Is Pareto optimality the most misleading definition in economics?

John Quiggan thinks so (HT: Tim Haford). I often disagree with John but understand the different perspective he is coming from. But this post has me really perplexed.

John's post starts with a discussion of Pareto's political views, suggesting that his construction of the concept of Pareto optimality and his other main intellectual contribution, the Pareto income distribution, were motivated by an antipathy to government redistribution policy. This may be right, but that fact in itself doesn't make the the concept of Pareto optimality misleading or dangerous. 

On the term itself, John's first point is that the use of the word "optimality" is misleading. On this, I agree to an extent. Optimality suggests the result of an optimisation problem with a well-defined objective, but one of the first things we teach our students when invoking Pareto optimality is that there are many different allocations that are Pareto optimal, and the Pareto welfare criterion (the value judgement that making someone better off without making anyone else worse off is a good thing), is silent on how to compare these different optimal allocations. Indeed, typically the first thing undergraduate economics students see after encountering Pareto optimality is the two welfare theorems, the second of which specifically refers to different Pareto optimal allocations, and how all can be sustained by a competitive market given an particular allocation of property rights. Yes, optimal is a poor choice of word, but the context in which it is used does make it clear that it doesn't imply the single-best (by some notion) outcome. 

But then John says: 

Recognising the inappropriateness of describing radically unfair allocations as “optimal”, some economists have used the description “Pareto efficient” instead, but this is not much better. It corresponds neither to the ordinary meaning of “efficient” nor to the meaning with which the term is commonly used in economics, which is also misleading, but in a different way.

A few comments are in order here: First, the "some economists", surprised me. I thought that "Pareto efficiency" was overwhelmingly the preferred term for the concept. I quick google of "Pareto optimality" and "Pareto efficiency", yielded 263,000 hits for the former and 377,00 for the latter, which is a way smaller ratio for the latter than I was expecting, but still a majority. Second, I thought that Pareto efficiency corresponds exactly to the way the term "efficiency" is used in economics. In fact, I always teach my students that if the noun "efficiency" is used without an adjective, it is always Pareto efficiency that is implied. I would be interested to know how our commenters perceive the term. 

John suggests instead using "opportunity cost". 

The concept of opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs. Conversely, if there is a positive opportunity cost for any benefit, then we can’t make anyone better off without making someone else worse off. So, a “Pareto optimal” situation may be described, more simply as one where all opportunity costs are positive.

This doesn't seem right to me. Opportunity cost is a tautological statement about scarcity, not about welfare. If I take resources away from some use (say private consumption) and use it for another (say the provision of a public good), and do it in such a way that it is Pareto improving, there has still been an opportunity cost. TINSTAAFL still applies: we didn't get the public consumption for free; it's just that we all preferred what we got to what we had to give up to get it. 

So while "Pareto optimality" may be a bit misleading, I don't think "Pareto efficient" is, and I'm not sure what is a viable alternative to what is a very useful concept. So let's get back to whether the concept itself is dangerous. 

The nicest thing about the concept of Pareto efficiency is that it expresses outcomes purely in terms of the values of the individuals on society, not the values of the particular economist or government, employing the concept. There are more things that we might value than just Pareto efficiency, but how we weight them is a personal value judgement. Best to leave them as separate concepts and report them all, rather than obscure the weighting value judgement in the construction of a single well-being metric. (That is the main reason I am nervous about moves to move beyond GDP to "Gross National Happiness", but that is the subject for another post.)

Where Pareto efficiency becomes dangerous is when it is confused with the Kaldor-Hicks notion of potential Pareto improvements and then implicitly used as a welfare measure. Recall that according to this notion, a policy is desirable if in principle it would be possible to implement it and then make side payments where the winners compensate the losers even if those side payments are not made. Of course, it would be rare for an economics course to put that principle in front of students and suggest that it is a reasonable one, but sometimes, in taking the view "economists can talk about efficiency, but have nothing to say about equity", economists make it all to easy to confuse "we are only qualified to talk about efficiency, not equity" with "only efficiency matters, not equity". This does not mean in any way that we should abandon the concept of Pareto efficiency or change its name; we just need to be more careful to be clear that it is not a single measure or well-being.