Notes

1. Coase's (for example 1960) and Buchanan's (for example 1974) works also address a variety of other issues.

2. The major applications include analyses of slavery, of segregation, of trespass, of the law of dueling, of theft, of abortion, of rape, of benefit-cost analyses of dam removal to preserve salmon, of Christmas giving, of the Lorenzen case, and of the efficiency of the common law.

3. The Kaldor-Hicks measures are loosely defined as being satisfied when the winners from a policy gain more than the losers lose. More precise definitions are given below.

4. In its strong form, Pareto efficiency claims that state A is preferred to state B when state A is ranked higher than state B for one person and all other persons rank A at least as high as B. If the utility (well-being) of each individual is higher in state A, then state A is preferred according to the weak form of Pareto efficiency (Boadway and Bruce 1984, p. 62).

5. I challenge the reader to recommend one. Even a voluntary sale of a good by one person to another is probably not Pareto efficient, since even though both the seller and the buyer are better off as a product of the sale, other members of the community may suffer, at least marginally, since the sale might drive the market price up (harming consumers) or down (harming suppliers) (Posner 1984, p. 13). Of course, the probable harm to potential buyers and sellers is low, approaching zero, but any potential harm defeats Pareto efficiency.

In this, the Pareto principle is similar to, but significantly more demanding than, Rawls's (1971) proposal that, subject to basic freedoms and liberties, no project should harm the least well off. Rawls's suggestion has generally been rejected in practice as too demanding and the Pareto principle as a practical approach has been similarly rejected (Black 1969).

Hammond (1985) notes that it was also assumed that individuals had the same marginal utility of income schedules. However, Lerner (1944) had by the mid 1940s shown that equal incomes maximized expected utility even if their schedules were different, provided that there was diminishing marginal utility of income.

That is, an improvement can be assumed by looking at changes in income as long as, in modern terminology, the marginal utility of income with respect to income changes is the same for all individuals.

Robbins (1938, p. 635) believed it politically expedient to treat all people as if they had the same marginal utility of income, but was concerned that this be seen to rest on an ethical not a scientific principle. In fact, he says, 'But I do not believe that, in most cases, political calculations which do not treat them [men] as if they were equal are morally revolting' (emphasis added).

This debate about whether or not prescriptions of economics were scientific is paralleled by the 1980s debate, mostly in the legal literature, about the normative foundations of wealth maximization. For example, see the Hofstra Law Review, 1980, volume 8, numbers 3 and 4. The 1980s debate was haunted, and confounded, by the issues that I consider in this book.

I found 425 references to 'Kaldor-Hicks' directly; 92 more are found under the rubric 'potential Pareto,' and 1,416 cites are to some form of 'wealth maximization.' The numbers reported here were generated by three Westlaw searches on 29 October 1997, all of which were conducted using the Journals of Law Reviews database.

These are, in the main, those already mentioned: Robbins, Hicks, Kaldor, and Harrod, all writing in the Economic Journal.

Chipman (1987, p. 524) suggests that the compensation principle may be traced back to Dupuit in 1844, and, later, to Marshall (1890). Marshall used the concept of consumer surplus to compare losses of consumers to gains to the government. Lerner (1944) invoked a potential compensation principle in measuring monopoly power. Hotelling (1938) anticipated the KH test by suggesting that a new public investment is justified, given its benefits, if its costs could - in theory - be distributed so as to make everyone better off. Anticipating issues of distribution, Hotelling noted that where extreme hardship resulted from a policy, actual compensation was needed.

The term 'Kaldor-Hicks' was used, at least as early as 1951, by Arrow (1951, p. 928), and, in 1952, by Mishan (1952, p. 312).

The other concept, of course, is that of Pareto optimality, but this is a concept ill suited to discussion of economic changes and is, therefore, of limited practical application. Posner sometimes uses wealth maximization to mean KH but at other times seems to use it to mean an increase in GDP or the maximization of monetary wealth. In this regard, Posner uses it to support his tastes in favor of a work ethic and the importance of production as compared with consumption (see Posner 1987a, pp. 19-20). This is, however, a different meaning from KH. The fact that economic efficiency is not the same as national income was shown by Harberger (1971, p. 785). Economic efficiency is the opposite of common but narrow concepts such as workplace efficiency, in which people are to be managed as machines (Kanigel 1997).

Certainly Mishan (1952, p. 312) was aware that questions of distribution belonged to welfare economics and recognized that the separation was useful, since there was less agreement about the income distribution issues.

I will note some rather random examples from reputable sources. Boardman et al. (1996, p. 412) note that, 'Strict use of the Kaldor-Hicks test means that information on how benefits and costs are distributed among groups is ignored in decision making.' Friedman (1984, p. 170) notes, 'Some analysts would like to ignore equity altogether and use the compensation test as the decisive analytic test ... [A] second rationale for relying on the compensation test is the belief that concern for equity is simply unfounded.' Posner (1992b, p. 13) notes that wealth maximization is simply the Kaldor-Hicks tests and that wealth maximization ignores distributional effects (Posner 1984, pp. 132-133). McCloskey (1982, p. 229) incorrectly contends that the consumer surplus measure of social happiness is the same as the national income measure. Of course, the national income measure contains no measure of income distribution.

19. The CV measure is generally the standard for benefit-cost analysis.

20. For a discussion of the historical development of the theory of compensation principles, see Chipman (1987).

22. In this 1941 article, Scitovsky is listed as Scitovzsky but the simpler spelling was used thereafter and is generally used.

23. This result arises only in comparing first-best states. A first-best state is an efficient state in which two conditions are satisfied. First, no more of any good can be produced without reducing the amount of some other good. Second, the marginal rate at which one good can be transferred into another in production is the same marginal rate at which the two goods are valued.

24. The problem of reversals arises from the difference between the CV and EV. If there is no difference, there can be no reversals. The greater the difference the more likely are reversals (see generally Mishan 1981, Chapter 7).

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