Kaldor-Hicks efficiency

Indian Economy glossary

Also called: Potential Pareto improvement · Topic: Market Structures, Market Failure and Competition · NCERT: Beyond NCERT

Meaning

Kaldor-Hicks efficiency, set out by Kaldor (1939) and Hicks (1939), is a looser test of efficiency than Pareto's. A change counts as efficient if the gainers gain enough that they could compensate the losers and still be better off. The compensation does not have to be actually paid.

It matters because almost every real policy creates some losers. A strict Pareto test would block nearly everything. Kaldor-Hicks is the logic behind cost-benefit analysis.

Example

An expressway may create gains for road users and businesses that are far larger than the losses of the families whose land is acquired. It passes the Kaldor-Hicks test. But if the families are not properly compensated and rehabilitated, they are still worse off, which is why actual compensation matters politically.

Don't confuse with

  • Pareto improvement: a change where nobody at all is made worse off. Kaldor-Hicks allows real losers, as long as the gains are big enough to make up for their losses in principle.

Related concepts

Read more