Transcript 13-2015-13 Paving the Way to Perdition

Paving the Road To Perdition: The
unintended consequences of
otherwise good intentions.
Often economic issues are influenced by external factors such as appeals to justice or fairness which is
defined outside of the economic framework and have impacts inside the framework in ways that are
totally surprising. These approaches constitute deadweight losses that are profound and in some cases
are greater than the impact of either business structure or taxes on welfare.
Adam Smith coined the phrase “laisser faire” as the appropriate economic approach to avoid these
types of pitfall. It is often touted in current debate as “let the market decide” when in fact it is the
market operating efficiently that incorporates the deadweight loss and allows us to identify its extent.
There are two major areas of focus that are currently being discussed amongst economists:
“over” regulation (supply manipulation)
“over” compensation (demand manipulation)
“Over” Regulation (Supply Manipulation)
• Governments have become involved in manipulating markets through supply management as a method of
transferring benefits from a chaotic market to a more predictable one.
• Many agricultural products have been marketed this was as a method of protecting the farmers themselves
from large corporations. The provincial Marketing Boards cove eggs, chicken, turkey, vegetables, pork and a
host of other foods. Freshwater fish and dairy are managed federally. These operations provide a “quota” to
the producers who then markets according to the conditions of that quota and also has the right to buy and
sell quota from anyone who may be interested. The value of that quota then is a capital cost of the
operation or a barrier to entry to others.
• The Principal Agent Problem in economics refers to a case where the value of the system is greater than the
value of the purpose of that system to those who manage the system. In other words those who “serve”
derive more benefit than those who are “served”. It is readily identified where a government agency
extracts more from the economy than it contributes or when the transactions costs associated with
accessing the service exceed the benefit to those who wish to access the service itself.
The Principal Agent Problem
•
The Principal is the owner of the system… usually a government or a large corporation and the Agent is the management team assigned to manage the system in
the interests of the owner. The problem occurs when the promoted supply exceeds the actual supply and the surplus generated for the producer exceeds the
original consumer surplus. CDE > ABC. Note also that the Agent is aided by those who supply to the system who gain surplus CDF as they also benefit. Note the
deadweight loss is CFDE because of the excess supply. It is a deadweight loss because it removes resources from other wealth generating opportunities.
Price
A
Supply Actual
Demand
Supply Promoted
Equilibrium
Price
B
C
E
D
F
Quantity
Equilibrium
Quantity
Over Supplied
Quantity
Promoted
Quantity
“Over” Compensation (Demand
Manipulation)
• Excessive compensation derives form the process of over valuing a system based on expectations of a forthcoming reward
or fear of a forthcoming calamity. In this way military expenditures are often pursued with fervor in the face of an
impending invasion, cultural initiatives are funded in the face of a national unity crisis but also investment processes are
encouraged in the face of a new technology that everyone “has to have” and funding for athletes is accelerated in the
hope of winning international events (Olympics or World Cup).
• These approaches tend to set an expectation of an outcome that governments tend to prepare for as a mark of due
diligence. The criteria then shift from effectiveness ( protection, harmony, innovation, or pride) to the more readily
efficiency measurements (firepower, number of performances, the number of users of the new technology, or the number
of patriotic demonstrations) In every case the efficiency measure is more readily observable than the effectiveness
measure and is known as Proxy Deception.
• In the absence of feedback from the other participants inn the economy there emerges an attitude of “if it isn’t broken,
don’t fix it” that perpetuates the deadweight loss and becomes the norm rather than the exception as standing armies
proliferate, endless conferences talk about issues, technologioes are pursued even if they don’t appear to make sense, and
athletes become icons .
The Proxy Deception Problem
•
The Proxy is the claim made by those with an interest in the issue and the Deception arises because it is otherwise never challenged. The potential threat or blessing
elevates a promoted demand that increases the resources spent on the issue by expanding consumer surplus by an amount of ABDC but from which an amount BCD is
immediately syphoned off to the producer surplus. Only when consumers note a loss of welfare such that ABC < BDE will there be an issue regarding the overall welfare of
society as a whole.
A
Demand Promoted
Price
Price
Promoted
Supply Actual
B
C
Price Over Paid
D
E
Equilibrium
Price
F
Demand Actual
Quantity
Equilibrium
Quantity
Resetting the Pathways to Progress
• The Over Regulation and the Over Compensation issues emerge because of the existence of a promoted
rather than a measured Supply or Demand curve. This difference exists because of the predisposition to
consult “experts” who have a vested interest in the end result that they profess to understand (John Muth)
Often both consumers and producers have no way to differentiate between what is verifiable and what is
not.
• The scientific maxim is to “trust but verify” but the “inertia of the moment” often leads this approach
astray. The market mechanisms of price and quantity are often ineffective in this situation.
• Economists have come up an approach to non-market issues that focusses on placing the responsibility for a
market action (environmental degradation, food quality, product safety, etc.) on those who benefit rather
than those who cause the problem. This is accomplished through class action lawsuits which organizes all
affected to prosecute a case and thereby internalize the externalities even if they cannot be assigned to a
single specific source. (Robert Coase)
• In this fashion more of what is bad can become a good and the market forces are reset.