Setting externalities straight: the elephant in the room

A recent comment on Megan McArdle's blog gave me a chance to explain (again) what I think is wrong with "glibertarian" (glib libertarian) solutions to the problem of externalities.

Basically, I think that when people complain about negative externalities, what they are really complaining about is a negative externality that they also find morally objectionable, but for well-grounded, intuitive, practical reasons. To suggest that the victim of such shenanigans should have to pay off the wrongdoer, thus misses the point. That is exactly the reasoning I elaborate on in the comments section of that post.

So, to the discussion. Jim Glass said:

... *if* transaction costs were zero *then* "externality problems" like pollution would be bargained away in the market, but these problems aren't bargained away in the market, *thus* transaction costs are large -- and should get a lot more attention from economists and other social planners than they do.

So I responded:

Jim_Glass: actually, as I said above, I think the problem people intuitively have with this Coasean reasoning is that it's not true, even in the pure case of no transaction costs.

Think about it this way: what if while you were sleeping I came close to your window -- though still outside your property, and revved my motorcycle loud enough to keep you from sleeping. And let's say that, because of some technicality, there's no law or property right you can invoke to make me stop.

Would you seriously try to pay me to go away, thinking, "hey, problem solved!" Hopefully, you're not that stupid. Because then you just created the incentive for people to extort more money out of you. Yet economists would pat themselves on the back and say, "See? Because of property rights, this so-called 'problem' has an efficient solution."

But it's a load of crap.

Now, as an economist, you might admit that, okay, sure, you suffered a bit -- you lost some of your consumer surplus. But that "doesn't matter" because it's "just" a transfer payment. You lost, and I gained. Only when there are are *no* gainers do we see an "inefficiency" and therefore a problem. Here, there is no problem.

Hell yes there is! A system in which people can extort money this way is a system in which people just don't make as big investments in property [which results in less wealth for everyone], knowing that that will just make them a better target for extortion. It's a systematic weakening of property rights.

So no, Jim_Glass, the appropriate solution is not to "get transaction costs to approach zero, and let bargaining take over." The appropriate solution is to require those who try this extortion to pay up for it!

Deliberately annoying people should *not* be a path to wealth. People see this intuitively. And for the exact same reason, the victims of global warming should *not* be the ones that have to buy out the polluters, even if the transaction costs would be zero.

The thing is, in these internet debates, people who object to e.g. pollution, are doing so in a way perfectly consistent with the basis I laid out -- yet rarely do the participants get around to identifying these underlying assumptions! Instead, they just throw the same non-responsive points at each other, and ultimately miss identifying the optimal solutions -- both in the moral and economic senses. I seem to be the only being in the world capable of actually seeing what the dispute is ultimately about.

So, again I have to ask: is the world insane, or just me?

"Cynical comment left elsewhere" of the day

I've been pretty fed up with the combined favoritism and outright stupidity in the financial system these days. This has led me to guess that any exchange involving a promise from a large, old (and therefore probably protected at all costs by our Overlords in Washington) corporation is going to, less and less often, be treated as something they have to *sigh* actually honor. With Sears and K-Mart reinstituting layaway (in which you make installment payments and then, after the last, receive the product), I figured this would be just another promise you can't trust anymore.

Well, a former happy customer of layaway services, calling herself "Princess of Swords", didn't seem to notice this trend and so disputed my prediction in a discussion on a Megan McArdle post. (UPDATE: previous link was to the wrong site.) Here, I post my response, in which you'll start to understand the basis for my pessimism:

******

Princess_of_Swords: Thanks for taking the time to detail your experience with the intricacies and standard practices prevailing with respect to layaway at the time you availed yourself of it.

Now I'm going to explain to you how it works in the real world.

In the real world, an obligation no longer means anything.

-GM was obligated to pay pensions. They didn't even bother to internally classify them on the same level as a bond, until forced to by law.

-Insurance companies are obligated to pay when disaster strikes. They fight as hard as they can to avoid paying, even for plain vanilla cases.

-Individual consumers buy things on credit, deferring the first payment for a long while. They are routinely caught not having saved for that big first payment.

-Securities brokers engage in naked short-selling of stocks, which obligates them to produce actual ownership of that stock at a later date. Yet as we've seen recently, they've ended up flooding the market with fake stocks and then casually aver that they "can't locate your stocks" and offer to reverse your purchase as if it were no big deal.

-Gift card issuers are unilaterally stealing money from gift card owners on the grounds that "they need it" because they're in financial trouble, despite having obligated themselves to treat the gift cards as equivalent to cash.

-AIG got a massive bailout from the Fed, but, we were assured, they would be obligated to pay a hefty penalty interest rate and start immediately and orderly unwinding their enterprise. Well, the Fed went back and cut their payments in exchange for nothing, thus debasing the Fed's assets (and thus the dollar). And AIG has done virtually nothing to liquidate its assets.

You get the point. I just don't care how you think things used to work back then. We are in a new world, where only us responsible commoners have to keep our word.

GM attempts to boost sales by losing (some of) the weasels

So CNN's Money reports that GM is trying its employee discounts for everyone program again. What this means is that it will give everyone, not just its employees, their cars at n% under the MSRP. More importantly, that in turn means that so long as program exists, everyone gets the same price. The article in fact notes that this converts their retail outlets into "no-haggle" operations of the kind used by GM's own Saturn brand. (Toyota's Scion does the same thing.)

This has long been something I've wanted car manufacturers to do. Not the discount necessarily, but ensuring that everyone pays the same price for the same car. Car salesmen have a well-earned reputation for using every legislative and psychological trick to gore you for as much as they can on any purchase. And it is this fear of being "played" that led me (and undoubtedly lots of othes) to put off buying a car. Who wants to go through that? Half the dealerships I went to left me wanting to vomit at their vileness.

Think about that for a minute. As an automaker, you use advanced technology most can only dream of. You have enormous, well-capitalized facilities for training, for testing, for building. You accomodate thousands (if not millions!) of design constraints. And what do you depend on for your cash flow? What barrier must your ultimate customers bypass to have a chance to give you money?

"So what kind of monthly payment were you looking for? ... Uh huh, up to ...?"
"Now, we're going to see what kind of financing deal we can get for you, okay? If you could just stay for a few minutes, in case the bank wants to talk to you. It'll just be a few minutes, I promise."
"Oh, yeah, those guys just need a few more minutes to look at your car, so we can give you the best deal, it won't be much longer. Now, which option did you want to go with?"
"Oh, just one more thing before you drive off, we'll need you to talk to our finance department about extended warranties, which I never mentioned before today."
"Internet sales department: please call Lisa at ..." (!!!)
"Okay sure, but I've never used SYNC ..."

Who enjoys dealing with that? Not me. While obviously I'm not one of the geniuses currently in charge of a large corporation, I strongly suspect that they would realize greater sales and a more liquid auto market if they could just signal their commitment to fair dealing and ditch some very useless middlemen (who these days usually know less than the customer about the car) by using this sales model. Certainly, there's something to be said for squeezing out the consumer surplus from less savvy buyers. But it kind of defeats the purpose when the real impact is to get most people to just say, "You know what? **** it. I'm just not going to bother." (Discretion like that would have been welcome in the recent real estate bubble.)

(Of course, the real reason such garbage can persist is that the retail car sales lobby has, in every state, been successful at severely restricting retail car sales, including internet sales, thereby killing the kind of competition that would eliminate vile sales tactics. Also, not suprisingly, this doesn't stop people like Malcom Gladwell from using instances of this vileness (like race/sex discrimination) as an indictment of free markets.)

So keep it up, GM: maybe you'll be able to chug along an extra six months, more than enough for your shareholders to dump their take on some idiot.