A lot of free market economics follows the exchange paradigm, which throws out much of the cost-benefit methodology because of its theoretically untenable interpersonal utility comparisons. This idea is closely linked to James Buchanan, who argued that economists should see exchange as the focus of their field. Much of this is justified theoretically by invoking Arrow’s impossibility theorem, which rigorously showed that preferences expressed in the political process don’t really behave in such a way that they can be aggregated and acted upon by representatives in a meaningful sense. Buchanan’s solution was to step back from this and start with Pareto, or two parties making a mutually beneficial exchange as a starting point for determining what happens in the political sphere.
The problem is that Pareto doesn’t fix anything.
We give now a simple example of the type of impossibility that is involved in Theorem II by taking a special case of two individuals and three alternatives. There is one copy of a certain book, say Lady Chatterly’s Lover, which is viewed differently by 1 and 2. The three alternatives are: that individual 1 reads it (x), that individual 2 reads it (y), and that no one reads it (z). Person 1, who is a prude, prefers most that no one reads it, but given the choice between either of the two reading it, he would prefer that he read it himself than exposing gullible Mr. 2 to the influences of Lawrence. (Prudes, I am told, tend to prefer to be censors than being censored.) In decreasing order of preference, his ranking is z, x, y. Person 2, however, prefers that either of them should read it rather than neither. Furthermore, he takes delight in the thought that prudish Mr. 1 may have to read Lawrence, and his first preference is that person 1 should read it, next that he himself should read it, and worst that neither should. His ranking is, therefore, x, y z.
Now if choice is precisely between the pair (x,z), i.e., between person 1 reading the book and no one reading it, someone with liberal values may argue that it is person 1′s preference that should count; since the prude would not like to read it, he should not be forced to. Thus, the society should prefer z to x. Similarly, in the choice exactly between person 2 reading he book (y) and no one reading it (z), liberal values require that person 2′s preferences should be decisive, and since he is clearly anxious to read the book he should be permitted to do this. Hence y should be judged socially better than z. Thus, in terms of liberal values it is better that no one reads it rather than person 1 being forced to read it, and it is still better that person 2 is permitted to read the book rather than no one reading it. That is, the society should prefer y to z and z to x. This discourse could end happily with the book being handed over to person 2 but for the fact that it is a Pareto inferior alternative, being worse than person 1 reading it, in the view of both persons, i.e., x is Pareto superior to y.
Sen, Amartya. 1970 “The Impossibility of a Paretian Liberal.” Journal of Political Economy 78 (1).
Empirically this may not be that important, although I’m convinced that the desire to throw out Kaldor-Hicks was more theoretical than empirical. And theoretically, you go precisely nowhere by starting with Pareto instead.