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Ethics and Economics

ETHICS AND ECONOMICS

Economics is linked to both ethics and the theory of rationality. Economics complements and intersects with moral philosophy in both the concepts it has constructed and in its treatment of normative problems.

Rationality, Utility Theory, and Welfare

At the foundation of economics lies a normative theory of individual rationality. The theory raises no questions about the rationality of ultimate ends and few questions about the rationality of beliefs. It maintains that an agent A chooses (acts) rationally if A's preferences are rational and A never prefers an available option to the option chosen. A's preferences are rational only if they are transitive and completethat is, A can consistently rank all alternatives. If an agent's preferences are complete and transitive and satisfy some technical conditions, they can be represented by numbers. These numbers, which are arbitrary apart from their order, are "ordinal utilities." If an agent's preferences satisfy additional conditions concerning risky or uncertain alternatives, then they can be represented by a cardinal utility function. In contemporary economic theory, utility is merely an index locating alternatives in a preference ranking, not a substantive good.

Given economists' commitments to utility theory in explaining human choices, it is natural that they would look to levels of utility (preference satisfaction) as the measure of welfare. It is, however, difficult to justify identifying welfare with the satisfaction of preferences, even as a simplification. Satisfying preferences that depend on false beliefs is often harmful, whereas satisfying preferences that do not concern oneself is typically irrelevant to one's welfare. Many philosophers endorse a more nuanced identification of well-being with the satisfaction of "informed" and self-interested preferences, and they can thus employ some of the framework of normative economics. Even with these qualifications, it is questionable whether taking well-being to be the satisfaction of preferences is suitable for assessing claims to scarce resources. Should one measure the well-being of those who have learnedpossibly quite rationallynot to want what they have not gotten by the satisfaction of their preferences?

Some economists propose different conceptions of well-being. Of particular contemporary interest is Amartya Sen's capability approach. In Sen's view, a capability is the ability to achieve a certain sort of "functioning": literacy is a capability; reading is a functioning. People may value capabilities for their own sake as well as for the kinds of functioning they permit; someone who stays in his or her room may still be glad to know that the door is not locked.

One advantage of more objective approaches such as Sen's is that they avoid the problems of interpersonal comparison that derive from identifying well-being and preference satisfaction. Formerly, economists such as Pigou cited diminishing marginal utility of income to argue that a more equal distribution of income would increase total welfare. This argument compares the contributions income makes to the well-being of different people.

Once one takes seriously the preference-satisfaction view of well-being, these comparisons become problematic. Lionel Robbins argued that there is no objective way to compare the extent to which A's and B's preferences are satisfied, and most (though not all) economists maintain that economic evaluations must not rely on interpersonal-utility comparisons.

Efficiency and Pareto Optimality

Efficiency has a technical meaning within normative economics. Suppose that utility is the satisfaction of preferences. Consider some allocation of resources SS is a "Pareto Improvement" over some other allocation R if and only if it increases the utility (preference satisfaction) of at least one person without decreasing anyone's utility. In other words, S is a Pareto improvement over R if and only if someone prefers to R, and nobody prefers R to S. S is "efficient" or "Pareto optimal" if no other allocation is a Pareto improvement over S. If S is Pareto optimal, then every alternative that satisfies someone's preferences better leads to someone else's preferences being less well satisfied. The Pareto concepts permit economists to rank some social states in terms of preference satisfaction without making interpersonal-utility comparisons.

If one is minimally benevolent and favors satisfying people's preferences, then, other things being equal, one will endorse Pareto efficiency. Moreover, it can be proved that competitive equilibria under certain idealized conditions (no externalities, no public goods, no informational limits, and so on) are Pareto efficient. Minimal benevolence then implies that competitive equilibria are (other things being equal) morally good economic states. A second theorem shows that an efficient economic outcome with any desired distribution of welfare can be attained by a competitive market, given the right initial distribution of endowments to agents. A preference-satisfaction view of well-being combined with minimal beneficence establishes the moral claims of efficiency.

Efficiency judgments capture only one moral dimension along which to assess economic policies, institutions, processes, and outcomes. Rather than pretending that efficiency judgments are conclusive or conceding that they reflect only one of a great many evaluative perspectives, economists generally regard economic evaluation as two-dimensional. In addition to questions of efficiencywith respect to which economists claim a special competencethere are also questions concerning distribution or equity, about which economists typically have little to say.

This view of economic evaluation is inadequate because the Pareto concepts have very limited applicability: Economic changes usually involve winners and losers. One way to extend the assessment of efficiency is via the notion of a potential Pareto improvement, where there are winners and losers in terms of preference satisfaction but the winners are able to compensate the losers. No compensation is actually required. Kaldor and Hicks thought that a potential Pareto improvement showed that the economic "pie" had grown larger, whereas questions about who wins and who loses concern equity not efficiency and should be left to the political process. This view is subject to technical difficulties, and the bottom line is that there is no way to judge changes that affect distributions while remaining neutral on distributive questions.

Moral Mathematics

The tools and theories of economists have contributed significantly to moral philosophy. Contemporary examples can be found in the literature on egalitarianism or on measures of freedom. The two branches of economics that have been most relevant to moral philosophy are social choice theory and game theory.

One can call any ranking of social states a "social-welfare function," and normative principles can be regarded as constraints on social-welfare functions. The Pareto principle, for example, picks out those social welfare functions that rank R over S if somebody prefers R to S and nobody prefers S to R. Economists have hoped to identify additional plausible normative principles relating individual and social welfare and from them to deduce some general method of evaluating outcomes, policies, and institutions. This framework is quite limited. Procedural matters such as fairness or due process apparently count only instrumentally. Furthermore, in investigating the implications of principles constraining acceptable relationships between individual and social values, Kenneth Arrow wound up establishing a striking impossibility theorem.

Social choice theory is the proof and interpretation of theorems concerning the aggregation of preferences, judgments, and interests. The relevance of social-choice theorems to morality depends on what is being aggregated and for what purpose. Does one seek principles for making social decisions or for carrying out social evaluations? Is one aggregating preferences or judgments? A good deal of social-choice theory, like John Harsanyi's derivation of utilitarianism, consists of formal arguments for moral conclusions, but the most important role of social choice theorems has been to reveal ambiguities and difficulties in apparently plausible moral principles. The interpretation of social-choice theorems is a subtle and complex task.

Game theory is concerned with strategic circumstances, where outcomes depend on the choices of several agents. The theory of games is particularly relevant to moral philosophy in its analysis of interaction problems of moral importance. Problems of social cooperation are often complicated, and it may be enlightening to think about recurring patterns. The most famous of these is the so-called "prisoner's dilemma," in which individuals who act in their self-interest reach a worse outcome for everyone than agents who do not. Prisoner's dilemmas vividly represent problems of social cooperation, free-riding, and public-goods provision.

Modeling interactions with game theory is a subtle task, because there are many different simple games and because simple models abstract from so much. Actual interactions, unlike prisoner's dilemmas, are rarely "one-shot" games, and game-theoretic analyses of repeated interactions are complicated and controversial. Even if game theory were in a more settled state, there would be grounds to hesitate before employing it to address ethical questions. One may have qualms about its focus on preference satisfaction and about whether the only perspective for individuals to adopt in social interactions is individual maximization. Nevertheless, some philosophers and economists such as Geoffrey Brennan, James Buchanan, David Gauthier, and Ken Binmore have used game theory to argue for views of justice.

Conclusion

Economists and moral philosophers share interests in rationality and in evaluating social institutions, processes, outcomes, and policies. Although the theoretical starting points of economists and moral philosophers differ, the two subjects have a great deal to offer each other. Moral philosophers who want their work to bear on social institutions, policies, and outcomes have much to learn from economists, who have studied the consequences of alternative policies and who have sought operational measures of theoretical concepts. Economists also offer moral philosophers formal and conceptual tools. At the same time, economists concerned with evaluating institutions and policies cannot avoid thinking about ethics.

See also Good, The; Utilitarianism; Value and Valuation.

Bibliography

Arrow, Kenneth. Social Choice and Individual Values. 2nd ed. New York: Wiley, 1963. This seminal contribution gave birth to social choice theory.

Binmore, Kenneth. Game Theory and the Social Contract. Cambridge, MA: MIT Press, 1998. A two-volume application of game theory to the theory of justice by a leading game theorist.

Brennan, Geoffrey, and James Buchanan. The Reason of Rules: Constitutional Political Economy. New York: Cambridge University Press, 1985. An application of game theoretic reasoning to problems of constitutional design.

Broome, John. Weighing Goods. Oxford: Basil Blackwell, 1991. A philosophical treatment of problems of rationality and well-being.

Dworkin, Ronald. Sovereign Virtue: The Theory and Practice of Equality. Cambridge, MA: Harvard University Press, 2000. Essays on egalitarianism that reflect the influence of economics.

Elster, Jon. Sour Grapes: Studies in the Subversion of Rationality. New York: Cambridge University Press, 1983. A study of the notion of rationality and of failures of rationality.

Elster, Jon, and John Roemer, eds. Interpersonal Comparisons of Well-Being. Cambridge, U.K.: Cambridge University Press, 1991.

Gauthier, David. Morals by Agreement. Oxford: Oxford University Press, 1986. An ambitious attempt to derive a theory of justice from bargaining theory.

Hardin, Russell. Morality Within the Limits of Reason. Chicago: University of Chicago Press, 1988. An application of game theory and rational choice theory to the defense of utilitarianism.

Harsanyi, John. "Cardinal Welfare, Individualistic Ethics and Interpersonal Comparisons of Utility." Journal of Political Economy 63 (1955): 309321. A social-choice theoretical "proof" of utilitarianism.

Harsanyi, John. Rational Behavior and Bargaining Equilibrium in Games and Social Situations. Cambridge, U.K.: Cambridge University Press, 1977. A general development of rational-choice theory and game theory with a systematic discussion of interpersonal utility comparisons.

Hausman, Daniel, and Michael McPherson. Economic Analysis and Moral Philosophy. Cambridge, U.K.: Cambridge University Press, 1996. A comprehensive survey of literature on ethics and economics.

Hicks, John. "The Foundations of Welfare Economics." Economic Journal 49 (1939): 696712. A classic statement of "new welfare economics" based on the compensation criterion.

Kaldor, Nicholas. "Welfare Propositions of Economics and Interpersonal Comparisons of Utility." Economic Journal 49 (1939): 549552. The first presentation and application of the notion of a potential Pareto improvement.

Kolm, Serge-Christophe. Justice and Equity. Translated by Harold See. Cambridge, MA: MIT Press, 2002. A pathbreaking book drawing on economic concepts in addressing philosophical questions.

Little, Ian. A Critique of Welfare Economics. 2nd ed. Oxford: Oxford University Press, 1957. A classic discussion of the difficulties of welfare economics without interpersonal comparisons.

McClennen, Edward. Rationality and Dynamic Choice: Foundational Explorations. Cambridge, U.K.: Cambridge University Press, 1990. A general development of the theory of rational choice including a critique of the standard theory and the development of an alternative.

Nussbaum, Martha. Women and Human Development. Cambridge, U.K.: Cambridge University Press, 2001. An alternative presentation of the capability approach.

Pigou, Arthur C. The Economics of Welfare. London: Macmillan, 1920. The classic statement of traditional utilitarian welfare economics.

Robbins, Lionel. An Essay on the Nature and Significance of Economic Science. 2nd ed. London: Macmillan, 1935. A major methodological overview with a classic argument against the possibility of interpersonal comparisons.

Samuelson, Paul A. "Evaluation of Real National Income." Oxford Economic Papers N.S. 2 (1950): 129. A demonstration of the impossibility of disentangling efficiency and distributional questions.

Scanlon, Thomas. "Preference and Urgency." Journal of Philosophy 72 (1975): 655670. An argument that questions of justice cannot be decided only by considerations involving preference satisfaction.

Sen, Amartya. Inequality Reexamined. Cambridge, MA: Harvard University Press, 1992. An introduction to Sen's more recent work on inequality, capabilities, and welfare.

Sen, Amartya. On Ethics and Economics. Oxford: Blackwells, 1987. A concise but demanding introduction to the subject.

Sen, Amartya, and Bernard Williams, eds. Utilitarianism and Beyond. Cambridge, U.K.: Cambridge University Press, 1982. An influential anthology of essays on economics and ethics with particular reference to utilitarianism.

Taylor, Michael C. The Possibility of Cooperation. New York: Cambridge University Press, 1987. A technical and philosophical study of game-theoretical problems of repeated interactions.

Daniel M. Hausman (2005)

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