in Economics, Opinion

Robin hood

As somebody who would openly admit being a fan of Milton Friedman (and watching him verbally sucker punch hippies) mainstream economics, at least how it’s practiced, annoys me.

So in this blog post I want to cover two things:

  1. Why economics ignores equity at the cost of its own relevance; and
  2. Why taking the derivative of something is a waste of time unless it results in a sandwich.

Why economics ignores equity at the cost of its own relevance

This entire section is built on a simple assumption that $1 given to someone with less money is worth more than taking that dollar from someone with lots of dollars.

This seems pretty obvious, people who are poor are going to get more satisfaction out of a dollar than somebody who is rich. Now when I say ‘worth more’ I really mean a person’s wellbeing.

And although it might seem like a ‘fluffy’ concept, it’s a fundamental one to economics, as we should be aiming for policy which achieves the greatest good given the alternatives available.

More income means more happiness at a diminishing rate:


(Source)

As a person’s income rises so does their self-reported happiness, but at a diminishing rate.

However, the problem is that in most benefit cost analysis this point is ignored. That is we’ll calculate the impact of a policy and assume that any changes in who gets the money is irrelevant (or admit it’s too hard to estimate). We focus on efficiency and ignore equity.

For example let’s imagine we have 2 people and distribute the country’s GDP ($100) as follows:


So Person 1, who never was the sporty type (and had the wind against her), ended up getting a raw deal and Person 2 managed to grab 2/3 of the money.

Person 1     $33

Person 2     $67

Now at this point, the total wealth is at $100. In fact, no matter how many times we slap person 2 upside the head to share her cash, the total wealth is going to be $100.

But if there are really diminishing returns to moolah ($s) then it’s likely that Person 1 would receive more happiness from receiving an extra dollar, than Person 2 would from losing a dollar.

Economists are well aware of this, it’s not rocket science. But generally we ignore it when conducting a benefit-cost analysis as we don’t have any hard data about what the welfare impacts will be.

For example how would we say how much extra happiness that dollar would generate in Person 1?

But even if you don’t know exactly how much happier person 1 is as a result of a dollar, you know it would be generally more than the loss of welfare from person 2, that is there is likely to be a net gain.

Not only that, if we choose to ignore the equity component of any policy then we’ve implicitly assumed that the benefits of redistribution are nil, which is something in most circumstances we know isn’t true. Consequently by ignoring it we’re making an implicit assumption about the status quo being more worthwhile than the alternative.

The only point I’d like to make here is that a good guess is better than no guess, because with a good guess of what the benefits of an income transfer will be; on average we’ll probably be right. But when we don’t make a guess at all, we’re more likely to be wrong, and consistently so, meaning good policy will consistently be represented as being less beneficial than it is.

To illustrate my point, imagine you’re trying to throw a ball into a basket behind you. You have a reasonable feel of where the basket is, but you don’t know exactly where.

My argument is that you’re better off to throw the ball behind you than dropping it where you stand.

It’s the same deal with making estimates of the intangible, by having a guess you’re going to get closer, on average, than not.

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