- The criterion that, for a change in policy or policy regime to be viewed as beneficial, the gainers should be able to compensate the losers and still be better off. The criterion does not require that thecompensation actually be paid, which, if it did, would make this the same as the Pareto criterion. Due to Kaldor (1939), Hicks (1940).
This is a criterion (compensation test) for judging whether a proposed change (say, the introduction of a new drug or the demolition of a new hospital) is welfare -enhancing. It is named for Nicholas (Lord) Kaldor (1908-86) and Sir John Hicks (1904-89). The Kaldor criterion says that if the minimum the gainers from the change are willing to pay is more than enough to compensate the losers fully, then the project is welfare-enhancing. The Hicks criterion says that if the maximum amount the losers are prepared to offer to the gainers in order to prevent the change is less than the minimum amount the gainers are prepared to accept as a bribe to forgo the exchange, then the project is welfare-enhancing. The Kaldor compensation test takes the gainers' point of view; the Hicks compensation test is made from the losers' point of view. If both conditions are satisfied, both gainers and losers will agree that the proposed activity will move the economy toward Pareto optimality.
There is the possibility that the Kaldor-Hicks criterion might sanction a move from state A to state B and then from B to A (ad infinitum and, probably, nauseam). This has led to the explicit ruling out of the reversal possibility, known as the Scitovsky criterion, which also needs to be satisfied if a change is to be judged to be welfare-enhancing. Note that the compensation does not actually have to be paid. For true Pareto optimality compensation must actually be paid.