Thursday, May 28, 2020

We Can Have a Fairer, More Prosperous World: The Deep Emptiness of Efficiency as a Concept Is Even Deeper Than It Seems

by Neil H. Buchanan

Pretty much everyone who has studied even a tiny bit of economics is likely to have come across the familiar "efficiency-equity trade off," which posits not only that there are two distinct concepts called efficiency and equity but that they are in conflict.  If we want more efficiency, the logic goes, we must accept less equitable outcomes.  If we want more equity, we must give up some efficiency.  Sound familiar?

This is, in fact, not only wrong as a matter of logic but tragically so in its consequences.  Even though it is wrong, however, the liberal/conservative divide in the U.S. (and probably in many other countries as well, although what counts as left-ish in this country is clearly to the right of center in any other country to which we might compare ourselves) is in some ways built around this false choice.  Liberals have accommodated themselves to the idea that they are trading away some amount of efficiency when they promote things like minimum wages and income supports, and conservatives delight in saying that liberals want to kill the proverbial golden goose.  We thus see right-wing think tanks pumping out op-eds with headlines like this recent New York Times guest piece: "The American Dream Is Alive and Well: We have bigger issues than inequality."

To be sure, left-leaning economists and other policy analysts can do a lot of interesting work within the narrow strictures of that debate, sometimes pointing out when efficiency (as typically conceived) can be enhanced by pursuing more equitable policies.  The most obvious examples are in medical care and health insurance, where it is particularly easy to describe how the usual conservative economic assumptions are violated in ways that cause "free market" choices to be wasteful, hugely unfair, and self-defeating,

But this framing of a trade-off between equity and efficiency is, as I noted above, deeply wrong.  As Professor Dorf announced in his column here two days ago: "A New Buchanan/Dorf Paper Explains Why We Don't See More Conflict Between Law & Economics and Originalism/Textualism."  Our article draws from the authors' respective areas of specialization (I write mostly about economics and policy, Professor Dorf focuses on constitutional law and legal interpretation, among other things) to note an unexpected similarity between how conservatives in my field and conservatives in Professor Dorf's field rig their respective games: both groups claim to be using neutral, objective, and even scientific methods of analysis, yet somehow those analyses can be manipulated to produce conservative results every time.

There is much more to the article, of course, and interested readers should take a look at Professor Dorf's column.  People who have run out of Netflix content might even find a pleasurable diversion in the paper itself: "A Tale of Two Formalisms: How Law and Economics Mirrors Originalism and Textualism."  Here, I want to move the analysis from the broader economic critique that forms the basis of half of the article to a particularly alluring misuse of the efficiency concept in legal and policy analysis.

So as not to be coy or evasive, I will state my bottom line as clearly as I can here: Not only is efficiency an empty concept, but it is deeply empty in the sense that it is wrong even to fall back on a narrower claim, which generally goes like this: "Well, it's true that efficiency is manipulable, but there are some situations where it so obvious that something is inefficient that it is still meaningful to use the concept, albeit modestly."  No, even that minimalist defense cannot be sustained.

Although I did not realize that I was doing it at the time, I previewed the core arguments in what later became the economics sections of the latest Buchanan-Dorf paper in a series of columns on Dorf on Law last summer ((here, here, here, here, and here).  In the final entry in that series, I described the project as
"... criticizing the concept of economic 'efficiency' from various angles. The scare quotes are necessary to emphasize that this supposedly neutral concept is ultimately a shell game that allows any minimally clever economist to claim that what he (yes, economics is still one of the most gender-unbalanced academic fields) likes is efficient and what he dislikes is inefficient."
The simplest way to describe our critique of economic efficiency is to ask how we know when something is inefficient, which is particularly easy to see when we note that economists regularly use the term "distortion" to describe an inefficient policy or market outcome.  Distorted?  What does something that is not distorted look like?  To know that, one must first know what the baseline is against which all other possibilities are compared.

The baseline that necessarily underlies any efficiency analysis is composed of the preferences, technology, and legal rights that exist in an economy.  If I have a right to hold the copyright on a book for five years, that is a different baseline than a 25-year copyright period or none at all.  Whether tort claims must be pursued under strict liability doctrines, and whether they can be brought as class actions, will determine how people and firms make decisions and pay the consequences of those decisions (or not).  Whether a jurisdiction adopts contract formalism or realism profoundly changes outcomes.

Because of this lack of a neutral baseline, any set of economic outcomes can be called efficient if one merely takes the time to specify a baseline that supports those outcomes.  That is why Professor Dorf and I call efficiency "incoherent," that is, that it means nothing to claim that one set of outcomes is efficient or inefficient.  As I put it in the block quote above, "any minimally clever economist [can] claim that what he ... likes is efficient and what he dislikes is inefficient."

Many readers might feel some nagging discomfort with so broad and surprising a claim, but in fact there is no "other side" to this debate.  There is no way to defend a claim that some set of legal rules is objectively the correct and neutral baseline and that all deviations from the economic outcomes that flow from that baseline are axiomatically inefficient and distorting.  As Professor Dorf and I argue, that does not stop conservatives from claiming -- usually implicitly -- that theirs is a neutral baseline, but such a claim is unsupportable.

What is the fallback position, for those who (reluctantly or not) concede that they in fact have no greater claim to being able to rely on their baseline than anyone else does to rely on other baselines?  As I noted above, a standard response is to say that some core concept of inefficiency nonetheless remains.  Somewhat like Justice Stewart's oft-quoted claim about pornography -- "I know it when I see it" -- the idea is that although there might be a lot of gray, there is still some black and white when it comes to efficiency and inefficiency.

When Professor Dorf and I presented our paper to my colleagues at the University of Florida Law School's workshop series, one colleague formulated this idea (very much in good faith) in what I now think of as "the Room 204 example."  UF Law's building is a bit of a maze, and we were meeting in a room on the third floor.  Room 204 is down a set of stairs and (if I recall correctly, although I have not been there physically for months) in a different wing of the building.  The questioner asked if it is not obvious that -- no matter how right Buchanan and Dorf are about the incoherence of efficiency -- it would be inefficient to place the seminar's beverages and snacks in Room 204 rather than within every participant's easy reach at the back of the room in which we were meeting.

And to be clear, that is an appealing thought.  "Come on, Buchanan and Dorf, can't you at least admit that some things are inefficient?"  No.  No we cannot.  The only reason that the Room 204 example seems so obviously inefficient is because the questioner has not thought of any countervailing reasons that would lead to a different conclusion.  If the university wanted to be able to offer refreshments but not spend much money to do so, the provost might indeed ask us to make it inconvenient for people to consume them.  Or if there were a campus-wide push to get everyone to be less sedentary, there could be a very good reason to set out the food a long way away.

Indeed, why did we hold the event at the law school rather than at my home?  I have not checked, but I suspect that my house is closer to more of my colleagues' homes than the seminar room is.  And although Professor Dorf presciently changed his plans for our March 7 presentation by appearing via Zoom (only days before UF and most other universities shut down live meetings), why did we not originally plan to meet at Gainesville's tiny regional airport, at Jacksonville's larger airport 90 minutes away, or at a hub airport between Professor Dorf's home in Ithaca and mine in Gainesville?  Charlotte Douglas International is lovely in early March.

These alternatives are in no way silly, and each of them could be justified by some set of objectives that can be easily defended.  Or, to put it in the terms of baselines above, a decision to hold the seminar in an alternative setting would lead to different outcomes -- some people not choosing to attend, others opting in -- and each outcome would be an "efficient equilibrium" given the baseline that was created by the organizers of the seminar series.

In the fifth of my five-part series of columns last year, I described the version of the Room 204 example that is most familiar to tax scholars: administrability.  This is the idea that beyond equity and efficiency lies a third concern that is entirely non-theoretical and non-normative, which is that we should not set things up in an obviously silly and wasteful way.  As I put it there, however,
"administrability ... is merely a subspecies of efficiency.  Both standard efficiency analysis and administrability concerns are, after all, directed at the idea that we are using resources in a way that 'makes no sense,' that is, that we are imposing costs on ourselves that we could avoid but have chosen to take on in an expensive effort to defeat the dictates of the Invisible Hand (which efficiently mediates costs and benefits)."
I concluded: "I am not saying that one cannot spin a perfectly good story" in which something like the Room 204 example seems obviously wasteful, but "one can just as easily spin a no-less-defensible story" that would justify it on falsely objective grounds.  "Our willingness to buy one argument over the other ultimately depends on our hidden values."

In the end, then, there is nothing wrong with saying that it is silly to make refreshments available in an inconvenient place.  But calling that wasteful, or distortionary, or inefficient is just as wrong as any other attempt to justify calling something inefficient based an unacknowledged choices in setting a baseline.

The title of this column begins: "We Can Have a Fairer, More Prosperous World."  That claim is actually less grand than it sounds, however, because "prosperous" is simply a stand-in for efficiency.  What we call prosperity differs wildly under different circumstances and based on our ethical commitments.

When anyone makes an efficiency argument, then, we should always bear in mind that the argument is in reality an argument about what matters and what does not matter.  We can and should have robust debates about what matters, and those debates will be much clearer if everyone concedes up front that we are arguing about our normative commitments and not about scientifically objective truth.

7 comments:

Jonny Scrum-half said...

This makes a lot of sense, but regarding efficiency and the Room 204 example, isn't it accurate that efficiency can be seen as the best way to proceed from the core policy choices? Thus, if a decision is made to hold a meeting at the airport, having beverages available at the law school is inefficient. But that doesn't mean that the location of the meeting is any more or less efficient than any other.

Thus, in real-world terms, efficiency would describe how policies proceed from a baseline, and inefficiency can be defined as when policies contradict one another.

Greg said...

I'm not sure I buy this argument about efficiency unless you also are arguing that economic utility is a myth (which it probably is, but that isn't a given in the above discussion.)

I've always understood an efficient system to be one that maximizes total utility. Based on this definition, if utility is measurable, then two sets of choices can be evaluated for relative efficiency by measuring the relative total utility of the two systems.

In the opposite way, if utility is not measurable, then it's meaningless to talk about efficiency because then entire definition of efficiency relies on being able to measure utility.

The problem, of course, is that utility can be manipulated. The most obvious way to me is that I would argue that the actual marginal economic utility of one US dollar is different for a poor person than a rich person. However, most economic models that I've seen assume that the marginal utility of a single dollar is the same to both a rich person and a poor person. Those two assumptions about the definition of utility can have dramatically different results about what systems they consider to be efficient.

My overall point is: I'm not sure it's efficiency that's meaningless, I think it's utility, and utility being meaningless just happens to take efficiency with it.

Greg said...

To follow up on my point, I think the Room 204 example is an example where someone is really saying "surely no one can come up with a reasonable measure of utility where putting the snacks in room 204 results in higher utility."

Your response really amounts to "watch me."

I'm pretty sure it's possible to come up with systems where between two choices there is one option that clearly maximizes utility relative to the other, at least given a certain understanding of the system. Most of your arguments amounted to adding extra information to the description of the system that were previously considered to be outside its original scope, and had the effect of changing the utility function applied to the system.

For another example, consider the choice between:

1.) Shipping raw materials to a location and paying people to build state parks
VS
2.) Shipping raw materials to a location and paying people to repeatedly dig the same hole and fill it with the same dirt, while the building materials rot.

As stated, there should be no other significant changes other than the presence of the completed park vs a rotted pile of building materials, and so by any reasonable definition building the park results in higher utility and thus is more efficient.

It might be possible to change the description of the system in a way that changes the answer of what maximizes utility, but I'm not sure that's enough to argue that efficiency (when defined as a system's total utility) is meaningless.

Neil H. Buchanan said...

In response to Jonny Scrum-half: I like where you're going with your comment, but in fact my point goes even further. It turns out not to be accurate to say that "if a decision is made to hold a meeting at the airport, having beverages available at the law school is inefficient." One can specify a baseline in which it would be efficient to do it that way, even though it seems contradictory. The greater distance between the law school and the airport does not make this categorically different from the Room 204 example itself.

It is, in fact, quite eye-opening to see just how incoherent efficiency analysis is. As Professor Dorf and I note in our article, Gary Becker (a famous neoclassical economist) made a career out of expanding efficiency analysis beyond all recognition, most notably his "efficient suicide" analysis. Anything can be described as efficient, which means that everything and nothing is efficient in any disciplined or objective way.

Nico Banks said...

Johnny Scrum-half: I agree with your point that “efficiency can be seen as the best way to proceed from core policy choices” even though efficiency can’t itself justify those core policy choices. I tried to make a similar comment on a related blogpost published two days ago on this site, but I could not articulate that point as clearly and concisely as you did.

I think it is helpful to see an example of proceeding from core policy choices (or a "baseline" as Professor Buchanan puts it) to understand why "efficiency" is not meaningless. In A Tale of Two Formalisms, the authors use the example of a woman named Jane who has a certain level of wealth and, based on that level of wealth, buys a certain set of goods. Since she rationally chooses how to spend her wealth, the ultimate outcome--the set of goods she ends up owning--is efficient.

The authors then argue that it is actually meaningless to say that the outcome is efficient because the original assumption--Jane's level of wealth--is arbitrary. The level of wealth we attribute to her is arbitrary because it is calculated using some set of arbitrary set of property laws; neoclassical economic theory has no way of arguing that that those property laws are the right laws to be using. As the authors rightly point out, Jane might have stolen the wealth that we are assuming she has.

But saying that the outcome of the hypothetical is efficient is not really "meaningless;" economists can meaningfully and objectively determine whether the set of goods Jane now owns is efficient, even though they cannot determine whether Jane's initial level of wealth--and the set of baseline assumptions that determined that level of wealth--was just or arbitrary: The set of goods that Jane now owns is efficient if and only if there is no change you could make to that set of goods to make one person better off without making anyone else worse off (which, according to the Coase theorem, will be true if she rationally used her wealth in a free market, regardless of how many resources she initially had or whether she acquired those resources justly). That efficiency insight is certainly not a complete moral justification for Jane's ownership of property. But it would be a meaningful insight for a judge who needed to determine the set of goods that Jane should own, especially if the judge was powerless to change any of the baseline assumptions (i.e. Jane's initial wealth and the property laws that determined that level of wealth).

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