17 Jul 2012

Fair to efficient to fair

I recently did some consulting on "making markets" for water.

In the conversation, we arrived quickly at an important point:
  1. The government is going to decide (or affirm) the initial distribution of water, but
  2. There needs to be some form of market to REdistribute that water for efficiency.
Further, (1) determines who gets the "rents" from water resources, but (2) will make sure that water goes to highest and best use -- in economic terms.

I still think that environmental flows that provide public goods (making them hard to value) should be reserved before (1) even occurs.

Also note how this pattern (fair, then efficient) contradicts the conventional pattern in political economy, i.e., allow economic activities to happen first, then use political tax transfers to deliver fairness, but it really doesn't if you think in terms of ordering, stocks and flows, namely:
  1. Make a politically fair allocation of a stock of assets (land, water, etc.) to citizens.
  2. Allow an economically efficient reallocation of those stocks via markets so entrepreneurs can produce flows of benefits to themselves and customers.
  3. Politically redistribute some of those economic surpluses (via taxes*) to pay for public goods.
Bottom Line: Keep incentives aligned with stocks and flows of economic and natural assets if you want to maximize BOTH fairness and efficiency.

* I prefer property taxes as the purest type of tax. Income taxes discourage work; expenditure taxes are labor intensive. Both are much harder to track/administer.