# Unit 5 The rules of the game: Who gets what and why

## 5.3 Evaluating institutions and outcomes: Fairness

Pareto criterion
The Pareto criterion is a way of comparing two allocations, A and B. It states that A is is an improvement on B if at least one person would be strictly better off with A than B (in other words, would strictly prefer A to B) and nobody would be worse off. We say that A Pareto dominates B.
Pareto efficient, Pareto efficiency
An allocation is Pareto efficient if there is no feasible alternative allocation in which at least one person would be better off, and nobody worse off.
fairness
A way to evaluate an allocation based on one’s conception of justice.

As explained in Section 4.5, one way to evaluate the outcome of an economic interaction is to assess the allocation according to the Pareto criterion and Pareto efficiency. But a second important criterion is fairness.

Suppose, in the ultimatum game, the Proposer offered one cent from a total of $100. Responders in experiments around the world typically reject such an offer, apparently judging it to be unfair. Many of us would have a similar reaction if we witnessed two friends, An and Bai, walking down the street. They spot a$100 bill, which An picks up. She offers one cent to her friend Bai, and says she wants to keep the rest.

We might be outraged. But we might think differently if we discovered that, though both An and Bai had worked hard all their lives, An had just lost her job and was homeless while Bai was well off. Letting An keep $99.99 might then seem fair. We might therefore apply a different standard of justice to the outcome when we know all the facts. We could also apply a standard of fairness not to the outcome of the game, but to the rules of the game. Suppose we had observed An proposing an even split, allocating$50 to Bai. Good for An, you say, that seems like a fair outcome. But if this occurred because Bai pulled a gun on An, and threatened that unless she offered an even split she would shoot her, we would probably judge the outcome to be unfair.

The example makes a basic point about fairness. Allocations can be judged unfair because of:

substantive judgement of fairness
An evaluation of an outcome based on the characteristics of the allocation itself, not how it was determined. See also: procedural judgement of fairness.
procedural judgement of fairness
An evaluation of an outcome based on how the allocation came about, and not on the characteristics of the outcome itself (for example, how unequal it is). See also: substantive judgement of fairness.
• How unequal the allocations are: in terms of income, for example, or subjective wellbeing. These are called substantive judgements of fairness.
• How the allocations came about: for example, by force, or by competition on a level playing field. These are called procedural judgements of fairness.

### Substantive and procedural judgements

To make a substantive judgement about fairness, all you need to know is the allocation itself. However, for procedural evaluations, we also need to know the rules of the game and other factors that explain why this allocation occurred.

Different criteria can be used to evaluate the fairness of an allocation (substantive judgement). The criteria could relate to financial wellbeing, such as whether one person has more income than another or whether one person has more wealth than another. Alternative criteria could be whether one person has more freedom than another in the outcome of a strategic interaction or whether one person has more happiness than another. There is not one right way to evaluate fairness, with different criteria being appropriate in different circumstances.

Two people making substantive evaluations of fairness about the same situation need not agree, of course. For example, they may disagree about whether fairness should be evaluated in terms of income or happiness. If we measure fairness using happiness as the criterion, a person with a serious illness may need much more income than a person who is very healthy to be equally satisfied with their life.1

### Exercise 5.2 Substantive fairness

Consider the society you live in, or another society with which you are familiar.

1. To make society fairer, would you want greater equality of income, happiness, or freedom? Why? Would there be a trade-off between these aspects?
2. Are there other things that should be more equal to achieve greater fairness in this society?

The rules of the game that brought about the allocation (procedural judgement) may be evaluated according to aspects such as:

• Legitimacy of voluntary exchange: Were the actions resulting in the allocation the result of freely chosen actions by the individuals involved, for example, each person buying or selling things that they had come to own through inheritance, purchase, or their own labour? Or was fraud or force involved?
• Equal opportunity: Did people have an equal opportunity to acquire a large share of the total to be divided up? Or were they subjected to some kind of discrimination or other disadvantage because of their race, sexual orientation, gender, or who their parents were?
• Deservingness: Did the rules of the game that determined the allocation take account of the extent to which an individual worked hard, or otherwise upheld social norms?

### Exercise 5.3 Procedural fairness

Consider the society in which you live, or another society with which you are familiar. How fair is this society, according to the procedural judgements of fairness listed above?

We can evaluate the ultimatum game considering both substantive fairness and procedural fairness. The experimental rules of the game may be judged as procedurally fair because of the following:

• Proposers are chosen randomly.
• The game is played anonymously.
• Discrimination is not possible.
• All actions are voluntary. The Responder can refuse to accept the offer, and the Proposer is typically free to propose any amount.

The substantive fairness of the allocation, or how the pie is shared, depends on what the Proposer offers and what the Responder or Responders accept. We know from the behaviour of experimental subjects that many people would judge an allocation in which the Proposer took 90% of the pie to be unfair.

### Evaluating fairness

The rules of the game in the real economy are a long way from the fair procedures of the ultimatum game, and procedural judgements of unfairness are very important to many people.

To find out more about what people regard as unfair and the many types of unfairness and how they are perpetuated, read The Economy 1.0 Unit 19 and the CORE Econ Insight Persistent racial inequality in the United States.

People’s values about what is fair differ. Some, for example, regard any amount of inequality as fair, as long as the rules of the game are fair. Others judge an allocation to be unfair if some people are seriously deprived of basic needs, while others consume luxuries.

The American philosopher, John Rawls (1921–2002), devised a way to clarify these arguments, which can sometimes help us to find common ground on questions of values. We follow three steps:

1. Justice is impartial; fairness applies to all people: For example, if we swapped the positions of An and Bai, so that it was Bai instead of An who picked up $100, we would still apply exactly the same standard of justice to evaluate the outcome. 2. Imagine a veil of ignorance: Since fairness applies to everyone, including ourselves, Rawls asks us to imagine ourselves behind what he called a veil of ignorance, not knowing the position that we would occupy in the society we are considering. We could be born male or female; we might be healthy or ill, rich or poor, a member of a dominant ethnic group or a group excluded from positions of power and privilege, and so on. In the$100 on the street game, we would not know if we would be the person picking up the money, or the person responding to the offer.
3. From behind the veil of ignorance, we can make a judgement: For example, evaluating the choice of a set of institutions—imagining as we do so that we will then become part of the society we have endorsed, with an equal chance of having any of the positions occupied by individuals in that society.

The veil of ignorance invites you, in making a judgement about fairness, to put yourself in the shoes of others quite different from yourself. You would then, Rawls argued, be able to evaluate the constitutions, laws, inheritance practices, and other institutions of a society as an impartial outsider.

### Exercise 5.4 Splitting the profits in a partnership

Suppose you and a partner are starting a business involving each of you selling a new app to the public. You are deciding how to divide the profits and are considering four alternatives. The profits could be split:

• equally
• in proportion to how many apps each of you sells
• in inverse proportion to how much income each of you has from other sources (for example, if one of you has twice the income of the other, the profits could be split one-third to the former and two-thirds to the latter)
• in proportion to how many hours each of you has spent selling.

Order these alternatives according to your preference and give arguments based on the concepts of fairness introduced in this section. If the order depends on other facts about this joint project, say what other facts you would need. How (if at all) would your answer differ if you used Rawls’s veil of ignorance to order these alternatives?

Neither philosophy, nor economics, nor any other science, can eliminate disagreements about questions of value. But economics can clarify:

• How the dimensions of unfairness may be connected: For example, how the rules of the game that give special advantages to one or another group may affect the degree of inequality.
• The trade-offs between the dimensions of fairness: For example, do we have to compromise on the equality of income if we also want equality of opportunity?
• How public policies can address concerns about unfairness, and potential policy trade-offs: For example, whether these policies compromise other objectives, such as efficiency.

Figure 5.2 summarizes the concepts developed in this unit, and in Unit 4, that we can use to judge the impact of an economic policy. Having gathered evidence to describe the resulting allocation, we ask: is it Pareto efficient, and fair? Is it better than the original allocation by these criteria?

Figure 5.2 Efficiency and fairness.

1. Andrew Clark and Andrew Oswald. 2002. ‘A Simple Statistical Method for Measuring How Life Events Affect Happiness’. International Journal of Epidemiology 31 (6): pp. 1139–1144.