Welfare Economics

Welfare economics is the branch of economics that studies how individuals and societies exchange goods and the properties of the resulting outcomes. As such, it is concerned with the well-being of individuals and societies. Analyzing exchange and outcome is done through various means, including if the process needs to incorporate rights and duties for participants and whether or not outcomes are seen to be equitable or just.

The broad scope of the subject and the difficulties in defining concepts such as well-being and judging equity causes welfare economics to cut across several disciplines, including history, philosophy, political science, and sociology. Consequently, there is a long and rich literature associated with the topics. Moral philosophers, from Aristotle, the Scholastics, Hobbes, Nozick, and Rawls, have also focused on what constitute the properties of a “good” or just society and how such an outcome might be reached.

In economics, welfare economics originates in the claim by Adam Smith in The Wealth of Nations that self-interested individuals, acting in competitive markets, will reach an outcome that is a social optimum. Smith's evocative use of terms such as “the invisible hand,” “natural law” and policy prescriptions of laissezfaire, and the paradoxical vision of people being led “as if” by an invisible hand to do a larger social good while they were merely trying to do well for themselves has been a cornerstone of classical and later neoclassical economics. His “invisible hand” as deus ex machina has also been mistaken by some to mean that Smith believed that there was a supraindividual purpose or design (teleogical explanation) to the individualist-based market system.

Smith's claims for markets and self-interest echoes that of the French Physiocratic school that coalesced around François Quesnay in the mid-1700s and with whom Smith had personal contact. Physiocratic doctrine stressed the interrelations of economic sectors and the self-governing and balancing flows of expenditures and resources among the sectors. The Physiocrats identified land as the source of all wealth, natural law as the source of motion in the system, and believed that governments should follow a policy of laissez-faire. This was symbolized in Quesnay's Tableau Economique, a circular-flow diagram anticipating the modern-day macroeconomic approach to national income and expenditure analysis.

Others have claimed that Smith's system, while conferring rights to voluntary exchange requires of us no duties (e.g., of honesty, probity). However, a reading of Smith's Theory of Moral Sentiments relying as it does on his impartial spectator representing society's interest by limiting individual's opportunistic behavior, and his view that competition among sellers would be a natural constraint on opportunism, should at least absolve Smith—if not all his later followers—of that charge.

For other schools of economic thought, for example, the Marxists, Smith's proposition has been viewed as hostilely as they view private property and the competitive process itself. The competitive exchange process, as Marx saw it, is based on asymmetric power and rights between the labor and capitalist classes. Still other schools of thought, for example, the Austrian School, have questioned the notion that there is enough knowledge available to allow individuals to home in to an end state of rest or systemic balance, called an equilibrium. Thus, in their view a social optimum, even if it exists, will not be reached in finite time. Consequently, they stress the subjective characteristics of the process individuals use to exchange and allocate goods.

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