Friday, 5 February 2010

Pareto improvement FAIL

The launch document for Big Potatoes, a "manifesto for innovation", starts with some worthy goals:
We believe innovation is an indispensable premise for improving the quality of life. It is...a means to a better life...For innovators, today's challenges can inspire new gymnastics in the mind and new ingenuity in the lab.
Great - innovation is an amazing and important thing, and I'd never argue against it.

But this pro-one-thing document strays into the anti-something-else area soon enough.
We distinguish innovation from fiscal, regulatory, legal and cap-and-trade responses to today's challenges. Unlike these technocratic measures, innovation has the potential, at least, to increase wealth and opportunity for everyone: it is not a zero-sum game.
The tragedy here is the failure to understand the promise and potential of economics. The whole point of the field is that economic transactions are not a zero-sum game.

Whether an action is fiscal, regulatory, legal or (cap-and/or-) trade, there's no reason at all to think it will be zero-sum. It can easily, and usually does, create a net benefit.

This common error arises, mainly, from a failure to understand the difference between goods and utility.

If I have a pound of butter and you have a loaf of bread, we can each trade half for half. Someone who only understands commodities and not humans might think this was a zero-sum action - after all, we still have the same total of one loaf and one pound of butter.

But anyone who thinks about how people use and benefit from bread and butter will realise that we are both better off. This is called a Pareto improvement - a change where everyone benefits and nobody is left worse off.

[someone might argue that you may have preferred to keep all the bread and miss out on the butter. This is why, wherever we can, we prefer to rely on voluntary trades to make our lives better]

Fiscal, regulatory, and legal actions are all similarly designed to increase total human utility. Naturally this intention occasionally fails, but you combat that by making regulation better, not by stopping it altogether.

There is a more subtle point here - a point about innovation, as it happens. If a Pareto improvement is available, and the parties involved are aware of it, it should have already taken place. So in order to find a new Pareto-improving fiscal transaction, or trade, or rule, we need to...innovate! Somebody has to come up with a new idea, find a new match between people and things they would like to buy, or design a new intervention that will make people better off.

All of these things are genuine innovations, and make up what Jared Diamond calls social technology. At some point, everything - from mortgages to co-operative societies, from limited companies to contracts, from the justice system to governments themselves - had to be invented. But it seems that the designers of Big Potatoes don't really think that counts. In fact, it turns out that they don't actually mean to support innovation at all. What they want is physical technology.

There's nothing at all wrong with physical technology. But by pursuing it exclusively, you're closing yourself off from a major - arguably the major - source of human fulfilment and happiness.

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