Categories
Economics Society

[2543] Safety bought through ransom is a cost to society

Amid the political wrangling on Bersih and its aftermath, a son of two expatriates living in Kuala Lumpur was kidnapped. The kidnapping of Nayati became a minor sensation. Twitter was abuzzed with it. Posters were put up across the city and flyers handed out. Just outside of my office in Damansara Heights, just by the busy road, somebody hang a large poster of Nayati, appealing for information and help. Judging by the impressive and expensive effort, the parents are well-off.

He was found later outside of the city in Rawang and it was reported that the parents paid the kidnappers some unknown ransom.

I am glad Nayati was found and I am glad he is safe.

Nevertheless, it must be highlighted that Nayati is one person. The more important fact here is that we live in a society. The handling of the case gives signal to the society. That signal will inform future decision of both victims and criminals.

The “ransom solution” creates an expectation on the side of the criminals that crime pays. That creates adverse incentive.

When the incentive is big enough over the cost of crime (either through the increase of actual payoff or the higher probability of payoff), we can expect greater occurrence of kidnapping in the future. The ransom solution will create a systemic problem and it will make the society less safe.

For Nayati’s parents, the police may have helped them. Nayati’s father has thanked the police. In fact, if I were the father, I would thank the police for their aid despite paying off the kidnappers with my own money. In tough times, any help will be appreciated. And I do not blame the parents for paying off the ransom. No money worth more than the life of your loved ones.

But, from societal point of view, such emotional attachment should be stripped in favor of pure rational economic analysis.

When it is stripped, then the incentive structure will tell us that each ransom solution represents a failure of the societal institutions.

Any safety bought through ransom is a cost to the society as a whole. Call it negative externality; each time you pay, you may make somebody else worse off.

So, from societal perspective, the Nayati case is a failure. It will continue to be a failure until the kidnappers are caught and sufficiently punished to tell everybody that crime does not pay.

Categories
Economics Environment

[2131] Of compensation yes but there are concerns

It appears that Malaysia and other similar countries with significant forest cover may end up as winners out of the ongoing 15th Conference of the Parties to the United Nations Framework Convention on Climate Change in Copenhagen. Whether these set of countries will be net winners are another matter altogether but as far as compensation for maintaining forest cover, or within the context of COP15, carbon sink goes, reports are coming out that this is one aspect that is going pretty well.[1]

The economics behind such compensation is as sound as the economics behind carbon tax or cap and trade. It is about pricing externality.

The difference between such compensation and carbon tax or cap and trade is that the former addresses positive externality while the latter addresses negative externality. That is in econolese. In English, it means paying someone for doing something that affects others in a good way and penalizing someone for doing something that affects others in a bad way. It is about accounting for spillover effect. In a way, it is a full cost accounting.

While I am excited at seeing an economic theory being put into practice, I am curious at how exactly will it be implemented. The biggest issue here is related to opportunity cost. The compensation will have to be big enough to address the problem of opportunity cost faced by owners of forest.

Some forested land may not be opened even without compensation. That put the opportunity cost of such land very low. I would imagine, some countries would not admit to that and instead, would overestimate their opportunity cost. It is not hard to come up with a plan to open up new land, project its economic value to some monstrous value that could be outrageous compared to actual situation and have that as the opportunity cost.

I know, forest has its inherent value. I am sympathetic to that argument. Inherent value however is hard to measure, and no one will pay for it despite all the sound moral argument defending it. The best way to price forest by its concrete opportunity cost: what other alternatives are possible to have a covered land and what is the value of that alternatives?

While I do support such compensation, these concerns must be resolved conclusively. Else, the arrangement will be a farce that only redistribute wealth unfairly.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — COPENHAGEN — Negotiators have all but completed a sweeping deal that would compensate countries for preserving forests, and in some cases, other natural landscapes like peat soils, swamps and fields that play a crucial role in curbing climate change. [Climate Talks Near Deal to Save Forests. Elisabeth Rosenthal. New York Times. December 15 2009]

Categories
Economics Liberty

[2099] Of Ostrom’s Prize in Economics, commons, coercion and libertarianism

Libertarians celebrate two winners of the Prize in Economics of whom one of them is Elinor Ostrom. That is because her works show that commons can be managed efficiently by groups of users rather than the State. I am unsure, however, if libertarians, especially the free market purists quite absorb the full implication after accounting for footnote associated with Ostrom’s works.

Her findings do very little to expunge coercion from solutions relating to large tragedy of the commons. This fact, through my observation, is what many libertarians have missed.

On purists, I know, I know, I have been accused as a purist myself but if I am a purist, then you are in for a big surprise at how other people can be purer in this thinking that me. These purer purists, if I may say so, are more anarchist than libertarian, with their hostility against the State bordering madness. I may sympathize with these anarchists however but I am convinced that the state of anarchy is unstable and in fact, detrimental to individual liberties. I am becoming more convinced of that position as I finally begin to read Robert Nozick’s Anarchy, State and Utopia, further settling in the minarchist pool of libertarians.

Many, I have seen, tend to celebrate one conclusion of Ostrom’s work but tend to ignore the other consequence that comes from the footnote to the celebrated conclusion. Most unfortunate, that footnote does not eliminate the case for intervention. Such intervention or really, coercion, may not originate from the State but by groups of individuals nonetheless.

A group of individuals should really be no different from the State if there is coercion. Coercion is really the key here and it is not whether it is the State or not. This is what most libertarians, when discussing this, have overlooked. To miss it is to miss the entire point of libertarianism.

When it comes to commons, I have long accepted the need for government, or any kind of intervention for that matter, for fear of tragedy of the commons occurring. I first accepted it when I first learned of it as an undergraduate in economics. Concern for tragedy of the commons, is perhaps, the only remnant of environmentalist thinking that remains with me.

That is the reason why, if I want to differentiate myself from other libertarians, I identify myself as a green libertarian. The green symbolizes my concern for market failures, which is what tragedy of the commons really is.

Market failures here are not as left-wingers tend to define it, which is more of rhetoric wrongfully attacking free market principles through mischaracterization and misleading definition but rather it refers to the economic definition, which is when there is a large difference between public and private costs, or more concisely, when there is externality. Examples include emissions of carbon or harvest of the ocean. It is for this reason too that I am largely supportive of Pigovian taxes: I definitely would like, for instance, to see fuel subsidy in Malaysia be replaced with carbon tax.

While I am admonishing libertarians here, I too made a mistake of celebrating Ostrom’s work prematurely, thinking that it solved my problem. I am well aware how hard it is to reconcile my concern for market failure with free market libertarianism that I hold. So, I was happy to see Ostrom seemingly offering a solution to me by stating users of commons do spontaneously organize themselves to prevent tragedy of the commons. Alas, upon further reading, I realized that I initially failed to comprehend the full conclusions by overlooking the footnote. And I do think libertarians who are celebrating Ostrom are misreading her conclusions by not reading the footnote too.

Traditional solutions to tragedy of the commons do not fall within the compound of pure free market libertarianism that completely intolerant of government intervention save for the classical liberal purpose of the state and that is the protection of individual negative rights. Such solutions typically involve the allocation or assignment of rights to users of resources of commons. In other words, to price such rights to internalize externality and then auction to it to achieve allocation efficiency.

In commons with multiple claims on it, some entity — government or some local body — has to be the final arbitrator for allocation of rights purpose and that will require coercion. These rights may be in form of permits that expire regularly or outright privatization (privatization is attractive but it does present complications; for instance, how do you privatize the atmosphere with respect to climate change? Clearly, enforcement of such rights is impossible, at least with current technology). Ostrom simply discovers that local groups may be better managers of the commons than government. She does not specifically say that it is will be done voluntary.

Yes, these local bodies can be voluntarily formed by users of commons. Self-organization out of spontaneous order which of voluntary in nature can be achieved but as stated in a write-up by the Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences[1] and Ostrom’s article in Science Magazine[2], size of users and engagement time length matter, among others, affect the success of having such spontaneous order. There are multiple other factors but I am in the opinion that these two are the most important. The bigger the size, the harder it is to agree on voluntarily act to prevent exhausting the commons and make everybody worse off. The shorter the period of engagement, the harder it is to reach to an agreement.

The issue on number of users is really a matter of cost. As in the case of climate change, which is really the biggest common of all, bringing 6 billion individuals together is clearly unfeasible. Consider also the fact that even with hundreds of representatives sitting together in one hall, an agreement is hard to achieve. The planned climate summit in Copenhagen organized to find a replacement for the failing and expiring Kyoto Protocol is widely expected to fail.

On top of this, monitoring activities are costly. Monitoring is important because there is a strong incentive to — out my lack of creativity in selecting a word — cheat in the case of tragedy of the commons. Monitoring and enforcement are important in discouraging cheating.

On time length, it is a matter of repeated game. To make it more explicit, it is a repeated prisoner’s dilemma where cooperation is clearly a better option for both to failure to cooperate but there exists strong incentive to not to cooperate. Repetition of that game with the ability to communicate could bring about cooperation but again, that is highly dependent on the size of participants. Ultimately, achieving cooperation may take too long a time before the system collapses.

Further strengthening the argument, status quo effect is strong. Look at the Israeli-Palestinian conflict. Such conflict can be modeled as hawk and dove model, which is essentially another form of prisoner’s dilemma. They could cooperate and skip the deadly conflict, but they do not. In a game like this, it is crucial for trust to be built at the very beginning.

Trust simply takes a long time to rebuild once broken, if it is to be rebuilt at all, if the first step proved to be disastrous. This, known as tit-for-tat game, is one of the basic important lessons of game theory, in my humble opinion.

Given that, solving the problems of the commons through voluntary means, are likely hard if not impossible. Thus, intervention is still required to introduce market instruments like quotas, permits or taxation. Intervention may originate from the government, or some local groups but it is an intervention nonetheless, with not too implicit coercion demanding certain positive action, positive as defined by Isaiah Berlin when he differentiated between positive and negative rights.

If Ostrom is to be celebrated, then it is decentralization from government to local groups. That however should be mistaken as solving the problem of tragedy of the commons by voluntary means. Someone or something has to assign rights to users to commons. That means, the element of coercion, unfortunately, is still present.

That certainly does not solve my problem of reconciling concern for tragedy of the commons and free market libertarianism.

To summarize: it is a common and somebody or someone has to take control and assign rights to solve the problem of externality, i.e. tragedy of the commons. It does not have to be the government and local groups may be better manager but something or someone has to act as the assigner. And the footnote to Ostrom’s works indicate that it is hard to do so voluntary, save for, I think, localized commons. In the end, the element of coercion exists.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — See Scientific Background on the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 2009: Economic Governance. Economic Sciences Prize Committee of the Royal Swedish Academy of Sciences. October 2009

[2] — See A General Framework for Analyzing Sustainability of Social-Ecological Systems. Elinor Ostrom. Science Magazine. July 24 2009.

Categories
Economics Environment Politics & government

[2066] Of in Down Under revisiting carbon trading and carbon tax debate

Before I begin, I must admit that there is much reading for me to do to understand the current debate on carbon emissions trading in Australia. I have not been following Australian affairs as closely as I should; I am still stuck with the New York Times, the Wall Street Journal and to a lesser extent, the Washington Post. But each time I took a peak at least up until two weeks ago, either The Australian or the Australian Financial Review, emissions trading, and climate change at large, seemed to dominate the headlines.

Even on campus here at the University of Sydney, a number of posters critical of the scheme are up.

While the debate is unique to Australia in a sense that the Liberal and others out of government squabbling with each other — the odd thing is that, the Liberals, who under Howard administration was friendly to the idea (in fact, it was the Liberal government that first introduced the idea), and the Greens are against the idea of carbon trading, at least in its current form as proposed by Rudd government — as well as the fact that the government does not have enough vote to get it past unilaterally, the mechanism of the policy is largely the same.

There is even a possibility of a general election if the bill failed to be passed. It is a possibility because the general sentiment is that, if there is an election today, the Liberals are going to get further beating with the Rudd administration strengthened. WIth that strengthened government’s position within the Parliament, the bill can then be passed without much trouble.

I acknowledge the need to address negative externality associated with greenhouse gases emissions that massively contribute to anthropogenic climate change. I have written it about in the past. As a freshman and later as a junior at Michigan, I wrote two papers related to the issue, though not specifically on the trading scheme. The acknowledgement, really, is the reason what I identify myself as a green libertarian.

For the benefits of those unfamiliar with the term externality and alien to the field of economics, here is a short introduction to it. Externality is a market failure where individual or private cost does not correspond to social or public cost. As a simple demonstration, in a situation of no law against littering at all, an outsider littering in a public space effectively suffer no cost of doing so. The community living in that public space however does suffer from the cost associated with that littering. Somebody has to clean it up but the one causing it does not suffer the cost of cleaning it up. Instead, the community does. That misalignment of private and public cost is externality, or more precisely, negative externality.

Meanwhile, positive externality is where private action brings about public benefit. For instance, if a person has a collection of really good music and he plays it on the radio that he bought, positive externality is when you happen to sit close enough to him to listen to the music without paying anything for it. You get the benefit of good music. Here, he enjoys the music and you do too without paying. Of course, if he plays bad music, the situation immediately switches from positive to negative externality. He enjoys it but you risk deafness, and uncompensated at that.

A model known as Tragedy of the Commons is the most utilized model to impress the consequence of negative differential between private and social cost. In the model, there is a grazing field, henceforth called the commons. Headers of cows have their cows grazing the field freely because it is a commons and an unregulated one at that. It is then in the interest of the herders — assuming that there is little cooperation between them — to have their cows to graze the commons more and more. They compete for the use of the commons and this competition leads to overgrazing as everybody seeks to keep resources from the commons to themselves. Overgrazing then will turn the whole commons worthless as it is left dead without grass. In the end, everybody loses in the long run.

Greenhouse gases emissions is more or less like that. Economic progress in general and definitely in the current framework, requires consumption of energy and by and large, it produces greenhouse gases, in particular, carbon dioxide. Meanwhile, carbon emissions impose little cost to individual emitter, i.e. little private cost. Assuming that economic progress is desirable, it is in the interest of individuals to commit to progress and emit carbon. But if everybody continue to emit carbon, combined emissions contribute to climate change (I will not go into the science) and climate change imposes cost on all in the end, i.e. social cost. There is obviously more nuance — for example, the cost will not be evenly distributed and in fact, some may experience benefits from climate change; one example of such benefits is the opening of sea route up down in the Arctic Ocean — to the whole issue but that simplification here is done to show why carbon emissions phenomenon, which contributes to anthropogenic climate change, is a negative externality.

The solution to this negative externality or tragedy of the commons is to equalize private and social cost. This can be done by pricing the externality. In terms of climate change and carbon emissions, it means pricing carbon.

Two most popular solutions in mainstream discussions involve tradable quota (more popularly called cap and trade) and tax (carbon tax). The tax is also known as Pigovian taxes, named after a British economist that first proposed such tax to align private and social costs, Arthur Pigou.

By quota, it means assigning rights to emit to market participants and then letting these participants trading among themselves given their endowment. The typical setting is that the government gives (either freely or auctioned) certain amount of quotas to all industries (or even individuals) players. Once endowed with permits, all players are allowed to trade it so that these players can reach to their efficient level of emissions, given multiple constrain.

Carbon tax on the other hand is simply a tax on all activities that emit carbon. I am being sloppy with definition here because even human being organically emit carbon. The idea is to reduce carbon emissions from perhaps, mechanical and electrical operations, as well as one of commercial and industrial of nature. Here again, I am being sloppy but let us not dwell on the matter because that is not the reason for this long-winded entry.

Theoretically, the two methods are the same. A certain number of quotas or permits can have the same effect to a certain level of taxation.

However, political impacts of the two policy differ and most often than not, quota is the most the popular one because nobody likes to be taxed. Quota, despite its ability to imitate the impact of carbon tax, does not directly impose tax and therefore, less obvious in its impact. It is being considered in the United States and Australia — with great controversy in Australia — and it is already in force within the European Union.

The granting of quota however is a messy business vis-à-vis carbon tax. I warn though, much written below is not original. The issue has been debated over and over again by various individuals that trying to cite them may seem like trying to cite somebody just to indicate that the sky is blue.

Firstly, the granting of quota appears to be arbitrary. How exactly does the government determine how much quota a particular firm will get? Past emissions? Forecast emissions?

If it is past emissions, paraphrasing the efficient market hypothesis, past data does a bad job at predicting the future because it does not incorporate future data that are not yet available. If forecast is used, clearly the firm has the incentive to provide overly optimistic forecast that the imposition of quota does little or even nothing to align private and social cost.

Secondly, who should get the quota is a huge problem. Relative over-endowment of permits to certain players in the market and under-endowment to others may turn the whole scheme into an unfair wealth distribution exercise rather than a mechanism to reduce carbon emissions. Some firms may find it more profitable to trade permits rather than engage in productive activity.

Thirdly, the quota system is overly open to political compromise that it stops becoming an equivalent of a tax. This happens when quotas are granted freely such as what happened in Europe and may appear to be the case in Australia. Free quotas, coupled with the first issue, tend to render the whole exercise worthless that it is practically business as usual.

Fourthly, for tradable permits to become an equivalent of carbon tax, it needs to be auctioned. The problem is that, the auction component is almost never implemented. In Australia in its current proposed form, only a fraction will be auctioned while most will be given freely. In Europe, auction is a foreign term. In the US, 85% of the permits will be given freely, if the Senate passes the American Clean Energy and Security Act or more commonly called the Waxman-Markey Bill. The House of Representative narrowly passed the bill earlier in June this year. This is perhaps the cost of political compromised.

Fifthly, the auctioning, monitoring as well as the assignment of permits require a kind of bureaucracy which I am, as a libertarian, unwilling to see taking root. That bureaucracy will require resources to run, definitely more than mechanism for carbon tax demands for.

Carbon tax does not suffer from the complexity revolving around bureaucracy and distributive issues. Imposition of tax rate can be introduced uniformly. Sure, some will lobby to be hit with more generous levels of taxation or even request for downright exemption but compared to cap and trade method, carbon tax, even under compromised outcomes, is better. Unlike tradable permits which must be auctioned in order for it to be effective, tax imposes direct cost to carbon emissions to align private cost with social cost.

This is why I prefer carbon tax.