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.People coming fromgraduate school are going to fall flat on their face if they try to apply ultra-sophisticated modelsin tough real-world situations like the ex-Soviet empire.Those situations will be much betterunderstood, diagnosed and acted upon by more fundamentals-oriented people who say, Wellhere we ve got proto-markets that are just now being created; how do we see the forces ofsupply and demand working here?.(Ibid.)This interest in applying the forces of supply and demand to real-world situationsalso led him to some 43 consultant positions over the years with non-governmentalorganizations, US governmental agencies, and foreign governments.In his policy workHarberger found welfare measurement to be an indispensable tool, and could not under-stand economists reluctance to participate. The measurement of deadweight losses isnot new to economics by any means , he said, citing Jules Dupuit and more recent theo-retical work by Harold Hotelling, Sir John R.Hicks, Gerard Debreu, James Meade andHarry Johnson.Nonetheless I feel that the profession as a whole has not given to the area the attention that Ithink it deserves.We do not live on the Pareto frontier, and we are not going to do so in thefuture.Yet policy decisions are constantly being made which can move us either toward oraway from that frontier.What could be more relevant to a choice between policy A and policyB than a statement that policy A will move us toward the Pareto frontier in such a way as togain for the economy as a whole, say, approximately $200 million per year, while policy B willproduce a gain of, say, about $30 million per year? What could be more useful to us as a guideto priorities in tax reform than the knowledge that the deadweight losses stemming from the taxloopholes.open to explorers for oil and gas are probably greater in total magnitude than thedeadweight losses associated with all the other inefficiencies induced by the corporate incometax? What could be more tantalizing than the possibility (which I believe to be a real one) thatthe U.S.tariff, whose indirect effect is to restrict the equilibrium value of U.S.exports, producesby this route a gain for the U.S.from a partial exploitation of U.S.monopoly power in worldmarkets which nearly offsets (or perhaps more fully or more than fully offsets) the efficiency-losses produced by tariff-induced substitution of more expensive domestic products for cheaperimports? These and similar questions seem to me so interesting, so relevant, so central to ourunderstanding of the economy we live in, that I find it hard to explain why the measurement ofdeadweight losses should be the province of only a handful of economists rather than at leastthe occasional hobby of a much larger group.(Harberger 1964a, pp.58 9)Harberger of course made it much more than an occasional hobby.Harberger used the deadweight loss measure in three main applications during the1950s and early 1960s.In his first application, one close to Stigler s own heart, Harbergerestimated the deadweight loss from monopolists output restrictions (Harberger 1954).Assuming that in long-run equilibrium distortion-free returns to capital would be equal-ized in all industries, Harberger estimated monopoly distortions as the diversion acrossindustries of rates of return from economy-wide averages.Taking the simple expediencyof assuming constant marginal costs in all industries and a constant unit-elastic demandfor a representative consumer, he then estimated deadweight loss as the curvilinear tri- The Chicago School of welfare economics 65angles under this demand curve up to the point that would bring about the average rateof return (and likewise for competitive industries the area above the demand curve asresources are reallocated to the monopolized industries).This procedure yielded a sur-prisingly small welfare cost, on the order of $1.40 per capita.As noted previously, Stigler(1956) critiqued some of the assumptions of this analysis, but not the overall attempt atsuch a computation.8Harberger s second application was to distortions in developing countries, part ofhis well-known consulting in Chile and elsewhere in Latin America (Harberger 1959b).Here, he estimated similar simple measures of deadweight loss from trade barriers, againusing a stylized demand curve and assuming the shadow price of all trade barriers wasequivalent to a tariff of 50 percent.To estimate the effect of labor and capital distortions,he employed a simple analytical general equilibrium model, assuming Cobb Douglasutility of a representative consumer and Cobb Douglas production for 10 industriesusing labor and capital and inputs.He then analyzed a few what-if distortions acrosssectors to compute the share of income lost.Again, the take-home message of this workis that the distortions appear small, on the order of 5 to 10 percent of GDP.His third application was to a set of domestic tax issues
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