Toward a Libertarian Reconstruction of Neoclassical Welfare Theory
Hummel, Jeffrey Rogers, Journal of Private Enterprise
Many libertarians, especially those inclined toward the Austrian school of economics, counter the market-failure justification for government intervention by denying any legitimacy whatsoever to the neoclassical concept of efficiency. But properly interpreted, neoclassical efficiency, rather than providing an open-ended justification for all sorts of government intervention, provides one of the most powerful and comprehensive objections to government coercion in general.
JEL Codes: D60, H10, H40
Keywords: Welfare economics, Efficiency, Public goods, Government
Many libertarians, as well as other free-market advocates, have extreme reservations about the welfare theory of neoclassical economics. They especially object to the derivative notion of market failure and the frequency with which it is employed to justify government intervention. When libertarian economist Bryan Caplan recently defended welfare economics and other aspects of neoclassical analysis from the criticisms of the Austrian school, he elicited an array of dissenting replies from such Austrians as Walter Block, Jörg Guido Hülsmann, and Edward Stringham. These critics utterly reject neoclassical efficiency as a coherent standard for comparing different outcomes in the real world. Indeed, Block has gone so far as to assert that "[t]here are no such things" as market failures.1
Caplan, in my opinion, has done a superb job of exposing the weaknesses of various Austrian alternatives to efficiency, but I believe that his defense of neoclassical welfare theory can be taken a step further. Going beyond philosophical debates about the ultimate validity of efficiency, I intend to demonstrate that market-failure justifications for government intervention are usually a misuse of this neoclassical standard. This brief comment strives to combine much of what has become standard fare among economists, some of Caplan's points, and a few original insights into a comprehensive reappraisal of neoclassical welfare theory. Together they demonstrate that efficiency, properly interpreted, offers a far more encompassing rejection of government overall than is generally appreciated.
II. The Proper Use of Neoclassical Welfare Economics
Those inclined toward the Austrian school of economics often counter the market-failure justification for government intervention by denying any legitimacy whatsoever to the neoclassical concept of efficiency. See, for instance, Murray Rothbard's classic article on welfare economics (1956). The problem with this approach is that it throws out the baby with the bath water. Some standard of efficiency, however crude and whatever its shortcomings, stands implicitly behind Ludwig Mises and Friedrich A. Hayek's socialist calculation critique of socialism. Without such a concept it would likewise be impossible to show that tariffs make economies poorer, and libertarians would be left with purely normative objections, completely divorced from any consideration whatsoever of net economic consequences.2
A few neo-Chicago economists go in the opposite direction, with ironically similar results. They imply that if you consider all opportunity costs, including transaction costs, then all actual outcomes in the real world are efficient. We therefore live, according to them, in the best of all possible worlds. This broad definition of efficiency (like the broad definition of self-interest that claims all conscious choices are self-interested) may be an informative tautology for certain questions. But it strips us of a positive standard, grounded in an objective if imperfect assessment of people's preferences, for comparing economic outcomes.3
Therefore I accept the usual neoclassical approach to market failure. In the pure-Pareto formulation, it asks the following question: Given factor endowments and people's preferences, can an omniscient and benevolent bureaucrat god imagine any transaction that does not take place on the market even though it would make at least one person better off without making a single person worse off? …