“The sky is the limit, but the clouds are very low.”
One of the most important ideas in what is termed “welfare economics” is The Second Fundamental Theorem of Welfare Economics. Our book puts it this way: “society can attain any Pareto efficient allocation of resources by making a suitable assignment of initial endowments and then letting people freely trade with each other” (p44). The book also quotes an interesting explanation of the theory by author Tim Harford in his The Undercover Economist on the 100 meter sprint:
“If your goal is to have all the sprinters cross the line together, you could just change the rules of the race, ordering the fast runners to slow down and everyone to hold hands as they cross the line. A waste of talent. Or you could move some starting blocks forward and some back, so that although each sprinter was running as fast as he could… the fastest had to cover enough extra ground that he would end up breaking the tape neck-and-neck with the slowest [pp 73-74].”
This theorem does sound great, but I think it is fundamentally false. Changing the starting blocks is no different from making people slow down and hold hands to cross the finish line together. The only difference is that the first one is a more blatant waste of talent. Just to be clear, what is meant by “moving the starting blocks” and “making suitable assignment of initial endowments,” is taking money from one person and giving it to another. In the context of one 100 meter sprint, this moving the starting blocks may sound like a great idea, but what about in the context of multiple sprints? Wouldn’t someone catch on and not work as hard, if they know that no matter what they do, they will merely end up in the same place as everyone else at the same time?
The thing that people forget when using such examples as the race is that to have money to give out as “initial endowments” the government would have to have taken it from someone already. The government cannot create money out of thin air (and it if does, we have the examples of pre-WWII Germany and present-day Zimbabwe to show the consequences). Those people whose money was taken away are very much aware of why it was taken away from them and given to other people. They may run as fast as they can for a while, but life is not one sprint, it is a multitude of sprints and marathons. In game theory, we might say that there is an infinite number of repetitions of the game being played. When that happens, people learn what the rules are and therefore what incentives exist because of them. In other words, this whole theorem lacks the context of human psychology and even worse, incentives, which are supposed to be the foundation of economics itself. If everyone has the same amount of money in the end, if all work ultimately ends in the same reward, then there is little incentive to sprint as fast as you actually can or work as hard as you might. The only thing that still gives incentive to strive is pride in accomplishment and your own work. This incentive will not last long, however, when there is no reward for it and sloth is on equal footing with excellence. Creating a system of incentives that promotes lack of effort and effectively punishes talent and excellence is no better than forcing people into slowing down and holding hands over the finish line. Both such systems are a waste of talent. The second only lacks the honesty of clear intention. However, they are not only a waste of talent, but also a waste of human potential.
April 13th, 2009 at 5:53 am
Are sloth and excellence the only things that determine intital placement at the starting line?