Vilfredo's victims

For nearly a dozen years now, India has been ruled by coalitions of one sort or the other. Wittingly or unwittingly, each of them has adopted an impossible principle of governance, namely, the principle that economists call Pareto Optimality, named after the welfare economist Vilfredo Pareto.

Simply stated, this principle says that any move from one situation to another must ensure that no one is worse off, and at least one person is better off.

Indeed, so zealously have the various governments since 1996 adhered to this principle that they have pushed themselves into a corner where quite often no action is possible (on oil prices, for instance) because someone will be the loser. On occasion, this has perversely left everyone worse off, as when subsidies bloat and it is the taxpayer who has to foot the bill.

This implicit adherence to the strictest version of Pareto Optimality has spawned another mindset. This is that all statements made by everyone have been taken to be true and, therefore, worth taking into account even though "" as we know from formal logic "" if that is indeed the case, then all statements must also be false! The result is a standstill in terms of policy even when there is no threat to the government.

The latest example of such a standstill can be found in the complaint by the chairman of the Knowledge Commission, that the government resists all change. He probably doesn't know that this is as much due to sheer cussedness as to the venerable Vilfredo.

So, what is the way out? How can governments solve the unsolvable problem of undertaking only those changes that leave everyone better off? Or to put it in everyday terms: how do you make an omelette without breaking the egg?

Two other economists, Nicholas Kaldor and John Hicks, grappled with this problem because they saw that democracy, and the impulse that it generates towards redistributive policies, could lead to paralysis.

They came up with the idea that if those who are made better off by the change from one state to another can compensate those made worse off by it, it should be an acceptable principle of governance. This was important because it altered the definition of social efficiency "" now, a more efficient outcome could leave some people worse off.

The problem, of course, was of compensation: how much or little was good enough? Hicks and Kaldor came up with separate formulations. Hicks said that it was ok if the "maximum amount that the losers were prepared to offer to the gainers in order to prevent the change was less than the minimum amount the gainers were prepared to accept as a bribe to forgo the change."

Kaldor, on the other hand, looked at it from the gainers' point of view and said it was ok if the maximum amount the gainers were prepared to pay was greater than the minimum amount that the losers were prepared to accept.

But this too was a stand-off and the result was a huge body of literature in welfare economics, a discipline that has been largely forgotten because of the American insistence on, or obsession with, empirics.

The moral of this story is that the issues that are being debated in India today have been examined threadbare in the past. Western capitalism did not allow the strict Pareto rule to come in the way of progress. India needs to do the same if it wants to get on, just as China has.