Kaldor-Hicks efficiency

It isn’t only economists who use their ideology to affect public policy. Judge Richard Posner of the Seventh Circuit Court of Appeals has been a leader in the application of economic theory to deciding court cases. Posner led a panel discussion of the use of cost-benefit analysis in formation of public policy about 10 years ago, and published his remarks at 29 The Journal of Legal Studies 1153 (2000). He describes himself as an advocate for the use of the Kaldor-Hicks criterion in deciding cases under the Common Law, that is, cases not governed by specific statutes. He describes the Kaldor-Hicks criterion elegantly: “wealth maximization rather than utility maximization” (1153). I discuss it at greater length here.

He justifies using this economics approach as follows (1154):

What the Kaldor-Hicks concept particularly leaves out of normative consideration is distributive justice; it treats a dollar as worth the same to everyone. … But to the extent that distributive justice can be shown to be the proper business of some other branch of government or policy instrument (for example, redistributive taxation and spending) and that ignoring distributive considerations in the particular domain of decision making that is under consideration will not have systematic and substantive distributive consequences, it is possible to set distributive considerations to one side and use the Kaldor- Hicks approach with a good conscience.

Posner sets two limits on application of Kaldor-Hicks criterion to the cases that come before him. First, he should show that “distributive justice” is someone else’s responsibility. He doesn’t have to show that that someone is actually carrying out that duty. This is a low bar indeed. Courts decide specific cases. They aren’t responsible for redistribution of wealth or income. He could end his inquiry there, without noticing that the current system carries out distributive justice by taking from the poor (Social Security taxes and benefits), and giving to the rich (tax cuts). If distributive justice isn’t the province of the courts, neither is evaluating the actions of the distributors (federal and state legislatures).

Second, he has to show that his decisions do not have “systematic and substantive distributive consequences.” Only rarely will a single decision in a single case affect the system of distribution of income and wealth. But no case exists in a vacuum. Through the principle of stare decisis, individual decisions add up to a practical jurisprudence, a system for making decisions that people can rely on in planning their own actions. If corporations know that judges apply the Kaldor-Hicks criterion, they can shape their activities accordingly, and maximize their own money. We know that giant businesses do apply cost-benefit analysis in the Kaldor-Hicks sense to their own decisions, and that regulators use this methodology to evaluate proposed regulations.

Knowing that courts will apply a cost-benefit analysis to, for example, designs for cars, you could make very plausible guesses as to the amount of money you needed to spend on safety considerations. Suppose you could increase the safety of your car by some specific and small percentage if you added a part at a cost of $15. You could then estimate your costs of litigation and ancillary costs such as damage to reputation, and make a cash decision on whether to add the part. The result is that standards like cost-benefit analysis wind up telling us what we get in the way of safety.

If only corporations are making the decisions that set the parameters of risk, then how do individuals protect themselves? If you don’t know that the neck of the gas tank in your car is likely to break in a rear-end collision, how do you make a decision about the risk for yourself? That is not relevant under the Kaldor-Hicks criterion. All it cares about is maximization of wealth. So a few people burn up. Society as a whole (meaning the manufacturer and its shareholders) has more money, so it’s all good.

If individuals can’t protect themselves, then they depend on effective regulators to make good decisions about the levels of acceptable risk. Unfortunately, the same people who argue for application of the Kaldor-Hicks criterion to safety and regulatory decisions also argue for getting rid of regulators, and effectively did so, beginning with the Reagan administration, and culminating in the corporatist Bush era, which brought us the Great Recession. There is no protection for individuals. We are at the mercy of corporate decisions about safety, whether from cars or financial systems.

At least Posner was intellectually honest enough to change his mind about regulation (abstract only, article available to subscribers). The rest of the political and financial elites and their enabling economists haven’t. Good luck with that can of beans.