Title: Welfare Economics and Water Allocation
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Title: Welfare Economics and Water Allocation
Physical Description: Book
Language: English
Publisher: The Conservation Foundation
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Spatial Coverage: North America -- United States of America -- Florida
 Notes
Abstract: Richard Hamann's Collection - Welfare Economics and Water Allocation
General Note: Box 12, Folder 11 ( Conservation Foundation - Symposium Papers on Water Allocation in Eastern U. S. - 1956 ), Item 47
Funding: Digitized by the Legal Technology Institute in the Levin College of Law at the University of Florida.
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Bibliographic ID: WL00003194
Volume ID: VID00001
Source Institution: Levin College of Law, University of Florida
Holding Location: Levin College of Law, University of Florida
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23-a.


5, Welfare Economics and Water Allocation


In an attempt to develop criteria for public policy, economists have de-

veloped a branch of normative economics called "welfare economics." More re-

cently, this branch has become known as the "new" welfare economics to empha-

size its development in England and the United States since the 1930's. Its

essential problems were recognized and its relevant theorems developed in the

1890's by Pareto.1/

In formulating policy criteria, welfare economics takes explicit account

of differences in individual preferences and incomes and of the resulting prob-

lems in aggregating individual utilities. It is an economic axiom that the

marginal utility of individual income decreases with increasing income. There

is no agreement among economists on whether and in what sense--ordinally or

cardinally--individual utilities can be compared; but welfare criteria that

avoid interpersonal comparisons are generally preferred.

Classical and neoclassical economists were well aware of these problems.

They, however, focused on an increase of (real) aggregate national income as the

main criterion of economic welfare.W Pareto's views were not in conflict with this
-------------------- -----------------'---------

1/Pareto, Vilfredo, Cours d'Economique Politique (Lausanne: F. Rouge,
Libraire-Editeur, 1897).

2/The first edition of Alfred Marshall's Principles of Economics appeared
in 1890, seven years before publication of Paretols main work in French.
Marshall mentions Pareto only in passing and in a different connection.


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emphasis because he believed--supported by historical experience as he saw

it--that an increase of aggregate national income and greater equality of

income distribution tended to be associated. In this case, an increase of

aggregate national income means also an increase of economic welfare according

to Pareto's criterion at least under some generally accepted assumptions.

The positive correlation between changes of aggregate national income

and of equality of income distribution--sometimes called "Pareto's law"--was

challenged by Pigou/and others; but Pareto's welfare criterion is indepen-
dent of his "law." This does not imply that the correlation noted by Pareto

does not exist nor that Pareto's criterion is of greater significance for

economic theory than his "law." Quite the contrary, one may wonder whether

the great intellectual effort of the last 20 years which has been invested in

developing Pareto's criterion might not have yielded greater dividends, in

terms of knowledge as well as welfare, if it had been employed for further

investigation of Pareto's law and of the problems associated with the increase

of aggregate national income.

-------------------------rr ---- ---------------

l/Pigou, A. C., The Economics of Welfare (London: Macmillan and Company,
Limited, 1938).











The Pareto criterion says that a change that makes at least one individual

better off and leaves no individual worse off represents an increase of welfare.

This criterion is usually interpreted to mean that welfare is increased by a

change rendering it "possible" to make at least one individual better off and

leave no individual worse off by compensating the losers. Most of the discussion

in the new welfare economies deals with this compensation principle.

The Pareto criterion "without" compensation is so restrictive that it has

little relevance for an appraisal of public policies--even if it could be

practically applied. There are scarcely any policies which make nobody worse

off. Furthermore, if there were such policies, the criterion would be ineffec-

tive for choosing between more than one alternative to the status quo. The

Pareto criterion "with" compensation is not so restrictive, but its application

is even less practical.

The Pareto "with" criterion is conceptually not identical with the criterion

"increase of aggregate national income." But the latter criterion may be regarded

as a practical first approximation to the former, provided that the policy under

consideration does not appreciably increase inequality of income distribution;

and provided further that there are other policies in operation which work

independently and continuously in the direction of greater equality of income

distribution. Such policies are, for example, progression in income and property

taxes, high inheritance taxes, and "social welfare" legislation in the narrower

sense (relating to old age, invalidity, unemployment, minimum wages, and public

health, education, and so on). These two conditions can be regarded as fulfilled

when considering resource policies in modern western societies.


O











Accepting an increase of aggregate national income as an economic criterion

for public water policy does not imply that application of this criterion faces

no theoretical and practical difficulties or that it is the most useful cri-

terion under conditions where economic change and uncertainty are the central

problems. We shall return to these problems in the concluding section.(Section 6).

The contribution of welfare economics has been a clarification of the theo-

retical meaning (or absence of it) of a social welfare function and social indif-

ference curves and of the difficulties (or impossibility) of applying the Pareto

criterion in actuality.2The disservice of welfare economics has been that its

terminology is used by economists and others without pointing out these theoretical

and practical difficulties. The false impression is created that a simple cri-

terion is available that can be used for legislation, court decisions, administra-

tive regulation, and social planning in general.

In the field of water allocation policy, such use of welfare economics can

best be shown by an example.

In a recent paper, optimum water allocation in social planning is analyzed

by superimposing smoothly convex social satisfaction indifference curves on a
2/
single production possibilities curve equidistant from the point of origin.-

Anyone with a little knowledge of high school geometry has no difficulty in

locating accurately a point of maximum social satisfaction in water allocation

between two uses.

^ ~~ -, - - - - - - - - - -
l/For the last (but probably not final) word in this clarification, see:
Samuelson, Paul A., "Social Indifference Curves," Quarterly Journal of Economics,
vol. LXX, February, 1956, pp. 1-22. This article cites the significant previous
literature.

He Earl O. and John F. Tiamons "Ec Frework for P a

y Zone LPrw Center 0ce .ed
iversi 1Of Iow."ii c7-" s cn=Icul U"e, I_ e College, Ames,
Iowa&, M Zc'h' :, i 2, .p Processed,


__________________________________________--------- -- --- n ______








27.

No information is given as to how the social satisfaction indifference

curves can be determined theoretically and computed in actuality. A higher

indifference curve does not become "Pareto-better" by word magic. The sugges-

tion that such curves could be used for water allocation in legislating and

planning must be regarded as not warranted by the state of welfare economics.

For some time, cost and revenue indifference systems have been in use to

analyze decision making in firm economics.2 But applying a single equidistant

possibilities curve to policy decisions raises questions no less serious than

the use of social satisfaction indifference curves.

The ancestry of a single production possibilities curve, the apparent sim-

plicity of which has made it rather popular recently, can be traced to two

basic assumptions of programing.W These assumptions are, first, existence of

limitational factors--especially capital--and, second, independence of decisions

regarding the intensity of each process and decisions regarding the combination

of processes. No information is given as to what limitational factors are

assumed. From the standpoint of policy, capital and other factors are limita-

tional only under narrowly defined short-run static assumptions. Under such

assumptions, water allocation through legislation, court decisions, and adminis-

trative regulation has little meaning.



/ Ciriacy-Wantrup, S. V., "Eeonomics of Joint Costs in Agriculture," Journal
of Farm Economics, vol. XXIII, no. 4, December, 1941.

/ The reader with no technical training in economics may want to consult an
easily understandable explanation of the assumptions and techniques of programing,
for example: Soles, James N., "Linear Programing and Farm Management Analysis,"
Journal of Farm Economics, vol. XXXVII, no. 1, February, 1955.








28.


Under long-run static and under dynamic assumptions, policy decisions

regarding water allocation are not independent of policy decisions regarding

water development (Section 4). A single production possibilities curve "assumes

away" the essential problem of the meaning and the determination of marginal

costs of water development. Water allocation policy deals with a whole system

of cost indifference curves. Which one is relevant can be ascertained only

after comparing them with a system of "revenue" indifference curves. The

optimum point of water allocation then becomes a curve of "optimum direction"--

using the terminology of vector analysis.- This curve is not monotonic, and

under assumptions approaching reality, it is a space curve.

The equidistant feature of the single possibilities curve implies that

changes in the water use vector have no influence upon production possibilities.

By this implication, one "assumes away" another essential problem of water

allocation. This problem is created by great differences in water quality

requirements between water uses. This problem presents itself in economic terms

through important relations between quality, quantity, and costs. Some of these

relations were indicated above (Section 2).

One must conclude, therefore, that a single equidistant production possibil-

ities curve has no meaning for water allocation policy--whatever its use may be

in firm economics.

The foregoing example is of some interest because it combines the approaches

and techniques of the two most important branches of normative economics--welfare

economics and firm economics--and attempts to derive from such a combination

criteria for public water policy. The questions raised so far with respect to

this attempt are overshadowed in their implications for water policy by another:

Is it conceptually useful to make the maximization principle the basis of economic

criteria for pursuing the public interest?

I/ Ci acy-Wantrup, S. V., "rconoios of Joint Costs in Agriculture," ~. ci.,
p. T94.


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