Guggenheim, externalities, public goods and game theory

Former journalist and city councillor Nils Torvalds wrote a column last sunday in the newspaper Hufvudstadsbladet on the debate on the planned Guggenheim Helsinki museum. A major motivation for building the museum has been the alleged increase in tourist inflows that the museum would bring to Helsinki. Among the beneficiaries of this we presumably have restaurants and hotels.

Torvalds thinks it shortsighted of these private beneficiaries to free ride by not willing to contribute towards the costs of Guggenheim. In terms of moral, this might be the case. Nevertheless, a lot of investments have similar kinds of externalities, ie. they benefit somebody else than the decision maker (ie. the City of Helsinki in this case).

In theory, it would be good if you could make the beneficiaries of these externalities pay for the benefits they receive. Nevertheless, this is often not feasible. To see why, consider the decision making of an individual restaurateur. His benefits from the Guggenheim is not enormous. And even if it was, what are his incentives to pay for it? Is everybody else's investment in Guggenheim really conditional on his investment? That is, if he were not to invest, will the project falter, and if he is to invest, will it really be build? It would seem unlikely.

Due to these kinds of externalities, investments with this kind of public good features are often financed with tax funds, as the costs are then covered by the general public, who also receives the benefits. And mind you, those greedy, short sighted restaurants are also paying taxes.

Nevertheless, even if we ignore what is practical at the moment and think in moral terms ("The restaurants should pay") we still have some problems with the suggestion. Let's say that the current restaurants and hotels pay for the Guggenheim. Even if we somehow could convince every single restaurant in Helsinki to pony up exactly the sum by which they benefit from the Guggenheim, would we then have arrived at a equitable solution?

The answer to the question must be no. Even if we can force the currently existing restaurants to pay, the alleged influx of new tourists would probably lead to new restaurants being started. New restaurants which wouldn't have started if their older competitors hadn't paid for the Guggenheim. So we're back at the free riding problem. Which really is solved using the public purse. That is of course, provided that it makes sense for the public sector to invest in the project...

Special interests vs. the public interest

Yesterday I blogged about experts and special interests groups lobbying for legislation to increase demand for their services.

A recent related example of this can be found in the regional newspaper Kouvolan Sanomat, where a health and construction expert suggested that all buildings should be subject to a inspection system similar to the one currently in place for cars.

This would surely be a great thing for the special interests the expert represents. Whether it would be it for the taxpayer and/or home owners is a different story. Mandatory car inspections can be motivated by the fact that car usage can impose consequences (externalities) on outsiders.  It is not evident that this is the case for houses.

On regulation and impact studies

Frequently papers and news sites report on various groups suggesting that various impact studies should be carried out when any new legislation or regulations are drafted.

Typically this takes the form of experts in the field, say environmental experts suggesting that any new legislation should be analyzed to see what impact the new legislation may have on the environment.

These kinds of impact studies may occasionally make sense. However, critical journalists should point out that calling for systematic impact studies really also (only?) serves the interests of the experts in the field. Mandatory impact studies carries a cost to the taxpayer, while the experts in the field benefits through higher demand for their services.

In order to mitigate this, my suggestions is that all new legislations and regulations should be subject to economic impact studies, or cost-benefit analysis. This suggestion is of course made only in the interest of the taxpayer. Any insinuations that I propose this because it would benefit me as an economist is cynical and daft.

Culture vs. health care – On conflicts and priorities

Today the report on the Guggenheim’s Helsinki project will be published.  Rumors suggest that the report will find that Helsinki is a suitable place for a Guggenheim museum. A museum that the city of Helsinki should pony up a few hundred millions of euros to build. Spending this much taxpayer money on a museum may seem preposterous to some.

Some have suggested that in a time when the public sector has to save money by cutting down on funding for health care, building a brand new museum for 200-300 million euro is a bad idea.

However, inevitably an argument far too often heard has also been made suggesting that pitting health care against culture is populistic and a false conflict. City council member Laura Kolbe was quoted in the local newspaper Hufvudstadsbladet on January 3^rd as saying exactly this.

Her argument was that since the money for a museum comes from the city’s budget for culture, while the money for health care, comes from another part of the budget. Thus, no conflict between the two!

Charming as this argument may seem to some, this is really not that sensible. Fundamentally, the money comes from the same source, that is the taxpayer. Just because fraction X of the budget this year is devoted to culture and fraction Y to health care doesn’t mean that these fractions have to be the same for all eternity. It’s not as if these fractions were some law of nature that man cannot change.

Thus, as long as the proponents of the museum cannot show that it really is a profitable investment for the city, in the sense that it will bring in more money to the city than it costs, then they should really be honest and acknowledge the conflict.

This is not to say that the museum shouldn’t be built if it’s not a profitable investment from a economic point of view. But if it’s not, then the argument should be made clearly why it is more important than say health care. Anything else is intellectual dishonesty.

On Christmas and deadweight losses

In the aftermath of Christmas, it is time to reflect on how economists view Christmas. Talking about the subject, many people will come to think of some economist talking about how important consumer spending during the Christmas season is for economic growth. Let’s call this the macro-story.

While that macro-perspective may be informative, the economist Joel Waldfogel published an article in the premier peer reviewed economics journal, American Economic Review in 1993 entitled “The deadweight loss of Christmas.” In the article, Waldfogel set out the argument for why the giving of Christmas presents is not as benign as the macro-story would suggest.

The problem that Waldfogel highlights is the fact that those giving Christmas presents tend to make bad choices. His argument is founded on some fundamental microeconomic theory, suggesting that when people get to choose themselves how they spend their money, they will maximize their own utility (you can think of utility as happiness). When somebody else spends money for a person (as in buying a Christmas present), the best he can do is buy exactly the same thing as the person would buy himself. Buying anything else will by definition give the receiver less utility, for if it would give him more utility he would have bought it himself in the first place.

Thus, based on a very simple theoretical argument, Waldfogel establishes that buying somebody a Christmas present for say 20 euros will at best give the receiver as much utility as he would have got had he himself chosen how to spend the 20 euros. And this is the best scenario. More likely the receiver will receive something that he himself would not have bought for 20 euros, thus creating what’s known as a deadweight loss.

So what is the deadweight loss in this case? The deadweight loss is the difference in the receivers valuation of the gift and it’s price. Say the gift giver receives a book that cost the giver 20 euros, but the receiver would only be willing to pay 15 euros for it. Then the deadweight loss is at least 5 euros. It could be larger, because the gift giver might be able to buy a shirt for 20 euros, that he’d be willing to pay 40 euros for. If this was the object he’d value the most, then the deadweight loss amounts to 25 euros.

The argument of Waldfogel is sound, but it can of course be criticized. It might be that the fact that the book is given by the gift giver actually has added value for the receiver. Also, the basic microeconomic argument rests on a full information assumption, that is it is assumed that the receiver has full information of all the different things he could buy for the 20 euros, including how useful/delightful the product will turn out to be. If this is not the case, and the gift giver has more information, then he might be able to make a better choice.

So what are the policy implications? When buying presents, buy something where you have superior information to the receiver. Thus, if you know that the receiver enjoys reading the odd book now and then, but has a hard time finding interesting books, while you yourself has immense knowledge of literature, buy the person a book. And of course, do take into account that the receiver may have differing taste, or as an economist would put it, preferences.

Which brings us to the other part of the Waldfogel article. Waldfogel also takes a stab at analyzing the issue empirically. What he finds out is that people more distant buy worse Christmas presents than close relatives and friends. Which might imply that you should really only buy presents for people you care about.

Lobbying for restrictions on competition

Lobbying for restrictions on competition is a really simple phenomenon. It is a bit depressing that journalists reporting on various commerce associations' initiatives for "improving" the workings of the market. Currently, parliamentarians are concerned that instant/quick loans are offered at outrageous terms, in particular that the associated costs are very high. See the article in English at Helsingin Sanomat's website here.

The association of instant loan companies is of opposed to the proposed measures. However, they have a most "helpful" suggestion. They suggest that making instant loans should be a business subject to more regulation and licensing. Today, outrageously enough, anyone can start a instant loan company. This requirement of licensing would of course be in the interest of consumer protection, as the licensing would ensure that only "serious" companies engage in this business.

On the surface, this may sound sensible. But even the slightest scratching of the surface unveils a more plausible reason for the lobbying. Introducing licensing requirements increases the barriers to entry to the market. This reduces competition in the market, increasing profits. The currently active companies are likely to be in a good position to get licensed, as they already know the industry. Apparently they are also good at organizing themselves for lobbying for their industry, which might make it easier to ensure favorable regulation.

In defense of telesales

Yesterday's papers reported on a new initiative by the Finnish consumer protection agency, proposing outlawing telesales, unless the individual consumer has given express permission to the salesorganization targeting him. Clearly, many individuals are annoyed at receiving aggressive telesales phone calls, so these people might be happy about this kind of law. However, these kind of benefits typically come with costs attached, costs which aren't often immediately detected by everybody.

The largest daily newspaper Helsingin Sanomat noted yesterday that outlawing/restricting telesales would dent the circulations of papers and magazines, as these rely heavily on telesales. While Sanoma Magazines, who publishes many magazines in Finland may have reason to worry about the proposed law cutting down their circulations, the affect on them would not be all bad.

Worst hit by the law would be potential entrant into the magazine business, or any business for that matter. For while the encumbents, like Sanoma Magazines may find attracting new customers more difficult, they will still have their current customer base. New, potential entrants on the other hand will not have the option of using the, presumably highly cost effective telesales device for attracting customers. This will likely lead to some potential entrants finding entry to the market too costly, with them as a result deciding not to enter.

Outlawing, or severely restricting a cost effective way of reaching potential new customers essentially amounts to increasing the barriers of entry into a market. Increasing the barriers to entry means that the encumbents, those currently in the market will face less competition. This will make serving the market will be more profitable for the encumbents. Here it is of course necessary for the encumbents to be able to keep their hold of their current customer base. Nevertheless, maintaining a customer relationship is always easier than creating a new. 

So who will at the end of the day suffer from this proposed restriction? Encumbents in any market where telesales is a cost effective way of signing up new customers will face the cost imposed by more expensive signing up of new customers. On the other hand, they will face less competition. Potential entrants only face the cost. Consumers, those who are supposedly protected by the law will have to deal with firms facing less competition. This in general leads to higher prices, less variety and potentially worse quality.

So what would the policy recommendation of this post be: Just don't do it. Those individuals who are annoyed at receiving telesales phone calls can sign up to the Don't call registry. Anecdotal evidence suggests it is highly effective. Then let those who are not as annoyed continue receiving offers for magazine subscriptions, boxers, mobile phones, etc. over the phone, at the same time ensuring a decent level of competition in these markets.