[dragonwriter]

> It would be a good thing because following the principal of maximizing profits is what is most socially beneficial, in the absence of externalities.

"In the absence of externalities" is a pretty enormous qualifications -- very few real world exchanges have no externalities.

> Such a framework exists and is called general equilibrium theory, which predicts that profit maximizing companies maximize social utility.

It predicts that, in a market with rational actors (as defined in the rational choice model -- utility maximizers with perfect information) and no externalities, a Pareto efficient equilibrium will be achieved. But Pareto efficiency means that for anyone to do better, someone would have to do worse. This is not the same as maximizing social utility (while it seems obvious that the point of maximum social utility must be a pareto efficient point, it is not clear that all pareto efficient points maximize social utility.)

And, of course, the conditions in which it makes those predictions (both the perfect information part of the rationality condition, and the no-externalities condition) don't reflect real world decisions very well.

[swatow]

Externalities don't invalidate the entire theory, they just mean that adjustments have to be made in the cases where there are externalities. Hence my emphasis on the fact that a person losing their job is not an externality.

I think you read my sentence as "(following the principal of maximizing profits is what is most socially beneficial) in the absence of externalities" where what I meant was "following the principal of (maximizing profits (in the absence of externalities)) is what is most socially beneficial".

Classical economics with optimal "Pigovian" taxes can be thought of as a first order approximation to reality.

Also, you can produce any Pareto efficient outcome from free markets + redistribution. In practice things aren't quite so simple since redistribution has some deadweight loss (e.g. some estimate that it costs $1.30 to the economy to raise $1.00 in taxes).

EDIT: rewrote after a better understanding of the parent. EDIT 2: added more explanation.

[mpyne]

> Externalities don't invalidate the entire theory, they just mean that adjustments have to be made in the cases where there are externalities.

Are your adjustments the epicycles upon epicycles hammered onto ancient astronomy's theory of mechanics to make the orbits of the planets appear to work? Or are they like the relatively slight adjustments to Newton brought about by Einstein?

I personally feel that any discussion of sociological issues cannot be reduced simply to linear optimization problems, which implies the former view for me.

[swatow]

I think the best analogy is that general equilibrium theory is a zeroth order approximation to reality, and optimal (Pigovian) tax theory is the first order approximation. You might think a priori that no simple model can tell us much about sociological issues. All I can say is that I was very skeptical before I studied economics, but the theory is actually very compelling. I would recommend looking more into it (e.g. textbooks on micro or macro).

There is this strange disconnect where educated people who don't know much economics believe that economists have become tools of the ruling class, and therefore don't need much consideration. And economists are so stuck in their bubble that they don't believe that any educated person would completely reject economics (e.g. I specifically asked them if they thought that reasonable people could disagree with my original post, and they said no).

[dragonwriter]

> Externalities don't invalidate the entire theory

The model is a simple deductive truth only when its premises -- which include actors that behave strictly according to the rational choice model (including perfect information) and the absence of externalities.

Neither of these is generally true in the real world.

> I think you read my sentence as "(following the principal of maximizing profits is what is most socially beneficial) in the absence of externalities" where what I meant was "following the principal of (maximizing profits (in the absence of externalities)) is what is most socially beneficial".

Both have the failing when being applied to the real world that they silently assume the assumptions of the rational actor model, including perfect information, and either way they present problems when used as a statement about a real-world decision in which externalities are present (though the exact nature of the problem differs between the two.)

> Classical economics with optimal "Pigovian" taxes can be thought of as a first order approximation to reality.

Not justifiably. I'd agree that approximating optimal Pigovian taxes is a worthy goal for government policy, but I don't think that there's any justification for assuming that actual government policies do that.

(In fact, given the distribution of power over government policy that would have to occur for that to be true, there's a pretty good reason to assume that its not even approximately true.)

Further, the behavioral model underlying classical economics are a tolerable first order approximation of reality in select markets, and useful baseline from which, via different circumstances in other markets which explain variation, to explain the behavior that occurs in other markets were they aren't good as such an approximation, which (aside from the prominence of ideologies which are justified by giving that model too much weight) is why its still taught.

> Also, you can produce any Pareto efficient outcome from free markets + redistribution.

Making many of the same assumptions with limited and occasional connections to real behavior that underlie your previous statements, starting with the rational choice model (including perfect information), this is true.

Not sure what your point is with it, or how it is supposed to be germane to the discussion.

[ThomPete]

It is an externality when they don't get it back or loose income to keep it. And that is in reality what is happening.

[swatow]

That's not what is meant by an externality in economics. See http://en.wikipedia.org/wiki/Externality

[ThomPete]

I am aware of what is meant by externality in economics however economics have a lot of blind spots, the consequence of technology being one of them which makes it an externality for exactly that reason.

[swatow]

ok so your point is that when technology creates long term downwards trends in the value of labor, anything that decreases the value of labor can be thought of as an externality?

Redistribution can counteract this effect. If productivity increases but it also increases inequality, then there is some level of redistribution that will correct the inequality while making everyone better off (in the sense that the number of people earning more than X increases for all X). Not exactly a theorem, but a rough consequence of general equilibrium theory. You might claim that this kind of redistribution is impossible, but there are countries (e.g Scandinavia and Aus/NZ/Canada/UK) that redistribute a lot more than the US.

[dragonwriter]

> ok so your point is that when technology creates long term downwards trends in the value of labor, anything that decreases the value of labor can be thought of as an externality?

Almost certainly, it is an externality in the strict economic sense, in that the "thing that decreases the value of labor" is almost certainly the product of investment decisions made by actors that are not the same set of people who are impacted by the reduction in the value of labor.

> Redistribution can counteract this effect.

Right, but in practice rarely does not, because what redistribution occurs is controlled by who has power over government, and power over government is disproportionately in the hands of those who have gained the most benefit from the economy, so those harmed by externalities and who would be most inclined, on a self-interested level, to seek redistribution are also the least likely to see their wishes reflected in government policy.

> If productivity increases but it also increases inequality, then there is some level of redistribution that will correct the inequality while making everyone better off (in the sense that the number of people earning more than X increases for all X). Not exactly a theorem, but a rough consequence of general equilibrium theory.

Its not really a "rough consequence of general equilibrium theory", whereas general equilibrium theory holds that without externalities (and with rational choice) a pareto-efficient result will be achieved, your conclusion requires the assumption (which general equilibrium theory does not support) that with externalities, a pareto-efficient result will not be reached, and further that the actual result will be such that there will exist an alternative result reachable by redistribution which features less inequality by whatever the relevant measure of inequality is, and is closer to being pareto-efficient.

But general equilibrium theory does not guarantee pareto-inefficiency with externalities, and if a pareto-efficient result is attained prior to redistribution, no redistribution can "make everyone better off" (since the definition of pareto-efficiency is that no one can gain without someone losing.)

[ThomPete]

I am from Scandinavia originally and know all about those models. They aren't as solid as you seem to believe.