This is a bit of a drive-by blog post – a collection of short thoughts with a common theme: market failure (and in one case, success). Remember, out of my three-year economics degree, we spent about a week learning how the market worked, and the rest of the time learning about all the entertaining failure modes.
Let’s start with the banks.
The Independent Commission on Banking has made some recommendations in its interim report, including firewalling retail banking from casino banking, and increasing the cash reserves required for the retail side of the operation to 10% of capital. According to Robert Peston on the Today Programme this morning, the banks’ first reaction was to complain that these measures would increase costs. I find bankers’ lack of a grasp of basic economic principles (We’re talking Introductory Microeconomics here!) both amusing and disturbing.
Let me introduce you (probably not for the first time on this blog) to the concept of externalities. Externalities are costs or benefits which for some reason are not reflected in the market. The Introductory Microeconomics textbook example of a negative externality (a cost) is pollution. Say you run a factory which makes some sort of chemical. You pay for your raw materials, for your staff, transport, electricity, water, etc. However, your factory’s waste is leaking into my local river, killing the fish and giving me cancer. I can no longer fish for a living, and I have to pay for cancer treatment, but because this has no direct cost impact on you, you have no incentive to clean up your act. Essentially, I’m picking up a part of your production costs because the market by itself has no way of making you pay up for the damage you’re causing.
Now imagine you’re a banker. You run a bank which includes a retail operation and an investment operation. There’s very little regulation on what you can and can’t do. You can promise all sorts of things without having the cash to back it up, you can take unreasonable risks on your investment side and absorb the impact on the retail side, and if you fail, the tax payer will pick up the bill, because you’re so vital to the economy that you’ve got them by the balls. The true cost of the risks you’re taking is not reflected in your operating costs – it’s picked up by the tax payer when you fall flat on your face, and then the rest of us suffer a spectacular hit to our disposable income while you still wave your £10-notes in our faces. Now, here’s a textbook externality if I ever saw one.
What that new proposed regulation would do is not increase costs. It would simply help you internalise your cost, correcting a market failure, so that you can make informed choices about how you run your business without holding a gun to my head. There’s a minor difference here.
Who do you trust more – Nick Clegg, or the guy who fixes your car?
My car’s at the garage today, having its break fluid changed and its handbrake looked at. The way such adventures invariably go is that halfway through the morning I get a call from the garage, and someone babbles at me in a thick Geordie accent and deliberately throws incomprehensible words at me trying to get me to panic and ask them to do more work than I originally intended. I’m getting better at stopping them, asking some questions and trying to sort out what actually needs doing from what they would simply like to charge me some money for because they’re having a quiet day. But I still suspect they’re getting away with way more than is strictly speaking necessary.
This is a classic example of a different kind of market failure: asymmetric information. See, when Conservatives and Libertarians tell you how great and efficient the market is, what they mean by the word “market” has nothing to do with what exists in the real world. A theoretical, efficient market relies on a whole house of cards of entirely unrealistic assumptions, including the one that states that all parties have perfect information.
As, however, I am not a car mechanic, the actors in this particular market have far from perfect information. I know nothing about fixing cars, while the mechanic knows everything. What’s even worse is that he knows perfectly well that I know nothing, and is willing to exploit this fact. So he gets to tell me all sorts of horror stories and I’m left there trying to work out which of these things will kill me if I don’t pay him to fix it. Today is one of those days when I wish we lived in the Tory Utopia of Market Efficiency. Instead, I find myself in the paradoxical position of trusting Nick Clegg, a man known for breaking promises, more than I trust the guy who’s supposed to make sure my car doesn’t malfunction in an entertainingly fatal sort of way.
And finally, thank you, Rupert Murdoch!
This one’s a story where arguably the market has worked. For those who haven’t noticed, the Times paywall is down today. I don’t know whether this is a glitch – there certainly has been no formal announcement – or if they’ve decided to quietly drop it. The universal reaction I’ve seen on the web, however, has been a resounding “Meh…”
You see, for the last six months or so, Rupert Murdoch and the Times have been persistently training us not to click on any Times links, and not to link to the Times. Any fool who clicked was asked for money, while anyone who linked risked a barrage of abuse from their readers who did not appreciate being directed to the paywall.
Humans, therefore, do appear to respond to incentives. And the incentive in this particular case has been to quietly let the Times online presence fade into digital obscurity. I am amused by how well this has worked.