Generality Versus Context Specificity: First, Second and Third Best in Theory and Policy

Second-best theory established that a policy's effect on community welfare (or any other objective function) varies with its specific context. In contrast, Ng argues that fulfilling first-best conditions piecemeal is optimal whenever the policy-maker's information is insufficient to determine the direction of the change in the variable under consideration that will raise welfare, irrespective of the conditions in that market. It is argued in the present paper: (i) that Ng's own assumptions imply not that first-best conditions should be established under these circumstances, but that the status quo should be maintained; (ii) that when Ng's key assumption is altered to be empirically relevant, all policy decisions become fully context-specific; and (iii) that Woo's argument for accepting Ng's conclusions in spite of point (ii) is incorrect. The conclusion discusses valid uses of piecemeal welfare theory in spite of second best.