Sunday, July 01, 2007

Fair Pay and Price Signals

Social justice is a fine goal, but we should be careful how we pursue it. Too often, it leads people to manipulate economic exchanges in a way that disrupts the efficient functioning of the market. For example, they might oppose a Pigouvian tax on gasoline -- or, even worse, support gas subsidies (!?) -- "for the sake of the poor." Or they might advocate "pay equity" across diverse jobs, in hopes of ensuring that people are paid "what they deserve." But the idea that income should track desert is deeply misguided, as Elizabeth Anderson (drawing on Hayek) explains:
First, if you fix prices on a backward-looking standard [e.g. desert], they will no longer be able to perform their informational function. Producers will produce for what was demanded last quarter, even if it isn't demanded today. This creates enormous waste and generates huge opportunity costs. We'd be much poorer in an economy that worked like this...

[Second,] there is no coherent way to determine how much of what people get is due to luck, and how much is truly their responsibility...

[Third,] any attempt to regulate people's rewards according to judgments of how much they morally deserve would destroy liberty. It would involve the state in making detailed, intrusive judgments of how well people used their liberty, and penalize them for not exercising their liberty in the way the state thinks best.

Forget desert. Our economic institutions should be forward-looking, and use prices to incentivize socially beneficial behaviour. That means paying people for providing desired goods and services -- and paying more for what society needs more of. This won't necessarily track desert: just because engineers are in higher demand than librarians, doesn't mean there's anything especially virtuous about the former. Still, we need more of them, and offering greater rewards is the way society can induce its members to meet this need.

The price system serves to signal scarcity (relative to demand), and - thanks to the profit motive - provides incentives for individuals to respond accordingly. Hayek illustrated the economic principles with a simple example:
Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all his without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all. The mere fact that there is one price for any commodity—or rather that local prices are connected in a manner determined by the cost of transport, etc.—brings about the solution which (it is just conceptually possible) might have been arrived at by one single mind possessing all the information which is in fact dispersed among all the people involved in the process.

Conclusion: If you want to help the poor, then just give them more cash. Far better to increase their purchasing power than to artificially deflate the market price for a particular good. Offering "cheap gas" is bad for society, as it disrupts the signaling function of market prices. Moreover, offering an unconditional basic income (or the like) is better for the poor. Redistribution is thus superior to price regulation in every important respect.

In other words: leftists should be left-libertarians.

1 comment:

  1. It's not as simple as that. Where does the money for redistribution come from? Presumably taxation. So some goods and services are going to be taxed to provide for this redistribution. Assuming that the level of taxation required goes beyond correcting for market failures, we are going to be left with a distortion of the market, so redistribution creates market distortions too. So the question is which method of advances social justice provides the most justice for a given amount of distortion.

    One reason to favour in-kind distribution is that governments can exploit economies of scale securing more benefits that individual welfare recipients could. further, the electorate are less hostile to in-kind distribution and so you are likely to be able to achieve greater redistribution with in-kind benefits. Of course your post is contrasting welfare payments with price manipulation to aid the poor, but you conclude "just give them more cash", so in-kind redistribution is relevant here.

    One reason for preferring cash payments to price manipulation is that recipients can choose to spend these payments on what they like and thus generating a more efficient outcome. Of course, this also provides a reason for not providing cash payments - the recipients may fritter them or spend them building temples to their gods instead of feeding their children.

    One might be sceptical of these type of efficiency arguments, at least at the margins, as what is efficient is relative to an initial distribution. if we give no particular weight to that distribution why value the efficiency that goes along with it. If the initial distribution were different then individuals' sets preferences would have different power then they currently have and thus the prices of goods and services would change, and along with it market efficient outcomes.

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