that a coefficient of 0.3 is an appropriate measure of the impact on life satisfaction of a unit change in absolute log income. With average income of $30, 000, the loss of $1 is equivalent to 1/100,000 WELLBYs (0.3/30,000). It follows, they suggest, that “we” should be willing to pay up to around $750, 000 to save a year of life (7.5 WELLBYs).

Layard and Oparina point out that the $750, 000 would be shared over the whole population. Nevertheless, it still seems an extremely large sum to pay to prolong a life by just one year.

One possible source of error is that life may have no value for people with very low life satisfaction, for example those with a rating less than 2/10. If you assume that a life year is equivalent to 5.5 WELLBYs (7.5 minus 2.0), the estimated sum that “we” should be willing to pay to prolong life by one year is reduced to $550, 000. That still seems implausibly high.

The estimate could be further reduced by taking account of the fact that the people who are most vulnerable to COVID19 often have pre-existing ailments that would tend to reduce their life satisfaction, and many of those in nursing homes would be unlikely to live another year in any case.

However, let us return to the question of whether $550,000 is a plausible estimate of what “we” should be prepared to pay to prolong by one year the life of a person with an average life satisfaction rating. An alternative way to approach the issue of determining the monetary value of a year of life is to consider estimates of the impact of changes in healthy life expectancy on average life satisfaction. Regression analysis suggests that the addition of one year to healthy life expectancy adds only 0.033 to average life satisfaction (Table 2.1, World Happiness Report, 2019). The income loss providing an equivalent loss of life satisfaction is only $3,300 (0.033*100,000). That strikes me as an implausibly low estimate of the value of a year of life.

My view of what is a plausible estimate of the value of one year of life is not based solely on my own gut feelings. The assumed value of a life year in cost-benefit analysis typically ranges from $50, 000 to $250, 000. Those assumptions are based on surveys asking people how much they would be willing to pay to extend their lives and estimates of amounts people need to be paid to accept jobs involving greater risks to life.

Estimates of the value of a year of life within that range seem to be broadly consistent with community expectations. Some groups may lobby for lives to be valued more highly in assessing whether life-saving drugs should be subsidized by governments. However, I don’t see large numbers of people suggesting that they would be willing to pay higher taxes to fund that.

There seems to me to be a fundamental problem in attempting to assess the value of a life-year from the relationship between average income and average WELLBYs. As I explain in Freedom, Progress, and Human Flourishing, psychological well-being is just one of the basic goods of a flourishing human. When you ask individuals open-ended questions about how they are faring, their responses are not confined to the extent that they are “satisfied” with life. They are likely to talk about whether they are achieving their aspirations, the state of their health and their personal relationships. If you ask a person who already has high life satisfaction why they aspire to earn a higher income, they are not likely to claim that they expect a higher income to enable them to become more satisfied with their own life. They are more likely to say that they want to put some money aside for various reasons, for example to assist with education of children or grandchildren, or to have something to fall back on in the event of illness.

If an individual is faced with a decision about whether to use accumulated wealth (or to mortgage their house) to purchase an expensive drug that might prolong their life for a year, the quality of that extended life (WELBYs) is not the only factor that they are likely to consider. The choice they make may well give consideration to their desire to improve opportunities available to the next generation of their family. There is an intergenerational choice involved in placing a value on an additional year of life.

What value should be placed on the lives of potential humans?

Frijters, Foster, and Baker include among the costs of lockdown the shutting down of the in-vitro fertilization (IVF) program during lockdowns in the UK because it was deemed to be a nonessential service. This resulted in about 30 fewer IVF births per million citizens per month of lockdown.

The cost of disruption of the IVF program is not critical to the authors’ conclusion that the cost of lockdowns exceed the benefits. Nevertheless, in my view there is a strong case for it to be taken into account. Potential parents clearly place a high value on the new lives that the program makes possible.

However, the methodology which Frijters, Foster, and Baker use to estimate the cost of disruption of the IVF program is a straightforward application of the WELBY concept to value lives. They calculate that each of these potential humans could be expected to enjoy 480 WELLBYs during his or her life – each is assumed to have a value equal to 6 WELLBYs and to live on average for 80 years. With the loss of 30 IVF babies per month, that amounts to the loss of 14,400 WELLBYs worth of human well-being per month per million citizens.

The reasoning is impeccable if you accept the utilitarian assumptions associated with use of the WELLBY concept to measure the value of a human life. Within that framework, if government policies prevent potential humans from being born, that diminishes the sum of human happiness by the amount of happiness they would have enjoyed during their lifetimes.

I have already indicated that I don’t accept that people value their own lives exclusively on the basis of WELLBYs. However, if I have not yet persuaded you to reject the WELLBY approach to evaluation of lives, you may wish to consider the following possible outcome of applying that approach.

Let us suppose that a government is considering a ban on all forms of contraception and seeks the services of some utilitarian advocates of maximization of human happiness to evaluate the costs and benefits of the proposal. It seems reasonable to predict that the utilitarians would conclude that the additional births resulting from the policy change would result in a large net increase in WELLBYs, and therefore an increase in the sum of human happiness. The more, the merrier they might say!

Conclusions

The WELLBY concept has a useful role to play in evaluation of some policies that have an impact on psychological well-being.

However, the valuation of lives according to the number of WELLBYs individuals might enjoy seems to be at variance with the approach that individuals take in making choices in relation to extension of their own lives. That approach to valuing lives is widely at variance with the approach most people in advanced countries adopt in considering the value of potential lives of the many additional humans that they could bring into the world if they felt inclined to do so. It counts the lives of potential people as having equal value to the lives of the living.

The WELLBY approach to valuation of human life should be rejected.

Postscript

A survey conducted by UBS has provided relevant information on the proportion of wealth that investors are willing to sacrifice for additional years of life. The survey covered 5,000 wealthy investors in 10 countries. On average, those with financial wealth in the $1 to $2 million range indicated that they were willing to give up 32% of their wealth for an additional decade of healthy living. That may seem a lot, but amounts to only $32,000 to $64,000 per annum when spread over 10 years.

Those figures are far lower than the $750,000 (discussed above) that an application of the WELLBY approach to life evaluation has suggested that “we” should be willing to pay to save a year of life.

Why should economists practice humanomics?

 

Adam Smith practiced humanomics. It came naturally to him. The famous pioneer of economic science did not need to pretend that humans have been programmed to maximize utility in order to develop his argument that economic specialization stems from a propensity in human nature to “truck, barter, and exchange”.

The word, humanomics, was coined by Bart Wilson, an experimental economist, and is explained in the book, Humanomics, Moral Sentiments, and the Wealth of Nations for the Twenty-First Century, which he co-authored with Nobel winner, Vernon Smith. In that book, humanomics refers to the very human problem of simultaneously living in the personal social world (which is the context which Adam Smith had in mind when writing Moral Sentiments) and the impersonal economic world (which is the focus of Wealth of Nations).

Some important aspects of human behavior cannot be adequately explained if we adopt the assumption, still common in much economic analysis, that individual human behavior is characterized by narrow self-interest. Vernon Smith and Bart Wilson found in their experimental work with people playing economic games that while self-interested utility maximization could explain individual behavior in simulated market contexts, it could not do so in social exchange contexts. In playing two-person trust games, people tend to be more other-regarding than most modern economists assume. I take that to mean that most people are sufficiently civilized and self-regarding to behave with integrity towards others – they see virtue in being trustworthy rather than opportunistic.

Deirdre McCloskey advances the argument for humanomics further in her recent book, Bettering Humanomics. She writes:

“A big part of our human behavior is thinking and talking about human action, not merely solipsistic and thoughtless reaction to, say, a budget constraint. Human action … is the exercise of free will, so typical of humans. It is in fact the free will about which theologians argue. Humanomics therefore goes beyond the artificially narrowed evidence of a silent, solitary, reactive, positivistic, predestined, observational behaviorism.” (p 5)

McCloskey argues that economists should engage in more philosophical reflection about what a speaking species does. The behavioral paradigm of stimulus and response does not adequately explain much of human behavior. Humans often think about the meaning of events before responding to them, and they often consciously explore the options that are available.

Innovation is an example of an economic activity that cannot be adequately understood within a behavioral paradigm that does not allow for thinking and talking. In this context, McCloskey mentions the important contribution of Israel Kirzner in pointing out that real discoveries cannot be pursued methodically – or they would be known before they are known. Innovation requires entrepreneurial alertness. McCloskey adds that a discovery “requires sweet talk to be brought to fruition”:

“An idea is merely and idea until it has been brought into the conversation of humankind”.

McCloskey presents a strong argument that humanomics is needed to explain the great enrichment – the massive improvements in standard of living that have occurred in many countries over the last 200 years. Those who have some familiarity with her trilogy of books on economic history – that should include everyone who is interested in the reasons why the people who live in some countries tend to be wealthier than those who live elsewhere - will not be surprised that she argues that ethics and rhetoric are the “killer app” explaining the great enrichment. She argues that a novel liberty and dignity for ordinary people, including the innovating bourgeoisie, explains the great enrichment.

For present purposes, the important point is that for economists to understand the economic growth process, with its massive implications for human flourishing, they need some knowledge of ethics and rhetoric – ideas in letters and literature that are studied in the humanities. McCloskey argues that if economists consider themselves to be serious scientists, they should use all relevant evidence that they can get their hands on. She makes the point thus:

“A future economics should … use the available scientific logic and evidence, all of it—experimental, simulative, introspective, questionnaire, graphical, categorical, statistical, literary, historical, psychological, sociological, political, aesthetic, ethical.” (p 66)

Many economists spend much of their time on “sweet talk” without being aware of it. I spent most of my working life trying to tell people that incentives matter and that they need to consider whether current institutions – the rules of the game of society – provide appropriate incentives. For example, I am fond of pointing out that if the rules of the game reward rent-seeking – individuals or groups seeking to have governments provide them with assistance at others’ expense - then potential beneficiaries will tend to spend more time rent-seeking and less time engaged in productive activities.

Economists engage in that kind of activity – labelled by some as preaching – because they think that ideas matter and that interests do not always prevail in determining government policies. In my view, people who are trying to obtain greater recognition of the role of institutions and incentives are walking in the footsteps of Adam Smith.

McCloskey might suggest that people like me should consider whether we give too much attention to the role of formal institutions – constitutions, laws, and regulations – and too little attention to ethics and ideology. In discussing the great enrichment she suggests:

“The important “institutions” were ideas, words, rhetoric, ideology. And these did change on the eve of the Great Enrichment”.

The only problem I have with McCloskey’s exposition of humanomics is her dismissal of happiness studies and behavioral economics. Her negative views on these areas of research sit oddly with her argument that economists should consider all available evidence. I agree that many people who are engaged in such research are paternalistic behavioralists, seeking to advise governments how to make people happier. However, I don’t think that provides sufficient reason to suggest that the findings of such research are no relevance to individuals who are looking for information to help themselves to flourish.

In my discussion of the findings of happiness research and behavioral economics in Chapter 7 of my book, Freedom, Progress, and Human Flourishing, I have tried to adopt a contractarian approach. That is the approach adopted by Robert Sugden, a self-confessed behavioral economist, and an admirer of the contractarianism of James Buchanan, in his book The Community of Advantage. Sugden notes that contractarian recommendations are “addressed to individuals as directors of their own lives, advising individuals how to pursue their own interests”.

I concur with the view of James Buchanan that the heartland of economics is considering human behavior in market relationships and other voluntaristic exchange processes. However, I can see no reason why anyone should consider Philip Wicksteed, or any other economist, who offers practical advice on avoiding common mistakes in decision-making, to be stepping beyond the realm of humanomics.    

When economists step outside their comfort zone of voluntaristic exchange processes, they certainly need to remember to take their bullshit detectors with them. That certainly applies in considering the findings of happiness studies and behavioral economics. It also applies in considering literary contributions, such as a book I read (and commented on here) about the significance for our understanding of happiness of Samuel Richardson’s 18^th century novel, Pamela.

Conclusions

Economists should practice humanomics because they can’t expect to be able to understand human behavior unless they do. Humans do not always behave as self-interested maximizers. It makes no sense to assume that human action always occurs at a subconscious level as an automatic response to stimuli. Individuals often think about the meaning of events, consider their options, and talk to others, before responding. Self-direction is integral to human flourishing.

In seeking explanations for human behavior, economists should not confine themselves to a focus on institutions and incentives. They should be open to considering all relevant information that they can get their hands on, including information on ethics, ideology, and happiness ratings.

How is behavioral economics relevant to human flourishing?

The practitioners of behavioral economics have tended to direct their research findings mainly at “choice architects”, including paternalistic governments. For example, in their book, Nudge, Richard Thaler and Cass Sunstein adopt the term “libertarian paternalism” to propose:

“Choice architects can preserve freedom of choice while also nudging people in directions that will improve their lives”.

An example might help to clarify what a nudge involves. If the government were to invest a certain proportion of your income in a superannuation fund on your behalf this would amount to a nudge, rather than a push or a shove, if you were allowed to withdraw the funds at any time to use as you wished. Because of a tendency for people to avoid choices, or to choose default options, such an arrangement would be likely to result in more investment in superannuation than one that relied solely on tax incentives. It would do this without the interference in personal choice that is involved in compulsory superannuation, such as exists in Australia. (That example is taken from my review of Nudge.)

However, if you view human flourishing as an essentially self-directed activity, as I do, you may be sceptical about claims that such nudging can improve your life. Even if the people doing the nudging have your interests at heart, their perception of what will improve your life will not necessarily accord with your own preferences.

In the example provided above, additional transactions costs may be imposed on the person being nudged. For example, investment in superannuation might not be the best option for a young person wanting to save for a deposit on a house. Over the longer term, the value of an investment in a superannuation fund could be expected to rise to a greater extent than cash in the bank, but short term fluctuations in equity prices make superannuation a less suitable vehicle for shorter term saving. Withdrawing funds for a house deposit could result in capital losses being incurred.

Robert Sugden suggests that “something is clearly wrong if economists think that their response to the discovery of mistakes in individual decision-making must take the form of a recommendation about public policy” (The Community of Advantage, p 44). If you want to help individuals to make better decisions it makes more sense to address the information to those individuals rather than to address it to autocrats.  (I have previously discussed The Community of Advantage here, here and here.)

Sugden makes the point that nudgees (people who are nudged) do not always explain their failure to follow expert advice in terms of self-control problems. For example, an obese person who fails to follow expert advice about choosing fruit rather than cake, could explain his choice in a range of different ways that do not involve a self-control problem. If he sees nothing wrong with his choices, he has no reason to want to be nudged by having the fruit placed in a more prominent position in the cafeteria relative to the cake (p 47).

However, if the obese person acknowledges that he has a self-control problem, research findings about the influence of placement of products on consumer purchases might help him to modify his behaviour. His trusted advisers might be able to suggest how he could nudge himself to make better choices. By coincidence, earlier today, I heard a news item indicating that there is a supermarket chain in Australia that refrains from placing confectionary near checkouts. That information could be relevant to a person with an acknowledged self-control problem, who was wanting to avoid impulse purchases of confectionary.

The fact that supermarkets often place confectionary near checkouts illustrates that choice architects may not always have paternalistic motives. It should not be assumed, however, that their motives are exploitive. Supermarkets want loyal customers, so it is not likely to be in their interests to have shoppers end up feeling that they have been manipulated to make unhealthy choices and/or to spend more money than they wanted to spend. It is possible that the placement of the confectionary helps give most shoppers good feelings about their shopping experience. The nudge that one person views as manipulative may be viewed by others as benign, or even as providing a helpful reminder.

As a rule, it is good to be aware how you are being nudged in the choices you make. It is necessary to be aware that you are being nudged, as the first step in making a conscious choice to accept or reject the suggestion involved. Behavioural economics can make a useful contribution in helping to make us aware of how nudges may affect the choices we make.

Sugden suggests that behavioural economists who discover possible mistakes in individual decision-making are in an analogous situation to epidemiologists who discover an apparent causal relationship between some activity and the prevalence of an illness. The epidemiological findings are made available to the public in various ways and begin to influence behaviour prior to any public policy intervention being contemplated (p 43). 

Similarly, happiness researchers who discover that average life satisfaction of various groups is affected by factors such as leisure, or commute times, are providing information that individuals may wish to consider in the choices they make.  Individuals are likely to be affected differently, but rarely so differently that information about others is irrelevant.

Sugden acknowledges that normative economics has almost always been directed toward public decision-makers rather than private individuals, but suggests that “since economists often characterize their discipline as the science of rational choice one might expect them to recognize the potential value of helping individuals to make better decisions in their private lives” (p 43). He notes that Philip Wicksteed, one of the founders of neoclassical economics, presented economics as a study of the “general laws of the administration of resources” and insisted that these laws apply “from end to end of life”. He gave practical advice on how to avoid common mistakes in decision-making. The passage quoted above reflects the role he saw for economists in helping people to make better choices.

Sugden’s view that there is a role for economists in helping individuals to make better choices seems somewhat at variance with the view of James Buchanan. In his article “What should economists do?”, published in 1964, Buchanan argued that the theory of choice should be removed from “its position of eminence in the economist’s thought processes”. He suggested that economists should concentrate their attention on human behaviour in market relationships and other voluntaristic exchange processes, and upon the various institutional arrangements that can arise as a result of this form of activity.

I maintain the view, as previously expressed, that Buchanan is correct in identifying the heartland of economics to be concerned with voluntaristic exchange processes, but that does not rule out the potential for economists to make useful contributions in helping individuals to make better personal choices. It is in the latter context that behavioural economics is most relevant to human flourishing.

Will blockchain enhance our opportunities to seek mutual benefit in cooperative enterprises?

As noted in my review of The Community of Advantage, Robert Sugden suggests that it is appropriate for people to adopt the principle of mutual benfit in participating in voluntary interactions with others. The principle requires individuals to meet normal expectations concerning the consequences of the interaction of those with whom they are interacting, unless their behaviour indicates that they can’t be trusted. It may be seen as an alternative to seeking only personal benefit. It does not preclude seeking to benefit other people in some interactions.

Sugden suggests that the principle of mutual benefit is relevant to market exchange and many other forms of voluntary interaction. I want to focus here on the relevance of the principle to individuals participating in cooperatives and self-governing communities.

Governing the commons

Elinor Ostrom’s research on management of common pool resources illustrates how the principle of mutual benefit has been applied in some cooperative enterprises. In Governing the Commons: The Evolution of Institutions for Collective Action, which I have previously discussed in different contexts here and here, Ostrom suggests that individual participants have been willing to make a contingent self-commitment of the following type:

“I commit myself to follow the set of rules we have devised in all instances except dire emergencies if the rest of those affected make a similar commitment and act accordingly”.

In making such commitments people expect that governance rules will be effective in producing greater joint benefits, and that monitoring (including their own) will protect them against being suckered. Ostrom adds:

“Once appropriators have made contingent self-commitments, they are then motivated to monitor other people’s behaviors, at least from time to time, in order to assure themselves that others are following the rules most of the time. Contingent self-commitments and mutual monitoring reinforce one another, especially when appropriators have devised rules that tend to reduce monitoring costs."

That contingent self-commitment strikes me as an adaptation of the principle of mutual benefit to a cooperative enterprise.

Self-governing communities

The principle of mutual benefit also has potential to play a role in democratic government. I am personally willing to commit to participating in the political process in ways that will promote mutual benefits for us all, and to refrain from using politics opportunistically to obtain benefits for myself and my family at the expense of others, provided the behaviour of most other people indicates that they have made a similar commitment.

However, from my observation of national and state politics, it is obvious that few other people behave as though they have made a such a commitment. So why would anyone? Norms of reciprocity have been lost to democracy at a national and state level. Most voters now seem to view the taxing and borrowing powers of government as a common pool resource to be used for their own personal benefit. Rather than improving the opportunities available to the ‘average citizen’, the outcomes of politics often diminish incentives for productive activity and constrain the opportunities available to all (except perhaps those most adept at rent seeking). 

We have learned from Elinor Ostrom that Garret Hardin’s “tragedy of the commons” story – impoverishment through over-use of common property resources – is fiction when boundaries are clearly defined, and participants voluntarily commit to follow appropriate norms of behaviour. Rather than a tragedy of the commons, wealthy societies are now experiencing a tragedy of democracy at a national and state level.

In his book, The Meaning of Democracy and the Vulnerability of Democracies, Vincent Ostrom set as an ideal the re-establishment of self-organizing and self-governing communities in which each person “is first his or her own governor and is then responsible for fashioning mutually productive relationships with others”. Such communities would be characterised by “mutual understandings grounded in common knowledge, agreeable patterns of accountability, and mutual trust”. As discussed in my review of his book, Vincent Ostrom wrote of re-establishment because American society in the 19^th century was observed by Alexis de Tocqueville to have many of the characteristics of self-organizing and self-governing communities. They were the kinds of communities in which those seeking mutual benefit were more than likely to be rewarded personally and collectively.

Blockchain technology

Does blockchain technology offer potential for the principle of mutual benefit to be exercised to a greater extent in cooperative enterprises and local communities? A few months ago, while reading The Social Singularity, by Max Borders, I became enthusiastic about the potential for blockchain and smart contracts to enable people to act together to produce some public goods cooperatively without involving central government. Since then, I have learned a little more about blockchain and am still enthusiastic about the potential it offers.

There are good basic explanations of blockchain on sites such Upfolio. For present purposes, all you need to know is that blockchain technology is designed to let people safely undertake transactions without the need for trust, or middlemen to check transactions. It offers a new mechanism to manage opportunistic behaviour once property has been given a digital identity. Smart contracts are self-enforcing. They require no external authority for enforcement because all conditions of the contract are managed on-chain.

In a recent paper, Sinclair Davidson, Primavera De Filippi and Jason Potts make a strong case for blockchain to be viewed as a new form of economic institution. They define a Decentralized Collaborative Organization (DCO) thus:

“A DCO is a self-governing organization with the coordination properties of a market, the governance properties of a commons, and the constitutional, legal, and monetary properties of a nation state. It is an organization, but it is not hierarchical. It has the coordination properties of a market through the token systems that coordinate distributed action, but it is not a market because the predominant activity is production, not exchange. And it has the unanimous constitutional properties of a rule-of-law governed nation state, by complicit agreement of all “citizens” who opt-in to such a Decentralized Collaborative Organization, and the automatic execution of the rules of that DCO through smart contract enforcement” (“Blockchains and the economic institutions of capitalism”).

Transactions are likely to occur in blockchains, rather than in firms or markets, when blockchains offer the prospect of reducing transactions costs, e.g. by reducing costs of monitoring managers to ensure that they are acting in the interests of owners. Blockchain organisations can be expected to be carved out of those parts of firms in which they lower transactions costs.

My understanding is that the transfer of transactions to blockchains has the potential to reduce transactions costs in all forms of enterprises – whether they are owned by investors, producers, consumers or governments.

As with markets and firms, blockchain systems offer people the opportunity of being able to get what they want by helping others to get what they want, even though the self-enforcing nature of the blockchain itself means that those who seek mutual benefit will gain no additional advantage by appearing to be trustworthy.

It is worth noting, however, that when using smart contracts to facilitate governance, trust is transferred to the code that defines them, and to those who write the code. That point has been made by David Rozas, Antonio Tenorio-Fornés, Silvia Díaz-Molin and Samer Hassan in a recent paper (“When Ostrom Meets Blockchain: Exploring the Potentials of Blockchain for Commons Governance”)

Who will you trust to write the code? I imagine that smart contracts would be no easier for a layperson to read and understand than the intellectual property agreements that we all have to claim to have read and understood before we can update our computer programs.

It seems to me that some of Henry Hansmann’s comments about the benefits of ownership of enterprises are relevant to the question of whose code is trustworthy. Even though the owners of an enterprise may have limited ability to reduce transactions costs by monitoring managers, ownership provides them with some assurance that managers are not serving interests that may be opposed to their interests (Henry Hansmann, The Ownership of Enterprise, 1996, p 48). Similarly, producers, consumers and investors could each be expected to place most trust in code written by technicians whom they perceive to be serving their respective interests. In many instances, distrust of code will be less of problem and transactions costs will be lower if multi-purpose DCO architecture can be purchased off-the shelf.

Backfeed, an experimental operating system for decentralized organizations, may well turn out to be a good example of blockchain technology which enhances opportunities for those seeking mutual benefit in cooperative endeavours. Its inventors claim that it enables “massive open-source collaboration without central coordination”. Backfeed’s governance system enables a decentralized network of peers to reach consensus about the perceived value of any contribution within the network, and reward it accordingly. Those participants who feel that their contributions are not adequately valued by their peers have an opportunity to fork-off into different communities that might be more appreciative.

Backfeed may or may not succeed but, one way or another, it does seem likely that blockchain will enhance our opportunities to seek mutual benefit in cooperative enterprises.

When can economists adopt a contractarian approach to provision of policy advice?

Cartoon by Peter Nicholson: from this site

Robert Sugden explains his use of the term ‘contractarian’ thus:

 “the most fundamental characteristic of this perspective is that a recommendation is addressed to a set of individuals, showing those individuals how they can coordinate their behaviour to achieve mutual benefit."

This post is prompted by my reading of his book, The Community of Advantage, reviewed on this blog a few weeks ago.  

Sugden’s adoption of a contractarian approach was inspired by the work of James Buchanan, in which social arrangements are assessed from the several viewpoints of individual members of society considered as potential parties to a social contract.

Contractarian reasoning implies a baseline of non-agreement from which benefit is measured. For agreement to occur, each party to a potential agreement must recognize that, for all the parties severally, agreement is more beneficial than the status quo.

Contractarian reasoning is readily applied in considering adoption of general rules. When individuals consider adoption of a general rule, a veil of uncertainty about future circumstances often makes it difficult for them to assess where their interests might lie. They become more likely to identify as an “average” citizen than a member of a narrow interest group.

Sugden contrasts the model of contractarian reasoning with two other approaches to normative economics, the model of the benevolent autocrat and the model of public reasoning. He suggests that each of these different approaches to provision of public policy advice, may be appropriate, depending on the circumstances.

When economists employ the benevolent autocrat model, they are providing executive decision-makers with their best judgements about what should be done. In stylized terms, Sugden suggests that they are implicitly saying: “If I were an impartially benevolent autocrat, this is what I would do”. In my experience, when economic advisors employed by governments are striving to be their best selves, they tailor their advice to the values and priorities of the governments they are serving. That doesn’t mean that bureaucrats should attempt to ‘second-guess’ political reactions in providing advice. As Roger Kerr pointed out, soon after leaving the New Zealand Treasury to become executive director of the New Zealand Business Roundtable, attempts to second-guess political reactions “can lead to a narrowing of policy options” and does less than justice to those politicians who are prepared “to tell the story like it is”. Roger explained:

“Economists of all people should be conscious that the performance of bureaucrats in trying to pick winners and losers in the policy-advice market is likely to be as unimpressive as in the industrial domain – and for much the same reasons, namely the lack of information and incentives. Perceived political constraints are not always immutable. They can be shifted by reasoned analysis and well-constructed strategies for policy change, developed by interaction between political managers and technical advisers” (Roger Kerr, ‘Ideas, interests, experience and the economic adviser’, World Economy, 10 (2) June 1987).

The model of public reasoning provides a stylized view of politics as an arena for debate about the public good, where the participants strive to deploy impartial and reasoned argument. By contrast, in the real world, many participants in public debate on economic policy strive to deploy arguments to advance their own interests. Members of the economics profession who participate in such debates have potential to play an important role in ensuring that the merits and demerits of the arguments advanced are subjected to appropriate public scrutiny. That role has been made part of the public policy advisory process in Australia by being embodied in the public inquiry system of the Productivity Commission and its predecessor organisations.

My mention of the ‘economics profession’ brings to mind some provocative comments of Ludwig von Mises, an eminent Austrian economist, about professional economists:

“By virtue of their connection with definite parties and pressure groups, eager to acquire special privileges, they become one-sided. They shut their eyes to the remoter consequences of the policies they are advocating. With them nothing counts but the short-run concerns of the group they are serving. The ultimate aim of their efforts is to their clients prosper at the expense of other people. They are intent upon convincing themselves that the fate of mankind coincides with the short-run interests of their group. They try to sell this idea to the public …” (Human Action, fourth revised edition 1996, p 869).

I disagree with Mises description of such conduct as professional. It is unprofessional for economists to sell their souls to interest groups. It doesn’t matter how much knowledge of economics they might have, those who sell their souls are not behaving like members of an honourable profession.

Improving policy transparency

Some people with institutional expertise in public policy development have suggested that the advisory role of economists should be more akin to provision of information than normative advice. Bill Carmichael, a former chairman of the Industries Assistance Commission (a predecessor organisation to Australia’s Productivity Commission) argued for greater efforts to improve ‘policy transparency’ – to improve public understanding of the economic effects of policies that assist particular groups at the expense of the broader community. With reference to trade protection policies, he argued:

“Public availability of information about the effects, on national welfare, of responses which avert adjustment to economic change would improve domestic understanding and narrow the range of disagreement about what policy responses are appropriate. While it would not eliminate resistance to change by those who will be adversely affected, it would enable the grounds for such resistance to be weighed against the community-wide effects” (W B Carmichael, ‘National Interest and International Trade Negotiations’, The World Economy, 9 (4) December 1986).

Bill’s reference to ‘national welfare’ might raise tangential issues in the minds of some readers about the impossibility of aggregating, or averaging, the welfare of different individuals in a meaningful way, and the value judgements that are involved in using per capita GDP, or any other measure of income, as an indicator of welfare. In order to avoid getting bogged down in such issues, I interpret ‘national welfare’ as code for ‘the opportunities available, individually and collectively, to members of the community’.

When economists view their role as providing information publicly on the impact of policy change on opportunities available to various groups in a community, it seems to me that they are adopting something close to a contractarian approach to provision of policy advice. Such information enables the various groups affected to obtain a better understanding of how they are likely to be affected by policy change. Nevertheless, a public policy process of weighing the interests of those adversely affected by change against the interests of broader groups is likely to fall short of the ideal of a contractarian negotiation because the outcomes are unlikely to receive unanimous support. Unanimity is rarely possible since those adversely affected by change often have a strategic interest in withholding their support in the hope of obtaining a better outcome from the process. Perhaps the most that can be hoped for is that by the time policy decisions are made, the process will have persuaded those adversely affected by change that they are unlikely to benefit from lobbying to have the decisions reversed.

Compensation

Robert Sugden suggests that contractarian advisors have a better chance of achieving unanimous support for policy change if they give attention to compensation. When a policy proposal imposes significant harms on a group of individuals, the addition of compensation payments may have potential to make it mutually beneficial.  Unfortunately, Sugden doesn’t discuss the potential for those opposed to change to negotiate strategically in a context where policy outcomes are likely to be strongly influenced by the political muscle of narrow interest groups. When governments seek to negotiate compensation packages with powerful interest groups, they risk putting the rest of the community in a position somewhat akin to seeking to negotiate a settlement with an extortionist. The above cartoon relating to negotiations for deregulation of the Australian sugar industry illustrates the problem. After receiving substantial adjustment assistance to gain acceptance for deregulation about a decade ago, the industry has since been re-regulated.

Nevertheless, it is possible to cite instances where compensation payments do seem to have enabled better policy outcomes to be achieved in contractarian policy negotiations. In an article published a couple of years ago, reviewing literature on agricultural adjustment in Australia, Geoff Edwards, and I expressed the view that “economists advocating adjustment assistance during the 1970s helped shift the focus of agricultural policy in Australia away from price support and input subsidies, leading to greater acceptance of policies to facilitate adjustment rather than to impede it”.  We concluded that “adjustment assistance can sometimes enable less efficient and less equitable forms of assistance to be avoided” (Geoff Edwards and Winton Bates, ‘Antipodean agricultural and resource economics at 60: agricultural adjustment’, Australian Journal of Agricultural and Resource Economics, 60, pp 573-589).

Conclusions

So, when can economists adopt a contractarian approach to provision of public policy advice? My experience leads me to think that a contractarian approach has been used effectively in considering changes in the ‘rules of the game’ relating to economic policy in some countries. During the 1980s and 90’s, some economists in Australia and New Zealand adopted important elements of a contractarian approach in successfully proposing trade liberalisation, privatisation of public enterprises, regulatory reforms and government spending restraint. The focus of analysis was the potential for changes in the ‘rules of the game’ to improve the opportunities generally available to community members. Reports were published with a view to obtaining broad community support for changes in the rules. Many influential opinion leaders were receptive to the view that the rules of the game needed to be changed in order to avert looming economic disaster.

For reasons expressed elsewhere on this blog (for example here and here) I think the democratic political processes of western countries have been corrupted so much over the last few decades that in the event of a future economic crisis it is unlikely to be possible to implement reforms to prevent emergence of widespread economic misery. I doubt whether use of a contractarian approach to policy advice will help much in this context, but such an approach is still more likely to be successful than the alternatives available. The best contractarian advice I can offer to individuals is to reduce your dependence on government as far as possible, and to seek out opportunities for mutually beneficial interactions that do not involve governments.

Over the next few decades, I expect that economists adopting a contractarian approach will play an increasingly important role in helping people to use new technology to negotiate mutually beneficial agreements to obtain what they want without government involvement. I will write more about that later.

Isn't it good to be able to get what you want by helping others to get what they want?

When I was at university studying neoclassical welfare economics - about half a century ago - the standard discussion of the benefits and limitations of free markets began with a demonstration that, under certain assumptions, individuals with stable and internally consistent preferences could maximize their utility through voluntary transactions. As I write, I have a picture in my mind of neat sets of indifference curves in an Edgeworth Box, rather than the gains from trade diagram shown above.

Of course, in the 1960s and 70s a great deal of attention was given to market failure stemming from violation of competitive market assumptions and the existence of externalities. Since then, research by behavioural economists has provided evidence that individuals’ preferences tend to be context-dependent, rather than stable and internally consistent. For example, as we all know, what we choose to buy may be influenced by the placement of items on supermarket shelves.

Just as evidence of market failure led many economists to advocate remedial government interventions, evidence that individuals’ preferences tend to be context-dependent has been used by some behavioural economists to argue for paternalistic interventions to nudge people to make better choices. Wise economists urge that consideration should also be given to government failure - the tendency for government intervention to make matters worse even when politicians intend to produce better outcomes.

Robert Sugden has shone light through the smog caused by the standard neoclassical assumptions about individual preferences in his recently published book, The Community of Advantage. Sugden dispenses with assumptions about individual preferences by substituting the principle of individual opportunity – the idea that individuals will choose to have more opportunities rather than less.

Sugden’s book has been praised by some eminent scholars working at the interface between economics, psychology and ethics. It is pleasing that Cass Sunstein, whose advocacy of paternalistic nudges is challenged in the book, describes it as “one of the very few most important explorations of liberty in the last half-century.

Sugden makes the powerful point that there is no basis for behavioural economists to interpret contraventions of the standard neoclassical assumptions as necessarily attributable to cognitive error or self-control problems. There is no known psychological foundation for human decision-making to be modelled as “a neoclassically rational inner agent, trapped inside and constrained by an outer psychological shell”.

Nevertheless, humans obviously make cognitive errors and experience self-control problems. Should economists wash their hands of those problems and leave them for psychologists to deal with? Sugden suggests that economists may be able to help by adopting a contractarian approach – addressing their recommendations to individuals - usually by showing them how they can coordinate their behaviour to achieve mutual benefit - rather than addressing recommendations to paternalistic governments. It is consistent with a contractarian approach for economists to point out the mistakes that individuals are liable to make and to suggest types of choice architecture (e.g. nudges) that they could use, if they wanted, to avoid making those mistakes.

One of the highlights of the book is the perception it offers of the workings of “the invisible hand” of the market. The invisible hand is sometimes portrayed as something that has to be mysterious since it is able to convert self-interest into community benefits. Sugden suggests that the invisible hand is far from mysterious when perceived in terms of the activities of profit-seeking traders looking for arbitrage opportunities. If some individuals are willing to sell something at a lower price than other individuals are willing to pay to buy it, traders can take advantage of the profit opportunities of that situation. From the perspective of the buyers and sellers the transaction helps realize an opportunity for mutual benefit, whether traders are involved or not.

As I see it, from an individual’s perspective the market provides expanded opportunities along the lines suggested in the gains from trade diagram shown above. A person who subsists without trading with others has little leisure time left after eking out a living. By participating in trade - earning a market income in this example - her consumption possibilities are expanded. She is able to get more of what she wants – more leisure and/or more other goods - by helping others to get what they want.

Opportunities for mutual benefit are not limited to market exchange. Mutual benefit is possible in many different types of cooperative interaction. Sugden provides an insightful analysis of team reasoning, contrasting a contractarian approach in which individual team members seek to achieve mutual benefit with the alternative of perceiving the team as a single entity and seeking to maximize the overall good of the team, as judged from some neutral viewpoint.

The author’s analysis of adherence to voluntary practices is also insightful. He notes that individuals realize mutual benefits directly by conforming to voluntary practices, e.g. tipping conventions, because regularities of behaviour provide salient benchmarks for expectations about one another in specific interactions. By conforming to the practice, they also sustain the expectations upon which it depends and help to maintain it as an institution.

In my view, the most important contribution of the book is its discussion of the ethics of intending mutual benefit. A long-standing and recurring theme of criticism of market exchange is that it involves extrinsic motivations that are not virtuous. That line of thinking implies, implausibly, that the intrinsic satisfaction that I obtain from blogging might evaporate if I were to obtain monetary rewards for my efforts. Sugden observes that when people participate in markets they can act with the intention of achieving mutual benefit, rather than personal benefit. He urges readers to adopt the following principle of mutual benefit:

“When participating with others in a voluntary interaction, and for as long as others’ behaviour in that interaction is consistent with this very principle, behave in such a way that the other participants are able to satisfy normal expectations about the consequences of the interaction for them."

The author explains that one of the merits of the principle of mutual benefit is that what it requires of us individually is independent of the motivations of the people with whom we interact. It is in our interests to seek mutual benefit in interactions with as many other people as possible. The principle never requires us to make judgements about another person’s intentions.

The Community of Advantage is the best book I have read about the economics of human flourishing. This brief review has provided only a glimpse of what it is about. Hopefully, it has whetted your appetite to read the book.

The book has raised several issues that I hope to be able to explore further on this blog:

• Is the principle of mutual benefit consistent with the primacy of personal responsibility as discussed by Douglas Den Uyl and Douglas Rasmussen in The Perfectionist Turn?
• When is it possible for economists who are engaged in provision of public policy advice to adopt a contractarian approach?
• Does the principle of mutual benefit mesh well with the views of Elinor Ostrom on management of common property resources, the views of Vincent Ostrom on politics, and the views of Max Borders about the prospects of a Social Singularity?