Vickrey’s first paper on social choice theory, “Measuring Marginal Utility by Reactions to Risk” (1945) is considered the origin of the 'veil of ignorance device'.
Optimal public policy is that which “an individual would select were he asked which of various variants of the economy he would like to become a member of, assuming that once he selects a given economy -- he has an equal chance of landing in the shoes of each member of it.”
This is clearly foolish. Individuals have individual preferences and pursue regret minimizing strategies such that they are relatively shielded from the effects of changes in public policy. Decent people want different countries to pursue good public policies of the kind which their own smart, decent and sensible politicians and statesmen consider feasible and prudent. Optimality doesn't matter. Prudence does. It is better to spend more on Defence even when there is no threat to Peace rather than struggle to catch up once the threat of invasion or insurgency raises its ugly head.
Vickrey was a 'Georgist' and I suppose what he was getting at was which 'fiscal mix' rational people would prefer. Would the median voter try to fuck over those who owned land (the Henry George argument) rather than those who owned more elastic factors of production? No. There are ways to avoid tax and, anyway, 'economic rent' turns out to be 'quasi rent' as elasticity increases in the long run. Fucking over the propertied can cause a fucking environmental or sociological disaster. The traditional argument for being nice to the propertied class is that they have a bigger incentive to direct resources to National Defence and the upholding of internal order whereas entrepreneurs or skilled workers can always relocate to a safer continent. My point is that, optimal public policy has a lot to do with just keeping things from turning to shit or else managing decline while preserving social cohesion. There are plenty of other things- setting aside macro-economic policy, which affect our lives. We don't say that Doctors shouldn't be in charge of deciding Medical stuff and STEM subject mavens shouldn't be in charge of Sciencey stuff. Why should we think differently about macro-economic policy? This is an argument older than Plato and it is the one which has prevailed.
Still, I suppose, back in 1945 there were a lot of displaced people in Europe. Should they go to Capitalist America, where they might end up a millionaire or else a hobo? What about Soviet Russia? There you would be assured of a job though everybody's life might be somewhat drab. I think the answer to that question is now clear. Don't go to a place ruled by a Beloved Leader whom you can't kick out at the ballot box.
This was the first statement in the literature of what later came to be known, through John Rawls’ (1971) work, as the “veil of ignorance”. Vickrey combined the veil of ignorance with the then-recent concept of expected utility (von Neumann and Morgenstern (1944)). Since maximization of an individual’s expected utility behind the veil of ignorance is equivalent to the maximization of the sum of utilities over the population, Vickrey provided a sophisticated conceptual basis for utilitarianism.
It just cashes out as ppp adjusted per capita Income which is a good enough proxy for average utility. I suppose citizens do prefer a Government which promises to deliver higher growth ceteris paribus. At any rate, that was the post-war consensus on both sides of the Iron Curtain.
The next step Vickrey took was to recognize that, by examining an individual’s choices in risky situations, the elasticity of his marginal utility with respect to income (now termed the degree of relative risk aversion) can be calculated for different levels of income,
only if ceteris is paribus- i.e. risk is passively received. However, humans receive utility when they take active measures to reduce their exposure to risk- which, incidentally, is why people have relationships and socialize and acquire credentials of various sorts.
The plain fact is that risk aversion increases when your country is turning to shit. It falls when things are getting better and more and more credit and 'risk pooling' mechanisms are becoming available.
and that this permits calibration of the utility function in the utilitarian social welfare function up to an affine transformation, which is sufficient to determine optimal policy.
This just cashes out as maximize per capita GDP growth ceteris paribus.
Thus, Vickrey essentially derived the social welfare function by combining the veil of ignorance, expected utility theory, and observed choice under risk.
Because peeps think Income is related to Utility and so, ceteris paribus, growth is good. The fact is most of us don't know if we will be hit by a bus tomorrow or if our pension fund will turn out to be a Ponzi scheme. We are already behind a veil of ignorance. Still, if misfortune befalls us, it is better to be in an affluent country than a country where everybody is starving.
The procedure assumes that different individuals have the same tastes with respect to risk, which is certainly a limitation. Nevertheless, it provides a logically coherent and ethically defensible basis for specifying the social welfare function to be used in the derivation of optimal policy. The paper went further. At the time he wrote this paper, Vickrey was completing his Ph.D. thesis on income taxation (to be discussed later), so it was natural that his policy interest was optimal income taxation.
Sadly, elasticities can change very quickly and 'lumpsum' taxes are generally infeasible. So we are back with boring 'Canons of Taxation' and ensuring the bead-counters in the Treasury aren't smoking waccy baccy.
The second major contribution of the paper, a contribution that was highlighted in the Nobel Prize citation, was to provide the first statement of the optimal income tax problem, which was subsequently solved almost a quarter-century later by James Mirrlees (1972).
This is like Frank Ramsey's work. Sadly, the world was already becoming 'globalized' and so entry and exit at the margin were forcing fiscal convergence in one form or another.
“Assuming that the marginal utility of money declines with increasing income, maximizing the total utility derived by a population from a given fixed aggregate income implies that this income be distributed equally, due allowance being made for varying needs.
Sadly, even if individual marginal utility declines the Social Benefit of keeping money in the hands of the rich- because of their higher propensity to invest wisely- may be higher than putting more cash in the hands of drunken proles.
-- But the aggregate amount of income to be distributed cannot in practice be considered independent of the way in which it is distributed. It is generally considered that if individual incomes were made substantially independent of individual effort, production would suffer and there would be less to divide among the population. Accordingly, some degree of inequality is needed to provide the required incentives and stimuli to efficient cooperation of individuals in the production process -- the question of the ideal distribution of income, and hence of the proper progression of the tax system, [then] becomes a matter of compromise between equality and incentives.” (p. 25)
Sadly, all sorts of 'trade offs'- e.g. that between Inflation and Unemployment were breaking down around that time. There were two factors ignored by the economists of the period- the first was 'Tardean mimetics', whereby those lower down imitate those higher up the totem pole, and the other was Knightian Uncertainty which had increased for technological and geopolitical reasons. Both militated for the rise of the 'asset stripper' and 'private equity maven' who in turn yielded to the VCs who financed our present crop of Tech Titans.
The importance of the optimal income tax problem in the history of economic thought is widely recognized. Not only was it the first theoretical problem in economics that took explicit1 account of asymmetric information (including both hidden type/adverse selection and hidden action/moral hazard) but also the techniques employed in its solution by Mirrlees have subsequently been applied in the mechanism design literature to a broad range of public policy issues such as public utility regulation (Laffont and Tirole (1993)).
More importantly, Econ PhDs suddenly turned into the sort of people whom Jeff Bezos could find a use for. It was less a question of setting the world to rights over Sherry in the faculty lounge and more of making a billionaire even richer.
Thus, Vickrey’s paper is a precursor to the asymmetric information revolution which has profoundly altered the way economists think about policy problems and the appropriate role of government. Despite the importance of the ideas it contained, this paper had almost no impact.
Whereas all sorts of other nonsensical availability cascades and citation cartels flourished.
Its brilliance was recognized only after its main ideas were independently discovered by others. Why was the paper neglected, as were many other of Vickrey’s papers which contained important insights? It is often said that Vickrey was ahead of his time. This is a curious statement since it presupposes that there is a natural time for an idea to be born. A less flattering explanation is that Vickrey’s idiosyncratic cast of mind and, manner of presentation and his lack of interest in cultivating disciples, made him a poor salesman of ideas.
Or, maybe, the guy was a good economist not a moralistic scold in a tweed jacket. Economics is the veil of ignorance behind which lies nothing but ipse dixit bigotry.
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