J. R. Hicks: Lizard Monsters, Twix Bars, and Welfare Economics

The government’s radical changeover has come with some controversial changes. One of these is reducing the powers of the EPA, which some argue will be detrimental to our environment. More and more headlines fly across the screen, from the praising of the coal industry by EPA director to a call to exit from international climate defense accords.

Let’s say that a factory is pumping goop into a river, killing off some of the wildlife and turning others into giant lizard monsters.

giphy

How should a government respond? Should we stop all goop being pumped into the river entirely, should we tax the goop, or just leave it alone?

Unsurprisingly, economists are split on how to answer this question.

A lot of economists argue that their role is not to tell people what to do, but to figure out why people act in certain ways. Everybody values goods differently. So, since value is subjective, we have to be objective economists; free from any kind of moral bias. These type of economists of in the field of economic positivism.

For example, a positivist economist would likely share this particularly solution-less economic insight to our river pollution problem: “Restricting the amount of goop a factory can pump into the river will reduce competition as the costs of reducing pollution will be too high for smaller factories. On the other hand, it will also lead to cleaner rivers.”

John R. Hicks helped pioneer another camp known as welfare economics. He was the Nobel Prize winner in 1972, along with Ken Arrow, “for their pioneering contributions to general economic equilibrium theory and welfare theory.”

So what is welfare economics? They share the first step with positivists in that they would figure out why people are doing what they’re doing. The difference is that they would go a step further and prescribe the solutions to problems in our economy.

You may have seen welfare economists talking on the news, saying that in order to improve our economy we need to stop losing to China, that minimum wage needs to be raised, or that stopping a factory from pumping goop into the river is bad. They are called welfare economists because they argue for what is best for the welfare of our society.

John R. Hicks contributed heavily to welfare economics. In order to explain how, I’m going to have to throw a few more definitions in.

Before Hicks came along, economists held fast to something called the Pareto efficiency model. An economy is “Pareto efficient” if no one can become better off without making someone else worse off.

To illustrate: Let’s say you and I are an economy. I have $2 and you have a delicious Twix bar. I like Twix much more than I like $2, and you’d much rather have $2 than a Twix. If we don’t trade, we aren’t Pareto efficient. We can both be better off without making anyone worse off by trading the $2 for the Twix.

However, once we make that trade, I’m not giving you the Twix back for $2. If you start craving a Twix and want it more than the $2, we can’t trade without making me worse off and Twixless. This is Pareto efficient.

Pay me for advertising in Twix please

This is a really strict rule though. What if something makes a million people better off, but one person worse off? We’re already Pareto efficient, and with that model, we shouldn’t go any further.

With this scenario in mind, J.R. Hicks created the Kaldor-Hicks efficiency criterion.

So instead of Pareto efficiency, we can use the Kaldor-Hicks efficiency. In order to discover if something is KH efficient, we use something called the “compensation test”. The test determines whether the gains to those who benefit from a proposed policy, for example, compensate the losses to those who must incur the costs, and still have gains left over. If this is the case, then the policy is worth implementing.

Instead of going back to the Twix example, it might be better to use the factory example to see the benefits of using the KH model. When measuring the factory, let’s say in this case the benefits of the factory pumping goop outweigh the costs to the river. After all, Godzilla protects us from other giant beasts like King Kong.

With the Pareto efficient model, we would refuse to allow the factory pump goop because the benefits happen at the cost of others. However, with the KH model, we can state that the factory should pump goop because of the benefits.

The EPA attempts to figure this out by doing cost-benefit analyses on proposed regulations. Although these analyses are imperfect, they are useful tools to measure the economic and social impact of EPA regulations. Should we exit from the international environmental treaty? What benefits does adhering to that treaty bring, and does it outweigh the costs?

John Hicks wasn’t so easy to pin down as a pure welfare economist, as he constantly contradicted himself. He would write in broad support of welfare economics, but then turn around and say things like this quote from his Nobel autobiography:

“I have been reluctant to pronounce on larger issues of practical economics since I am convinced that one should not pronounce unless one knows the facts; and to keep abreast of changing facts on a world, or even on a nation scale, is more than can be done by one whose main concern is with principles. A mere familiarity with statistics that have been prepared and digested by others is not sufficient.”

This seems to claim that an economist shouldn’t make broad policy judgments because we shouldn’t claim to know the right policy unless we know all the facts in a changing world. Furthermore, a mere familiarity with the statistics won’t save us either.

In the end, we’re left with a better model for understanding and trying to change the world of economics, but words of caution about hubris. Economists face the tempting danger of thinking we can know enough to solve all the worlds problems.

Pulled from nobel.org

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