4. Welfare economics and market failure
4.1
4.2
4.3
4.4
4.5
4.6
4.7
4.8
Economist article
America’s great
headache/Jambusters
Pricking consciences
Constricting the pet
supply/Economies of scale
Flying blind
A great leap
forward/Drying out
Tuning out
Tipping the Hollywood
black spot
Knock offs catch on
Concept
Externalities + Solutions
Externalities + Solutions
Externalities + Solutions
Externalities + Solutions
Externalities + Solutions
Public goods + Solutions
Public goods + Solutions
Public goods + Solutions
Economist Work-Out 4.1
Read the attached articles on ‘America’s great headache’ (The Economist, June 4, 2005,
pages 34-35), and ‘Jambusters’ (The Economist, January 7, 2006, page 57). Each of
these articles is describing problems with car traffic in major cities.
1. Could you describe the problems with car traffic as an example of market failure?
How would you represent these problems using the model of PMB/PMC and SMB/SMC?
2. Choose two solutions to the problems caused by car traffic that are described in the
articles. Would these solutions change the level of car traffic towards the socially
optimal level? Are there any potential problems with the solutions?
3. Why is the congestion charge that is imposed in London described as ‘crude’? Is there
a way in which the congestion charge could be modified to make it a better policy
instrument for solving market failure in the amount of car traffic?
This article (‘America’s great headache, The Economist, June 4 2005, pages 34-35) is
reproduced with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
America’s great headache
WHAT is the price of America's love affair with the car? According to a recent "urban
mobility study" from the Texas Transportation Institute, it adds up to $63.1 billion a year
(plus another $1.7 billion if the latest petrol prices are included) in wasted time and fuel.
Most drivers would add an emotional cost in frayed nerves. After all, who wants to spend
44% of their daily commute--the figure for the regions around Los Angeles and
Washington, DC--in a crawl?
Most sufferers have no choice. As cities sprawl first into suburbs and then into cardependent "exurbs", the daily commute becomes an ever more painful fact of life.
According to the Census Bureau, Americans spend more than 100 hours a year
commuting to work; and the annual delay for the typical rush-hour traveller in
metropolitan areas of more than 3m has grown, since 1982, from 16 hours to 47.
What, if anything, can be done about it? For an answer, look at California, home to 23m
licensed drivers and 33m vehicles, and where "you are what you drive": Arnold
Schwarzenegger has gas-guzzling Hummers, while immigrant Mexican gardeners have to
make do with decrepit Chevrolet pick-ups. California's network of suburbs and "edge
cities" has become the model for much of the growth around the rest of the country.
According to the Texas researchers, the average driver in LA spent 93 hours stuck in
traffic in 2003 (see table on next page). By contrast, a driver in New Orleans spent just
18. Whether it is the ghastly I-405 clogged up around Los Angeles airport, or the I-101
tailback from San Francisco's Bay Bridge, California boasts the worst traffic congestion
in the country.
Some consider this a cause for celebration. "Long queues at restaurants or theatre boxoffices are seen as signs of success," says Brian Taylor, director of the Institute of
Transportation Studies at UCLA. He thinks congestion "is an inevitable by-product of
vibrant, successful cities". The examples of Paris, London and New York all show he has
a point.
His view is not shared by most Californians. Surveys consistently show that two-thirds of
the residents of Los Angeles County regard traffic congestion as "a big problem". By
contrast, only two-fifths cite crime. The non-partisan Legislative Analyst's Office reckons
that congestion--defined as freeway traffic moving at less than 35mph at peak commuting
times--cost Californians some $12.8m a day in time and fuel in 2002. It also added 530
tons of foul emissions to the air.
Hence the search for remedies--each of which comes with its own problems. More public
transport? Some of America's train and subway systems have been successful, notably
San Francisco's BART. But they cost a fortune. Chi-Hsin Shao, a traffic consultant in San
Francisco, reckons even light-rail systems cost at least $20m a mile, while going
underground can cost more than $200m a mile. The still-puny subway system of Los
Angeles has cost $4.5 billion, or some $258m a mile; the city's light-rail system has cost
well over $35m a mile.
Greens hope to get at least some of the long-distance passenger traffic out of cars. But the
fiasco of the Acela high-speed train system between Washington, DC, and Boston is
hardly likely to inspire confidence in a long-standing dream to build a 700-mile
(1,100km) high-speed rail system from San Diego to San Francisco (a proposed $9
billion bond issue is slated to go before the voters in November next year).
Public transport works well when there is a central hub--like Manhattan. But the
Californian sprawl is "multimodal": it works on the basis that everybody can go
everywhere. Go to the Inland Empire (the suburban sprawl covered by Riverside and San
Bernardino counties), the fastest-growing bit of the state, and you find people commuting
to Los Angeles, to Orange County, to Pasadena, to Ventura or to any of the burgeoning
edge cities within the Inland Empire itself. In 2000, 68% of Californians drove to work
by themselves, but the figure rose to 77% for the new neighbourhoods, where half the
new houses were built in the 1990s. When the commute gets too long--40 minutes is
supposedly the cut-off point--people tend to move either their job or their home.
Driving alone explains why car-pool lanes have a limited appeal. High Occupancy
Vehicle (HOV) lanes stretch for a mere 1,112 miles of California's freeway system--and
are often virtually empty. One idea is Mr Schwarzenegger's decision, still awaiting
federal approval, to let fuel-efficient hybrid cars use the HOV lanes whether they have
passengers or not.
In the end, virtually all the solutions involve making drivers pay. More realistic fuel
prices would make a difference: a gallon of petrol costs around $2.50 in California,
compared with $5.90 in Britain. There are some subsidies for greener fuels, but there is
no enthusiasm for a carbon tax, even though petrol taxes produce in real terms about one
third of the revenue per vehicle mile that they did in 1970.
Road-pricing has been a little more successful. California has a few straightforward toll
roads, such as state route 73, north of San Diego. But most tax-paying drivers fiercely
oppose them. An alternative is the toll lane. High Occupancy Toll (HOT) lanes, such as
those on state route 91 in Orange County, allow single drivers to drive on them for an
extra fee--with the toll collected electronically and varying according to the level of
congestion.
Early criticism of SR-91 was that a HOT lane amounted to a "Lexus lane", favouring the
wealthy solo mogul over the blue-collar pick-up-truck driver. In practice, it has worked
out more democratically. Mr Taylor says 250,000 drivers have bought the transponders
needed for the electronic billing system, and they use them--rich and poor alike--when
speed is important.
The paradox, say the sceptics, is that HOT-lanes, like HOV-lanes, may actually increase
car use: by freeing up extra capacity on the freeways, they allow more cars to use them.
Nonetheless, simply to get at least some people from A to B quickly, it would surely be
sensible to make more HOT-lanes available.
Another scheme being mooted in San Francisco is to imitate London and impose a
congestion charge on drivers who enter the central area of the city. Jake McGoldrick,
chairman of the San Francisco County Transportation Authority, calls this "a home run":
it would relieve congestion, lessen pollution and provide money for public transport.
Unfortunately, there are relatively few other American cities with the public transport
systems in place to follow the London example--and voter opposition would be a nearcertainty.
In some cases, fighting congestion does not mean Californians coming up with ingenious
ways to prevent it, so much as stopping doing things that encourage it. Donald Shoup and
Michael Manville, colleagues of Mr Taylor at UCLA, point to the way that Los Angeles
requires both office and residential buildings to provide parking spaces for their tenants.
Whereas New York and San Francisco have strict limits on parking in their central
business districts, Los Angeles "pursues a diametrically opposing path".
Thus, the Louise Davis Hall, home to the San Francisco symphony orchestra, was built
without a parking garage; when concerts end, the audience streams out into local bars and
restaurants. By contrast, LA's Disney Hall has a six-level, 2,188-space underground
garage that cost a hefty $110m. Disney Hall now has to guarantee at least 128 concerts
each winter in order to generate enough parking revenue to service the garage's debt.
And, when concerts end, the audience drives away, leaving LA's moribund downtown
virtually untouched by their presence.
This reflects land-use laws. Under the current rules, for every single job in the central
business district of Los Angeles there is 0.52 of a parking space; in San Francisco, there
is 0.14 of a parking space for each job; in New York, just 0.06. Last week, a $1.8 billion
project to revitalise LA's downtown area around Grand Avenue was unveiled: it
envisages offices, a 275-room hotel, up to 2,600 housing units--and as many as 5,500
new parking spaces. Land-use policies help explain why San Francisco County's 2m
licensed drivers have a mere 382,000 cars between them, while LA County's 5.9m drivers
have 5.9m.
All true. But the main reason why both Disney Hall and the new Grand Avenue
developments have huge parking spaces is simple: nobody would go there if they didn't.
California is a car culture--as is most of suburban America. Congestion is the inevitable
result. Politicians could reduce that congestion by charging motorists more for the petrol
they guzzle and the roads they use. But it will only be a change at the margin.
Californians have the traffic they deserve.
Ranked by annual delay per traveler, 2003
VERY LARGE CITIES
Los Angeles-Long Beach-Santa Ana, CA
San Francisco-Oakland, CA
Washington area, DC VA MD
Atlanta, GA
Houston, TX
LARGE CITIES
Riverside-San Bernardino, CA
Orlando, FL
San Jose, CA
San Diego, CA
Denver-Aurora, CO
HOURS
93
72
69
67
63
HOURS
55
55
53
52
51
Source: Texas Transportation Institute
This article (‘Jambusters, The Economist, January 7 2006, page 57) is reproduced with
kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Jambusters
DESPITE the doubts, and despite complaints from shop owners, London's congestion
charge--introduced in February 2003--has managed to ease the gridlock in the city centre.
Traffic is down by 18%, jams by 30%. The scheme's biggest weakness is that it is crude:
drivers pay £8 ($14) to enter the zone between 7am and 6.30pm, regardless of how
congested the roads are, or how long they stay.
So road-pricing fans are watching trials by Transport for London (TfL) of a new
detection system, called tag-and-beacon, with interest. Under such a scheme (used in
Singapore and on some European roads) cars are fitted with electronic tags that are read
by roadside masts. If the trial is successful, TfL says that the city could switch to the
system once the contract to run the congestion charge is re-let in 2009.
Currently, cameras are used to read licence plates and track motorists. They are not
always reliable: an individual camera identifies only around 70% of cars. Most drivers
get photographed more than once, which boosts the system's effectiveness to over 95%,
but that still leaves several thousand vehicles per day whose details must be laboriously
checked by hand. Tag-and-beacon technology is much more accurate, with an
identification rate of over 99%.
TfL says the trial is partly designed to see whether the new system could allow drivers to
pay charges by direct debit. That would be popular with motorists, who complain that the
current payment system is unfriendly: the toll for a day's travel must be paid manually-online, by phone or in a shop--by midnight, with steep fines levied on forgetful drivers.
More precise detection also allows for more precision in policy, and road-pricing
enthusiasts see radical possibilities ahead. TfL says it is considering using the new
technology to charge drivers each time they cross the zone boundary (up to a daily
maximum), instead of paying once for an entire day's travel. That would be cheaper for
drivers who make few trips into the zone, although drivers who spend a long time
trundling around without leaving (thereby causing the most congestion) would get off
lightly, too.
Further refinements may be possible. The current system has cut traffic most drastically
in the middle of the day, when congestion is at its lowest (see chart). Demand for road
space would better match supply if charges were variable--high at the busiest times of
day and low in quiet periods. That would be difficult to do with the current system, which
allows many motorists to pass its cameras undetected, but easier with tag-and-beacon.
Such a time-sensitive, variable-charging scheme using a tag-and-beacon system was
endorsed last year by Bob Kiley, then TfL's boss, who also said that he wanted to extend
the congestion charge to other parts of London. That would be controversial, and Mr
Kiley's underlings were quick to insist that his musings were not official policy. But the
original scheme was controversial too, yet Ken Livingstone, London's mayor and its
biggest backer, was re-elected after introducing it. It would be a shame if timidity took
hold now.
Economist Work-Out 4.1
Solutions
1. The problem of the amount of congestion on roads can be described as an example of
market failure due to existence of a negative externality. When any individual car driver
decides to drive on a particular road, they impose a cost on other drivers on that road by
increasing traveling time due to the larger number of cars (increase in congestion). We
would expect individual drivers to take into account the benefits and costs to themselves
of driving on the road, but would not be expected to take into account the costs on other
drivers. Hence the SMC is greater than PMC for driving. As the diagram below shows,
this implies that the socially optimal amount of cars on a road is greater than the market
(privately optimal) outcome.
$ SMC PMC PMB=SMB Q** Q* qty of cars on road 2/3. One option would be to increase the amount of public transport. Availability of
public transport would reduce the PMB of traveling by car, and hence reduce the amount
of cars on roads towards the socially optimal quantity. Problems with this type of
solution are that the cost of implementing the solution may outweigh the benefits of
reducing the negative externality from car travel, and public transport does not offer a
very satisfactory alternative to car travel in ‘multi-modal’ cities.
A second option is toll roads whereby drivers pay a fee for traveling on some roads.
Where the fee for traveling on a road reflects the size of the negative external effect
imposed by each driver on other drivers, this will cause a driver’s opportunity cost of
traveling on the road to be equal to the SMC. Hence we would expect this to cause the
amount of cars on the road to be socially optimal. Problems with this type of solution are
that it may simply cause drivers to substitute to driving on other roads (which then
become congested), that it may have adverse distribution consequences causing lowincome drivers to be less able to travel, and it may be difficult to set the size of the toll to
equal the negative external effect.
A third option would be a congestion charge, a fee that is paid where a driver enters a
designated region such as central business district area. The article on ‘Jambusters’
suggests that this option – by raising the opportunity cost of traveling by car - has been
successful in reducing the amount of traffic entering the London CBD. The main
problem with the solution that is discussed is setting the size of the fee to match the size
of negative external effect. The current system involves the same charge for any driver
entering the London CBD zone anytime between 7am and 6.30pm, which is why it is
described as ‘crude’. It is suggested that congestion (and hence the size of negative
externality from an extra driver) differs by time of day, and hence it would be most
desirable to have a congestion charge that varies by time of day. Economist work-out 4.2
Read the attached article on ‘Pricking consciences’ (The Economist, March 17 2007,
p.86). The article describes the decisions that individuals make about whether to have a
flu vaccination, and the outcome that results for society.
1. Is there an external effect associated with an individual member of society choosing to
have a flu vaccination?
2. Given the nature of any external effect, would you expect the proportion of society
who choose to have vaccinations will be socially optimal? Is your prediction consistent
with what the article describes?
3. What policy solutions could you suggest to ensure that a socially optimal proportion of
the population have a flu vaccination?
This article (‘Pricking consciences’, The Economist, March 17 2007, page 86) is
reproduced with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Pricking consciences
What is good for the individual is not always best for society
MATHEMATICIANS like to play games. In particular, they like to play games that
examine how people pick ways of behaving that will maximise returns. One such
mathematician is John Nash, who won a Nobel economics prize for his work on the
subject. He demonstrated that there are games (the most famous being known in the trade
as "prisoner's dilemma") where the players can arrive at a situation now known as a Nash
equilibrium. This is the point at which no one has anything to gain by changing his
strategy unilaterally. A Nash equilibrium, however, is rarely the best possible outcome; it
is merely the one that pertains if the players are unable or unwilling to co-operate.
That insight has found wide application in both the social and the biological sciences.
The latest example is a paper published in this week's Proceedings of the National
Academy of Sciences, by Alison Galvani, of Yale University, and her colleagues. Dr
Galvani looked at a classic example of a case where the best choice for the individual
may not lead to an optimal outcome for society: vaccination.
The vaccination programme Dr Galvani studied was for influenza in America, a country
where people are offered flu jabs once a year to protect them from the most severe form
of the disease likely to be in circulation that winter.
Dr Galvani asked almost 600 university employees about their attitudes towards flu jabs
for themselves and their families. Her survey found that people aged 65 and over were
more likely to be vaccinated than other adults. From a Nash point of view, that makes
perfect sense, as the elderly are at greatest risk of dying if they contract influenza.
However, as the parents of any small child know, it is the young who bring pestilence
into the home. Thereafter, adults spread coughs and sneezes in their workplaces.
Vaccinating the young would reduce the spread of flu, thus saving lives. The researchers
therefore asked whether any children living in the household had been vaccinated and
found that immunisation rates for the young were lower than for adults. Again, that
makes perfect Nash sense, since children rarely die of seasonal influenza.
Indeed, from a public-health point of view, the situation could be even worse.
Mathematical theories such as Dr Nash's tend to assume a world populated by individuals
who behave in fully rational ways, because they have perfect knowledge. Dr Galvani and
her colleagues recognised that this was unlikely to be completely correct, even among
people working in American universities. Their results confirmed their suspicions. People
overestimated their chances of catching flu and the length of time for which the disease
would be contagious, and underestimated the effectiveness and duration of the vaccine.
The only aspect that most people were clued up on was the length of time for which they
would suffer symptoms, which was between four and five days. Combining those
findings with the other results of the survey, the researchers concluded that if their
subjects were better informed, their incentives to act more selfishly would increase, and
the pattern of immunisation would look even more like a Nash strategy.
The converse approach to vaccination, known as a utilitarian strategy, relies on the
concept of "herd immunity". The idea is that when a critical proportion of a group is
immune to a disease, too few individuals are susceptible for that disease to be passed
from one to another. A disease that cannot transmit itself rapidly dies out.
The researchers calculated that a population which followed a Nash strategy would
contract 100 times more infections than one which followed a utilitarian strategy. Indeed,
if 77% of young people were given jabs, seasonal flu could be all but eliminated. A
utilitarian strategy, however, is a top-down affair because it relies on a community-wide
programme, rather than on individuals' choices about whether to get vaccinated.
Persuading people to act in the interests of society rather than on their own behalf is
likely to be harder than showing mathematically that this is the best thing to do.
However, the researchers did identify a case where individual and societal interests were
more closely aligned. This was a second type of influenza: pandemic, rather than
seasonal, flu. When a pandemic takes hold, it kills millions of people in many different
countries.
In this situation, the utilitarian strategy is also the Nash strategy. Because the disease kills
the young as well as the old, parents have good reason to get both themselves and their
children vaccinated. Which is a small piece of good news for those charged with
contemplating how to deal with an influenza pandemic.
Economist work-out 4.2
Solution guide
1. There is a positive external effect associated with an individual member of society
choosing to have a flu vaccination. Influenza is a contagious disease. Hence, one when
member of society lowers their own likelihood of catching influenza by having a
vaccination, they also lower the likelihood of their friends and relative catching influenza
since they cannot catch flu from the individual who has been vaccinated. This raises the
well-being of those friends and relatives, but it is not an effect that would be taken into
account by the individual who has the vaccination in their decision about whether to have
the vaccination. In other words, the individual does not incorporate the benefit to other
members of society into his or her own private benefit.
2. Economic theory predicts that where a positive external effect is associated with an
activity, that the amount of that activity undertaken in a competitive market, will be less
than the socially optimal amount. Hence the prediction would be that the proportion of
society who choose to have a flu vaccination is less than the socially optimal proportion.
What is described in the article seems consistent with this prediction. First, that a higher
proportion of people aged 65 years and over are vaccinated than the proportion of
children who are vaccinated, is consistent with the idea that people take into account
private benefit in making decisions. As the article points out, influenza is more likely to
be fatal for older adults than children, so the private benefit of being vaccinated is much
higher for older adults than children. Hence the difference in the proportions of older
adults and children vaccinated can be seen to reflect differences in the private benefit of
vaccination. Second, the article suggests that transmission of influenza occurs primarily
through children. Hence vaccinating children could significantly reduce the proportion of
the population who catch flu, so that the social benefit of having children vaccinated is
significantly greater than the private benefit. But as the theory would predict, the
proportion of children who are vaccinated does not reflect the significant social benefit
that would result from them being vaccinated.
$ $
PMC=S
MC PMC=S
MC SMB
SMB
PMB
PMB Q* Q** Qty vaccinated Q* Adult Q** Qty vaccinated 3. Possible polices would be: (a) Direct regulation requiring that all members of the
population or perhaps specific age groups within the population have an influenza
vaccination; (b) Subsidy to decrease the cost of influenza vaccination designed so that the
lower cost would reflect the social benefit from specific groups being vaccinated (for
example, perhaps there should be a larger subsidy for children than adults if there are
larger positive external effects from reducing transmission of influenza associated with
children being vaccinated); or (c) An education campaign about benefits of vaccination
(since the article suggests that individuals under-estimate the private benefits of being
vaccinated; and education about benefits to society from vaccination might also induce
individuals to ‘internalise’ some of the benefits to society into their own private benefit
from vaccination).
Problems with direct regulation would be that some members of society may have a
moral objection to being vaccinated; as well, the article suggests that a vaccination rate of
about 77% amongst the younger population would be sufficient to eradicate influenza –
so that requiring all of even the younger population to be vaccinated may be above the
socially optimal level of vaccination. Problems with the subsidy are knowing enough
about the size of subsidy that will achieve the socially optimal levels of vaccination rates
for different age groups. The main problem with the education campaign is that its effect
on vaccination rates is likely to be very uncertain (depending, for example, on the quality
of the advertising).
Economist work-out 4.3
Read the attached articles ‘Constricting the pet supply’ (The Economist, February 13
2010, p.33); and ‘Economies of scales’ (The Economist, September 20 2008, p.18).
Some questions to consider
1. What do the articles suggest are the externalities associated with breeding of boa
constrictors and pythons in the United States, and with fishing for halibut in Alaska?
What does this imply about the levels of snake breeding and fishing relative to efficient
levels?
2. What policy solutions have been proposed for the market for large constrictor snakes?
How is it intended that the solutions would correct market failure?
3. What policy solution has been implemented in Alaskan halibut fishing? How is it
intended that the policy will correct market failure? Is there any evidence in support of
the policy having this effect?
4. Describe some issues that it is suggested need to be addressed to implement the policy
solutions; and some examples of how it is suggested that the polices might have perverse
effects.
This article (‘Constricting the pet supply’, The Economist, February 13 2010, page 33) is
reproduced with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Constricting the pet supply
BOA CONSTRICTORS, pythons and corn snakes decorated sellers' tables at the Reptile
Show in White Plains, New York, last month. Awestricken visitors peered at them with
delight. Experts examined them under the light and scrutinised their colouration. The
breeding of snakes is serious business in America. Revenue from the sale of boas and
pythons amounts to around $1.6 billion-1.8 billion each year.
Americans own more than 2.5m snakes, according to the Pet Industry Joint Advisory
Council, a trade association. The snake industry has grown dramatically over the past
decade because of frenzied competition to create new "morphs", the industry term for
new colours of snakes. Rare morphs can fetch astonishingly high prices, sometimes more
than $20,000.
The recession, however, has hurt what used to be a lucrative hobby. Fewer people want to
splurge on snakes that cost thousands, if not tens of thousands, of dollars. According to
Brian Barczyk, a snake-breeder, demand for "pet-grade" snakes, which cost under $50,
has sunk even more than demand for "investment-grade" ones, because the average
person is hesitant to buy a new pet.
The snake industry's most dangerous predator, however, is not the economy but the
government. Ken Salazar, the secretary of the interior, wants to add nine types of large
constrictor, including the Burmese python (pictured), to a list of "injurious" species
regulated by the federal government. This would make it illegal to import or transport
these types of snakes across state lines. Congress may also consider a bill that would do
the same.
The spread of Burmese pythons in the Florida Everglades is responsible for sparking this
wave of herpetophobia. Burmese pythons are thought to have found their way into the
wild because pet-owners released them, and now thousands are slithering around there.
They are eating some endangered species, like the Key Largo woodrat.
Breeders are up in arms at the prospect of the ban. Some opponents speculate that if
snake-owners are unable to transport or sell some of their snakes beyond state lines, they
may just release them into the wild. The federal government may have to consider
offering "amnesty days", as Florida does, when snake owners can turn in their foreign
pets. Florida has also started giving people permits to kill Burmese pythons. Some may
say this is cruel. But that depends on whether you side with the pythons or the woodrats.
This article (‘Economies of scales, The Economist, September 20 2008, page 18) is
reproduced with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Economies of scales
BEFORE 1995 the annual fishing season for Alaskan halibut lasted all of three days.
Whatever the weather, come hell or--literally--high water, fishermen would be out on
those few days trying to catch as much halibut as they could. Those that were lucky
enough to make it home alive, or without serious injury, found that the price of halibut
had collapsed because the market was flooded.
Like most other fisheries in the world, Alaska's halibut fishery was overexploited-despite the efforts of managers. Across the oceans, fishermen are caught up in a "race to
fish" their quotas, a race that has had tragic, and environmentally disastrous,
consequences over many decades. But in 1995 Alaska's halibut fishermen decided to
privatise their fishery by dividing up the annual quota into "catch shares" that were
owned, in perpetuity, by each fisherman. It changed everything.
Despite their salty independence, even fishermen respond to market incentives. In the
halibut fishery the change in incentives that came from ownership led to a dramatic shift
in behaviour. Today the halibut season lasts eight months and fishermen can make more
by landing fish when the price is high. Where mariners' only thought was once to catch
fish before the next man, they now want to catch fewer fish than they are allowed to-because conservation increases the value of the fishery and their share in it. The
combined value of their quota has increased by 67%, to $492m.
Sadly, most of the rest of the world's fisheries are still embroiled in a damaging race for
fish that is robbing the seas of their wealth. Overfished populations are small, and so they
yield a small catch or even go extinct. Yet the powerful logic in favour of market-based
mechanisms has been ignored, partly because the evidence has largely been anecdotal.
Now a study of the world's 121 fisheries managed by individual transferable quotas
(ITQs), one form of market-based mechanism, has shown that they are dramatically
healthier than the rest of the world's fisheries.
By giving fishermen a long-term interest in the health of the fishery, ITQs have
transformed fishermen from rapacious predators into stewards and policemen of the
resource. The tragedy of the commons is resolved when individuals own a defined (and
guaranteed) share of a resource, a share that they can trade. This means that they can
increase the amount of fish they catch not by using brute strength and fishing effort, but
by buying additional shares or improving the fishery's health and hence increasing its
overall size.
There are plenty of practical difficulties to overcome. In theory, for instance, you should
allocate shares through auctions. But if fishermen do not agree to a new system, it will
not work. So fishermen are typically just given their shares--which can lead to bitter,
politicised arguments. In Australia, a pioneer in ITQs, a breakthrough came when
independent allocation panels were set up to advise the fishing agencies, chaired by
retired judges advised by fishing experts. The next test will come in November, when two
large American Pacific fisheries decide whether to accept market management.
ITQs, and other market mechanisms, are not a replacement for government regulation-indeed they must work within a well regulated system. And they will not work
everywhere. Attempts to use ITQs in international waters have failed, because it is too
easy for cheats to take fish and weaker regulations mean there are no on-board observers
to keep boats honest. And ITQs will not work in slow-growing fisheries, where fishermen
may make more money by fishing the stock to extinction than they ever would by waiting
for the fish to mature. But in most of the world's fisheries, market mechanisms would
create richer fishermen and more fish.
There was a time when fishermen were seen as the last hunter-gatherers--pitting their
wits against the elements by pursuing their quarry on the last frontier on Earth. Those
days are gone. Every corner of the ocean has been scoured using high technology
developed for waging wars on land. Politicians and governments still seek to cope with
fishermen's poverty by subsidising their boats or their fuel--which only accelerates the
decline. Instead governments should promote property-rights-based fisheries. If
fishermen know what's good for them--and their fish--they will jump on board.
Economist work-out 4.3
Solutions
1. What do the articles suggest are the externalities associated with breeding of boa
constrictors and pythons in the United States, and with fishing for halibut in Alaska?
What does this imply about the levels of snake breeding and fishing relative to efficient
levels?
The article ‘Constricting the pet supply’ describes an externality associated with breeding
of boa constrictors and pythons as being that pet snakes of these breeds that have been
released into the wild are eating endangered species – for example, in Florida where they
are eating the Kay Largo woodrat. This is an externality since: (i) The action taken by
snake owners in releasing snakes into the wild is having a negative effect on well-being
of the American population by reducing the quality of environment; and (ii) The snake
owners – in their decision on whether to release their snakes - are not taking into account
the effect of their decision on the well-being of the American population.
The article ‘Economies of scale’ describes externalities associated with fishing for halibut
in Alaska. First, the attempt by each fisher to catch as many fish as possible in the
allowed time period was causing depletion of the overall stock of halibut, in a way that
would eventually have caused fishing to become unsustainable or caused extinction of the
stock. Second, the concentrated fishing period meant that the attempt by each fisher to
catch as many fish as possible would cause a large increase in supply of halibut at that
time, and hence a large decline in price. These are externalities because: (i) Each
fisher’s decision about their size of catch was causing depletion of the fish stock and
lower prices that adversely affected the well-being of other fishers; and (ii) Each fisher –
in deciding on the size of catch to attempt – did not take into account the effect on wellbeing of other fishers (even though a fisher would experience a decline in price of halibut,
that would adversely their own well-being, they would not take into account the effect of
decrease in price of well-being of other fishers).
In both these cases there are negative externalities. Hence the level of each activity
(releasing snakes and fishing of halibut) will be above the efficient level.
2. What policy solutions have been proposed for the market for large constrictor snakes?
How is it intended that the solutions would correct market failure?
The main policy solutions proposed have been to: (i) Forbid inter-state commerce in
these types of snakes; and (ii) Reduce the populations of these types of snakes (for
example, by allowing killing of them). Both policy solutions are seeking to reduce the
size of populations of these types of snakes, and hence reduce the size of negative
externalities from these snakes being released into the wild. For example, forbidding
inter-state commerce is intended to reduce the scope for trade in these types of snakes,
and hence to reduce the incentive for supply and breeding activity.
3. What policy solution has been implemented in Alaskan halibut fishing? How is it
intended that the policy will correct market failure? Is there any evidence in support of
the policy having this effect?
The policy solution that has been implemented is a system based around ‘individual
transferable quotas’ (ITQs). This system involves: (i) Fishers being allocated perpetual
rights to specified shares of an overall catch of halibut per season; and (ii) Fishers being
allowed to trade their fishing catch rights.
By giving fishers ownership of a share of the halibut catch in perpetuity, each fisher then
has an incentive to maximise the value of the total catch in perpetuity. This is done by
only catching an amount of fish each year such that the stock of surviving halibut remains
sufficient for fishing in future years. Whereas previously fishers simply had an incentive
to catch as many fish as possible each season, since they did not derive any benefit from
seeking to maintain a sufficient stock of halibut to allow fishing to continue forever, and
because other fishers, also lacking any long-term interest, were also seeking to catch as
many fish as possible in the current season. Hence it would be expected that fishers
would seek to catch less fish each season with the system of ITQs than without this
system.
Two main pieces of evidence are cited in support of the policy having been successful in
correcting market failure. First, it is stated that the value of the halibut quotas has
increased by 67% since the system of ITQs was introduced in 1995 (instead of decreasing
as would have been expected in the absence of the system). Second, a study of the 121
fisheries managed by ITQs has shown that using this system decreases the chance of the
fishery collapsing by one-half compared to other fisheries.
4. Describe some issues that it is suggested need to be addressed to implement the policy
solutions; and some examples of how it is suggested that the polices might have perverse
effects.
Implementing the policy solutions for dealing with boa constrictors and pythons would
require decisions about issues such as how to enforce the ban on inter-state transport of
these snakes, or what size of payment might be needed to induce snake owners to hand
them in on amnesty days. One potential perverse effect it is suggested might come from
the policy for banning inter-state transport is that in the short-run this could actually
cause an increase in the number of snakes released into the wild as breeders, now unable
to sell as many snakes, seek to get rid of surplus stock.
A variety of issues are important in thinking about implementing an ITQ system into a
fishery. First, it is necessary to judge whether the ITQ will ‘work’ in a specific fishery.
It is suggested that ITQs are not likely to be effective in international waters (due to the
inability to enforce the quotas), or for slow-growing fish. Second, it is necessary to have
a system for allocating ITQs that is politically feasible – for example, that existing fishers
agree to.
Economist work-out 4.4
Read the attached article ‘Flying blind’ (The Economist, February 21 2009, page 4). The
article describes problems associated with increasing amounts of space debris.
Some questions to consider
1. Do you think there is an external effect (or effects) associated with the decision by the
government of a country or a private organisation about whether to launch a new satellite?
2. Given the nature of any external effect(s), would you expect that the number of active
satellites and amount of space debris are socially optimal?
3. What types of policies does the article suggest may be required to achieve a socially
optimal amount of space debris, and to reduce the potential adverse consequences
associated with existence of debris? How would these policies work to solve any
problems of market failure?
4. What is the ‘free-rider’ problem that the article describes? How does the problem that
the article identifies relate to the concept of a public good? What solutions could you
suggest to the problem?
This article (‘Flying blind’, The Economist, February 21 2009, page 4) is reproduced
with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Flying blind
The Earth's orbit is getting crowded. The past few years have witnessed huge growth in
the number of satellites. Unfortunately, wherever civilisation ventures it leaves a trail of
rubbish. Of the 18,000 tracked objects travelling around the Earth that are larger than
10cm (4 inches), only about 900 are active satellites. The rest is debris--everything from
fragments of paint to entire dead satellites and bits of old rockets. Smashed bits of space
equipment orbit along with items dropped by astronauts, including tools and the odd
glove.
That is quite enough trash, without needlessly creating vastly more of the stuff by
smashing up satellites. Yet the destruction of the Chinese Fengyun-1C in an anti-satellite
missile test in 2007 accounts for more than a quarter of all catalogued objects in lowEarth orbit. And the collision of an American commercial satellite and a defunct Russian
military one has just added thousands more pieces of debris. For the sake of the whole
planet, the space industry needs to clean up its act.
Space junk is dangerous. Anything larger than a fleck of paint poses a hazard to the
useful working satellites that surround the Earth, and on which the world increasingly
depends for communications, broadcasting and surveillance. Space waste is not
biodegradable. You cannot sweep it up. Instead, it will stay in orbit for decades, or even
centuries, before it eventually falls to earth and burns up.
As the pile of rubbish grows, so does the risk of collisions. In the 1970s one NASA
scientist pointed out that debris from one collision could go on to create a second, which
would create still more debris and more collisions, and so on. Eventually, an entire orbit
would be rendered useless for generations.
The orbits around the Earth are too valuable to let this happen. Space is a public common
and humanity needs to value it. So it is time to stop so many satellites from flying blind.
Although some organisations collect and analyse data on potential collisions, they are not
always precise and there are gaps in their knowledge--as the recent collision has shown.
The European Space Agency has said it will encourage space agencies to share more
information. It will also establish standards for working more closely with America.
But that is too modest. What is needed is an international civil satellite-awareness system
that would provide everyone from small governments to business with the information
they need to operate safely. To create such a system cheaply, however, requires countries
to pool information from their separate ground sensors. The system should lay down the
rules of the road, such as who has to give way. All space-faring countries should comply
with international guidelines to minimise the amount of debris created by launches. There
is a strong case for a moratorium on debris-creating anti-satellite tests. And satellitelaunchers should be obliged to buy insurance to cover the risk of extra costs before they
venture into space, rather as car-drivers must before they take to the road. One such cost
arises when a satellite has to take evasive action and thereby uses up fuel, reducing its life
in orbit.
This plan need not be expensive, but it faces one big difficulty. Because orbit is open to
anyone with a launch-rocket handy, some countries may be tempted to let everyone else
bear the costs of precaution while they reap the benefits. The space powers can use all
sorts of levers to bring such recalcitrants round, from access to technology to moral
pressure. Ultimately, though, if free riders refuse, it is important that the resulting stink
does not block an agreement altogether. Do not let the mess on the ground exacerbate the
mess in the skies above.
Economist work-out 4.4
Solutions
1. Do you think there is an external effect (or effects) associated with the decision by the
government of a country or a private organisation about whether to launch a new satellite?
It does seem that a negative external effect exists. Each time a country launches a new
satellite it increases the amount of space debris that will exist in future years. A greater
amount of space debris raises the likelihood of collisions with active satellites; which will
have adverse effects on global communications and surveillance. But it is not likely that
any government or private organisation will take into account these adverse
consequences in thinking about whether to launch a new satellite. It might take into
account the likelihood of a collision in the future with one of its own satellites and the
consequent effect on its well-being, but would not be concerned with collisions with
active satellites owned by other organisations.
[It could also be suggested, that even when the satellite is active, there would be an
external effect. Active satellites can also be involved in collisions (as the article
described), and each extra active satellite, by adding to ‘congestion’ in space, raises the
likelihood of a collision occurring. A government or private organisation will take
account of the consequences on its own well-being of a collision, but not on the wellbeing of the other party who would be in the collision.]
2. Given the nature of any external effect(s), would you expect that the number of active
satellites and amount of space debris are socially optimal?
Launching a new satellite is associated with a negative external effect. Hence the number
of active satellites at any time, and the amount of space debris that subsequently exists,
will be greater than the socially optimal level.
3. What types of policies does the article suggest may be required to achieve a socially
optimal amount of space debris, and to reduce the potential adverse consequences
associated with existence of debris? How would these policies work to solve any
problems of market failure?
The article suggests a set of policies that together could assist in dealing with the market
failure associated with the satellites and space debris. First, it suggests collecting
information on the location of satellites and space debris. Second, where this information
reveals that collisions may occur, it suggests designing ‘rules of the road’ to avoid those
collisions. Third, it suggests a scheme of insurance whereby organisations launching
satellites would be required to make payments against the possibility that the ‘life span’
of their satellites is shorter than expected. Fourth, it is suggested that there should be a
ban on activities that needlessly increase the amount of space debris; such as a
moratorium on anti-satellite tests.
The first two suggestions deal with the problem that there is already ‘too much’ space
debris, and that since this debris cannot be removed (or dealt with by policies relating to
future launches), it is necessary to minimise the costs it imposes on society. It is
proposed that this could be done by improved information about the location of existing
debris, and protocols for then avoiding collisions with this debris. The third suggestion
seems akin to a tax – where the tax could potentially be larger the shorter a satellite’s life
span, and hence the longer the time it will spend as debris. This addresses market failure
by giving organisations an incentive to launch satellites that will have the longest life
spans, and hence reducing the number of satellites that need to be launched in the future.
The fourth suggestion is a type of direct regulation – seeking to reduce the amount of
extra debris that is created from the existing satellites by forbidding behaviour that would
have that effect.
4. What is the ‘free-rider’ problem that the article describes? How does the problem that
the article identifies relate to the concept of a public good? What solutions could you
suggest to the problem?
The ‘free-rider’ problem is that countries are likely to have an incentive to allow or have
other countries to abide by the policies to deal with space debris, but not abide by those
policies themselves. For example, the best outcome for a country may be where other
countries reduce the amount of satellites they are launching (thereby reducing the risk of
future collision with space debris for satellites from all countries), but that country does
not itself reduce its amount of satellite launches.
Actions to reduce the amount of future space debris can be thought of as a public good.
First, where one country takes an action to reduce future space debris and hence the risk
of collisions between debris and active satellites, it improves its own well-being by
making it less likely that its own satellites will be involved in collisions, but for the same
reason it also improves well-being of all other countries. This is the characteristic of nonrivalry. Second, it seems difficult to think that any country’s satellites could be excluded
from the benefits of the lower risk of collisions (or that other countries would want to
exclude a country – since all countries lose when collisions occur because of creation of
extra debris). This is the characteristic of non-excludability. Generally we expect that
public goods will be under-provided relative to the social optimum. This is what the
article describes – a concern that the public good of actions to reduce the future amount
of space debris may be under-provided.
Because of national sovereignty there is not really the capacity for any country to be
forced to participate in schemes to reduce the amount of space debris (for example, to not
undertake anti-satellite missile tests). Instead, getting countries to participate in schemes
to reduce the amount of space debris would seem to depend primarily on moral suasion;
that is, international agencies and countries that are involved in such schemes convincing
other countries that it is in their interests to participate.
Economist work-out 4.5
Read the attached articles on ‘A great leap forward’ (The Economist, May 11 2002, page
77), and ‘Drying out’ (The Economist, July 12 2003, page 28). Each of these articles
describes an environmental problem, and a potential solution that involves a combination
of: (a) direct regulation of quantity; and (b) creating market trade. In the article on
pollution in China a tradeable permit system has been established whereby: (a) the total
amount of sulphur dioxide emitted is determined by the government which then issues
permits to polluters for this amount of emissions; and (b) trade in permits is allowed
between polluters. In the article on water in Australia there are a set of systems whereby
each state: (a) determines the total amount of water that users in that state can take from
the Murray River system; and (b) trade of water rights between users is allowed.
1. How can direct regulation of pollution in China or of the amount of water used from
the Murray River in Australia improve social well-being?
2. How might allowing trade between polluters or between users of water improve social
well-being compared to a system where each polluter is assigned a permit to emit a
specified amount of pollution or water users are given the right to use a specified amount
of water and are not allowed to trade?
3. Why might each state in Australia having a separate system for determining water
rights and trading of those rights limit the potential benefits from regulation of water
rights?
This article (‘A great leap forward’, The Economist, May 11 2002, page 77) is
reproduced with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
A great leap forward
WE WANT to turn Taiyuan into a civilised place!" So proclaims Yuan Gaosuo, deputy
mayor of this grimy industrial city in the north-east of China. At first blush, this seems an
odd aspiration. After all, Taiyuan and the neighbouring bits of Shanxi province are one of
the earliest centres of Chinese civilisation. Architectural treasures, such as the Shuanglin
Si monastery and the Jinci Si temple, abound. Wutai Shan, one of Buddhism's most
sacred sites, draws visitors from all over the world.
Whatever its other deficiencies, civilisation ought thus to be the one thing that Taiyuan
does not lack. Mr Yuan disagrees. When air pollution levels in China's 47 biggest cities
were measured in 1999 and 2000, Taiyuan came last. "Without clean air, we simply
cannot consider our city civilised," he says. In fact, with pollution at nearly nine times the
level deemed safe, Taiyuan probably had the filthiest air in the world. Uncivilised,
indeed.
That embarrassing report (which merely confirmed what local people knew all along) has
at least wrought some good. It has spurred the city's officials to start tackling the soot,
smoke and sulphur dioxide spewing from Taiyuan's many coal-fired hearths and
industrial boilers. Their motive is the same as the one driving clean-air legislation in
other industrialising cities, such as London and Los Angeles, in the past. Their methods,
though, are intriguingly different.
Both London and Los Angeles adopted classic command-and-control measures to deal
with their problems. In Britain, burning coal was banned in cities. California did not go
so far as to ban cars. That would probably have caused riots on the streets (assuming
Angelenos could remember how to walk on them). But the regulations imposed on car
design were every bit as intrusive and prescriptive as anything dreamed up by a Comecon
government.
It is something of an irony, therefore, that the city government of Taiyuan, which is
located in what is, officially at least, still a communist country, should be looking to the
market to solve its pollution problem. But that is exactly what it is doing: it proposes to
use emissions trading in an attempt to achieve a 50% reduction in sulphur-dioxide output
within five years.
In April, local and provincial officials struck a deal with the Asian Development Bank
(ADB) to develop such an emissionstrading system. Permits to pollute will be issued to
the worst offenders. Those permits will be tradable, so that a polluter will be able either
to retain the right to release his own sulphur dioxide, or restrain his own pollution and
sell the right to somebody else. By reducing the total permitted tonnage of gas each year,
overall pollution levels can be reduced in the most economically efficient manner.
Taiyuan will not be the first Chinese city to experiment with sulphur-dioxide trading.
Nantong has already carried out a preliminary trial with the help of Environmental
Defence, an American lobby group. But Richard Morgenstern, of Resources for the
Future (RFF), a think-tank (also American) that is advising Taiyuan's government, thinks
that such trading is particularly suitable for the city. First, its problem is concentrated: a
small number of large polluters (about two dozen) emit half the gas. Second, those firms
face hugely divergent clean-up costs. According to RFF, these range from $60 to $1,200
per tonne of gas emitted. There is therefore something real to trade.
Until recently, conventional thinking has held that poor cities such as Taiyuan cannot
afford rich-world environmental standards: greenery, according to this theory, is a luxury
good that comes only with wealth. Over the past few years, though, economists have
realised that, besides being bad for individuals, pollution is bad for the economy. In a
report that proved influential in converting China's leaders to the virtues of pollution
control, the World Bank has estimated that in the late 1990s China lost between 3.5% and
7.7% of its potential economic output as a result of the health effects of pollution on the
country's workforce. Similarly, Louisa and Mario Molina, who work at the Massachusetts
Institute of Technology, argue that Mexico city could see benefits of perhaps $2 billion a
year, if officials reduced the concentrations of particulate matter in the air by just 10%.
Once the true costs of air pollution are recognised, argues Piya Abeygunawardena of the
ADB, the case for action becomes clear. He accepts that today's new megacities have a
more challenging task in tackling pollution than London or Los Angeles did, since they
are both bigger and poorer. But he points to several factors that make the task easier, too.
One is better science. Another is hindsight: studies of past policies elsewhere can point to
what works and what does not. And there is also more institutional support and money
from outfits such as his bank.
Such outside support may not, however, be needed forever, for there are growing
environmental movements — such as the Grupo de Cien in Mexico city and Friends of
Nature in Beijing — in many developing countries. In Delhi, noisy activism by an
organisation called the Centre for Science and Environment led to a recent Supreme
Court ruling that forced recalcitrant government officials to scrap dirty old diesel buses in
favour of cleaner ones that run on compressed natural gas. Effective pollution control
certainly needs grand plans. But civilisation also needs a myriad nitty-gritty decisions.
This article (‘Drying out’, The Economist, July 12 2003, page 28) is reproduced with
kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Drying-out
The mouth of the Murray, Australia's principal river, has dried up. For only the second
time since European settlement 215 years ago, the river system that feeds most of the
country has stopped flowing to the sea. The depleted Murray's salt levels are rising,
leaving Adelaide, one of Australia's biggest cities, facing a big problem: its water supply
will be undrinkable in 20 years unless a way can be found to restore the river to health.
Australians have been reminded of the fragility of life in a dry continent. A drought that
that has been ravaging much of eastern Australia for the past 18 months is only part of
the problem. A bigger one comes from the relentless demand by farmers for water from
the Murray and its main tributary, the Darling River, to irrigate their crops. The MurrayDarling basin, as it is known, covers an area the size of France and Spain, stretching
through four states in eastern Australia. It supplies almost three-quarters of Australia's
farm irrigation water. And it can no longer cope.
South Australia, where until recently the Murray flowed into the Southern Ocean at
Coorong, is the state at the end of the line. With little but desert and dry rivers to its
north, Adelaide, the capital, depends entirely on water piped from the Murray more than
100km (60 miles) to the east. People in Coober Pedy, a mining town in the middle of
desert, reckon their water, pumped and treated from ancient underground deposits, tastes
better than Adelaide's. South Australia's minister for the Murray River, John Hill, says its
rate of flow is half that needed to sustain it environmentally. From this month, irrigators
in South Australia will have their water allocations cut by one-fifth; in October each state
taxpayer will start paying a levy to raise A$20m ($13m) a year. The money will go
towards buying extra water from upstream and projects to restore the flow.
Victoria, New South Wales and Queensland, the more populous states that draw on the
Murray-Darling system more heavily than South Australia, guard their usage jealously.
The Murray-Darling Basin Commission, a regulatory body comprising the state and
federal governments, was formed only in 1988, despite stark evidence of land
degradation and salination related to over-use of the rivers stretching back decades. Don
Blackmore, the commission's chief executive, says it pumps 1,100 tonnes of salt out of
the river each day, and is about to spend A$67m to increase that by 700 tonnes a day.
Each state has a separate system for farmers to trade allocated water rights from the rivers
with neighbours, but not across state borders. Some reformers argue that nothing short of
an amendment to Australia's constitution, giving Canberra total power over the river
system, will save it. Meanwhile, dredges are pumping away the sand that has turned the
Murray's mouth into a series of brackish ponds. Even with heavy rains upstream it is not
expected to open again before September 2004. Unless Australians come up with a
tougher regime to manage their precious river, Mr Blackmore expects the mouth to go on
closing three years out of 10.
Economist work-out 4.5
Solution guide
1. By imposing a uniform quantitative restriction the government is directly requiring that
firms emit the socially optimal amount of sulphur dioxide or that farmers consume the
socially optimal quantity of water. This will increase social well-being where – due to
negative externalities – the market outcome would involve firms emitting an amount of
pollution greater than the social optimum, or farms using more water than is socially
optimal. [See Figures 1a and 1b]
2. Assigning property rights and allowing trade will achieve a greater improvement in
social well-being than simply having a uniform quantitative restriction where there are
differences between firms in their cost of reducing emission of sulphur dioxide or
differences between farmers in the socially efficient quantity of water they should each
consume. For example, suppose there are differences between farmers in SMB from
water consumption so that one has a ‘high’ optimal level of consumption, and another has
a ‘low’ optimal level of consumption. And suppose also that the amount of water
assigned to each farmer is between the ‘low’ and ‘high’ levels. Then it will be possible to
improve welfare by allowing trade – specifically, for the ‘low’ farmer to trade water to
the ‘high’ farmer. Both will be willing to engage in trade – since the ‘low’ farmer will
not be consuming some of his/her water, and the ‘high’ farmer will be willing to pay a
positive price for some amount of that water. And trade will improve social surplus by
reducing DWL for the ‘high’ farmer.
For example, in Figures 2a and 2b the ‘Low SMB’ farm will choose to use less than its
assigned amount of water, and the ‘High SMB’ farm will choose to use its assigned
amount of water. For the ‘High SMB’ farm, units of water just above the assigned
amount of water provide a PMB greater than PMC. Hence it will be prepared to pay
some positive amount to buy extra units of water. The ‘Low SMB’ farm has a zero
opportunity cost of supplying units of water above q1* . Thus there is scope for trade - the
‘High SMB’ farm will buy water from the ‘Low SMB’ farm. This will reduce the area of
deadweight loss shown in Figure 2b, and therefore improve social well-being. More
generally, provide that the government has assigned a total amount of water between the
two farms that is socially optimal, then trade between the farms should lead to an
outcome where each individual farm is using the individually socially optimal amount of
water.
3. The Murray river system extends across 3 states. Each state having its own system of
determining water rights may not be optimal where the actions of any one state have
negative external effects on the population in the other two states. For example, the
amount and quality of water available from the Murray river in South Australia will be
negatively related to the amount of water taken out of the Murray river in Victoria. But
the Victorian government – to the extent that it only takes into account the interests of the
Victorian population – will ignore that effect. If each state acts in this way, then the total
amount of water taken out of the Murray river will be greater than is socially optimal.
This problem could be overcome by one body taking responsibility for determining water
rights for the whole Murray river, and making that body responsible for the well-being of
the population in all three states. (This is the idea of a ‘merger’ to internalise the
externality that we discussed in the lecture on this topic.)
$ Size of negative external effect Direct regulation of qty of water used
$
SMC Price
SMC SArgentina PMC
DWL SArgentina + import qouta SMB
PMB = SMB
A Q* Q** Figure 1a qty water used
Q**
qty water used
Figure 1b
$ Max. qty of water $
SMC Max. qty of water SMC
PMC
DWL PMB = SMB
PMB = SMB
q1** q1* qty water
PMC
q2** Figure 2b – Farm 2: High SMB qty water Economist work-out 4.6
Read the attached article on ‘Tuning out’ (The Economist, June 30 2007, p.68). The
article describes about internet radio stations playing songs (sound recordings) without
paying royalties to owners of copyright in those songs.
1. Are sound recordings a public good?
2. What is the motivation for copyright protection that requires radio stations to pay
royalties for the sound recordings they play?
3. From the discussion in the article, do you think copyright protection will necessarily
have the desired effect on output of sound recordings?
This article (‘Tuning out’, The Economist, June 30 2007, page 68) is reproduced with
kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Tuning out
STEREO HITS, a radio station in Cobán, Guatemala, decided to go global last year. In an
effort to boost revenue from its advertisers, which include Coca-Cola, Panasonic and
PepsiCo, it began streaming its broadcasts over the internet, allowing anyone in the world
with a connection to tune in. Raúl Najera Ponce, head of the station's online unit,
estimates that this "webcasting" costs Stereo Hits just $100 a month, since it needs
neither a frequency licence nor a transmission tower.
Mr Najera Ponce also keeps costs down by neglecting to pay royalties on copyrighted
music. In theory, specialist agencies should collect fees for every song that radio stations
play and distribute them to the owners of the copyrights. The result is a complicated web
of contracts and payments among radio stations, collection agencies, record labels,
composers, musicians and their estates. But Mr Najera Ponce chose a simpler way to
remunerate musicians and labels. "If we need music from a band in London, we buy their
disc--that's how we collaborate," he says.
Collection agencies and the record labels they represent have long struggled to extract
royalties from radio stations. The International Federation of the Phonographic Industry
(IFPI), an industry group, estimates that half of Russia's radio stations fail to pay
royalties, for example. But internet radio stations are even harder to corral, because they
are smaller, more numerous and tend to be run by hobbyists who find it too complicated
and expensive to pay their dues. IFPI estimates that just 10% of Russia's webcasters
cough up.
Almost all of America's 14,000 or so webcast stations, which have 34m regular listeners
and income from advertising, do pay royalties. Nonetheless, for several reasons America
is where the big record labels and SoundExchange, the collection agency representing
them, are fighting hardest to bring in more money. For one thing, America's traditional
radio stations pay relatively little in royalties, thanks to a 1909 law that mandates fees for
composers but not for performers. (Low royalties, radio stations have argued, are justified
because playing songs provides performers with free publicity.) The frustrated record
labels are anxious to establish a less generous system for webcasters. Moreover,
America's strong legal system should make it easier to enforce their rights.
In March the record labels persuaded America's Copyright Royalty Board (CRB) to triple
royalties for webcasters, to roughly a fifth of a cent per-song per-listener, with retroactive
effect from the beginning of 2006. This will almost certainly put most webcasters out of
business. They will also have to pay SoundExchange $500 for each channel they stream
when the ruling takes effect on July 15th. This fee is likely to eliminate one of the most
cherished features of online radio: the customised channels that listeners can concoct
using software that produces playlists based on the names of favourite bands or songs.
One popular webcaster, Pandora, creates customised channels for some 7m users. It
cannot possibly afford to pay $500 for each one.
Outraged internet-radio fans have sent more than 400,000 e-mails, faxes and letters of
protest to America's congressmen. In response, several of them drafted a bill called the
Internet Radio Equality Act in the House of Representatives in late April. If voted into
law, it will nullify the CRB's decision. On June 26th many American webcasters stopped
broadcasting for a day and posted messages on their websites urging disappointed
listeners to lobby Congress on their behalf. The two sides are also doing battle in the
courts.
The quest for higher royalties may actually be doing record labels more harm than good.
People generally do not buy music unless they have already heard it. Internet radio makes
it easy to zero in on a preferred genre, so listeners are more likely to discover music they
would want to buy. Many online stations even provide links to online music stores--free
of charge.
Economist work-out 4.6
Solutions
1. Sound recordings would generally be considered a public good. First, they are nonrivalrous since any number of consumers can listen to the same copy of a sound
recording without reducing the capacity for other consumers to listen to the same copy.
Moreover, copies can be made of the original copy of a sound recording that then allow
an even larger audience to listen to the sound recording, again without diminishing the
capacity of other consumers to listen to that recording. Finally, where sound recordings
are broadcast on radio stations or webcast, this provides further potential for any number
of consumers to listen to the sound recording without reducing the capacity of other
consumers to listen to the same recording. Second, sound recordings are non-excludable
as it is relatively straightforward, once a consumer has purchased a copy, for that
consumer to make copies for other consumers without making a payment to the original
supplier. As well, broadcasting of the sound recording on the radio or by webcasting
further enables consumers to listen to a sound recording without making a payment to the
original supplier.
2. Copying of a product such as a sound recording, or broadcasting a sound recording,
introduces a gap between the benefit that society derives from the product and the amount
that the original supplier receives as payment. This is because some consumers who
benefit from the product are using copies or listening to broadcasts for which they have
not made a payment to the supplier. It is possible therefore that the benefit society
receives from a product exceeds its cost of production, but no supplier is willing to
supply the product since its sales revenue will be less than the cost of production. For
example, the cost of making a sound recording might be $1 million, the total benefit to
listeners from being able to listen to the sound recording may be $2 million, but due to
copying and broadcasting of the sound recording, the producers may only receive
$500,000 in revenue. This is a situation of market failure since it is efficient for the
sound recording to be supplied, but this will not occur as the market outcome. It is an
example of how public goods are likely to be under-supplied in a market economy.
Policy-makers have sought to develop approaches that overcome this problem of undersupply of public goods such as sound recordings. The main type of remedy has been to
introduce legal restrictions on the scope for parties other than the original producer of
certain types of products to derive commercial advantage from those products, or on
copying of the product. Copyright is one example of this type of legal remedy. With the
capacity to be applied to products such as sound recordings, movies and books, it assigns
sole right to the copyright owner to make copies or sell copies of the product for a
specified period after its initial publication, or to use the product for commercial
advantage. Copyright can be thought of as creating excludability. For example, in the
absence of copyright, there is no impediment to anyone who wants to listen to a sound
recording from copying it from someone else who has bought that sound recording. But
with copyright, this is deemed illegal. Hence, in theory, copyright makes it necessary for
anyone who wants to listen to a sound recording to make a payment to the original
producer by buying a copy from that producer. Consumers can thus now be excluded
from listening to the sound recordings unless they make some payment to the producer.
When all consumers are making a payment, then the revenue that the producer receives
will reflect the benefit that society receives from the sound recording. Hence we would
expect that any sound recording for which the benefit to society exceeds its cost of
production, will be made.
3. The article presents two perspectives on how copyright rules may not have the desired
effect of causing an efficient quantity of sound recordings to be supplied. First, copyright
will only be successful in increasing revenue to the original supplier of a sound recording
if all users of that recording are induced to make payments to the original supplier.
However, as the article describes, there are several reasons why this may not occur. In
some countries such as Russia few radio stations and webcasters make copyright
payments. Even in the United States, where radio stations and webcasters do make
payments, there are limits on the amount of payment required so that payments may not
reflect the full value that consumers are receiving from listening to the sound recordings.
Second, some commentators have argued that allowing webcasting may actually promote
sales of sound recordings by allowing consumers to ‘sample’ a broader range of music
than would otherwise occur. Hence, applied to webcasting, copyright may actually
decrease sales of sound recordings.
Economist work-out 4.7
Read the attached article on ‘Tipping Hollywood the black spot’ (The Economist, August
30 2003, pp.43-44). The article describes the increasing concern of Hollywood movie
producers about illegal copying and sharing of movie recordings.
1. Are movie recordings a public good?
2. What would you expect to be the effect on production of movies of peer-to-peer file
sharing services such as Morpheus and Grokster?
3. What remedies exist to solve the ‘problem’ of digital piracy?
This article (‘Tipping Hollywood the black spot’, The Economist, August 30 2003,
pp.43-44) is reproduced with kind permission of The Economist for use only for teaching
purposes (www.economist.com).
Tipping Hollywood the black spot
AS Hollywood bosses know all too well, digital piracy could plunder their industry. The
music business, where piracy has long been active, has lost a quarter of its sales already.
Watching its plight, the movie moguls say, has taught them a lesson: listen to what the
customer wants and keep the business model flexible. But investors are not convinced
that Hollywood's leaders are on top of the piracy threat. Like Scarlett O'Hara in "Gone
with the Wind", says Gordon Crawford, an investor at Capital Research and Management
in Los Angeles, many have decided to do something about it tomorrow.
It is true that movies are not yet as vulnerable as music. Hollywood starts from a better
position. Its products are priced more reasonably than CDs. People want to watch all of a
film, so there is no incentive to download a single track. It can take days to download a
movie from the internet, unlike a song, which takes minutes.
But rampant DVD piracy may be coming soon, both in the form of traditional
counterfeiting and downloading from the internet. Hard pirated copies are widespread,
and will proliferate further with the spread of DVD recorders and burners. Already as
many as 600,000 movie files are shared each day on peer-to-peer file-sharing networks
such as Morpheus and Grokster, according to the Motion Picture Association of America
(MPAA). That number is likely to soar as more households get broadband internet and
compression technology cuts download time.
Movie industry bosses say that they are doing plenty to combat the threat. As well as
helping local police with raids on counterfeiters, they are devising "digital rights
management" (DRM) techniques, such as deleting content after the user has "consumed"
it. They are also offering movies cheaply online and seeking new laws. This week they
won a battle against pirates when California's Supreme Court ruled that the First
Amendment right to free speech cannot be used as a defence by someone publishing trade
secrets on the internet--in this case, software to break DVD copy protection.
Next will come an Orwellian project to "re-educate" the young. With Junior
Achievement, a volunteer teaching organisation, the MPAA has developed a curriculum
for use in 36,000 American classrooms which teaches that swapping content is wrong.
Older file sharers will be hard to persuade, however, and hackers can usually get around
any copy protection the industry devises. According to the Pew Internet & American
Life Project, 65% of people who share music and video files online say they do not care
if material is copyrighted. Last month, the MPAA tried an emotional approach, with a
series of adverts in which a set painter, a stuntman, a make-up artist, a grip and an
animator explain how piracy hurts them, not just the big bosses. The campaign is
unlikely to have much effect, industry-watchers say, as everyone knows how many
millions the latest blockbuster grossed and how much the star got.
To frighten people, the big music firms are going after individuals in court. Movie firms
reckon that this will help them too, though for now they are leaning on universities to
stop their students file-sharing. One studio suggests that parents could be presented with a
bill for their child's downloading activities at college, and degrees could be withheld until
someone pays. Universities may stand by their students, however. For the Massachusetts
Institute of Technology (MIT) to withhold degrees, says a spokesman, the student would
have to be a "serious recidivist". This month a federal judge ruled that MIT, along with
Boston College, need not obey subpoenas from the music industry seeking the names of
students it suspects of being heavy file sharers, if only because they were filed from the
wrong jurisdiction. Legal attacks may scare people, but risk alienating customers and
making them try harder to rip off the industry, which cannot, even in America, sue
everyone.
Although Hollywood executives say they want to listen to customers, most of their
efforts have been to stop and punish downloaders, not to make their products more
attractive--with one exception. Five studios have launched Movielink, an online site
charging $3-5 to download a movie. But the service is still "clunky", admits a studio
spokesperson. It cannot beat a good video store either for range of titles or for having the
latest releases. Customers do not end up owning the film.
Assuming it is not resigned to milking all it can from its customers while awaiting
inevitable demise at the hands of the pirates, the movie industry should rethink its
business model. Movielink might be improved. Prices might be cut to reduce the appeal
of piracy. Hollywood should lower the price of DVDs from today's $15-20 to $7-10,
says Tom Wolzien, an analyst at Sanford Bernstein, and go for volume. The studios have
packed their DVDs full of extra content--director's cuts, and so on--supposedly offering
more value. Why not sell a no-frills, cheaper version? asks James Roberts, a consultant at
Mercer.
Studios might also change how they release movies. Opening a blockbuster in America
but not in Britain, for instance, increases demand for pirate copies, as does holding back a
movie from release on DVD and video. The studios need to shorten their release
windows, says Michael Wolf, director of McKinsey's global media and entertainment
practice. They have done this a bit already, he says--with simultaneous global "day-anddate" releases of, say, X-Men 2--but not enough.
In the 1980s, software companies used to fight online pirates with DRM technology. But
they found that copy protection annoyed users, and got rid of it. The makers of Lotus 12-3, a spreadsheet program, abandoned it after finding that they had merely created a new
market for software that could defeat copy protections. Now the music industry is
realising that often some of the downloaders it labels as thieves are actually trying out
music before they buy it, and that controlled, legal file-sharing could be a marketing tool.
Viral marketing of that kind, says John Rose, head of the anti-piracy effort at EMI, a
music company, could be powerful. Hollywood should take note.
The outlook would be much less grim if the entertainment business could do a deal with
the firms that make electronic gadgets. For copy protection to work, hardware needs to
spot it. So far, says an investor, Hollywood has not had the top-level discussions that it
needs with consumer electronics and PC manufacturers. Part of the reason, he says, is
that piracy is not being tackled by the bosses of media companies. The task gets
delegated. But even if Sumner Redstone, chairman of Viacom, were sitting down with
Sony's chief, Nobuyuki Idei, the discussion might not go far. The consumer-electronics
industry has little to gain by making products that seriously hinder piracy, as these would
be unattractive to customers and hurt sales.
If the movie industry does not work out its position quickly, says Mr Wolzien, it could go
the same way as music. This might even mean that actors would be paid a lot less. Some
are well aware of this. Several movie stars, says a studio executive, even offered to
appear for nothing (nothing!) in the MPAA's anti-piracy adverts, but were turned down.
This time, understandably, the industry pointed the cameras at its humbler members.
Economist work-out 4.7
Solutions
1. Movie recordings would generally be considered to have the characteristics of a public
good:
a) Non-rivalrous: An individual can ‘consume’ (watch) a movie, and this does not reduce
the capacity of any other individual to watch the same movie; and
b) Non-excludable: In the absence of government intervention, it is difficult to exclude
persons apart from those who have made a payment to the original ‘supplier’ from
watching a movie. This is because it is relatively easy to make copies, or to transfer the
same copy between individuals. Copyright legislation attempts to prevent copying by
persons who have not made a payment to the original ‘supplier’ of the movie by
assigning property rights to that original supplier. However, even with the existence of
copyright, it is difficult to completely prevent copying or use by individuals who have not
made a payment.
2. Peer-to-peer file sharing services make it easier for individuals to exchange movies or
to make copies of movies without permission of or making a payment to the copyright
owner. Hence, these services can be interpreted as increasing the ‘non-excludability’ of
movies; or in other words, to allow a greater amount of copying than would otherwise
occur. The effect that would be expected would be to reduce sales revenue to movie
producers. This can be interpreted as a decrease in the PMB of supplying movies. Hence,
a smaller quantity of movies will be supplied in a competitive market.
3. One solution that movie production companies have pursued is to seek to enforce
copyright legislation – for example, the article describes legal action against
counterfeiters and individuals engaging in copying, and opposing attempts to use the US
constitution as a defence of copying. Another solution has been an education campaign
to change attitudes of movie-watchers towards copying. Other solutions have been to
change the way movies are sold in order to reduce the incentive to engage in copying –
for example, the development of an on-line site where movies can be legally downloaded
for a payment, and scheduling the opening of movies to be at the same date in the US and
Europe.
Economist work-out 4.8
Read the attached article ‘Knock-offs catch on’ (The Economist, March 6 2010, pages
69-70). The article describes the proliferation of fake goods.
1. Can brand-names and design of goods such as Marlboro cigarettes, Porsche cars, and
Louis Vuitton luxury goods be considered as public goods?
2. What is the motivation for intellectual property laws that seek to restrict commercial
use of brand-names and designs to the originators of those brand-names and designs?
3. What reasons does the article give for why counterfeiting activity has increased
recently? How are businesses and governments seeking to counter this trend?
This article (‘Knock offs catch on’, The Economist, March 6 2010, pages 69-70) is
reproduced with kind permission of The Economist for use only for teaching purposes
(www.economist.com).
Knock-offs catch on
IMITATION is supposed to be the sincerest form of flattery, but that is not how most
brands see it. On March 1st Philip Morris, a tobacco giant, sued eight American retailers
for selling counterfeit versions of its Marlboro cigarettes. Thanks to the rise of the
internet and of extended international supply chains, and more recently, to the global
economic downturn, counterfeit goods are everywhere. Fake Porsches and Ferraris zoom
along the streets of Bangkok. A German bank has discovered an ersatz gold ingot made
of tungsten in its reserves, according to a German television channel investigating
persistent reports that many of the world's financial institutions have been similarly
hoodwinked. NASA, America's space agency, has even bought suspect materials.
Counterfeiting "used to be a luxury goods problem", says Therese Randazzo, who is in
charge of protecting intellectual property at America's customs service. Now people are
trying to traffic counterfeit items that have a "wider effect on the economy", she says,
such as pharmaceuticals and computer parts. A new study by America's Department of
Commerce shows that fakes have even infiltrated the army. The number of counterfeit
parts in military electronics systems more than doubled between 2005 and 2008,
potentially damaging high-tech weapons.
The OECD estimates that the international trade in counterfeit and pirated goods was
worth around $250 billion in 2007. The International Anti-Counterfeiting Coalition
(IACC), a lobby group, says the true figure is actually closer to $600 billion, because the
OECD's estimate does not include online piracy or counterfeits that are sold in the same
country as they are made. Counterfeit goods make up 5-7% of world trade, according to
the IACC.
Several factors have contributed to the growth of counterfeiting in recent years. The shift
of much of the world's manufacturing to countries with poor protection of intellectual
property has provided both the technology and the opportunity to make knock-offs. The
internet in general, and e-commerce sites like eBay in particular, have made it easier to
distribute counterfeit goods. MarkMonitor, a firm that helps companies defend brands
online, estimates that sales of counterfeit goods via the internet will reach $135 billion
this year.
The recession in the rich world may also have given a boost to counterfeit goods.
Frederick Mostert of the Authentics Foundation, an anti-counterfeiting group, has noticed
a "spike" in knock-offs this recession, as consumers short of money trade down from the
real thing. Cost-cutting measures may also have made firms' supply chains more
vulnerable to counterfeit parts. In 2008 the value of fake goods seized at America's
borders increased by nearly 40% over the year before. It subsequently fell by 4% last
year--far less than the 25% decline in imports overall (see chart). In Europe in 2008
customs services confiscated more than double the previous year's haul of counterfeit
goods.
Businesses, which feel the revenues lost to counterfeiters all the more acutely in a
downturn, are making an even greater effort to root out impostors. Complaints from
Louis Vuitton, a luxury-goods firm, for example, led to nearly 9,500 seizures of knockoffs last year, 31% more than in 2008. Lawsuits brought by companies against
manufacturers and distributors of counterfeits are at an all-time high, says Kirsten
Gilbert, a partner at Marks & Clerk Solicitors, a British law firm.
The technology used to counter pirates is also becoming more sophisticated. Holograms
are a cheap way to distinguish real items from fakes, although counterfeiters are getting
better at copying them. Special inks, watermarking, and other "covert" technologies
(meaning those invisible to the naked eye) are becoming more popular as a result. Many
"brand protection" firms have also started to peddle radio-frequency identification
(RFID) technology to help companies track shipments. This allows firms to tag boxes and
crates with chips which send out signals identifying them as authentic.
The most foolproof technique for identifying genuine goods involves incorporating
materials with special genetic markers into the packaging or product itself. Firms or
officials can then literally check an item's DNA to ensure that it is real. This is more
expensive than other anti-counterfeiting measures, but companies with very valuable
wares, such as the grandest wineries, are splurging on it. James Hayward, the boss of
DNA Applied Sciences, which sells such technology, insists that new clients are
"knocking down our door", in spite of the recession.
Online brand-protection services, which track counterfeiters on the web for their clients,
are also thriving. OpSec Security, which provides physical and online brand protection,
has seen revenues from its online monitoring business grow by more than 20% annually
for the past two years, even as revenues for its shipping services declined (because
companies are shipping fewer items). MarkMonitor raised the price of its online brandprotection service by 18% last year because demand was so high. America's biggest firms
spend $2m-4m a year to combat counterfeiting on average--a figure that is growing along
with internet shopping.
Governments are also boosting their efforts to crack down on counterfeiting, which
deprives them of tax revenue in addition to harming legitimate businesses. Counterfeiting
and piracy cost G20 economies [euro]62 billion ($85 billion) a year in lost taxes and
higher spending on unemployment benefits, according to a study by Frontier Economics,
a consultancy. For every dollar invested in the fight against counterfeiting in America,
the government receives $5 in extra tax revenue, estimates the US Chamber of
Commerce, a business lobby. In recent years France and Italy, among others, have
enacted laws that threaten consumers who buy fake goods with steep fines and even
imprisonment.
America appointed its first "IP tsar" last autumn and is developing a new enforcement
strategy. The European Union has formed an anti-counterfeiting "observatory" to collect
better data and disseminate tips on how best to detect fake goods. The EU, America and
Japan, among others, are also discussing a new treaty, called the Anti-Counterfeiting
Trade Agreement (ACTA), that would strengthen international controls on counterfeits
and piracy. It is expected to be launched later this year.
But in China, where 80% of the world's fake goods are thought to be produced, officials
are loth to crack down on a thriving local business. China is not expected to sign ACTA-undermining it before it has even been unveiled. Perhaps China could make a just-asgood fake treaty instead.
Economist work-out 4.8
Solution
1. Can brand-names and design of goods such as Marlboro cigarettes, Porsche cars, and
Louis Vuitton luxury goods be considered as public goods?
The brand-names and designs can be considered public goods in the sense that counterfeit
copies of these goods can be made. The ability to make counterfeit copies implies that it
is not possible to exclude other producers from using the same brand-name and design as
an original manufacturer such as Louis Vuitton; and brand-names and design are nonrivalrous – for example, it is possible to observe the design of a Louis Vuitton product
and then make a counterfeit copy that appears identical.
2. What is the motivation for intellectual property laws that seek to restrict commercial
use of brand-names and designs to the originators of those brand-names and designs?
These intellectual property laws are seeking to create excludability with regard to brandnames and designs. In the absence of these laws it would be possible to make counterfeit
copies of Vuitton products and sell them without the original maker of Vuitton products
being able to take any action against them. The ability to make counterfeit copies
reduces the expected benefit to the original maker from investing in design, and hence
there will be less effort put into this activity. By introducing intellectual property laws
potential manufacturers of counterfeit Vuitton goods then face being prosecuted and
fined for engaging in counterfeiting. This is intended to restrict and prevent
counterfeiting, and therefore provide greater incentives for companies such as Louis
Vuitton to put effort into design and to promoting its brand-name.
3. What reasons does the article give for why counterfeiting activity has increased
recently? How are businesses and governments seeking to counter this trend?
The article suggests a variety of explanations for the rise in counterfeiting activity. Two
explanations are: ‘The shift of much of the world's manufacturing to countries with poor
protection of intellectual property has provided both the technology and the opportunity
to make knock-offs. The internet in general, and e-commerce sites like eBay in particular,
have made it easier to distribute counterfeit goods.’ It is also suggested that the global
financial crisis has made consumers ‘…short of money trade down from the real thing’;
and that firms’ cost-cutting ‘…may also have made firms' supply chains more vulnerable
to counterfeit parts’.
One way that original manufacturers are seeking to reduce counterfeiting is by
incorporating ‘markers’ into their products that can be used to distinguish ‘genuine’ from
‘non-genuine’ versions – for example, genetic markers. The manufacturers can also hire
services that seek to track and expose counterfeiters on the internet. Governments,
concerned at the loss of tax revenue from the counterfeiting, have also been increasing
efforts to identify counterfeit activity.