Over at the American Prospect I find this article about what the Nobel Prize winners for Economics have to say to people thinking about dealing with global warming. The quote that caused this post:
So basically, the Nobel for Economics went to a bunch of guys who actually admit that markets don't always come up with the best possible answer and then explain WHY.
A key insight of mechanism design theory is that real-world economic transactions differ from an abstract "market" where a price falls from heaven and trade happens. When engaging in trade in the real world, economic actors (buyers and sellers), must abide by certain rules and/or norms (e.g. Is it ok to negotiate? Can you make more than one counter offer?). Mechanism design shows that the economic outcomes, including market efficiency, can be dependent upon those rules.
Thus all "free-markets" are not equal. In fact a marketplace does not exist independently from its rules and norms -- they one and the same. Saying that "the market works" to allocate resources depends on the specific market design and conditions. Thus (and contrary to much conservative rhetoric) economic theory -- of which mechanism design is a part -- does not say that markets always achieve an efficient outcome. Mechanism design can help us better understand when markets do perform well. And when markets no not reach an efficient outcome, mechanism design theory can suggest mechanisms that might work better.
One of their key public policy insights:
The fact that people have an incentive to not reveal their true preferences has obvious important consequences for public policy. If people are asked if they want a new highway built, they might rightly worry that they will be asked to pick up some of the expense, and so might not fully reveal their true preference, opting instead to try to game the system as a free-rider. Economic research building from the Nobel winners’ work analyzed ways to get around this -- to provide a mechanism by which people would volunteer their true valuation of the highway, and thus better evaluate the merits of a project that would benefit an entire community. (The key of this particular mechanism is to link an individual’s valuation response to the decision to build or not, but to de-link the exact mount they would pay).
So how does this impact a global warming discussion? Again from the article:
This brings us to global warming and cap-and-trade policy. If we -- and by "we" I mean the entire planet -- ever take global warming seriously, we will have to adopt some mechanism for reducing carbon emissions. A real program will require nations to implement some form of regulation and/or market mechanism to reduce carbon. But what kind of mechanism? How do we design a program that reduces carbon across nations? Some nations will be harmed significantly by global warming, while others will be better able to adapt, but in a negotiation, countries will have incentives to hide their true valuations, just like in the used car example above. Can we design a mechanism that is more likely to get nations to commit to reducing global greenhouse gases?
This fits in with my own experience. When I lived in famously libertarian New Hampshire (Official Motto: Live Free Or Die; Unofficial Motto: Fuck Off And Leave Me Alone) everyone religiously recycled everything recyclable. Why? Had they taken leave of their (conservative) senses and embraced nanny state regulation??
Of course not. You paid $1 per 35 pounds of trash that went into the landfill. And for stuff you recycled? Nothing. Even that nominal fee, a buck, probably nowhere near the true societal "cost" of 35 pounds of banana peel laying around rotting, was enough to very powerfully motivate independent Granite Staters to recycle like a Berkeley liberal.