Journal Entries

An extremely minor treatise on economics

I suppose I should really write a journal entry, after a mere 4 ½ years on hootoo, eh? Well not something personal, so I might as well gibber on about economics after studying it for almost as long. And I might as well talk about aviation, cos I used to work in it, and it sheds light on two of the most important features in economics.

The first feature is how markets work: free markets *are* good, with many caveats. Second, externalities occur when costs aren’t included in the market price. The aviation industry gives pretty good examples of both, with the arrival of low-budget airlines and also emissions-induced climate change (ignoring other environmental effects).

So first off, competitive markets. Economic theory holds that competition is bloody wonderful because different firms strive to reduce costs, allowing them to pass on lower prices, and it also leads to an increase in the amount of goods or services supplied. I started work for BA over 10 years ago. At the time, flying Glasgow-London without staying a Saturday night meant a fare of about £270 (British Midland were the same). Lower fares were available with a weekend stay, but couldn’t be changed under any circumstances. When ryanair etc came in and thought ‘fxxk that’, and started charging more reasonable prices with more reasonable fares, BA responded by copying them, as passengers haemorrhaged away. Now there are no minimum stays, most fares except the cheapest can be changed (for a fee, just like ryanair), and it’s a better deal all round for punters. There are more flights from gla-lon, to more airports. Also, there are many more destinations in Europe as well, from more airports. Longhaul flights are also cheaper and more flexible than they were 10 years ago.

This is a reassuring example that economists’ heads aren’t all up their arses, as often seems the case. Moving from what amounted to a cartel to a more competitive market led to more choice and lower prices. Yay! Everyone wins except those who formed the cartels, and even BA are starting to make money now that they’re more competitive and have reduced costs*.

(*By making me redundant, among other things. And cutting back on catering on short flights, making cabin crews’ pay & conditions worse, and generally making flying a worse experience than it was before. And ryanair are even worse, as I’m sure you know. The trend towards a poorer service as costs go down is something I’m not too sure about theoretically, although it’s there to be seen…)

The second, rather more important feature, is pollution, here CO2 which causes climate change. It’s called an externality because the costs involved are external to the market price, eg, the costs calculated by BA on their balance sheet take no account of Tuvalu being underwater, drought in India etc etc etc. If these costs were included, then the price of flying would be higher than it is presently. (This is kinda compounded by airlines not paying VAT or tax on aviation fuel, so we’re actually *subsidising* an industry that should be getting taxed pretty highly.)

The ‘correct’ price of flights, with all the externalities included, is called the ‘shadow price’. If flight prices were at this level, then as a society we’d get the maximum benefit from flights taken (in jargon, the marginal benefit would equal the marginal cost, and the net benefit would also be at its maximum). Specifically, the net benefit falls the more flights are taken because the cost of the emissions rise: so we stop at the point where the benefit is zero. As it is, we’re probably far beyond this level.

So all we need to do is find the shadow price, and adjust taxes or whatever so that the market price equals it, and then we’re laughing, right? Yeah! Except, what the hell are the costs of climate change going to be? Estimates range from $2-33 trillion, and the IPCC models predict a rise in temperature of between 1.8-4 degrees by 2100. But none of the IPCC’s models predict the large rises in the Arctic just now, so is it possible that the highest latitudes will warm much more than we think? If the Greenland ice sheet melts, sea levels will rise by 25 feet. If the Antarctic sheet melts too, it could be up to 80m. How do we even put a price on the disappearance of a million square miles of prime real estate, where hundreds of millions of people live, work, and farm? (This scenario isn’t included in the IPCC models, so $33tn is far below what this would cost.)

So it seems that the market can’t sort out the right (ie efficient) level for the amount of flights we should take. We just don’t know what the costs are, so we can’t say what the net benefit is. When costs are so difficult, or actually impossible, to measure, then what do we do? The market has failed, not that there’s much of an alternative.

I’m not even sure if this means economics is a waste of time, or if it just gives a limit to our potential knowledge, or what. All I do know is, that when some rabid free-marketeer rants on about the power of markets, they’re probably full of shite.smiley - smiley


PS, I've no idea who'll read this, it's more to get my thoughts down on smiley - erm paper than anything else, but please post something if you've got something to say.smiley - ok

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Latest reply: Aug 22, 2008


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