Allocation of resources

Economics is the allocation of scarce resources to better achieve prescribed ends. My previous post discussed the prescribed ends. What about the allocation of resources? The evidence tends to support economic theory in saying that markets are the most efficient way of making the most of our limited resource endowment. Perfect competition is the basis of the ideal market. Under perfect competition any single buyer or seller has a negligible impact on the market price and information is perfect. If firms make excess profits the absence of barriers to entry means that other firms will enter the market and drive the price level down until there are only normal profits to be made. Under perfect competition output will be maximised and price minimised.

Markets can fail when a single buyer or seller can significantly influence prices, when information is imperfect, or when they do not take into account the impact of an economic activity on outsiders. They also fail when they do not generate sufficient incentive to supply public goods.

The market's incentives and efficiencies can often work to improve the distribution of resources,even when resources are initially distributed randomly and inequitably. Markets can work to reallocate resources so that they maximise efficiency and reward the provision of those goods and services that people most value.

So far, so uncontroversial. Also widely accepted is that there is a strong case for government intervention when market failure creates demonstrable, significant negative externalities.

Unfortunately though, much government intervention actually makes things worse, and it does so in ways that entrench and reinforce social and environmental problems. Take agricultural subsidies: research has shown that they are economic nonsense and socially inequitable and environmentally destructive. Yet they have persisted for decades. The big agribusiness corporates like them, because they are the major beneficiaries. Grown fat and powerful on subsidy, they then exert huge leverage over political parties and governments and the result is the persistence of expensive, wasteful and corrupt policies. The subsidies are self-reinforcing. This is not unique to agriculture of course. Perhaps even more socially and environmentally destructive are subsidies to road transport and the energy sectors.

A Social Policy Bond regime would screen out this nonsense at an early stage. Instead of devising policies that allegedly 'help the family farm' or 'ensure a safe supply of food' - when they do no such thing - a bond regime would target meaningful and verifiable outcomes. If the real problem is rural poverty, then our target should be the reduction of rural poverty. If the problem is that some people can't afford food, then our target should be to ensure that nobody goes hungry. The same applies in other policy areas: if climate change is the problem, then reward people for stabilising the climate. If poor health and literacy outcomes are the problem, then reward people for improving them. It is not for government to dictate how these problems should be solved nor to reward its favoured institutions.

Markets are the most efficient means yet discovered of allocating society's scarce resources, but many believe that market forces inevitably conflict with social goals: accentuating extremes of wealth and poverty, for example, or accelerating the degradation of the environment. So it is important to remind ourselves that market forces can allocate resources in ways that serve public, as well as private, goals. Social Policy Bonds are a new way of channelling the market's incentives and efficiencies into the solution of our social and environmental problems.

Prescribed ends

Economics is the allocation of resources so as better to achieve prescribed ends. Who prescribes these ends? In most countries it appears that nobody bothers, and the ends are decided, by default, by bodies such as large corporations and government agencies. Apart from the inflation rate, which is explicitly targeted in countries like the UK and New Zealand, most other policy objectives are obscure or unstated. The UK does deserve a pat on the back for its targeting of child poverty, and it and other governments are beginning to realise that what really matters are outcomes, not amount spent, nor activities or outputs. That said, governments unfortunately subordinate their social and environmental policy not to outcomes but, most often, to existing institutional structures. It is these that in large part receive tax revenues and dictate how they shall be spent. They are most often government agencies, which are not known for being responsive, adaptive or efficient.

Social Policy Bonds would in contrast subordinate all policymaking to desired outcomes. So instead of assuming relationships between cause and effect that might be only temporary and tenuous, they would reward only the achievement of outcomes - whoever achieves them and however they are achieved.

This means that if society sees climate change as a problem, it would reward people for stabilising the climate - not (as with the Kyoto Protocol) for reducing greenhouse gas emissions. If war, anywhere in the world, is a problem, people could issue bonds that reward the achievement of peace - rather than fund the activities of institutions (including governments) that very often inflame conflict.

Social Policy Bonds would formulate policy in terms of ends. They could be issued by individuals or groups, by local or central governments, or by non-governmental organisations. They are explained briefly here. For more details, see the Social Policy Bond website. I will discuss how a Social Policy Bond regime leads to the efficient allocation of resources in my next post.

Your tax dollars at work

Why is the New Zealand Government introducing a Bill in a futile attempt to stop spam? Obviously because poverty in New Zealand has been eradicated, all other social and environmental problems have been solved; because the courts have plenty of spare capacity and because nobody (apart from several hundred private software companies) are offering solutions to the spam problem that does so much to make life miserable for New Zealanders.

Pap and politics

What are our politicians talking about?... Listen to Alan Milburn, New Labour's election campaign coordinator, trying to inspire us by declaring that 'the priority must be to fashion an active citizenship'. Or David Miliband, the cabinet office minister now writing New Labour's manifesto, attempting to kickstart the election campaign this week by promising a new era of 'individual empowerment' in New Labour's third term. it is like listening to the members of some exclusive club, using a code that is intended to keep their plans a secret. Mick Hume, From immigration to Iraq, they are a political class apart, 11 February

Mick Hume is writing about the UK, but he might just as well be writing about New Zealand or the US. Politicians daren't present us with clear choices anymore. Choices create winners and losers, and the debased language of politics, like that of make-believe, cannot admit that policies will make some people worse off. The notion of trade-offs is rigorously excluded from political debate. Instead we get vapid, vacuous platitudes that widen the distance between politicians and the people they are supposed to represent. Every policy statement is scripted, having first been tested on a focus group and fine-tuned by the public relations industry. Politics becomes a battle between PR professionals. As Hume puts it: the gap between the public and politics is yawning - in every sense.

A Social Policy Bond regime would start out by asking the basic question: what outcomes do we want to achieve? Targeted outcomes, not activities or the current institutional setup would dictate where government funds would go. And these outcomes would be transparent: everybody would know what they are. Political debate would revolve around what these outcomes should be and how they should be ranked. There would be more, and better informed, public participation in policymaking because outcomes, unlike the bland pap that is the current political fodder, actually mean something.

Peace in the Middle East - again

In the final chapter of How Israel Lost, Richard Ben Cramer explains how the men in authority, in both Israel and the occupied territories, benefit financially from the conflict. Talking about why he had mistakenly predicted peace, he goes on:

What I didn't see, or failed to think about, was the breakup of Israel's national consensus. ... What Israel lost—apparently while I looked elsewhere—was precisely the capcity to act in the national interest. The interest of the nation was replaced by tribal interests-and, in a lot of cases I see now, by purely indiviudal interest. Making money for instance....

Cramer ends his book on a pessimistic note. My take is that evidence he presents of collusion between the principals at the highest levels (for instance, over the casino near Jericho), is actually a cause for optimism. The underlying principle of Social Policy Bonds, is that financial incentives can be channelled into social goals. If the Middle East conflict is at least in part caused by financial self-interest, then it can be ended by financial self-interest. Middle East Peace Bonds would be non-interest bearing bonds redeemable for a fixed sum only when the conflict has subsided. If the governments involved, or the United Nations, won't issue them, then maybe it's time for philanthropists or non-governmental organisations to do so.

Kyoto

The Kyoto protocol, which requires developed countries to cut their emissions of greenhouse gases, comes into force today. Unlike most opponents, I do not question the underlying science - but nor do I accept it. We need a policy that will adapt to our rapidly expanding scientific knowledge. We need to mitigate climate change (or its negative effects), whatever is causing it and even if there's no proof that it's happening. See a published article about Climate Stability Bonds here. Or click here for more details about my short book on Climate Stability Bonds.

'The Revolution that Wasn't'

This story in the New York Times describes how even people elected on a platform of cutting government end up advocating more spending.

Peace in the Middle East

People make all sorts of compromises for money. We work not solely out of love, or dedication to duty but also because we receive payment. Financial incentives can liberate and focus our ingenuity. So when people talk about allegedly intractable conflicts, or ancient hatreds that can be ended only by the total crushing victory of one side or the other, I disagree. (See this discussion, on the Middle East for example.) In any conflict there are certain to be faults on both sides. But if we really want peace, we have to go beyond history, beyond notions of justice and revenge. All our activities and institutions must be subordinated to the goal of peace. Middle East Peace Bonds would reward people for reducing the numbers of people killed in that conflict to a sustained low level. We don't need to prejudge how peace is to be achieved, but we do need to reward its achievement. Bondholders could try all sorts of possibilities that the current protagonists cannot: they could set up school exchange visits; subsidise intermarriage between the opposing factions; or give everybody with beards first class, one-way tickets to the overseas golfing resort of their choice. The governments in the region have failed, so have the ideologues, idealists, generals and the men of religion. It's time to contract out the solution to the private sector. In short, to give greed a chance.

What Randians think

Why exactly are we supposed to pay taxes to help the poor? We aren't legally obliged to help our siblings or friends, so why are we legally obliged to help perfect strangers? And in the process of forcing people to pretend they love poor people they never met, don't we breach our far more obvious duty to leave people alone? These are not irrefutable proofs, but they are far more convincing than anything in Descartes' Meditations.

To this series of questions raised by Econolog I replied:

One of the reasons for helping perfect strangers is that we take actions that hurt them. Our government subsidises a physical infrastructure that favours corporate interests but does much to destroy communities; it promotes immigration and free trade - for sound economic reasons, no doubt. But there are losers from this, and they rarely have the power of veto. They are due their compensation.

Government and big business get away with reshaping our physical and social environment against the best interests of real people because, I believe, they do not express their policy objectives as outcomes. Instead, they target alleged means rather than ends. They direct taxpayer revenue to this or that agency. But agencies, public or private sector, have their own objectives, primarily self-perpetuation and growth. Policymakers escape or deflect censure because the relationships between their policies and outcomes are obscure. Government ends up subsidising corporate interests and funding the expansion of its own agencies regardless of how effective or efficient they are. It should, instead, target objectives that are meaningful to the people it is supposed to represent. Social Policy Bonds are about finding out what these objectives are and giving government and people the means of achieving them efficiently.

No suggestion of illegality

Australian Ministers' time is auctioned according to an illuminating article from the Age, Melbourne:

Before the October election... a 45-minute walk with Attorney-General Philip Ruddock and "a quicker-paced jog" with Health Minister Tony Abbott each fetched bids of thousands of dollars.

This practice is quite legal. But we need not worry that politicians benefit directly from this practice: the proceeds go straight into the election war chests of the major parties. Big government and corporate interests - what's the difference?

Over-regulation favours big business

On 31 January the European Union Commission unveiled exactly what EU law about food traceability means. EU guidelines spelled out the meaning of that new requirement,technically known as Article 18 of the General Food Law. Every business in the food and drink trade must now keep detailed records of every delivery from a supplier and every delivery out to a customer.

All records must be kept for five years, unless the products are perishable, in which case records must be kept for six months. The intention is to have standardised "traceability systems" across the EU, so authorities can track food almost instantly in the event of a crisis,such as an outbreak of food poisoning or contamination. Transport companies that merely ship food from place to place are also obliged to keep batch by batch records of every delivery they make to a restaurant, grocers or canteen.

There is something pathological about all this. Government and big business create an economic environment that, through (for example) agricultural, transport and energy subsidies, favours the large and global at the expense of the small and local. When this leads to large-scale outbreaks of food poisoning the government reacts by imposing regulations that make it even more difficult for small businesses to operate, because it is the small businesses that suffer most from the costs of complying with the regulations. It's a self-perpetuating process; most of us don't want it to happen, and if policymaking were about specifying and rewarding the achievement of agreed, explicit outcomes it wouldn't happen.

Ends and means

Treasury estimates that our GDP per capita would rise by 5.1 per cent if we lifted our participation rates overall to the average of the top five OECD nations. That's a worthwhile objective and at this time of labour shortage, it's a good time to be pursuing it. Extract from the New Zealand Prime Minister's statement to Parliament, 1 February

There is understandable confusion, at the highest levels of government, between means and ends. The only accepted ways of measuring the welfare of large societies involve numerical data, and the most widely used indicator has come to be GDP per capita. But as an indicator of welfare it is inadequate. It does not distinguish between helpful and harmful economic activity. It puts no value on any activity that bypasses the monetary economy. So it ignores leisure time, the environment, crime, health, and other things that are meaningful to natural persons.

Big business is very much the same in that its objectives are not those of real people: its goals are expressed in terms of profits, sales, growth and market share. Government and big business together are the major determinants of the sort of society in which we live. Their interests drive the current policymaking system. Yet their goals are quite different from, and often in conflict with, those of real people. Natural persons feel disenfranchised so it is hardly surprising that there is widespread cynicism about politics, a growing distance between government and people, and a growing disengagement from the political process.

A Social Policy Bond regime would be driven entirely by outcomes for real people. Under a bond regime, all government activity would serve broad outcomes, such as basic health and educational standards, low crime and a cleaner environment. Unlike the meaningless, abstract drivers of current policy, these outcomes would be explicit and transparent, as would the trade-offs between them. Policymaking would become comprehensible to real people and there would be informed debate about policy and where, as a society, we want to go.