[From PEL Citizen and friend of the podcast Roy Spence]
The publication of John Rawls’s A Theory of Justice in the early 1970s led welfare economists to derive various interpretations of the Rawls’ second principle of justice, generally known as the “difference principle. By way of background, a primary objective of “welfare economics” is to provide a guide for distinguishing between good and bad states or outcomes of economic activity. However, given the diversity of opinion as to the meaning of these terms, the ultimate validity of much of welfare economics remains a matter of personal value judgments, or an appeal to various philosophical positions.
The past great works in economics have typically dealt with challenges that go beyond the description and analysis of the workings of the economic system. Fundamental to the appraisal and evaluation of states of the economy or methods of organizing the economic system is the efficiency versus equity outcomes. Hence, the interest of some economists to translate the TJ, in particular the difference principle, into economic terminology. The challenge economists faced was in Rawls’ interchangeable use of utility, income and distribution of primary goods and expectations – and a mixture of these concepts in diagrams in TJ.
Contrary to some economists’ interpretations of Rawls, there is a focus on economic efficiency. In “The Principle of Efficiency” as Rawls refers to Pareto optimality (a state of the economy such that it would be impossible to alter the holdings of goods amongst individuals so as to make at least one person better off without, in doing so, making another person worse off), Rawls expects this principle will be accepted by individuals in the original position as a criterion for judging economic and social arrangements. Any outcome chosen must be Pareto optimal – that is, Rawls expects that individuals recognize the existence of what economists call a “utility possibility frontier” and would not accept a Pareto sub-optimal outcome. In the case of a strict allocation of goods amongst individuals, without reference to how those goods were produced, the difference principle implies an egalitarian social indifference curve as depicted in Figure 5 on page 76 of TJ. For Rawls, the difference principle “removes the indeterminateness of the principle of efficiency [Pareto optimality] by singling out a particular position from which social and economic inequalities of the basic structure are to be judged.” (TJ, page 75) In the early years after the publication of TJ many economists assumed that, with a traditional downward sloping utility possibility frontier where one person cannot be made better off without making someone else worse off, the outcome is always egalitarian and no application of the difference principle was necessary.
For inequalities to arise in one or all of income, utility, expectations, and the distribution of primary goods there appears to be a requirement of an upward sloping utility possibility frontier. This upward sloping function is implied by Rawls in TJ. There are a number of possibilities here. In one place, Rawls offers a trickledown explanation “the greater expectations allowed to entrepreneurs encourages them to do things which raise the long-term prospects of laboring class. The better prospects act as incentives so that the economic process is more efficient, innovation proceeds at a faster pace, and so on. Eventually the resulting material benefits spread throughout the system and to the least-advantaged” (TJ, page 78). In other places, Rawls maintains that “income and wages will be just once a (workably) competitive price system is properly organized and embedded in a just basic structure” (TJ, page 304), and wages will reflect “features of jobs that are significant on either the demand or the supply of the market, or both, such as experience and training, natural ability and special know-how, tend to earn a premium” (TJ, page 305). As such, differences in income and wealth could be justified by acting as incentives to attract candidates into certain jobs and encourage them to do well. Both views are very neoclassical style economics.
Another way in which the utility possibility frontier can be upward sloping is – as one person is made very worse off the other suffers as well, due to sympathy or perhaps the fear of a revolution. Not very neoclassical.
There is an alternative explanation. Rawls’ difference principle implies that individuals act for the good of the whole, or at least they are not “dog-in-the-manger” types – meaning that an individual is willing to accept his supply price of labor even if the economic rents accrue to someone else, presumably the least-advantaged members of society. (In neoclassical economics, an individual’s supply of labor is determined at the margin by the wage offered. However, the total benefit to the individual from supplying this total amount labor is greater than the supply price when the individual’s labor supply is the typical upward sloping curve.) In this understanding of Rawls, the difference principle could be viewed as a mechanism to maximize social rents. With disutility of work and varying productivities and abilities amongst members of society, Rawls may be interpreted in the following manner by considering two individuals, one with high productivity and one with low productivity. Both regard work as unpleasant (disutility) and have to be compensated for their efforts, and for simplicity assume that they have the same propensity to derive satisfaction from primary goods. An egalitarian starting position would be each individual providing the same work effort / number of hours and being paid at the same rate of pay. (This corresponds to the point O, the origin, in Rawls’ Figure 5, page 75.) Assuming that the ownership of the fixed factors of production are equally distributed, both will receive the same amount from both earned and unearned sources. The difference principle allows for the higher productivity individual to be paid a higher wage on the margin to induce more work effort, thereby achieving an efficient outcome for the economy. This individual is allowed to retain the income (supply price) necessary to compensate for the additional amount of labor expended. The economic rent (amount of primary goods less the supply price) generated from the expanded labor supply is then distributed amongst the members of society following the difference principle, to the least advantaged members. In Justice as Fairness: A Restatement, Rawls states “there surely exists some institutional device to transfer at least part of the large return of the more advantaged to the less advantaged, by taxation, say, to reduce their return . . . “ (JF, page 67).
The above result is egalitarian in the sense that utilities may be equal (the higher productivity individual earns more, consumes more, but this is exactly offset by his / her valuation of the addition labor supply). However, the income levels will differ – to the apparent advantage of the more productive individual. This interpretation assumes that society starts at an egalitarian position but recognizes that this is Pareto sub-optimal due to the inefficient engagement of the individual with the higher productivity. In a competitive economic system without application of the difference principle, each individual receives the value of their marginal productivity of labor and with no redistribution of rents, the income and benefits to the higher productivity individual is greater than the low productivity individual – an outcome that is efficient, but for Rawls with an undesirable distribution of primary goods. Through the application of the difference principle, individuals can achieve both efficient production and an outcome on the utility possibility frontier.