Monday, August 20, 2012

Euvoluntary Exchange, Efficiency Criteria and the Social Contract

The classroom description I usually give for Pareto efficiency is something like this: an outcome is Pareto efficient if no one can be made better off without making somebody else worse off. When discussing economic efficiency, this is usually a pretty good place to start. Unfortunately, it's not an especially good guide for allocation. Very few actions are truly costless and someone always bears the cost, which is why economists are fond of what might be in contention for the most awkward acronym of  all time: "TANSTAAFL", There Ain't No Such Thing As A Free Lunch. If we had to rely on Pareto criteria to make any changes to the status quo ante, we'd be paralyzed. That's why when evaluating what it is economists evaluate (a list that seems to get bigger by the year), we rely more commonly on the Scitovsky criterion, more commonly called Kaldor-Hicks efficiency or just cost-benefit analysis. K-H efficiency relaxes the Paretian concern over making no one worse off by simply insisting that the total benefits to exchange or production or whatever exceed the total costs. That is to say that when someone else is made worse off, they could be compensated using the residual value generated by the economic activity.

It sounds simple, but like with many seemingly simple things, there are hidden depths that complicate matters.When we're talking about routine exchange choices, it's pretty easy to identify the affected parties. When I buy a bucket of ice cream (euvoluntarily), I'm better off, my grocer is better off, and to the extent that sufficient stock remains that the next guy who wants rocky road is able to find what he's looking for, I'm not harming anyone. It might be true that I'm ever so slightly bidding up the price for ice cream in my gluttony, but by K-H criteria, the imperceptible effect my purchase has on the market is swamped by the surplus claimed when a deal is struck. But what happens when the parties to a decision don't yet exist?

Smarter people than me (like Scitovsky himself) have rigorously proven that Pareto improvements are necessarily K-H improvements, though the reverse need not be true. I am willing to make the intuitively plausible claim that euvoluntary exchanges are local* Pareto improvements under condition 4, no uncompensated externalities, and local K-H improvements in the absence of condition 4, as in the GTM's original paper. Note that this does not necessarily imply that all K-H improvements need stem from euvoluntary exchanges, but it does mean that if a trade is not K-H efficient, it cannot be euvoluntary.

Why is this important and what does it have to do with contracting with not-yet-existent parties? Quite a bit, really. Consider an honest-to-goodness Hobbesian wilderness: all against all, two men enter, one man leaves, you scratch my back, I bludgeon you and steal your stuff. From this condition, a Rosseauvian social contract is unquestionably a Kaldor-Hicks improvement. Future generations benefit twofold: first, they can enjoy law, order, and the social welfare and eventual economic growth that accompanies peace. Second, they get to exist. The easiest way to anthropomorphically increase the Earth's human carrying capacity is to cooperate. I am obviously better off for my ancestors' decision to form rules of law. Despite this, I have a hard time concluding that the social contract is euvoluntary. If for no other reason than confederacy with the state is not alienable nor are terms negotiable, the social contract does not conform to contract law. There is no meeting of the minds, no offer, default acceptance under penalty of imprisonment, no intent, and no remedy for usury or breach of merchantability. Lest I sound too glib here, let me give more concrete examples. Suppose I oppose a portion of my income bent towards violence against foreign nationals or directed towards the oppression of recreational drug users. Under normal contract law, I would be able to explicitly stipulate the acceptable use of my contribution towards services rendered. Under the social contract, if I'm in breach of terms I never agreed to, I become a tax cheat and a felon. I cannot for the life of me square this with the principles of euvoluntary exchange, even if I'm unmistakably better off living under the social contract. This suggests to be that this Euvoluntary Exchange project has even more to offer than is evident at a casual glance.

Indeed, we might use EE as another tool to examine the ethics of transacting across time and with absent parties. This is especially true of directional vs. destinational euvoluntarism. Perhaps when pondering how to treat unborn generations, we might also use an EE yardstick in addition to K-H and Pareto criteria when making sticky meta rules or writing constitutions.

Some questions for consideration:

  • Can ex ante institution creation be purely euvoluntary? If so, what are the natural limits to those institutions?
  • What components, if any, of EE should meta rules consider?
  • To what degree are EE conditions substitutes for standard efficiency criteria? To what degree are they complements?
  • When are constitutional rules not coercive over future generations? Does this question ultimately matter?
  • How do you suppose ordinary folks develop moral intuitions towards the social contract?

* by "local" I mean here that we're ignoring any psychic discomfort felt by curmudgeons who bear an aesthetic grudge against what ordinary people would regard as mundane, acceptable trade.That is, I mean to exclude the reductio ad absurdum often brought to bear against the Paretian criterion.

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Do you have suggestions on where we could find more examples of this phenomenon?