by Filip Palda
The separation of functions allows firms to concentrate on what they do best and allows for the tightest fit between employee aptitudes and the company’s ability to channel those aptitudes to productive ends. A “socially conscious” enterprise that acts as a caterer to the varied life-tastes of its employees is actually doing a disservice to all. For in attempting to be all things to all employees it provides social services at excessive cost by diverting its efforts from its core competencies and misdirecting them towards the administration of diaper change stations and meditation classes. If a company is able to eliminate all tied aspects of the hiring decision then the equalizing difference has no further role to play in equilibrating labor markets. It is a goal towards which all forms of tied exchange should strive.
That is the dream of those working on the economics of space.
References
Black, Duncan. 1948. “On the Rationale of Group Decision.” Journal of Political Economy, volume 56:23-34.
Downs, Anthony. 1957. An Economic Theory of Democracy. New York.
Hotelling, Harold. 1929. “Stability in Competition.” The Economic Journal, volume 39: 41-57.
Lancaster, Kelvin J. 1966. “A New Approach to Consumer Theory.” The Journal of Political Economy, volume 74: 132-156.
Nordhaus, William D. 1997. “Do Real Output and Real Wage Measures Capture Reality? The History of Light Suggests Not.” The Economics of New Goods. Edited by Robert J. Gordon and Timothy F. Bresnahan. University of Chicago Press for the National Bureau of Economic Research. 27-70.
Rosen, Sherwin. 1974. “Hedonic Prices and Implicit Markets: Product Differentiation in Pure Competition.” Journal of Political Economy, volume 82: 34-55.
Rosen, Sherwin. 1986. “The Theory Of Equalizing Differences.” Handbook of Labor Economics, Volume I. Edited by Orley Ashenfelter and Richard Layard. Elsevier Science Publishers. 641-692.
Welch, Finnis. 1978. “The Rising Impact of Minimum Wages.” Regulation, volume 28: 28-37.
EQUILIBRIUM 6
THE CONCEPT OF EQUILIBRIUM MOST likely originated in the sciences. In physics, discussions of equilibrium arose in the 19th century in the subfield of thermodynamics. A thermodynamic equilibrium is attained when a system of atoms has become so randomly dispersed that no further work can be squeezed out of them. The atoms may knock about but not in any manner that can be channeled to some specific use. Equilibrium in this context is generally a description of sterility or “system-death”. In the life sciences equilibrium is considered a temporary state in which nature is preparing some burst of creative energy that will carry it to a different state. Such equilibria are considered rare. Biologists prefer to look at nature as a process that rarely settles down to some fixed relationship between organisms. Despite these differences, both sciences see equilibrium as a group phenomenon. In physics the group is made of atoms, planets, and even galaxies attracting and repelling each other, while in biology, groups of one or several life-forms interact.
Economic equilibrium is also a group phenomenon, but it differs from the types found in physics or biology. Humans are not atoms nor rigidly programmed life-forms. They do not drift aimlessly, nor are they ruled by instinctive programs as are animals. They are conscious of the best way to take advantage of the present, and they dwell on the future. What they do with this consciousness is to seek some acceptable balance in their dealings with others. It is this search for balance that pushes groups of people to attain a type of equilibrium distinct from that found in the sciences. In physics equilibrium is a state of dissipation. In economics equilibrium is an optimal state, or at least a state that strives towards an optimum. This optimum engages all individuals and stands or falls on whether a sufficient number of them find the ledger of “social accounts” to be in some acceptable balance.
The quest to define and understand equilibrium in economics is the culmination of a research program begun with a radically different emphasis by Greek philosophers. Plato and his followers sought to define how social accounts should be arranged so that people can live in harmony. I am not sure if he ever used the word equilibrium but it cannot have been far from his thoughts. Starting with Adam Smith in the 18th century economists, or rather proto-economists who called themselves political philosophers, sought not to dictate how society should work but to understand how it does work.
The agenda of economists ever since has been to divine what accounting systems societies use to coordinate the actions of their members so as to attain a degree of stability and perhaps even prosperity. The accounting system now most widely accepted in economics is that of market supply, demand, and the equilibrium between the two brought about by the movement of prices.
Equilibrium may seem like a dry topic to a non-economist but only because economists have not sung their own praises sufficiently. Market equilibrium, and the criterion economists have invented to evaluate its worth, so-called Pareto efficiency, are discoveries that allow us to make sense of and evaluate the actions and interactions of the many. The Greeks would have marveled at this coherent, powerful intellectual device for peering into the workings of society. While market equilibrium is not the only possible accounting system upon which societies may be based, those wishing to propose alternate systems should take note. A thorough understanding of markets and the equilibrium that emerges is basic training to would-be social engineers as well as to those who would oppose them.
Balancing social accounts
BALANCE IN SOCIAL accounts may be the basis of equilibrium, but what do “balance”, and “accounts” mean? One view of societies is that they are groups of people bound together by a mixture of agreement, force, convention, and necessity. If the bonds are strong enough to keep the group together then society may be displaying a form of equilibrium.
The individual parts each have a role to play. In every person’s mind there is a calculator that tallies what he or she does for others and what others do for her or him. The calculation is personal, and may change as one matures and learns to count one’s blessings and forgive transgressions. Forgiveness is an instant means of balancing this mental ledger. Yet at any given moment the balance may be in the red. The world has harmed you. Friends betrayed you. Customers owe you money. If you see no balance ever coming back into your account you may either choose to “make an end with a bare bodkin” as Shakespeare put it, or if you are in a more proactive mindset you “stiffen the sinews, summon up the blood, and lend the eye a terrible aspect.” In other words, get mad.
If social accounts then are in people’s heads and are subjective, can economists have anything to say about them? It turns out that economists’ mathematical models of equilibrium are in fact tools for imagining how social accounts are balanced under very specific conditions, known today as “market economics”. These tools, which we will examine in detail can trace their lineage back to a time when market relations did exist but were not widespread. One of the earliest statements of the need for a balancing formula in relations between people comes 3000 years ago from Rabbi Hillel. In my book Pareto’s Republic, I wrote:
The Pharisaic rabbi Hillel the Elder had such a formula in mind when he stated that “What is hateful to you, do not do to your neighbour: that is the whole Torah, the rest is commentary.” This was a very precise mathematical statement of social obligations. It sought perfect balance in every exchange of effort or resources between people. Perfect balance meant you did not take advantage of someone when he or she was down to buy his or her farm at a depressed price. Hillel’s balance was a strict and highly specific formula for human interaction. Rabbi Hillel’s rule for balance in social interactions was one of many variants on what has come to be known as the Golden Rule. (2011, 7)
Golden Rule societies were small groups of people who were able to maintain cohesion as long as everyone contributed to the others in the group by at least as much as she or he got. There was often no need of a market or money or prices. In small, tightly knit societies, people helped
each other informally in a self-balancing act of long-term social preservation. The neighbor, the village gossip, the paterfamilias, all were the agents enforcing due diligence in social accounts. Opprobrium attached to those who failed to contribute their fair share.
Golden Rule balance or “equilibrium” in social accounts may have seemed a reasonable way for people to get along but such accounting had a limitation. It could not be easily scaled up to large, fast moving, anonymous collections of people. A new system of accounts had to be invented to help large numbers of people who did not know each other intimately to come to some agreement on how to use resources. Without such a mechanism of coordination, societies could not grow.
From central control to markets
WORKING OUT THE details of mass coordination through social accounting took thousands of years and went through false starts. Until a few hundred years ago, in the West the dominant model was to have a ruling military or priestly nobility dictate the terms of the accounts, that is, who should get what in return for what. A scribal bureaucracy helped verify that all was in balance. Egypt was able to subsist along these lines for over 4000 years because of the precise accounting possibilities inherent in a knowledge of the Nile. Knowing the relationship between the height of the river in any given season and the crops that could be expected to grow, Egyptian administrators were able to “tax to the max” and still keep the class of farmers just at the subsistence level needed to avoid rebellion. Similar examples of “hydraulic despotism” based on precise crop yield calculation can be found in ancient Mesopotamia and China.
Despite their longevity, all of these societies were highly unstable. There was a lack of surplus production that could be used to cushion unforeseen imbalances in the social accounts. When invaders attacked from outside the kingdom and overwhelmed the coercive capacities of the ruling class, servile classes often took the opportunity to rebel and go on the rampage. The result would be plunder and chaos by disparate groups who were not bound by social accounts. It could take generations to re-establish an equilibrium along the old lines, usually with different rulers. Ancient Rome seemed free from these problems for a while but the stability had an expiry date built into it. Rome balanced its social accounts on a constant diet of genocidal conquest. Some historians estimate that Caesar killed a million Gauls and enslaved a further million, effectively wiping out the young male population of what we now know as France. Tiberius did much the same to the Pannonians when they troubled Rome along the eastern stretch of the Danube. When Rome could push no further into barbarian lands it cannibalized itself by poaching slaves from among the free populations of its own provinces. Punitive taxes and debasement of the currency were further attempts by the ruling classes to patch up social accounts.
Christianity arose as a parallel to the Roman Empire and eventually evolved into a competing system of social accounting. It touched on most aspects of communal and even personal life. In serving as a model for the types of governments that would come after the Empire collapsed it attempted to moderate the depredations of rulers. In this sense Christianity was similar to Confucianism which arose in China to inculcate in the mandarinate a sense of social conscience.
Despite its novelty, Christianity did little more than breathe new life into the age-old model of central economic control of resources. Markets did exist, but for standard items such as wheat, wine, and wool. The really big decisions calling for imagination, such as property development, irrigation, education, and even what you could do with your labor, came from a small ruling elite. This elite looked with a worried eye on markets. Commerce was generally done outside the structure of social accounts dominated by military aristocracies. Even more troubling was the slow realization that the social accounts being balanced through markets were radically different from those balanced through central control. Markets worked on the principle of private property held by many different individuals. In deciding what to do with this property these individuals were creating a decentralized form of resource allocation.
Decentralized resource allocation through trade in property remained a marginal activity until about the 18th century. Then a series of administrative innovations allowed governments to accord private property the legal protection it needed to become a viable, large-scale tool of social accounting. The social accounting resulting from the trade in property allowed disparate individuals, perhaps even in different countries, to borrow money against their property and invest in large-scale ventures such as building toll roads or canals. You did not need to know who these people were, and you did not need to trust them as you would have to in a Golden Rule society, because property was starting to carry with it the systematic legal protection which today we call the rule of law.
In its ideal form, rule of law is the principle that the law should be knowable, constant, and the same for each person. Constancy means that if your business partner embezzles funds you can expect the court to apply the same punishment as it has applied to other such cases in the past. Similarity means that the judge will weigh your arguments against your partner as it would weigh his or her arguments against you should he have been the one bringing the suit.
What it amounts to in practice is a system of social accounting in the spirit of the Golden Rule that provides certainty and eliminates arbitrary advantage by treating all in the same manner. The importance of this system of accounts is that it is self-equilibrating on a case-by-case basis. If you buy a house that is deficient you can be certain of the redress you can seek, and you can be confident that the seller cannot crush your case by coercing the judge. Equilibration takes place without the need for guidance by a superior power. Rule of law enables imbalances in social accounting to fix themselves.
The shift to rule of law immensely broadens the scope of partners with whom you can engage. No longer must you know someone for years nor live in the same community to carry out balanced exchanges. Under rule of law you can be confident of mutual gain not because a Golden Rule is being followed but because the rule of law protects you against imbalance in social accounts. It is a mechanism for social accounting ideally suited to the needs of fast-growing societies where people are strangers to one another.
Pareto efficiency
ECONOMISTS ONLY STARTED to think conceptually about the manner in which markets equilibrate social accounts towards the end of the 18th century and systematically at the end of the 19th.
Between these intellectual bookends the field belonged mostly to philosophers. They sought utopian methods of social accounting in which the decentralized function of the market and rule of law was eliminated or heavily influenced by a powerful central mind. Amongst them the Utilitarians felt that the best society was one that maximized the sum of well-being.
This sounded nice on the surface but what it really meant was that social accounts achieved their balance by favoring some people who derived greater pleasure from a certain allocation of resources at the expense of others who were judged to suffer less pain. Marxists took a parallel line to Utilitarians and developed a form of social accounting in which it was acceptable to extirpate a group deemed to be outside the accounting structure, such as the bourgeoisie. Marxists tended to favor a group known as the proletariat.
The type of social accounting implicit in the market exchange of private property under the rule of law differed from these utopian systems in that it did not require a central authority to bully disenfranchised classes into compliance. Market exchange was decentralized and voluntary. Each exchange was balanced, as it only took place if both parties saw some benefit to it. Balancing each change in the use of resources at the individual level guarantees balance at the societal level. This realization captivated some thinkers from the late 19th century who saw in markets a basis for the emergence of the harmonious self-organization of society, a completely new way of thinking about human groups.
The first really precise statement of decentralized balance in social accounts is due to Vilfredo Pare
to, a 19th century locomotive engineer who in middle-age hung up his railway man’s cap to embark upon one of the most unlikely and remarkable careers in the social sciences. An allocation of resources is Pareto-improving if it harms no one and benefits at least one person. This is a bit vague, so in practice economists view a Pareto-improving change in the way resources are used as one which does not damage or violate the property rights of others without their consent and possibly payment of compensation. But such details need not concern us here. All we need to keep in mind is that once all Pareto-improving uses of resources have been discovered and exploited a state of Pareto efficiency is reached. No opportunity has been overlooked that will provide mutual gain without harming some third party.
As a form of social accounting the Pareto criterion seems quite easy for people of any political leaning to accept. After all, who can object to some use of resources that hurts no one and potentially makes some people better off? Perhaps sensing the broad appeal of his concept, Pareto attempted, with partial success, to prove that free markets were efficient, thereby producing a socially balanced and even desirable use of resources. His efforts launched a research agenda which is one of the most remarkable in the social sciences and which was only brought to fruition in the middle of the 20th century. To see how we came to understand the emergence and merits of social accounting through market equilibrium we need to look with a more focused gaze on how economists conceive of equilibrium.