Change the Incentive Structure

By Sean Carroll | December 13, 2007 11:46 am

Via Climate 411, through the intermediaries of Matthew Yglesias and Bradford Plumer, here’s a dramatic example of the government driving innovation — the number of patents granted for sulfur-dioxide control technologies per year, with major air-quality legislation marked.

sulfur-patents.JPG

The graph is originally from this paper (pdf) by Margaret Taylor, Edward Rubin, and David Hounshell. It illustrates a crucial point that both liberals and conservatives should be able to come together behind: the engines of free-market creativity can be brought to bear on global problems whose costs are all in the externalities. But it doesn’t just happen, if the short-term profitable course of action in the absence of massive government intervention is to keep despoiling the commons. Rather than legislating specific responses to complicated problems, change the incentive structure so that (for example) not polluting is more directly profitable than polluting. Right now, it’s much cheaper to drag oil out of the ground and belch greenhouse gases into the atmosphere than to think hard about alternatives. It’s far past time that we put our fingers on the scales to reward the hard thinking.

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  • Ryan

    I think this is a great idea Sean. However, it seems wishful thinking to assume conservatives would back this. The government would have to intervene in the free market to cause profit to come to those who reduce pollution. The free market ‘fundamentalists’ (i.e. the conservatives) would definitely say such an intervention is not a good idea.

  • SnarkFest

    Indeed. I know such a free market fundamentalist, who would much rather point out that “the climate has been changing since the Big Bang” [*] and deny that human activity has anything to do with it, than admit that the “Greenies'” concerns and proposed responses have some legitimacy. I gather that he is more interested in the market opportunities presented by massive population displacements and a warming Arctic (more oil and gas exploration!) than in doing anything to prevent these things from happening.

    It also seems that such people are generally convinced of what they take to be liberal hypocrisy, ie, that liberals use fossil fuels, have 401(k)s, etc, and therefore don’t really want to do anything to upset the free market gravy train. In other words, when push comes to shove, they can be bought off.

    Of course, all this free market activity involves borrowing money, eg, for the working capital most businesses need. Thanks to recent free market activities, this is becoming more difficult, a trend that promises to accelerate.

    ———————————
    [* I assume he meant the Earth’s climate. I was too polite to point out to him that the Earth wasn’t around for the first 9 billion years or so after the Big Bang—a mere quibble, after all.]

  • spyder

    This is not unlike what John Bogle has been saying for a while. As he sees it, the most significant problem with “pomo” capitalism is its tunnel vision on immediate short-term profit returns w/ very large compensation packages for managers (for whom special tax breaks and rates have been carved into legislation). Failing to look at the long run of a company’s assets and values (rather than just the bottom line profit) is, as he says, a failure of the boards to protect their shareholders. A good board would insist that management account for five, ten, fifteen years down the road. Today, five years is four years longer than most companies exist in their contemporary forms (divest this or that unit, buy and sell these pieces, etc.). The rush by the FCC to restructure access to what they euphemistically call “consolidation” (more accurately the need to allow further monopolization within cities and regions because the economy is tanking so badly), evidences this process. Buy it, get it, use it up, sell what is left of value, rake in enormous total compensation, and move on to another town.

    The massive subsidizing of corn to be converted into ethanol is destroying ecosystems all across this nation. The hybrid GMO corn that is planted for this purpose is not conducive to the environments in which most of it is grown. Draining aquifers to grow it is bad policy in the long run (and even in the short run in those regions experiencing horrendous droughts), but that hasn’t stopped greedy agribusiness from leasing massive amounts of farmland and marginal lands to grow it. These “subsidies” are representative of the incentives that must be restructured and changed, much sooner than most would imagine.

  • http://wintershaven.net Jacob Wintersmith

    I’d just like to point out that politically, “pro-business” and “pro-free-market” are (unfortunately) two quite different things. This self-described libertarian free-market fundamentalist thinks that using government regulation to internalize external costs is often a good idea. And I fully agree with Sean that doing so is always a better approach than having the state try to legislate a specific solution to a problem.

    Politicians are almost always “pro-business”, rather than “pro-free-market”. They enact idiotic things like corn ethanol subsidies, which are great for certain politically well-connected businesses, but sucky for everyone else. Farm subsidies and tariffs are prime examples of anti-market policies. The sane, effective, market-based approach to global warming is to institute a carbon tax or a cap-and-trade scheme. But throwing other people’s money at key constituencies wins votes, while pushing up gas prices does not. Hence the screwed up situation we find ourselves in.

  • tacitus

    You also need government to set a level playing field upon which businesses can compete fairly with one another. There have been any number of CEOs who have expressed a willingness to adopt stricter pollution controls and cleaner technology except that if they did so unilaterally, their company would no longer be competitive with those that refused to curb their polluting ways.

    There are some things that libertarian free-market fundamentalism cannot accomplish on its own or would delay for so long that they would be far too late to do any good. A partnership or responsible businesses with responsible government (who are, let’s not forget, supposed to be working for us) is the best solution to the problem of global warming.

  • http://orgprepdaily.wordpress.com milkshake

    I am sceptic about the man-made contribution to global warming but burning oil is such an incredible waste – one can use it to manufacture incomparably more valuable stuff. But there was no incentive for not burning it when the price was kept at $10 per barrel.

    Just few % of lacking supply is enough to bring out the real value of such irreplacable raw material as the market participants hold an auction on who will go without.

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  • onymous

    I am sceptic an ignorant denialist about the man-made contribution to global warming

    Fixed that for you, milkshake.

  • http://orgprepdaily.wordpress.com milkshake

    To make the matters worse, I also don’t recycle and I give nothing to the charities. And certainly Al Gore deserves the Nobel Price in the same sense as Arafat did.

  • Jason M. Hendler

    Ugh, is there anything more torturous than listening to liberals and scientists, who both get their funding through government, PAC and trust fund grants, pontificate on how capitalism does or should work? I guess you guys are hurting for work, and hope some government mandate comes along to line your pockets.

    A123, Nanosolar, Tesla Motors and countless other enterprises have sprung up to serve “green” market needs without any government mandate at all. You needn’t drive up the prices of fossil fuels to force consumers to alternatives. All you need to do is allow alternatives to be provided by private enterprises – specifically, many, many more hydro-electric dams, nuclear plants, river / ocean current turbines, wind turbines, solar panels, etc., but granolas and their greedy lawyers keep interferring.

    Fortunately for the auto industry, the UAW realized that if any CAFE standard increases were passed, the US automakers would be immediately driven out of the small car market, and eventually shut down altogether, so they renegotiated their contracts, to allow a green light to Dems to pass their increases. For once, Dems consulted an industry before making any moves, yet their alcohol fuel policies will devastate the poor through food price increases.

  • Mark B.

    Ugh. Is there anything more torturous than listening to self-righteous “free”-marketeers, who clearly did not read the fine article, construct ad hominem attacks?

  • http://tyrannogenius.blogspot.com Neil B.

    Speaking of the incentive provided by patentability/protection against infringement: Does anyone have opinions on the likely effect (or what has already happened) resulting from the recent SCOTUS decision KSR v. Teleflex diminishing the effectiveness of technical patents (I’ve put it roughly, you can find more) on their worth? For example, I am involved with a company’s efforts to get either licensing (preferred) or sell (last resort!) a patent regarding smart card operations. (If you need or care, it is USPTO number 6,609,655) Is it now likely effectively worth less (for either purpose) now due to that ruling? BTW how easy is it to sell a patent, and who is a good buyer if you have a clue. Thanks.

    Good dish at http://en.wikipedia.org/wiki/KSR_v._Teleflex.

  • http://backreaction.blogspot.com/ B

    The ‘invisible hand’ on the free market alone is no guarantee the system evolves towards what the society considers the best. To begin with, one needs to assure the market is actually ‘free’. But besides this there are factors that a priori have no monetary value and need to be included through politics. Call it ‘incentives’. Monetarism needs democracy for optimization to work properly. This implies a voice in the democratic system should not depend on the person’s wealth. Consumer democracy is the anti-thesis of democracy, it’s the biggest irony of western ‘civilization’ that people believe it works. Think variational principle, money is one dimension in a multi-dimensional plane.

    Goes for science as well. The number of publications is pretty much one-dimensional.

    Incentives?

  • http://tyrannogenius.blogspot.com Neil B.

    Bee, thanks for dropping by here again. You made a good point, and here’s more to support suspicion of not merely the efficacy, but the very existence in principle of “the free market”: it isn’t really free as a *background* entity anyway, even aside from specific, “overt” regulatory action! Just one example, look at how the money supply (at least in the USA) works: We have a fiat money based on monetization of debt, not a hard currency. That means that some authority (here, the Federal Reserve) has to decide whether to grow or shrink the money supply, raising and lowering interest rates etc. That has all kinds of effects on employment, ease of doing business, etc – that just can’t be made a neutral background to “letting it be.” Indeed, there is some evidence that the Fed even interferes for political results – many find some of Greenspan’s rate changes not rationally explicable unless you suspect he was trying to make the economy change in short term ways that made Bush et al more electable (in 2004 AFAIK.)
    (BTW, I don’t think that’s what you meant by “monetarism” which is the idea that money supply is the critical factor in the economy – I suspect you meant consumerism or market capitalism, did you?)

    As for patents etc: The government’s decision to have intellectual property protected for n years and not n’ years instead is of course somewhat arbitrary, as also how strongly to enforce and define “originality” (see my previous post.) That certainly affects how well you can do business, and it can’t be left to “the market” because enforcing encroachment is precisely what governments are for.

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  • Jason M. Hendler

    Regarding patents, it really is going to come down to companies that perform operationally most effectively, and not what patents they have. The companies that can move tech from the bench to the store shelf will prevail, period. Anything short of that is hype, the value of which is deflating more and more.

  • D

    I know the article does not make this implication, but it should be pointed out that an increase of the number of granted patents does not necessarily imply that innovation will follow. There are plenty of patents, which have been granted, for which nothing ‘good’ ever followed. So yes, incentives…and perhaps innovation (probably likely as money drives us all), but not necessarily.

  • http://backreaction.blogspot.com/ B

    Hi Neil B:

    Thanks. Yeah, sorry, I guess I didn’t use the word monetarism how you define it. I don’t think though ‘capitalism’ is the correct word either, since its an economical model, whereas I was referring to a governmental tool. Sorry if that is confusing, what I mean is that ‘capitalism’ which is a form of economy increasingly infiltrates politics, which is extremely bad since politics is supposed to be the tool to balance capitalism. Maybe it’s ‘consumerism’ what I mean, should consult an encyclopedia.

    And yes, I like your remark about the ‘free marketplace’. In a certain way, relying on the existence of a free marketplace is similar to working in a fixed background. What we consider ‘free’ depends on the market itself and will change over time (dynamically…), so maybe we should drop the fixed laws and allow for some background independence 😉

    Best,

    B.

  • http://lablemminglounge.blogspot.com Lab Lemming

    Dear Sean,
    What happens if you normalize this graph to the total number of patents filed each year, to account for innovation inflation?

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About Sean Carroll

Sean Carroll is a Senior Research Associate in the Department of Physics at the California Institute of Technology. His research interests include theoretical aspects of cosmology, field theory, and gravitation. His most recent book is The Particle at the End of the Universe, about the Large Hadron Collider and the search for the Higgs boson. Here are some of his favorite blog posts, home page, and email: carroll [at] cosmicvariance.com .

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