Published in the Laissez Faire City Times, July 23, 2001
The old joke goes this way. Walking together, a neoclassical economist and a friend see a $100 bill on the sidewalk. The economist has a quick look and keeps walking. "Why don't you pick up the $100 bill?", the friend asks. "Because," the economist answers, "if it were really a $100 bill, somebody else would have picked it up already."
There is a modern school of economics, called the Austrian School (Ludwig von Mises, Friedrich Hayek, Murray Rothbard, and many others), that is critical of the notion of equilibrium which underlies the concept of optimality. Austrian economists argue that we should focus on disequilibrium, non-optimal situations, and the adjustment processes put in motion by acting individuals and entrepreneurs. When everything is in a flux and when, moreover, individuals have complex subjective goals, not only does optimality not obtain at any point in time, but it is not always clear what it means.
Although these critiques are well taken, there are cases when we can quite confidently say that everything is optimal. You have been stuck in a freeway jam for two hours, with traffic crawling and stopping regularly. You come to an exit which, as you find on the map, leads to a one-lane road running more or less parallel to the freeway. Should you exit to this road in the hope that it will be faster? You can quite safely bet, like our neoclassical economist above, that if the small road was faster, others have already discovered it, and it is now roughly as slow as the freeway. Everything is optimal, and it won't make a difference whether you exit or not.
Now, consider a different example, developed in a well-known article by Nobel Prizewinner economist Gary Becker.[1] Special interest groups form to exploit other groups in society — for example, large corporations and unions obtain protectionist barriers and exploit the consumer. As long as the cost of exploitation is lower than the cost of setting up a counter-lobby, the exploited will remain disorganized and passive. Exploitation is optimal: it would cost more to remove it than to live with it.
If everything is optimal, what do we complain about? Suppose that you are among the Jews exploited by the Nazis. As long as the cost of resisting (in terms of dollars but also in terms of time, risk, etc.) is lower than the expected cost of your exploitation, you stay put and suffer silently. If you decide to resist and you lose, it is just because winning (or losing in a different way) was not worth it. You are not very happy (except if eternal life exists), but the Nazis are, and everything is optimal.
Are we justified in complaining about anything? To solve the conundrum, we have to inquire exactly what "optimality" means.
One concept of optimality is a tautology. It just means that everything is adjusted to everything else given all the constraints in the world. Saying that something is optimal means that it works in the only way it can work given all the environmental factors. "Efficiency" in the context of natural selection is an analogous tautology: it means that what survives survives.
Economists mean something else by "optimality." In the traffic example, optimality is the best possible attainment of the participants' goals. Here, we can use Hayek's formulation, even if he did not himself use the term: "optimality" amounts to maximizing the chances that an individual taken at random will realize his goals.[2] Satisfying all individual preferences is easy if all individual drivers share the single goal of getting from A to B in the shortest possible time. Given the actual state of the world (roads charge a flat or zero fee, and transaction costs prevent drivers from bidding for places on a less clogged road), the way to achieve optimality is to equalize driving time, which is the natural outcome of letting each driver choose his own route.
The concept of optimality becomes more complicated when individuals have different goals (because they have different preferences or face different constraints). Suppose there is one driver who did not want to minimize driving time and, before the traffic congestion, had chosen the small road in order to enjoy the quiet countryside. The rerouting of the traffic is making him worse off. If drivers have different goals, equalization of time travel on the two roads may not be optimal. We need a more general concept of optimality.
From an economic point of view, optimality — also called "efficiency" — has to do with reconciling individual preferences. The simplest way is to let individuals express their preferences in a common standard, money, and have institutions such that what comes out of their interaction is maximum value in monetary terms. This is the approach taken by economist Alfred Marshall (1842-1924) and his neoclassical followers, which is also the most contentious from an Austrian viewpoint. An alternative way, due to Vilfredo Pareto (1848-1923), another neoclassical economist, is to make sure that all exchange opportunities are realized as long as nobody is made worse off — so that we have only utility gains. The more general — and more fuzzy — Austrian way would aim at maximum coordination of individual plans.
The unifying idea of all these approaches is that, under certain conditions, freedom of contract realizes optimality or efficiency, just as free choice of roads was efficient in our traffic example. As soon as we leave such simplified cases, though, it is far from clear what optimality or efficiency means. Consider two problems: the meaning of "free" contract, and what happens if some individual preferences are incompatible.
The economist's rule of thumb is that a contract is free, and exchange is profitable to all parties, if none is coerced. But non-coercion is not a necessary condition of mutually profitable exchange: if you were going to kill somebody but decide to let him buy his life back, the exchange is coerced but still profitable to your victim if your readiness to kill him is considered as the starting point of the process. You might say that this is not the "right" starting point ("all men are created equal," "initiation of force is bad," etc.), but the necessity of choosing a starting point means that some extra-economic consideration is needed to anchor economic value.
Different individuals have not only different preferences, but sometimes incompatible preferences. A sadist who gets utility from killing people cannot satisfy his preferences on the free market if there is no masochist who actually enjoys being killed (at an acceptable price). Similarly, a paternalist who gets utility from controlling other people's lives cannot have his preferences satisfied as long as the victims of his altruism do not want to be controlled (and that a bargain cannot be struck at a mutually agreeable price). Think of Patrick Henry as the victim: "[G]ive me liberty or give me death." Slavery might have been "optimal" in 19th-century America, but not from the point of view of the slave.
To weight incompatible individual goals, we must resort to criteria that are external to economics. Contractarian theory à la Buchanan appears to sidestep the problem by arguing that such criteria are defined at a prior, "constitutional," stage. This does not completely solve the problem, though, as we need criteria to determine whether the social contract is optimal ("legitimate") or not.
To answer our starting question: No, everything is not automatically optimal in society. It depends on the normative value we attach to the starting point and to the rules of conduct. Any meaningful notion of optimality is rooted in values outside the social sciences.
One implication is that reconciliation of fundamental values is not automatic. Ultimately, in order to solve conflicts of incompatible fundamental values, we have to fight it out — if one side doesn't retreat. And the more values are imposed by the state, the greater is the probability that some individuals will have their own fundamental values trampled upon. Indeed, this is why states maintain large praetorian guards. This situation may be optimal for normative statists but, for a libertarian, it is only optimal in the tautological sense that they have won the war — for now.
[1] Gary Becker, "A Theory of Competition Among Pressure Groups for Political Influence," Quarterly Journal of Economics, Vol. 98, No. 3 (August 1983), pp. 371-400.[2] See, for example, Friedrich Hayek, Law, Legislation and Liberty, Vol. 2: The Mirage of Social Justice (Chicago: University of Chicago Press, 1976), pp. 100-130.