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- [Alex] We've already looked at one solution to the externality problem,
Pigouvian taxes and subsidies.
You might call that the economist’s solution.
There's another solution, however, which is very common
and quite popular to the man in the street
and that's command and control.
That's what we're going to look at now.
Command and control is pretty much what it sounds like.
The government says, "You cannot do this or you must do this."
For example, the Department of Energy
in an effort to reduce the consumption of electricity,
recently said that it is illegal to sell washing machines in the United States
if they consume more than a certain amount of electricity.
The only washing machines that it was legal to sell
had to consume less than this amount of electricity.
So, what were the results of this command and control program?
Well, here's Consumer Reports:
"Not so long ago you could count on most washers
to get your clothes very clean.
Not anymore. What happened?
As of January 2007, the US Department of Energy
has required washers to use 21% less energy...
but our tests have found that traditional top-loaders--
those with the familiar center-post agitators--
are having a tough time wringing out those savings
without sacrificing cleaning ability..."
So the government said you have to use 21% less energy,
but if things were that easy everyone would do them.
There are trade-offs everywhere,
and by requiring the washing machines to use less energy,
the trade-off is they didn't clean so well.
Eventually, the technology has gotten better and will get better,
and perhaps, this will be possible.
But one of the problems with a command and control approach,
is that the government is not always aware of the trade-offs.
They're not always able to choose the least cost way of achieving a goal.
Let's take a closer look at this problem.
Command and control is rarely an efficient way of achieving a goal.
Why not?
Well, there many ways to achieve most goals.
For example, let's look at some of the ways in which we could use less electricity.
We could turn down our thermostat a little bit.
We could shut the lights off when we leave a room.
We could turn off our computers at night when we're not using them.
We could use more solar power.
Firms which use a lot of electricity
have many, many different ways to use less by adjusting their production processes.
Now if we want to cut back electricity consumption by, say, 10%,
we want to cut back on the 10% of electricity uses
which are least valuable.
We want to reduce electricity use in the way which is least costly.
The problem is, out of all of the millions,
and perhaps, billions of ways of reducing electricity,
is government going to choose to command and control us
to reduce electricity in the least cost way?
Probably not.
Government simply does not have enough information
to order the least costly method of reducing electricity consumption.
Now, let's compare our command and control
with an alternative method, a tax on electricity.
A tax on electricity would allow the users--
would give them flexibility--
to find the lowest cost ways to reduce their use of electricity.
If a tax of, let's say, a few percentage points
would reduce electricity consumption
by exactly the same amount as the command and control approach.
The difference is,
is that each one of us would look at the higher price of electricity
and would choose,
based upon our different circumstances and knowledge and flexibility,
which ways we could reduce electricity in the least cost.
Some of us would turn down lights, some of us would turn down thermostats,
some firms would change the production processes a lot,
others would change their production processes just a little bit.
Each one of us would access our own information,
and in this way with much, much, much greater flexibility,
we could reduce electricity consumption
by exactly the same amount as the command and control approach.
But we would do so at much lower cost
because each user of electricity
would have the flexibility to choose the least cost ways of doing it.
Think about it--
how many people would choose to reduce electricity
by paying a lot more for a washing machine that doesn't clean very well?
Probably not too many.
That illustrates that when government chose to reduce electricity consumption
by requiring washers to be "more efficient"
that actually wasn't the least-cost way of reducing electricity.
That was actually a very high-cost way of reducing electricity,
because it meant that we had dirty clothes and we really didn't want that.
Finally, let's remember that the goal is not actually to use less electricity.
The goal is to reduce pollution.
That's why a Pigouvian tax
is really one of the most efficient ways of reducing or controlling an externality,
because a Pigouvian tax is targeted on the problem--
the pollution.
So, the closer we can get the tax
to the good which is actually causing the problem--
which is not electricity but instead which is pollution--
the more efficient, the lower cost way we will have
of solving the externality problem, of reducing pollution at least cost.
Is command and control ever a good solution?
Yes, it can be precisely when flexibility is not a virtue.
So, if the best approach to the problem is well known--
we don't need experimentation and innovation and new ideas--
we know the best approach,
and if success requires very strong compliance--
that is when flexibility is not a good thing--
then command and control may be the best approach.
So for example, let's consider the eradication of smallpox.
Now, smallpox is a terrible disease.
It has killed more people in the history of the world,
billions of people, than, perhaps, anything else,
except, perhaps, old age.
To get rid of smallpox we had to isolate--
every single time there was a new case of smallpox--
we had to isolate the people with the smallpox
and vaccinate everyone in the surrounding community.
And the World Health Organization and other organizations
did this time and time again.
Wherever a case, anywhere in the world, of smallpox appeared,
we isolated and vaccinated.
And over time smallpox had fewer and fewer places to hide,
until by 1979, there were no places to hide left.
Smallpox had been eradicated from the face of the planet.
That was a tremendous boon to humanity,
but really the only way it could have been done
was command and control.
If we'd subsidized vaccinations, that would not have been enough,
because that inevitably would have led to small pockets of people
who were not immunized and they would've continued to be carriers
to spread it to other people in the world.
So, command and control got us very strong compliance
and it eradicated smallpox from the world--
and that was a tremendous thing.
Very briefly, let's just say where we've been and where we're going.
We've been looking at solutions to externality problems.
So far we've looked at two: Pigouvian taxes and Pigouvian subsidies--
Pigouvian taxes for external cost
and Pigouvian subsidies when there are external benefits--
and command and control.
The next thing we want to do is to look at the Coase theorem
and private solutions to externality problems.
It turns out that we've been a little bit too pessimistic.
There can be some market or private solutions
to externality problems in certain circumstances,
and that's covered by the Coase theorem.
The last thing we're going to do is look at tradable allowances.
These have been extremely important in practice in reducing acid rain,
and may become more important in the future
in dealing with global climate change.
Tradable allowances, as we'll see,
are a sort of combination of command and control,
and ideas from Ronald Coase--
and it actually turns out
to be quite similar to Pigouvian taxes and subsidies in the end as well.
So, that's where we're going--
Coase theorem and private solutions and then tradable allowances.
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