WELFARE CRITERIA Witih ENDOGENOUS PREFERENCES: the ECONOMICS of EDUCATION*

iNTERNATIONAL ECONOMIC REVIEW Vol. 15, No. 2, Jtune, 1974

WELFARE CRITERIA WITIh ENDOGENOUS PREFERENCES: THE ECONOMICS OF EDUCATION*

BY HERBERT GINTIS1

1. INTRODUCTION

"BY ACTING on the external world and changing it," Karl Marx once re- marked, "[the worker] at the same time changes his own nature." [18, (197-98)] Much of Marxist theory is a development of this basic observation. The special position in Marxist theory of economic structure, its conception of materialism, of ideology, of classes and of social change, hinge on this connection. Indeed, again to quote Marx, "the whole of history is nothing but a continual transfor- mation of human nature" [19, (160)]. It is less than happenstance that the major competitor to Marxist theory, the tradition culminating in modern neo-classical economics, is grounded firmly not merely in the abstraction from, but the negation of this insight. The Marxist observation, translated into neo-classical terminology, holds that individual preference structures are products of economic activity. Or more precisely, individual preferences develop and change according to variables endogenous to the economic model: prices, quantities, and availabilities of consumption goods, jobs, and the social institutions conditioning the supply of labor. Neo-classical theory starts from the contrary position: the Walrasian system takes preferences as either fixed, or changirngonly in response to variables external to the model. In positive economics, the formationi of preferences is relegated to sociology or social psychology; and in welfare economics, preference structures are amonig the fundamiiental,unexplained data. In the words of Harrod [13], The method of procedure is to take certain elements of the structure as given-namely the preference lists of individuals for goods and services, the terms on which they are willing to contribute their assistance to production and the current state of technologyy... The object of this procedure would be to provide means of showing how changes in the fundamental data, desires, etc., will govern the course of events. To the confirmed neo-classicist, taking preferences as given is a sign of ethical neutrality [25]. To the Marxist, however, this approach incorporates the ma- terialist bias of capitalist society [12]. Because psychic development in capitalist society is merely instrumental to the growth of marketable goods and services, so the theoretical justification of capitalist institutions requires that we suppress consideration of the human outcomes of economic activity. To assume individuals as fixed or developing independently froin economic activity means

* Manuscript received December 11, 1972; revised December 3, 1973. 1 This paper owes its present form to the insights and constructive criticisms of Samuel Bowles, James Cox, and Duncan Foley, to whom I owe a large measure of gratitude.

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This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions 416 HERBERT GINTIS mnerelythat we do not evaluate, in a normative analysis of economic activity, the way they got to be the way they are-and the way they change. Neo-classical economics has not been oblivious to this weak but crucial link in its chain of reasoning. Numerous attempts have been made to justify it, with varying degrees of sophistication and success. While none stand up to close scrutiny,2 cross-paradigm disputation has never produced decisive victories nor weakened the social power of a dominant theory. De principiis non dis- putandum. But social theories do have the uncanny propensity to generate their own refutations in the course of their internal development. This paper treats one such apparent contradiction in neo-classical theory, involving the "economics of education." Neo-classical welfare economics employs, as a summary indicator of economic progress, a measure of Gross National Product. In the late 1950's, however, a number of studies [1], [28] indicated that historical increases in this indicator of output could not adequately be explained by increases in the supplies of labor and capital as conventionally measured. In response to this anomaly and spur- red by a growing concern with "poverty," an entire field developed: the economics of education. Denison [6] demonstrated the importance of changes in the "quality of the labor force" alongside of capital accumulation and technical change in the sources of economic growth. Schultz [27] illustrated the formal equality of human and material factors of production in the theory of capital. Minicer [20] and Becker [3] showed education as a central variable in the theory of the wage strtucture. And in developmiieniteconomics, the crucial role of edti- cation as a variable in general "modernization" policy, came to the fore [4]. But education is a prime example of a conisciousattempt to change preferences, or more broadly, individual personalities. Through schooling, individuals become what they were not. Individual psychic development is molded in the in- terests of productive participation in the economy. Hence the following problem: Neo-classical theory justifies market institutions on the basis of their contribution to growth and allocational efficiency. The norms of growth and efficiency are in turn justified on the basis of the exogenous-preferences assumption. In view of the empirically-determined importance of education in changing preferences to generate an adequate labor force, the theory then appears involved in a contradiction: the adequate performance of the institutions it recommends requires the invalidation of the assumptions on which its recommendations rest. An obvious counter-argument comes to mind. Does not education have direct "cconsumptionvalue" to the individual? Indeed, if the preference change oc- curring through education has 'positive utility' to the individual, then the neo- classical evaluation will simply underestimate the benefits of the institutions it recommends. This defense is scarcely neo-classical, as it requires ethical standards to evaluate differences in preference structures. Yet even the admission of such comparisons, and according to "widely accepted" normative standards, does not provide relief for neo-classical theory. Description and lament of the authoritarianism. pettiness, and repressive atmosphere of American education 2 For an extended discussion, see [7, (Chapter 1)].

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions ECONOMICSOF EDIJCATION 417 have dominated enlightened discussioni from John Dewey to the present. More- over, empirical analysis of the operation of schools has by and large confirmed the more descriptive surveys.' If education is in the service of creating the 'liberated' individual, with mature control over his or her life, it seems to have failed. Here the defender of neo-classical theory may argue that whatever the actual state of education, it remains that the specifically economic strictures on the educational system are compatible with ethically desirable educational patterns. Deviations from such patterns are thus not the concern of economic theory as such. The dominant form of this argument is based, explicitly or implicitly, on the notion that the increased earnings of the more highly educated worker are due to his or her increased level of cognitive development,which is at worst welfare-neutral. Yet several investigations indicate that only a minor portion of the association between schooling and earnings can be accounted for in terms of increases in the level of cognitive functioning [5], [8], [11], [15]. Nor is the association between education and occupational success economically irrational. Rather, an analysis of social relations of formal education and the personality traits rewarded in schools shows they conform admirably to the needs of a system of production characterized by the hierarchical division of labor, the heart of the modern capitalist enterprise [5], [81. This paper investigates some of the more imumediatedistortions iilducecl ill the neo-classical econiomics of educatiotn through the assuLmptiolnsof exog,enoLus preferences. These distortionis take on particular imyiportanlcewheni preference structures most conductive to individual well-beinig anid those requisite to effec- tive job performance in the hierarchical organization of production implicitly "Crecommenided"by neo-classical tleory in fact diveige. But the genieral tlheo- retical propositions will be independent of this assertion. In Section 2, I will investigate the basic welfare axioml expressing that an individual is "better off" if enabled to reach a position higher on his or her order of choice. This premise is used to justify market-mediated price and quantity determinations, while these determinations in turn invalidate the premise. Thus this assumption is pr-ima facie untenable. In Section 3, I introduce a multi-period partial equilibrium model, and introduce a theorem restoring, at least in part, the acceptability of the axiom in assessincgwelfare change. I argue that the conditions under which this theorem holds are quite stringent and generally untenable. At any rate, the admissibility of the fundamental premise of welfare economics, far from being "intuitively obvious," can be seen to be highly prob- lematic. In Section 4, I investigate the Pareto-efficiency and optimality of a general equilibrium model with endogenous preferences, exhibiting a set of conditions under which the competitive market equilibrium has the usual desirable properties. But again the conditions under which this situation obtains are quite uinrealistic, and cannot be expected even grrosslyto approximate those of a real social system. Neo-classical welfare economics, I conclude, is an inadequate 3 For an analysis of the statistical clata relevant to personality development through schoolinlg, see [51, [81.

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions 418 HERBERT GINTIS guide to educational and related social policy. In Section 5, I discuss some reasonable extensions of these results to the case of market externalities, as well as other elements of realism introduced in the modern neo-classical treatment. I conclude that it is more nearly correct to depict the market economy in terms of "price determining utility" than the contrary conception on which neo-classical welfare theory is based. A correct welfare theory, integrated into a correct positive theory, will no doubt develop the core idea of a dialectical relationship between use- and exchange-values. These considerations reveal a basic inadequacy of the neo-classical theory of economic policy. We shall see that the preference structures of individuals in a given period depend on the "economic plan" of the government in that period. The neo-classical treatment starts from the price structure and preference structures generated in the private economy, identify "market failures," and correct these according to benefit-cost analysis. Thus the inadequacies of the Walrasian solution in the absence of market failures are extended and incorporated in the economic plan in their presence. This dilemma admits of no solution within the neo-classical paradigmi.

2. THE ENDOGENEITY OF PREFERENCES IN A STATIC MODEL We shall consider goods and services as instruments used in the performance of personal, conscious activities. Viewed in this way, personal welfare is a function of the constellation of social activities undertakenby the indiviclual[10], [16]. To perform an activity requires the more or less perfected development of capacities - cognitive, affective, physical, aesthetic and spiritual - in the relevant directions. These capacities, which mediate between an individual's needs and the socia'l activities which satisfy them, must in turn be learned and acquired. Thus education is not only itself an activity, it is a central means of acquiring the capacities to perform, or to perform more perfectly, other activities (loving, sharing, competing, working, playing, appreciating, etc.). Education changes preferences structures by expanding, inhibiting the expansion of, or even con- tracting, individual capacities to undertake and derive welfare from corresponding activities, hence altering the relative importance of instrumental means to these activities. More formally, we may consider the individual's utility function u having as arguments goods and services q = (ql, * , qm). To introduce the activity-ori- entation and the possibility of preference change, we consider u as parametrized by a capacityvector a = (a1, * * *, an), representing the "level of capacity development" in various directions. At time t 0, the preference function can be written

( 1 ) u[a(O)](q) = u[al(O), * * *, an(0)](q) We may define a budget constraint as

( 2 ) p.q =g(a(O))

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions ECONOMICSOF EDUCATION 419 where p is the current commodity price vector, and g(a) is the income of the individual as a function of his level of capacity development (for simplicity we assume that the performance of work has no effect on utility, and that the amount of leisure is fixed). We shall assume that au/uaa = Uai and aglaai = gai satisfy all necessary con- tinuity and differentiability conditions. If Uak> 0 and gak = 0, we call ak a pure consumption capacity parameter. If uak = 0 and gak > 0 we call ak a pure production capacity parameter. In this case, ak can represent either a stock of physical capital of some type, or a level of pure human capital. In this formulation there is no distinction between the two. In general, of course, we will have

(with proper choice of sign for ak) either (Uak > 0, gak < 0) or (Uak > 0, gak > 0), representing the cases where a capacity is beneficial to consumption while harm- ful to production, and where a capacity is beneficial to both, respectively. Preference change occurs through the effect of consumption activities (of which formal education is a special case) on the parameters ak. Thus we can write the end-period capacity parameters ak(l) as

( 3 ) ak(l) =fk(q) k =1, *, n. This formulation includes as a special case the accumulation of physical capital. A totally present-oriented Homo Economicus will of course maximize (1) subject to the budget condition (2), thus rendering a(1) an "unintended out- come" of his activities. But a rational individual both understands that activities affect preferences, and evaluates potential changes and actual differences in preference structures. As Bertrand Russell has observed, As a matter of fact, we consider some tastes better than others: we do not merely hold that some tastes are ours and other tastes are other people's. We do not even always consider our own tastes the best: we may prefer bridge to poetry but think it is better to prefer poetry to bridge. In short, the individual has in some measure a set of "preferences-on-preference- structures." For instance, the individual who has not developed the capacity to appreciate classical music will not choose Bach in a commodity bundle; yet he may believe it is better (for whatever reason) to "prefer" Bach, and rationally seek to develop this capacity. The source of such valuations is an important but ponderous behavioral and philosophical problem,4 which we shall here leave unattended. That it is "better to prefer poetry to bridge" may involve a piece of personal introspection, a moral stricture, an element of ancient acquired wisdom, or a conclusion garnered from observing the satisfaction of the poetry- lover. At any rate, it is an absolutely necessary element in our daily decision- behavior, for it embodies our conscious impulses and motivations toward self- development. Formally, we might like to rewrite (1) as

4 This problem will be discussed in following sections. See also L7],[10], [23].

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(1') u[a(O)](q, a(1)), with the individual maximizing (1') subject to (2). That this is manifestly untenable can be seen by thinking in termiisof revealed preference analysis. Faced with two bundles of goods, which will our more enlightened Homo choose? The aniswer should be obvious: he will not know hvhichto chose unless he is also told the work and commodity availabilities open to him. in all succeeding time periods. Whether or not he decides to learn poetry depends on the extent of availability of poetry in succeeding periods. Whether or not to acquire a particular work capacity (e.g., the ability to end-uremonotony, or learn a skill) depends on his being able to exercise it-and with what economic benefit-in the future. Conclusion: In order to choose which capacities to develop, the individual must know the expected future prices or more generally the terms of availability (in the case no market exists for the entity) of all goods and work- activities instrumental to the exercise of his capacities. It follows directly that:

THEOREM 1. By the very logic of rational choice behavior in a market system, preferences depend on expected future prices. Thus expected future prices are parameters of the preference structure, and influence the development of preferences over time. This observation can be simply stated: in a nmarketsociety of rational individuals, use-values are affected by the structure of exchange-values. By observing expected future prices of the economic quantities associated with social activity, the individual develops a particular set of consumption and production capacities, and hence a particular pattern of "use-values." The economics of education is only one-although an importantt-illustration of the empirical weight of this proposition. Theorem 1 is of course quite obvious once stated. The above argument merely extends to endogenous preferences what has long been known in capital theory: the value of a capital good depends on future expectations. There can be no one-period model of an economy with welfare implications because revealed preferences reflect expectations as to future prices. The usual Walrasian general equilibrium model expresses the precise contrary to the above proposition: relative prices reflect underlying use-values (preferences). Neo-classical theory then justifies the economic mechanisms exhibited in the Walrasian model in that famous, Paretian-based judgment: use-values (together with relative costs) ought to determine exchange-values. However, Pareto-optimality fails as a welfare critierion in the face of changing preference structures. Welfare economics has often presented reasons whereby such an optimum might fail to hold in a market economy, but this is not our contentioni. Rather, the criterion of Pareto-optimality has no welfare implications in the face of endogenous preferences. This can be shown in terms of the basic assumptions of welfare economics alone. These basic assumptions are two in number [17, (122)]: (A) An individual is better off if he is enabled to reach a position higher tip

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on his order of choice.... (B) The community becomes better off if one individual becomes better off and none worse off. These propositions seem unexceptionial in the context of fixed preference struc- tuLres,and abstracting from questions of equity. However, if preferenicesthem- selves change in response to economic policy decisions, then all we are allowed to say in (A) is that each individual would be better off if he wvereat a position higher up on his scale of choice. But can we conclude that an individual is better off if he is enabled to reach a position higher up on his order of choice? It is evident that we can do so only if the process by which the (initially) preferred position is attained, does not entail a chanigein the individual's pattern of preferences. In particular, we clearly have THEOREM2. A necessary condition for the acpplicationof (A) is that all arguments of the individual utility function not within the domain of the individual's choice set be exogenous to the general equilibriummodel. Thus, accepting the proposition that present prices provide the individual with indications of future prices, we conclude: COROLLARY1. The use of (A) and (B) to determine the structure of relative prices at a point in time is prima facie unjustified. Hence, under the same conditions, the neo-classical justification of tlhe "market optimum" is invalid. For by Theorem 1, expected future prices are endogenous preference parameters, and since they lie outside the domain of the individual's choice set, Theorem 2 applies. In particular, we have: COROLLARY2. The neo-classical juistification of the market in labor -the de- termination of the wage structure as a function of supply and demand- is primc facie untenable, even abstracting from equity consider-ations. For the present wage structure will result from the clearing of labor markets. This will set up expectations as to the future returns to various types of education (capacity development) open to the individual, thus representing one of the elements in his or her decision as to path of individual capacity change. This will be manifest in revealed preferences, and affect future utilities. COROLLARY3. It is unjustifiable, prima facie, to draw policy or other normative:conclusions from rate-of-return and mnan-powveranalyses of education and labor-force needs.

The above assertions are immediate. To assume preferences as fixed is absurd- in a sense as absurd as assuming the non-existence of capital. When endogenous preferences are admitted to the general equilibrium model, no conclusions can be reached without an analysis of the dynamic multi-period economy (again, just as in the case of capital theory). As we shall see, the conditions under wlhich the traditional conclusions obtain are quite restrictive-and reminiscent of the subject of recent controversies in capital theory [22], [24].

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3. ASSESSMENT OF WELFARE Ct-LANGE WITH ENDOGENOUS PREFERENCES

SLuppOSe we nlow have a liomo EcollIoliCuS with "instanitanleOLuS" utility f UncGtionl

- *- = ( 4 ) lit u[a(t)] u[al(t), an SI(t)]9* t 07 1 , ?*T

anid intertemporal welfare funlctionl

T- (5 )W(qo, * ,qT) 2- L rtiit(qt) T=O where q, is the commodity bundle at time t, and rt is a subjective time discount factor. Again abstracting fromiithe direct effect of work-activities on preference change, we may generalize (3) to

( 6 ) ak(t) f kt(qo, q *, qt-1) all (k, t) so that, assumiinga(0) as given, the value of parameter at time t depends on the individual's past history of consumption activity. This procedure eliminates all parameters of the utility functioni previously endogenious to the model (the benefit) while rIequiringa multi-period dynamic treatment (the cost). We relate the earniingcapacity of the individual directly to the parameters of his utility fuinction by forming the budget equation

( 7 ) pt,qt = gt(al(t), ? * *, anl(t)) - Solving lhe constrained maximization problem implied by eqcuations(4) through (7) leaves uis with the first order conditions.5

[t i E - - ] ( 8) Tt ++ZZ 7s[au,_ &US___ ag__ Ia(s) 21tPt aqt___ aq't s k [ akr(S) 5ak(S) ' q/ i - 1, n , *t 0, * ,T. Since the Lagrangian variable 2t canl be initerpreted as the discounlted marginal utility of income at time t, equationi (8) is seen to exhibit the familiar equality between lhe opportunity cost of the good in question and the marginal benefits of acquiring the good. The latter, represented by the left-hand side of (8), is composed of the direct marginal utility of the good plus the indirect effect via the impact of q on the production and consumption capacities of the individual. Equationi (8) shows that the "measuring rod of money" approach of neo- classical theory can be extended to the case of endogenous preferences. Namely, we can show that if the individual has perfect knowledge of present prices, future prices, anid the structural determiniants of his own1 preference function, we then have:

THlEOREM 3. T7he wvelfare eJfects of san exogenous change in?the bun1dleof goods available to the inldividualcan be estimiiated,in equilibrium, by the change in the mariketvalue of the bundle.

5 This is an application of standard constrained maximization. Cf. L14, (Chapter 8)].

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This follows from the fact that the increment in welfare associated with sup- plying the individual an amount dqsi* of good i at time s, is equal to the discounted private cost of the increment to the individual, in the case of changing preference structures. More precisely, we have the

LEMMA. Suppose we replace q,i by q,i + q,i*, for fixed i and s, in the individual utility function and all constraints save the budget constraint - i.e., qsi* is a 'gift' of good i at time period s. Then dW (9 ) g T = 2sPs, - dqs* qsi*=O

The proof of this theorem, which is contained in [6], follows immediately from the interpretation given to the left-hand side of (8) as the marginal benefit of an incremental unit of qsi. This result should scarcely be surprising. Rather than extending the one- period model to a multi-period one, we have essentially telescoped a multi- period to a one-period. We have taken over to the multi-period case a set of assumptions the tenability of which is admissible (if at all!) only in the one- period model. That is, we have merely 'dated' our variables. Thus we must assume that the individual at time t = 0 has full knowledge of (a) the future price structure (Pt); (b) the way in which any sequence of consumptions

(qO, * * *, qT) affects his capacities; and (c) the impact of any path of capacity development a(O), * * * a(T - 1) on his welfare. While (a) may be reasonably defended, (b) and (c) are wildly at variance with reality. The dictum that each individual is capable of evaluating the sources of his own welfare may be reasonable when the individual has experienced a wide variety of alternatives (as is approximately the case with a shopper in the supermarket) and when these experiences do not themselves alter his preferences (as when the supermarket is devoid of addictive comestibles and drugs). Both these conditions are radically violated in the multi-period case. In the (necessary) absence of such firm knowledge, all societies provide non- experiential belief systems to give content to capacity evaluation. These are values, norms, theologies, ancient wisdoms, etc. But, as I have argued in [10], the cultural institutions that provide this "knowledge" are themselves normally predicated on the particular institutional and economic structures at hand, so that the corresponding valuations in (4) are once again endogenous to the dynamic equilibrium model. Of course, given the prices structure (or, in the case of non-market societies, the shadow prices of relative availabilities), individuals can see the effect of various courses of capacity development simply by observing the manifest well-being of their neighbors. Thus the "ancient wisdom" tends to validate itself. But the well-being of their neighbors is dependent on the price-structure, and cannot be separated from it without superhuman effort. Even admitting these assumptions, however, Theorem 3 most certainly provides no justification for the neo-classical procedures employed in evaluating the welfare impact of education. For these procedures involve evaluating the benefits

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of education not by "production costs," but by the benefits in terms of accruals to individual income. That this approach is incorrect is implied by the (stronger):

THEOREM 4. To the extent that an education activity q,' is biased toward increasing the level of consumptionicapacities as opposed to increasing the level of production capacities, the nleo-classicaltreatment will utnderi-estimatewelfare gains.

PROOF. Suppose qji is a "pure" educational input for the individual, in the sense that it has no direct consumption value (i.e., aus/lqsi = 0), but acts solely to alter the consumption and production capacity parameters {ak(t)} in periods t = s + 1, * *, T. In this case, the individual income change associated with a marginal unit increment of qsi supplied (and discounted to time t = 0) is given by T (10) AI = EZ i > aak(t) t =s k aak aqsq But from the first-order conditions (8) we easily derive the incremental welfare change as [ a_u gt] aak (t) (l11) XWw= EEZ fL;t + 2t ] t k aak aak aqsq Hence the discrepancy involved in the neo-classical procedure is equal to

(12) AW- AI= Z Z at aak(t) t k aak iqs Simply stated, the neo-classical estimation procedure recognizes the effects of capacity changes on the individual's budget conistraint, but not the parallel effects on his welfare function through altered capacities for deriving welfare from produiction and consumption activities. Finally, to say that qsj is biased toward the generation of consumption capacities (i.e., toward raising the level of consumption capacities) merely means that aak(t)/1qsi is relatively large for those parameters ak(t) for which aut/lak is relatively large. Theorem 4 exhibits the market-bias of benefit-cost analysis in the economics of education, insofar as it is geared toward evaluating the welfare effects of alternative educational choices. Moreover, if the arguments of Section 1 are accepted, then the particular educational systems of capitalist society increase the level of production capacities at the expense of individual welfare; i.e., the aut/lak corresponding to relatively large aak(t)/1qsi are ntegative. In terms of Marxist theory, this observation is simply formulated: In an economic system characterized by alienated work-activities, the good worker is the alienated worker; thus, the formation of productive capacities in the worker through education requires stunting his capacities for undertaking creative, welfare-pro- ducing activities [10]. Thus we have the COROLLARY 1. In a capitalist societj characterized by alienated work-activities, the estimation procedures recommended by the neo-classical economics of educa-

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions ECONOMICS OF EDUCATION 425 tion tend to over-estimate the absolute benefits. Similarly, since education is central to economic growth, we arrive at the more general:

COROLLARY2. Even abstracting from questions of equity and market failures, no variant of National Product estimation has any prima facie jiustification as a measure of welfare change.6

4. GENERAL EQUILIBRIUM WITH ENDOGENOUS PREFERENCES In the previous section, we noted that the application of neo-classical welfare criteria in the case of endogenous preferences requires that the individual have accurate expectations as to the future price structure. But given an initial distribution of factor endowments, the actual time paths of prices will reflect the aggregated preferences of individuals for certain paths of capacity development in a multi-period market model. Thus the possibility of a Pareto-efficient dynamic equilibrium must be admitted, insofar as the market model provides a mechanism bringing the actual and expected price structures into (approximate) equality. We now examine this question. We shall consider a society of individuals {h Ih = 1, , H}, with commodity vectors {hq} and capacity vectors {ha}, and define qt = Zh hqt for t = 0, , T. For simplicity, we assume an aggregate production function

(13) F(qt, LPC(h, t), b(t)) = 0 t 0, ..*, T where

LPC(h, t) - hK(ha(t)) is a vector-valued function representing the Level of Productive Capacity of individual h, and measures his contribution to production in (13). The vector b(t) represents technological change, and its form will remain unspecified. With the above formulation, we have the following theorem:

6 If neo-classical theory fails to supply an adequate quantitative estimate of welfare change, it might yet be capable of a qualitative criterion of welfare change adequate for the economics of education. Indeed Sidney Schoeffler [26], in a rare neo-classical acknowledgement of the problem of preference change, has preferred a simple criterion for assessing the direction, if not the magnitude, of welfare changes. A sufficient condition for welfare increase, argues Schoeffler, is that the second commodity bundle be preferred to the first under both initial and final preference structures. A simple argument shows that this sufficient condition is invalid. For clearly, any preference change which is accompanied by an increase in income will satisfy the Schoeffler condition. Also, examples abound illustrating the untenability of this "sufficient condition." For instance, I might prefer to be myself with John D. Rockefeller's goods, and Rockfeller might prefer to be himself with his goods. But this does not mean that Rockefeller is "better to prefer to be any commonly understood sense of the term. In fact, it is not irrational for me off" than I, in in my total sitliation than in Rockefeller's. Similarly, it is not irrational at the same time forRockefeller to prefer my total situation to his own. A similar argument obtains in the case of intra-personal, inter-temporal preference change.

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THEOREM 5. Assuming the usucalconditions concerning convexity and the absence of externalities, there is a price structure p and a factor reward structure {hg(lla)} stuchthat, if expected by utflity mnaximizing individuals (describedby equa- tions (4) through (7)), as wvellas by the production sector, wvhichequates marginal productivities to expected prices and factor rewards, wvillbe realized thirotughthe mnarketmechanissm. This allocation wvillbe Pareto-efficient. This theorem is proved in full in [7], where some technical emmendations are considered. But it follows from the fundamental existence theorem of general equilibriuLn and its corollaries (Cf. [2, Chapter 5]), if we note that preference functions hav7ebeen effectively rendered exogenous, and the vectors LPC(h, t) can be seen as "marketed" factors supplies (including capital goods). This theorem elucidates the Corollaries to Theorems 2 and 4. While the use of welfare axiom (A) is pi-ima facie untenable, there are certain complex conditions which, if satisfied, render it acceptable. Thus the viability of the assumption of fixed preferences hinges on the realism of these conditions. We have arrived at the neo-classical result once again by telescoping the multi-period into the single-period case, thus de jure eliminating endogeneity. Is this a reasonable procedure? I scarcely intend to haul out the traditional criticisms of noni-convexity and market externalities, though their consideration leads to interesting insights whenlpreference development, rather than resource allocation, is the question at hand. Nor do I wish to emphasize that the age-old question of distributional implications of market-determined outcomes takes a novel and striking form when it is realized that possession of wealth can "buy" desirable paths of capacity development (Marx would probably say here that the worker alienated from his means of production is thereby alienated from himself). I will, however, re-emphasize the criticisms of the previous section. Indi- viduals must have perfect knowledge not only of future prices, but also of the precise effect of alternative activities on their capacities, and the precise impact of alternative paths of capacity development on their well-being, given these price expectations. This knowledge is in fact absent, and much of social theory is built around understanding how societies fill this void with systems of belief (e.g., [23]). That these belief systems are endogenous to, while not determined by, the economic system is well-known, and elaborated in [5], [10], [19]. But there is another, and equally socially-relevant, criticism. Quite simply, there is absolutely no reason to believe the solution to the multi-period problem to be uinique. Given an initial distribution of factors, there will in general be multiple "self-fulfilling" sets of price expectations compatible with maximization and miarketclearance. Indeed, there may be a continuum of such solutions, a possibility whose likelihood is increased, the greater the extent to which technology (represented by b(t) in equation (13)) is endogenous to the system. For instance, suppose all individuals expect the price of good qk to be high. Con- sutmerswill not develop the capacity to tusethis good, and demnandwill be low. Producers will not develop technologies toward decreasing, the prodLuctioll costs

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions ECONOMICS OF EDUCATION 427 of qk, so the marginal cost will be high. Thus expectations will be fLulfilled. However, it is clear that had all individuals expected a low price, this too might have come about: consumers would have developed the relevant capacities to use the good, and producers the technologies to produce it more cheaply. Again, suppose individuals believe the factor reward to a particular level of capacity development (a(t)) to be low. Individuals will not develop these capacities, and their supply will be low. Producers will not develop technologies intensive in this factor, so marginal productivity will be low. Expectations will again be fulfilled, but initial high price expectations might also have led to market clearance. This observation has its counterpart, of course, in the famous "reswitching" theorem from capital theory, so I suspect the argument for multiple equilibria is quite independent from the endogeneity of technological change (though the existence of a continuum of equilibria might be so dependent). The endogeneity of technology, however, is clearly the socially relevant case - for instance in at- tempting to assess the efforts of developing nations, such as China, to follow alternative growth paths (Cf. [12]). Moreover, I suspect that the market system is not neutral with respect to the particular equilibrium it "seeks out." The dynamic local and global stability properties of the market economy will likely render some equilibria much more easily attained than others.7 In other words, in the market economy, we will still have exchange-value determining use-vclue, rather than the neo-classical inverse. The only realistic recourse, then, is to posit a collective economic instrument (e.g., a State Planniing Board) to replace the Iiivisible Hanidin the determnination of expected prices. The optiinality of market mechanisms can be restored, assuming this collective instrument has perfect knowledge of parametrized individual utility functions and all alternative technologies, and reflects tlheinterests of the community in assessing social welfare. In such an extended model, however, market mechanisms become instruments of social policy (clearinig mechanisms), rather than determinants of social outcomes. This represents a substantive inversion of neo-classical welfare theory, which recognizes the need for collective intervention only in case of market externalities. Of course the neo-classical economics of education does not fare any better under this system. For the eminenitly non-neo-classical State Planning Board would niot use equation (10), but in its omniscience equation (11) in determining the prices of various types of education. But the result is nonetheless significant: Pareto-optimality remains the criterion, and markets are instruments to its imn- plemnentation. Similarly markets in labor operate, and clear, at the expected prices. But the expected prices are determined by a criterion including the welfare-impact of preference change. Moreover, the results of this general equilibrium analysis fully corroberate our objections to the neo-classical economics of education. For we have seen

7 In the atatonnement" case, this is proved in [.2, (Chapter 12, 280)].

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions 428 HERBERT GINIIS that the "proper" role of the State Planning Board in this area is to determine not only the amount of various types of education offered, but also the returns to education (i.e., the wage structure).

5. CONCLUSION Among the fundamental institutions of the capitalist economy are markets in land, labor, capital, and goods and services. Neo-classical welfare theory argues that under fairly general conditions, the production and allocation of factors of production and products is best governed by such competitive markets. Thus neo-classical theory becomes a justification of major aspects of the capitalist economy. Critics of neo-classical welfare theory have taken one (or both) of two tacks: (a) the conditions under which market-instruments are indeed justified are in fact not general at all; economies of scale, imperfect knowledge, externalities, social goods, uncertainty, and the non-marketability of important factors, goods and services are ubiquitous and render the market solution inefficient, and (b) the distributional implications of the market solution render it inequitable. These criticisms are indeed sufficient to motivate a searcn for alternative institutional solutions to the "economic problem." But I have always felt that the critical failure of neo-classical welfare theory lies on a yet deeper level- on its false conception of the relation of the individual to society. This implicit conception can be elucidated by contrasting neo-classical with Marxian theory. Thus I have here assumed the most auspicious possible environment to neo- classical theory-abstracting from "market failures" of all types and leaving aside the question of distributional equity-arguing that this theory remains yet unacceptable. But at this point questions of market externality and distributional equity may be easily reintroduced. The first result of such an extension is greatly to expand the breadth and import of the assumption of endogenous preferences. The erection of a set of economic institutions -even simply market institutions - has repercussions on individuals moving far beyond the resultant allocation of goods, services, and factors of production. The historical development of community, environment, culture, the social relations of everyday life, the structure of and relations among social classes-all bear the stamp of the dominanlt social relations of production and have direct impact on individual welfare. Such entities do not have prices, but just as with commodities, they are available to the individual only in sets of alternative bundles-from which he must choose according to an (extented) "budget constraint" (Cf. [10]). The resultant strue- ture of availabilities of these alternative bundles extends the concept of the price structure, and comprehends the total configuration of availabilities of social relations and their instrumentalities. In brief, a society is its pattern of exchange- values; the difference between the U.S. and China, or the Soviet Union and Yugoslavia, can be succinctly expressed as the difference between their patterns of relative availabilities. We conclude that the development of preferences is

This content downloaded from 192.12.12.245 on Mon, 25 Jan 2016 20:55:12 UTC All use subject to JSTOR Terms and Conditions ECONOMICSOF EDUCATION 42 9 governed by the complex of institutions that constitute society itself, amnong which economic institutions figure prominently. To take these preferences as given in justifying one such set of economic institutions is simply fatuous. The basic criticisms we have adduced in the framework of the pure market economy lose no force in this extended model. The neo-classical method is to introduce a political entity (the State) possessed of a a social welfare function reflecting community preferences over distributional equity and the allocation of all economic entities subject to "'marketfailure." The State effects an equi- table initial factor endowment, ferrets out externalities, and restores marginal conditions via schemes of taxation, subsidies, and regulation, according to the rigorous dictates of cost-benefit calculation [21]. The problem, of course, is that community preferences, as reasonable aggregates of individual preferences, will be endogenous to the economic model just as described above. The conclusion is the same: in general, the State must use markets merely as instruments toward the satisfaction of its goals, rather than acting as a technical appendage to a market system which (imperfectly) "determiinesoutcomes." The conditions under which the traditional neo-classical treatment is tenable are grossly violated in actual societies. If the above analysis is correct, traditional welfare economics must be dis- carded. But no doubt, however crippled by criticism, it will not loosen its grasp on the minds of economists until a replacement is found. I only hope my remarks stimulate others to this, a task rendered imperative by the struggles of millions of individuals to find a more secure basis for social existence.

Harvard University, U.S. A.

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