View source for Living in a Second-Best World

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[[Category:Jodie Allen]]
[[Category:Theory Of The Second Best]]
[[Category:Deregulation]]
[[Category:Economics 101]]
[[Category:Assuming Theory Applies To A Real World Example]]
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{{DES | des = An introduction to why [[deregulation]] and competition may not create their intended benefits, due to the [[Theory Of The Second Best]]. | show=}}
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{{List|title=Living in a Second-Best World|links=true}}
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We disgruntled telephone and airline users are victims of a theory that doesn't apply.

By Jodie T. Allen
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Attention, all shoppers! A marvelous new marketplace is opening its doors. Soon, thanks to the next great wave of deregulation due to arrive in neighborhoods across the nation, you will be able to haggle over your electricity rates. What's that you say? You are not thrilled at the prospect of a new bunch of utility companies calling you at dinner time to offer you their special one-time-only package of cut-rate prices for customers who turn on their air conditioning only after 8 p.m., never run the clothes dryer except between 10 a.m. and noon, and use only fluorescent bulbs?

Are you worried, perhaps, that, when most of your neighbors are buying their kilowatts from elsewhere, your local utility will no longer gladly send crews to restore your power in an ice storm? Or that competing electricity producers won't invest in cleaner generators--or that they will switch to the cheapest and dirtiest coal they can find? Or that average prices won't really fall after they've paid for all the new executives and middlemen and advertising copywriters and telemarketers they will need in order to compete?
If you're suffering such qualms, you're probably the sort of person who doesn't appreciate the ample benefits telephone and airline deregulation have brought.

You're someone who still thinks it wouldn't be such an awful thing to have a single phone company reaching from coast to coast, because it means you need only one phone card to call anywhere in the country, who would willingly relinquish exciting new features such as dialing 11 extra digits in order to protect yourself against "surprise charges" by "no name" telephone companies (a fun service my local carrier recently introduced). You would just as soon avoid all those arguments about being "slammed" for charges by a phone company you didn't choose or being "crammed" for special services you didn't order.
You're also probably one of those people who needs to make flight reservations at the last moment, who has better things to do than search the Internet for bargain rates, and hates feeling the person next to you paid only half as much for a ticket. You long for leg room and semi-edible meals in coach class. You remember when confirmed reservations meant the airline would a) hold your seat and b) feel obliged to find you a substitute--on another carrier if necessary--if, for some reason, your flight didn't take off.

In other words, you're someone like me. What's the matter with us? Surely we know, from both economic theory and concrete example, that open competition is the best assurance of consumer satisfaction. Companies shielded from market pressures by monopoly position or government intervention grow fat, lazy, and indifferent to their customers. Why are we so dubious about the benefits that freely competing telephone companies and airlines shower upon us?
Well, partly it's because the world keeps offering us more and more choices--except the choice of lengthening the day. We've already got our hands full doing our jobs and caring for our families and shopping for the everyday things of life in malls and catalogs and now the Internet. We are not wrong to suspect that many of the corporate efficiency gains the economists extol come at the (usually uncounted) expense of our own time and convenience. When airlines overbook to minimize the chance they might fly with empty seats, the value of the hours we waste doesn't get counted in their costs. Unless it cuts our own employer's productivity--which in hard-to-track ways it may well do--it doesn't even get subtracted from the GDP. Ditto the time we spend trying to figure out whom to call when our phone is out of order. In other words, these companies are improving their bottom lines by shifting costs from measurable cash to immeasurable hassle.

What's more, there are theoretical as well as practical reasons why deregulation may not always produce net gains. That's because, for much of our day, we live in the world of the second best.
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P opular economists don't like to talk much about the world of the second best because it's such a messy place. It inhabits those sectors of the economy where one or more requirements of purely competitive markets--many suppliers, a relatively homogeneous product, easy access for new companies to the market, enough information for consumers to make the best buys--cannot be met to a substantial degree.

Sometimes the operative constraint is physical--you can't build airports just any old place. Or entry costs are so high that no one will pay them unless guaranteed a return, at least initially--as when cable TV was new. Sometimes it arises from the nature of the enterprise--you wouldn't want to have to have dozens of different telephone lines in your house just so you could connect with all the different phone companies your friends might select. Sometimes it's because there are nonmarket goods involved--the high value people place on personal safety, national security, a clean environment, or social welfare. Sometimes the products being sold--such as sophisticated medical care--really are too complex for anyone but a specialist to understand fully.
Of course, no markets are really perfect in this imperfect world, and you want to be careful not to let suppliers exaggerate the constraints to buttress an unwarranted case for de facto or legislated monopoly. But second-best situations abound, and here's the upsetting thing that economic theory tells us about them: In the world of the second best it is not guaranteed that a move toward eliminating the market imperfections will make the market more efficient. In such a situation, for example, cutting regulations and increasing competition might make consumers better off--or it might make them worse off. There are no guarantees.

This, of course, is not a very satisfactory state of affairs for theoretical economists--or, for that matter, policy-makers or speech writers. It means that instead of blandly assuming less regulation is better than more or more competition is better than less, you have to study the specifics of each case very carefully. And you have to keep experimenting with alterations and examining the results as external conditions change over time. And this can be very tiresome for everyone involved.

So I can't tell you if deregulating utilities will necessarily lead to lower-cost, more efficient electricity service. Or whether the recent move to consolidation among the regional companies created in the federal breakup of AT&T will make telephone service better or worse. But, a priori, neither can anyone else.
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