Whether conscious of it or not, economists rely on ethical norms and principles to carry out research and to inform policy choices. Economic efficiency, for example, is a powerful ethical concept, yet can be misapplied, as Jonathan Wight explores in this article. Understanding the institutional and ethical frameworks for policymaking is key to using economic tools correctly.
Ethics is the study and use of moral principles and values to determine right from wrong. Ethics permeates much of social interaction – including, of course, participation in market activity.1 Ethical values and principles are also embedded in the way economists explore both positive and normative economics, infusing the practice of economics. It behooves us to step back and take in this bigger picture.
The bigger picture would start with a pluralist understanding of ethics. The right or best action encompasses not only a utilitarian consideration of costs and benefits, but extends into realms of duty and virtue, where intentions and motives matter. Rules of behaviour often derive from right reasons instead of right outcomes. A pluralist ethos would include consideration of human rights, treating other people as ends in themselves and not merely as means to one’s own ends.
Welfare and Efficiency
Lacking a wider ethical vision, standard economics can lead to constrained reasoning that is not conducive to critical thinking. Take, for example, the economic modeling of “efficiency” or the optimal economic outcome. To read textbooks, the concept sounds scientific and impartial, backed by quantitative data that adds a veneer of objectivity. But when economists enter the realm of efficiency analysis, they are doing a narrow one-sided ethics that can produce disastrous consequences in the context of developing countries.
To understand why, we need to go back in history. The 18th century founder of utilitarianism, Jeremy Bentham, conceived of human welfare as based on pleasure and pain. The “best” economic outcome was one that produced the greatest overall pleasure minus pain for society as a whole. Jeremy Bentham’s focus on outcomes as a way to judge public policy was a wonderful innovation, vastly improving on tradition and the power of kings. Before this era, policies produced gains for elites at the expense of society at large. In Bentham’s reform view, everyone’s interests should be weighted equally, and the pain of a peasant should have an equal claim on our moral calculation as the equivalent pain of a king.
By the 20th century, economists had abandoned trying to measure pleasure and pain, and switched to defining human welfare not as any particular state of mind or body sensation, but simply as the outcome of individual choice. People’s actions revealed their welfare, their “satisfaction of preferences” measured by dollar votes cast in the marketplace. Measuring economic welfare in this manner requires us to trust that humans are dependably rational, that preferences reflect well-informed beliefs, formed outside the system of mass advertising, and that the distribution of income and wealth are irrelevant to optimal economic outcomes.
The only preferences that count, in this viewpoint, are those backed by money. The economically vulnerable have small claim to moral consideration since they have few chips to “vote with” in the market. A luminary who pays $1,000 for a spa treatment is said to provide 100 times greater value to society than an impoverished mother who spends $10 on a life-saving vaccine for her child. Saving lives is irrelevant in the economic calculation of welfare as preference satisfaction.
Amartya Sen, a Nobel laureate who for decades pushed against this canon, notes that an economy can be “optimal” in the efficiency sense but also “perfectly disgusting.”2 By severely constraining their vision of human welfare, and excluding any substantive measures of well-being or human capabilities, economists operate in a “barren informational landscape.”3 Sen, working with Mahbub ul Haq at the United Nations, developed the Human Development Index (HDI) in 1990 to address this issue. The HDI measures human welfare through an instrumental variable (GDP per capita) and two substantive variables (learning and health). While not perfect, this hybrid signals the importance of a pluralist ethical approach, one that includes non-market outcomes and values.
Layered on top of the notion of welfare as preference satisfaction is another ethical structure for the analysis of public policies. In the early 20th century Vilfredo Pareto, the Italian engineer, envisioned the optimal state of affairs that could unfold through voluntary trade. Both sides to a transaction only exchange if each gains, and hence, Pareto efficiency is reached when it is impossible to make anyone better off without causing harm to another. Since this state of affairs arises through voluntary interactions, it is ethically defensible not only in terms of outcomes but also in terms of respect for freedom and individual autonomy.
But Pareto efficiency deprives economists of the opportunity to weigh in on public policies, since any reform always causes harm to some, and injured parties would not voluntarily agree to it. Pareto efficiency is a beautiful ideal, with minor relevance for public policy. In the mid-20th century a revised approach, known as Kaldor-Hicks efficiency, asserted that welfare is enhanced whenever the net economic surplus is enlarged, regardless of how it comes about. As long as winners from a policy change gain more than the losers lose, the result is “better” for welfare –even if the injured parties are not compensated and even if this change results in greater inequality.
This is the essence of modern cost-benefit analysis and it is a heavy-handed ethical approach. It takes just a moment to realise that this version of efficiency can be justified only in countries with safeguards to protect basic individual rights.
Two examples bring this out. In 1991, as chief economist for the World Bank, Larry Summers distributed a “humorous” memo recommending that toxic industries in the United States be relocated to sub-Saharan Africa based on economic efficiency grounds. Since Africans badly need jobs, there would be large economic gains for those who find employment in these factories. And since earnings and life expectancy of the average African are low, the economic losses to those injured from pollution would be small relative to the US. Using impeccable economic logic, the memo concludes “health-impairing pollution should be done in the country with the lowest cost.” The costs are lower, in this view, because African lives are assumed to be worth less (more expendable) than American lives.
The memo was intended as an ironic critique of standard welfare theory. But most readers did not get the joke, and the memo became a huge embarrassment for Summers, who later apologised. For economic efficiency to work in the way intended, the costs of moving polluting industries to Africa would need to be transparent and include all negative externalities. Given that the polluted commons is a public good, villagers (in order to satisfy their preferences) would need to be able to debate the acceptable levels of contamination, they would need access to uncensored television, radio, and newspapers for information, and protests would be allowed. Voters would ultimately decide the proper trade-offs between pollution and jobs in fair democratic elections. Violence would not be used to intimidate workers or voters. In short, to make the standard efficiency view ethically palatable requires that we assume away virtually all the salient institutional characteristics of most poor, developing countries.
The Kaldor-Hicks version of efficiency – relied on by virtually all cost-benefit users today – is an ethical doctrine that cannot stand on its own. It assumes the healthy existence of what Adam Smith called “justice,” the “main pillar” without which society would “crumble into atoms.”4 While any policy is somewhat coercive in imposing losses on some, compulsion is mitigated by the possibility of redress, voice, and, ultimately, exit. Basic protections would include a transparent and fair legal system, good property and other human rights, low transactions costs for defending rights, a free press, and presumably a representative form of government. Kaldor-Hicks efficiency in public policy will be ethically questionable where these preconditions are tenuous.
This critique is not in opposition to cost/benefit analysis, which can be a powerful tool in the economist’s arsenal. It is instead a plea for humility and a broadminded ethical mindset, and for understanding the requirements of justice that should not be laid aside in calculating economic surplus gains. Economists trained in earlier eras were likely sensitised to this institutional context for public policy analysis. Frank Knight, one of the founders of the “Chicago School,” warns in 1960: “It is well to state explicitly at the outset that the society considered in this essay is the sovereign democratic state, that is, a modern Western nation, where law is made and enforced by a responsible government within the context of representative institutions.”5 Economists trained more recently, indoctrinated in the view that economics is a “value-free science,” may be oblivious to these problems.
New London, Conn., homeowner Susette Kelo talks to reporters outside the Supreme Court in Washington on Feb. 22, 2005, following arguments in her battle to stop the city of New London from seizing hers and others’ homes for an economic development project. Atty. Scott Bullock is at right. Photo Courtesy: AP Photo/Dennis Cook
Even where adequate safeguards exist, the efficiency goal can run roughshod over other values. In the legal sphere, for example, the “law and economics” movement asks judges to base rulings not on precedent but on maximising the economic surplus. This moved into the headlines when the Supreme Court in Kelo v. The City of New London ruled that a homeowner could be compelled to sell her property so that a private developer could use it more “efficiently” (and here Vilfredo Pareto must surely be rising out of his grave in protest).
Efficiency in public policy always requires some compulsion, and such is ethically justified in creating public goods like roads, environmental cleanups, and national defense, but becomes harder to rationalise when coercion is used for private gains alone. When institutional ethics is ignored because it is thought to be irrelevant, economic advice can go badly awry.
Training Economists in Ethics
Ethics in economics extends far beyond these issues. Economic scientists carry out research in ways that require them to make ethical choices, and to develop habits of virtue and dedication to duty. Norms of honesty, not unconstrained self-interest, should prevail in research. A large and growing literature also explores the ways that humans care deeply about the intentions and motives of others. It is not sufficient, anymore, to model the economic agent as a caricature of the Robinson Crusoe miser.
Fortunately, resources are becoming available for economists to learn the ethical landscape. The Oxford Handbook of Professional Economic Ethics (2016), edited by George F. DeMartino and Deirdre N. McCloskey, covers a range of topics for practitioners and theorists. DeMartino also authored The Economist’s Oath: On the Need for and Content of Professional Economic Ethics in 2011, which coincided with the American Economic Association’s tightening of its rules for author conflicts of interest and data disclosures.
The Association for Integrity and Responsible Leadership in Economics and Associated Professions (AIRLEAP) holds workshops to train practitioners about ethics. Textbooks and readings on this subject are now more widely available. Adam Smith would be well pleased.
Feature photo: In 1991, Lawrence Henry “Larry” Summers, as chief economist for the World Bank, distributed a “humorous” memo recommending that toxic industries in the United States be relocated to sub-Saharan Africa based on economic efficiency grounds. Photo Courtesy: Bureau of International Information Program https://flic.kr/p/86TqAU
About the Author
Jonathan B. Wight is Professor of Economics and International Studies and Philosophy, Politics, Economics, and Law at the University of Richmond. His most recent book, Ethics in Economics: An Introduction to Moral Frameworks (Stanford University Press, 2015), was selected by Choice as a 2016 Outstanding Academic Title. For other works see facultystaff.richmond.edu/~jwight/.
1. I use “ethics” and “morals” synonymously; some philosophers would quibble.
2. Amartya Sen, Collective Choice and Social Welfare (San Francisco: Holden-Day, 1970): 22.
3. Amartya Sen, “Rationality and Social Choice,” American Economic Review 85(1) (1995): 7.
4. Adam Smith, The Theory of Moral Sentiments, D. D. Raphael and A L. Macfie, eds. Glasgow edition (Indianapolis: Liberty Fund Press, 1982 ): 86.
5. Frank H. Knight, “Social Economic Policy,” The Canadian Journal of Economics and Political Science 26(1) (1960): 19.
6. Samuel Bowles and Herbert Gintis, A Cooperative Species: Human Reciprocity and Its Evolution (Princeton, NJ: Princeton University Press, 2011).