iNTERNATIONAL ECONOMIC REVIEW
Vol. 15, No. 2, Jtune, 1974
WELFARE CRITERIA WITIh ENDOGENOUS PREFERENCES:
THE ECONOMICS OF EDUCATION*
BY HERBERT
GINTIS1
1. INTRODUCTION
"BY ACTING on the external world and changing it," Karl Marx once remarked, "[the worker] at the same time changes his own nature." [18, (197-98)]
Much of Marxist theory is a development of this basic observation. The special
position in Marxist theory of economic structure, its conception of materialism,
of ideology, of classes and of social change, hinge on this connection. Indeed,
again to quote Marx, "the whole of history is nothing but a continual transformation of human nature" [19, (160)].
It is less than happenstance that the major competitor to Marxist theory, the
tradition culminating in modern neo-classical economics, is grounded firmly not
merely in the abstraction from, but the negation of this insight. The Marxist
observation, translated into neo-classical terminology, holds that individual preference structures are products of economic activity. Or more precisely, individual preferences develop and change according to variables endogenous to the
economic model: prices, quantities, and availabilities of consumption goods,
jobs, and the social institutions conditioning the supply of labor. Neo-classical
theory starts from the contrary position: the Walrasian system takes preferences
as either fixed, or changirngonly in response to variables external to the model.
In positive economics, the formationi of preferences is relegated to sociology or
social psychology; and in welfare economics, preference structures are amonig
the fundamiiental,unexplained data. In the words of Harrod [13],
The method of procedure is to take certain elements of the structure as
given-namely the preference lists of individuals for goods and services,
the terms on which they are willing to contribute their assistance to
production and the current state of technologyy... The object of this
procedure would be to provide means of showing how changes in the
fundamental data, desires, etc., will govern the course of events.
To the confirmed neo-classicist, taking preferences as given is a sign of ethical
neutrality [25]. To the Marxist, however, this approach incorporates the materialist bias of capitalist society [12]. Because psychic development in capitalist
society is merely instrumental to the growth of marketable goods and services,
so the theoretical justification of capitalist institutions requires that we suppress
consideration of the human outcomes of economic activity. To assume individuals as fixed or developing independently froin economic activity means
* Manuscript received December 11, 1972; revised December 3, 1973.
1 This paper owes its present form to the insights and constructive criticisms of Samuel Bowles,
James Cox, and Duncan Foley, to whom I owe a large measure of gratitude.
415
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416
HERBERT GINTIS
mnerelythat we do not evaluate, in a normative analysis of economic activity,
the way they got to be the way they are-and the way they change.
Neo-classical economics has not been oblivious to this weak but crucial link
in its chain of reasoning. Numerous attempts have been made to justify it,
with varying degrees of sophistication and success. While none stand up to
close scrutiny,2 cross-paradigm disputation has never produced decisive victories
nor weakened the social power of a dominant theory. De principiis non disputandum. But social theories do have the uncanny propensity to generate their
own refutations in the course of their internal development. This paper treats
one such apparent contradiction in neo-classical theory, involving the "economics of education."
Neo-classical welfare economics employs, as a summary indicator of economic
progress, a measure of Gross National Product. In the late 1950's, however,
a number of studies [1], [28] indicated that historical increases in this indicator
of output could not adequately be explained by increases in the supplies of labor
and capital as conventionally measured. In response to this anomaly and spurred by a growing concern with "poverty," an entire field developed: the economics of education. Denison [6] demonstrated the importance of changes in
the "quality of the labor force" alongside of capital accumulation and technical
change in the sources of economic growth. Schultz [27] illustrated the formal
equality of human and material factors of production in the theory of capital.
Minicer[20] and Becker [3] showed education as a central variable in the theory
of the wage strtucture. And in developmiieniteconomics, the crucial role of edtication as a variable in general "modernization" policy, came to the fore [4].
But education is a prime example of a conisciousattempt to change preferences,
or more broadly, individual personalities. Through schooling, individuals become what they were not. Individual psychic development is molded in the interests of productive participation in the economy. Hence the following problem:
Neo-classical theory justifies market institutions on the basis of their contribution to growth and allocational efficiency. The norms of growth and efficiency
are in turn justified on the basis of the exogenous-preferences assumption. In
view of the empirically-determined importance of education in changing preferences to generate an adequate labor force, the theory then appears involved
in a contradiction: the adequate performance of the institutions it recommends
requires the invalidation of the assumptions on which its recommendations rest.
An obvious counter-argument comes to mind. Does not education have direct
"cconsumptionvalue" to the individual? Indeed, if the preference change occurring through education has 'positive utility' to the individual, then the neoclassical evaluation will simply underestimate the benefits of the institutions it
recommends. This defense is scarcely neo-classical, as it requires ethical standards to evaluate differences in preference structures. Yet even the admission of
such comparisons, and according to "widely accepted" normative standards,
does not provide relief for neo-classical theory. Description and lament of the
authoritarianism. pettiness, and repressive atmosphere of American education
2
For an extended discussion, see [7, (Chapter 1)].
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ECONOMICSOF EDIJCATION
417
have dominated enlightened discussioni from John Dewey to the present. Moreover, empirical analysis of the operation of schools has by and large confirmed
the more descriptive surveys.' If education is in the service of creating the
'liberated' individual, with mature control over his or her life, it seems to have
failed.
Here the defender of neo-classical theory may argue that whatever the actual
state of education, it remains that the specifically economic strictures on the
educational system are compatible with ethically desirable educational patterns.
Deviations from such patterns are thus not the concern of economic theory as
such. The dominant form of this argument is based, explicitly or implicitly,
on the notion that the increased earnings of the more highly educated worker
are due to his or her increased level of cognitive development,which is at worst
welfare-neutral. Yet several investigations indicate that only a minor portion
of the association between schooling and earnings can be accounted for in terms
of increases in the level of cognitive functioning [5], [8], [11], [15]. Nor is the
association between education and occupational success economically irrational.
Rather, an analysis of social relations of formal education and the personality
traits rewarded in schools shows they conform admirably to the needs of a system
of production characterized by the hierarchical division of labor, the heart of
the modern capitalist enterprise [5], [81.
This paper investigates some of the more imumediatedistortions iilducecl ill
the neo-classical econiomics of educatiotn through the assuLmptiolnsof exog,enoLus
preferences. These distortionis take on particular imyiportanlce
wheni preference
structures most conductive to individual well-beinig anid those requisite to effective job performance in the hierarchical organization of production implicitly
"Crecommenided"by neo-classical tleory in fact diveige. But the genieral tlheoretical propositions will be independent of this assertion.
In Section 2, I will investigate the basic welfare axiomlexpressing that an individual is "better off" if enabled to reach a position higher on his or her order
of choice. This premise is used to justify market-mediated price and quantity
determinations, while these determinations in turn invalidate the premise. Thus
this assumption is pr-ima facie untenable. In Section 3, I introduce a multi-period
partial equilibrium model, and introduce a theorem restoring, at least in part,
the acceptability of the axiom in assessincgwelfare change. I argue that the
conditions under which this theorem holds are quite stringent and generally
untenable. At any rate, the admissibility of the fundamental premise of welfare
economics, far from being "intuitively obvious," can be seen to be highly problematic. In Section 4, I investigate the Pareto-efficiency and optimality of a
general equilibrium model with endogenous preferences, exhibiting a set of conditions under which the competitive market equilibrium has the usual desirable
properties. But again the conditions under which this situation obtains are quite
uinrealistic,and cannot be expected even grrosslyto approximate those of a real
social system. Neo-classical welfare economics, I conclude, is an inadequate
3 For an analysis of the statistical clata relevant to personality development through schoolinlg,
see [51, [81.
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418
HERBERT GINTIS
guide to educational and related social policy. In Section 5, I discuss some
reasonable extensions of these results to the case of market externalities, as well
as other elements of realism introduced in the modern neo-classical treatment.
I conclude that it is more nearly correct to depict the market economy in terms
of "price determining utility" than the contrary conception on which neo-classical welfare theory is based. A correct welfare theory, integrated into a correct
positive theory, will no doubt develop the core idea of a dialectical relationship
between use- and exchange-values.
These considerations reveal a basic inadequacy of the neo-classical theory of
economic policy. We shall see that the preference structures of individuals in a
given period depend on the "economic plan" of the government in that period.
The neo-classical treatment starts from the price structure and preference structures generated in the private economy, identify "market failures," and correct
these according to benefit-cost analysis. Thus the inadequacies of the Walrasian
solution in the absence of market failures are extended and incorporated in the
economic plan in their presence. This dilemma admits of no solution within
the neo-classical paradigmi.
2.
THE ENDOGENEITY
OF PREFERENCES
IN A STATIC MODEL
We shall consider goods and services as instruments used in the performance
of personal, conscious activities. Viewed in this way, personal welfare is a function of the constellation of social activities undertakenby the indiviclual[10], [16].
To perform an activity requires the more or less perfected development of capacities - cognitive, affective, physical, aesthetic and spiritual - in the relevant
directions. These capacities, which mediate between an individual's needs and
the socia'l activities which satisfy them, must in turn be learned and acquired.
Thus education is not only itself an activity, it is a central means of acquiring
the capacities to perform, or to perform more perfectly, other activities (loving,
sharing, competing, working, playing, appreciating, etc.). Education changes
preferences structures by expanding, inhibiting the expansion of, or even contracting, individual capacities to undertake and derive welfare from corresponding activities, hence altering the relative importance of instrumental means to
these activities.
More formally, we may consider the individual's utility function u having as
arguments goods and services q = (ql, * , qm). To introduce the activity-orientation and the possibility of preference change, we consider u as parametrized
by a capacityvectora = (a1, ***, an), representing the "level of capacity development" in various directions. At time t
0, the preference function can be
written
( 1)
u[a(O)](q) = u[al(O), * * *,
an(0)](q)
We may define a budget constraint as
(2)
p.q =
g(a(O))
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419
ECONOMICSOF EDUCATION
where p is the current commodity price vector, and g(a) is the income of the
individual as a function of his level of capacity development (for simplicity we
assume that the performance of work has no effect on utility, and that the
amount of leisure is fixed).
We shall assume that au/uaa =
Uai
and aglaai
=
gai satisfy all necessary con-
tinuity and differentiability conditions. If Uak> 0 and gak = 0, we call ak a pure
consumption capacity parameter. If uak = 0 and gak > 0 we call ak a pure production capacity parameter. In this case, ak can represent either a stock of physical
capital of some type, or a level of pure human capital. In this formulation
there is no distinction between the two. In general, of course, we will have
(with proper choice of sign for ak) either (Uak > 0, gak < 0) or (Uak > 0, gak > 0),
representing the cases where a capacity is beneficial to consumption while harmful to production, and where a capacity is beneficial to both, respectively.
Preference change occurs through the effect of consumption activities (of
which formal education is a special case) on the parameters ak. Thus we can
write the end-period capacity parameters ak(l) as
(3)
ak(l) =fk(q)
k =1,
*, n.
This formulation includes as a special case the accumulation of physical capital.
A totally present-oriented Homo Economicus will of course maximize (1)
subject to the budget condition (2), thus rendering a(1) an "unintended outcome" of his activities. But a rational individual both understands that activities affect preferences, and evaluates potential changes and actual differences in
preference structures. As Bertrand Russell has observed,
As a matter of fact, we consider some tastes better than others: we
do not merely hold that some tastes are ours and other tastes are other
people's. We do not even always consider our own tastes the best: we
may prefer bridge to poetry but think it is better to prefer poetry to
bridge.
In short, the individual has in some measure a set of "preferences-on-preferencestructures." For instance, the individual who has not developed the capacity to
appreciate classical music will not choose Bach in a commodity bundle; yet he
may believe it is better (for whatever reason) to "prefer" Bach, and rationally
seek to develop this capacity. The source of such valuations is an important
but ponderous behavioral and philosophical problem,4 which we shall here leave
unattended. That it is "better to prefer poetry to bridge" may involve a piece
of personal introspection, a moral stricture, an element of ancient acquired
wisdom, or a conclusion garnered from observing the satisfaction of the poetrylover. At any rate, it is an absolutely necessary element in our daily decisionbehavior, for it embodies our conscious impulses and motivations toward selfdevelopment.
Formally, we might like to rewrite (1) as
4
This problem will be discussed in following sections. See also
L7],[10], [23].
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420
HERBERT GINTIS
(1')
u[a(O)](q, a(1)),
with the individual maximizing (1') subject to (2). That this is manifestly untenable can be seen by thinking in termiisof revealed preference analysis. Faced
with two bundles of goods, which will our more enlightened Homo choose?
The aniswer should be obvious: he will not know hvhichto chose unless he is
also told the work and commodity availabilities open to him. in all succeeding
time periods. Whether or not he decides to learn poetry depends on the extent
of availability of poetry in succeeding periods. Whether or not to acquire a
particular work capacity (e.g., the ability to end-uremonotony, or learn a skill)
depends on his being able to exercise it-and with what economic benefit-in the
future. Conclusion: In order to choose which capacities to develop, the individual must know the expected future prices or more generally the terms of
availability (in the case no market exists for the entity) of all goods and workactivities instrumental to the exercise of his capacities. It follows directly that:
THEOREM 1. By the very logic of rational choice behavior in a market system,
preferences depend on expected future prices. Thus expected future prices are
parameters of the preference structure, and influence the development of preferences over time.
This observation can be simply stated: in a nmarketsociety of rational individuals, use-values are affected by the structure of exchange-values. By observing
expected future prices of the economic quantities associated with social activity,
the individual develops a particular set of consumption and production capacities, and hence a particular pattern of "use-values." The economics of education
is only one-although an importantt-illustration of the empirical weight of this
proposition.
Theorem 1 is of course quite obvious once stated. The above argument merely extends to endogenous preferences what has long been known in capital
theory: the value of a capital good depends on future expectations. There can
be no one-period model of an economy with welfare implications because revealed preferences reflect expectations as to future prices. The usual Walrasian
general equilibrium model expresses the precise contrary to the above proposition: relative prices reflect underlying use-values (preferences). Neo-classical
theory then justifies the economic mechanisms exhibited in the Walrasian model
in that famous, Paretian-based judgment: use-values (together with relative
costs) ought to determine exchange-values.
However, Pareto-optimality fails as a welfare critierion in the face of changing
preference structures. Welfare economics has often presented reasons whereby
such an optimum might fail to hold in a market economy, but this is not our
contentioni. Rather, the criterion of Pareto-optimality has no welfare implications in the face of endogenous preferences.
This can be shown in terms of the basic assumptions of welfare economics
alone. These basic assumptions are two in number [17, (122)]:
(A) An individual is better off if he is enabled to reach a position higher tip
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ECONOMIC'S
OFEDUCATION
421
on his order of choice....
(B) The community becomes better off if one individual becomes better off
and none worse off.
These propositions seem unexceptionial in the context of fixed preference structuLres,and abstracting from questions of equity. However, if preferenicesthemselves change in response to economic policy decisions, then all we are allowed
to say in (A) is that each individual would be better off if he wvereat a position
higher up on his scale of choice. But can we conclude that an individual is
better off if he is enabled to reach a position higher up on his order of choice?
It is evident that we can do so only if the process by which the (initially) preferred position is attained, does not entail a chanigein the individual's pattern of
preferences. In particular, we clearly have
THEOREM2. A necessary condition for the acpplicationof (A) is that all arguments of the individual utility function not within the domain of the individual's
choice set be exogenous to the general equilibriummodel.
Thus, accepting the proposition that present prices provide the individual with
indications of future prices, we conclude:
COROLLARY
1. The use of (A) and (B) to determine the structure of relative
prices at a point in time is prima facie unjustified.
Hence, under the same conditions, the neo-classical justification of tlhe"market
optimum" is invalid. For by Theorem 1, expected future prices are endogenous
preference parameters, and since they lie outside the domain of the individual's
choice set, Theorem 2 applies. In particular, we have:
COROLLARY
2. The neo-classical juistification of the market in labor -the determination of the wage structure as a function of supply and demand- is primc
facie untenable, even abstracting from equity consider-ations.
For the present wage structure will result from the clearing of labor markets.
This will set up expectations as to the future returns to various types of education (capacity development) open to the individual, thus representing one of
the elements in his or her decision as to path of individual capacity change.
This will be manifest in revealed preferences, and affect future utilities.
3. It is unjustifiable, prima facie, to draw policy or other normaCOROLLARY
tive:conclusions from rate-of-return and mnan-powver
analyses of education and
labor-force needs.
The above assertions are immediate. To assume preferences as fixed is absurdin a sense as absurd as assuming the non-existence of capital. When endogenous
preferences are admitted to the general equilibrium model, no conclusions can
be reached without an analysis of the dynamic multi-period economy (again,
just as in the case of capital theory). As we shall see, the conditions under
wlhich the traditional conclusions obtain are quite restrictive-and reminiscent
of the subject of recent controversies in capital theory [22], [24].
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422
HERBERTGINTIS
3.
ASSESSMENT OF WELFARE Ct-LANGE WITH ENDOGENOUS
SLuppOSe we
a liomo
nlow have
with
EcollIoliCuS
PREFERENCES
"instanitanleOLuS" utility
fUncGtionl
anid intertemporal
*-
-
lit
( 4 )
u[a(t)]
welfare
t =
an SI(t)]
9*
u[al(t),
07 1 ,
T
?*
funlctionl
(5 )W(qo,
*
2-TL rtiit(qt)
T=O
,qT)
where q, is the commodity bundle at time t, and rt is a subjective time discount
factor. Again abstracting fromiithe direct effect of work-activities on preference
change, we may generalize (3) to
(6)
f kt(qo,
ak(t)
q
*, qt-1)
all (k, t)
so that, assumiinga(0) as given, the value of parameter at time t depends on the
individual's past history of consumption activity.
This procedure eliminates all parameters of the utility functioni previously
endogenious to the model (the benefit) while rIequiringa multi-period dynamic
treatment (the cost). We relate the earniingcapacity of the individual directly
to the parameters of his utility fuinction by forming the budget equation
pt,qt = gt(al(t), ? * *, anl(t)) -
( 7)
Solving lhe constrained maximization problem implied by eqcuations(4) through
(7) leaves uis with the first order conditions.5
8
( )
[t
i
E
+ZZ
s k
+
Tt
aq't
au,_
ag
akr(S)
5ak(S)
[7s[
&US___
]
__
'
Ia(s)
aqt___
q/
i - 1,
21tPt
n , *t
0,
* ,T.
Since the Lagrangian variable 2t canl be initerpreted as the discounlted marginal
utility of income at time t, equationi (8) is seen to exhibit the familiar equality
between lhe opportunity cost of the good in question and the marginal benefits
of acquiring the good. The latter, represented by the left-hand side of (8), is
composed of the direct marginal utility of the good plus the indirect effect via
the impact of q on the production and consumption capacities of the individual.
Equationi (8) shows that the "measuring rod of money" approach of neoclassical theory can be extended to the case of endogenous preferences. Namely,
we can show that if the individual has perfect knowledge of present prices,
future prices, anid the structural determiniants of his own1preference function,
we then have:
THlEOREM 3. T7he wvelfare eJfects of san exogenous change in?the bun1dleof goods
available to the inldividualcan be estimiiated,in equilibrium, by the change in the
mariketvalue of the bundle.
5 This is an application of standard constrained maximization.
Cf. L14, (Chapter 8)].
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ECONOMICSOF EDUCATION
423
This follows from the fact that the increment in welfare associated with supplying the individual an amount dqsi* of good i at time s, is equal to the discounted private cost of the increment to the individual, in the case of changing
preference structures. More precisely, we have the
LEMMA. Suppose we replace q,i by q,i + q,i*, for fixed i and s, in the indi-
vidual utility function and all constraints save the budget constraint- i.e., qsi* is
a 'gift' of good i at time period s. Then
(9 )
dW
g
dqs*
T
= 2sPs, -
qsi*=O
The proof of this theorem, which is contained in [6], follows immediately from
the interpretation given to the left-hand side of (8) as the marginal benefit of
an incremental unit of qsi.
This result should scarcely be surprising. Rather than extending the oneperiod model to a multi-period one, we have essentially telescoped a multiperiod to a one-period. We have taken over to the multi-period case a set of
assumptions the tenability of which is admissible (if at all!) only in the oneperiod model. That is, we have merely 'dated' our variables. Thus we must
assume that the individual at time t = 0 has full knowledge of (a) the future
price structure (Pt); (b) the way in which any sequence of consumptions
(qO, * * *, qT) affects his capacities; and (c) the impact of any path of capacity
development a(O), * * * a(T - 1) on his welfare. While (a) may be reasonably
defended, (b) and (c) are wildly at variance with reality. The dictum that each
individual is capable of evaluating the sources of his own welfare may be
reasonable when the individual has experienced a wide variety of alternatives
(as is approximately the case with a shopper in the supermarket) and when these
experiences do not themselves alter his preferences (as when the supermarket is
devoid of addictive comestibles and drugs). Both these conditions are radically
violated in the multi-period case.
In the (necessary) absence of such firm knowledge, all societies provide nonexperiential belief systems to give content to capacity evaluation. These are
values, norms, theologies, ancient wisdoms, etc. But, as I have argued in [10],
the cultural institutions that provide this "knowledge" are themselves normally
predicated on the particular institutional and economic structures at hand, so
that the corresponding valuations in (4) are once again endogenous to the
dynamic equilibrium model. Of course, given the prices structure (or, in the
case of non-market societies, the shadow prices of relative availabilities), individuals can see the effect of various courses of capacity development simply by
observing the manifest well-being of their neighbors. Thus the "ancient wisdom"
tends to validate itself. But the well-being of their neighbors is dependent on
the price-structure, and cannot be separated from it without superhuman effort.
Even admitting these assumptions, however, Theorem 3 most certainly provides no justification for the neo-classical procedures employed in evaluating the
welfare impact of education. For these procedures involve evaluating the benefits
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424
HERBERT GINTIS
of education not by "production costs," but by the benefits in terms of accruals to
individual income. That this approach is incorrect is implied by the (stronger):
THEOREM 4. To the extent that an education activity q,' is biased toward increasing the level of consumptionicapacities as opposed to increasing the level of
production capacities, the nleo-classicaltreatment will utnderi-estimate
welfare gains.
PROOF.
Suppose qji
is
a "pure" educational input for the individual, in the
sense that it has no direct consumption
value (i.e., aus/lqsi = 0), but acts solely
to alter the consumption and production capacity parameters {ak(t)} in periods
t = s + 1, ** *, T. In this case, the individual income change associated with a
marginal unit increment of qsi supplied (and discounted to time t = 0) is given
by
(10)
AI =
T
Z i &gt
E
t=s
aak(t)
aqs
q
aak
k
But from the first-order conditions (8) we easily derive the incremental welfare
change as
[ a_u
gt]
(t)
(l11)
Z fL;t
XW
w= EE
t
k
]
+ 2t
aak
aak
aak
aqsq
Hence the discrepancy involved in the neo-classical procedure is equal to
(12)
AW- AI=
ZZ
t
k
at
aak
aak(t)
iqs
Simply stated, the neo-classical estimation procedure recognizes the effects of
capacity changes on the individual's budget conistraint, but not the parallel
effects on his welfare function through altered capacities for deriving welfare
from produiction and consumption activities. Finally, to say that qsj is biased
toward the generation of consumption capacities (i.e., toward raising the level
of consumption capacities) merely means that aak(t)/1qsi is relatively large for
those parameters ak(t) for which aut/lak is relatively large.
Theorem 4 exhibits the market-bias of benefit-cost analysis in the economics
of education, insofar as it is geared toward evaluating the welfare effects of
alternative educational choices. Moreover, if the arguments of Section 1 are
accepted, then the particular educational systems of capitalist society increase
the level of production capacities at the expense of individual welfare; i.e., the
are ntegative. In terms of
aut/lak corresponding to relatively large aak(t)/1qsi
Marxist theory, this observation is simply formulated: In an economic system
characterized by alienated work-activities, the good worker is the alienated
worker; thus, the formation of productive capacities in the worker through
education requires stunting his capacities for undertaking creative, welfare-producing activities [10]. Thus we have the
COROLLARY 1. In a capitalist societj characterizedby alienated work-activities,
the estimation procedures recommendedby the neo-classical economics of educa-
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425
ECONOMICS OF EDUCATION
tion tend to over-estimate the absolute benefits.
Similarly, since education is central to economic growth, we arrive at the more
general:
2. Even abstracting from questions of equity and market failures,
COROLLARY
no variant of National Product estimation has any prima facie jiustification as a
measure of welfare change.6
4.
GENERAL
EQUILIBRIUM WITH ENDOGENOUS
PREFERENCES
In the previous section, we noted that the application of neo-classical welfare
criteria in the case of endogenous preferences requires that the individual have
accurate expectations as to the future price structure. But given an initial distribution of factor endowments, the actual time paths of prices will reflect the
aggregated preferences of individuals for certain paths of capacity development
in a multi-period market model. Thus the possibility of a Pareto-efficient dynamic equilibrium must be admitted, insofar as the market model provides a
mechanism bringing the actual and expected price structures into (approximate)
equality. We now examine this question.
We shall consider a society of individuals
{h Ih = 1,
,
H}, with commodity
vectors {hq} and capacity vectors {ha}, and define qt = Zh hqt for t = 0,
For simplicity, we assume an aggregate production function
(13)
F(qt, LPC(h, t), b(t)) = 0
t
0,
,
T.
..*,
T
where
LPC(h, t)
-
hK(ha(t))
is a vector-valued function representing the Level of Productive Capacity of
individual h, and measures his contribution to production in (13). The vector
b(t) represents technological change, and its form will remain unspecified.
With the above formulation, we have the following theorem:
6 If neo-classical theory fails to supply an adequate quantitative estimate of welfare change,
it might yet be capable of a qualitative criterion of welfare change adequate for the economics
of education. Indeed Sidney Schoeffler [26], in a rare neo-classical acknowledgement of the
problem of preference change, has preferred a simple criterion for assessing the direction, if not
the magnitude, of welfare changes. A sufficient condition for welfare increase, argues Schoeffler,
is that the second commodity bundle be preferred to the first under both initial and final preference structures. A simple argument shows that this sufficient condition is invalid. For clearly,
any preference change which is accompanied by an increase in income will satisfy the Schoeffler
condition. Also, examples abound illustrating the untenability of this "sufficient condition."
For instance, I might prefer to be myself with John D. Rockefeller's goods, and Rockfeller
might prefer to be himself with his goods. But this does not mean that Rockefeller is "better
to prefer to be any commonly understood sense of the term. In fact, it is not irrational for me
off" than I, in in my total sitliation than in Rockefeller's. Similarly, it is not irrational at the
same time forRockefeller to prefer my total situation to his own. A similar argument obtains
in the case of intra-personal, inter-temporal preference change.
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426
I-IERBERT GINTIS
THEOREM 5. Assuming the usucalconditions concerning convexity and the absence of externalities, there is a price structure p and a factor reward structure
{hg(lla)} stuchthat, if expected by utflity mnaximizing individuals (describedby equations (4) through (7)), as wvellas by the production sector, wvhichequates marginal
productivities to expected prices and factor rewards, wvillbe realized thirotughthe
mnarketmechanissm. This allocation wvillbe Pareto-efficient.
This theorem is proved in full in [7], where some technical emmendations are
considered. But it follows from the fundamental existence theorem of general
equilibriuLn and its corollaries (Cf. [2, Chapter 5]), if we note that preference
functions hav7ebeen effectively rendered exogenous, and the vectors LPC(h, t)
can be seen as "marketed" factors supplies (including capital goods).
This theorem elucidates the Corollaries to Theorems 2 and 4. While the use
of welfare axiom (A) is pi-ima facie untenable, there are certain complex conditions which, if satisfied, render it acceptable. Thus the viability of the assumption of fixed preferences hinges on the realism of these conditions. We have
arrived at the neo-classical result once again by telescoping the multi-period
into the single-period case, thus de jure eliminating endogeneity. Is this a reasonable procedure?
I scarcely intend to haul out the traditional criticisms of noni-convexity and
market externalities, though their consideration leads to interesting insights
whenlpreference development, rather than resource allocation, is the question at
hand. Nor do I wish to emphasize that the age-old question of distributional
implications of market-determined outcomes takes a novel and striking form
when it is realized that possession of wealth can "buy" desirable paths of capacity development (Marx would probably say here that the worker alienated
from his means of production is thereby alienated from himself).
I will, however, re-emphasize the criticisms of the previous section. Individuals must have perfect knowledge not only of future prices, but also of the
precise effect of alternative activities on their capacities, and the precise impact
of alternative paths of capacity development on their well-being, given these
price expectations. This knowledge is in fact absent, and much of social theory
is built around understanding how societies fill this void with systems of belief
(e.g., [23]). That these belief systems are endogenous to, while not determined
by, the economic system is well-known,
and elaborated in [5], [10], [19].
But there is another, and equally socially-relevant, criticism. Quite simply,
there is absolutely no reason to believe the solution to the multi-period problem
to be uinique. Given an initial distribution of factors, there will in general be
multiple "self-fulfilling" sets of price expectations compatible with maximization
and miarketclearance. Indeed, there may be a continuum of such solutions, a
possibility whose likelihood is increased, the greater the extent to which technology (represented by b(t) in equation (13)) is endogenous to the system. For
instance, suppose all individuals expect the price of good qk to be high. Consutmerswill not develop the capacity to tusethis good, and demnandwill be low.
Producers will not develop technologies toward decreasing,the prodLuctioll costs
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ECONOMICS OF EDUCATION
427
of qk, so the marginal cost will be high. Thus expectations will be fLulfilled.
However, it is clear that had all individuals expected a low price, this too might
have come about: consumers would have developed the relevant capacities to
use the good, and producers the technologies to produce it more cheaply. Again,
suppose individuals believe the factor reward to a particular level of capacity
development (a(t)) to be low. Individuals will not develop these capacities, and
their supply will be low. Producers will not develop technologies intensive in
this factor, so marginal productivity will be low. Expectations will again be
fulfilled, but initial high price expectations might also have led to market
clearance.
This observation has its counterpart, of course, in the famous "reswitching"
theorem from capital theory, so I suspect the argument for multiple equilibria
is quite independent from the endogeneity of technological change (though the
existence of a continuum of equilibria might be so dependent). The endogeneity
of technology, however, is clearly the socially relevant case - for instance in attempting to assess the efforts of developing nations, such as China, to follow
alternative growth paths (Cf. [12]). Moreover, I suspect that the market system
is not neutral with respect to the particular equilibrium it "seeks out." The
dynamic local and global stability properties of the market economy will likely
render some equilibria much more easily attained than others.7 In other words,
in the market economy, we will still have exchange-value determining use-vclue,
rather than the neo-classical inverse.
The only realistic recourse, then, is to posit a collective economic instrument
(e.g., a State Planniing Board) to replace the Iiivisible Hanidin the determnination
of expected prices. The optiinality of market mechanisms can be restored, assuming this collective instrument has perfect knowledge of parametrized individual utility functions and all alternative technologies, and reflects tlheinterests
of the community in assessing social welfare.
In such an extended model, however, market mechanisms become instruments
of social policy (clearinig mechanisms), rather than determinants of social outcomes. This represents a substantive inversion of neo-classical welfare theory,
which recognizes the need for collective intervention only in case of market
externalities.
Of course the neo-classical economics of education does not fare any better
under this system. For the eminenitly non-neo-classical State Planning Board
would niotuse equation (10), but in its omniscience equation (11) in determining
the prices of various types of education. But the result is nonetheless significant:
Pareto-optimality remains the criterion, and markets are instruments to its imnplemnentation. Similarly markets in labor operate, and clear, at the expected
prices. But the expected prices are determined by a criterion including the
welfare-impact of preference change.
Moreover, the results of this general equilibrium analysis fully corroberate
our objections to the neo-classical economics of education. For we have seen
7 In the atatonnement" case, this is proved in [.2, (Chapter 12, 280)].
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428
HERBERT GINIIS
that the "proper" role of the State Planning Board in this area is to determine
not only the amount of various types of education offered, but also the returns
to education (i.e., the wage structure).
5.
CONCLUSION
Among the fundamental institutions of the capitalist economy are markets in
land, labor, capital, and goods and services. Neo-classical welfare theory argues
that under fairly general conditions, the production and allocation of factors of
production and products is best governed by such competitive markets. Thus
neo-classical theory becomes a justification of major aspects of the capitalist
economy.
Critics of neo-classical welfare theory have taken one (or both) of two tacks:
(a) the conditions under which market-instruments are indeed justified are in fact
not general at all; economies of scale, imperfect knowledge, externalities, social
goods, uncertainty, and the non-marketability of important factors, goods and
services are ubiquitous and render the market solution inefficient, and (b) the
distributional implications of the market solution render it inequitable.
These criticisms are indeed sufficient to motivate a searcn for alternative
institutional solutions to the "economic problem." But I have always felt that
the critical failure of neo-classical welfare theory lies on a yet deeper level- on
its false conception of the relation of the individual to society. This implicit
conception can be elucidated by contrasting neo-classical with Marxian theory.
Thus I have here assumed the most auspicious possible environment to neoclassical theory-abstracting from "market failures" of all types and leaving
aside the question of distributional equity-arguing that this theory remains yet
unacceptable.
But at this point questions of market externality and distributional equity
may be easily reintroduced. The first result of such an extension is greatly to
expand the breadth and import of the assumption of endogenous preferences.
The erection of a set of economic institutions -even simply market institutions has repercussions on individuals moving far beyond the resultant allocation of
goods, services, and factors of production. The historical development of community, environment, culture, the social relations of everyday life, the structure
of and relations among social classes-all bear the stamp of the dominanlt social
relations of production and have direct impact on individual welfare. Such
entities do not have prices, but just as with commodities, they are available to
the individual only in sets of alternative bundles-from which he must choose
according to an (extented) "budget constraint" (Cf. [10]). The resultant strueture of availabilities of these alternative bundles extends the concept of the price
structure, and comprehends the total configuration of availabilities of social relations and their instrumentalities. In brief, a society is its pattern of exchangevalues; the difference between the U.S. and China, or the Soviet Union and
Yugoslavia, can be succinctly expressed as the difference between their patterns
of relative availabilities. We conclude that the development of preferences is
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429
ECONOMICSOF EDUCATION
governed by the complex of institutions that constitute society itself, amnong
which economic institutions figure prominently. To take these preferences as
given in justifying one such set of economic institutions is simply fatuous.
The basic criticisms we have adduced in the framework of the pure market
economy lose no force in this extended model. The neo-classical method is to
introduce a political entity (the State) possessed of a a social welfare function
reflecting community preferences over distributional equity and the allocation
of all economic entities subject to "'marketfailure." The State effects an equitable initial factor endowment, ferrets out externalities, and restores marginal
conditions via schemes of taxation, subsidies, and regulation, according to the
rigorous dictates of cost-benefit calculation [21]. The problem, of course, is that
community preferences, as reasonable aggregates of individual preferences, will
be endogenous to the economic model just as described above. The conclusion
is the same: in general, the State must use markets merely as instruments
toward the satisfaction of its goals, rather than acting as a technical appendage
to a market system which (imperfectly) "determiinesoutcomes." The conditions
under which the traditional neo-classical treatment is tenable are grossly violated
in actual societies.
If the above analysis is correct, traditional
welfare economics
must be dis-
carded. But no doubt, however crippled by criticism, it will not loosen its grasp
on the minds of economists until a replacement is found. I only hope my
remarks stimulate others to this, a task rendered imperative by the struggles of
millions of individuals to find a more secure basis for social existence.
Harvard University, U.S. A.
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