Today’s big problems can only be solved with free-market economics
14 November 2008
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Economic Theory
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In each of the last two weeks the IEA has hosted panel discussions in front of packed houses. Last week the topic was public sector pensions and this week it was the Third Heathrow Runway. Economics is not well regarded in today’s Conservative Party as a tool for approaching economic problems – many public statements have been made by leading figures in the Party to the effect that the 1980s was the decade when the economy had to be fixed but now other things have to be fixed. This takes a rather narrow view of economics and ignores the fact that most problems have their economic aspects even if, on the face of it, they are not fundamentally economic issues. With regard to public sector pensions and the Third Runway there is a lot of thrashing around by politicians (I don’t just refer to the Conservatives now) but a simple economic analysis can at least provide the basis for a solution in both cases.
With regard to public sector pensions all that needs to happen is for the Treasury to start charging public sector employers (schools, hospitals etc) the true cost rather than the supposed cost of pension benefits. Then there will be strong incentives for both employers and employees to sort the situation out. Employers will have the carrot of cutting costs; employees will have the carrot of cash replacing an expensive benefit in kind if pension benefits are changed. With the Third Runway why not do something radical along the following lines? Let’s accept that the right to cause current noise levels are a property right that belongs to BAA – after all most people have bought their houses near the airport knowing that they will be affected by noise. A way will have to be developed of determining who is affected and appropriately weighting noise at different times of day but that would not be difficult. If BAA wishes to create any more noise or affect new groups of people it should have to buy the right to do so from affected residents. An institutional mechanism would have to be found to facilitate this process – this could be through local councils or directly with representatives of local residents. If the compensation local residents demanded was higher than BAA was willing to pay then the Third Runway would not get built. If it was lower than BAA was willing to pay then the parties would have an incentive to settle. BAA could then charge airlines for slots according to how noisy their planes are, so the incentives then get passed all the way down the line to the engine makers.
Of course, this mechanism is not perfect (though it is difficult to see the problem of using economics to resolve public sector pension problems). The greatest difficulty would be that different local residents would put different values on noise reduction. However, at least the incentives would run in the right direction. We would have a well defined property right. BAA could buy more of that property (the right to make noise) but would have to purchase that right from local residents. The winner takes all approach to planning in this country is a disaster as far as large infrastructure projects are concerned – the Channel Tunnel Rail Link is another example. Defining property rights and charging prices provides incentives for these problems to be sorted out where the information is to be found – amongst businesses and the people – instead of in Whitehall. Three cheers for economics!
With regard to public sector pensions all that needs to happen is for the Treasury to start charging public sector employers (schools, hospitals etc) the true cost rather than the supposed cost of pension benefits. Then there will be strong incentives for both employers and employees to sort the situation out. Employers will have the carrot of cutting costs; employees will have the carrot of cash replacing an expensive benefit in kind if pension benefits are changed. With the Third Runway why not do something radical along the following lines? Let’s accept that the right to cause current noise levels are a property right that belongs to BAA – after all most people have bought their houses near the airport knowing that they will be affected by noise. A way will have to be developed of determining who is affected and appropriately weighting noise at different times of day but that would not be difficult. If BAA wishes to create any more noise or affect new groups of people it should have to buy the right to do so from affected residents. An institutional mechanism would have to be found to facilitate this process – this could be through local councils or directly with representatives of local residents. If the compensation local residents demanded was higher than BAA was willing to pay then the Third Runway would not get built. If it was lower than BAA was willing to pay then the parties would have an incentive to settle. BAA could then charge airlines for slots according to how noisy their planes are, so the incentives then get passed all the way down the line to the engine makers.
Of course, this mechanism is not perfect (though it is difficult to see the problem of using economics to resolve public sector pension problems). The greatest difficulty would be that different local residents would put different values on noise reduction. However, at least the incentives would run in the right direction. We would have a well defined property right. BAA could buy more of that property (the right to make noise) but would have to purchase that right from local residents. The winner takes all approach to planning in this country is a disaster as far as large infrastructure projects are concerned – the Channel Tunnel Rail Link is another example. Defining property rights and charging prices provides incentives for these problems to be sorted out where the information is to be found – amongst businesses and the people – instead of in Whitehall. Three cheers for economics!
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It’s rather more complicated than just noise from a third Heathrow runway.
The airport would need geographical expansion, which implies compulsory purchase orders (otherwise would they be frustrated by just one unwilling seller), increased pollution, increased local congestion effects, etc.. Then there is the question of whether the relatively low level of taxation of aviation generates more demand than if there was a neutral tax situation.
It’s rather more complicated than just noise from a third Heathrow runway.
The airport would need geographical expansion, which implies compulsory purchase orders (otherwise would they be frustrated by just one unwilling seller), increased pollution, increased local congestion effects, etc.. Then there is the question of whether the relatively low level of taxation of aviation generates more demand than if there was a neutral tax situation.
Talking of incentives, what are the incentives facing politicians? As far as I can see overwhelmingly the most important objective from the point of view of practically all elected politicians who are not planning to retire at or before the next election is simply to get re-elected. For MPs, this implies a time horizon, on average, of about two years. The House of Lords is by no means perfect (few human institutions are), but at least it avoided this very serious problem of the ‘lower’ House.
Talking of incentives, what are the incentives facing politicians? As far as I can see overwhelmingly the most important objective from the point of view of practically all elected politicians who are not planning to retire at or before the next election is simply to get re-elected. For MPs, this implies a time horizon, on average, of about two years. The House of Lords is by no means perfect (few human institutions are), but at least it avoided this very serious problem of the ‘lower’ House.
I agree with HJ, of course. I was really just using noise as one example of the problem. Compulsory purchase is also a tricky issue because people are often compensated at market value when they are not marginal sellers, and there are ways of pricing congested road space too. All I was suggesting is that some economic principles can help take ensure that these sorts of problems are resolved using the maximum amount of information about costs, benefits and subjective preferences.
I agree with HJ, of course. I was really just using noise as one example of the problem. Compulsory purchase is also a tricky issue because people are often compensated at market value when they are not marginal sellers, and there are ways of pricing congested road space too. All I was suggesting is that some economic principles can help take ensure that these sorts of problems are resolved using the maximum amount of information about costs, benefits and subjective preferences.
re: D.R. Myddelton
What you say is interesting, and something I think Hans Hoppe talks about well in his book Democracy: the God that Failed.
Steven
re: D.R. Myddelton
What you say is interesting, and something I think Hans Hoppe talks about well in his book Democracy: the God that Failed.
Steven
Philip, exactly.
Lots of people (including me) say that local councils should be allowed to auction off landing/take-off slots (higher prices in early morning and late at night etc), so that airlines pay their share of external costs (noise, congestion etc). It’s like airborne ‘Land Value Tax’. Peak times slots from LHR are worth up to £10 million or so (i.e. on an amortised basis £3,000 per landing/take-off). These ‘belong’ to the airlines but they never paid for them.
Philip, exactly.
Lots of people (including me) say that local councils should be allowed to auction off landing/take-off slots (higher prices in early morning and late at night etc), so that airlines pay their share of external costs (noise, congestion etc). It’s like airborne ‘Land Value Tax’. Peak times slots from LHR are worth up to £10 million or so (i.e. on an amortised basis £3,000 per landing/take-off). These ‘belong’ to the airlines but they never paid for them.