Scales of Pareto Efficiency: Global and National

Note: This post is part of our League Symposium on inequality. You can read the introductory post for the Symposiumhere. To see a list of all posts in the Symposium so far, click here.

In economics there is a concept called the “Production Possibility Frontier”. It’s a theoretical simplification used to illustrate certain economic concepts such as opportunity costs and productive efficiency.

For the purposes of our discussion, we’re interested in how production possibilities illustrate the concept of productive efficiency. The PPF illustrates the outer limit of the productivity of an economy, where the factors of production can only produce more of a given product by producing less of another product.

An economy operating at the PPF is called “Pareto Efficient”. An economy is considered “Pareto Inefficient” when you can increase production of one good, without producing less of another good.

The rest of this post will deal with how the concepts of PPF and Pareto Efficiency play into discussions of inequality and global growth.

Before we begin, it’s important to note what Pareto Efficiency and Productive Efficiency are not. Both are microeconomic concepts meant to illustrate the efficiency of an economy’s factors of production. Neither has anything to say about the social value of the goods being produced. In the most simplistic sense, it tells us how much total guns and butter we can produce and whether or not we’re efficiently allocating our resources by producing a said volume of guns and butter, but NOT whether the ratio of guns to butter is socially optimal. There’s no moral or even utilitarian value here. It’s all about productivity.

“Productivity” in this case refers to how we use scarce resources to produce goods and services. The scarce resources are ANY factor of production. Labor, natural resources, machines, technology. All of these things are factors of production. Production Possibilities use an economy’s aggregate factors of production. This means it doesn’t really care what these factors are, so long as the pool of productivity increases.

With that out of the way…

Modern discussions about inequality focus on two broad scales. The first is usually on a national level. Most conversations about inequality in the political sphere deal with the internal distribution of economic resources. The second is on the global level. In international affairs, we often talk about “the rise of the rest” and how there is a smaller gap between the developing world and the developed world.

This means we’re dealing with two different scales of production efficiency. Because the national economies operate on a global stage, the impact of movement along the global production efficiency curve directly impacts the national scale through trade. This in turn has the tendency to create vague debates regarding “positive” and “zero-sum” thinking. (See: Roger’s post earlier in the symposium regarding types of thinking.)

Although a perfectly Pareto Efficient economy is an impossibility in the real world, some economies are closer to Pareto Efficient than others. The strength of market economies has been their ability to create more Pareto Efficient economies, where they’re able to maximize the productivity given their factors of production. Industrialization and the reduction of labor intensity of agriculture all tend to have the effect of increasing the production efficiency of a given economy. In effect, national level economies of developed states like the US are close to Pareto Efficient. (Remember, this tells us nothing of whether or not this is the socially optimal use of factors of production, just that the factors of production are being efficiently utilized to make goods or provide services) In order for these economies to grow, they’re required to shift the PPF outward.

The global economy on the other hand, is far from Pareto Efficient. The legacy of the Cold War, colonialism and trade barriers has created a world where only a handful of countries are close to Pareto Efficient, and the rest are playing catch up with production efficiency. This means that even accounting for scarcity of resources, the global economy can afford to continue producing more goods and services without a corresponding opportunity cost in another category. For “global” growth, there’s no actual need to shift the PPF itself, just move production toward the PPF.

Where the discussion becomes muddled, is when we account for the impact of the global economy’s move toward Pareto Efficiency on the national scale. When the global economy becomes more Pareto Efficient, this reflects on national economies of developed states as changing the factors of production. Why? Because trade by definition is a shift in your PPF: you’re adding external factors of production to your own. When the global economy becomes more Pareto Efficient, additional goods and services begin entering your national economy. As growth increases the Pareto Efficiency of the world economy toward the global PPF, trade helps move the PPF of national economies towards the global PPF. In a perfectly Pareto Efficiency global economy, the national economy production possibilities frontier would be the same as the global one.

How does this impact our discussions of inequality?

First: moving the global economy towards Pareto Efficiency is an important way of decreasing overall GLOBAL inequality. A Pareto Inefficient economy is one where lots of resources are squandered.

Second: the increasing global Pareto Efficiency makes it difficult to tell just how much national growth comes from the gains of global efficiency, or from changes that impact the factors of production. This makes gauging the impact of new technologies and innovations more difficult.

Third: because the global economy itself is Pareto Inefficient, we’re not actually sure how much scarcity would impact the rate of growth of national economies once we get closer to global Pareto Efficiency. The world by definition is finite. That’s not in question (or at least I hope it isn’t.) It’s just what those finite resources can get us that’s left unexplored.

Finally, let’s remember that it’s never enough to actually get to Pareto Efficiency. Once Pareto Efficiency is reached, the question then becomes what the socially optimal use of the factors of production would be. A world where the ratio of guns to butter is 8:2 is not as good a world as one where the ratio is 2:8, Pareto Efficiency being equal. Liberals like to ask questions about the socially optimal factors of production. This is good, but we also need to acknowledge that we’re not actually anywhere near to maximizing the factors of production. By acknowledging the fact that there are different scales in this debate, we can make a more productive debate by committing to both maximizing the factors of production and looking for the most socially optimal USE of that production.

 

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38 thoughts on “Scales of Pareto Efficiency: Global and National

  1. How predictable was it that Nob would write this kind of lowest-common-denominator, crowd-pleasing, mass-appeal post? Red meat, through and through. It’s as if Michael Bay was your editor! For shame, Nob. For shame.

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  2. Nob, at what point do you think the United States reached near-efficiency?

    I was watching a documentary the other day on the copper mining around here. It was told from the POV of the workers, their dismal conditions, and the labor unrest that followed. It was hard not to be primarily sympathetic to the workers, though the thought that kept running through my mind was “But it’s also vitally important to get that copper!” Copper was essential to the increasing to increasing overall economic efficiency for everybody, including the workers.

    The focus on efficiency, however, and accepting the costs of it, becomes an easy thing. As long as we’re chasing that next big rainbow, we can argue things like “the whole country is helped on the sacrifice of a comparative few.” Which is great, as long as you aren’t one of the few. It was left uncertain to me how much of that sacrifice could have been foregone without the sacrifice being quite so steep. The division of spoils therefore becomes important, to the extent that it was not so required.

    But it seems like we’re in a different place now than we were then. Having reached, or come close to, the Poretto Efficiency threshold, might explain the difference. Why I am at once more and less sympathetic to unions more generally today than looking backwards at the ones who were fighting for their members’ lives.

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    • The problem is that it’s actually pretty hard to tell when it’s a change of a factor of production, or whether it’s an increase in Pareto Efficiency that’s changing what the economy looks like. Reality doesn’t like clear cut theoretical models like this one.

      In general my belief is that after large-scale disruptions like industrialization or deindustrialization, shifts to Pareto Efficiency happen pretty quickly in a consumer economy. I think the defining moment for the US was when labor and goods became more mobile following the construction of canalways, railroads, the interstate highway system and the abolition of slavery. In essence when the barriers to trade WITHIN the continental United States started to go away, the economy was able to more efficiently assign factors of production to maximize productivity.

      An unstated conclusion to my post is that global inefficiency and the move toward efficiency is masking a lot of the distributional problems within the national economies and muddling the debate between socially optimal use of resources with the concept that everyone can get ahead.

      Everyone IS getting wealthier because there’s more production thanks to greater global inputs. But whether this shows a socially optimal use of resources is a different matter entirely.

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      • Everyone IS getting wealthier because there’s more production thanks to greater global inputs. But whether this shows a socially optimal use of resources is a different matter entirely.

        It seems pretty clear to me that it’s not socially optimal. The question for me, going forward, is the extent to which we can make it optimal without introducing inefficiencies. I mean, back in the 1900’s, you might have been able to look around and say “Look! We’re as wealthy as ever! Let’s start looking at ways to divide resources up, because we’ve got nowhere to go from here.” Maybe things could have been divided more equitably and socially optimally without hindering the progress that was made on the backs of those with few economic options. But it seems to me that it might have been tempting to think that the efficiency progress had been made and that it was a better time to look at fairness, inequality, and so on. Not realizing what was around the corner and that what we thought was efficient was still wildly inefficient.

        Yet when I look around us now, I feel that way. I don’t know where we have to go from here (other than waiting for the rest of the world to catch up?). Or that where we go will be positive enough to outstrip the fears I have about where it will leave significant portions of the labor pool without the ability to sufficiently contribute (and, thus, without the ability to be sufficiently compensated).

        Yet every generation thinks it’s at the end of history… so I don’t know.

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        • We’re slowly hitting a lot of technological barriers to moving forward. There’s simply going to be a resource scarcity issue coming up at some point unless we see some massive technological shift in energy (possible) and transportation (not as likely) that shifts the global production possibilities out.

          That said, we have a long way to go until the global economy is Pareto Efficient… And until we do, I have a feeling we can continue to put off that discussion about allocation.

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          • contract the “globalization” of resources, and you don’t need the transportation. Do it enough, and horse & buggy will suffice.
            We’ll get to energy eventually, but I’m still waiting for the fusion reactor prototype to get built. (the plans were “easy” to get money for…)

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      • whether this shows a socially optimal use of resources is a different matter entirely.

        One of the problems is that there is no objective way to define what is a socially optimal use of resources. It’s a purely subjective measure. You say we need more butter, less guns. I say without guns I can’t bag enough game, so all I have to eat is butter, which will surely cause my death from heart disease.

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        • You know very well that guns vs. butter isn’t a literal comparison of guns and butter. :p

          And while socially optimal use of resources is a subjective measure, it’s no more subjective than the social valuation of marginal labor valuation.

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        • if that was all you were gonna use the guns for, and you weren’t gonna use them as cheap ways to gain profit at the cost of bloodshed in the cities, I wouldn’t have any problem with you getting guns. Probably better for the environment than you driving 100 miles for butter (WV, again)

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  3. I doubt we’ll hit actually resource scarcity, as the resources, though finite, are vast. It’s more a question of not actually producing from the available resources due to economics, labor costs, insufficient technical abilities, or that the energy required to access and refine the resources has a higher market price than the materials produced.

    Currently we’ve used much less than the top millimeter of continental crust for all our existing materials. If we went down 20 meters every single human on Earth would get a string of luxury hotels, 600 Boeing 747’s, a Nimitz class aircraft carrier, 4 Soviet Alfa class attack submarines, and hundreds of tons of metals like vanadium and chromium, plus many pounds of platinum and gold. But production on that scale is not easy. Our abilities still fall far short of exploiting the full potential of just the Earth, much less the solar system.

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      • And that’s why people will stay poor. The resources are almost infinite, their willingness to benefit from them is almost nonexistent. That’s why even rich Westerners are only using the top millimeter of soil, and why the US only has a dozen aircraft carriers instead of the world having 7 billion of them (that, and boating accidents would be a pressing problem).

        Many people don’t like mining, yet almost every tool in their daily life, their house, their car, their laptop, their silverware, the wiring that supplies them with power, comes from mining. If you decree that resources can’t be extracted, you won’t have much of anything and will live like a poster child for Unicef.

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    • “…or that the energy required to access and refine the resources has a higher market price than the materials produced.”

      But it’s already pretty clear that energy is going to be the limiting factor. And electricity in particular. If everyone in China and India were to consume electricity at the per-capita rate of Japan (currently the most efficient large economy), you need to more than double the world’s output. Then add to that for population growth. There are no practical ways to do that. I have a standard bet these days, although I’m getting old enough that the odds are worse than 50/50 that I’ll live long enough to see if I’m right. By 2037 (25 years from now), the US Eastern Interconnect will be having serious problems keeping the lights on reliably.

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  4. Curious at the lack of response.

    I’d be interested in seeing critiques about the meta.

    Is this post too obtuse? Am I missing something important with this discussion?

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  5. I can see how government expenditures might be organized along the arc of guns and butter. I’m not sure I see how this can be applied to working markets. If demand increases for a particular product, guns, butter, oatmeal, aircraft, the market responds with ever more efficient means of production. Even capital, though it seeks the highest rate of return, will retreat from the market in the face of endemic risk.

    The problem is not mere resources. Even abysmally poor countries have resources for sale. If the West has become more Pareto Efficient, it has done so by rising above the sale of logs and ore. The West has investment capital to fund the development of multi-axial turret lathes to turn those logs into furniture and that bauxite into aluminium skinned aircraft.

    It seems to me market inequalities between rich and poor nations arise from their relative places in the technological and financial hierarchy. The West stays on top by technology transfer, selling tools to the poor nations so they can sell furniture and not logs. The global economy is horribly efficient, seeking exploitable resources of every sort, including human beings.

    Poor nations open the door to the exploiters in hopes of rising in the world — and there is no shame in starting at the bottom, selling logs, if your aim is to become a nation of woodworkers. But that’s not how it works out in practice. Entire towns in China have become centred around pillar industries: one neighbourhood in Foshan, Lekong, is entirely dedicated to the manufacture of furniture. Yanbu Town only makes underclothes. The spectrum of guns and butter is irrelevant in the city of Foshian. This neighbourhood does guns, that one does butter and it’s hugely efficient.

    Da Vinci tells us to consult nature for solutions to our most vexing problems. Nature teaches us specialization and interdependency are the hallmarks of successful species. Were an alien to come a-visiting, he would probably not look to us for any real picture of life on this planet. He would consult the insects, the true working societies of this earth.

    The world is moving beyond the nation-state and its absurd notions of National Economies. Liberals and Conservatives are different sides of the same coin: the Liberal sees an individual in the context of society and the Conservative sees the society comprised of individuals. If there is to be any equality in the world, it will only arise when mankind proposes to live in the light of equal justice.

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  6. Nob,

    I basically agree to this.

    That said, I wanted to bring forward something you said on my post. I bring it here is because I doubt you are still tracking the other.

    You wrote:
    “You constantly bemoan that “liberals” are out to paint libertarians as strawmen, yet you applaud a post that says liberals and progressives are avid, greedy, narrow-sighted zero-sum thinkers, while libertarians are on the side of saints and angels and positive sum gains for everyone…really?”

    The point of my piece was to suggest progressives are more prone to mistakenly viewing the world as zero sum, even when it isn’t. But have you actually read the comments by your fellow self described progressives? They aren’t denying it. They are arguing that it is true. That the rich have raped and stolen from the poor and that is why inequality is as it is.

    They aren’t just making my point, they are making it more vehemently and extremely than I ever would have. I agree that not all progressives fall for this bias, and I agree that libertarians tend to fall for the opposite bias. What do you believe?

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