La Flèche right, brilliant economist by Jean Dreze
Kenneth Arrow was one of the rarest economists – exceptionally bright, learned, gentle, and public-minded. His departure from this world earlier this week, at the age of 95, was a huge loss not only to the economic profession, but to all of us.
Arrow gained fame with his doctoral thesis, published as a monograph (Social Choice and Individual Values) the same year, 1951. The thesis includes a proof of what has been called the “Arrow’s Impossibility Theorem. “. The theorem states, roughly speaking, that social preferences cannot be derived from individual preferences (eg by voting) without violating at least one of the five plausible conditions. It looked like, at the time, a heavy blow to the possibility of democratic decision-making. As Amartya Sen pointed out, however, what the theorem really showed was that social choice required a richer information base than individual and ordinal rankings of social states. In addition, partial orderings of social states were still possible under the stated conditions, and sometimes these can take us far. Seen in this light, the impossibility theorem has become a constructive foundation of social choice theory, a field of economic investigation alive to this day.
Three years later, Arrow makes another historic contribution to the economy (with Gérard Debreu) by proving the existence of an equilibrium in a competitive economy under general conditions. This work belonged to a body of research which clustered around the so-called “fundamental theorems of welfare economics” (Arrow himself presented evidence for these theorems in 1951). The first theorem states that a competitive equilibrium is Pareto efficient, in the sense that no other possible allocation of resources would make some people better off and no one worse. The first fundamental theorem of welfare economics is often invoked as proof of the efficiency of the market, but this interpretation can be reversed: the theorem can also be read as a proof that the conditions under which markets are efficient ( even in the limited sense of Pareto efficiency) are very restrictive. Some of these conditions are relatively well understood, such as the absence of “externalities” – the situation in which one person’s consumption or production decisions affect other people. In the real world, externalities are so pervasive that they should be seen as the rule rather than the exception.
The theorem, however, also involves implicit assumptions which are rarely discussed. For example, it is based on a model that excludes non-market institutions – the only “agents” are consumers and producers. This makes it impossible to consider those aspects of market economies which are, in practice, very important. Consider, for example, the increasingly recognized fact that extreme inequality tends to undermine democracy. This question cannot even be discussed in the Arrow-Debreu model because there are no democratic institutions.
Arrow himself was well aware of the limitations of the theorem. Much of his later work, particularly on the economics of information and uncertainty, can be seen as an exploration of various deviations from the strict assumptions of the theorem. Arrow is one of the founders of the information economy, widely concerned with the consequences of so-called “asymmetric information” – what happens when economic transactions involve people who have access unequal to information. For example, in healthcare, the asymmetry of information between doctor and patient is a major problem: the patient is a sitting duck, and an unscrupulous doctor can easily take advantage of his ignorance.
I suspect that the term “moral hazard” (Arrow preferred to call it “hidden action”) originally referred to this type of exploitation, although it later acquired a more restricted meaning in the context. insurance contracts. The situation just described, that of a physician exploiting a patient, was the focus of another Arrow’s seminal article, “Uncertainty and the Welfare Economics of Medical Care” (published in 1963). The paper still makes illuminating reading today. He argues, for example, that health care is not an appropriate for-profit object. As Arrow pointed out, the doctor-patient relationship depends on trust, and the patient’s trust would be shaken if he thought the doctor was just trying to maximize profits. Medical ethics and other institutions are essential to restrict the power of profit seeking.
Going beyond this specific question, the paper examined a range of ways in which market competition is not a guarantee of efficiency (let alone fairness) in healthcare. As Arrow put it in his concluding remarks: “It is clearly the general social consensus that the laissez-faire solution for medicine is intolerable.” Supporters of health care privatization in India (or rather more privatization, since India’s health care system is already one of the most commercialized in the world) would do well to read or re-read the in-depth analysis of India. ‘Arrow on market failures in this area. .
These are just a few glimpses of Arrow’s early work, which has spanned a huge canvas over the years. In addition to being a brilliant economist, Arrow was also a devoted citizen. He has applied his formidable powers of analysis to many important social issues, from world peace to climate change. He spoke and wrote on these matters with characteristic candor until the very end of his life. In this and other ways, Arrow has been a role model for generations of economists concerned with bringing their work to real world problems.
(The author is a visiting professor in the Department of Economics at Ranchi University.)
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