The Economics of Industry Regulation or Breakfast in Bed

 

Every mother knows the sweet joy of having your children treat you to breakfast in bed.  Whether it is your birthday, Mother's Day or some other occasion, there is that morning when your kids come giggling into the bedroom with a dangerously balanced tray of food ready for your praise and consumption.  The eggs and pancakes may not be up to standard, but the affection surpasses all understanding. 

Then you go into the kitchen and see the debris field of spills, mess and mistakes that have been left behind.  That kitchen is going to take considerable time and effort to be made right.  But you and your family have shared a special time and that makes the mess worth the moment. 

In economics we call this a cost/benefit analysis.   

There are some people who want our relationship with industry to be like that of an indulgent parent and carefree child.  Those people have rarely had to clean up a mess, which means it has no value to them.  We can see this in other things as well.

Suppose there is a power plant that gets water from a local river to provide cooling for its steam turbines.  The power is then sold to the community for $0.10/kilowatt hour.  That price represents a sweet spot where the cost of electricity produced, and the cost consumers are willing to pay meets.  Everybody thinks they are happy.

Upriver from the power plant is a lumber mill.  They take raw lumber and turn it into boards.  This sells for $7/board foot.  At this price they can pay their bills and make enough profit to keep in business.  Everybody thinks they are happy. 

But what about that messy kitchen?

If the lumber company is allowed to dump their slurry into the river, without any cost attached, it keeps the cost at a $7 low and people think it is a good deal.  But that mess travels down river and the power company must put in special filters to clean the water before it is useful in their cooling towers.  That special equipment cost the company money, which is reflected in a higher price for its electricity.  The people who buy the electricity at that price do not include those who won’t pay $0.10/kilowatt hour but would buy it at $0.08/kilowatt hour.  For example, a plant that manufactures small kitchen appliances.  It operates on a slim margin and needs to watch energy costs, which are a daily expense.  Therefore, they locate their new facility in a place with lower electric costs. 

Even if the owner of the lumber mill wants to clean up his mess, he can’t add that expense to the cost of his product and stay in business.  That $7/board feet does not include the people who would not buy his lumber at $8/board feet.  That clean lumber mill would lose business to all the dirty lumber mills, despite “doing the right thing.”

The answer to this problem is making all lumber mills clean up their mess.  That is called regulation.  You don’t do it to be socially conscious; economics is an amoral science.  It deals in mathematical facts.  You do it so the price accurately reflects the cost of the product (both manufacture and the clean-up).  You do it so other products (like the power plant) don’t have to inflate their products to pay for someone else's problem.  You do it because it is economically correct. 

Some industries need regulation because what they do changes the price of other products, affecting everyone.  Let’s deal with those industries intelligently.  As to the messy kitchen after your kids make you breakfast in bed, clean it up with a smile.  Then make sure your children have regular kitchen chores as they get old enough.  Little chores for little kids, bigger chores for bigger kids.  Come to think of it, we could say the same for those industries. 

Learn a little economics and keep the faith.