Normative Economics
Definition
1) "...A body of systematized knowledge discussing criteria of what ought to be...; a system of rules for the attainment of a given end." [1]
2) "Economics that tries to change the world by suggesting policies for increasing economic welfare..."[2]
Normative economics concerns itself not with what is, but with what should be. It is focused on the ends rather than the means. Normative economics discusses the philosophical implications of economics, specifically value judgements and ethics.
Examples
Here are some examples of normative statements. They are theoretical, and describe the world as it should be:
- Government should not interfere with the free market
- Income ought to be distributed equally so that all people have a decent standard of living
- Cheap imports threaten the living standards of US factory workers, and the only way to adequately improve the lives of these workers is through protectionism
- Central Banks of countries should not be allowed independence because it will grant them too much power
Graphs
Figure 1: A graph of efficiency vs. fairness[3]
This graph shows in a two player game where movements from the initial division of food would lead to a Pareto-optimal solution (production) or a win-lose situation (distribution). The question of how a loss or gain in the total amount of food in the game should be divided is a normative question.
Adam Smith
Sympathy and Normativism
In one of his most famous works, The Theory of Moral Sentiments, Smith introduces the idea of sympathy as a guiding force for our actions in society. More akin to what we might call empathy, Smith's idea of sympathy is our ability to identify with others and to, in some sense, share in the pain and pleasure which we see them receive.
"When we see a stroke aimed, and just ready to fall upon the leg or arm of another person, we naturally shrink or draw back our own leg or our own arm; and when it falls, we feel it in some measure, and are hurt by it as well as the sufferer."[8]
Smith views this as similar to switching places with another and yet retaining your consciousness, in other words, to "put yourself in their shoes". Thus, because of sympathy, people will naturally try to make their actions appealing to what others are willing to go along with. Sympathy is also a way that we can "step outside of ourselves" and regard our actions objectively. In this way, sympathy will normalize our behavior, causing us to socialize our behavior even if we are free to do as we choose. Thus, sympathy is the foundation of rules and justice. Smith's arguments about moral sentiments which are based on this theory of sympathy is the foundation of modern normative economics.
Logistics and Positivism
However, Smith is not simply interested in the morals and ethics of economics, he also considers the positive side of economics. In his book The Wealth of Nations he talks about many more logistical aspects of economics. His main point is about the power of the division of labor in producing beneficial outcomes above and beyond the what several people could achieve working individually. He speaks of three chief benefits that the division of labor produces:
"first to the increase of dexterity in every particular workman; secondly, to the saving of the time which is commonly lost in passing from one species of work to another; and lastly, to the invention of a great number of machines which facilitate and abridge labour, and enable one man to do the work of many."[6]
Additionally, Smith talks about the way in which expansion of the market allows further division of labor and thus prosperity of men. Waterways in particular for him are stock of natural captial which allows some lands to further the division of labor and increase their wealth over other nations. Thus it's clear from his writings that Adam Smith was concerned with both the normative and positive aspects of economics, even if the specific language for these distinctions had not yet come about.
Levy and Peart
In their book Vanity of the Philosopher, Levy and Peart discuss the transition from classical thinking to "new welfare economics". They talk about the Compensation Principle, though not explicitly as such, and the historical shift away from sympathy and the morals that entails. Thus this "new welfare economics" runs into the problem of the tyranny of the majority.
"If, as James Mill claims, the social norm is identified with the happiness of the majority then why isn't this happiness enhanced by plundering the minority?""[11]
"A policy that is consistent with such a utilitarian norm that is unconstrained by sympathy leads to repugnant conclusions, to a violation of our intuitive sense of justice.""[11]
Amartya Sen
"I would argue that the nature of modern economics has been substantially impoverished by the distance that has grown between economics and ethics."[7]
In Economic Behavior and Moral Sentiments Sen discuss the distancing that has occured between normative and positive economics, which he believes is one of the major detriments to modern economic theory. He argues that ethical considerations have a bearing on human behavior and that influencing human action is a core part of ethics. Since welfare economics must have some role in affecting actual behavior ethics should have a greater role in welfare economics. Yet, historically, logistical (what Sen terms positive economics) has been allowed to greatly influence welfare economics, while the role of ethics in this topic has been largely ignored. There has been significant progress made by logistical approach in economics and much of it because the logistical approach has been so broadly used. Sen argues though that welfare economics can benefit greatly from the inclusion of ethical considerations. Descriptive economics, prognosis, and policy suggestions can all be improved by the inclusion of ethics. The study of ethics itself will also be further be enriched by the addition of economics as an area on inquiry.
History
Phillipe Mongin gives a history of normative economics, with three distinct forms. In his paper Is There Progress In Normative Economics he also proposes that contemporary normative economics might be moving into a new stage.
- First form: The first form of normative economics for Mongin is "old-style welfare economics", which is a simplification of Pigou's Economics of Welfare as being utilitarian.
- Second form: "New welfare economics" which appears in the 1930s is the second form of normative economics. This is clearer than old welfare economics, specifically about its premises. The Pareto Principle becomes one of the primary methods of determining whether something is improving welfare, and eventually creates a clear separation between optimality conditions and their applications to markets and economic policies. The Compensation Principle, which allows the gainers from an economic decision to compensate losers as long as everyone is still left better off, was also developed as a way to move beyond the restraints of pareto optimality but avioded utilitarianism and comparison of individual utility. However, the main ideas to come out of new welfare economics were the "fundamental theorems of welfare economics":
- Competitive equilibrium satisfies conditions for a pareto optimum, under relevant conditions.
- Any pareto optimum can be obtained as a competitive equilibrium after agent's initial endowments have been modified by suitable lump-sum transfers.
- Third form: The third for of normative economics is social choice theory and public economics. Social choice theory is a method that uses voting to study how individual choices can be aggregated into some sort of social preference. Kenneth Arrow's Social Choice and Individual Values contains the modern form of social choice theory which brings together elements of welfare economics and voting theory. Public economics studies the economy and society and the effect that the public sector has upon it.[10]
