Kenneth Arrow Quotes

As is by now well known, attempts to form social judgments by aggregating individual expressed preferences always lead to the possibility of paradox.

Trust is an important lubricant of a social system. It is extremely efficient; it saves a lot of trouble to have a fair degree of reliance on other people's word. Unfortunately this is not a commodity which can be bought very easily. If you have to buy it, you already have some doubts about what you have bought.

Collective action is a means of power, a means by which individuals can more fully realize their individual values.

Finding out the prices of a large range of commodities is itself a costly enterprise, and knowledge of this fact by price setters is itself enough to create incentives for inefficient market behavior. If one individual has more information about the quality of a good than the second, the first may exploit the situation, and the second, distrusting him, may not take advantage of what is in fact a desirable trade.

The competitive system can be viewed as an information and decision structure. Initially, each agent in the economy has a very limited perspective. The household knows only its initial holdings of goods (including labor power) and the satisfactions it could derive from different combinations of goods acquired and consumed. The firm knows only the technological alternatives for transforming inputs into outputs. The “communication” takes the form of prices. If the correct (equilibrium) prices are announced, then the individual agents can determine their purchases and sales so as to maximize profits or satisfactions. The prices are then, according to the pure theory, the only communication that needs to be made in addition to the information held initially by the agents. This makes the market system appear to be very efficient indeed; not only does it achieve as good an allocation as an omniscient planner could, but it clearly minimizes the amount of communication needed.

The need for coordination has two basic causes: the various members (e.g., production units) are competing for a common pool of resources, financial and material; and different decisions complement or substitute for each other. For both reasons, the effectiveness of decisions made by one participant is influenced by the decisions of another. With limitations on the flow of information, the decisions themselves cannot be coordinated. That would require transferring all the information available, precisely what is to be avoided. It has been emphasized earlier that when information will be available, the individual should choose a decision function, a policy or strategy that determines what his actual decision should be for each possible signal he receives. Hence, ideally, in an organization there should be prior agreement on decision functions or strategies for all participants.

If the state of information (the set of signals received) is given and constant, then optimal choice is a problem of decision making under a given uncertainty, a situation that has been the subject of considerable analysis in the last thirty years. The problems of the economics of information proper arise when the probability distribution of states of the world is a variable. In the language adopted here, the signals received can vary. The existence of signals creates two important possibilities for the improvement of decision making. The first is taking advantage of the existence of signals. If the individual knows that a signal will be received before the decision has to be made, his optimal choice should be a function of the signal. We can think, alternatively but equivalently, of making the decision after the receipt of the signal and basing it on the probability distributions of consequences conditional on the signal, or of making the decision in advance for all possible values of the signal.

The meaning of information is precisely a reduction in uncertainty. From the viewpoint of economics or decision theory, uncertainty is relevant because it concerns the consequences of decisions. An individual making a decision may be supposed to be choosing one among a set of feasible alternatives. In general, these alternatives are themselves plans extending in time, and he will want to choose the one that yields the most satisfying consequences. These may be profits in successive periods for a business firm, or they may be other satisfactions, such as consumption, power, bequests, or interesting challenges. It can be assumed that the individual compares the entire set of consequences deriving from each alternative in his decision set with those of the others and chooses the preferred one.

I have argued that forecasts will be based on more information than is contained in econometric models and in general on information differing from agent to agent. I also want to argue that they will not necessarily use all the information contained in an econometric model. In fact, the two propositions are intimately linked though they seem to move in opposite directions. We have to assume that information-processing ability is scarce. As I have already said, this is one of the main justifications for and explanations of a decentralized economy. But then it follows that an individual concentrates on acquiring the information most useful to him and will have to crowd out the information which is less useful. In particular, information that is broadly pertinent to the economy as a whole may have very little predictive power for the future of an individual.

I disagree with the widely accepted proposition that econometric models should have expectations consistent with them. To the extent, it is argued, that the economic theory underlying the model involves anticipations, the anticipations that appear in the model as determining individual behavior should be equal to the forecasts made from the model. More generally, in fact, I would disagree with the weaker proposition that anticipations made by individuals should be necessarily dependent on broadly available general data about the economy and in particular about government actions.

If the markets for durable goods are peculiarly sensitive to price anticipations, while those for perishable goods are more sensitive to current prices, then there is a little more scope for explaining economic fluctuations.

Ironically, the current conservative model explaining the supposed association of capitalism and democracy relates to the Marxist as a photographic negative to a positive. It too suggests that the political “superstructure” is determined by the “relations of production.” The conservative model contrasts the dispersion of power under capitalist democracy with its concentration under socialism. Political opposition requires resources. The multiplicity of capitalists implies that any dissenting voice can find some support. Under socialism, the argument goes, the controlling political faction can deny its opponents all resources and dismiss them from their employment.
This theoretical argument presupposes a monolithic state. It is something of a chicken-and-egg proposition. If the democratic legal tradition is strong, there are many sources of power in a modern state. Adding economic control functions may only increase the diversity of interests within the state and therefore alternative sources of power. It is notoriously harder for the government to regulate its own agencies than private firms. Socialism may easily offer as much pluralism as capitalism.
The overpowering force in all these arguments is the empirical evidence of the Soviet Union and the other Communist countries, and it is strong. But the contrary proposition, that capitalism is a positive safeguard for democracy, is hardly a reasonable inference from experience. The example of Nazi Germany shows that no amount of private enterprise prevents the rise of totalitarianism. Indeed, it is hard to see that capitalism formed a significant impediment. Nor is Nazi Germany unique; Fascist Italy, Franco’s Spain, and the recurrent Latin American dictatorships are illustrative counterexamples to the proposition that capitalism implies democracy.

The comparative economic efficiency of capitalism and socialism remains one of the most controversial areas. The classical socialist argument is that the anarchy of production under capitalism leads to great wastage. An appeal to the virtues of the price system is, in fact, only a partial answer to this critique. The central argument, which implies the efficiency of a competitive economic system, presupposes that all relevant goods are available at prices that are the same for all participants and that supplies and demands of all goods balance. Now virtually all economic decisions have implications for supplies and demands on future markets. The concept of capital, the very root of the term “capitalism,” refers to the setting-aside of resources for use in future production and sale. Hence, goods to be produced in the future are effectively economic commodities today. For efficient resource allocation, the prices of future goods should be known today. But they are not. Markets for current goods exist and enable a certain coherence between supply and demand there. But very few such markets exist for delivery of goods in the future. Hence, plans made by different agents may be based on inconsistent assumptions about the future. Investment plans may be excessive or inadequate to meet future demands or to employ the future labor force.

To sum up, the basic values that motivated my preference for socialism over capitalism were (1) efficiency in making sure that all resources were used, (2) the avoidance of war and other political corruptions of the pursuit of profits, (3) the achievement of freedom from control by a small elite, (4) equality of income and power, and (5) encouragement of cooperative as opposed to competitive motives in the operation of society.

Social theories are also social facts. Whatever explanatory value the “Marxist” or “conservative” models may have, they surely cannot be regarded as established with any degree of firmness. Yet excessive confidence in one or the other may have serious consequences. If “conservatives” believe too strongly that any move to socialism undermines democracy, then they may indeed act in accordance with the “Marxist” model, and vice versa. (Robert Merton long ago alerted us to “self-confirming” and “self-denying” social theories; here we have a pair of rival theories which are “other-confirming.”)