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The Theory of the Second Best concerns what happens when one or more optimality conditions cannot be satisfied in an economic model. Canadian economist Richard Lipsey and Australian-American economist Kelvin Lancaster showed in a 1956 paper that if one optimality condition in an economic model cannot be satisfied, it is possible that the next-best solution involves changing other variables away from the ones that are usually assumed to be optimal.

This means that in an economy with some unavoidable market failure in one sector, there can actually be a decrease in efficiency due to a move toward greater market perfection in another sector. In theory, at least, it may be better to let two market imperfections cancel each other out rather than making an effort to fix either one. Thus, it may be optimal for the government to intervene in a way that is contrary to laissez faire policy. This suggests that economists need to study the details of the situation before jumping to the theory-based conclusion that an improvement in market perfection in one area implies a global improvement in efficiency.

Even though the theory of the second best was developed for the Walrasian general equilibrium system, it also applies in microeconomic (partial equilibrium) cases. For example, consider a mining monopoly that's also a polluter: mining leads to tailings being dumped in the river and deadly dust in the workers’ lungs. Suppose in addition that there is nothing at all that we can do about the pollution. But the government is able to break up the monopoly.

The problem here is that increasing competition in this market is likely to increase production (since competitors have such a hard time restricting production compared to a monopoly). Because pollution is highly associated with production, pollution will most likely increase. This may actually make the world worse off than before.

International economic integration is treated as second best solution since it provides degree of trade advanced according to stages of economic integration (gradual abolishment of customs tariffs, non-tariff barriers such as registration rights etc. due to coherence policy of economic unions). It seems that the first-best option (free trade) is achieved when economic integration reaches a stage of political union (EU in 2009).


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Up to date as of January 22, 2010

From Wikisource

Second Best
by Rupert Brooke

Here in the dark, O heart;
Alone with the enduring Earth, and Night,
And Silence, and the warm strange smell of clover;
Clear-visioned, though it break you; far apart
From the dead best, the dear and old delight;
Throw down your dreams of immortality,
O faithful, O foolish lover!
Here's peace for you, and surety; here the one
Wisdom - the truth! - 'All day the good glad sun
Showers love and labour on you, wine and song;
The greenwood laughs, the wind blows, all day long
Till night.' And night ends all things.
                                          Then shall be
No lamp relumed in heaven, no voices crying,
Or changing lights, or dreams and forms that hover!
(And, heart, for all your sighing,
That gladness and those tears are over, over. . . .)

And has the truth brought no new hope at all,
Heart, that you're weeping yet for Paradise?
Do they still whisper, the old weary cries?
‘’Mid youth and song, feasting and carnival,
Through laughter, through the roses,as of old
Comes Death, on shadowy and relentless feet,
Death, unappeaseable by prayer or gold;
Death is the end, the end!’
Proud, then, clear-eyed and laughing, go to greet
Death as a friend!

Exile of immortality, strongly wise,
Strain through the dark with undesirous eyes
To what may lie beyond it. Sets your star,
O heart, for ever! Yet, behind the night,
Waits for the great unborn, somewhere afar,
Some white tremendous daybreak. And the light,
Returning, shall give back the golden hours,
Ocean a windless level, Earth a lawn
Spacious and full of sunlit dancing-places,
And laughter, and music, and, among the flowers,
The gay child-hearts of men, and the child-faces
O heart, in the great dawn!



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