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.