22 February 2012

Cheap talk or walk the walk?

NB: This post may be one of the most important in the year, in the same way that this one on climate change negotiations led me to conclude that the real price of carbon is zero.*

In my recent keynote talk (38min, 13MB MP3) at the Water Rights and Trading Summit in Scottsdale, AZ, I wanted to spend less time on anecdotes and theory and more time on impact.

I asked participants to "raise you hand if you want water markets in Arizona to work better" (at about 5:30). As I circulated among the tables (it was a lunch talk), it looked like over 60 of the 70 or so participants raised their hands.

I then went on to talk about the problem of transaction costs (TCs), and how high TCs can make it harder to trade water or operate a water market.

From there, I outlined how all of them would benefit from lower TCs, and how policy changes would lower those costs. Water markets in Australia, e.g., are much more "liquid" due to changes in rules on moving water between irrigation districts, registering ownership rights, etc.

I went on to say that the difficulty in lowering TCs was not the time or effort involved in promoting and implementing reforms (usually through some form of lobbying), but finding the right people to put in that effort. The audience for my talk represented a healthy portion of the total population who stood to make direct gains from lower TCs and a better functioning market in Arizona, but which of them was going to put in the time to improve policy?

In my book, I define a collective action problem as the case when...
A small number of people can do a lot of work that benefits everyone. For example, members of Group A could spend a total of 500 hours to save $100 for each person in Group A and Group B. Members of Group B would get $100 in benefits at no time cost. When given the choice of which group to join, most people will join Group B as free riders. The results of this collective action are too few people in Group A, no action, and the continuation of a status quo without savings.
So the members of my audience also faced a collective action problem: who was going to take his own time to move for policy changes that would benefit everyone when it was possible to wait for someone else to do that work?

Luckily, I had a solution to this problem of "first mover disadvantage" that draws on economic research, i.e., a group commitment to act.

So I reminded everyone how about 60 people had agreed that they wanted to improve markets. I then said (paraphrasing)
I want each of you who really does want to improve markets to take out your business card and put it in the hats that are going around. If we collect more than 50 cards, then each card will represent your pledge of $100 towards improving water markets in Arizona. I am not going to handle this money -- we will figure out how to use it later -- but now is your chance to show that you are really committed to improving water markets. If we collect fewer than 50 cards, then nothing happens.
The idea here is that we avoid the collective action problem by using a "threshold" commitment mechanism. If 50 of the 70 or so people signed up, then, first, there would be enough group cohesion to make those few who act feel as if they are supported (the money can work towards that), and second, that there would be enough people in the majority that holdouts may join, so as not to not be left out.

Unfortunately, only 31 people followed my lead by putting their cards in the hats.**

So, no, a bunch of people who said they wanted to improve water markets in Arizona seemed more interested in cheap talk than walking the walk.***

Bottom Line: Water markets do not just make themselves. Market institutions need care and attention to emerge from existing and re-written rules, and their participants need to contribute time towards making those institutions work. Unfortunately, it does not look like Arizona's "market makers" understand how they need to work as a group to improve their markets before they can reap their individual rewards from the function of that market.

* The implication of zero price carbon is not only that most renewable energy projects are a mistake, but that we should put 100 percent of our attention on adapting to climate change.

** I was surprised that Clay Landry (an organizer) did not put in his card, but he said his "card" was setting up and running a conference that cost many times $100. Fair point.

*** By the end of the conference, there were 37 cards in the hat. What shall I do with them or suggest that this group of "doers" do?

NB: This post has been edited to remove some material.

4 comments:

  1. In my experience the "free rider" problem is the single most important problem we, as a society, face today.

    Next time someone in conversation suggests that "the government" ought to do something, ask them if they think their taxes should be increased to pay for the new governmental service; and if they think so, are the private transaction costs avoided greater than the new taxes they would pay.

    I have yet to find an example where the advocate was 1) not looking for a free ride, or 2) not looking to increase their own power and discretion over others.

    Bottom Line: Don't call someone a free rider to their face if you want to get along.

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  2. David, I threw a card in the hat, but don't have a great suggestion about what to do with the group that did. I suspect it would take a lot more than $3700 to solve this problem by changing Arizona laws and regulations to reduce TC. In addition to the free rider problem, there are many water market supporters who are not optimistic about the chances of convincing federal, state and local officials that markets should be enhanced, even though they are firmly convinced themselves.

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  3. @Wes -- the $3700 was not the "solve" the problem as much as give the group a common link (and drinking fund :). The problem is going to be solved with TIME, not money :)

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  4. In response to your question ("what's happened since February"), my answer is that Arizona water markets are still thinly traded at best, with significant institutional obstacles blocking potential activity in a number of market segments. Some folks are pushing at the barriers while others are interested in making them stronger. I expect to see some deals (likely fairly modest in scope) proposed in the next couple of years (particularly relating to Colorado River supplies) that will be designed to find paths through some of the institutional minefields, but I do not expect any widespread ‘prison releases’ for various market segments.

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