Can inefficient public production promote welfare?

Abstract

Politicians believe in an old fashioned conjecture. They all think welfare must always be increased if one only reduce inefficiency. But this intuition is wrong. If we look at piecemeal price changes, temporarily decreasing efficiency can be necessary for improving welfare. This conclusion shows that the usual argument of political administrations to advise the management of public enterprises to reduce the inefficiency of production can, under the above mentioned circumstances, lead to welfare losses. On this account the efficiency rule of thumb must be supported by welfare considerations, otherwise misleading results can occur. But we should not be too concerned. If the starting point of the piecemeal policy path is located not too far from the welfare optimum, the usual efficiency argument leads to satisfactory results. Last not least we mentioned the economic duality of decreasing efficiency and instability; here our results fit into the usual conception of the economists' world.