The Kaldor-Hicks efficiency criterion and transfer programs

The Kaldor-Hicks efficiency criterion is a test in welfare economics against which hypothetical policies are often measured- click here for the Wikipedia article. We’ve clashed horns with it many times on this blog.

Here is another demonstration of the absurdity of the Kaldor-Hicks criterion: it implies that we should abolish all transfer programs. Perhaps you agree with the result, but even if you do, I hope you will concede we haven’t got there by way of the right reason.

The argument is a way of bringing out the anti-egalitarianism of KH, using existing welfare policies. Consider a welfare program, for example an unemployment benefit. Let us make two assumptions about it:

  1. The citizens who are net payers for the program pay more for the program in dollars than the recipients get in dollars, whether due to program administration costs or dead-weight loss.
  2. There are no broader, positive economic effects of the program to consider- the program doesn’t make society more productive overall. This assumption is more controversial, but is at least plausibly true.

On the assumptions we’ve given, the aggregate income of the citizens given that the program exists is less than what the aggregate income of the citizens would be if the program did not exist:

(Beneficarcies1+Payers1)<(Beneficarcies2+Payers2)

It follows that if the program were abolished, the “payers” could afford to compensate the “beneficiaries” so long as transfers could be made losslessly, an assumption of the KH approach.

Of course the winners won’t compensate the losers, but that’s not the point when it comes to the KH test.

Similar logic could be applied to any transfer program whatsoever. Admittedly, it is possible, or at least plausible, that assumption two does not hold and so these transfer programs do stimulate the economy, but I don’t think the defence of these programs should have to rely on this contingency. In general, consistently applying the KH criterion means being totally apathetic about distribution, and since shifting money has costs, a government obsessed with the KH criterion might well do nothing to combat inequality.

This all might seem painfully obvious, after all the KH criterion is meant to be about efficency not equity, but the argument does, I think, make the fault with KH pretty clear. Maybe a criterion that implicitly condemns all transfer programs shouldn’t be the sole formal yardstick of welfare economics.

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