Wednesday, 2 February 2011

Turbulence ahead, and externality entrepreneurs

I have just remembered to link to Turbulence Ahead, the blog of Gerard O'Neill, who spoke on a panel with me last year at the Geary Institute.

His latest post has a nice quote from Sean Corrigan:
"...prosperity cannot be forced, but must be built one exchange at a time as individuals further their own self-interest by catering to the interests of others..."
Corrigan intends this as an argument for his Austrian, laissez-faire philosophy. And it does support that case. But when we think about it a little more deeply, it also illuminates a different view.

The quote hints at, but perhaps underplays, the role of the entrepreneur. Presumably each consumer knows about a certain range of available goods, and they are already choosing whichever subset is best for them (I'd usually insert a critique about economic rationality here, but this time I'll leave that alone and make a different point). Given this starting point, in order to get economic growth we need one of two things to happen:
  • Wholly new goods or services become available - because someone has invented an entirely new technology. The iPhone being a typical recent example: before the iPhone, we spent our money on other phones, or other things less good than an iPhone; now that it is available, we spend some of our money on that, we get more utility and the world is happier. Economic growth has occurred.
  • A consumer is introduced to a good or service they weren't previously aware of. This could be a product they haven't heard of before (I was told about a service called Dropbox recently which I think is pretty good) or it could be a service provider they hadn't met before, such as a good graphic designer or hairdresser.
Consumers are busy (they've already allocated all their time to utility-maximising activities) so these inventions, discoveries or introductions are the job of the entrepreneur. As an entrepreneur, I will do one of two things.

Either I have an idea for an invention, and take the risk of investing in it in the hope that consumers will want to buy it later. Or I might identify a consumer desire which is currently not met, and introduce suppliers to consumers in order to fulfil it. The latter is a much more common entrepreneurial path - most businesses are not fundamentally inventing new stuff. Instead, they build their understanding of a set of customers, and then find some resources - employees, subcontractors or capital - which together can meet those customers' needs.

Corrigan says that prosperity must be built "one exchange at a time". That's trivially true, but actually the input of the entrepreneur is somewhat different from the straightforward operation of market exchange. Simple exchange is a trade between two people who know what is on offer and decide to swap (typically) an amount of money for a quantity of product. The entrepreneur, by contrast, is trying to (paternalistically?) guess what a person will want before they know it themselves. They they create the product or service, offer it to consumers and try to persuade them that they want it. Of course this is still a process made up of freely chosen transactions, but it is not entirely a gradual process of micro-level decision-making. Apple's invention of the iPhone was, in one sense, imposed from above and swept suddenly out to a large market. The involvement of the cellphone networks and their subsidy of the phones through service contracts makes this an even more complex scenario than the simple free-market model would suggest. But these complexities were absolutely necessary to the introduction of the product.

And importantly, this whole process works properly only if the private company can capture all the returns to its innovation. If they are unable to charge the full value of their product or service because of consumer biases or competition, or if there are big positive externalities where third parties benefit in addition to the buyer, then some products might never get invented even though there would be a net benefit to society.

This seems more often to be true of services than goods; and in particular, certain kinds of social goods to do with education, health or security. Education has vast positive externalities and it seems unlikely that a wholly private market will generate enough of it to be optimal. Public health is the same. And basic universal security is almost a precondition for any other market exchanges to take place.

But to look again at the question of building prosperity "one exchange at a time". Imagine that I can figure out that person A - with a four-week training course - could be effective at doing job B. The company offering the job hasn't met A, and A is not aware that the job is available (or is disillusioned after nine months of searching for work). I could introduce the two of them. I could even offer the training for free to make the trade more likely; and if I'm a government which will benefit from tax revenue if the person is employed, it would be worth my while to do so. But if I don't step in, it will probably never happen on its own.

Of course, jobs do get filled in a private market; and recruitment agencies exist which charge for this service; and a big share of the benefits of a job is captured by the parties who enter into it. But by no means all of them. A job generates a multiplier effect, with spin-off benefits for the family of the employee, those who supply goods to them, the customers of the employer, and society as a whole. This is especially true if the employee is in the bottom half of the wage distribution; recruitment agencies are less interested, the employee may well be unmotivated or lack some of the skills required to find a job, but it's still in everyone's interest for the person to get one. It is entirely legitimate for someone to help match the parties up; and it may well be that this help is initially unasked-for (just as nobody asked for an iPhone before Apple invented it). The government, as society's representative, can act on our behalf in bringing about externalities - because society benefits when those externalities occur.

I don't suggest that person A should be forced to take job B; indeed, if this government employee discovers the potential match it is their responsibility to try to sell the idea to both parties - just as the entrepreneur has to sell their concept both to the consumer, and to the providers of labour or capital that enable the product to be created. And this doesn't (necessarily) mean monolithic, universal government plans for the whole economy; it can be done on a small scale and probably will be the better for it.

In other words, just as entrepreneurs have a role in finding undiscovered opportunities for exchange, governments can have a role in finding undiscovered opportunities for positive externalities, and making them happen. The government may be usefully looked at as an "externality entrepreneur".

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