Free market environmentalism gone wrong

I've been writing for some time the problems of trying to save endangered species (see here, here, here, here, and here). One potentially effective (and controversial, compared with orthodox environmental values) solutions is to grant property rights over endangered species and allow them to be farmed. Of course, this would also entail legalising the trade in endangered species. Then the farmers have incentives (backed by legal rights) to protect their herd of rhinos from encroachment by others (including poachers), and will be much more likely to sustainably manage their herd (otherwise, their livelihoods will suffer). You could argue this is one of the reasons why rhinos are endangered, but cows are not.

Now, it seems that South Africa has moved one step closer to this ideal, as Science Alert reports (emphasis added):

A high court judge has upheld a decision to lift the ban on buying and selling rhino horn within South Africa. Rhino horn trade has been outlawed in the country since 2009, and internationally since 1977, but if the high court's decision holds up against an appeal, that could all be about to change...

The push to lift the ban on selling rhino horn came from game breeders, John Hume and Johan Kruger, who claim that legalising the trade within the country will reduce rhino deaths - rhino horn is similar to our fingernails, and can actually be harvested without harming the animal. Hume also argued that if the ban on rhino trade continued, he'd no longer be able to afford to keep his 1,200 farmed rhinos.

However, this doesn't solve the overall problem, because the international trade in rhino horn is still illegal:

But there's a big problem with their argument, and that's the fact that pretty much all of the demand for rhino horn comes out of Asia - and lifting the ban on being able to sell within South Africa isn't going to do anything to stop that...

In fact, if the ban is lifted, it'll probably just create a new market for rhino horn, and put more pressure on the already endangered species.

So, rather than reducing the price of rhino horn by flooding the international market with supply of farmed rhino horn, this measure likely increases the demand for rhino horn, raising the price, and increasing the incentives for poachers!

It'll take something more coordinated internationally to create the right conditions to eliminate (or at least, minimise) poaching of endangered rhinos.

[HT: Marginal Revolution, back in January]

Read more:

• Can technology save the rhinos?
• Because crushing ivory is so much better than burning it
• Poisoning rhino horns to save the rhinos
• This couldn't backfire, could it?... Ivory burning edition
• Lions are dying to be saved

The deadweight loss of rent control

Caleb Malik pointed me to this blog piece he wrote recently about rent control. Given that rent control is covered in the ECON100 test this week, I thought it would be timely to discuss it again (I previously discussed rent control in the short run and long run here).

Caleb's piece covers the ground well, but I want to look specifically at the economic welfare effects of rent control, and who gains and who loses from controlled rents. Remember that governments (local or central) typically enact rent controls in order to help low-income tenants who may be struggling to pay high rents (often in inner-city neighbourhoods).

Consider the market in the diagram below. If the market is at equilibrium, the market rent is R0, and the quantity of housing rented is Q0. Now say instead that there is a binding rent control at R1 (below the market rent). The lower rent makes renting more attractive relative to owning your own home. Some people would find it cheaper or more convenient to be a renter at this lower rent, so the quantity of rental housing demanded increases (to QD). However, the lower rents make rental housing a less attractive investment for landlords. Perhaps they convert that rental housing into commercial rentals instead (e.g. offices) or maybe they choose to live there themselves (the opportunity cost of living in the house is now lower). Either way, the quantity of rental housing decreases (to QS). The difference between QD and QS represents the excess demand for rental housing at the controlled rent – there are fewer houses available than the quantity people want to rent.

It should be obvious that landlords are made worse off by rent controls - their rental housing attracts lower rents (R1 instead of R0), and they provide fewer rental housing units at that lower rent (QS instead of Q0). The producer (landlord) surplus is a measure of the landlords' economic welfare - it is the difference between the rent they receive (either the market rent or the rent controlled rent), and their costs (which are shown by the supply curve). Without the rent control, the landlord surplus is the area R0EF on the diagram, but with the rent control, the landlord surplus falls to the area R1CF. Landlords are made unambiguously worse off by the rent control.

What about tenants? The consumer (tenant) surplus is the difference between the amount that tenants are willing to pay (shown by the demand curve), and the amount they actually pay (the market rent, or the rent controlled rent). Without the rent control, the tenant surplus is the area AER0, but with the rent control this increases to the area ABCR1 [*]. Tenants as a group are made better off. However, this ignores that many prospective tenants are missing out on rental accommodation (remember the amount of rental housing has fallen from Q0 to QS). Because of the shortage of rental housing, landlords have choice over who they rent their housing units to. Given the choice between, say, a couple who both have professional jobs earning relatively high income, and a low income family who have precarious jobs, the landlord is likely to choose the former, who they probably assume to be lower risk. So, it is likely that the tenants that the rent control policy is designed to help most are likely to be one of the groups that loses from it - an unintended consequence of the policy.

Finally, the sum of the tenant and landlord surpluses in this market is what we term total welfare - a measure of the benefit to society arising from this market. Without the rent control, total welfare is the area AEF, but with the rent control this falls to the area ABCF. There is a loss of total welfare of the area BEC - the deadweight loss of the rent control. This deadweight loss arises because the gains to tenants (in terms of more tenant surplus) from the rent control are much less than the losses to landlords (in terms of lost landlord surplus).

Moreover, there are other negative effects such as landlords' incentives for keeping their housing units in good repair are reduced (because there is a shortage of housing - tenants can't afford to be choosy about the unit they rent), and the incentives to build new developments are reduced (because they will be much less profitable than if the market rent prevailed). The effects are also worse in the long run (including a larger deadweight loss). So, as Caleb Malik concludes:

...rent control is often marketed by politicians as a way to help the lower class. They paint the landlord as an old miser who is simply out to get the poor, and rent control as a way to stop this antagonist. The public often idealizes such a scenario. When not critically analyzed, rent control sounds utopian. One of our largest expenses has now been limited? Who wouldn’t sign up for that? Yet, the effects are rather tragic, as both liberal and conservative economists agree.

On the one hand, tenants find extremely limited housing, and the housing they do find is run down or comes with a price tag that is nowhere near affordable. On the other hand, landlords can no longer profit from their investments. This results in both a loss of new developments and a reduction in the quality of current housing.

*****

[*] However, it is by no means certain that tenant surplus would increase. If the controlled rent is too far below the market rent, then tenant surplus starts to decrease. To see why, consider the extreme example where the controlled rent is zero - at that rent no landlords would offer their properties for rent, and the tenant surplus falls to zero!

Read more:

• Why rent controls have worse effects over longer time horizons

The advantages of creating a market for live kidney donations

In the ECON100 tutorials, one of my favourite questions covers the welfare effects of creating a market for live kidney donations. And it's topical too - there was a front page story on the issue on the New Zealand Herald on 8 April (though it is no longer available online?).

The premise for the market approach is fairly basic. At the moment in most countries (including the U.S. and New Zealand) there is no market for kidneys, and kidney donors are not directly compensated for their kidney. Effectively this means that, in the market for kidneys, the price is fixed at zero, as in the diagram below. At this price, the quantity of kidneys demanded (QD) is greater than the quantity of kidneys supplied (QS). So, there is a shortage of kidneys - not every patient who has a need for a kidney transplant is able to receive one. The waiting list for a kidney transplant is about 450 in New Zealand, and about 93,000 in the U.S.

If live kidney donors (or deceased donors' estates) were compensated for giving up their kidneys, this would remove the effective price control from this market. The market price for a kidney would rise from zero to P1 (in the diagram above). The quantity of kidneys supplied would increase from QS to Q1 (as at least some people who wouldn't have given up kidneys for nothing would choose to do so in return for compensation), while the quantity of kidneys demanded would fall slightly from QD to Q1 (the slight decline here is because demand for kidneys is very inelastic - there are few substitutes for a kidney [*]). There would no longer be a shortage of kidneys.

The welfare impacts are likely to be large. Without the market for kidneys, the consumer surplus (a measure the amount by which transplant recipients benefit from kidneys) is the area ABCO (plus the triangle above AB which extends above the top of the diagram), which is also the measure of total welfare because there is no producer surplus. If the market was allowed to operate (no pun intended!), consumer surplus would be ABEP1 (plus the area above AB), and producer surplus (a measure of the amount that donors benefit from the market) would be P1ECO. Total welfare would now be ABECO (plus the area above AB) - an increase of BEC.

There are other ways of demonstrating the gains from compensating kidney donors. A recent paper in the American Journal of Transplantation by Philip Held (Stanford), Frank McCormick (Bank of America - retired), Akinlolu Ojo (University of Michigan Health Systems), and John Roberts (University of California San Francisco Transplant Service) evaluates the costs and benefits of government compensation of kidney donors. The paper is very readable, and I encourage you to read it (it is ungated). It's also notable for having twelve supplements of additional material to the paper, supporting the analysis and conducting sensitivity testing. The abstract provides the best summary of the results:

From 5000 to 10 000 kidney patients die prematurely in the United States each year, and about 100 000 more suffer the debilitating effects of dialysis, because of a shortage of transplant kidneys. To reduce this shortage, many advocate having the government compensate kidney donors. This paper presents a comprehensive cost-benefit analysis of such a change. It considers not only the substantial savings to society because kidney recipients would no longer need expensive dialysis treatments—$1.45 million per kidney recipient—but also estimates the monetary value of the longer and healthier lives that kidney recipients enjoy—about $1.3 million per recipient. These numbers dwarf the proposed $45 000-per-kidney compensation that might be needed to end the kidney shortage and eliminate the kidney transplant waiting list. From the viewpoint of society, the net benefit from saving thousands of lives each year and reducing the suffering of 100 000 more receiving dialysis would be about $46 billion per year, with the benefits exceeding the costs by a factor of 3. In addition, it would save taxpayers about $12 billion each year.

There's a lot that my ECON110 students can gain from reading this paper, as it makes extensive use of techniques we develop in a much simpler way in that paper. Among other things, Held et al. demonstrate that kidney transplantation is more cost-effective than kidney dialysis ($49,000 vs. $186,000 per Quality-Adjusted Life Year gained) for end-stage renal disease.

The overall conclusion though is again, that compensation for live donors of kidneys makes economic sense. Held et al. have a final comment for those who still hold a dissenting view:

Finally, we encourage those who oppose compensating kidney donors to place a monetary value on their concerns and to show how they outweigh the very large net benefits demonstrated by this analysis. If they do, they may discover—as we did in Supplement 6—that many of the arguments usually made against compensation of kidney donors turn out instead to be arguments in favor.

[HT: Marginal Revolution for the Held et al. paper]

*****

[*] Although, it could be argued that the demand for kidneys would actually increase, because a kidney transplant can be expected to last only 10-15 years, after which the transplant recipient would require another kidney transplant.

Are robots the cure for the cost disease?

I just finished reading William Baumol's book "The Cost Disease", which is based on his long-standing research explaining why costs in education and health care are spiralling out of control. In short, the premise of the cost disease can be fairly easily summarised, as follows.

Baumol contends that there are two sectors in the economy: (1) a "stagnant sector" where labour productivity growth (the growth in the amount of 'stuff' that can be 'produced' in each hour of a worker's time) is slower than average; and (2) a "progressive sector" where labour productivity growth is faster than average. Activities that fall into the "stagnant sector" are those that require substantial human input that cannot be easily reduced (at least, not without a consequent reduction in quality). For example, it is difficult for a doctor to see more patients per hour, without the quality of care being reduced. In contrast, activities that fall into the "progressive sector" are those where technology is making workers much more productive, such as in manufacturing.

Now, because these two sectors have diverging productivity trends, Baumol argues that this has implications for costs. Because workers in the "progressive sector" are becoming more productive over time, their wages increase. This should be familiar to students of economics, as we expect that in competitive labour markets the wage will be equal to the value of the marginal product of labour (VMPL; the value of stuff that the next worker employed will produce). If productivity increases, the VMPL increases, and so will wages. However, the situation in the "stagnant sector" is different. In that sector, wages increase not because of productivity gains, but because if wages didn't increase the labour force would increasingly move into the "progressive sector" to take advantage of the higher wages (which would reduce labour supply in the "stagnant sector", increasing wages there).

Now, think about the implications for costs. In the "progressive sector", wages are increasing, but the workers are producing more, so the cost of producing each unit of output are stable or declining. In contrast, in the "stagnant sector", wages are increasing but productivity gains are low, so the cost of 'producing' each unit of output are increasing.

Which brings us to the central conclusion of the cost disease: that costs (and prices of things produced) in the "progressive sector" will tend to decline over time, while costs (and prices of what are typically services) in the "stagnant sector" will tend in increase over time.

I think there are a number of interesting implications that flow from this realisation of the cost disease. First for me is that this has implications for the "throw-away society". Because manufacturing goods (from the "progressive sector") become cheaper over time, while most repairs must be conducted hands-on (in the "stagnant sector"), then it will get increasingly less expensive to throw away and replace items that cease to function rather than repair them. So for example, when my watch strap broke the other week, it was much cheaper for me to buy a new watch than it was to pay to have the strap repaired (helped of course by the watch being an inexpensive Warehouse watch).

The second implication of interest is the implications for economic growth. Over the long term, economic growth is essentially based on increases in productivity. However, if the "progressive sector" is becoming more productive (through labour-saving technology), it seems to me that an increasing proportion of the labour force will end up working in the "stagnant sector" (e.g. low paid service work). Since the "stagnant sector" is not increasing in productivity as fast, then the implication is that economic growth will slow down as a result.

Finally, it was interesting to read this book while the Labour Party's Future of Work Commission was in the news. In particular, we heard a lot about the 'rise of the robots'. No, not this:

But this: "Robots could do 46 percent of NZ jobs". Many of the jobs cited in that article (drivers, clerical workers, technicians, accountants) would probably be considered to be in Baumol's "stagnant sector". Even baristas might be at risk. So, that suggests to me that the "stagnant sector" may not remain stagnant for much longer. As labour-saving robots (and drones, and machine-learning algorithms, and other new technologies) increasingly take over these jobs, productivity growth in those industries will increase and costs should eventually fall. So, perhaps robots will cure the cost disease?

But in the process put a lot of people out of work. As Brian Fallow notes in this interesting New Zealand Herald article:

You might have every confidence people will come up with plenty of new ways of earning a living that do require the intelligence of the human brain, the dexterity of the human hand or a sympathetic heart.

And that the time and effort digital technology saves will get distributed as more leisure for everybody.

Eventually.

In the meantime, however, it is clear that the scale and pace of the technological revolution we are in the midst of is overwhelming the ability for those good things to happen.

Though technology boosts some people's productivity, it collapses others' to zero as they become redundant or struggle to find their first job.

Fallow concludes that a universal basic income might be necessary. However, the cost is large, but Fallow argues that this could be covered by broadening the tax base - starting with taxing capital gains. However, I'll leave that discussion for a future post.