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Economics in an age of abundance

By Kevin Cox on April 29, 2008 3:09 AM | Permalink | Comments (0)

Traditional economic theory is built around the idea of scarcity and consumer choice through competitive markets. The theory says that markets work because when goods are scarce, price contains all the information that a consumer needs to make an informed choice This makes it possible for a person to not only rationally choose to buy from a particular supplier, but to choose between different types of products.

Unfortunately in the modern market place the assumptions about scarcity and prices reflecting value do not apply.

In a modern economy there are many situations where prices fail to reflect cost or value. Modern problems tend to relate to abundance rather than scarcity. The tool of scarcity pricing on money value alone fails in many different ways and a new approach is needed to allow markets to allocate resources efficiently with objectives other than minimising monetary value.

We now produce too many greenhouse gases at the same time as we produce energy. We eat too much food and we have an obesity epidemic. We are able to gamble too easily and produce problem gamblers. We have cheap and easy access to alcohol so that we have a tendency to binge drink. We spend large amounts of money on elite sports while neglecting our grass roots children's exercise programs. We fail to put a value on volunteerism or on looking after our own families while relying on government-supplied services to address homelessness and other social ills. We allow monopolies and oligopolies to flourish which in turn prevent innovation. We allow the blockbuster syndrome in art and entertainment to starve the development of grass roots and community initiatives while delivering excessive profits to the few. We create too much money which in turn creates asset bubbles and distortions in investments and produces the situation where only ten per cent of housing loans result in the construction of a new dwelling. We allow interest rates to dominate the investment culture so that we favour short term investments over lasting investments. Finally our measure of success - the GDP - is so distorted that it values the amount we spend on cigarettes as equal to our spending on medical research to combat the effects of cigarette smoking.

There is something seriously wrong with a system which, while growing overall, creates wider divisions of wealth with some groups going backwards. To solve these problems we need to reassess the way we focus the power of markets. We need to use markets to maximise the total well being of society rather than maximising the total money measure of consumption.

This is achievable if we add extra information to money. If, in addition to value, money held information that could be used to direct expenditure in ways to achieve social as well as financial objectives. The approach is significant because it enables us to address the failures of markets caused by abundance and by the failure of prices to give us all the information needed to make choices while still using markets to allocate funds efficiently.

Following is an example of how the technique could be applied to the problem of greenhouse gas emissions.

Reducing greenhouse gas emissions

The problem of reducing emissions is a classic "Tragedy of the Commons" market failure. Each of us knows that reducing our emissions is good for us all but it only works if everyone does it. The market failure occurs because price does not reflect the value to society of reducing emissions.

The problem is really one of three related areas:

1.      developing infrastructure to generate energy without producing greenhouse gases;

2.      developing strategies and infrastructure to save energy consumption; and

3.      developing carbon sinks.

The problem of global warming can be resolved through investing money with these goals in mind. The social and economic issue is in finding the most efficient yet fair way to allocate resources so that we can build infrastructure to reduce greenhouse emissions.

The traditional economic approach is to capture our preference for clean energy in the price we place on energy. To do this we invent new products such as carbon credits or emissions permits to increase the price of energy. The theory is that the price of polluting energy will now include the value that we place on reducing emissions. Consumers are now able to make rational choices and investors will be encouraged to invest in energy savings technologies and in ways to produce energy without emissions because they receive price signals that direct their choices.

Unfortunately it is an approach that is unlikely to be effective. It is a blunt instrument to solve a relatively simple problem.

We have an existing market in clean energy technologies. We can invest in wind farms, solar farms, insulation, hybrid cars etc. What we don’t have are enough buyers. So let us create some money specifically for this purpose. That is, let us create money that has extra information on it; money that can ONLY be spent on building infrastructure or technologies that will reduce emissions. That is we turn market forces onto the problem of reducing emissions.

We know that the best way to allocate resources is through fair and free markets. Reducing emissions is an investment problem more than a pricing problem. If we spend money on greenhouse gas reduction measures we will solve the problem. How we create the money to spend on infrastructure is relatively unimportant. If we can devise a method that is seen to be fair and reasonable it will be widely accepted and adopted. This, in turn, will allow the infrastructure marketplace to allocate resources most efficiently to reduce greenhouse emissions.

Creating and distributing money tagged with infrastructure information

There are many ways we can create this “tagged” money. The simplest is to add a surcharge on the price of fossil fuel energy. This is sensible because it adds a price signal to polluting energy.

Let us now distribute this tagged money in inverse proportion to the amount of energy each individual consumes in their household. Let us call this money Rewards for Frugality. The Rewards come with one major stipulation. They must be spent in the infrastructure market place. That is we have created a surcharge but given the money collected back to consumers. According to economic theory this does not affect the GDP of the country. It redistributes money from one purpose to another but does not increase total consumption.

Rewards must be spent on any approved infrastructure project that will reduce greenhouse gases. It could be used for solar hot water heaters, to buy new shares in a geothermal company (but not buy existing shares), to purchase a bicycle etc.

Implementation of this strategy requires a communications infrastructure such as a mobile phone network and a mobile phone network could classify as an infrastructure project under the international fund. See Edentiti Rewards for ideas on how a market place can be implemented.

How might it work?

By distributing Rewards we have now created the buyers we need to foster an infrastructure market.

Under such a system individuals would not be required to receive Rewards and if they cannot think of a way to spend their Rewards they could always sell them to others. Participants - both buyers and sellers - who break the rules associated with Rewards would be excluded from the system for a period of time. This creates a self-regulating compliance regime.

Rewards must be spent on infrastructure that reduces greenhouse gases. This will work because it is seen as a "fair trade" and like all good trades, both sides win. It is important to note that the market is in infrastructure not in carbon, nor in emission permits, nor in energy. It is a direct way of addressing investment - not an indirect way.

The system is easy to understand. If I use less energy then I am rewarded but I must spend my Rewards to reduce emissions. This solves the Tragedy of the Commons as the funds I receive are spent on infrastructure that benefits not just me but the whole community.

The system is easy to implement but the details will depend on the communications infrastructure available in the country. Systems can be established with a mobile phone network but more complex systems become possible where there is a widely available broadband Internet.

The cost of implementation is low and running costs are expected to be less than a percentage point of investment dollars spent.

The system is socially inclusive as the low consumers of energy tend to be the poorer in society. In those cases where the poor consume more greenhouse producing energy we can allocate some Rewards on the basis of overall income or any other such factor.

The system leads to stability in prices and is guaranteed to work. Emissions targets can be set and surcharges defined. These steps in turn determine the value of infrastructure investment.

How much money do we need to invest?

The following calculations are indicative of the cost of developing renewable energy technologies, they are also conservative.

Each Australian, on average, consumes for all reasons about 75,000 kwhs per year of energy.

It costs $3,000 to build a solar powered or geothermal power source capable of generating 1 kw continuously for a year (or about 9,000 kwhs). Thus an investment of $25,000 will produce all the energy needed for one Australian to be greenhouse neutral. This equates to a total of $500 billion for the entire population at current prices.

If this amount is spread over 12 years, it becomes an investment of $2,100 per person annually. The running costs (excluding financial costs) of renewable energy sources are about 1 cent per kwh or half the running costs of coal fired stations.

By the end of 2020 we could have zero net greenhouse emissions for a relatively low cost of $2,100 per person per year with energy being produced at half the current price and with no reduction in GDP.

A solution with multiple objectives.

At present our society is marked by systems that create alienation and dissension, and which actively cause the powerful to unfairly compete and use their financial or regulatory advantages to stifle innovation and competition. Our heads of companies can earn hundreds as times as much as the ordinary worker in the same company. The greatest rewards seem go to manipulators of finance rather than creators of wealth and innovation. We have pockets of generational poverty and disadvantage where children are condemned to a life of deprivation simply because they were unfortunate in the accident of birth or location.

Rewards won’t solve all these problems, but it is a system that can help. The greenhouse gas example is just one way of adding extra information to money to redirect market focus and achieve multiple objectives. It’s a question of defining what you want to achieve and in our current environment, the answer is rarely purely monetary.