Theory of the Second-Best

Atanu Dey elaborates on a fundamental truth we need to understand and never forget:

The problem with the second-best world is this: policies that are wonderful for first-best systems (systems that have no imperfections) don't necessarily work in the second-best world. In general, removing less than all the distortions simultaneously in a second-best world may indeed make the system worse off.

To repeat the argument just once more: first-best systems have no distortions; second-best systems have distortions. Policies that work for first-best systems need not necessarily work in second-best systems. Finally, removing less than all the distortions may make a second-best system worse off.

Many times, when we think about solving a problem, we forget that we are in a second-bext world. So, we look at solving one problem, not realising that we may actually end up worsening the situation. Taking a wholistic view and focusing on all the key issues is very important.

I need to apply this thinking to the two worlds that we are involved in: SMEs and Rural India.

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