Social Accounting: A Tool of Social Engineering

Steven Landsburg writes about social accounting here and here. In the first-linked post, Landsburg says:

Economic theory tells us that under quite general hypotheses, the private value of an activity is in synch with its social value. If growing an orange makes you a dollar richer, that’s because growing that orange makes the world a dollar richer. And that’s good, because it encourages people to grow all and only those oranges that are (socially) worth growing.

Here’s my version of the “general hypotheses”: People engage in voluntary exchange if it benefits them. The buyers of an orange is willing to pay the grower $1 for the orange because the benefit derived from the orange is worth (at least) $1 to the buyer. At the same time, the grower is willing to sell oranges for $1 apiece because he expects (at least) to cover his costs if he sells oranges at that price. (His costs include the interest that he could have earned had he put his money into, say, an equally risky corporate bond instead of land, trees, and equipment.)

Now comes the hard part, which Landsburg skips. Does growing an orange and selling it for $1 really make the world a dollar richer? The buyer of the orange is “richer” (i.e., better off) only to the extent that the enjoyment/satisfaction/utility he derives from the orange is greater than the enjoyment/satisfaction/utility that he would have derived from an alternative use of his dollar. The alternatives include giving away the dollar, buying something other than an orange (maybe something less expensive that yields the buyer as much or more enjoyment/satisfaction/utility), and saving the dollar, that is, making it available for investment in, say, an orange grove.

It may be convenient to add the dollar values of final transactions and call the resulting number GDP (or GWP, gross world product). But adding $1 to GDP doesn’t mean that the world (or the U.S.) is $1 richer for it, even in the scenario described by Landsburg. For one thing, there’s no common denominator for enjoyment/satisfaction/utility, which are personal matters. For a second thing, the marginal gain in enjoyment/satisfaction/utility — the difference between first-best (buying an orange for $1) and second-best (e.g., saving $1) — is also a personal matter without a common denominator. (What’s more, there are many scenarios in which the addition of $1 to GDP makes the world poorer; for example: government entices workers into government service by offering above-market compensation, and then has those workers produce economy-stultifying regulations.)

As for the essential meaninglessness of GDP as a measure of anything, I borrow from an old post of mine:

Consider A and B, who discover that, together, they can have more clothing and more food if each specializes: A in the manufacture of clothing, B in the production of food. Through voluntary exchange and bargaining, they find a jointly satisfactory balance of production and consumption. A makes enough clothing to cover himself adequately, to keep some clothing on hand for emergencies, and to trade the balance to B for food. B does likewise with food. Both balance their production and consumption decisions against other considerations (e.g., the desire for leisure).

A and B’s respective decisions and actions are microeconomic; the sum of their decisions, macroeconomic. The microeconomic picture might look like this:

A produces 10 units of clothing a week, 5 of which he trades to B for 5 units of food a week, 4 of which he uses each week, and 1 of which he saves for an emergency.

B, like A, uses 4 units of clothing each week and saves 1 for an emergency.

B produces 10 units of food a week, 5 of which she trades to A for 5 units of clothing a week, 4 of which she consumes each week, and 1 of which she saves for an emergency.

A, like B, consumes 4 units of food each week and saves 1 for an emergency.

Given the microeconomic picture, it is trivial to depict the macroeconomic situation:

Gross weekly output = 10 units of clothing and 10 units of food

Weekly consumption = 8 units of clothing and 8 units of food

Weekly saving = 2 units of clothing and 2 units of food

You will note that the macroeconomic metrics add no useful information; they merely summarize the salient facts of A and B’s economic lives — though not the essential facts of their lives, which include (but are far from limited to) the degree of satisfaction that A and B derive from their consumption of food and clothing.

The customary way of getting around the aggregation problem is to sum the dollar values of microeconomic activity. But this simply masks the aggregation problem by assuming that it is possible to add the marginal valuations (i.e., prices) of disparate products and services being bought and sold at disparate moments in time by disparate individuals and firms for disparate purposes. One might as well add two bananas to two apples and call the result four bapples.

The essential problem is that A and B will derive different kinds and amounts of enjoyment from clothing and food, and that those different kinds and amounts of enjoyment cannot be summed in any meaningful way. If meaningful aggregation is impossible for A and B, how can it be possible for an economy that consists of millions of economic actors and an untold variety of goods and services? And how is it possible when technological change yields results such as this?

GDP, in other words, is nothing more than what it seems to be on the surface: an estimate of the dollar value of economic output. It is not a measure of “social welfare” because there is no such thing.

And yet, Landsburg (among many economists) seems to believe that it’s possible to measure “social welfare,” that is, to measure how much “richer” the world is because of voluntary exchange. (I wouldn’t think of accusing Landsburg or any other economist — Paul Krugman and Brad DeLong excepted — of equating government spending and “social welfare.”)

This isn’t a first for Landsburg. About four years ago he wrote this:

Suppose you live next door to Bill Gates. Bill likes to play loud music at night. You’re a light sleeper. Should he be forced to turn down the volume?

An efficiency analysis would begin, in principle (though it might not be so easy in practice) by asking how much Bill’s music is worth to him (let’s say we somehow know that the answer is $10,000) and how much your sleep is worth to you (let’s say $25). It is important to realize from the outset that no economist thinks those numbers in any way measure Bill’s subjective enjoyment of his music or your subjective annoyance. Only a crazy person would think such a thing, and I’ve never met anybody who’s that crazy in that particular way. Instead, these numbers primarily reflect the fact that Bill is a whole lot richer than you are. Nevertheless, the economist will surely declare it inefficient to take $10,000 worth of enjoyment from Bill in order to give you $25 worth of sleep. We call that a $9,975 deadweight loss.

Landsburg properly denies the commensurability of the two experiences, and then turns around and declares them commensurate. My comment, at the time:

The problem with this kind of thinking should be obvious to anyone with the sense God gave a goose. The value of Bill’s enjoyment of loud music and the value of “your” enjoyment of sleep, whatever they may be, are irrelevant because they are incommensurate. They are separate, variably subjective entities. Bill’s enjoyment (at a moment in time) is Bill’s enjoyment. “Your” enjoyment (at a moment in time) is your enjoyment. There is no way to add, subtract, divide, or multiply the value of those two separate, variably subjective things. Therefore, there is no such thing (in this context) as a deadweight loss because there is no such thing as “social welfare” — a summation of the state of individuals’ enjoyment (or utility, as some would have it).

Prices serve the useful purpose of helping individual persons and firms to move toward maximum utility and maximum profits. (I say “move toward” because the vagaries of life seldom accommodate the attainment of nirvana.) Prices do not — do not — enable the attainment of “efficiency,” that is, the maximization of “social welfare.” They cannot because there is no such thing.

Only a dedicated social engineer could believe that it’s possible to sum degrees of happiness across individuals, or claim that a public project is justified because the costs (imposed on one set of persons) exceed the benefits (enjoyed by a mostly different set of persons).

* * *

Share this:

Related