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Social Welfare: Shall We Aim at Economic Growth?

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Social Welfare: Shall We Aim at Economic Growth? Green Growth and New Models of Prosperity Conceptions of social welfare: Shall we aim at economic growth? Ottmar Edenhofer Martin Kowarsch, Jan Steckel, Linus Mattauch, Michael Jakob Summer semester 2013, May 17 What this lecture will be about Economic growth is feasible despite climate mitigation Yet also desirable (as usually assumed in economics)? How much priority should policy-makers give to economic growth – compared to other objectives? The search for the “common good”, or “social welfare” (in the broadest possible sense) Compare insights on the normative dimension of cost-benefit analysis (previous lecture): the social planner, problem of discounting, etc. 2 Structure of today’s lecture 1) The “standard“ welfare function in economics: pro growth Welfare economics, and application in predominant IA models Is a social welfare function feasible at all? The Arrow Paradox 2) Amendments: Distribution, and sustainability of growth Criticism of standard welfare economics within “welfarism“ paradigm Distribution of wealth, and the importance of natural capital 3) Widening the horizon beyond welfarism Many variants of “multiple objectives“ Alternatives to pro-growth social welfare functions 4) Outlook: In-depth assessment of social welfare functions How to assess the value of growth? A complex normative problem Indicators, or multi-functional means: correlations? Trade-offs? 3 Structure of today’s lecture 1) The “standard“ welfare function in economics: pro growth Welfare economics, and application in predominant IA models Is a social welfare function feasible at all? The Arrow Paradox 2) Amendments: Distribution, and sustainability of growth Criticism of standard welfare economics within “welfarism“ paradigm Distribution of wealth, and the importance of natural capital 3) Widening the horizon beyond welfarism Many variants of “multiple objectives“ Alternatives to pro-growth social welfare functions 4) Outlook: In-depth assessment of social welfare functions How to assess the value of growth? A complex normative problem Indicators, or multi-functional means: correlations? Trade-offs? 4 A short reminder: Welfare in Ramsey Model From Lecture 2 • Future utility is discounted by rate • Objective function is given by intertemporal utility W: t t W U( Ct )e dt t0 • The optimization problem can be expressed as: state variable control variable t max U (Ct ) e dt C t 0 subject to K Y(K ) C K constraint + initial condition t t t t K(t 0) K0 5 Mainstream economics on social welfare • Economic welfare conception predominant in public policy – Major objective: wealth in terms of economic goods • Economic growth as most decisive means – Consumption and efficiency as core concepts • Some core underlying assumptions – Consequences in terms of (narrowly understood) utility, based on consumption of economic goods – Normative individualism, individual preferences • Diminishing marginal utility of C: sometimes neglected in Cost-Benefit Analysis (see previous lecture) • Additively separable aggregation (independence of individuals) – Importance of free (competitive) markets as an instrument 6 Mainstream economics on social welfare • Positive vs normative economics • Economics as engineering? As purely positive science? Or also normative? Most economists fear value judgments (deemded subjective), e.g. Menger and Walras. Collapse of the fact/value dichotomy and of logical positivism underlying mainstream economic methodology (Putnam 2002) • Welfare economics • At least axiomatic reference to ethical values • Ex-post evaluation of public policies (also: comparison) and support of decision-making • Brief overview of history: 7 Early Welfare Economics • The early economists were utilitarians: Bentham, Mill and Edgeworth thought about utility not in terms of preferences, but in terms of subjective well-being. Utility for them was directly measurable and comparable. • 100 years of debate in economics: Is utility cardinal? Is utility comparable between persons? Jeremy Bentham (1748-1832) 8 Utilitarianism • Hume, Bentham, Mill (18th/19th century) Jeremy Bentham: “greatest happiness for the greatest number” • Three core elements of utilitarianism – Consequences for individuals (which might differ) determine distribution/allocation, exclusively – Utility (in a rather narrow sense) as the only decisive consequence – Utility as a good to satisfy a want of whatever kind – Welfare is the aggregation of individual utilities (additively separable) • Further aspects • Major means: Economic incentives, private property and reliability in planning (Hume). • Redistribution (“eminent domain”) ok, if aggregated utility is increased then. • An action might be considered morally justified even if it is undertaken for unworthy reasons 9 What is utility? The (interim) resolution • Utility in the 20th century (pioneered by A. Bergson and P. Samuelson, ca. 1940): – The decisions individuals make, reveal their preferences. Social welfare only makes sense as aggregation of individual preference orderings. Utility which different individuals derive from one situation is not comparable (heavy influence of behaviorism). • The utilitarians currently strike back: – Recent social psychologists (e.g. D. Kahneman) find that subjective well- being is measurable and comparable, leading to “economics of happiness“ (TOPIC OF NEXT LECTURE). Daniel Kahneman Paul Samuelson (1934- ), Nobel (1915-2009), Prize 2002 Nobel Prize 1970 10 Paretian welfare economics • Pareto efficiency – Attempt to be less normative – Yet often several welfare optimal situations, several points on Pareto- possibility frontier: which one to choose? – Bias towards status quo? • Broadening the range of options: Kaldor/Hicks – Comparing social states via possible compensation payments between winners and losers, beyond Pareto • Difficult to operationlize, therefore development of “social welfare functions” (SWFs) 11 Social choice and SWFs • Social choice theory: moral mathematics – Purpose of social choice theory: understand the possibilities of social aggregation and their informational requirements (Sen, 1999). – Major problems addressed: formal representations of certain social values and their logical coherence • Social welfare functions (SWFs) – Real-valued function, ranking social states for public policy! – Bergson/Samuelson, ordinal SWFs – A social welfare function is an aggregate measure of the wellbeing of members of a society – “Paternalist” and non-paternalist SWFs • Do we know what “utility” means for different people? Or better refer to their actual preferences (regarding commodity bundles)? 12 SWFs for climate policy • Integrated Assessment Models (IAMs) & other economic applications – Social planner (sometimes!) and “paternalism“ – Market equilibrium: 1st fundamental theorem of welfare economics – Implications regarding welfare far beyond climate policy etc. – Distribution as hot topic: “Negishi weights“ to avoid redistribution by the social planner due to diminishing marginal utility • Social welfare functions in current IAMs: the “standard approach” – D/RICE, ReMIND, PAGE, etc – Bergson/Samuelson type • Intertemporal maximization of utility (as a function of consumption) • E.g., MIND • SWFs have impact on public policy: IAMs are used for policy advice! 13 Feasibility of standard (pro growth) SWF • Is such a social welfare function (SWF) feasible at all ?! – The Arrow Paradox (1950, 1951) • One of the greatest achievements of social science in the last century. • Founding result of the `homeless‘ discipline of social choice theory (which is on the borderline of mathematics, philosophy, economics and political science) • Nobel Prizes for K. Arrow (1972) and A. Sen (1998) for developments of social choice theory (among other achievements) 14 Arrow‘s Theorem: Introduction • Assume here a specific representation of social welfare: Social welfare is the aggregation of individual preferences. • Arrow‘s Theorem states that under some desirable properties of aggregation, no `reasonable‘ social welfare function exists. – Arrow does not say that a SWF is impossible in general, but only if there is a specific, limited body of information available • Arrow‘s Theorem thus provides the benchmark for how much you can demand concerning the aggregation procedure. The interesting discussion is which desirable properties to leave out. 15 The essence of Arrow‘s Theorem is… …the Condorcet Paradox: Suppose there are three people A, B, C and three alternative options x,y,z. Suppose the people have the following preferences: A B C First choice x y z Second choice y z x Third choice z x y The people cannot decide by pairwise majority voting which option to choose! This is a very strong form of Arrow‘s Theorem, who proved that this paradox can happen under much weaker assumptions. Marie Jean Antoine Nicolas Caritat, Marquis de Condorcet (1743-1794), mathematician, philosopher, politican and revolutionist 16 Arrow‘s Theorem: the conditions Arrow‘s conditions for a SWF: • (O) The welfare function must be ordinal (only rankings matter, intensities do not matter) • (P) Weak Pareto: If everybody prefers A to B, then A is better than B. • (I) Independence of irrelevant alternatives: Whether A is better than B should depend on how individuals rank A and B and on nothing else. • (D) Non-dictatorship: Whether A is better than B should not depend on the preferences of a single individual regardless of what everybody else prefers. Additionally, one requires: • Unrestricted domain (U): All possible individual
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