What’s Your Problem?

July 29, 2010

Yesterday’s post on Ronald Coase’s “The Problem of Social Cost” suggested that different ways of managing resources have different associated costs. It’s often said that economics is about employing resources in their most valued uses, but it’s important to recognize that getting resources to be used in a certain way is itself a costly process. Another article that helps clarify this concept is Harold Demsetz’s “The Exchange and Enforcement of Property Rights,” written in 1967.

In the article, Demsetz takes on the “problem” of zero-price parking at shopping centers. Most shopping centers don’t charge people to park in their lots, and often don’t even monitor the lot to make sure that people who park there really are there to shop. With basic economic principles, it’s easy to see that because the parkers aren’t being charged, they overuse parking spaces, and the lot owner has to build an inefficiently large number of spaces to accommodate this overuse. But, Demsetz says, this problem isn’t a real problem except in comparison to something else. It doesn’t help merely to point out an inefficiency; you have to ask, “What’s the alternative?” It’s possible that the method you employ to “solve” this problem involves wasting even more resources than you save by leaving it unsolved.

The reality is, charging people for parking is not free. If the parking lot owner decides to charge, he must monitor the lot and collect fees from parkers. That may include hiring an employee, setting up a toll gate, printing out parking slips, buying a machine to make change, etc. All to avoid the inefficiency of building too much parking. Demsetz writes, “while we have reduced the resources committed to constructing parking spaces, we have increased resources devoted to market exchange. We may end up by allocating more resources to the provision and control of parking than had we allowed free parking because of the resources needed to conduct transactions. By insisting that the commodity be priced, we may become less efficient than had we allowed persons to ration spaces on a first come, first serve basis.”

When we say something is “inefficient” from an economic perspective, we usually mean that resources are being wasted. But to say something is “inefficient” relative to an impossible-to-attain situation is useless for economic analysis. You might as well say it’s inefficient to grow food for consumption, because all of those resources are wasted relative to a scenario in which food is freely available to everyone, (say) because it falls from the sky and into your pantry. True, but irrelevant.

Terminological battles are a waste of time, and if you want to call zero-price parking “inefficient” or a “market failure,” I can’t stop you. But the point of Demsetz’s article is that such terminology isn’t very useful as a standard for economic analysis. You can’t look at a situation and say, “I can imagine something better.” You have to compare the imperfect reality with its imperfect alternative. And in light of this comparison, you might conclude that a problem that is more expensive to fix than to leave alone isn’t properly a problem at all.

Next time, I’ll go back to Coase and try to explain why I once suggested the absurdly exclusionary rule of thumb that anyone who doesn’t mention Coase or Demsetz when talking about “market failure” should be ignored.

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