Why economics is not a morality tale

Among other things, morality is a bunch of heuristics that work pretty well -- often better than explicit calculation, given our limitations -- to produce outcomes that are better for all concerned. (Of course they don't always work.) One reason why the heuristics can work better than explicit calculation is that they take into account (albeit fuzzily and inaccurately) things that may get missed completely in our explicit calculations.

For instance: We tend to think of monopolies as morally bad. But that isn't just because they produce too little of their product and keep prices high. It's broader than that: the intuition is more that they have "too much power" and we don't trust their motives.

For instance: We tend to think of polluting firms as morally bad. But that isn't just because they produce too much of their product. In fact, it isn't at all because they produce too much of their product. If they could produce 10x more of the product without polluting more, that would be just fine. It's because they are doing something harmful -- and because their choice to do that might indicate that they'd be willing to do other harmful things too, if it increased their profits.

Put those two together. A polluting monopoly has too much power and too much willingness to do harmful things. That's a bad combination. Even if they do better than a polluting non-monopoly or a non-polluting monopoly at producing the optimal amount of their product.

For instance: You can change your level of pollution by other means than making more or less product: you can, for instance, change your manufacturing processes. A company that cares about its public image may pollute less in order to preserve that image. A company that demonstrably doesn't mind polluting, and that doesn't need to care about its image to keep its sales up, is unlikely to do that.

For instance: A company that doesn't care about harmful externalities, and that can afford to be inefficient because it has a monopoly, may be more willing to engage in other socially harmful behaviour: bribing politicians (more or less openly; in Western democracies one common way is to offer board seats or lucrative advisory positions to ex-politicians who have voted the "right" way), making products that are themselves harmful, reducing the quality of their product without lowering prices in order to take more profit, etc.

Economics is not a morality tale. But sometimes it is something worse.

The real life example here is electric utilities. The way they're regulated they charge a kWh price roughly equal to the average total cost (let’s say about 12 cents). The proper way to price would be at the marginal cost (at around 4 cents). The fact that marginal costs are below average total costs are what makes them a natural monopoly.

The somewhat obvious better solution would be to charge marginal cost for each kWh and then have some other method to collect the massive fixed costs. But for whatever historic reasons, we don't do that and most (all?) utilities price each kWh at about the average total cost. This means that as a society our quantity demanded kWh is way below where economic theory says it should be.

However, there is probably a fairly substantial pollution/CO2 externality to producing electricity. Without some analysis it isn't obvious whether we're producing too much electricity or too little.

I did try once to look at estimates of the size of the externality to see if it made up for the pricing way above marginal cost issue and the preliminary results were that the externality was smaller (meaning, global warming considered, we're still not using enough electricity). However, there were a couple of points I'd need to get into deeper.

• 1) The pricing above marginal cost issue is greatest for residential rates and smallest for industrial rates. I was looking at residential rates. Using the same cursory analysis on industrial rates would mean that we're over using electricity in industrial sectors.

• 2) The carbon externality number I used from the EPA seemed to be derived by figuring out how high the price of electricity would need to be to get usage down to the level they wanted. Under correctly priced utility rates (i.e., priced at the marginal costs), their analysis may have had a much higher $ / kWh externality number. But at the same time, I’m a little suspect of that method of calculating the externality as it would indicate if the cost of production halved it wouldn’t be optimal for society to produce more. So I’d need to do some more research to make sure I’m using good pollution/CO2 numbers.

I haven't seen this issue discussed by people like Mankiw when they talk about the Pigou Club and I think it probably should be. If there's interest I could probably write this up a bit more formally and make it a post.

Monopolies are bad because they can capture much more of the consumer surplus than they would otherwise, not just because they underproduce.

Economic theory isn't a morality tale because we use it for figuring out what different economic polices will result in, as opposed to whatever it is morality tales are for.

(morality and economics agree here)

I am sorry, which morality is that? I know of a whole bunch of different moralities with rather different views on many issues.

Soviet factories polluted far more while producing far less.

The formula isn't "Five units of pollution per unit of good produced" - that is, the amount of pollution produced is not dependent on the amount of goods produced. Your post assumes this is the case.

Additionally, "natural" monopolies (as opposed to government-instituted monopolies such as Bell) such as Standard Oil -didn't- underproduce. They can't afford to.

If a company is not paying the true cost of the pollution they produce, then they may well be selling their product cheaper than they otherwise would, and thereby selling more of it.

However the amount they sell isn't the thing causing a problem for society. It is just a symptom. In this case, you can't fix the root problem just by treating the symptom.

The problem is that the profits of the company are not correctly tied to the problems they cause, and they therefore have insufficient incentive to invest in ways of reducing the problems (by, for example, buying a different raw material that is slightly more expensive, but far less polluting).

Other factors causing them to reduce production or increase the price they charge customers won't get them to change their behaviour on which raw material they buy.

economics is not a morality tale

Yes it is with economic growth being the good guy and Adam Smith's invisible hand being his motivation.

The invisible hand causes firms that pollute to produce too much, but the invisible hand causes firms that are monopolists to produce too little. Put the two effects together and you get a happy ending.

Comparing China under Mao vs Deng Xiaoping most certainly constitutes an extremely illuminating morality tale.

For a second, much better reason why economics can't be a morality tale, see Elizabeth Anderson's recap of Hayek's argument:

In two of his important works of political economy, The Constitution of Liberty (see esp. ch. 6), and Law, Legislation, and Liberty (vol. 2), Hayek explained why free market prices cannot, and should not, track claims of individual moral desert.

Warning (in case you care): highly political.

I'm confused: Why are monopolies and firms which project more than zero negative externalities morally bad?

Pollution, and other negative externalities, cause firms to produce too much of their product.

...if you fail to account for corporate reputations and government regulation.

The equilibrium behaviour for monopolies is to produce too little of their product, to keep prices and profits high.

That's why real economeis typically feature a Monopolies and Mergers Commission, or similar organization.