by Filip Palda
Pareto’s Republic
and the new science of peace
Filip Palda
PUBLISHING INFORMATION
COPYRIGHT ©2011 BY FILIP PALDA. All rights reserved. No part of this book may be reproduced in any manner whatsoever without written permission except in the case of brief passages quoted in critical articles and reviews.
Date of issue: December 2011.
Printed and bound in Canada by the Gilmore Press.
Published by Cooper-Wolfling. None of the advisory board of Cooper-Wolfling are responsible for the opinions expressed in this text, which remain the responsibility of the author.
Editor: J. Kristin McCahon
Typesetting and final design supervisor: Lindsey Thomas Martin
Proofreader: Mirja van Herk
Cover design and typesetting: Gibaudrac Studios
About the cover: The cover is an image derived from the Evgeniy Vuchetich sculpture Let Us Beat Swords into Plowshares donated by the Soviet Union to the United Nations in New York in 1959. The derived image is used with the written permission of the legal division of the United Nations.
Palda, Filip, 1962–
Pareto’s Republic / Filip Palda.
Includes bibliographical references.
ISBN 978-0-9877880-0-9
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About the author
Filip Palda is full professor at the École nationale d’administration publique. He earned his Ph.D. in economics at the University of Chicago under the supervision of Nobel Prize winner Gary Becker. He is the author of six books, the editor of a further six, and has written hundreds of newspaper and magazine articles as well as over twenty-five articles in refereed academic journals. He is a high-scoring author on the RepEc website of economic working papers and is best known for his work on exposing the self-interest politicians hold in crafting election finance laws and for his role in bringing to light and giving the first full theoretical treatment of the displacement deadweight loss of tax evasion, minimum wage evasion, and rent-seeking.
Dedication
PRO MEMU OTCI.
Acknowledgments
I thank my father Kristian Palda who commented on several drafts of this book. His qualifications are particularly suited to giving feedback on a work of this sort. He received his Ph.D. in business at the University of Chicago under Nobel Prize winning economist George Stigler, and Harry Roberts, the founding statistician of marketing in business. My father then won the Ford Foundation Prize for original dissertations. He discovered the now famous Lydia Pinkham database which allowed him to prove that advertising could have cumulative effects and from this discovery he showed how to measure the value that advertising can contribute to a firm. This and other discoveries made him a leading figure in business economics. Yet he also has a second, very particular qualification, which is that he grew up first under German occupation forces during their reign of terror in Europe and Russia, and after the liberation of his country, Czechoslovakia, was chased from law school, dispossessed of all he owned, and then chased from his country by fellow students-become-collaborator and other home-grown communists acting with the backing of Russian arms. This has given him a unique perspective on conflict, personal separation, corruption, and absolute power, and one which I have drawn upon extensively in writing this book.
I thank Dan Usher for his detailed comments. Professor Usher received his Ph.D. in economics at the University of Chicago and went on to make foundational contributions first to development economics and then to the theory of tax evasion and deadweight loss, including what I believe is the first discussion of displacement deadweight loss. In a burst of creativity he also founded the field of the dynamics of predation in economic systems, which he called dynastic cycles. I believe though that his most enduring contribution to political economy will be his idea that there are economic prerequisites to democracy. The elegance of his analyses is without peer.
I thank Leonard Dudley, a founder along with Claude Montmarquette of the economic analysis of foreign aid, who provided invaluable comments on my views about economic development. Professor Dudley wrote the sort of book which inspired this one. It is called The Pen and The Sword published by Basil Blackwell and is an example of how economic reasoning can rise above economics to become accessible to anyone with the requisite curiosity. Thanks also to Alexandre Couture-Gagnon for her detailed comments.
I thank Kristin McCahon for her invaluable help as editor, proof-reader, and advisor in all matters relating to bringing a book to press. Kristin has for over twenty years been the director of publication production at the Fraser Institute in Vancouver and has been deeply involved in the publishing industry there. Without her patient guidance and brilliant conceptual and detail editing this book simply would not have been possible. Thank you Kristin. Any remaining errors are mine alone! Thanks are also due to Mirja van Herk for final copy-editing and to Lindsey Thomas Martin for supervising the typesetting of this book as well as cover design and dealing with all matters relating to ensuring the manuscript would be fit to send to the printers as well as to Dezso Vaghy for early suggestions on cover design. And finally but not least I thank Jim McIntyre, of the Gilmore Press.
USER GUIDE
This book can be read from start to finish because it has a uniting theme: Pareto efficiency as a recipe for peace. It has also been designed so that you can go to any page and start learning ideas in economics, political science, and Public Choice theory, because everything in this book relates to some important idea in one or all of these fields.
The book’s main idea
Only a peace that is based on Pareto efficiency, implemented through private property rights, can lead to prosperity and respect for human rights in large societies. What is Pareto efficiency? Some people have heard of something called the Pareto 80-20 rule which says that eighty percent of the profits go to twenty percent of the people. Pareto was a multi-genius, spawning ideas in statistics, sociology, demography, and economics that came to dominate the field. But the 80-20 rule has nothing to do with his notion of efficiency. Pareto efficiency is a much more powerful and subtle concept. A division of resources in society is Pareto-efficient if the pie cannot be re-cut in such a way as to improve the lot of at least one person whilst not making others worse off. This whole book is devoted to exploring this seemingly simple but devastatingly powerful definition of economic efficiency.
Extended summary
A socieTY Stands or falls depending on whether its members feel they are getting as much out of it as they are putting in. Social accounting is the vital ingredient of a successful society; the kind of accounting that creates balance between the efforts people make and the benefits they receive. Societies that get the social accounting right are both rich and peaceful. By peaceful, I mean a condition in which people within those societies cannot arbitrarily coerce each other. If I cannot force others to do something or give me something that I want, I must find another way to convince them to part with something they own, which I can do by offering them something of mine to which they attach a greater value. Persuasion is a viable basis for balance—and peaceful relations—in all human interactions. And to compound the benefits, persuasion is the source of riches. Riches, in this case, means finding new and better ways of using resources, finding new ways to do old things more efficiently. Studies overwhelming support the view that societies based on voluntary consensus are the most prosperous.
That is the big picture. The book also explains
how to achieve Pareto efficiency in practice. Because the essence of Pareto efficiency is the way resources are used, the book explains the two the methods available for allocating their use. Either you can centralize control of resources by putting them under the direction of some organization such as the government, or you can allow individuals to decide how to use resources by letting people own property and decide for themselves what to do with it. The decentralized option works best because it forces people to reveal their true preferences and their abilities, which is the basis of balanced social accounting. The truth emerges from competition. When consumers compete with each other to buy some product, they reveal how much they are willing to pay. When producers lower their prices to beat their competitors, they reveal how low their costs really are.
The ideas in this book are by no means the consensus position. Some serious thinkers have argued that the centralized version of resource control—coercion—not persuasion, is the source of prosperity and peace. Communists believe that a dictatorship of the proletariat can organize things so that people who put in their time at the metal press can go home to a pleasantly chilled bottle of Slivovic. However, to get social accounting right, coercive systems must rely on the wisdom and honesty of their leaders. The paradox is that the one mechanism that could ensure a functional level of both ingredients is not feasible in a state that controls all resources. Democracy is the only feasible check on the venality of rulers because it is the governmental analogue of competition in the private sector. By putting all of society’s resources under the control of government, democracy becomes a contest between interest groups to divide the riches of the state, a situation that leads ultimately to civil war.
This book shows how property rights balance social accounts, but also shows that sometimes property rights themselves cannot be established. When this is the case, government must intervene. The proper balance between government and private property rights is the main quest of this book.
Principal components of this book’s main idea
Social accounts are a tally of the efforts people make in society and the rewards they receive. When these accounts tip too far out of balance, then strife, and possibly the dissolution of that society are the result. This is why a robust system of social accounts is needed to ensure peace in society. This book explains how to get such peace through the exchange of property rights in markets where individuals make choices about the use of private resources. The foundation of the peaceful use of resources is something called Pareto efficiency. An exchange is Pareto-improving if it increases the well-being of at least one person without harming anyone else. When all such exchanges have been made, a society is considered Pareto-efficient.
Pareto efficiency can be attained only if there is an established system of rules that protect private property rights. Such a system ensures that every party to an exchange of resources takes into full account the preferences of the opposite party before the exchange takes place. This ensures balance in social accounts. Governments can serve as useful interveners when property rights and voluntary exchange break down as a means for social accounting.
CHAPTER TWO INTRODUCES the idea of peace as a form of managed war. This book is not about changing people. It is about changing something much more amenable to alteration, namely, the environment in which people live. Given the right setting, such as one in which people can resolve their disputes peacefully by exchanging property rights according to rules that are the same for all, prosperity and an effective, if not necessarily loving peace, may result. The chapter introduces the ideas of Vilfredo Pareto, who conceived of such a system of voluntary exchanges that, when executed perfectly, have come to be known as Pareto efficiency. This chapter explains that in societies above a certain size, such a peace can only be achieved in a decentralized market system.
Chapter 3 explains that property is a legal concept with three dimensions: the right to enjoy, modify, and transfer the resource you own. Understanding these dimensions of property, also known as property rights, is the key to understanding whether we should allow people to manage their own resources, or whether we should entrust this management to a central authority such as government. Government fails in managing property because true information on the value of property is only revealed in the market and cannot be plucked from theories put forth in the calculating office of a central planning agency. Entrust to government the management of all resources and democracy would be little else than a joust for resources. Without democratic competition to discipline leaders, even the most clear-headed leaders will succumb to corruption. This chapter explains why private property rights protected by rule-of-law succeed, where central control of resources fails to attain Pareto efficiency.
Chapter 4 explains that when you cannot create private property rights, then you must call on the public sector. This is the only justification for government intervention. At all times government must be ready to devolve management of resources to the private sector once technological advances make it feasible for the private sector to create legally defensible accounts surrounding property.
Chapter 5 argues that to fund government intervention we need taxes. These taxes should minimally disrupt Pareto-efficient exchanges. This chapter explains how to create a Pareto-efficient tax system by minimizing the so-called deadweight loss from taxation.
Chapter 6 unites the economics of the four previous chapters with insights from politics and further explorations of the ideas behind Pareto efficiency. It is the most challenging chapter of the book.
Chapter 7 highlights the dangers that our societies face today. The absence of property rights creates a forum in which social calculations get mixed up. The errors may accumulate to such an extent that an economy founders. The solution to creating Pareto efficiency throughout the world lies in migration. Some countries are to a greater or lesser degree Pareto efficiency. If people can move to countries with Pareto efficiency, they will force the regimes they abandon to reform, while at the same time giving force to the Pareto-efficient societies they join. We may never be able to reach the ideal of Pareto’s Republic, but we can certainly get close.
Qualifications needed to understand this book
This book is designed for all readers. It will appeal to anyone interested in understanding how a single principle unites economics and politics to create a new science of peace.
PEACE
The theme of this book is peace, but not the sort you find being discussed at international arms reduction conferences. This book is about the peace that people arrange between themselves, face to face when they confront each other to dispute the control of some resource. Disputes over resources are the main reason for enduring conflict. Sure, someone can become your enemy because he or she simply does not like the way you look. But such conflicts follow no pattern and must be considered part of the inevitable background noise of living, to which we can reconcile ourselves because for every such idiosyncratic hatred you may find someone who likes you equally well. Likes and dislikes of this sort will balance each other out.
What may not balance out are conflicts over resources. A gold mine can incite generations of miners to battle each other. The never-ending conflicts in Africa bear testimony to the tendency of people to persist in conflicts over resources that matter. Africa is a cautionary tale. What should be the richest continent is the poorest. North America is the richest continent but should really be the poorest because it is relatively impoverished in natural resources. What it lacks in these resources it makes up more than a hundredfold in providing its people with a means by which they can convert their personal antagonisms into mutual riches. America and a few select other parts of the world have figured out the principles of what is coming to be understood as the modern science of peace. This science seeks to understand how to convert hostile conflicts into mutually profitable outcomes. The present book is your guide to this emerging science. So let us start at the beginning and have a look at what previous t
hinkers had to say on the topic.
Transforming aggression into production
Three thousand years ago, the Hebrew prophet Isaiah foresaw a day when people would “beat their swords into ploughshares, and their spears into pruning hooks: nation shall not lift sword against nation, neither shall they learn war anymore.” We do not know how much progress was made towards his vision in the years that followed. We know that several centuries later Virgil, the court poet and chief propagandist for the Roman emperor Augustus, clearly felt that relations between groups of people were taking a bad turn. In his Georgics he wrote that war and crime were ravaging the countryside so that “no meet honour hath the plough; the fields, their husbandmen led far away, rot in neglect, and curved pruning-hooks into the sword’s stiff blade are fused and forged.” Although Virgil seemed to be cribbing from Isaiah, it was not the case. Virgil had no knowledge of Isaiah. A thousand years of history and thousands of miles of sea separated the two. Yet both used the same image to capture the idea that the step between mowing wheat and mowing down an enemy is all too short.
The image of a person beating his or her sword into a ploughshare is powerful because it acknowledges the complexity of human aggression and suggests a means of harnessing it to some peaceful, productive end. The idea of peace as a productively managed conflict arising from the ongoing animosities and tensions between people is not new. Chinese emperors sometimes went to war with the barbarians on their frontiers, but most of the time kept them quiet with bribes. The empire became so skilled at this form of violence management that it eventually absorbed most marauders in a mutually beneficial relationship. In the Middle Ages, European peasants paid armed thugs hefty sums to provide protection against other marauding bandits. It took hundreds of years to work out ever better terms for both sides. Modern democracies that tax their citizens in an orderly manner and spend the money according to public wishes can trace their ancestry to these early attempts to transform violence into something fruitful. One can even find the idea of managed peace in the myth of St. Francis of Assisi who convinced a wolf to stop terrorizing the villagers of Gubbio in return for a regular handout of food, and in the story of Saint Gall who gave bread to a monstrous bear in return for the security of his Swiss parishioners.
