Tibor Scitovsky
Welfare and Competition
Irwin, Homewood, Illinois, 1971
Chapter 1
THE SUBJECT MATTER OF ECONOMICS
(pp. 3-11)
Economics is a social science concerned with the administration of scarce resources. Resources are objects and services that are capable of satisfying human wants either directly or indirectly by helping to produce other objects and services whose use satisfies human wants. The administration of resources does not always create economic problems. Some resources are so plentiful that they are more than sufficient to satisfy completely all the human wants which depend on them. Air, for example, is such a resource. These resources are called free resources; and there is no need for organizing their use, because any waste or inefficiency in their utilization can be made good from their excess supply and need not abridge the satisfaction of human wants.
By contrast, scarce resources are those that are insufficient to fill completely all the wants they cater to; these wants therefore can only be satisfied partially. This raises problems of administration which are the subject matter of economics.1 To begin with, one problem of administration is to insure the full utilization of scarce resources, because their incomplete utilization would result in a loss of human satisfaction. Second, when scarce resources are fully utilized, there is the further administrative problem of properly allocating these resources among their different uses and to the satisfaction of different wants. For when scarce resources are fully utilized, the fuller satisfaction of any one want can only be achieved at the cost of the lesser satisfaction of some alternative want or wants. Third, yet another problem of administration is the proper distribution among consumers of these resources or of the goods and services produced with their aid.
Most of these problems would present themselves even to an isolated and completely self sufficient person. Such a person, to fill his needs, would have to rely on his limited capacity to work and would face the problem of how best to husband his energy and divide his time between leisure and different types of work. This is a problem of administering the scarce resources of his time and energy; but it is his private problem, which he may be left to solve as best he can, because its solution has no repercus
1 The term "administration" is used here in its broadest possible sense and is not restricted to mean only administration by a central authority.
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sions on other people's welfare. Only when several people cooperate for the purpose of satisfying their wants do one man's actions affect other people's welfare. Only in this case does the use and allocation of scarce resources and the distribution of their products raise problems of social organization; and it is only these problems that are of interest to the economist.
The foregoing makes it obvious how important the distinction between free and scarce resources is. That distinction however depends on the quantitative relation between human wants and the supply of resources available to satisfy them; and this relation is always changing. Free resources can become scarce and scarce ones free with the passage of time, as wants and resource availabilities change. For example, the population explosion and our increased affluence are rapidly turning parking space from a free into a scarce resource; the same is happening, and for much the same reasons, to fresh air in the cities and to fresh water everywhere. The opposite change, once scarce resources becoming free, is exemplified by the thousands of abandoned cars, appliances, plumbing fixtures, empty bottles, etc., that dot the American countryside, most of which would be considered valuable (i.e., scarce) in less affluent societies. If these examples also point to some of the more intractable problems of our tune, the reason is new problems are always harder to resolve than routine ones. Society finds it especially difficult to recognize and deal with a problem where none existed before or to treat as valuable and learn to budget resources that, within memory, could be considered free and ignored with impunity.
People cooperate in the use of their scarce resources even in the most primitive societies, because specialization improves their efficiency and the division of labor increases their total product. The more specialization and division of labor there is among the members of a society, the better use they can make of their limited resources for the satisfaction of human wants. Most economic progress consists in increasing these potentialities; and, from the economist's point of view, almost every innovation and technical invention is merely a new and more efficient method of specializing and dividing up the task of catering to human wants.
The blessings of economic progress however are gained at the cost of the increasing complexity of economic organization. The more division of labor there is among the ,members of a society, the more they lose their economic self sufficiency and become dependent on each other. Economic interdependence is not a bad thing; but it turns the administration of scarce resources into a social problem. Means must be found whereby different members of society can exchange their respective products, whereby they can be induced to work and to produce different goods in the proportions wanted by society; and when a good embodies the contributions of several people, these must be brought together, their work coordinated, and the fruit of their joint effort shared among them. The organization
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that this requires may be efficient or inefficient, equitable or unjust; it may function smoothly or be subject to occasional breakdowns. The farther the division of labor is pushed, the more intricate does economic organization become, and the greater is the likelihood of something going wrong with it. The task of economics is to study economic organization, to appraise its efficiency and equity, and to suggest ways and means whereby its imperfections can be lessened or eliminated.
To appraise the efficiency of economic organization, a standard of perfection is, if not always essential, at least very desirable. In the natural sciences such standards are easily established. A perfect locomotive, for example, would be one that transforms all the heat energy of its fuel into traction; and the efficiency of an actual locomotive can be measured by the percentage of energy so transformed. In the social sciences the establishment of standards of perfection is usually very difficult and constitutes one of the main problems. The function of economic institutions is to organize economic life in conformity with the community's wishes; and to find out how well they fulfill this function, one must first ascertain the community's wishes. Sometimes these are expressed through the politically appointed organs of the community. For example, the community's wish to assure a minimum income to the old and to the unemployed may be expressed by a legislative body when it enacts laws providing old age assistance and unemployment relief. It is even conceivable that all the wishes of the community might be expressed collectively through its politically appointed organs. This is more or less the case in the communist state. In such a state, appraising the efficiency of economic organization is very simple and consists of little else than ascertaining the extent to which and the speed with which the central production plan has been fulfilled assuming, of course, that this plan is a true expression of the community's wishes.
In a democratic society, most of the community's wishes are not expressed collectively but must be found out by ascertaining the wishes of each member of the community. In some cases, this is relatively simple. For example, an approximate indication of the community's desire to work is found in the individual actions of its members who accept employment or register with employment exchanges. A comparison of the total number of people who have thus expressed their willingness to work with the number actually employed gives a rough measure of the economic system's efficiency in providing employment.
As a rule, however; to ascertain the community's wishes in a democratic society is a difficult problem; and a large part of this book will be taken up with it. We shall have to ascertain the way in which the market reflects people's preferences between different consumers' goods, between different types of work, and between leisure and the income to be earned by work; for the efficiency of economic organization will to a large extent be judged by its conformity to the community's preferences in these matters.
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Having stated the subject matter of economics and the problems that economic organization must solve, we proceed to consider the nature and forms of economic organization. Economic organization consists partly in bringing together different resources in farms, workshops, factories, and other centers of production for the purpose of producing with their aid new, produced resources. These centers of production may be owned by private persons and managed for their personal profit or may be owned by the state and managed by public officials according to rules and directives issued by the state. The two types of production centers exist side by side in most economies; but, depending on which is the dominant type, we distinguish between private enterprise and socialism.
In addition, economic organization also consists in coordinating the activities of different centers of production, allocating resources among them, and distributing their products. This, too, may assume two forms. One is trade, which we shall interpret in its broadest possible sense to mean all exchange of goods and services. The other is direct regulation by a system of duties and rights. Trade is a coordinating factor because, in the course of trade, prices are established which to a greater or lesser extent reflect the preferences of the trading parties and which enable both the trading parties and others to act in conformity with these preferences. That the activities of different production centers can be coordinated also by direct regulation goes without saying. Trade and direct regulation occur side by side in most economies; moreover, trade itself may be subject to regulation by the state. But, according to whether trade or direct regulation predominates, we distinguish between market and planned economies.
It has long been a tradition to associate private enterprise with the market economy and socialism with planning, although such a pairing of the two sets of concepts is not necessary nor invariable; and we are increasingly getting away from it. Nazi Germany provided an example of planning in a private enterprise economy, so did the United States and Great Britain during the Second World War, and so does France today with respect to the very important area of investment planning. As to a market economy under socialism, its theoretical possibility was proved a long time ago,2 and an increasing number of communist countries today are recognizing the advantage and instituting the practice of market prices and profit incentive. Their adoption by them is no more a betrayal of socialism than our occasional use of planning is of capitalism.
Under private enterprise in a market economy, trade determines most of the relations of firms with each other and with the suppliers of original
2 Cf. A. P. Lerner, "Economic Theory and Socialist Economy," Review of Economic Studies, Vol. II (October, 1934), pp. 51 61; and Oscar Lange and Fred M. Taylor, On the Economic Theory of Socialism (Minneapolis: University of Minnesota Press, 1938); also Lerner's Economics of Control (New York: Macmillan Co., 1944). In fact, much of the economic theory of socialism consists in proving that socialism and the market economy are compatible.
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resources and the consumers of final products. The firm itself, however, may own and control several production centers; and the activities of the several plants and workshops of the firm are coordinated through direct regulation by the management of the firm, which in such an economy is the authority that makes production decisions.
In a planned economy, most or all relations between the different centers of production are subject to direct regulation and central control by the state; but, for securing the services of labor and distributing final products among consumers, even the planned economy often relies on trade and the market mechanism. Not to rely on the market mechanism at all would necessitate the direct regulation of everybody's economic relations by a system of duties and rights. The state would have to determine who had the duty of performing labor, in what occupation, and for how many hours per day; and it would also have to determine who had the right to consume how much of each commodity.
Such a direct regulation of all economic relations by a system of duties and rights may be conceivable within the family circle or in a primitive tribe; but it would be insupportably rigid and oppressive in a more complex economy. It would require an excessive amount of regulation; and the connection between duties and rights would become so remote as to obscure the fact that the performance of duties is the payment, the quid pro quo, for the enjoyment of rights. In consequence, people would soon regard their duties as oppressive, unfair, or unreasonably hard. Moreover, the assignment of duties and the granting of rights can hardly allow for personal differences and preferences and is bound to be rigid and lead to inefficiency and injustice.
Trade is free from many of these shortcomings. It stresses the principle of give and take and renders the connection between services performed and benefits received very explicit. As a result, a man who would resent as slavery the state imposed duty to work may consider himself a free man when working for a wage even if he is forced to work by economic necessity. The market gives people a freedom of choice in consumption and in the selection of occupation that direct regulation can hardly provide. Furthermore, in the course of trade, market prices are established for the goods and services exchanged; and, provided that certain conditions are fulfilled, these prices express the preferences of the trading parties and their valuation of the resources exchanged. This characteristic of prices enables the market mechanism to register people's preferences and to organize production, allocate resources, and distribute products according to these preferences. In fact, the pricing system provides such a simple means of ascertaining the community's wishes and is so powerful an aid to economic organization that no economy except the most primitive can afford to do without it.
But trade is not superior, to direct regulation in every respect. To begin
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with, the principles of equity and social justice are easily forgotten and ignored when people rely exclusively on the automatism of the market. Moreover, trade is not always efficient as a means of organizing economic life. Its degree of efficiency depends on the nature of markets the number of people in the market, their sureness of judgment, the degree of equality in their economic power, and so forth; and to insure the efficiency of trade often requires legal safeguards. Hence, even in the market economy, trade is often subject to legal regulation. This may take several forms. Most commonly, it consists of restrictions and corrective measures imposed on private trading. Antitrust legislation and the public regulation of railroad fares and rates are examples of restriction in the interest of the greater efficiency of trade. Minimum wage legislation, unemployment insurance, and progressive taxation are correctives aimed at modifying the distribution of income as determined by the market.
Finally, there are many goods and services in whose provision and distribution trade and the market cannot play an efficient role, even under the best circumstances. These are called collective or public goods and services. Obvious examples are defense, police protection, communications, all of which are better provided collectively, through public action, even though they too had their origin (and occasionally still have their counterpart) in private bodyguards, vigilante groups, private messengers, and private pigeon posts. The distinguishing feature of collective goods is partly that they affect several people simultaneously and cannot therefore be distributed to each according to his different wants, partly that they are usually easier and cheaper to provide collectively. Police and fire protection provided for my neighbor benefit me too to some extent; and they can easily and cheaply be extended to give me full protection.
The dividing line, however, between collective and individual goods is blurred: a public park benefits the whole neighborhood but even a private garden gives some pleasure to neighbors and passersby. Moreover, this dividing line is not only blurred but continuously shifting, just as the dividing line between free and scarce resources is shifting. For example, the substitution of private for public transportation is one of the manifestations of our rising standard of living; at the same time however, the rise in the standard of living, together with the increasing density of population, also increases our potential to disturb the environment and step on each other's toes, which turns many hitherto private enjoyments into matters of public concern.
We shall try to deal with all these issues; but the main concern of this book is with private enterprise in a market economy. It is customary to distinguish between two types of problems in such an economy. One pertains to the degree of employment of scarce resources, and the other has to do with the efficiency and equity of their employment and of their allocation and distribution. Throughout this book, we shall only be con
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cerned with the latter type of problem. In particular, we shall analyze the behavior of firms and the functioning of markets; and we shall try to appraise the efficiency and equity of the economic organization which results from the independent production decisions of private firms whose behavior is coordinated by the market mechanism. Before doing so, however, we must say a few words on the problem of employment and on the exact relation that this problem bears to the problems with which we shall be concerned.
We mentioned at the beginning of this chapter that free resources, being more than sufficient to fill all the wants they cater to, exist in excess supply. This means that they remain underemployed. Scarce resources, however, may on occasion also remain underemployed, because, though insufficient to fill all the wants they cater to, they may be more than sufficient to fill the demand for them. For the wants whose satisfaction depends on scarce resources are filled only to the extent that they are backed up with purchasing power and become effective as demand in the market. Demand therefore need not correspond to wants; and the failure of the economic system to register wants properly and make them effective as demand results in the underemployment of scarce resources and a consequent loss of human satisfactions.
When demand is insufficient to call for the full employment of a scarce resource, the only way to increase the satisfaction of wants that depend on this resource is to raise the demand for it. Hence when a scarce resource becomes underemployed, it no longer matters whether it is used efficiently or not. The only consideration that remains relevant is that of equity. It is not worthwhile to eliminate inefficiency in the utilization of underemployed resources, because, as long as demand is insufficient to maintain full employment, inefficiency diminishes unemployment and not the satisfaction of wants.3 Similarly, it does not matter if too large a proportion of underemployed resources is devoted to the satisfaction of one particular want, because this again results in less unemployment and not in the lesser satisfaction of other wants.4 Efficiency in the use of underemployed scarce resources is as irrelevant as it is in the administration of free resources, and for exactly the same reason. In both cases, there is an unemployed reserve of resources, which is drawn upon to offset losses due to wasteful or improper use. Here however the parallelism ends. For the underemployment of free resources is due to the saturation of the wants they cater
3 It should be noted, however, that if an increase in efficiency happened at the same time also to raise effective demand, then it would increase the satisfaction of wants.
4 In fact, if we regard unemployment not only as the cause of a loss of output and satisfaction but as a bad thing in itself, we might even go further and argue that inefficiency in the administration of underemployed resources is desirable, because, while it does not lower the satisfaction of wants, it lowers unemployment. See, however, pp. 10 11.
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to and therefore causes no loss; whereas the underemployment of scarce resources is due to imperfection in the economic system and does result in economic loss.
A situation in which there is both underemployment and an inefficient use of scarce resources may be compared to that of a prisoner who serves two sentences concurrently. He would gain by having his longer sentence revoked or revised; but as long as this sentence stands unchanged, he would derive no benefit from proving his innocence of the crime that earned him the shorter sentence, because it would not set him free sooner. Similarly, at a time when the insufficiency of demand causes unemployment, the only way to increase the satisfaction of human wants is to raise demand; for the mere existence of unemployment proves that the loss of satisfactions due to the insufficiency of demand exceeds and absorbs any loss that may be due to faulty allocation. Hence if insufficient demand and inefficient administration were equally important, unemployment would disappear. The existence of unemployment is proof that the effect of inefficiency is less important than the effect of insufficient demand.
The problem of unemployment has first claim to the economist's attention. Only in a fully employed economy does allocation become an economic problem. In other words, only when scarce resources are fully employed does the way in which they are employed and allocated among alternative uses become relevant from the economist's point of view. This is why the problems of allocation and distribution dealt with in this book are described as the economic problems of a fully employed economy.
Nevertheless, the usefulness of the following analysis is not confined to those comparatively short periods of high prosperity when all resources are fully employed. For if it seldom happens that all resources are fully employed, it is equally rare that all scarce resources are underemployed. Neither labor nor productive equipment is homogeneous; and the underemployment of labor as a whole or of equipment as a whole seldom means that all kinds of labor or all kinds of equipment are underemployed. As a rule, underemployment in some occupations and of some types of equipment exists side by side with full employment in other occupations and of other types of equipment; and the proper use and allocation of the fully employed resources do create economic problems.
Furthermore, the problems to be discussed in the following chapters are not entirely irrelevant even at a time of general underemployment. For the efficiency or inefficiency of economic organization at any one time inevitably bequeaths a legacy of efficiency or inefficiency to the future. Accordingly, although the efficiency with which employed resources are used and allocated during a period of underemployment is of no immediate relevance, it does become relevant later, when full employment has been restored. For example, technological improvements introduced during a depression often fail to raise output while the depression lasts and only
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aggravate unemployment. Nevertheless, their introduction at that stage may still be desirable, because it may be the condition of higher output in the subsequent prosperity. Similarly, an employment policy adopted in depression must be judged not only by its immediate effectiveness in raising demand and relieving depression but also by its effects on efficiency. For as soon as the increase in demand has eliminated unemployment, problems of allocation will arise; and the seriousness of these problems may depend on the particular way in which full employment was achieved. While unemployment exists, all cures seem equally good if they are equally effective. But equally effective cures of unemployment may affect the allocation of resources differently; and if they do, they will be differently appraised once full employment has been restored and the proper use and allocation of resources have again become the primary aim of economic policy.5 Hence, the subject matter of this book, although it is confined to the problems of a fully employed economy, has a bearing even on the choice of employment policies if their long run effects are taken into consideration.
BIBLIOGRAPHICAL NOTE
For a more detailed and more complete statement of the subject matter of economics, see Oscar Lange, "The Scope and Method of Economics," Review of Economic Studies, Vol. XIII (194516), pp. 12 32. See also Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: Macmillan & Co., 1932); and R. F. Harrod, "Scope and Method of Economics," Economic Journal, Vol. XLVIII (September, 1938), pp. 383 412.
5 For a detailed discussion of this subject, see Melvin W. Reder, Studies in the Theory of Welfare Economics (New York: Columbia University Press, 1947), chap. X.
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