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Gamma Ray Economics The Intellectual Super-Hero Powers Endowed by Economics ENGAGEMENT Definition: How to act or react within the public policy arena Discussion:

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Presentation on theme: "Gamma Ray Economics The Intellectual Super-Hero Powers Endowed by Economics ENGAGEMENT Definition: How to act or react within the public policy arena Discussion:"— Presentation transcript:

1 Gamma Ray Economics The Intellectual Super-Hero Powers Endowed by Economics ENGAGEMENT Definition: How to act or react within the public policy arena Discussion: Economics and public policy are deeply intertwined. One of the most important issues for any business, entrepreneur, or family is understanding how they, their market, and their trading partners are impacted by government action. It may be regulation, taxation, legislation, government spending, fees, incentives, rebates, liability, or judicial oversight. Most likely, it is a combination of all of the above. Being educated in economics allows you to identify and participate in these issues at the local, state, national, and international level. As you might expect, many public actions based on laudable intentions have little chance of achieving their stated goals. For example, some companies are pro-global warming regulation in certain countries and anti-global warming in others. This happens when a company produces in one country and sells internationally. If its competitor’s production facility is in a different country, they will push for pro-global warming regulations there and be against the same in the country which host’s their production. Finally, engaging doesn’t mean dealings to ‘scam’ the system, but it does mean understanding when and how to define and demand a level playing field. Photo from Flicker Commons: National Archives President George W. Bush and Speech Preparation. Used under Flicker Commons Rules:

2 Gamma Ray Economics: Engagement Markets and Government Perfect competition needs minimal government activity to achieve socially beneficial results. Not every market is perfect. Market Failure Some products (think local Police) cannot be allocated in competitive markets. Some markets are perceived as “broken” due to resource, equity, historical, or other reasons. Government Solutions Government solutions often cause bigger problems. Government action tempered by market discipline and incentives improves government performance. Return to Market Dynamics

3 Gamma Ray Economics: Engagement The Pros and Cons of Government “Economic cases can be made for and against government. The case for government stresses the productive nature of some government actions: removing individuals from prisoner’s dilemma settings that they want to be removed from, adjusting for externalities, and providing nonexcludable public goods. The case against government stresses the fact that government can act as an agent – a transfer mechanism – that makes it possible for one group to take from another and give to itself. This type of activity often creates a divisive society, wherein individuals and groups are pitted against each other. Also, the case against government is based on government actions sometimes producing adverse unintended effects.” Roger Arnold, Microeconomics 10 th Edition

4 Gamma Ray Economics: Engagement The Typical Cases for Government Monopolies – When only one business supplies a product, it has the power to manipulate the market and government regulation or ownership of the product is often recommended. For example, police power is held exclusively by the government. Meanwhile, electricity transmission is generally provided by a heavily regulated private sector. Public Goods – Parks and roads are the classic examples of goods that no individual business seeks to provide because they have no practical means to generate a return on their investment. Thus, except in limited cases where limited use of the facilities is possible, the government tends to provide these goods. Negative Externalities – If the production of product creates a negative output (secondhand smoke or toxic wastewater, for example) the total costs are not reflected in the price and, thus, the product is over produced. Government intervention to address the negative externality is often implemented. For example, industrial paint shops are required to operate in sealed, airtight environment that prevent the spread of chemicals from the painting process. Positive Externalities – If the product generates a benefit to individuals who neither produce, purchase nor consume the product, then the government often promotes or provides financial incentives to promote the product. Typical examples are funding for solar panels, higher education and housing. All of these carry the perception that greater use will mean a better society.

5 Gamma Ray Economics: Engagement The Typical Cases Against Government Rent Seeking – Most companies will claim their product has positive externalities and attempt to lobby for incentives or tax breaks for their product. Only the largest companies tend to be successful in lobbying and this reduces market competition and encourages the overinvestment in products by skewing the prices seen in the market. Regulatory Capture – Regulated companies tend to develop close relationships with those that regulate them. The specialized knowledge necessary to regulate means that many individuals in government will seek jobs in the regulated industry in future or, started their careers in the regulated industry. This prevents effective regulation because regulators are biased for their former or desire future companies. And, regulators tend to create hurdles that are expensive for smaller, start-up firms to pass. Crowding Out – Any government activity crowds out a market opportunity for the same. A classic example is the municipal recreation center. These often have work out equipment, treadmills, racquet ball courts, indoor sports and other amenities, just like their private sector competitors, the health club. The construction of a municipal recreation center will discourage a private investor from building a health club. Likewise, the opportunity to lend to the government is often preferable to lending to the private sector. Thus, businesses cannot get loans to expand when government borrowing is high. Moral Hazard – Risk tends to encourage people to be more cautious. A government safety net for people or for big business eliminates the downside of risky behavior. Just as the firm that expects a bailout doesn’t mind spending all its money on foolish activities so too the average citizen is less likely to save for their retirement if the promise of a government-funded retirement is available.

6 Gamma Ray Economics: Engagement Assessing Your Market Whatever your business, commercial or personal, you need to figure out what the government is doing that impacts you. Any action by the government has ripple effects that must be considered. The indirect or unintended impacts of policy are often the most important. Flicker/Sean Rogers

7 Gamma Ray Economics: Engagement Assessing Your Market Is there a real market failure? Yes Is the government involved in the market? Yes Make sure the government action is an improvement over the market failure No Consider government action only if it can improve the situation No Is the government involved in the market? Yes Get the government out of the market No Keep the government out of the market

8 Gamma Ray Economics: Engagement Situational Engagement The market for eating out has a failure. Each restaurant has an incentive for maintaining a clean and healthy kitchen; their reputation suffers if people get sick eating their food. However, they also face competition from many nearby restaurants and they have no way of knowing how clean their competitors are keeping their restaurants. Thus, while most restaurants’ need for a good reputation is enough to incentivize healthy standards, some may be tempted to neglect cleaning in order to save time or money. This hurts the people who get sick and it makes all people less likely to eat out at all since we cannot inspect each kitchen prior to dining. This impact on society is a negative externality. Thus, local governments intervene in this market failure by enforcing health standards. If you encounter a similar situation, you’ll want to make sure the inspection regime is fair. For example, larger restaurants have more customers to split the costs of meeting regulatory burdens. They may push for regulations that are only intended to place high burdens on their smaller competitors. Since big restaurants often lose key staff who go to start their own smaller competing locations, big restaurants will want to burden new entrants to the restaurants business with high regulations in order to discourage them. Market Failure with Government Involvement

9 Gamma Ray Economics: Engagement Situational Engagement The market for landline telephone service has a failure. Once one company has started building a network of transmission lines, it creates a natural monopoly. No other company has an incentive to build a full transmission network. All the customers want to speak with each other and they are all already on the first network. Thus, most countries create a regulatory agency to oversee the monopoly landline telephone transmission line provider. Some countries never had the demand or stability to warrant the creation of a landline telephone system. The same natural monopoly existed in theory, but not in practice. For example, Somalia never had landlines and went straight to cell phones because cell towers can be erected at relatively low costs by competing cell phone companies. The cell phone market isn’t subject to the same market failure that generates the natural monopoly for transmission lines. Contract enforcement is another classic example. If the judicial system in a country fails to enforce contracts related to lending, capital formation or other business transactions, no one will do business. Business needs a robust legal system that holds businesses accountable. Without the power of legally enforceable contracts, individuals and businesses don’t have the trust necessary to trade. This market failure without government action prevents economic growth in many countries. Market Failure without Government Involvement

10 Gamma Ray Economics: Engagement Situational Engagement Without government involvement an efficient free market for housing would exist. However, two different levels of government interact with the housing market in order to meet social goals unrelated to the standard economic concept of a market failure. Local governments pass strict housing standards related to where and how to build housing that have the impact of increasing costs. In the absence of these standards, individuals would still be able to select housing based on their own assessment of quality and location. Some builders would get bad reputations and freely negotiated insurance requirements would take the place of local fire and quality standards. National subsidies and policies in the U.S. have typically centered around a preference for home ownership. This placed households in politically preferable single family homes but also contributed to the recent financial crisis because the underlying financial portfolio of many of the impacted families were simply a better match for rental units. In the absence of these, the day-to-day negotiation between households, lenders, builders and landlords would come to natural equilibrium. Some people would have smaller dwellings on less land. Some would choose to drive farther to obtain the housing they desire in more exurban areas and some would forgo an automobile purchase to get better housing closer to their destinations. Many more would share habitations to save money. Is removing unnecessary government involvement possible? Yes, many countries that left the influence of the Soviet Union introduced free markets to slowly replace government- run markets. No Market Failure but the Government is Involved

11 Gamma Ray Economics: Engagement Situational Engagement Perhaps the most prominent example of a well-functioning market achieved with no government involvement has been the development of the internet. Technology developed for U.S. defense applications during the Space Race and Arms Race of the 1950’s, 1960’s and 1970’s provided the technical capability to start up the internet. With the technology made available, no regulatory or tax framework guided the development of the infrastructure of the internet or the various companies from America Online to Ebay to Google to Skype that have found various ways to build business. The rules that ‘govern’ internet protocol were not written by the government. They are voluntary technical standards developed by the industry. Why? Because the self-interest of each party includes the need to work together. We could have the government oversee the assignment of I.P. addresses but, the market has a more efficient way of doing it. The government could have required use of its own internet exchanges but the market developed them first. The peering system itself is an example of self-regulation because it is the cooperation between networks that makes the internet beneficial. We could have the government establish how neutrality on the internet should function but the market has a better way of policing neutrality. No single organization controls the internet. It has grown due to the market incentives associated with cooperation. Any market you encounter with similar incentives for cooperation can operate without a heavy hand from the government. No Market Failure and the Government is not Involved

12 Gamma Ray Economics: Engagement Economically Efficient Government A broad range of thought now exists on using market forces to correct and guide the market. Here are some examples: Rules for action based on market signals – perhaps the Federal Reserve should only act when certain conditions are met in the bond or currency markets, negating the dynamic of market fluctuations based on what the Federal Reserve might do. Competition amongst government entities – perhaps as different local governments compete to attract residents, they will create ever improving educational opportunities for their children, negating the need for Federal oversight of education. Competition in the provision of government services – perhaps out-sourcing traditional government functions like trash pick up allows efficiencies into a sector, negating the need for every local government to own and operate waste hauling equipment.

13 Gamma Ray Economics: Engagement Rules of Engagement Don’t assume a need for government action. Order and accountability are features of the market, even imperfect markets. Seek market interventions that increase the competitive aspects of the market, particularly the drive to innovate. Recognize that many businesses get involved in government and media only to increase profits; their lobbying efforts are likely to have a profit motive. Don’t be part of the problem, ask the government to level the playing field, not to tilt it in your favor.

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