'W' is for welfare

The Economics of ABC Literacy
Insights Newsletter
1 August, 2014

The biographies of top economists indicate that they were often motivated to study economics in order to be better able to contribute to the common good.  

But what is meant by the common good and what policies contribute to it?  After all, in general elections, voters are commonly confronted with at least one party advocating higher taxes in order to make New Zealand a better place for New Zealanders – and at least one other party advocating lower taxes in the same cause.

Welfare economics is a branch of economics that explores what might be meant by the common good, and seeks to evaluate economic policies on the basis of their effects on the well-being of members of a community.

As explained previously in the economic ABCs, an insight that has endured since Adam Smith (1776) is that competition, in conjunction with security in person and property, induces even solely self-interested butchers, bakers and the candlestick makers to serve their customers' interests. Otherwise we freely take our business elsewhere.

During the 20th century, welfare economics formalised this insight into the proposition that stylised competitive processes will produce a zero waste welfare outcome.  It is optimal in the sense that no one person's (self-perceived) welfare can be increased with reducing that of at least one other person (whether such a change is worth doing regardless remains a moot point).

Welfare economics has clarified the many situations in which the same competitive processes will potentially fail to maximise welfare in this sense. These include problems of monopoly, public goods (such as national security and communicable diseases), environmental pollution, income distribution, poverty, malleable preferences and distorting taxes. Economists have formally shown in many of these cases how a well-motivated government might ideally use taxes or regulations to improve general well-being.

Nevertheless, related branches of economics have also illuminated many difficulties that confront government action, including problems of voting behaviour, inadequate information and political and bureaucratic incentives.  The UK TV series, Yes, Minister, brilliantly depicts these difficulties. "Doing good" in government is subject to the Law of Unintended Consequences.

What about the welfare state? One of the earliest uses of this term was in the1942 Beveridge Report that ideologically proposed that the state was responsible for individual welfare "from the cradle to the grave". What followed was a dramatic increase in taxes and social service spending in member countries of the OECD, albeit with significant national variations. Its effects on well-being will long be debated.

Loosely coinciding with this year’s election campaign, Insights is campaigning for economic literacy from A to Z. Coming up next week: ‘X’ for x-efficiency.  

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