Socially wasteful?

As a long-time debate aficionado, it seems to become rarer and rarer that I come across a debate that I haven’t heard yet and makes me think. I came across such a debate between Steve Landsburg and Don Boudreaux about socially wasteful spending.

It goes something like this:

Company A has a product that produces value for society, let’s say $100. Company B faces a decision to make a competing product that is slightly better and would add marginally to the overall value for society, let’s say $10. So, Company B’s product would produce value of $110.

Company B faces an incentive to invest more than the marginal improvement in societal value, $10 in this case, because it can also attract Company A’s customers.

So, maybe Company B invests $50 to produce $10 more in value for society, because it can attract the some or all of the $100 of value already served by Company A’s product.

On net, society is worse off because a $50 investment has been made to produce $10 of value, for a net loss of $40. Landsburg says the $50 is socially wasteful spending, though he admits that the simple example doesn’t capture all the complexities of the real world, like the possibility that the $50 investment accidentally produces more than $50 of value.

But, I think his main point is that this incentive to make socially wasteful investments is, perhaps, one weakness in the normal feedbacks of capitalism.

I’m having a hard time fitting the real world onto the simple example, where there is uncertainty, risk, prudence, competition, different value propositions for different people and such.

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4 thoughts on “Socially wasteful?

  1. I think Landsburg is making a false argument.

    First, it’s true that capitalism is destructive of wealth. Any time resources are employed less than optimally, value is destroyed. Innovation destroys old wealth almost axiomatically. A simple example, that puts the falsehood to Picketty’s claim of r>g, is Bill Gates used to be worth 136B, now it’s 76B. Now this is not entirely due to the fluctuating valuations of his Microsoft stake, but 60B of invested wealth was destroyed.

    However, if this destruction was happening more than wealth creation, if it was net destructive, over time society would become poorer. Clearly that’s not the case in our society, but we can think of examples and hypotheticals where it would be.

    It seems to me that much wealth destruction of this kind is more a culling of less productive wealth to make room for new innovations.

    Now your example paints an interesting picture of inefficient markets and irrationality. But that’s a little bit of the reality of markets, human decision making, innovation, and imperfect allocation of resources. The problem with the argument is it opens the door to outside interference by those who think they know better. It can be used to justify protectionist policies, price-fixing, and other manner of gross distortions that are worse than the ill they are trying to cure.

    So, how about we accept that wealth, even overall societal wealth, is destroyed all the time in markets. But, the reason markets work is that they reward producing a net positive. Innovation, growth, optimization, efficiency, and cooperative value enhancement are uniquely rewarded by market mechanisms resulting in more wealth and higher standard of living for all of us.

    The other part of Landsburg’s argument about the “race to the bottom” is just another way of discussing comparative advantage. Of course, the example in the link seemed to show net benefit (overall increase in total wealth) no matter how the accounting was done. This is what we’d expect from a comparative advantage situation.

    Of course, it also helps that we’ve developed incredible sources of energy that have magnified human productivity immensely over the last 150 years. But that’s another topic.

    • Interesting, Adam.

      I agree with this: “The problem with the argument is it opens the door to outside interference by those who think they know better.”

    • I also think that such interference is a danger to the potential of a ‘net positive’ because it would restrict trials that may result in accidental innovations. Landsburg did acknowledge this potential.

      • Agreed. Among the problems with bureaucracy is it fosters a “zero defect” mentality. We need mistakes, lots of them.

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