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Efficiency and the Market

I’m not an economist, but I disagree that efficiency is the foundation of the free market. Competition seems a more likely candidate. If government regulations prevent an organic meat producer from getting his product for a reasonable price to those who would want it, then in what sense is the market “efficient”? It hasn’t fulfilled its function because one producer has moved to stifle competition. ~Mitch Muncy, Crunchy Cons

One basic point: efficiency is a technical description of obtaining maximum value at minimum cost as measured by money. In this view, efficiency is the desired goal for any transaction, and things that impose extra costs are held to have introduced inefficiencies into the system. These might be tangible things, such as a government regulation, or seemingly intangible stigmas and social norms that stress loyalty to community or local firms.

What is deemed valuable depends on what commands the greatest monetary value, as money is the only thing with which to measure "preferences"--he who is willing to pay the most decides what is most valuable. If no one is willing to pay for those seemingly intangible goods by paying the higher prices on commodities that maintaining these goods might entail, for example, the "preference" for them is less valuable than the "preference" for a major chain store. Here is part of Paul Heyne's very concise and useful definition:

Economic efficiency makes use of monetary evaluations. It refers to the relationship between the monetary value of ends and the monetary value of means. The valuations that count are, consequently, the valuations of those who are willing and able to support their preferences by offering money.

From this perspective a parcel of land is used with maximum economic efficiency when it comes under the control of the party who is willing (which implies able) to pay the largest amount of money to obtain that control. The proof that a particular resource is being used efficiently is that no one is willing to pay more in order to divert it to some other use.

I think we can see that efficiency, as described here, is the guiding principle of modern economic life, and it is what informs the indifference or hostility of homo oeconomicus to those primary moral, political and spiritual goods that stand in the way of economic efficiency. In a slightly roundabout way, I think the Kelo decision relies on this conception of efficiency: to make the greatest use out of a property, its current owner will not be allowed to hold the property when a developer is willing to pay more for its purchase than the owner is willing to pay for its continued possession. That the owner should not need to pay anything to be secure in his property rights is obvious to sensible people, but sensible people have little to do with the current form of economic development or modern jurisprudence. The local government can now legally compel him to give up his property, so that it might be turned to a more efficient use. In a world in which efficiency is one of the chief virtues, even personal property rights can become an obstacle to be knocked down.

An Austrian economist would make any number of arguments about how regulation hampers efficiency (because it imposes burdens that increase cost), and we all know those arguments, and it is true that there are many such inefficiencies in "the economy" we have today. Though traditional conservatives and libertarians, for example, find common ground in regarding these sorts of regulations as undesirable for very different reasons, traditional conservatives do not see the virtue in maximising efficiency when in its hampered state the requirements of this sort of "efficiency" are also undesirable.

Mr. Muncy is correct to some extent that what we have today is obviously not a strictly free market. In certain respects, what bothers traditional conservatives about the current state of affairs is the concentration of wealth and power in themselves and the uses the holders of concentrated wealth and power are putting their considerable resources towards. This taps into the decentralist and localist strands of conservative thought and the principle of subsidiarity. But where laissez-faire may have seemed to make sense in a largely undeveloped country such as ours was in the 18th and 19th centuries, it produced the very concentrations of wealth and the development of strong industrial interests dedicated to national political consolidation as a means of removing barriers to the old desire of "internal improvements." This concentration and consolidation were plainly detrimental to the decentralised and more localised economic and political life that had gone on without centralised regulation.

However, just because there is no longer a relatively more laissez-faire market (in the end, there has never been and never can be a purely laissez-faire market, nor would most people ever want there to be one, as norms and mores will always impose 'irrational' costs on what can and cannot be exchanged) does not mean that actors in a regulated state capitalist economy do not in most respects prize the efficiency as their guiding standard. This is ultimately as basic as assessing costs and benefits, but under this scheme most of the attachments to local businesses, community or even the idea of the "common good" are counted as things that create inefficiencies. It has become an accepted attitude that these things should give way when they conflict with the obvious "greater good" of "growth."

Daniel Larison | February 27, 2006


Daniel, I have been reading your blog almost from its birth, and economics is one of the few fields you write on where I feel I can sustain a meaningful discussion (unless it gets too specific). These days, academic economics has to be shielded from misinterpretations. Namely, the concept of efficiency you present, dreadfully influential as it might be, is not the mainstream understanding of efficiency by the economic profession.

You begin by explaining that "efficiency is a technical description of obtaining maximum value at minimum cost as measured by money." This is how individual agents in the economy tend to view efficiency. To assess the impact of an economic policy or regime on the whole, or part of the economy, one has to look at the resulting allocation of goods and compare the outcomes of different policies. This leads us to the concept of allocative efficiency, of which the best-known, and the least controversial, variety is Pareto efficiency, which guarantees against a certain sort of waste and does not require interpersonal utility comparisons.

Unfortunately, welfare economics, which studies distributional aspects of economic policy, has to resort to interpersonal utility comparisons of various types. One could see the "willingness and ability to pay" approach (as opposed to mere "willingness") as an extremist cardinalization of utility. I suspect it was this approach (applied to civil litigation) that Richard Posner promoted in his early writings, 30+ years ago. I also assume that he has since abandoned it. Yet this simplistic way of thinking must have embedded itself deeply into the minds of various vulgar economists (such as SCOTUS judges) in perfect accord with Keynes' maxim about practical men being slaves to some defunct economist.

The Russian Dilettante | 02/28/06 08:14

Thanks for your astute comments and your long-time support. I appreciated your clarification and the distinction between the two kinds of efficiency. In my admittedly amateur understanding of these things, there is allocative efficiency when the "most valued" goods are produced in a way that allocates resources to produce those goods at lowest cost. Wouldn't the same conflict arise between allocative efficiency and the sorts of intangible goods I was referring to in the post? I wish I could write more right now, but I must run.

Daniel Larison | 02/28/06 10:35

The problem at the heart of all this is how to define "most valued." Since people have different preferences, and these preferences span over different sets of goods, including various intangibles, there is, apart from Pareto (and Kaldor-Hicks, perhaps) efficiency, no definition of efficiency that would not involve some kind of interpersonal utility comparison. Paul Heyne's definition is not an exception. If most people had very similar preferences, his "willingness and ability to pay" approach would simply value the preferences of the rich above those of the poor.

The Russian Dilettante | 03/03/06 05:37

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