Incentives for Environmentally Responsible Markets

Incentives for Environmentally Responsible Markets

When it comes to environmental issues, no single actor is completely to blame, and that means no single actor can make the necessary changes to prevent catastrophic climate change. This means we can’t put all the weight on governments to take actions to change the course of our climate future, and we can’t blame individual actors either. We have to think about economies, polities, and incentive structures.


In their book Nudge, economists Cass Sunstein and Richard Thaler look at what this means for markets and regulation as we try to find sustainable paths. They write, “markets are a big part of this system, and for all their virtues, they face two problems that contribute to environmental problems. First, incentives are not properly aligned. If you engage in environmentally costly behavior next year, through consumption choices, you will probably pay nothing for the environmental harms that you inflict. This is what is often called a tragedy of the commons.”


One reason markets bear some of the blame and responsibility for the climate change crisis is because market incentives can produce externalities that are hard to correct. Climate change mitigation strategies, such as research and development of more fuel efficient vehicles and technologies, are expensive, and the costs of climate change are far off. Market actors, both consumers and producers, don’t have proper incentives to make the costly changes today that would reduce the future costs of continued climate change.


A heavy handed approach to our climate change crisis would be for governments to step in with dramatic regulation – eliminating fossil fuel vehicles, setting almost unattainably high energy efficiency standards for furnaces and dishwashers, and limiting air travel. Such an approach, however, might anger the population and ruin any support for climate mitigation measures, making the crisis even more dire. I don’t think many credible people really support heavy handed government action, even if they do favor regulation which comes close to being as extreme as the examples I mentioned. Sunstein and Thaler’s suggestion of improved incentives to address failures in markets and change behaviors has advantages over heavy handed regulation. The authors write, “incentive-based approaches are more efficient and more effective, and they also increase freedom of choice.”


To some extent, regulation looks at a problem and asks what the most effective way to stop the problem is if everyone is acting rational. An incentives-based approach asks what behaviors need to be changed, and what existing forces encourage the negative behaviors and discourage changes toward better behaviors. Taxes, independent certifications, and public shaming can be useful incentives to get individuals, groups, and companies to make changes. I predict that in 10-15 years people who are not yet driving electric cars will start to be shamed for continuing to drive inefficient gas guzzlers (unfortunately this probably means people with low incomes will be shamed for not being able to afford a new car). In the US, we have tried to introduce taxes on carbon output, but have not been successful. Taxing energy consumption in terms of carbon output changes the incentives companies have with regard to negative environmental externalities form energy and resource consumption. And independent certification boards, like the one behind the EnergyStar label, can continue to play an important role in encouraging technological development of more efficient appliances. The incentives approach might seem less direct, slower, and less certain to work, but in many areas, not just climate change, we need broad public support to make changes, especially when the costs are high up front. This requires that we understand incentives and think about ways to change incentive structures. Nudges such as the ones I mentioned may work better than full government intervention if people are not acting fully rational, which is usually the case for most of us. Nudges can get us to change behaviors while believing that we are making choices for ourselves, rather than having choices forced on us by an outside authority.
Markets and Environmentalism - A Call for Better Incentives

Markets and Environmentalism – A Call for Better Incentives

Earlier I wrote that climate change and environmental concerns seemed to be too large of a problem to be left to nudges. Toward the end of Nudge, Cass Sunstein and Richard Thaler acknowledge the reality that nudges alone cannot tackle climate change, but they still encourage actions that follow the spirit of nudges, or at least learn from the psychology that makes nudges effective. Incentives play a huge role in behavior, and  need to be considered when governments approach businesses in an effort to redress the harms of climate change. Markets and environmentalism cannot be separated if we are to have a sustainable climate. Better incentives need to be implemented within markets to adjust for environmental needs.


The authors acknowledge market failures related to climate change by writing, “when the air or the water is too dirty, the standard analysis says that it is because polluters impose externalities (that is, harms) on those who breath or drink. Even libertarians tend to agree that when externalities are present, markets alone do not achieve the best outcome.” Pollutants are common externalities, as are traffic congestion and decimated wildlife populations. The cost of negative externalities is squarely on the shoulders of the individuals in the market, either the consumer or the producer. Governments are necessary to deal with these externalities and prevent them from harming innocent bystanders.


Additionally, regarding market failures and climate change, the authors continue, “When people are not in a position to make voluntary agreements, most libertarians tend to agree that government might have to intervene.” Most libertarians agree that labor contracts should be voluntary, with an employer reserving the right to hire anyone, and laborers reserving the right to walk away if their wages or working conditions are unfair. In reality, many people would starve if they walked away from a job, or at least face serious challenges, so voluntary agreements are not always possible. Within the climate change arena, many people cannot simply chose to travel to work by more fuel efficient methods, many people cannot afford the switch to solar power, and many other potential solutions are similarly unavailable, meaning people and businesses are often stuck, involuntarily, with polluting norms for travel, work, and heating or cooling their homes and offices. Markets alone don’t provide the impetus to change the status quo to reflect the reality of climate change.


The next post will dive deeper into the incentives and solutions to these problems, but it is clear that markets alone will not direct society toward a climate change solution. The danger of climate change is a long-term danger, where the costs are not experienced in the immediate moment but are instead experienced years and decades later. However, the costs of making adjustments to limit climate change are experienced up front. Upgrading infrastructure, investing in electric and solar technology, and living in more economically friendly ways present immediate costs that nudges cannot overcome. Nevertheless, we can consider the ways in which nudges work and build on those principles to begin to make changes. We can start to better align incentives to limit externalities, and we can preserve choice structures as we move forward with investments and innovation to help us meet the needs of the climate crisis. Government will play a big role and can learns a lot from the psychology of nudges to help address the challenges we face.
Irrational Market Cycles - Joe Abittan

Irrational Market Cycles

I think about markets a lot, often focusing more on market failures than on market successes. I think our country generally views markets as infallible, and that drives me (in a somewhat contrarian strain) to look at spaces where markets don’t work. I also started my career in healthcare and have some relatively expensive healthcare concerns of my own, which also drives me to look at market failures with more energy than market successes. While there are many positive aspects of markets (they certainly do create a good level of efficiency and innovation and may also be generally pacifying across the globe), I think it is important to continue to highlight irrational market cycles, tragedy of the commons type situations, and areas where a market simply can’t be established because goods are nonrivalrous and nonexcludable. This post will specifically highlight an irrational market cycle, by which I mean a cycle of irrationality supported by market forces.


One of the strongest points of markets is that they help to weed out poor performers and eliminate waste. Someone selling a product that doesn’t provide value shouldn’t be able to find any customers. They might dupe a few people into buying their product, but overtime, we expect the market to marginalize the seller and for his business to eventually go bust. But this market efficiency mechanism only works if people are rational, and irrationality can be manipulated and exploited in a market, creating irrational market cycles. Cass Sunstein and Richard Thaler use extended warranties (not the spam ones you get calls about for your car but real ones offered when you buy a fridge) in their book Nudge to describe irrational market cycles. They write:


“If consumers have a less than fully rational belief, firms often have more incentive to cater to that belief than to eradicate it.”


There are products that don’t make sense. Sometimes they pop up as a fad, sometimes they are deliberate scams, and sometimes they are a new gadget that is attached to a new technology as an additional aid, but are in reality effectively useless. People can get sucked into purchasing these items, and they can be marketed as effective and must-have items, only to be irrational junk. The people selling the junk don’t have an incentive to help us think clearly about the product, they have an incentive to hide the truth and make their product appear more attractive by playing into and reinforcing irrational behaviors.


Using the extended warranty example Sunstein and Thaler continue, “If Humans realized that they were paying twenty dollars for two dollars’ worth of insurance, they would not buy the insurance. But if they do not realize this, markets cannot and will not unravel the situation. Competition will not drive the price down.”


An irrational market cycle can arise when incentives exist to encourage people to participate in irrational markets. People’s fear, lack of information, and cognitive biases can be leveraged by market actors to further irrational spending. A market on its own cannot correct this issue as Sunstein and Thaler show. Nudges can be helpful in diverting people out of the market, but it is worth recognizing that there is a role for outside forces to shape markets that fall into these irrational cycles.
Do People Make the Best Choices?

Do People Make the Best Choices?

My wife works with families with children with disabilities and for several years I worked in the healthcare space. A common idea between our two worlds was that the people being assisted are the experts on their own lives, and they know what is best for them. Parents are the experts for their children and patients are the experts in their health. Even if parents to don’t know all the intervention strategies to help a child with disabilities, and even if patients don’t have an MD from Stanford, they are still the expert in their own lives and what they and their families need.


But is this really true? In recent years there has been a bit of a customer service pushback in the world of business, more of a recognition that the customer isn’t always right. Additionally, research from the field of cognitive psychology, like much of the research from Daniel Kahneman’s book Thinking Fast and Slow that I wrote about, demonstrates that people can have huge blind spots in their own lives. People cannot always think rationally, in part because their brains are limited in their capacity to handle lots of information and because their brains can be tempted to take easy shortcuts in decision-making that don’t always take into account the true nature of reality. Add to Kahneman’s research the ideas put forth by Robin Hanson and Kevin Simler in The Elephant in the Brain, where the authors argue that our minds intentionally hide information from ourselves for political and personal advantage, and we can see that individual’s can’t be trusted to always make the best decisions.


So while no one else may know a child as well as the child’s parents, and while no one knows your body and health as well as you do, your status as the expert of who you are doesn’t necessarily mean you are in the best position to always make choices and decisions that are in your own best interest. Biases, cognitive errors, and simple self-deception can lead you astray.


If you accept that you as an individual, and everyone else individually, cannot be trusted to always make the best choices, then it is reasonable to think that someone else can step in to help improve your decision-making in certain predictable instances where cognitive errors and biases can be anticipated. This is a key idea in the book Nudge by Cass Sunstein and Richard Thaler. In defending their ideas for libertarian paternalism, the authors write, “The false assumption is that almost all people, almost all of the time, make choices that are in their best interest or at the very least are better than the choices that would be made by someone else. We claim that this assumption is false – indeed, obviously false.”


In many ways, our country prefers to operate with markets shaping the main decisions and factors of our lives. We like to believe that we make the best choices for our lives, and that aggregating our choices into markets will allow us to minimize the costs of individual errors. The idea is that we will collectively make the right choices, driving society in the right direction and revealing the best option and decision for each individual without deliberate tinkering in the process. However, we have seen that markets don’t encourage us to save as much as we should and markets can be susceptible to the same cognitive errors and biases that we as individuals all share.  Markets, in other words, can be wrong just like us as individuals.


Libertarian paternalism helps overcome the errors of markets by providing nudges to help people make better decisions. Setting up systems and structures that make saving for retirement easier helps correct a market failure. Outsourcing investment strategies, rather than each of us individually making stock trades, helps ensure that shared biases and panics don’t overwhelm the entire stock exchange. The reality is that we as individuals are not rational, but we can develop systems and structures that provide us with nudges to help us act more rationally, overcoming the reality that we don’t always make the choices that are in our best interest.
Markets and Fairness

Markets and Fairness

Research from Daniel Kahneman’s book Thinking Fast and Slow may help explain some of the anger and anti-capitalism sentiment that has cropped up in the United States in the last several years. Senator Bernie Sanders is incredibly popular among a segment of the population and he is not afraid to categorize himself as anti-capitalist and as a socialist to a degree that would have been unthinkable just a decade ago. From my perspective, many people feel that they have been treated unfairly by markets, and this lack of fairness contributes to the Sanders support, especially among young people.


Kahneman’s writes, “a basic rule of fairness, we found, is that the exploitation of market power to impose losses on others in unacceptable.”


My experience is that people are feeling the forces of market power in many different areas, and becoming discontent with their own economic standing and with feeling as though they are being treated unfairly by large market players. It may be that most people can still afford to buy more than what they need and to live comfortably, but on a daily basis they are faced with a barrage of unfair market practices. There may not be anything legally wrong with a market practice, and the market practice may be adjusting for real value rather than just collecting rents, but nevertheless, the exploitation of market power still feels unfair.


I spend a lot of time thinking about healthcare in the United States, and for many years the costs of healthcare and health insurance has risen much quicker than employee wages. With employees feeling their wages stagnate, unfair exploitation of market power can become a major outrage. This has been seen with drug prices as some individuals and companies have specifically targeted pharmaceutical mergers and acquisitions with the intention of increasing drug prices. Some medications have risen dramatically in price at the same time that many deductibles for health plans have shot up beyond the savings levels of most Americans. Even though a drug may provide an incredible value like saving a life or dramatically improving the quality of a life, an increase in price while wages stagnate feels deeply unfair to people. This could be a basis for our discontent with markets and capitalism (at least on the healthcare front), and a source of support for Bernie Sanders and his socialism lean.


When I think about it, I see this type of market exploitation beyond the world of healthcare. Ice cream cartons continually get smaller, the fun-sized candy is a depressingly small size now, good quality razors seem to be unreasonably costly with the cheap alternatives being effectively useless. Outside of smartphones, most markets seem to be providing less value for higher costs, and it is not hard to understand the frustrations that so many people may feel with markets and market solutions, even if they can still afford to live a comfortable lifestyle. For any given firm, exploiting market power is a rational and reasonable thing to do, but for customers, this adds up to an untenable sensation of loss, and a deep feeling that markets are unfair and should not be trusted. In a global market sense, it is as if we face a universal tragedy of the commons problem, but instead of a habitable grazeland being decimated, it is our economic wellbeing that is destabilized as each player in the market flexes more market power to impose marginal losses on each consumer.
Drug Related Violence

Drug Related Violence

In his book Chasing The Scream, Johann Hari writes about common misconceptions related to drug violence in the United States. Misconceptions influence drug policy, shape the way people think about drug crimes and drug users, and prevent us from taking real action to help reduce the conflicts and negative externalities related to the American war on drugs.


Hari writes, “When we hear about drug-related violence, we picture somebody getting high and killing people. We think the violence is the product of the drugs. But in fact, it turns out this is only a tiny sliver of the violence. The vast majority is … to establish, protect, and defend drug territory in an illegal market, and to build a name for being consistently terrifying so nobody tries to take your property or turf.”


What Hari suggests throughout the book is that many of the negative things we relate to drug use is more associated with prohibition against drugs. Making drugs illegal and trying to stamp out any drug use in an all-out war creates negative externalities that justify violence and prohibition. The war on drugs creates a positive feedback loop, making drug use and drug trafficking more dangerous, building support for harsher treatment and destruction of drug users and sellers.


When we make something illegal, we create a black market. On the black market, as I wrote about from Brookings Scholar John Hudak’s book Marijuana: A Short History, suppliers don’t have to meet safety and quality standards that would exist in a regulated legal market. This is where the dangers of drug use arise and where drug related violence comes into the picture. Many of the people using drugs directly are non-violent, and don’t want to cause harm to others when using drugs. They harm others when they need to obtain drugs illegally, on a costly and dangerous black market. The sellers create relationships and build territory, and use their own force to control their territory, since relying on police protection and legal backing to defend property and product is not an option in a black market.


I don’t know what the world would look like without a war on drugs and with a legal market for obtaining drugs. I don’t know what new externaliteis would arise and how we would face them. But I do think that Hari is correct and that we should acknowledge that much of the drug related violence and crime, and much of the safety concerns related to drug use, stem from the very prohibition and war that we approve of to stamp out drug use. The current approach seems incapable of eradicating drugs, but it does seem to spur substantial drug related violence and safety issues.
Transparent Price Bundles

Transparent Price Bundles

One of the items that Dave Chase calls for in his Fair Trade for Health Care Plan in his book The Opioid Crisis Wake-Up Call is bundled prices. He wants pricing to be transparent and up-front so that patients know what services they are receiving, and he wants prices to be bundled for any procedures that we undergo.


As chase writes, “Imagine buying a car and getting a bill for the transmission six months later. You’d be livid, yet this sort of thing happens all the time in the healthcare industry.” If you have ever gone to an emergency room or had a surgery, you likely have experienced what Chase is talking about. You were probably billed for the procedure and the doctor who saw you, but then you might receive a separate facility bill some time later, or you might receive a separate bill from the anesthesiologist months after you thought you had finished paying everything from the procedure or emergency room visit that you had.


The amount of additional bills that keep rolling in from a single procedure can be frustrating and overwhelming. You likely get an explanation of benefits that to an ordinary person doesn’t explain much of anything, and then you get multiple bills from multiple entities with no clear explanation of why you are receiving another bill. The confusion can easily frustrated patients and prevent them from being able to contest what many see as unreasonable charges.


In Chase’s Fair Trade for Health Care, providers would have to be up front about any costs that patients are going to incur before a procedure or encounter. This would include bundling all prices together ahead of time to reduce surprise billing. A patient can try to anticipate charges, but if they can’t anticipate who will be billing them, they cannot truly have a sense of what a procedure will cost them. This is an unfair practice from healthcare providers and drives up costs for everyone.
The Specter of Rationing Care

The Specter of Rationing Care

American’s fear having to wait for anything. We want to order things from the comfort of our own home and have them delivered in two days. We don’t want to wait behind more than three people in line at the grocery store, and we don’t want to wait for medical care (to be honest these are all examples from my own life – not picking on anyone who isn’t like me here). Our fear of waiting is used as a reason against universal health coverage. We are told about Canadians who cross to the United States to have surgeries that they would have to wait several months to have in Canada. We are told that we won’t be able to schedule an immediate primary care appointment if more people were to have access to health care. And we are told that the high costs of medical care stop unnecessary care from happening, preventing us from having to wait to see a doctor.


However, these fears of waiting and the specter of rationing care presented to us in these scenarios is overblown. It is true that some Canadians chose to get care in the United States for elective procedures, but presenting that fact to us in isolation is misleading and done in bad faith. The reality of our waiting for care is much more complex. Dave Chase does a good job of explaining it in his book The Opioid Crisis Wake-Up Call, “People often raise the specter of rationing care. In reality, it’s overuse (i.e., unnecessary and potentially harmful care) that leads to reduced access by squandering enormous financial resources that would be better used for individuals who actually need care and can’t get it.”


We act as though our healthcare system is following good market incentives to find a good balance between wait times and receiving the right care. But we often fail to acknowledge that our healthcare system isn’t performing like an ideal market, and that it often pushes people to too much of the wrong type of care. Chase details this in his book with unnecessary back surgeries. Those who have a legitimate need for a back surgery might have to wait, because primary care providers get a bonus when they refer patients to orthopedic surgeons who are paid to operate. The right path for a patient might be physical therapy, but the money for the providers is in the surgery.


We should not raise the specter of rationing care when we are so wasteful with the care we provide through our current system. We waste a lot of money when we don’t have a concern about rationing care, and when we reward providers for doing more surgeries, prescribing more pills, and offering more treatment, even if the efficacy isn’t proven. In his book, Chase doesn’t advocate for a universal coverage system with healthcare covered by the federal government, but he does show how employers today can do more to ensure their patients get more of the good care (the effective PT and preventative check-ups) for free. This reduces the demand on the expensive and unproven treatments later on, and actually reduces the demand on the system for services that we are afraid of rationing.
Black markets and Marijuana

A Thought About Black Markets

A line from John Hudak’s book Marijuana: A Short History is worth thinking about if we are someone who frequently thinks about public policy. Hudak writes, “The black market just has to deliver marijuana; the legal market must meet consumer demand.” 


Hudak’s line comes from an early paragraph in his book where he discusses historical trends in the strength of marijuana overtime. Marijuana strength is often measured by the amount of THC in the final product to be consumed. Dr. Mahmoud ElSohly, a researcher with the University of Mississippi, has been analyzing the THC content in seized marijuana since the 1970’s and has found that THC content has increased overtime from about 3% to 7-8%. However, marijuana that can now be purchased in dispensaries in states that have legalized marijuana often has a much higher THC content, closer to 20% or more.


My interest is not so much in the marijuana itself, although the plant and product is interesting (Note: I have asthma and can’t smoke and I have never tried any edible forms of marijuana). What is really interesting is the degree to which the black market under-served those who wanted to purchase marijuana from 1970 to today. Marijuana that could be purchased from a drug dealer or a friend was not as potent as people would have liked. If people were intent to buy marijuana, their only option was a product that we would consider inferior to the options available in states that have legalized marijuana today, a product that many likely wouldn’t chose if they’d been able to chose an alternative product.


The point I want to highlight is not that people were purchasing weak marijuana from the 1970’s until 2019 when Hudak’s book was published. Instead, the point I am trying to make is that the black market delivers sub-par products to people who use them. In the case I am writing about, illegal supplies of marijuana were simply less potent, not something that non-marijuana users are likely to care much about. However, if we think about other black markets, we should be more concerned about the products that people purchase illegally. Other black market products, that people cannot obtain legally and that cannot be regulated by a true market mechanism, likely come with more dangers than just being weak. Other illicit drugs can be even more dangerous and harmful when purchased on the black market. Health products, purchased on the black market where they might be cheaper than licensed and regulated products obtained legally, could also pose serious risks of harm.


This creates an argument for reasonably regulated markets, even of things we find deviant and would rather people be unable to purchase. We want some type of government oversight to ensure that products and services are safe, effective, and authentic, but we should be concerned about government regulation that drives a product or service into a black market. The market itself will find a way  to deliver the service or product, but it may do so in a dangerous and illicit manner. Government and regulation can be forces for good and bad within this dynamic. What is important is that we think critically of how regulation relates to markets, and consider the impact on people’s lives, including the lives of those who will still pursue a product or service once it is forced to a black market.

Markets & Civil Society Organization

I tend to be a bit hard on the idea of free markets. I grew up learning about the invisible hand and in a family that started a business and did well. I (mostly because of my family’s business) appreciated the idea that setting up a market and running a business was a good thing from the standpoint of finding an efficient point at which to price a product or service. Today however, perhaps as a result of my healthcare interests, I see numerous examples of markets falling short of the goal we establish in our minds based on the idea of the invisible hand.


Rather than seeing markets find an efficient point where competition drives efficiency and provides everyone with better products at better prices, I see too many externalities from free markets and unfettered competition. We are producing a lot of greenhouse gasses that harm life on the planet. CEOs are getting better (maybe deservedly so) at capturing greater salaries from their companies, driving economic inequality, and straining social stability. Private health insurance markets seem to drive overall healthcare costs up at every turn, and no one seems to be able to understand how health insurance actually works. The free market, and open competition, does not appear to function as clearly and organize as succinctly as my simple understanding from high school would have suggested.


What is missing is something that ties markets and capitalism back into civil society. Bruce Katz and Jeremy Nowak, in their book The New Localism, suggest that shifting political power and decision making back to local contexts within cities and metropolitan regions can help correct these problems. They write, “New Localism is a mechanism for converting the self-organizing power of markets and civil society into structured fiscal and financial resources, and ultimately, political power.”


National and multinational sized corporations often have a responsibility to maximize profits for shareholders or top executives. Their huge scale means that any local or regional place is less important for them, since there are always markets in other countries and other states. However, when local governments exert more control over such companies, the local contexts begin to matter more. When CEOs and executives from these companies are invited in to help shape policy beginning at the local level, and are held accountable to the local individuals in the places where their markets are strong or where their employees actually live, the business motives that encourage negative externalities are shifted. The dynamic becomes one where civil responsibility is elevated, and ultimately political power is shifted in a way to help organize business in a more responsible manner in relation to the local context.


The lesson that Katz and Nowak share is that businesses on their own are encouraged to organize themselves in a way that maximizes profit at the expense of the local communities in which they operate. By giving localities more power and better networked governance structures, big businesses can instead be a cooperative part of the political and social structure, re-organizing themselves within society in a way that helps make Adam Smith’s invisible hand dream a little more plausible. The Invisible hand in this model is not so invisible, but more of a structured handshake creating a commitment to more than just profits.