Thursday, October 1, 2015

Once upon a time in the land of Machinea

Once upon a time in the land of Machinea there was a problem The economy was powered by machines produced by different factories and rented by producers. There were those machines that were distinguished by being a bit wider than their substitutes, the W’s. There were those that were distinguished by being a bit bigger than their substitutes, the B’s. And there was a third kind that was atypical, the A’s. Each kind of machine was produced by a number of factories. The largest number were the W’s, then the B’s then the A’s. The machines were difficult to construct and thus there was significant variation in their efficiency – by which is meant their productivity and reliability. Statistically speaking it known that an A was likely to be more efficient than a W or a B, and a W more efficient than a B. As a result, since all they knew about the machines was their type and average efficiency producers were reluctant to hire them at the same rate as the W’s. And since it was frowned upon (and in some place illegal) to pay a lower rent to a B than a W, the likelihood of a B being rented was significantly less than the of a W being rented. The problem that the policy makers wanted to solve was that the rate at which B’s were hired, rented, was too low for their liking. The B factories were struggling to survive.

The proffered solution was to strongly incentivize the machine renters to hire more B’s, that is, to hire more than they would have given their expectations of their efficiency. The reasoning underlying this solution is that the low productivity of the B’s is endogenous, it is a result their low rental earnings feeding back into the budgets of the B factories, which, then, in turn, struggle to produce efficient machines. By intervening in this way, a judicious public policy could break the vicious cycle producing self-sustaining B inferiority. So, they instituted a policy of mandatory affirmative B rental requirements. Each producer had to produce a report showing that his B-rentals were at or above the proportion of B-machines in the market.

Though it seemed like a good idea, albeit at the cost of some inefficiency imposed on the producers and their customers, there were unintended consequences. The managers in the B factories realizing that the likelihood of renting their machines was now higher, regardless of their efficiency, faced a reduced incentive to produced efficient machines, and the quality of the machines actually went down, even as they produced more machines. This raised the hiring mandate under the policy and further reduced the incentive for quality production. So, the policy was actually counter productive and accentuated the negative cycle of B inferiority. The B factories now became wholly dependent on the government to enforce the affirmative rental of their machines.

A minority of policy makers and advisors pondered alternative policies. Perhaps the initial problem lay in a structural defect in many, though not all, of the B factories. These defects were endemic and though not irremediable would require substantial changes in the incentives faced by the B-producers. They suggested policies that would allow B’s to compete by offering lower rental rates, and the scrapping of all policies that deterred the B-producers from making painful but necessary changes.

There were other more wide-ranging policy change suggestions like those that pertain to the inadequate training that B-producers received in their training schools, but these are beyond the scope of this brief. 

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