Making Markets Work

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Chapter 13

• Making Markets Work

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What Markets Do

• Purpose to allocate scarce resources efficiently
  over the short run
• Cannot do everything desired
• Cannot replace politics, ethics or religion
• Not meant to achieve community, integrity,
  beauty, justice, sacredness or sustainability

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Some Myths about the Perfect Free Market

• Everyone has perfect data on the future
• Perfect competition exists
• Price signals reflect every cost to society
• No sole buyers/sellers
• No individual transaction can move the market
• No transaction costs
• No transaction lags
• No subsidies or other distortions

• No barriers to market entry/exit
• No regulation
• No taxation
• Investments can be traded in uniform,
  standardized chunks
• Unlimited capital available to everyone at a
  risk-adjusted interest rate
• Everyone is motivated solely by maximizing
  personal wealth or income

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But, in reality ...

• Corporations that benefit from subsidies,
  externalizing their costs, avoiding transparency
  monopolizing markets tend to ignore market
  realities lobby for new rules that will best
  achieve their goals
• People are far too complex to be perfect
  benefit/cost maximizers often irrational,
  sometimes devious clearly influenced by many
  things besides price

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Capital Misallocation

• Most managers pay little attention to small
  line-items such as energy
• Most manufacturing firms choose investments that
  increase output in preference to those that cut
  operating costs
• What isnt realized is that saved overhead
  drops directly from the top to the bottom line

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Different Languages

• Operating engineers use a rule-of-thumb procedure
  called simple payback which calculates how many
  years of savings it takes to repay the investment
• Corporate officers dont know how to translate
  simple payback into financial language
• They may miss substantial rates of return, many
  times the cost of the invested capital
• Result, most firms are not purchasing nearly
  enough efficiency

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Individuals also have trouble allocating capital
to energy efficient investments

• Efficient Lightbulbs
• Few will pay 15 when an ordinary one is 0.50
• 13x longer life saves tens of dollars keeps a
  ton of CO2 out of the air
• Photovoltaics
• Few can afford to pay 20 years worth of
  electricity up front

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Adjusting the Market

• Southern California Edison Company - gave away 1
  million compact fluorescent lamps cut retail
  price with subsidy to lamp makers
• Other utilities lease the lamps with free
  replacements
• Sacramento municipal utility finances
  photovoltaics and rolls them into mortgages

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Organizational Failures

• Endless familiar excuses for not addressing
  problems
• Infectious repititis (do over over the same,
  savings untapped)
• Abysmally low R D investments stagnation
• Individual initiative snuffed out by bureaucracy
• Satificing - doing just enough to get by
  satisfy all parties
• Information not flowing to those who can act on
  it (ex., simple labeling of light switches saved
  a company 30,000/year

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Regulatory Failures

• Some regulations produce the opposite of intended
  results
• Perverse incentives - ex., utilities rewarded for
  selling more energy penalized for cutting bills
• Some obsolete, some misinterpreted
• Minimum standards offer split incentives -
  those who choose the technologies dont pay the
  bills
• CATNAP - Cheapest Available Technology Narrowly
  Avoiding Prosecution - no incentives to improve
  performance

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Informational Failures

• Business reluctance to act because of a lack of
  accurate up-to-date information (if you dont
  know something is possible, you cant choose to
  do it)
• One solution labeling
• Energy Star 30 savings on energy
• EPA Green Lights retrofits 30 savings

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Value Chain Risks

• Manufacturer uncertainty that customers will buy
• Efficient equipment isnt available where when
  customers want it
• Distributors frequently reject the risk of
  carrying non-plain-vanilla inventory that may
  sell slowly or not at all

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False or Absent Price Signals

• Externalities of resource depletion pollution
  not accounted for
• Polluter Pays Principle accepted in industrial
  economies, but not implemented (esp. in energy
  pricing)
• Utility bills not often itemized by piece of
  equipment or time of day
• For renters, utility bill often prorated, not
  sub-metered
• Chains franchises may never see energy bill,
  sent to remote accounting departments
• Large firms may see energy as a fixed cost not
  worth examining
• Solution - get the incentive right so that
  rewards are granted for what we want - lower
  bills, and not the opposite - higher sales

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Incomplete Markets

• No significant market yet for negawatts -
  electricity saved by reducing inefficiencies in
  use
• Utilities can set these up and some have
• For every resource, there is an equal and
  opposite anti-resource entrepreneurs can exploit

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Creative Policy Frameworks - Examples

• Pay at the Pump - automatically purchase
  collision liability insurance with each tank of
  gas (American pay more per mile for insurance
  than for gas)
• Eliminate all transport-related subsidies - make
  each pay all of its own way - let the true market
  help consumers decide

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Fair Rules Make Markets Work

• Market competition works only if rulebook is
  adhered to by all players enforced by honest
  umpires
• Historical abuses in U.S. led to anti-trust laws
  formation of Security Exchange Commission
  other watchdog agencies
• Markets little more than a way of exchanging
  information about what people have what they
  want
• Systems without feedback are stupid by definition
• System with feedback loops can grow smart in a
  hurry

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2 Examples of Direct Market System Feedback

• How clean a car would you buy if its exhaust
  pipe, instead of being aimed at pedestrians, fed
  directly into the passenger compartment?
• A factory that discharges pollution into a river
  is more likely to clean it up if its water intake
  is downstream of its effluent outfall

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The authors challenge ...

• If we dont change where were going, we may get
  there