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January 11, 2010

Government Action To Reduce Externalities

Government Action To Reduce Externalities11/01/2010

Posted by opemipo3655 in Economic PolicyEconomicsEfficiency,ExternalitiesPolicyPollutionPublic GoodsSocial Justice
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We all know the feeling: You’re on your way to an important business meeting (even a job interview) and then you end up stuck in a traffic jam. An hour later, you’re already late and you find out that the disruption was caused by some company digging up the roads. Then you think to yourself “Deja vu! I could have sworn traffic was held up by another road-digging crew yesterday, and the day before.” (NB: I don’t know the feeling, I don’t drive and I live on campus at university and secondly, WHY ARE YOU DRIVING IN LONDON? Tube, bus, maybe bike- but then I forget that you can’t be seen on the modes of transport of the masses even if it means sitting for such a length of time that you get a clot the size of your heart… IN YOUR LEG[Sorry for complaining, I understand perfectly]).

This is an example of a negative externality. Negative externalities occur when the market does not lead to the socially optimum price level and output level. Negative externalities arise when the private costs of a good are lower than the social costs (private costs+external costs) leading to a lower price level (as only private costs are recognised by the market) and thus to overproduction of a “bad” which leads to inefficiency and reduction in public welfare (does harm to society or reduces the overall good to society of having cars).

In this case the social costs would include the business deals or jobs that would be lost if everyone that was held up was late to work, their job interview or their meeting and can be estimated quite easily (I won’t) in monetary terms; this is the opportunity cost (to society) of sitting in a car for four hours instead of working. Other social costs include the pollution (smog, CO2 and other gases) from thousands of idly-running cars everyday; affecting the health of those in the area (passengers, drivers, pedestrians, road-diggers, those who live nearby) as well as contributing to climate change; and noise pollution. Even though these costs are quite difficult to estimate monetarily, it doesn’t mean they don’t matter, we shouldn’t try to,  or that it is impossible to. For instance, costs of pollution can be estimated from the costs to treat or cure people who get respiratory problems mainly explained by constant exposure to gases emitted from vehicles.

One way to reduce social costs is for regulators (usually government) to do their job and regulate. Issuing directives on the amount of CO2 and other gases that cars can emitforcing manufacturers to produce less emitting cars and more efficient ones; banning the use of leaded-petrolwhich emits lead (lead poisoning) into the atmosphere; even possibly, requiring manufacturers to make sure their cars are not louder than X decibels.

Another way of reducing externalities (which I think is more efficient as it works through the market) would be for government to raise the private costs of the good to meet the social costs so that the new market equilibrium is at the point where social costs equals social benefits (socially optimum point). This can be done by the government taxing goods with externalities; the new car tax bands are an example- car taxation based on CO2 emittedby the car aiming to make people buy less emitting cars.

I first heard the term social engineering used to describe this type of government intervention some days ago in this Robert Frank NYT article(he writes about global warming, but the theme is transferable) which is unsympathetic to that view and tries to show that it is not a crime against individual liberty to tax harmful goods that some people gain satisfaction from consuming (h/t Mark Thoma):

…Although both proposals pass muster within the Coase framework, conservatives remain almost unanimously opposed to the cap-and-trade proposal approved last year in the House… Much of this opposition is rooted in a passionate distaste for “social engineering”…

But social engineering is just another term for collective action to change individual incentives. And unconditional rejection of such action is flatly inconsistent with the Coase framework that conservatives have justifiably celebrated. …

In the case of global warming, markets fail because we don’t take into account the costs that our carbon dioxide emissions impose on others. The least intrusive way to have us weigh those costs is by taxing emissions, or by requiring tradable emissions permits. Either step would move us closer to the conservative/libertarian gold standard — namely, theoutcome we’d see if there were perfect information and no obstacles to free exchange.

Finally, back to the issue I started with. There was an article in the Guardianabout plans for the government to price and coordinate the road-digging/traffic disruption timetable in London (SHOCK, HORROR- GOVERNMENT) so as to reduce disruption and Londoner’s frustration. “Oh, I thought the government caused the disruption with too much regulation just like it causes everything?” No the private utilities did because they could. No regulation and no costs meant they could dig up the roads whenever they felt like it.


"The Fairness of Financial Rescue

“The Fairness of Financial Rescue”30/12/2009

Posted by opemipo3655 in Economic PolicyEconomicsFinancial Rescue,Great RecessionRecessionSocial Justice
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Brad DeLong (HT Mark Thoma- Economist’s View)

The Fairness of Financial Rescue, by J. Bradford DeLong, Commentary, Project Syndicate: Perhaps the best way to view a financial crisis is to look at it as a collapse in the risk tolerance of investors in private financial markets. … [W]hen the risk tolerance of the market crashes, so do prices of risky financial assets. … This crash in prices of risky financial assets would not overly concern the rest of us were it not for the havoc that it has wrought on the price system… The price system is saying: shut down risky production activities and don’t undertake any new activities that might be risky.

But there aren’t enough safe, secure, and sound enterprises to absorb all the workers laid off from risky enterprises. … Ever since 1825, central banks’ standard response in such situations – except during the Great Depression of the 1930’s – has been the same: raise and support the prices of risky financial assets, and prevent financial markets from sending a signal to the real economy to shut down risky enterprises and eschew risky investments.

This response is understandably controversial, because it rewards those who … bear some responsibility for causing the crisis. But an effective rescue cannot be done any other way. A policy that leaves owners of risky financial assets impoverished is a policy that shuts down dynamism in the real economy.

The political problem can be finessed: as Don Kohn, a vice-chairman of the Federal Reserve, recently observed, teaching a few thousand feckless financiers not to over-speculate is much less important than securing the jobs of millions of Americans and tens of millions around the globe. Financial rescue operations that benefit even the unworthy can be accepted if they are seen as benefiting all – even if the unworthy gain more than their share of the benefits.

What cannot be accepted are financial rescue operations that benefit the unworthy and cause losses to other important groups – like taxpayers and wage earners. And that, unfortunately, is the perception held by many nowadays, particularly in the United States.

It is easy to see why.

When Vice Presidential candidate Jack Kemp attacked … the Clinton administration’s decision to bail out Mexico … during the 1994-1995 financial crisis, Gore responded that America made $1.5 billion on the deal.

Similarly, Clinton’s treasury secretary, Robert Rubin, and IMF Managing Director Michel Camdessus were attacked for committing public money to bail out New York banks that had loaned to feckless East Asians in 1997-1998. They responded that they had not rescued the truly bad speculative actor, Russia; that they had “bailed in,” not bailed out, the New York banks, by requiring them to cough up additional money to support South Korea’s economy; and that everyone had benefited massively, because a global recession was avoided.

Now, however, the US government can say none of these things. Officials cannot say that a global recession has been avoided; that they “bailed in” the banks; that – with the exception of Lehman Brothers and Bear Stearns – they forced the bad speculative actors into bankruptcy; or that the government made money on the deal.

It is still true that the banking-sector policies that were undertaken were good – or at least better than doing nothing. But the certainty that matters would have been much worse under a hands-off approach to the financial sector, à la Republican Treasury Secretary Andrew Mellon in 1930-1931, is not concrete enough to alter public perceptions. What is concrete enough are soaring bankers’ bonuses and a real economy that continues to shed jobs.


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