Picking the wrong pockets

A basic course in economics always starts with the four questions every economy must face, regardless of the economic system that prevails. These are: 1) what to produce, 2) how much to produce, 3) how to produce them, and 4) for whom. At one extreme, the task of answering these questions is entrusted to the government, based on the (often wrong) premise that it would know society’s needs best. This “command economy” approach was taken by the former Soviet Union, China and Cuba for many years, and, to this date, North Korea.

At the opposite extreme, a country could leave it entirely to the market system to answer these four questions by itself. Adam Smith called it the “invisible hand” of the price system, whereby the free interplay of supply and demand could answer these questions automatically. If society needs or prefers more of a good or a service relative to others, the higher demand would be manifested in a higher price, which would signal producers to provide it, and entice them to produce more of it (thereby answering the “what” and “how much” questions). If the economy has an abundance of labor relative to capital, the excess supply would keep wages down, which in turn encourages producers to choose more labor-using techniques than capital-intensive ones (how to produce). Those able to contribute more to production by providing more labor, skills, talent, or capital to produce what the consumers need or want also receive more income (for whom).

The Soviets, the Chinese and Cuba had long abandoned the command-economy route. Only North Korea persists in maintaining complete control, and the results have been disastrous. At the other end, no country had ever taken a full free-market approach—not even the United States, often considered the bastion of free-market capitalism. Nothing works perfectly, and neither does the market system. There’s such a thing as market failure, which is when government must play an important role to set things right. Thus, the rest of the world lets government intervene, while still relying largely on the price signals of the market to answer the four basic economic questions.

Our energy sector has traditionally been problematic because price signals had constantly been messed with. In the old days of oil industry regulation, the prices consumers paid for petroleum products reflected politicians’ choices rather than true market conditions. The Oil Price Stabilization Fund (OPSF) mechanism of the 1980s proved to be a misnomer because it only led to more drastic price changes when the politically set prices could no longer hold. Worse, the mechanism forced all taxpayers, whether or not they consumed oil products, to pay for the purchases of oil consumers, including those of rich and/or wasteful ones. This was because the OPSF had to be subsidized massively out of the government budget—the outcome of holding back oil price adjustments too long for political reasons. This is why I shudder every time someone calls for a return to oil industry regulation. Our persisting issues with the cost of electric power also come out of a history of price mismanagement in the electric power sector. Before privatization, the rates charged by the National Power Corporation reflected preferences of political leaders wishing to look good to voters, rather than the actual cost
of generating electricity. In the end, those voters, regardless of their power consumption, paid even more for Napocor’s huge deficits, compared to what direct power consumers could have paid in the first place. Ultimately, taxpayers were all forced to pay massively for purchases by power consumers, including (again) those by rich and/or wasteful ones.

I recently wrote of an important advantage of pursuing public-private partnerships over funding infrastructure with government loans (and ultimately, taxpayer money): The former makes actual users of the facility pay for its construction and upkeep. This is better than charging it to all taxpayers, including those who will never use the facility. These examples all illustrate cases that are tantamount to picking the wrong pockets to pay for someone else’s bills. Sound economic policymaking is about making sure that unless the common good calls for it, no one gets a free lunch.

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