Philosophy of Economics
Reading guideline
Chapter 1:
‘To educate a person in mind and not in morals is to educate a menace to society.’ ~ Theodore
Roosevelt. This book is about introducing the reader to ethical standards that can be used to
evaluate policies and their application to economic policies.
1.1 Economic ethics
What is economics?
Economics is the study of the economy. Neoclassical approach: the science which studies
human behavior as a relationship between ends and scarce means which have alternative uses.
What is ethics?
Ethics: the study of morality (standards that an individual or a group has about what is right and
wrong). Moral standards are imperative in nature and may imply moral duties. There are many
non-moral normative standards as well. They differ in a few aspects:
- Moral standards are prescriptive statements: Ethics makes prescriptive or value
statements knowledge about ‘what ought to be done’.
- We feel that moral standards should overrule other, non-moral standards.
- Moral standards should be impartial. This means that moral standards are evaluated
from a point of view that goes beyond the interests of a particular individual or group to
a universal standpoint inn which everyone’s interests are impartially counted.
- Moral standards deal with issues that have serious consequences for the welfare of
human beings.
Moral standards include:
- Values (happiness, justice, freedom). Concern ends or ideals that persons pursue and
give content to how they define the good life. They can be both intrinsic and extrinsic in
nature. Intrinsic values are values that have value in itself, apart from valuing anything
else. Extrinsic values (also called instrumental values) are values that are merely good as
a means to something else (money).
- Norms: concrete behavioral rules that should be followed up in order to realize moral
values (thou shall not steal). They relate to values as means relate to ends.
- Virtues (honesty, prudence, industry)
Conflicts between: Moral standard Practical standard
Moral standard Moral dilemma Motivational dilemma
Practical standard Motivational dilemma Practical dilemma
,Descriptive statements: Economics make descriptive statements about the economy
knowledge about ‘what is’.
Value statement: the government should foster goal x
Positive statement: x is the most efficiently realized by using policy instrument y
Normative statement: same as value statement
Policy conclusion: the government should apply policy instrument y
Economic ethics
Economic ethics: Kouwenhoven distinguishes between two strands of economic ethics:
1. Microeconomic ethics: evaluates the actions of individual economic agents given the
economic structures or institutions. How should the economic agent behave on the
market? Belongs to the broader category of individual ethics.
2. Macroeconomic ethics: considers the morality of economic structures. Does the
economic order respect ethical standards? Belong to the broader category of social
ethics.
Macroeconomic ethics cannot do without micro economic ethics: the evaluation of the
institution of the market often revert to the micro ethical roots. On the other hand, micro
economic ethics can also not be studied in isolation from macro economic institutions. Now
we’ll talk about other ethics:
- Business ethics: can be interpreted as a further specialization of economic ethics. It’s
the study of moral standards that apply to business only given the institutional setting of
the market.
- Social ethics: the morality of the societal relationships and structures. It studies the
collective decisions of groups and the structural relations that connect these groups.
- Individual ethics: studies the individuals as the subject of ethical considerations and
actions, often in direct relations with other individuals.
- General normative ethics: the philosophical attempt to formulate and defend basic
moral principles. These principles can be applied to a certain field the application or
further specification of moral action guides to a certain field is commonly referred to as
applied ethics.
- Economic ethics: reflect on the moral standards that apply to economic phenomena.
1.2 Defense and critique of the free market
Traditional defense of the free market
On what values are the classical defenses of the free market based?
- John Locke: the free market economy respects the right to freedom. Locke based the
market system on a theory of moral rights. The two rights that free markets are
supposed to respect are
o The right to freedom
o Right to private property
- Adam Smith: the free market economy will produce the greatest benefits. Adam Smith
is an utilitarianist and defends the free market on the utilitarian argument that market
institutions will produce greater benefits than any other institution that coordinates the
, demand and supply of goods. Adam Smith praises the high specialization and division of
labor that is made possible by capitalism. Competition will then efficiently allocate the
resources of the economy among the various industries of a society.
An interesting aspect of Smith’s theory is that this optimal situation is realized by
self-interested actors. Motivated by their own micro-goals of maximum utility or
maximum profits, consumers and producers carry out plans that serve the macro-goal of
maximal economic utility of the society at large. Theory of unintended
consequences: greatest benefits are realized by self-interest of economic agents
invisible hand.
Economic objections
Criticism on free market economy:
- Efficiency negative externalities (pollution), companies have incentive to reduce
competition.
- Justice (inequality)
- Many market imperfections (entry barriers, corruption)
- Bounded rationality of the people
Ethical objections
- From a justice ethical point of view, perfect markets allow large inequalities. Without
government intervention, the gap between the rich and the poor will widen until large
disparities of wealth emerge.
- Locke takes the assumption that people have rights to liberty and property as self-
evident, but this assumption is unproven.
- From a virtue ethical point of view it can be argued that free markets ignore the
demands of caring. The dominant attention to efficiency may foster character traits that
maximize individual well-being, but may neglect character traits associated with building
close relationships with others.
Two models of capitalism:
1. Anglo Saxon model (UK, US):
- Free market operation
- Government secures private property and contract rights, but does not intervene or
regulate the economic process.
- Shareholder model f
- or companies: maximize stock value (bonus system for managers)
2. Rhineland model (Germany, France)
- Market operation, but within some limits
- Government regulates the market and provides for welfare state
- Stakeholder model for companies: balance of interests of stakeholders
Ayn Rand: Atlas Shrugged
- Only self interest is rational
- Solidarity is a vice and leads to injustice
, - ‘never live for another and never ask others to live for you.’
- Laissez-faire capitalism
Chapter 2 Utilitarianism
2.1 Characteristics of utilitarianism
Utilitarianism: the greatest happiness of the greatest number. An action is right if and only if
the sum total of utilities produced by that act is greater than the sum total of utilities produced
by any other act the agent could have performed in its place. 3 characteristics:
1. Consequentialism: asserts that actions, choices or policies must be judged exclusively in
terms of the resulting, or consequent, effects, rather than by any intrinsic features they
may have. Outcome, not process matters.
2. Welfarism: the only goal is utility / welfare. Requires that the goodness of a state of
affairs be a function only of the utility or welfare obtained by individuals in that state.
Different types of welfarism:
a. Bentham: Utility is pleasure (hedonism). Two ‘sovereign masters’, pleasure and
pain, regulate all human behavior and all human experience might theoretically
be measured in terms of these basic units. Bentham applies a monistic conecpet
of utility by assuming that all values can be measured on the same scale of
pleasure (and pain). Mill distinguishes, in reaction to the accusation that
utilitarianism is a philosophy of pigs, higher pleasure that are qualitatively
different from the lower pleasures suach as eating: the intellectual pleasures of
writing an academic article are such that no amount of mere physical enjoyment
could counterbalance them. ‘It ist better to be a human being dissatisfied than a
pig satisfied.’ ~ Mill.
b. Economists: Utility is satisfaction of actual preferences. They prefer individual
sovereignty. This implies that individuals are the best judges of their own
welfare. It rejects paternalism.
3. Sum ranking: total sum of utilities should be maximized with equal weight to utility of
different individuals. The fundamental thesis of utilitarianism is that one should do
whatever maximizes the total sum of utilities.
2.2 Cost-benefit analysis
Interpersonal comparison: utilities of different persons can be added and used to compare.
Utilitarianism assumes interpersonal welfare comparisons. In order to solve the lack of
comparability of utilities of different people, Kaldor and Hicks proposed a compensation test
that tests whether the winners might be able to overcompensate the losers. For each policy,
one could ask the winners how much they would like to pay (WTP) for a certain policy and ask
the losers how much compensation they would like to receive. The policy with the largest net
benefit is best. This is also the based for the Cost-benefit analysis.
Advantages of utilitarianism / cost-benefit analysis:
- Systematic analysis of all consequences
, - Includes utility effects that are not priced by the market
- It links to current interest in happiness research
2.3 Problems of utilitarianism
Criticism on utilitarianism:
- Consequentialism
o can violate individual rights of local population. As only consequences matter,
utilitarianism is unable to deal with moral issues that relate to rights.
o Also it doesn’t consider the intentions of people.
o A third problem is that it abstracts from considerations of retributive justice:
refers to the just imposition of punishments upon those who do wrong.
Utilitarianism would suggest setting the penalty for a crime at thel least point
where any greater penalty would cause more additional unhappiness for the
criminal than would reduce the unhappiness of the victim and the happiness of
the potential victims of the crimes deterred by the additional increase in
punishment. This might result in a penalty well below the retributive level.
o A final problem is that consequences of an action, and hence the costs and
benefits it generates, are difficult to predict and subject to different degrees of
uncertainty. As a result, the benefits and costs of an action cannot be adequately
measured.
- Welfarism preferences of leaders can be perverse.
o Happiness is not the only relevant argument in an evaluation of an action or
policy. A person may value promotion of certain things, even if they do not
advance his happiness.
o Utility does not adequately represent well being.
o Welfarism assumes that different values are reducible to one basic value, namely
utility. This only holds for the monistic variants of utilitarianism. Monism means
that the value of every action can be measured in terms of one dimension. In
other words, welfarism assumes commensurability (=gelijkwaardigheid) of
values.
o A fourth problem arises if individuals have morally unacceptable preferences
according to standard group norms. For example pedofiles.
o Relying on actual preferences or WTP assumes that individuals are not rational.
- Sum ranking Utilities are difficult to compare, difficult to weigh the consequences for
Animals.
2.4 Adaptations of utilitarianism
In response to all these problems, some philosophers have adapted utilitarianism in order to
reduce its disadvantages:
- Rule utilitarianism (diminishing the problems of consequentialism):
