Links - Market Design edition

Regular readers[*] will know that a favourite theme of this blog is thinking about how — and where — markets function "optimally", versus cases where some form of intervention/regulation might be preferable. In that tinkering spirit...

1) The Boston Globe has a profile on Harvard's Alvin Roth, who specialises in optimising market design in a variety of sectors. Apart from his dedication to solving real-life problems, about the most interesting aspect of Roth's work is that he focuses on recreating market processes in precisely the industries where markets seem out of place, or even "repugnant" (e.g. organ donors). Much of this involves dealing with goods that are intrinsically hard to evaluate in monetary terms. [HT: Michael Giberson. I'd recommend a visit to Roth's Market Design blog as well.]

Reading the article, I was immediately reminded of the literature on "intrinsic motivation" and "moral crowding out", which highlight the pitfalls of trying to replace moral contracts with monetary incentives. The most famous example of this is probably the study of late parent arrivals at day-care centres in Haifa, which went up after monetary fines were introduced. In other words, the introduction of fines had the exact opposite effect of what was intended. Parents no longer felt bad about making a teacher stay late looking after their kids, since they were incurring a fine in return... A "fair" trade in their eyes.

2) Rob Stavins on the design options for cap-and-trade versus the alternatives. This is an older post, but one that is well worth revisiting for anyone interested in the options regarding climate policy and, as per usual, Stavins gives a really good breakdown of the key issues. To be honest, I've been meaning to write a brief summary on the differences between cap-and-trade and carbon taxes for a while (pros, cons, etc)... But this post (and others by Stavins) are a great place to start if you want to understand the basic arguments for and against the different climate policy instruments.

3) Daniel Kuehn is frustrated by the asymmetries in the public choice discourse. In particular, he takes issue with the assumption that being interested in market failure somehow makes you oblivious to government failure. I've trod a similar line here before and strongly agree that this is a false dichotomy.[**] However, and while I believe that Daniel is referring more to the armchair proponents of the public choice school than anything else, I would still note that the leading public choice figures themselves generally offer a far more nuanced and considered view of the market-vs-government debate. (E.g. See the paper by James Buchanan that I mention towards the bottom of this post. Some more thoughts on the matter here.)

Daniel quotes a segment from George Akerlof's seminal paper on information asymmetry, A Market For Lemons, which points to a careful arbitration between government intervention and private solutions:

It should be perceived that in these markets social and private returns differ, and therefore, in some cases, government intervention may increase the welfare of all parties. Or private institutions may arise to take advantage of the potential increase in welfare which can accrue to all parties. By nature, however, these institutions are nonatomistic, and therefore concentrations of power - with ill consequence of their own - can develop.

I replied in kind in the comments section by quoting the closing paragraph of Ronald Coase's 1960 essay, The Problem of Social Cost, in which he established the underpinnings for his eponymous theory on bargaining rights and (environmental) externalities:

It would clearly be desirable if the only actions performed were those in which what was gained was worth more than what was lost. But in choosing between social arrangements within the context of which individual decisions are made, we have to bear in mind that a change in the existing system which will lead to an improvement in some decisions may well lead to a worsening of others. Furthermore we have to take into account the costs involved in operating the various social arrangements (whether it be the working of a market or of a government department), as well as the costs involved in moving to a new system. In devising and choosing between social arrangements we should have regard for the total effect. This, above all, is the change in approach which I, am advocating.

So, ya... Call me crazy, but that's two Nobel Prize laureates — whose respective theories can and have been twisted by completely opposing factions — essentially coming down on the same side of the issue.

[*] Both of us... Hi Mom. Other readers might be interested in the "regulation" or "externalities" taglines.
[**] I imagine that some might think me slightly schizophrenic to strongly criticize overbearing government in some posts on this blog and then complain about a lack of decent regulatory frameworks in others. However, I'm very much a horses-for-courses man. My basic premise is that markets work fantastically well by themselves most of the time... But it's the exceptions that make life interesting.