During my 15 years of working as a financial arbitrage trader in Chicago and London, more often than not I found myself glued to the trading desk when lunchtime rolled around. Our runner, Jack, knew all of my favorite sandwich shops.
One day, on his recommendation, I agreed to try the Jo-jo Special, a new sandwich from a local Italian deli. The Jo-jo Special consisted of fresh mozzarella cheese, prosciutto, fresh basil, tomatoes, olive oil, and balsamic vinegar on a crusty Italian grinder. Yum! This solidified my longstanding love affair with good quality prosciutto, my favorite piece of pork.
Prosciutto is a difficult meat to prepare for consumption. It is an extremely tough cut of pork, and as such, requires a top-notch professional meat slicer to generate slivers sufficiently thin to enable the connoisseur to savor this Mediterranean delicacy. Try using a butter knife on a whole side of prosciutto and see how far you get.
The image of a butter knife and prosciutto came to mind this week as I was reading an economic commentary which carried a familiar theme: “we need to get back to the principles of freedom our founding fathers intended, instead of this highly regulated governmental overreach.”
We discussed two weeks ago that freedom is not a very helpful tool for making economic decisions. Freedom is an imprecise ruler. It is nigh unto impossible to compare two options and determine which one yields a net gain of freedom.
As a homegrown example, each and every year Red’s Eats in Wiscasset creates a remarkably tedious and frustrating traffic jam during the busy tourist months. If local or state government were to force the roadside eatery to relocate to a quiet side street, proprietor Debbie Cronk would justifiably feel that her freedom had floundered.
As an offset to this loss of freedom, many scores of thousands of motorists would find their own freedom to use Route 1 enhanced. What would be the net result of this? You might be inclined to say that the net freedom would favor moving Red’s Eats. But keep in mind that what is good for the goose is good for the gander.
If Red’s Eats must move, so it must be for each of us. If we have businesses which disrupt others, we also must relocate. Now how does the net freedom work out? Quite honestly, I don’t know, and I am highly skeptical of anyone who believes they have the “correct” answer. Freedom is simply a nonstarter for economists. It is the butter-knife solution to cutting prosciutto.
How then would an economist approach the issue of Red’s Eats? The answer is “efficiency.” Efficiency is a concept central to the thinking of economists. If it is not the most important tool we ever use, it is most certainly the first and foremost gadget we grab when a policy choice is proposed.
The economic concept of efficiency is a method of thinking which can take a great deal of time and effort to fully digest. As a starting point, economic efficiency can be increased if one can take the same ingredients, and generate more of something by employing the ingredients in a different way.
Let’s reconsider the Red’s Eats situation from the point of view of efficiency. The traffic logjam imposes a cost on each driver (and passenger) who is subjected to the slowdown. Economists call this type of cost a “negative externality.” Red’s Eats, as a byproduct of its production, creates an externality similar to a factory that pollutes the air.
When multiplied across scores of thousands of individuals, the cost in time, additional fuel consumption, and carbon emissions is staggering. Compare this to the modest additional income Red’s Eats enjoys from the location at the side of the Sheepscot River. These costs do not line up.
Economists employ a market-based thought experiment to determine whether a more efficient outcome might be possible. Imagine that an E-Z Pass-type technology were available that could take from each driver an amount of money that driver would be willing to pay in order to breeze through Wiscasset sans traffic. Would the total amount collected in a season be sufficient to bribe Red’s Eats to relocate? If the answer is “yes,” our current situation is inefficient. If “no,” leave well enough alone.
In other words, economists theorize that each driver can hypothetically put a price on his or her time, gas, emissions, and so forth. The owner of Red’s Eats is also presumed to have a price at which she would willingly move the business to a side street. If the perceived cost to the motorist exceeds the “bribe,” then the current situation is inefficient.
I invite the reader to do his or her own rough, best-guess calculation to see whether he or she believes an economic inefficiency exists on Route 1. I am satisfied that indeed we have been suffering a huge inefficiency for decades.
As an addendum, economic Nobel laureate Robert Coase demonstrated that in the case of a negative externality, the same efficient outcome will be realized (albeit with a different distribution of wealth) regardless of who holds the property rights. In our Red’s Eats example, we have implicitly assumed that Red’s Eats holds the property rights to the location, i.e., Red’s Eats has the right to generate a traffic jam. We have presumed that an imaginary toll would generate enough money to induce Cronk to move.
Now consider the situation from the other perspective. Imagine that the motorists hold the rights to the traffic flow. Imagine that we had an E-Z Pass-type technology that would put into each driver’s bank account enough cash to induce him or her to sit in the traffic jam. Could Red’s Eats come up with enough revenue to pay that reverse-toll tab? I think not.
Thus, whether we assign the road rights to the drivers or to Red’s Eats, either way we come up with the efficient outcome of a move on the part of Red’s Eats.
By the way, I mention this neither to stir up controversy nor to advocate for a bypass. As I sat through the Wiscasset traffic on my way to Boston this past week, I realized that this might be a good way to introduce the notion of economic efficiency. As I crawled through the “prettiest little village in Maine,” I wished that I had had a Jo-jo Special to munch on and share with my wife, who is also a fan.
Next week, we will begin to examine the clash which exists between efficiency and another economic goal we seem to cherish.
(Marcus Hutchins is a former economist, treasury-bond arbitrage trader, and hedge fund manager. He retired to Southport in 1997, where he resides with his wife, Andrea, and youngest daughter, Abbey. He welcomes feedback at coastaleconomist@me.com.)
