Economics and Government

It is customary for economists to presume that technological innovation is a process exogenous to economic activity. So, the economic forces are helpless in the process of new capital formation, in spite of the grandiose desire of the entrepreneurs. Instead, it is some ingenious scientist that announces his innovation (like a laser), which later gets incorporated into the manufacturing of cool-looking gadgets and gizmos (entrepreneurs are happy again).

One might be tempted to speculate that innovation is a pure function of its funding. However, a stubborn attempt to inject money into seemingly dead projects has historically proven to be an ineffective technique. It is so because technological innovation emerges in the minds of scientists, which is a non-linear and dynamic process. Conclusion: the almighty market itself is helpless when it comes to innovation.

Unlike the technological innovation, a market for existing technologies (like electricity generation) stubbornly tries to persuade us that it will take care of things on its own. It begs us not to call the government, unless it is in trouble, unless the market fails.

We, economists, recognize there might be a role for government to play in cases of a monopoly, a public good, or an externality. Few months ago, if asked whether acid rain truly represents a negative externality, I would have expressed an undisputable “yes.” However, it seems to me now, the theory of negative externality is not that certain in the case of acid rain. In my previous post “Acid Rain- a Silent Agitator” I have described the process of this external cost being captured by the market. My question is: if acid rain is really not a negative externality, could there still be a legitimate role for the government to play?

Here is the way I see it. A producer creates pollution in the process of generating electricity. That pollution is not internalized in the prices, and is therefore external to the transaction. It is, however, captured by a different market, one for property insurance. Hence, no negative externality exists. At this point an economist would typically express an opinion to refrain from government intervention and not to implement a corrective tax. But isn’t there something inevitably wrong with this picture? Despite the fact that the home insurance market is internalizing the damage, property owners sustained genuine damage that is objectively measurable. Do they not deserve the compensation? Just like in the case of technological innovation described above, the almighty market is helpless on the grounds of efficiency. The Gods have spoken.

Another issue would involve determining which one of the thousands of manufacturing plants has released the chemicals into the atmosphere and is ultimately responsible for the property damage of the homeowners. If that question does not seem tricky enough, try measuring harm accrued to individuals’ health that was caused by pollution. Or was it? Maybe they just had a genetic predisposition to lung cancer and just happened to live nearby a coal-fired plant? We might never know.

Now assume I am very wrong on this and wrong in my previous post to this blog. You suspected acid rain was an externality and you were right all along. When the government taxes the manufacturing plants, trying to remove that marginal external cost, where does the money go? Does it go to compensate the “victims” of pollution? If there aren’t any, does the government pay a third-party contractor to install the filters inside the smoke stacks so that such high concentration of chemicals is never released into the air again? Or does the government keep the money, appropriating it to whatever means it desires (ha!), yet mandating the manufacturer still installs the filters? I think the latter is true. If caught, a producer is mandated to pay a fine (once again, I’m not sure where the money goes) and then to install the filters.

So where do those funds go? Where can they be spent/invested? Could those funds subsidize or even fully finance building a new nuclear reactor? Larry Eubanks only knows. But if such monetary expenditure of funds is considered appropriate, it would be attributable to market failure in a slightly different meaning of a term. Private market would be quite hesitant to forgo such sizable investment due to the following reasons:
1) Enormous initial investment coupled with minuscule profit margins. It is thus highly unlikely an entrepreneur will recover initial investment and/or be profitable.
2) Inability to price discriminate.

That is precisely why a newly created nuclear reactor would be government-owned. Does anyone know if those things can be leased to qualified private businesses, under close supervision of the Big Brother of course, or would it be the “national defense- strategic resource” argument to justify the government maintaining it? More on nuclear power industry in my next post.

Acid rain- is it really an externality?

An idea of an unintentional market interdependence in the form of a spilled cost onto a third party as a result of a market interaction between two other entities is very tempting to embrace. But is acid rain really an externality? And if it is, could there perhaps be something we never hear our colleagues speak of? If there is a market interdependence in the case of crime (such as the market for insurance) and crime is then not considered a negative externality, could we find such markets in the case of acid rain?

It is clear the “primary market” exists- a supplier of energy through coal burning interacts with the consumers of electricity as a result of the derived demand for coal. Hence, there is an initial market. Then let’s assume that some of the byproducts of electricity production cannot be sold in the market and the producer is disposing of them in the least costly way (blow them out of the stack). Due to the tall stacks of this factory (perhaps as a result of government regulation), the chemicals released are being transferred to a different location (area B), and descend back into the atmosphere via the harmful acid rain (or some other objectively harmful phenomenon).

So it seems, because of the production of the economic “good” such as electricity, we produce an economic “bad” such as acid rain. Unbeknownst to the residents of area B, they suffer this economic “bad” in a form of an acid rain that causes property damage to residents of area B. My first question: are these “negative externalities” captured by any market at all? In the case of acid rain, a market for property insurance will capture the damage. So can the pollution that caused the acid rain and subsequently property damage still be classified as a negative externality? Whatever the answer, is there anything else to it?

For simplicity purposes, let us assume 100 residents hold property in area B (each owning only one house). If 35 houses sustain measurable damage attributable solely to long-run effects of the acid rain, the insurance rates for the entire area will rise. Therefore, the house owners who are currently the customers of the insurance company will now have added costs associated with added risks (that is perhaps another justification how acid rain is not a negative externality). This suggests more individuals will realize the “status quo” of their neighborhood with regard to acid rain. Thus they will consume more insurance because of the higher probability of being rained on. Notably, it is an example of adverse selection.

Finally, as more residents of area B consume the insurance, as well as the increase in the quantity demanded by the current insurance customers in that area, they cast their dollar votes opting to be more risk averse. By casting their dollars in such a manner, they opt for insurance and opt away from consumption of alternative goods and services. Such pattern of spending money could lead to a reallocation of resources with ramifications extending into tempos of new capital formation, employment within insurance, other sectors of area B’s economy as well as certain political outcomes, the nature of which is quite uncertain and highly speculative due to the circumstantial details of this scenario.

I think John Stossel is Great! In this article (along with a video piece on 20/20 and a interview on ABC news), Stossel shows us how ethanol is not the save all to our energy problems. Stossel splits the article into 2 major parts: the subsidy and the science.

But if ethanol made so much sense, we wouldn't have to subsidize it or mandate its consumption. Jerry Taylor of the Cato Institute said, "If you can make a profit in this economy by putting something on the market, the government doesn't need to put a gun to your head." The "gun to your head" is the reference to governments coercive power in regards to collecting taxes and then giving those revenues to the subsidy. So, actually we wind up paying a higher price for ethanol- once in taxes for the subsidy, and then once at the pump.

Stossel then talks to the politician:

When I interviewed Sen. Evan Bayh of Indiana, he griped that "we have allowed our dependency on imported petroleum to grow and grow and grow -- that's not healthy for our country."
I asked Bayh, "But isn't the ethanol program robbing Peter to pay Paul -- with all of us being the Peters and the corn producers being the Pauls?"
"You're currently being robbed to pay sheiks in the Middle East," said Bayh. "Doesn't it make more sense to have Middle Western farms producing America's fuel?"

I'm pretty sure we do not pay a subsidy to sheiks in the middle east. I have the option now of choosing which country (through various filling stations) I get my gas- it is a choice I make. I could, if I choose, to not even buy gas (say if I biked and used public transportation). But with the subsidy, I am forced to pay taxes which in turn are used for the subsidy.

The politician does not see the market here, he just sees votes and staying in power. It should be obvious to all who the bootleggers and the Baptists are.

Even if we do not use ethanol in our cars, we still pay the subsidy. I want to note, along with this thought, that we are going to see a higher price in food as well, due to the high price of corn- and the subsidy still continues.

Education vouchers are a controversial topic in education. The oppoisition argues that a voucher system will increase inequality and leave behind the less privileged students. However, with vouchers in place the standard of education would rise significantly. Schools would have to compete for students and this will in turn rise the quality of education in general. Meaning that every student would be better off not just the privileged few.

If parents are allowed to take their voucher funds to private schools, then we could see a prominent increase of private schools into education. The increased presence of the private sector will increase the quality of education in both state run schools and currently functioning private schools. We all know that government operates inefficiently, and that govenrment funded programs do not face any incentives to improve quality. A voucher system along with a more prominent role of the private sector in education could drastically improve America's education system.

Article: http://www.iht.com/articles/2007/05/01/business/01food.php

The FDA is supposed to be in charge of keeping our food safe. Whether this is an efficient way to do things is not really the focus of this post as much as how well this article about the FDA highlights one of the points we talked about a little earlier this semester.

What is the goal of every government bureau? To maximize its operating budget. For the FDA the wave of food contamination is the perfect opportunity to get a new larger budget pushed through whichever process is required. There are ample baptists (this article calls the critics) to decry the small budget of the FDA as the reason for these contaminations were not caught before they reached the public. Clearly with the assumption that a bureau's primary concern is to make sure they are constantly in demand and given a higher budgets each year, it is pretty to think of who the bootleggers are. Even though the increase in bad press may seem like a bad thing for the FDA it is unlikely that anyone there will be held personally responsible. So to recap.. they messed up but no one will have to face any tangible consequences and because of the press they will probably be looking at an increased budget fo next year. Sounds pretty good to me.

And by good I of course mean bad and terrible and just wrong. There have to be better ways to do thins sort of police work that provides the right kind of incentives instead of screw and get more money...

EDIT: Well lame another post about the FDA right before this one... oh well it is a different angle on the whole thing at least.