Posts tagged Cost
I’ve spent much of the past couple of years trying to explain my political philosophy. It’s hard to do, though, because it’s not particularly simple.
Oh, sure, to most conservatives I probably look like a raging liberal, looking forward to the day when government owns all forms of commerce in a nice, liberal utopia of collectivism. I suspect I look mighty conservative to hardcore liberal people. But all of that turns into caricature.
Part of the problem is that I’m forced to describe my political views through peepholes. It would take an entire book to describe it in its entirety. And so I end up feeling like I write “fan”, “wall”, “rope”, and “tree” articles when I’m trying to describe the elephant.
Today I’d like to come closer to writing an “elephant” article, drawing upon those previous ones.
I’m quite the fan (!) of free markets. A truly free market has the following characteristics:
- No barriers to entry or exit
- Perfectly available information to both buyers and sellers
- No affected parties in a transaction besides the buyers and sellers
A truly free market is sort of like the perfectly elastic bodies or perfectly frictionless surfaces in classical mechanics. They’re wonderful tools in academia to describe fundamental principles. And they make terrific starting points upon which to layer the imperfections of the real world, so as to address the inevitable additional complexity made necessary by those imperfections.
This means that there is no such thing as a truly free market, in the same way that there is no such thing as a frictionless surface. If we built machines with the assumption that there was no friction, the machines would not work. Similarly, when we build markets assuming that they are perfectly free, they don’t work, either. We should no more be surprised that the free markets fail us than we should be surprised that machines built for a frictionless world fail us.
At the same time, acknowledging that there is no such thing as a truly free market doesn’t invalidate the underlying theory, any more than introducing friction invalidates the law of inertia. Making markets work, then, requires acknowledging the higher orders of complexity that we are forced to layer upon the fundamental principles.
In many respects, then, good government regulation is oil for machines. It reduces the friction that comes from cost externalities, or imperfect information, or barriers to entry or exit. Let me provide some examples of each in turn.
I’ll take them in reverse, starting with barriers. Any time there is a natural scarcity of a resource, there are barriers to entry. The whole reason companies attempt to achieve monopolies is that they are inherently insurmountable barriers to entry for competitors, which allows for the business to capture a purely demand-based income. That is, the price is based entirely on the demand for the product, typically at the point where profits are maximized. When there are no barriers to entry, income is supply-based instead; prices fall to a point close to the marginal supply cost. As entry barriers rise, then, prices move along that continuüm between the marginal supply cost and the maximum profit price.
In my view, government should, then, aim to minimize barriers to entry, with the exception of intellectual property. Since the value is in the idea, rather than the product, it does make sense for there to be a temporary monopoly granted to the creator of the idea. But copyright law has gone too far when that monopoly is essentially granted in perpetuity. It makes a mockery of the fundamental behind it, which is to encourage exploring new ideas.
How can government do better in this area? How about prohibiting exclusive contracts? Every exclusive contract creates monopolies. They stifle competition. They ultimately cost consumers more for the same goods, which puts a drag on the economy. Our commerce laws should aim to minimize barriers to entry and barriers to exit markets. I recognize that this policy is viewed as hostile toward business. In a sense, that’s true. Businesses, like the people who run them, are lazy. They want to get profits with minimal effort. When a business is able to achieve a monopoly, there is no longer incentive to innovate. To the extent that monopolies are countered, profits are reduced. But we all get more for our money, and we get more rapid innovation. It’s a rising tide that ultimately lifts all boats.
That’s not to say that there is always value in fragmenting a market further. To a point, businesses can gain economies of scale and economies of scope by growing. In fact, those economies can lead to lower prices and greater value as well. But that exists only as long as competition remains high and barriers to entry and exit remain low.
And not all markets are able to support low barriers. For example, it isn’t cost-effective to run power lines for multiple power supply companies in most communities (although San Francisco has two completely separate power systems: a public one for government and a private one for the residents). Nor does it make sense to have multiple waste collection companies. So one entity ends up being granted a monopoly. Perhaps it’s government-run, or perhaps it’s a contracted private company. In those cases, though, government is obligated to manage the pricing and service, because there is no option for competition. Our government does us a disservice when we are unable to validate that we are getting the service we deserve at a fair price. And in order to do this we need access to free information.
And free information is the next pillar of a free market. If we cannot trust the item we are purchasing, and compare it to substitutes, we cannot have a free market. If we had unlimited time to comparison shop, and unlimited capacity to learn, we would have a much easier time making well-informed decisions. But we don’t. We are forced to take shortcuts. This is why we end up trusting specialists, whether they work for private industry or for government. It’s why we should feel threatened when politicians attempt to undermine our trust in specialists. Reducing our trust in specialists makes us poorer economically, because it makes us poorer in our economic decisions. It takes us away from freer markets. Government should be doing everything possible to encourage better information, particularly since many businesses benefit by avoiding disclosure. It’s poor information that led people to invest in real estate derivatives nearly a decade ago, and contributed mightily to our worst recession since the 1930s.
And it’s poor information that leads us to throw our global climate out of whack, which will hurt our society for generations to come…a huge cost externality.
I discussed cost externalities in “Blowing Our Inheritance”, where I described temporal costs — where one generation is forced to bear the cost that translates to another generation’s benefit. But these externalities show up all over the place. When I drive my car, I get the benefit of quickly getting to my destination. It’s a benefit to one person. The pollution I generate affects anywhere from thousands to billions of people (depending on the type of pollution). The costs may be infinitesimally small from my lone act of driving to the grocery store, but when you multiply that infinitesimally small number by a huge number of people performing the same action, the aggregate cost is significant. So we each gain a large amount of benefit from each action, while burdening the rest of the world a small amount, but collectively we may all be worse off in the end.
What if we had to pay money to everyone in the world for the burdens we cause? I’m not talking about a penny to each person each time we drive. That would be far too high a compensation. Imagine instead that we had to put our global cost into a bank account, and each of us got a check once a year to cover the cost of what was in the account, based on the particular burden we all bore from the collective pollution. Then everyone would pay for the burdens they create, and everyone would be compensated for the burdens they received. The closer we can come to achieving this, the better we address cost externalities and more accurately reflect the true economic value of a transaction.
Those externalities don’t exist solely as costs. They also can be external benefits. For instance, imagine a scenario where there is a major street running through a neighborhood. It has been cracked and potholed, and this has made travel down that street very uncomfortable…not to mention damaging to the cars that drive on it. The residents band together to pay to have the street repaved. You don’t live in that neighborhood, but you pass through it on that road every day as part of your commute. You get the external benefit of a smooth road, while the residents bore the cost of paving it.
It turns out that much of the Internet behaves in this fashion. We directly pay for very little of the network over which our communications run. We do, however, gain a great deal of external benefit by virtue of others paying for the bulk of the network.
Typically, it makes sense for us to collect those external benefits in cases where it is too onerous to directly charge for each use. In those instances, it makes more sense to aggregate the costs and distribute the collected money for the beneficial services. This is the primary basis for taxation. Enough of us want those benefits that we are willing to pay for them in a collective fashion, so as to reduce the friction that would otherwise arise if we had to individually pay for each instance of reaping the external benefit.
But how to tax us? Fairly, of course. But fair taxation means different things to different people. It can mean the same number of dollars per person, or the same percentage of income or wealth per person, or the same amount of marginal utility per person. I am a fan of the marginal utility model, but I suspect that’s because of the amount of time I’ve spent learning about economics. It’s not a concept that most people are able to understand without a lot of explanation. Typically, those who understand it and continue to oppose it subscribe to the belief that paying a lower marginal utility tax is just reward for the hard work that led to more wealth.
But there’s another way to view taxation. Taxes produce drag on the economy. Government spending that is covered by those taxes stimulate the economy. But different taxes produce different levels of drag for the same amount of tax revenue, just as different government spending stimulates the economy to different degrees. Therefore, another goal might be to maximize revenue per “unit of economic drag”. That would fund our government with minimal negative impact on the economy. This model ignores any degree of “fairness”, but it can make all of us better off than we would be in any of the ideally “fair” models. Would we be happier with more, even if the distribution was less equitable? Or would we prefer a more equitable distribution, even if it means every one of us is worse off in the end? It’s a good set of questions to ask, but nobody is asking it.
And, much as I wish it weren’t the case, not everything can be handled with a free market. Humans are particularly short-sighted, especially when they are younger. Monotreme would point out that it’s because of the underdeveloped amygdala, but I’m less concerned with the why than the what in this case. That shortsightedness puts us at a social crossroads.
The compassionate side of us doesn’t want us to subject people to extreme suffering, even if it comes from poor decisions earlier in life. We don’t want old people to be on the streets, picking their dinners out of garbage cans until they die of some easily curable malady. We don’t want young people to die after automobile accidents simply because they don’t have insurance to cover the medical costs incurred in the accident.
Yet, the personal responsibility side of us (to which I alluded on Saturday in “Self-Doubting Thomas”) makes us want people to be self-sufficient. We want more ants and fewer grasshoppers. Generally speaking, a society of ants will have a more robust economy than a society of grasshoppers. To the extent, then, that we shield people from poor decisions, we encourage more grasshoppers.
How do we, as a society, address this paradox? Poorly, to be perfectly frank. Grasshoppers tend to collect external benefits without contributing to cover the associated costs. But they do so whether they are shielded from their poor decisions or left to be subject to them. We could go Jonathan Swift on them, of course. But even the most callous among us seem unwilling to go to those extremes. This leaves us with unavoidable grasshopper costs. Our options are to focus on the lowest-cost ways of dealing with them (perhaps a return to the poorhouses of the 19th century?), or to accept the fiscal costs of dealing with them in a compassionate way. If we choose the latter, we must accept that it will almost certainly increase the number of grasshoppers. That simply becomes one of the costs of appealing to our sense of compassion.
Naturally, I lean toward that more compassionate model, in no small part because I recognize that it is nearly impossible to separate those who choose to be grasshoppers from those who have grasshopperness thrust upon them (e.g., those who grew up without the resources that would have led them to become ants, or had extreme circumstances that precluded anthood).
This becomes particularly important when dealing with healthcare, since it doesn’t fit well into any form of free market. This is why I noted, so long ago, that “Health Insurance Isn’t Really Insurance at All”. Healthcare is so complex, because it deals in so many submarkets, that we cannot hope to address the costs we have without teasing the separate parts from each other, and addressing them individually, but in a holistic fashion.
Ultimately, these principles are what led me to align with the Democrats. I don’t want socialism. I don’t want anything close to it. But I want to compassionately address our healthcare and the social safety net necessary to support our society’s compassion for our fellow humans. I want to achieve the goals of lower crime and better lives for Americans — not just today, but for generations to come — at the lowest net present cost possible. I want to encourage market competition so as to maximize economic Darwinism, but do so in a fashion that encompasses the total costs of the transactions, so that those engaged in commerce don’t benefit by stealing from those around them.
While I don’t believe that the entirety of the Democratic Party Platform aligns with those beliefs, far more of it does than does the Republican Party’s counterpart.
But what I long for most is for these issues to be discussed. We haven’t had many true political debates in the United States in my lifetime. It’s too easy to go for the cheap shot, and those who do receive too much benefit to stop doing it. It was my hope from the start that Logarchism could be a beacon of light, a place where the issues could be discussed without devolving into cheap shots. I think we’ve done better than most corners of the Internet, and I’m proud of that. But I’m also sorry that we haven’t been able to do more.
What does our future look like when we can’t look holistically at policy, when we must reduce everything to simple solutions to complex problems…simple solutions that we all know (or should know) won’t work? As we approach the 237th anniversary of the official signing of the Declaration of Independence, I fear for our country. We cannot solve anything if we are unwilling to consider, reconsider, and rethink that which we already “know”.
That is the real elephant in the room.