A Buying Power Externality?

This is more in the nature of a bleg than a post.  I recently completed an abstract for a project I plan to work on this fall.  I’d love to hear any comments from interested readers.  My main idea is to try to build a law & economics more adequate to technology fields, but as you’ll see, I touch on a lot of topics on the way there.  It builds on some ideas presented at this talk, so if you liked that idea, you’ll love this one (I hope!)  More below the fold.More...

The Buying Power Externality:
Toward Legal Economic Acknowledgment of the
Diminishing Marginal Utility of Money
Frank Pasquale

Economics is becoming increasingly relevant as it models competition and value-creation in specific realms of human experience. Just as the fields of chemistry, biology, and physics arose from “natural philosophy,” today the fields of information economics, labor economics, behavioral economics, and health economics are developing in response to shortcomings in conventional microeconomic theory. Two of the most important new challenges to conventional microeconomic theory are a) a growing recognition of the degree to which individual consumption decisions influence others’ capacity to consume and produce and b) the development of hermeneutical economics based less on quantification and measurement than on sophisticated interpretations of the meaning of economic exchanges for those affected by them.

 

Each of these developments in microeconomics should inform a law & economics that takes inequality seriously.  Rapidly growing income and wealth inequality is the most important economic development of the past decade.  Yet mainstream law & economics persists in ignoring how different economic reality appears to those on the top and bottom of the distributional ladder.  Moreover, bland indifference to the distribution of wealth in a given society obscures the ways in which excess consumption can deplete resources generally.  This is particularly true in the energy and housing sectors, where real scarcity often creates zero-sum games, and in the health and technology fields, where artificial scarcity (created by licensing restrictions and intellectual property laws) can generate similar auction dynamics.
In the field of natural resources, inelastic demand for gasoline among the wealthiest may exacerbate extant energy shortages.  Compare the following situations:

A) Large luxury vehicles leave in their wake sticky particles that make all standard vehicles have to “work” much harder to travel (say the particles require as much effort to get past as, say, a 10% uphill grade in the road). The average driver of the cheaper vehicles has to buy twice as much gas in order to travel the same distance.
B) A luxury vehicle consumes five times as much gas as standard vehicles. The price of gas doubles due to the popularity of such vehicles.

Economists would have no problem identifying the particles in A) as an externality. But why not the extraordinary demand in B)? In both cases the drivers of standard vehicles are paying twice as much for gas because of the actions of the luxury car drivers (ceteris paribus).  A classical response would be: the extra demand just shifts the demand curve out, and eventually suppliers will respond by bringing more fuel to market. But in the short and medium term, supply is relatively fixed: refineries are difficult to build, and oil exploration is a notoriously slow process. If their buying power is very high, the luxury car drivers will not be sensitive to the “signals to conserve” the market is sending via high prices, and may instead force those signals to become ever “louder” to those lacking their buying power.  As food and fuel become increasingly interchangeable (alternative fuels like ethanol are often made of grains), Lester Brown’s worry about our “starving the people to feed the cars” becomes compelling.


 The same “buying power” externality can occur wherever inelastic supply prevails.  For example, in previous work on “boutique medicine,” I have examined how new patterns of health care financing can lead U.S. doctors to dump 50-75% of the patients at their practice, thereby focusing attention on the remaining clients (whose “retainers” more than make up for loss of revenue due to the culling).  The Canadian Supreme Court’s recent Chaouilli decision took a major step toward enshrining such a business model as constitutional right in that country.  In the intellectual property field, stronger legal protections and digital rights management systems can enable “high-margin, low-volume” business practices.  In a world of relatively equal incomes, producers are more likely to aim at a price that maximizes the prevalence of their product.  As incomes diverge, it makes more sense to aim one’s production at the “top.” 


Having characterized “information overload” as an externality of copyrighted expression in prior work, I propose to model the negative effects of increasing income inequality as a “buying power externality” in this chapter.  Awareness of such effects brings richness and complexity to a legal-economic discussion too frequently oblivious to the diminishing marginal utility of money.  We cannot adequately account for the effects of excess fuel consumption by the relatively wealthy without understanding how a bidding up of prices affects the relatively poor.  The costs and benefits of a developing class of “courtier-doctors” can’t be calculated absent an acknowledgment of the medical services effectively denied by this diversion of human resources. 

Of course, mainstream economists may retort that any accounting of a “buying power externality” is chimerical, insisting that whatever cannot be measured cannot be counted.  Both empirical and hermeneutic economic research programs provide responsive solutions.  Empirically, we can measure the costs taken on by low-income consumers when they are displaced by richer ones.  When a tycoon converts a 15-apartment building into his own personal residence, the ejected tenants’ moving costs, search costs, and additional transportation needs are easily quantified.  Yet even in cases where such measurement is not so easily achieved, a hermeneutic law and economics may make a great contribution to our understanding of the ultimate effects of the legal system on human welfare.  The cost of inequality cannot be assessed without a deeper understanding of the social meaning of increased buying power when its accruer uses it to outbid others for a fixed supply of resources.

As we better understand those costs, we can start to develop better law and policy for the “inelastic resources” mentioned above.  Transportation, housing, health care, and intellectual property are pervasively regulated fields, and perhaps “inequality impact statements” should accompany rulemaking in them (just as “envirnomental impact statements” now govern projects with a major impact on the natural world).  Compliance schemes based on “ability-to-pay” may also play a constructive role.  The buying power externality should become an important feature of any legal economic effort to respond to growing inequality and the diminishing marginal utility of money that it accentuates.