The Pareto Efficiency Swindle

This continues a sequence of posts explaining how conventional economics is actually the economic theory of the top 1%: ET1%: Blindfolds created by Economic Theories. Eight central concepts of economic theory are shown to be deceptive – they have an appearance of objectivity, fairness, and equity, but actually conceal a strong bias in the favor of the wealthy. The previous post was the “Illusion of Scarcity.

We call the concept of “Pareto Efficiency” a swindle because it encapsulates a normative principle that property rights of the wealthy take precedence over the right to basic needs of the poor. However, it is disguised to have an appearance of scientific objectivity, while the opposite normative preference, which most people have, is said to depend on subjective and unreliable value judgments.

The principle of Pareto efficiency has a harmless and innocuous appearance. Who could object to the idea that if we give more material goods to everyone, then the society as a whole would be better off? However, we will show that Pareto Efficiency is deceptive and fully qualifies for the label ET1%. It appeals to everyone when we say that increasing social welfare requires giving more goods to all. But the hidden consequence of accepting this principle is that you cannot take wealth away from the super-rich to give to the hungry, because that would decrease the wealth of the super-rich. It also provides moral cover for increasing inequality, as we shall see. It also protects property rights against the taxation required to fulfill social needs of the poor.

1       Protecting the Rich from Re-distribution

Like the dog who did not bark, the Pareto principle protects wealthy not by what it says, but by what it refuses to say. While increasing wealth of everyone increases social welfare, assessing welfare impacts of redistribution requires interpersonal comparisons of utilities, which is stated to be unscientific.  Without explicit mention, this legitimizes status quo (existing property rights), and puts them out of reach of any questions.

A key element of the Pareto principle is that utilities cannot be compared across people – interpersonal comparison of utilities is ruled out. Earlier, using the principle of diminishing marginal utilities, it was possible to argue the wealthy derived less pleasure from their last dollar, while the poor would derive much more, justifying re-distribution. Against this, Pareto argues that we cannot compare the utility/pleasure derived by aristocrats with refined tastes, and the utility derived by the coarse and crude peasants. Of course, this apparently fair, objective and neutral refusal to compare, conceals a preference for the wealthy. Clearly, the Pareto principle can be, and was used to prevent taxation of the rich to support the poor. When the status quo is one where the aristocrats have five course meals, while peasants eat coarse bread, refusal to compare amounts to supporting the status quo, and arguing that social welfare would decline if we took from rich to give to the poor. The Pareto Principle is used by economists today in the same way – to prevent moves to re-distribute wealth in an equitable way. It does not allow us to take away luxuries from the rich to distribute food to the starving. Thus, it serves as an ideology which favors the wealthy.  This is the general characteristic of ET1%, that these theories appear to be fair and equitable, but conceal strong support for the wealthy. We can oppose this principle by an alternative which would be part of an ET90% – an economic theory for the public.

ET90%: A transfer which does not reduce access to comforts for the wealthy, while creating access to essential needs for the poor, improves social welfare.

As stated, the principle is somewhat vague and imprecise. There are many ways to sharpen it so that it would command greater consensus. Taking the usual classification of consumption into necessities, comforts, and luxuries, we could argue that taking luxuries away from someone to provide life-saving medical treatments, or to meet essential minimal nutritional requirements, would improve social welfare. This involves accepting the normative principle that the right to live takes precedence over the right to property. It should be obvious from the discussion that the Pareto Principle upholds the reverse normative principle: the right to property of the wealthy takes precedence over the right to live of the poor. However, more important is the fact that this normative position is hidden within an apparently objective framework. This concealment prevents and open debate and dialog which could generate consensus on the relative importance of property rights over the basic needs of the population. Such a consensus would undoubtedly be harmful to the interests of the wealthy, so the Pareto Principle creates an obstacle to open dialog about this by creating a false impression that the matter has already been settled in a scientific and objective manner, without any need for social consensus.

Islamic ideas of social responsibility strongly advocate the principle that wealth may be taken away from those who have an excess, and given to those in need. Islamic principles regarding re-distribution work at three levels. Compulsory re-distribution in the form of Zakat is mandated at 2.5% of wealth over a specified minimum. This is specifically meant for the poor. Additionally, the Quran (70:24,25) states that the poor have a right in the wealth of rich. Islamic Scholars have traditionally understood this to mean that if Zakat is insufficient to provide for basic needs of the poor, additional redistribution must be done, to the extent required. In addition to these compulsory, and semi-compulsory measures for re-distribution, Islamic teachings are full of encouragements and exhortations for the wealthy to spend on the poor. Historically, this has been effective in generating large  amounts of charitable spending among the Muslims. Many recent studies show that even today, Muslims are more generous than others in same income group. We can encapsulate this discussion in the form of three principles which would be part of Islamic Economics, viewed as ET90% — the economic theory of the people:

  1. A small percentage (2.5%) of the wealth is the right of the poor, and must be redistributed.
  2. When the basic needs of the poor exceed the resources available, additional levies can be made on the wealthy to ensure that all such needs are met.
  3. Social norms of generosity, and collective responsibility for the needs of all, are encouraged to create an atmosphere of cooperation, community and charity, leading to large scale voluntary expenditures by the wealthy on those who are needy.

2       Power Corrupts

Contrary to the Pareto Principle, Islam teaches us that increase in wealth is not always a good thing.

(89:15) And as for man, when his Lord tries him and [thus] is generous to him and favors him, he says, “My Lord has honored me.”

Wealth in excess of our needs is perceived as a gift and an honor, but it is actually a trial. If excess wealth is used in good ways, then it becomes a blessing. But, excess wealth creates power, and the potential for abuse of power. For example, the Quran (42:27) states that

(42: 27) And if Allah were to enlarge the provision for His servants, they would surely rebel in the earth.

The Quran gives many examples of people, like Qaroon, and nations, like the ‘Ad, who abused the power created by wealth, using this power to exploit, oppress, and cheat others. As a nation, the Muslims are also warned against the soul-destroying effects of wealth:

Amr ibn Awf reported: The Messenger of Allah, peace and blessings be upon him, said, “By Allah, it is not poverty I fear for you, but rather I fear you will be given the wealth of the world just as it was given to those before you. You will compete for it just as they competed for it and it will destroy you just as it destroyed them.”

According to conventional economics, more money and more consumption always increases welfare, and this is the basis for the Pareto principle. However, Islam has a far more sophisticated and complex view of this matter. Excessive wealth can be beneficial if it is used correctly, and can be harmful if used incorrectly. There are many ways to abuse excessive wealth which are actively discouraged in the Quran. The following principles form part of Islamic Economics  (ET90%), which prohibit use of wealth in ways that cause harm to the general public:

  1. Excess, wasteful and prodigal consumption – called Israf and Tabzeer – is prohibited.
  2. Conspicuous consumption, designed to cause envy in others, is prohibited.
  3. Wealth creates power. This power is to be used to help the oppressed, rather than to oppress. Wealth in excess of needs should, voluntarily, be given to those who are in need.
  4. Spiritually, we are required to understand that the wealth we have is a gift and a trial from our Lord, rather than something we have earned due to our own intelligence and struggle.

3       Supporting Increasing Inequality

The Pareto Principle can also be used to argue that increases in inequality and concentration of wealth are socially beneficial. While typical economists shy away from examining this implication, Martin Feldstein (1999:34, cited in Hill & Myatt Anti-Textbook) has no qualms about spelling it out: “I am interested only in evaluating changes that increase the incomes of high income individuals without decreasing the incomes of others. Such a change clearly satisfies the common-sense Pareto principle: It is good because it makes some people better off without making anyone else worse off. I think such a change should be regarded as good even though it increases inequality.”

Whereas the Pareto Principles supports increasing inequality by increasing the wealth of the already wealthy, the Quran tells us otherwise. The Quran (59:7) informs us that wealth should not be allowed to concentrate in the hands of the rich; instead, we should distribute it to the deserving parties, including the orphans, the needy, and the travelers:

(59:7) Whatever Allah has bestowed on His Messenger belongs to Allah, and to the Messenger, and to his kinsfolk, and to the orphans, and to the needy, and to the wayfarer; so that it may not merely circulate between the rich among you.

The reason for this caution has already been explained in verse (42:7) cited earlier: if we increase the wealth of the already wealthy, they will have greater power and will cause greater damage – for instance, increased corporate profits have enabled them to buy politicians, and pass laws enabling them to destroy the planet for a profit. The mass hallucinations created by modern economics depends on preventing the public from realizing the obvious connections between wealth and power. Because economists are not allowed to look at politics, the primary cause of the increasing inequality today cannot be understood, leading to a large, confusing, and misleading literature on the topic of increasing inequalities in wealth and income. For instance, see Piketty’s famous book, Capital In the 21st Century, which focuses on technical details of how the wealth of the wealthy increases faster, without coming to grips with the underlying structures of power which enable this.

To oppose increasing inequality and concentration of wealth, an Islamic Economic system could incorporate the following principle, based on verse 59:7 above

  1. Wealth should circulate freely from those with excess to those in need, using the mechanisms (both compulsory and voluntary) indicated above. This is to be achieved by regulations targeted at institutional, social, and personal levels.

In Conclusion: As we have seen, the Pareto Efficiency principle hides within an apparently objective framework, a strong bias towards the wealthy. This is built on the idea that more wealth is always better. The objection that the additional wealth may only be better for the wealthy is handled by an indifference/preference for inequality, coupled with an appeal to the trickle-down effect. All of these ideas are strongly in conflict with many Islamic teachings to the contrary.

 

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5 comments
  1. Love your posts, Assad. One of these days I hope to see you discussing objective utility :: namely, if there is a good reason for ‘subjective utility’ as opposed to obtaining benefits but not a sufficient level of benefit to consider oneself (or society) better off in some definable way. Certainly, if I get 1000 calories per day instead of the 2000 or 2500 I need to replace the energy I use just living, it can be said that, although I do get a benefit from the foods I can ‘consume’, the reality is that {1000 – 2500}/2500* is a measure not only shortcomings in what I am able to buy but also of ‘why’ I can obtain a benefit but not be better off over time.

    *Generally, [Achieved benefit minus Needed Benefit]/Needed Benefit with zero as a point on a number line.

  2. I always thought it was a swindle, but it’s often assumed. Or it’s taboo to challenge it. Putting marginal utility on a logarithmic scale is a much more truthful, and that’s why high marginal tax rates are justified.

    • Not sure I understand this “putting…” business.

      In my view, a logarithmic scale adds nothing while seemingly adding mathemagics beyond those already implicit or explicit an the improper use of mathematics to create ‘values’ objectively for what is fundamentally not measurable objectively.

      Perhaps I’m simply misunderstanding you?

  3. Linear scale: If someone has 1 million and they get 1 more million they’re twice as happy.

    Log scale: If someone has 1 million and they get another million they’re just a little bit happier.

    Most of the problems in the world are because money adds up linearly but is enjoyed on a log scale. That extra million is take from the workers who really need it, to make the rich person just a little bit happier.

    • I am more concerned with what quantitatively empirical units could possibly measure ‘happiness/pleasure/satisfaction’ or ‘losses of these’.

      I do understand what you’re saying: E.g., a billionaire may not even notice an additional million dollars relative to a worker on Main Street who would definitely notice. The improvement in the quality of life (expressed in terms of the ability to pay for a wider range of goods and services) is very noticeable in terms of changes in the range and mix of their respective consumption baskets (and I would include savings a part of such baskets), with such changes being miniscule for billionaires.

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