Scales of Pareto Efficiency: Global and National
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.