Against Double-Counting Virtue: the Many Faces of Value

At times I fear that the highlight of my blogging career will be pointing out minor errors in Scott’s otherwise excellent posts. But his quality is so high that this is probably a commendable achievement anyway – or so I reassure myself. Anyway, now I’m back from the Midwest and have internet again, I can continue this sacred quest.

Recently, Scott wrote a post about how charity is a better mechanism than political activism for discharging any positive moral obligations we might have. As an aside, he points out that it’s credible that he actually has no such obligations, as his net impact on the world is positive anyway:

The marginal cost of my existence on the poor and suffering of the world is zero. In fact, it’s probably positive. My economic activity consists mostly of treating patients, buying products, and paying taxes. The first treats the poor’s illnesses, the second creates jobs, and the third pays for government assistance programs.

However, while I agree that ordinary productive members of society plausibly do not have such obligations, this argument involves double-counting. He basically does two positive things:

  1. Treating patientshttps://effectivereaction.wordpress.com/wp-admin/post.php?post=142&action=edit&message=1 in his job (imagine Scott does surgery)
  2. Buying things (say bread)

(We’ll ignore the bit about taxes.1)

Now consider Scottlynn, the farmer. She figures her net impact is positive as well. She basically does two things:

  1. Growing corn and turning it into bread
  2. Buying things (say surgery)

Yet now we have the same activities appearing in two people’s lists!  Scott considers both his buying from, and selling to, Scottlynn as his positive impact. Yet Scottlynn counts those exact same transactions as part of her positive impact!

This is because (ignoring for the moment the inherent dignity that comes from productive work) Scottlynn doesn’t really value being employed per say – she values it because it gets her money, which she can then use to buy surgery. Buy surgery… from Scott. He shouldn’t count his purchases as part of his positive impact; the only reason it’s good is because it will later on allow her to buy the other thing he counted as positive impact! To avoid double-counting, he needs to pick one or the other. This is similar to how we have multiple ways of measuring GDP – the production method, the income method and the expenditure method – but we can’t mix them together.

The money/price system serves three purposes; it rations scarce resources, it signals which need to be produced more, and it incentives their production. But it is only a means to an end; ultimately, what matters is the goods and services that are produced, and that they go to those who want them.

Some macroeconomic theories do suggest that there might be times when simply spending money is a good thing; for example, if you have cyclical under-utilization of resources due to sticky prices. But it is unclear if that’s actually ever really an issue; other equally plausible theories of macroeconomics say it’s not. And even if the Neo-Keynesians are right, their theory implies that sometimes (when you have cyclical over-utilization of resources) simply spending money is a bad thing! Over the long run the economy operates at above and below capacity roughly as often, so these two effects will cancel out.

I’m sure there are other positive non-charity things Scott does. For example, he’s probably pleasant to his coworkers, and he creates a lot of value through his blog. But buying stuff isn’t one of them.

 


  1. We’ll assume Scott works for the private sector, and otherwise ignore the government, though if you thought the government was very evil, or taxes very immoral this might change the conclusion. 
Advertisements

How not to reform the insurance industry

Browsing the comments on Scott’s blog recently, I came across an interesting suggestion for reforming the insurance industry.

If I were declared supreme fascist dictator of the world (which would be GOOD for the world), I’d decree that insurance companies had some specific fixed amount of time to investigate a client and return the premiums not consumed by that investigation. After that, unless they could prove deliberate fraud they were on the hook for their contract.

– William O. B’Livion

However, this is probably a pretty bad idea.

At the moment insurance companies only need to investigate clients who make a claim. If enacted, this would require insurance companies to investigate at length everyone who took out a policy.  As such, investigation costs would be much higher, requiring higher premiums for everyone.

Additionally, at the moment there is an implicit punishment for attempting to cheat an insurance company: you pay the premiums, but then don’t get the payout, so the premiums paid act like a fine for your attempted fraud. If insurance companies had to investigate at the very beginning instead, people would have more incentive to try to defraud insurance companies, as there would be less cost. As such, both fraud and anti-fraud costs would rise, both of which require an increase in premiums for everyone.

Finally, at the moment these foregone premiums go to the insurance company. As the insurance market is pretty competitive, this money ultimately results in lower premiums for honest customers. Requiring insurance companies to investigate immediately would take away this cross-subsidy and again raise premiums for everyone.

So it turns out that, like most such suggestions involving restricting people’s ability to freely sign contracts without any clear market failure identified, the proposal is a bad idea. Perhaps this might be a popular policy, if people somehow ignore the costs, or assume they’re being paid by evil corporations. Indeed, this might even be popular with incumbent insurance companies, if the high upfront costs of investigation it would require act as a barrier to entry and protect them from competition. As usual, ultimately the consumer pays. But it’s interesting how, in exploring why it’s a bad idea, we come to appreciate more the virtues of the current system.

The Future of Socialism is Privatizing the Atmosphere

Scott recently wrote a quite interesting review of John Roemer’s ‘Future for Socialism’. It sounds rather like Schumpeter’s Capitalism, Socialism and Democracy. Funnily enough his vision for socialism also reminds me of Margaret Thatcher’s plan for property-owning democracy. I haven’t read the underling book, so I can’t comment on that, but I can talk about Scott’s writing. More importantly, it provides an excellent excuse to talk about how to save the environment by privatizing the atmosphere.

Central planning could never work, so a socialist economy doesn’t need it. Bosses and managers seem to be doing a good job keeping their firms profitable, so they can all keep their jobs under socialism. Everyone has different skills, so clearly in a truly socialist system they deserve different wages, in fact whatever wage the market will bear.

…you give everyone an equal amount of these stocks. When the corporations make money, they pay them out in the form of stock dividends, which go to the people/stockholders. So every year I get a check in the mail representing my one-three-hundred-millionth-part share of all the profits made by all the corporations in the United States.

We’ll assume that when Scott says ‘Stock Dividend’, he actually means ‘non-stock dividend.’ A stock dividend is when a company gives extra shares to its existing shareholders. This increases the number of shares outstanding, but has no real economic impact. What Scott presumably means is ‘cash dividend’, which is when a company gives cash to all its shareholders.

However, this immediately opens up a problem with the next part.

Roemer proposes a law that stocks cannot be sold for money, only coupons and other stocks. Every citizen is given an equal number of coupons at birth, trades them for stocks later on, and then trades those stocks for other stocks. This allows smart citizens to invest wisely, and allows a sort of “stock market” that sends the correct signals (this business’s stock price is decreasing so maybe they’re doing something wrong) but doesn’t allow stock accumulation by wealthy capitalists.

While I applaud Roemer’s attempt to make use of the valuable signals sent by prices, his plan for preventing people from selling their shares won’t work. If such a policy was instigated, there would probably be strong demand from people for a way to turn their shares into cash. They’d even be willing to accept a discount for the sake of the liquidity cash offers. So some companies would sell all their assets and pay out all the money as one massive liquidation dividend. By announcing this in advance, the company would basically become a way to turn your shares into cash – just swap your other shares for its shares, and then wait for the single massive dividend.

In this system, businesses would raise funds not by selling stock but by seeking loans from banks.

This is where it really gets crazy. Earlier on Scott said that companies would pay out all their profits as dividends. So they can’t issue new equity, and they can’t retain the profits they’ve earned: companies would eventually become 100% debt financed. As soon as they hit the slightest downturn, without a buffer of equity to absorb losses, they would all go bankrupt. And bring the banks down with them. Then you have zero companies, shareholders would envy those who got their money out before the end, and the living would envy the dead.

So perhaps we’ll lighten the requirement that companies have to pay out all their profits. Companies that routinely raise new equity will be in trouble, like tech companies, but lets assume they solve that problem. Utilities also rely on continued equity issuance, so we won’t be able to charge our devises anyway.

More seriously, this would present massive problems for new companies. Or rather, it would prevent there being any new companies. The way you found a company is by investing some money and becoming the owner of a startup – effectively, the startup sells stock to you. Without this, there’s no way to found a new company. So we have a finite number of companies, that occasionally go bankrupt, take each other over, or liquidate themselves. These companies own all the factors of production, leading to a less and less competitive economy, dominated by a couple of few firms, with absolutely no fear of new entrants shaking up their cosy oligopolies.

So there are some problems with Roemer’s ideas. In fairness to Scott, he spots a lot of other problems himself, and he doesn’t even have an economics background. In fairness to Roemer, perhaps Scott misrepresented him. Lets just say that Roemer-as-paraphrased-by-Scott’s plan has some serious disadvantages.

However, it did make me think of an interesting idea I had a while ago. Here is an way of using joint-stock corporations to solve collective action problems.

How to solve the problem of pollution by privatizing the atmosphere.

At the moment, people are incentivized to over-pollute. If my factory releases dangerous emissions, I get much of the benefit, in the form of profits from selling my product (along with my customers, employees, suppliers etc.) I pay only a fraction of the costs though – most of the pollution effects other people. Since I gain much of the benefit, and little of the cost, I tend to pollute too much.

The problem here is one of negative externalities. Equivalently, it the tragedy of the commons. And what is the solution to the tragedy of the commons? Privatization. If one person owns the field, they have the right incentive to preserve its value.

Similarly, we could privatize the atmosphere. People who wanted to use the air (say, by breathing, or burning fuel) would be charged a fee. This would cause them to internalize the external cost, and restore efficiency to the market for pollution.

Of course, this would be rather difficult to administer. How are we going to charge people for breathing? Do people get charged more for having bigger lungs? If people fall behind on their payments, do we cut off their oxygen? Doing so would plausibly count as theft, as currently they enjoy use-rights to the air.

Fortunately, this can easily be solved. Simply give everyone shares in AeroCorp. Because AeroCorp gets most of its money from coal plants and gasoline companies, it pays a dividend each year well in excess of the breathing price. So everyone’s breaths are just netted against the dividend, and they never have to send any money to AeroCorp. Because polluters now have to pay AeroCorp to emit pollutants, they’re less keen to do so, and the negative externality problem is solved.

We could even have a dual share class system. Every human is given a single A-share at birth. These are non-transferable, dilution-protected, and their purpose is to ensure that everyone can afford to breathe. We also have B-shares. These have the same voting and dividend rights as A-shares, but are transferable and dilutable. These are initially auctioned off in a standard IPO. They money raised will be used to fund AeroCorp’s operating expenses. Trading in these shares would ensure price discovery, efficient capital allocation and allow secondary issuance.

There some problems with this system. For example, the firm would be a monopolist, so would tend to charge polluters too high a fee. As such, society would actually end up underpolluting.

Additionally, we need to ensure the two share classes don’t take advantage of one another. There are probably more A-shares than B-shares, but B-shares will be more closely attended to.

One strategy B-shareholders could use would be to have AeroCorp buyback stock. Ordinarily this would be fine – it would raise the value of A-shares. However, in this instance we’re relying on the dividends paid to B-shares to cover the oxygen charge.

A strategy A-shareholders could use would be to insist on new equity issuance, diluting B-shareholders, then paying out the funds raised as a dividend, thereby benefitting themselves.

These two problems could be solved in an attractively symmetrical fashion by giving the B-shares a veto over buybacks and giving the A-shares a veto over new equity issuance.