The traditional Pareto criteria of allocative efficiency, which have predominated in economics up to this point, are tainted with a definite static character and therefore are inadequate to be applied as normative guidelines to the rich dynamics of real-life social institutions (1). Consequently, it is necessary to replace the traditional standards of efficiency with an alternative criterion, one which will fill the serious gaps in the traditional Pareto approach and be easily applicable to the realm of social institutions. We will call this alternative standard the “criterion of dynamic efficiency.”
This paper comprises three distinct sections. In the first, we will review the process by which the concept of Pareto efficiency emerged. This standard was modeled on the principle of energy efficiency, which arose in nineteenth-century physics and mechanics. The above explains why the traditional criterion of Pareto efficiency, which has become the pivot of all welfare economics and much of the economic analysis of law, is heavily restricted by comparative statics, and thus cannot be easily applied to the rich dynamics of institutions.
In the second section, we will present the alternative notion of dynamic efficiency, which followed naturally from the theory of market processes driven by the creative and coordinating potential of entrepreneurship. Although the standard of dynamic efficiency has not yet entered the mainstream of our discipline, various authors have contributed to the field. Leading economists such as Mises, Hayek, and Schumpeter, along with other more recent theorists like Rothbard, Kirzner, North (with his concept of “adaptive efficiency”), and even Leibenstein (with his notion of “x-efficiency”), have proposed or developed alternative criteria which have coincided to a varying extent with our idea of dynamic efficiency. In this section, we will study and compare the different contributions these authors have made in this area.
The third and final section of this article embodies what we see as one of its most significant and promising contributions: an analysis of the close relationship we believe exists between the proposed criterion of dynamic efficiency and the framework of ethical principles which prevails in every society. A major, auspicious field of research thus opening up for future economists consists of the systematic application of the standard of dynamic efficiency to each of society’s institutions (legal, moral, and economic) and the subsequent evaluation of each according to a standard other than the traditional Pareto criterion. Furthermore, our analysis will allow us to identify the ethical principles which make dynamic efficiency possible and, as a result, permit the progress and coordinated advancement of society and civilization. We thereby intend to establish a direct relationship between economics and ethics and in this way to foster a highly productive relationship between the two thus mutually-strengthened disciplines.
Jesús Huerta de Soto
Professor of Political Economy
King Juan Carlos University of Madrid, Spain
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