Efficiency Ex Ante, Equity Ex Post

But I’m a big fan of clever policies, which means I always end up advocating too-clever-for-their-own-good policies. Since the telos of the nation is above my paygrade, I try to focus on the wonky, technocratic stuff: how do we achieve more output for the same effort, such that whatever our national goals are — a high average standard of living, environmental harmony, world conquest, moon colonies, whatever — are easier to achieve?

My outlook is fundamentally Coasian, in the sense that I view transaction costs as the biggest constraint on optimization. There are many resources that would be better-allocated if they were priced optimally, but it’s hard to price them, so my usual approach is:

  1. Imagine that you could put a price tag on something.
  2. Think very hard about what the world would look like, until you think your way into a plausible equilibrium.
  3. Decide what policy mix would get close to that equilibrium absent pricing.

For example, it seems obvious to me that public transportation should charge you by the mile and reimburse you by the minute. Clearly, we aren’t there yet. But we could get some of the way there if MTA employees had a bonus pool determined by their on-time statistics. If you take it as a premise that the MTA is not perfectly optimized around maximum throughput with minimum delay, you can easily justify a very hefty incentive program. Consider: the MTA does roughly 1.7bn rides per year. Let’s say those are 30 minutes apiece on average. So, about 850m hours per year are spent on New York’s trains and busses. Let’s assume two thirds of that is commuting time, which is probably a very low estimate. So, 565m worker-hours are spent on the subway each year.

New York’s median income is $51k, and the US worker works about 1,800 hours per year, so average hourly compensation is about $28.30. Which means that the value of a 1% decrease in time spent on subways is $160 million per year, valuing non-work time at zero. The MTA’s annual budget is about $8.4bn per year, and since it’s subsidized, that’s a good proxy for its annual revenue. I looked up the public company with the closest revenue, which happens to be J. B. Hunt. They pay their CEO around $6.6m/year, most of which is variable compensation, so that seems like a rough proxy for how much the head of the MTA would make running a similar-sized organization (also in the transportation sector!). The head of the MTA makes about $350k instead.

If we paid the MTA’s management like we pay private-sector CEOs — and I mean “like” in both the sense of “similar amounts” and “similarly as a function of performance,” — then we’d probably get better results.

One of which would be layoffs. The MTA’s shoddy timeliness and safety record can partly be chalked up to old technolgy, but a lot of it is human error. And one definition of “technology” is “anything that replaces human effort with machines and robots.”

So we started with a nice, abstract theory of how to make the world a better place, and concluded that we should put middle-class jobs on the chopping block and mint some millionaires while we’re at it.

This is not an uncommon pattern with such thought experiments. When you think about shortages during a crisis, the complexity is dizzying. As Matt Shapiro puts it:

I’m not worried about running out of bread; I’m sure some bureaucrat or economic consultant had enough common sense to make sure that the wheat supply chain was labeled “essential business,” and the flow of flour will continue uninterrupted. But what happens if we run out of plastic bags to put the bread in? What happens if we run out of twist-ties to close the bags? Things that are very small and so cheap that they seem worthless become very important when you run out of them. We have a central authority that decided our invisible hand only needs one thumb and a forefinger up to the second knuckle, and I’m not confident they’ve covered all contingencies.

In the normal, non-pandemic economy, we have a very efficient system for preventing such shortages: prices. But during a pandemic, it feels morally dubious to say that prices should fluctuate freely. That’s tantamount to saying that rich people should be able to outbid doctors, nurses, and nursing-home workers for masks and gloves. Do we really want that?

In a first-order sense, we certainly don’t. If we’re handing out the last million masks, every one of them goes to healthcare professionals and everybody else is advised to shelter in place.

But the problem with making decisions about the present is that there’s not much present and there’s a whole lot of future. The immediate problem is what to do with the first million masks, but the bigger problem is what to do about the next billion. As it turns out, this is a key constraint. We don’t have enough masks because, among other things, we’re not willing to pay upfront and we’re not willing to pay a premium. Other countries do this, and those countries have more equipment.

We can’t be agnostic on this issue, either, because masks have inputs, and those inputs have other uses. Mask shortages are partly driven by melt blown material, and even if everyone agreed to price controls on masks, the cost of the inputs would eventually make masks unprofitable. We could work one stage back in the supply chain, and restrict price gouging for that, too, but what if those manufacturers face a shortage of some other key input. Unless you know every input — raw material, processing, capital equipment — and every link between them, and you can track changes in real-time, controlling prices leads to scarcity. At higher prices, and with faster payment terms, mask suppliers can afford to either source more inputs or switch to alternatives. Solving the mask shortage is literally what they’re getting paid to do, and they’re in the best position to figure out how to do it.

At higher mask prices, some people will be unable to afford masks, and those people will (by definition) be people with less money. But at least there will be masks. And, if demand and price remain elevated, there will eventually be lots of masks, and then entirely too many masks. The path from every-mask-is-out-of-stock to every-dumpster-has-100-pack-of-masks passes through a period where mask prices have gone up.

Imagine this, but during a horrific global crate shortage.

This is a constant in policies that maximize economic efficiency: to get the most possible output, you have to incentivize people who can produce a lot to work harder, and those people are already paid better than average. Maximizing economic efficiency tends to directly increase inequality.

Plenty of economic thought experiments go further than this. Robin Hanson once proposed taxing leisure time. And since leisure time by his definition means time not spent working, this amounts to a proposal to punish the unemployed with fines. The argument for why this is inequitable is obvious; the argument for why it wouldn’t lead to an increase in work, and thus an increase in material standards of living, is much less obvious.[1]

Fortunately, there is a way out. Economic inefficiency happens at the margin, when individuals decide which action to take or not take. But aggregate outcomes can be nudged through redistributive policies. Assuming a given policy is economically efficient and produces $x of GDP, we can divide that $x into one amount that’s captured by the people behaving differently (MTA managers who have a Hamptons share that isn’t a bribe, PPE Profiteers), and another amount that’s dumped into a universal basic income to offset the change in inequality.

UBI affects decisions at the margin, too, but the net effect is diminishing over time. As the economy gets more mediated by technology, and becomes more global, the output gap between the most productive workers and everybody else expands. In that model, the incentives that matter the most are intra-1% ones — should you use your robotics PhD to build a surgical robot, or to get a job pricing exotic equity derivatives? — not the incentives elsewhere.[2]

In strictly monetary terms, offsets and indulgences are an effective policy tool. Price systems aggregate information, and sometimes it’s information we don’t want to hear. Right now, Covid-19 makes almost everyone in the world substantially worse off, whether it’s through ill health or economic disruption. It makes some people and companies much more essential, and while we can try to guess who’s essential and how essential they are, we can do better. Supply chains are hard to model (don’t believe me? Ask an oil trader.).

Macroprudential policy focuses on blunting the average impact of a crisis, whether it’s purely financial or driven by some external cause. But sufficiently effective macroprudential policy gives us the flexibility to allow individual actors to pursue the ideal microprudential policies. Since one of the crucial shortages in a crisis is a shortage of information, we should expect these to look superficially foolish, or even evil. As long as that’s true in only a monetary sense, a sufficiently active money printer can brrrrr the negative side effects away.

I write a regular newsletter on inflections in tech and finance. Recent Covid-19-related posts include “What Will Be Normal Five Years from Now?” and “Amazon Sees Like a State.” You can sign up here.

[1] The usual way to argue against Hanson’s thought experiment is to make an argument that uses the terminology of economic efficiency but ultimately gets back to equity, probably by way of diminishing marginal utility. For the purpose of this argument, my claim is that Hanson’s proposal would increase output, not that it would increase happiness. A world with a leisure time tax is a world where sadder people own nicer stuff, not a better world. However, one of today’s most pressing problems is a shortage of stuff, so pure economic efficiency sounds more compelling.

[2] You can push back on this by combining cost disease with skepticism about automation. There are some jobs that a) computers and robots can’t do, but b) people don’t do for very much money. Unclogging toilets, picking strawberries, and waiting tables are all tasks that can’t be easily automated, but whose labor force is paid at near-UBI levels. One consequence of economic growth generally is that either the outputs of those jobs get more expensive (strawberries probably won’t go away) or they disappear (welcome to the office bathroom of the future! Here’s your plunger).

I write about technology (more logos than techne) and economics. Newsletter: https://diff.substack.com/

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store