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« Negative Externalities: Double Dipping | Main | Links: Immigration, Taxes, and Coffee »

The Insufficiency of Efficiency

By Chris | February 8, 2008

I recently came across the book No One Makes You Shop at Wal-Mart, by Tom Slee. I didn’t purchase it, but read the first chapter which is available for free at Slee’s website. Slee’s title is a bit misleading. He argues that while no one makes you shop at Wal-Mart, it is very possible that everyone’s individual choice to do so can lead to an inefficient outcome. Because individuals don’t internalize the external benefits of a vibrant downtown and a variety of grocery stores, everyone’s individual decision to shop at Wal-Mart could conceivably make everyone worse off. He models an imaginary world where identical “Jacks” living in the imaginary town of Whimsley shop at Wal-Mart and are ultimately worse off because of it.

People who believe firmly in the virtues of individual choice will assert that Jack must be happier now than he used to be, because he has exercised his freedom of choice. If he didn’t like Wal-Mart he would not have shopped there. If he valued the lively downtown so much, he would have shopped there to save it. They will assert that, as a consumer, Jack is sovereign and the market always gives him what he wants. Yet in this story there is no individual choice that Jack could have made that would have improved his outcome. Even if Jack had chosen to continue shopping downtown, his minuscule individual contribution to the revenue of the downtown stores would not have stopped their closing.

Basically, Slee argues that our decisions are tangled with others and often devolve into prisoner dilemmas; we could achieve more efficient outcomes by working cooperatively. I take issue with Slee on a number of claims including “…that a system of private enterprise and free markets is particularly likely to produce such poor results on a regular basis.” However, I won’t critique Slee here. Alex Tabarrok, has read the entire book, and does a nice job reviewing it.

No One Makes you Shop at Wal-Mart got me thinking about the holy grail that efficiency enjoys in the field of economics. Ignoring the very real problem of government failure, when is it appropriate for the government to use coercion in the name of efficiency? In Slee’s imaginary town of Whimsley, everyone has exactly the same preferences and the case for government intervention is strong. Keeping Wal-Mart out of town would make everyone better off, and would be Pareto efficient. However, in the real world people have heterogeneous preferences, and they are difficult to know. Surveys are notoriously inaccurate. Externalities are ubiquitous, and more often then not its hard to tell even if they are positive or negative.

For example, externalities plague social interactions. When someone considers moving, he considers the cost of losing his friends, but he doesn’t internalize the impact his absence will have on them. A close-knit group of young professionals might be collectively better off staying in their current location, but each individual is too eager to abandon the group when a lucrative job offer comes along. This dilemma is made worse because an individual considering staying put, has no guarantee that his friends will stick around. Friendship, the source of so much happiness and meaning in our lives, is plagued by externalities. And yet, the idea that the government should somehow step in to correct this failure would repulse all but the strictest totalitarian. We place enormous value in the freedom to choose and leave our friends. Social norms have developed to limit the failures of the friendship market. People invest more time in people they think are likely to stick around. Friends can cooperate and make commitments to mitigate some of these problems. Moreover, we would hope that true friends internalize the costs imposed on those they truly care about. Ultimately though, we value the freedom to do as we wish.

Freedom and efficiency often go hand-in-hand. The invisible hand of the market usually makes society better off. When it doesn’t, efficiency sometimes requires us to suspend individual liberty. For example, most people consider it prudent to act collectively to build roads. However, freedom has its own intrinsic value. A system of free choice might occasionally take away a close friend, or put the downtown grocery store out of business. But, would we really prefer to have a group of bureaucrats dictate where we shop and who we associate with?

Topics: Markets, Political Science, Book Reviews, Economics |

14 Responses to “The Insufficiency of Efficiency”

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    Allen Taylor

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