Naked Economics by Wheelan, Charles (best books to read .TXT) 📗

Gordon Gekko told us in the movie Wall Street, greed is good, so make sure that you have it working on your side. Yet Mr. Gekko was not entirely correct. Greed can be bad—even for people who are entirely selfish. Indeed, some of the most interesting problems in economics involve situations in which rational individuals acting in their own best interest do things that make themselves worse off. Yet their behavior is entirely logical.

The classic example is the prisoner’s dilemma, a somewhat contrived but highly powerful model of human behavior. The basic idea is that two men have been arrested on suspicion of murder. They are immediately separated so that they can be interrogated without communicating with one another. The case against them is not terribly strong, and the police are looking for a confession. Indeed, the authorities are willing to offer a deal if one of the men rats out the other as the trigger man.

If neither man confesses, the police will charge them both with illegal possession of a weapon, which carries a five-year jail sentence. If both of them confess, then each will receive a twenty-five-year murder sentence. If one man rats out the other, then the snitch will receive a light three-year sentence as an accomplice and his partner will get life in prison. What happens?

The men are best off collectively if they keep their mouths shut. But that’s not what they do. Each of them starts thinking. Prisoner A figures that if his partner keeps his mouth shut, then he can get the light three-year sentence by ratting him out. Then it dawns on him: His partner is almost certainly thinking the same thing—in which case he had better confess to avoid having the whole crime pinned on himself. Indeed, his best strategy is to confess regardless of what his partner does: It either gets him the three-year sentence (if his partner stays quiet) or saves him from getting life in prison (if his partner talks).

Of course, Prisoner B has the same incentives. They both confess, and they both get twenty-five years in prison when they might have served only five. Yet neither prisoner has done anything irrational.

The amazing thing about this model is that it offers great insight into real-world situations in which unfettered self-interest leads to poor outcomes. It is particularly applicable to the way in which renewable natural resources, such as fisheries, are exploited when many individuals are drawing from a common resource. For example, if Atlantic swordfish are harvested wisely, such as by limiting the number of fish caught each season, then the swordfish population will remain stable or even grow, providing a living for fishermen indefinitely. But no one “owns” the world’s swordfish stocks, making it difficult to police who catches what. As a result, independent fishing boats start to act a lot like our prisoners under interrogation. They can either limit their catch in the name of conservation, or they can take as many fish as possible. What happens?

Exactly what the prisoner’s dilemma predicts: The fishermen do not trust each other well enough to coordinate an outcome that would make them all better off. Rhode Island fisherman John Sorlien told the New York Times in a story on dwindling fish stocks, “Right now, my only incentive is to go out and kill as many fish as I can. I have no incentive to conserve the fishery, because any fish I leave is just going to be picked up by the next guy.”13 So the world’s stocks of tuna, cod, swordfish, and lobster are fished away. Meanwhile, politicians often make the situation worse by bailing out struggling fishermen with assorted subsidies. This merely keeps boats in the water when some fishermen might otherwise quit.

Sometimes individuals need to be saved from themselves. One nice example of this is the lobstering community of Port Lincoln on Australia’s southern coast. In the 1960s, the community set a limit on the number of traps that could be set and then sold licenses for those traps. Since then, any newcomer could enter the business only by buying a license from another lobsterman. This limit on the overall catch has allowed the lobster population to thrive. Ironically, Port Lincoln lobstermen catch more than their American colleagues while working less. Meanwhile, a license purchased in 1984 for $2,000 now fetches about $35,000. As Aussie lobsterman Daryl Spencer told the Times, “Why hurt the fishery? It’s my retirement fund. No one’s going to pay me $35,000 a pot if there are no lobsters left. If I rape and pillage the fishery now, in ten years my licenses won’t be worth anything.” Mr. Spencer is not smarter or more altruistic than his fishing colleagues around the world; he just has different incentives. Oddly, some environmental groups oppose these kinds of licensed quotas because they “privatize” a public resource. They also fear that the licenses will be bought up by large corporations, driving small fishermen out of business.

So far, the evidence strongly suggests that creating private property rights—giving individual fishermen the right to a certain catch, including the option of selling that right—is the most effective tool in the face of collapsing commercial fisheries. A 2008 study of the world’s commercial fisheries published in Science found that individual transferable quotas can stop or even reverse the collapse of fishing stocks. Fisheries managed with transferable quotas were half as likely to collapse as fisheries that use traditional methods.14

Two other points regarding incentives are worth noting. First, a market economy inspires hard work and progress not just because it rewards winners, but because it crushes losers. The 1990s were a great time to be involved in the Internet. They were bad years to be in the electric typewriter business. Implicit in Adam Smith’s invisible hand is the idea of “creative destruction,” a term coined by the Austrian economist Joseph Schumpeter. Markets do not suffer fools gladly. Take Wal-Mart, a remarkably efficient retailer that often leaves carnage in its wake. Americans flock to