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Hoppe in One Lesson, Illustrated in Welfare Economics

January 8, 2010

Tags Free MarketsHistory of the Austrian School of EconomicsMonetary TheoryPhilosophy and Methodology

[Excerpted from Property, Freedom and Society: Essays in Honor of Hans-Hermann Hoppe.]

Every schoolboy learns that, to reach a true conclusion, one must start with true premises and use valid logic. The lesson, unfortunately, is largely forgotten later in life. Most lack the intelligence, interest, or courage to apply the lesson rigorously. Many break or bend the rules to further their own agendas or careers. Others can only muster the will to follow the rules in some part or in some cases. Rare is the person who masters the lesson.

Hans-Hermann Hoppe has demonstrated the intellectual heights that can be reached by employing the lesson with a brilliant mind, fervent devotion to the truth, and unflagging moral courage. What follows is a brief account of how he set right the entire field of welfare economics.[1]

Old-welfare economics attempted to overturn the laissez-faire conclusions of the Classical school on the basis of the theory of marginal utility ushered in by the marginalist revolution. If utility can be compared interpersonally, by various assumptions such as cardinal utility or identical utility schedules or utility of money among people, the old-welfare economists argued that diminishing marginal utility implied a social-welfare gain from, among other interventions of the state, redistributing wealth from the rich to the poor. This line of argument was brought up short by the demonstration that the subjectivity of value precludes interpersonal-utility comparisons. Therefore, social welfare can only be said to unambiguously improve from a change if it makes at least one person better off and no one else worse off. This Pareto rule forbade economists from claiming social-welfare improvements from state interventions since they do make some better off and others worse off.

New-welfare economics tried to weave a case for state intervention within the constraints of the Pareto rule. The conclusions of new-welfare economics can be drawn from its main theorems. The first welfare theorem states that a perfectly competitive general equilibrium is Pareto optimal. From this theorem, the new-welfare economists conclude that a divergence of the real economy from this hypothetical condition justifies state intervention to improve social welfare. Economics journals are replete with cases demonstrating how the market economy fails to achieve a perfectly competitive general equilibrium and what interventions the state should make to remove the market's inefficiency.

The second-welfare theorem states that any Pareto-optimal solution can be brought about by a perfectly competitive general equilibrium. For each pattern of initial endowments of income among persons, the perfectly functioning market economy would reach a different Pareto-optimal outcome of production and exchange. From this theorem, new-welfare economists conclude that the state can distribute income, in whatever pattern it wants, e.g., to achieve a particular conception of equity, without impairing the social-welfare-maximizing property of the perfectly functioning market economy.

In his article on utility and welfare economics in 1956, Murray Rothbard demonstrated that new-welfare economists were wrong to think that a case against laissez-faire could be constructed on the ground of the subjectivity of value.[2] He argued that new-welfare economists were correct to infer the impossibility of interpersonal-utility comparisons from the subjectivity of value. Value is a state of mind without an extensive property that could be objectively analyzed. As such, no common unit of value exists among persons in which their mental states could be measured and, thus, compared.

Having accepted the subjectivity of value as the reason for the impossibility of interpersonal-utility comparisons, which they made a pillar of their welfare economics, new-welfare economists commit themselves to other corollaries of subjective value. In particular, Rothbard contended, they must embrace the concept of demonstrated preference. Because preferences exist solely in a person's mind, another person can acquire objective knowledge about them only by inferring them from his actions. Since no other objective knowledge of a person's preferences exists, only demonstrated preference can be used in the analysis of welfare economics.

Both the impossibility of interpersonal-utility comparisons and demonstrated preference are deduced directly from the subjectivity of value, and therefore, new-welfare economists cannot, validly, accept one and reject the other. The impossibility of interpersonal-utility comparisons constrains welfare economics by the Pareto rule, making it harder to justify state intervention than otherwise, but demonstrated preference raises the bar for justifying state intervention that much higher. According to new-welfare economists, the level set by the Pareto rule is determined by the market's deviation from the optimal result of a perfectly competitive, general-equilibrium model, but demonstrated preference eliminates any use of hypothetical values, including the utility functions of economic agents that underlie such models. To be scientific, welfare economics must confine itself to statements about preferences that actual persons demonstrate in their actions. Rothbard wrote,

Demonstrated preference, as we remember, eliminates hypothetical imaginings about individual value scales. Welfare economics has until now always considered values as hypothetical valuations of hypothetical "social states." But demonstrated preference only treats values as revealed through chosen action.[3]

The first welfare theorem, reconstituted along Rothbardian lines, does not refer to the general equilibrium state of models invented by economists. It refers to the actual economy, for which it is more difficult to demonstrate social-welfare improvements from state intervention. If market outcomes are compared to other realizable conditions reached in actual economic systems, instead of unrealizable outcomes of perfectly functioning, fictitious models, then market failure seems unlikely. And, as Rothbard showed, the market does surpass the levels of social welfare reached in other, actual economic systems.

The second welfare theorem, however, seemed unscathed by Rothbard's critique. New-welfare economists could still advocate one intervention of the state. Without impairing the efficiency of the market in bringing about a Pareto-optimal point, the state could still distribute income to achieve its conception of equity. Rothbard responded that private property was the proper initial distribution of wealth from which market activity renders a Pareto-optimal outcome. And, because the initial distribution of private property is not arbitrary, but follows the lines of self-ownership of labor, homesteader ownership of land, and producer ownership of goods, state intervention in property ownership could not produce an outcome commensurate in social welfare with the Pareto-optimal outcome of laissez-faire.

New welfare economists, however, not being adherents to Rothbard's natural-rights theory of property, denied that state distribution of property ownership would lead to a market outcome inferior in social welfare to that of the unhampered market. Even some economists who favored laissez-faire agreed that the pattern of property ownership in society is arbitrary with respect to the market achieving a Pareto-optimal outcome, and hence, the state can rearrange it without detrimental consequences on social welfare.

It was left to Hoppe to work out the logic of Rothbard's argument and reach a definitive conclusion about the effect on social welfare of state distribution of property ownership.[4] In so doing, he reoriented welfare economics to its true course. Although latent in Rothbard's analysis, Hoppe was the one who demonstrated that the Pareto-rule approach to social-welfare economics leads, not to an optimization end point, but to a step-by-step Pareto-superior process with an objective starting point.

As Rothbard had done before him, Hoppe confronted new-welfare economists with a logical inconsistency in their argument. They had accepted a basic principle, this time self-ownership, from which they inferred social-welfare consequences of voluntary exchange, i.e., they pronounced on the social-welfare consequences of voluntary exchange from the viewpoint of the traders themselves. But, in embracing self-ownership, they must also accept its logical corollary, namely Lockean property acquisition. Hoppe pointed out that self-ownership is a necessary precondition to all acquisition and use of property and not just voluntary exchange. Therefore, it is the starting point for each succeeding step of social interaction.

In critiquing Kirzner's view of welfare economics, Hoppe writes,

If, however, the Pareto criterion is firmly wedded to the notion of demonstrated preference, it in fact can be employed to yield such a starting point and serve, then, as a perfectly unobjectionable welfare criterion: a person's original appropriation of unowned resources, as demonstrated by this very action, increases his utility (at least ex ante). At the same time, it makes no one worse off, because in appropriating them he takes nothing away from others. For obviously, others could have homesteaded these resources, too, if only they had perceived them as scarce. But they did not actually do so, which demonstrates that they attached no value to them whatsoever, and hence they cannot be said to have lost any utility on account of this act. Proceeding from this Pareto-optimal basis, then, any further act of production, utilizing homesteaded resources, is equally Pareto-optimal on demonstrated preference grounds, provided only that it does not uninvitedly impair the physical integrity of the resources homesteaded, or produced with homesteaded means by others. And finally, every voluntary exchange starting from this basis must also be regarded as a Pareto-optimal change, because it can only take place if both parties expect to benefit from it. Thus, contrary to Kirzner, Pareto-optimality is not only compatible with methodological individualism; together with the notion of demonstrated preference, it also provides the key to (Austrian) welfare economics and its proof that the free market, operating according to the rules just described, always, and invariably so, increases social utility, while each deviation from it decreases it.[5]

Hoppe showed that the Pareto rule needed to be applied to the social-welfare consequences of the acquisition of property and not just its use. Self-ownership is the immutable starting point for the process of acquiring and then using property. State distribution of income to achieve an ostensibly more equitable "initial" endowment of income among persons fails to satisfy the Pareto rule. In other words, the second welfare theorem, reconstituted along Hoppean lines, is false. Only one initial endowment, the Lockean one, is capable of producing a Pareto-optimal outcome.

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Moreover, Hoppe's argument dispatches entirely the notion of Pareto optimality as a social-welfare-maximizing end state. Welfare economics starts with the objective fact of self-ownership and then demonstrates that each step of voluntary acquisition and use of property satisfies the Pareto rule and thereby, improves social welfare. Moreover, each instance of state intervention into the voluntary acquisition or use of property benefits some and harms others and, thereby, fails to improve social welfare. The actual market, then, is not compared to some end point it may eventually reach but has not yet achieved. If that were the case, it might be claimed that some interventions of the state could facilitate the actual market in achieving the higher level of social welfare at its end point. Instead, welfare economics is constrained to comparing the actual market to actual state intervention. No room is left for the claim that the market fails to attain some ideal which might be used to justify state intervention. Hoppe definitively established that the unhampered market is superior in improving social welfare.

Welfare economics is arguably the least of Hoppe's accomplishments in employing the lesson. In every field that has drawn his attention, he has, like Ludwig von Mises and Murray Rothbard before him, exemplified sound reasoning in social analysis. He improved the edifice they constructed by clarifying first principles and relentlessly and fearlessly tracing out the logical implications of these premises to their conclusions. He is an exemplar for all those who love the truth.

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This article is excerpted from Property, Freedom and Society: Essays in Honor of Hans-Hermann Hoppe.

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Notes

[1] On the development of Welfare economics, see Mark Blaug, "The Fundamental Theorems of Welfare Economics, Historically Considered," History of Political Economy 39, no. 2 (2007): 185–207 and Jeffrey M. Herbener, "The Pareto Rule and Welfare Economics," Review of Austrian Economics 10 (1997): 79–106.

[2] Murray N. Rothbard, "Toward a Reconstruction of Utility and Welfare Economics," The Logic of Action, One (Cheltenham, U.K.: Edward Elgar, 1997), pp. 211–54.

[3] Ibid., p. 240.

[4] Hans-Hermann Hoppe, "Review of Man, Economy, and Liberty," Review of Austrian Economics 4 (1990): 249–63.

[5] Ibid., pp. 257–58.


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