Sebastien Gay

This is the English transcript of Dr. Sebastien Gay’s interview with BFM, Business&FM newspaper and Business FM radio.

1. The efforts to overcome crisis in all countries where economies have suffered from the global developments involve two major principles - increasing role of the state in strategic industries and large-scale financial support. What are the long-term risks of such approaches?

There are several long-term risks associated with adopting a government-driven strategy to address the emergencies in strategic industries.  Most concerning is the incentive structure that is established by such an approach; those large companies that struggle in a weak economy will attempt to hold the country hostage by claiming their necessity.  As the responsibility for business mistakes shifts from big companies to the government, the companies’ management teams will be more willing to take greater risks because they will not bear the costs if they fail.  It is also important to point out that the term “strategic industries” is a judgment-based term, where “strategic” is based on whether the industry is a significant player in the economy.  If government takes a greater role in those industries it considers “strategic” it is, in essence, selecting the winners and losers of the economy and denying the market its role in making that choice.  Greater government involvement in strategic industries can also discourage innovation and entrepreneurship, encourage more mergers and acquisitions, and dissuade private investment, particularly in small companies.

Large-scale financial support by the government also bears similar long-term risks; however, the increase in financial support brings an additional factor to consider.  For now, the government is supporting its increased spending by printing money (a short-term solution) and borrowing from growing nations like China.  International relations may be seriously impacted by the shifting dynamic between the United States as a debtor and other international players as its lenders.

2. Bad assets represent a key problem that has led to the freezing of the markets. How would you assess the idea to create special banks to accumulate such assets, the so-called “bad banks”. What should be the proportion between public and private capital in such banks? And what could be the mechanism to raise private capital for this purpose?

The “bad bank” concept is a good idea so long as the government is able to resell the bundled bad assets on Wall Street.  The government should have 100% capital in the bad banks in the beginning.  The government can issue bonds to raise capital for the new banks.  The mechanism to raise private capital for this purpose is the securities market. The first issue to unpack is the idea of the “bad assets.”  These assets, particularly sub-prime mortgages, were always high-risk assets.  The reason they were high risk was because (1) the sub-prime mortgage industry was very fragile and (2) there was a chance that significant amounts of money could be made by securitizing them as mortgage-backed securities.  Some market players who refrained from selling off the assets on the stock market profited off the short-run fees, but should reasonably have been aware that the long-run result was collapse.  What has changed from then until now is the lack of uncertainty; before, there was a chance – however small – that the risky assets could succeed on the stock market and there were investors willing to buy and resell them quickly.  In order to restore investor confidence in these so-called “bad assets,” there must be increased uncertainty (i.e. the possibility of positive yields) injected into the securities market.  The market player in the best position to do so is the government.  The government should work on the other side of the market to make sure there is less certainty about foreclosures so that a positive risk-analysis is put back in the securities market.  Whoever grabs the bad assets at their cheapest can potentially make a huge gain.  In the long run, however, the problem remains that such markets for risky mortgage-backed securities and other similarly risky assets exist at all.  The so-called “bad banks” should be temporary to allow such securities to eventually disappear and greater regulation over such industries must be implemented.  There should be no newly created sub-prime mortgage-backed securities, and the existing ones will expire at the final payment of the corresponding loans.  Moreover, loan regulations must be put in place to prevent dishonest loan practices from occurring as freely as they have in the past.

3. Are there any dangers in expanding the consumer credit stimulation program, Term Asset-Backed-Securities Loan Facility (TALF)?

The purpose of TALF is to increase the availability of credit to small businesses and consumers.  There are many benefits of such a program; namely, it can restore consumer confidence, stave off increasing unemployment, and clean up banks’ balance sheets.  Of course, it fails to resolve other pressing concerns.  First, there is no guarantee that banks will offer new loans under the program.  The brief experience with TARP suggests that banks do not want to use the money provided by the government for the intended purpose of loosening the credit market. Second, the program is only delaying what could be a more dangerous problem down the road if the newly-acquired loans fail, which adds greater burden to the government in the long run.

4. During the last years, there has been much discussion that America “lives beyond means”, that the “world finances the American economy”, etc. If we put aside politics, the new stimulus package to be passed by the Congress requires more than $800 billion. It means the public borrowing will rise. What could be the sources of further borrowing for the administration, particularly - internal or external?

There are not many options available on the borrowing front.  The government can issue bonds to raise capital and will certainly borrow heavily from international players, particularly China.  It is not a good situation for the US economy.  The most the government can hope for is earning tax revenue from new or growing industries in the future.

Find the original interview at: http://www.bfm.ru/news/2009/02/20/sebastien-gay.html

The latest government stimulus plan is another disappointing addition to the collection of recent stimulus packages mistakenly trying to fight fire with fire.  The logic of Congress and the White House seems to be that the economy will be revived by giving people more money to spend. Government officials – from Obama to Pelosi – caution us on the importance of regaining confidence to restore the economy.  How quickly they forget what brought the economy to its knees!  We are in this crisis because Americans’ expectations of spending are too high.  We gambled on credit card debt and convinced ourselves to buy houses we could not reasonably afford.  We had too much faith in our government to watch over us, and too much faith that our nation’s companies were playing fair.  I do not claim that the White House or Congress has bad intentions, but sometimes the best of intentions can turn into a nightmare.   The cynicism Americans are feeling toward big company players like AIG and toward Congress and the White House is a good thing.  We are responsible for vigilant oversight of them, too.  Developing a practice of bailouts lessens the expected cost of financial failure – both personal and corporate – which can create dangerous risk analyses down the road.  Furthermore, in the long run, the stimulus package can itself become a part of the problem, as we will sustain the bad habits of over-spending.

Instead of reinforcing bad habits, a perhaps good (albeit painful) solution to the economic crisis is to let Americans go through the pain to set lower spending expectations.  We need to let people go through hard times in terms of lowered consumption (not lowered health, of course) to bring reality to the economy.  The economy will then be built on reasonable expectations, and we will be more prepared for the next inevitable recession.  A good way to accomplish these needed long-term goals while also ensuring that basic necessities are given to struggling Americans is to give people a small, monthly rebate check of $50 or $100 over the next two years.  A small rebate will allow Americans add a little money in the economy without overspending and creating a spending bubble.  My proposed solution is not an electroshock to the economy, but rather a supervised slow recovery process.  In addition, “short-term responsibility” legislation should be put in place to limit financially over-extended individuals and over-leveraged companies from pursuing new lines of credit and leveraging.  People and companies over the limit should be required to report to financial advisers on a monthly basis to verify that they are making sound decisions (Think about it as a parole officer for credit).

Achieving a reasonable level of consumption and returning to full responsibility for our debts will help us return to the optimal level of consumption.   Let’s all acknowledge the elephant in the room.  We cannot return to the kind of spending we once mistakenly enjoyed.

Call them customers of size (like Southwest) or passengers with a high body mass (like Air France), but one thing is for certain:  As airline passengers become larger, they are taking up more space on planes.  Traveling is uncomfortable enough as it is with consistent delays, lost luggage, and – most recently in Seattle – accidental gassing of passengers, without having to deal with the awkwardness of other passengers encroaching into seat space they did not purchase.  Of course, there is no need to blame only obese passengers; passengers wearing giant coats and passengers who have extremely broad shoulders, to name a couple, are also encroachers.  Most airlines keep quiet about their internal policies for addressing encroaching passengers, but a few are upfront about their procedures.  Air France, for example, lists the width of the aisles and onboard seating, stating tersely, “If your waist measurement exceeds this, you must reserve an additional seat.”  Southwest avoids the measurement standard, instead relying on the simple rule:  If you cannot lower your armrests, you need to purchase an additional seat.  JetBlue uses a different test:  “People who are unable to sit in the seat in the full upright position with the seat belt fastened” may not be allowed to fly at all.  Airlines that require large passengers to purchase an additional seat do not actually require the passengers to pay fully for it.  Air France offers a 25% discount to their high body mass passengers when they purchase two seats.  Southwest refunds the additional seat at the end of the trip.

At first glance, the policies established by the airlines may seem to resolve the problem, but anyone who has traveled knows that there are plenty of passengers who pass the tests described above but still take up extra space.  Your neighbor’s hips push into your seat a couple inches and you have to squeeze yourself into the opposite side of your seat to avoid the unwanted physical contact.  Moreover, as our nation becomes increasingly more politically correct, you might feel a lingering guilt about reacting strongly against the contact.  You look around at the other passengers as you lean heavily away from your large neighbor, and worry that they are thinking:  How rude of him to treat his neighbor as if being fat is somehow contagious!  Poor thing, she probably has a glandular problem. From the perspective of the large passenger, she may feel very uncomfortable knowing that she is taking up your space, but she cannot do anything about it…right?

Wrong.  What happens when someone trespasses on your property?  You can call the police and file a lawsuit for the resulting damage.  What happens when someone steps into your personal space at work?  You are legally protected to confront the person and can seek support from human resources.  It is inconsistent to fail in providing airline passengers similar recourse when another person infringes on their right to enjoy a full seat.  People who use public transportation might respond to such an argument by reporting the many uncomfortable experiences they have had on the subway or in a city bus.  There is an important difference between public transportation and airline travel:  As an airline passenger, you are paying for the rental rights to a specific seat on a specific plane.  Sure, on Southwest you have choice of your seat, but ultimately you have purchased a seat.  As a public transportation passenger, you are paying for the option to ride on a specific bus or train.  If one bus is packed, the choice is yours to push on in or wait for the next one to arrive.

Unlike public transportation passengers, when an airline passenger purchases a plane ticket, she is paying for two primary things:  the transportation from her point of departure to her arrival destination, and the quality of the transportation.  The quality of transportation varies, depending on whether she purchases a coach, business, or first class ticket.  The airline may offer snacks or individual television sets to improve its quality; however, the single-most significant component of the transportation quality is the airplane seat.  Airplane passengers are, essentially, extremely short-term tenants who rent the space in which they sit for the duration of the flight.  They do not just rent the seat itself; they rent an invisible box that includes the empty space from the seat to the ceiling and from the seat to the floor.  The armrests are divided in half, meaning that window- and aisle-seat passengers have one and a half armrests, whereas middle-seat passengers only have access to one arm rest (the sum of each half of an armrest they can access on either side).  If we visualize this abstract box, we can draw cubic inches that compose it.  When a passenger purchases a ticket, she is buying all of those cubic inches that compose her personal box.  The value of the cubic inches is calculated by the difference of the price of the ticket and the value of transportation.  For example, if a passenger purchases a ticket from San Francisco to New York City for $500 and the value of transportation is $250, then the value of her transportation quality, in sum, is $250.

Let’s assume away the value of snacks, drinks, and the tiny televisions that hardly work (their value is minimal), and assume that a passenger buys the rental rights to 100 cubic inches when she purchases a plane ticket.  That means that each cubic inch is worth $2.50 to her – not to the airline.  The airlines do not need to have these passengers buy an additional seat; rather, they need to facilitate transactions between passengers so that the encroaching passenger compensates her neighbor for the extent of encroachment.  The practical concerns can be easily resolved.  All the airlines need to do is include extendable rulers so that passengers can estimate the extent of the encroachment and address the transaction.  Worried that your new, giant hat will get crushed in the storage bins?  Looks like 5 cubic inches of encroachment.  Pay up the $12.50 to your neighbor.  The naysayers who will criticize the idea for its practicality problems or undoubted disputes that will arise should be reminded that we already go through a great deal of largely impractical airport practices:  We take off our shoes, we pay extra for our luggage, and we make airport restaurants filthy rich from all the food we buy over delays.  One more moment of awkwardness and one more swipe of the credit card will have a minor, marginal impact on the challenges of traveling today.

Last week England decided against switching from informed consent to presumed consent for organ donations because a committee of experts felt it would not significantly raise donations.  In informed consent countries, agents are only donors when deceased if they registered to do so while alive. Conversely, in presumed consent countries, everybody is a potential donor once deceased. Therefore people need to register if they do (respectively do not) want to donate their body in informed (respectively presumed) consent countries.

While some studies found that there is a positive effect of presumed consent on organ donations, it is difficult to actually make the leap of faith that a change of legislation would increase donations.  The problem of presumed consent countries, such as France and Portugal, is that they rely on the fact that a deceased person is a donor by default.  Hence, in case people die and did not express any preference over organ donation, the next of kin that survives her has the choice between giving the organs and preventing the organs from being harvested.  Given that the family ends up making the final choice, the informed consent system might lead to more organ donations.  Spain is often regarded as an example of successful presumed consent country.  But their success is driven by the presence of organ coordinators that are trained to identify potential transplant organs and to talk to the families about the process of donation.

For England, the solution to the problem of organ donations requires a more dynamic approach involving more than new legislation, such as harnessing market forces and involving members of the community.  For starters, markets could potentially eliminate organ shortages and significantly reduce health care costs (see Becker and Elias, 2006, Introducing Incentives in the Market for Live and Cadaveric Organ Donations).  A market for buying and selling organs would result in the existence of an equilibrium price for living and cadaveric donors.  It would also decrease medical costs:  Today, the cost of kidney dialysis is about $44,000 per year.   The cost of kidney transplant and medical care for the first year is about $90,000.   After the first year, medical treatments, mostly for immunosuppressant drugs to prevent rejection are $16,000. That means after about two and a half years transplants save the medical system $27,000 per year as opposed to patients remaining on long term dialysis.

Secondly, the success of organ donation programs in England  depend primarily on people understanding what   the complete set of benefits:  England is now making the right first step by starting a $9 million public awareness campaign to raise donations.  But in order to stay on the right track, the English government should favor the creation of organ coordinators to produce a steady and permanent increase in organ donations.  Responsibility of people and the existence of a registry that collects people’s preferences on organ donations (yes or no) and not only one side of the question (for example, saying non donor if you are in a presumed consent country) would lead to a much needed donation spike.

The bailout of the Big Three U.S. car companies – General Motors, Ford, and Chrysler – cannot be expected to receive the same public support as did the last bailout.  People rely on a secure financial system to engage in transactions and maintain employment.  Even if they did not understand the underpinnings of the collapse, they appreciated the necessity of intervention.   The Big Three are quite different, however, because they supply non-necessary goods, given the availability of alternative transportation. If Congress bails out individual, goods-supplying firms, people reasonably may feel that Congress might as well launch its own “American Idol” television show to find the next struggling industry to bail out.  Furthermore, it is difficult to imagine that a bailout is the solution per se to the automobile companies. At best, the bailout will help them stay afloat for the next five to ten years; but, if they do not change their strategies, it will be money wasted. Americans are beginning to voice their frustration that the Big Three have been stuck in their ways for years and needed to change their strategic focus toward building products in high demand, like ecologically-friendly cars, to prevent this disaster.  In light of this developing general opinion, the bailout will very likely have a severely negative public relations impact on American consumers.  One compelling argument for Congress’s bailout of the Big Three is that it will prevent the fall of one of the significant symbols of American soft power. Professor Joseph Nye defines soft power as a nation’s ability to influence others through its ideas, culture, and way of life. The automobile industry represents a pillar of the American soft power. If the Big Three were to disappear, part of the visible U.S. culture around the world would follow suit. While it is an initially attractive argument, that line of reasoning leaves no end in sight for future bailouts.

The alternative proposal to the bailout is to force the Big Three to declare bankruptcy, similar to what K-Mart did in 2002.  Those in favor of the alternative praise the benefits of refinancing and the capitalistic cultural of survival-of-the-fittest.  Bankruptcy is a more viable solution than the bailout because it does not involve as much public money and gives the companies much-needed time to restructure themselves.  In addition, it allows the companies to renegotiate their contracts and, perhaps, regain some strength in the market.  There are compelling concerns, however, that refinancing will not be a realistic option for the automobile companies, given the current financial crisis.  Furthermore, opponents argue, there are too many American workers employed directly or indirectly by the Big Three to permit the risk of collapse.

The current framing of the automobile industry problem — bailout or bankruptcy — leaves out a third approach that largely avoids the concerns voiced over the first two options.  As stressful as the automobile crisis is, it is not a new problem to international markets.  Take Renault, a French car company, for example.  Instead of pleading for government aid when it faced collapse in the late 1990s, Renault fostered an alliance with the Asian car company, Nissan.  During that time, the world market for automobiles was witnessing its worst recession in 20 years, but Japanese competitors had a major cost advantage compared to Renault. Despite its financial mess, Renault had the significant advantage of major brand recognition in Europe. Together, Renault and Nissan focused on complementary markets (Renault in Europe, Nissan in the U.S and Asia), shared research and development efforts to more efficiently improve their cars, and in the long run decreased their costs through streamlining European car production. Since then, Renault Nissan has been very successful. Importantly, Renault managed to keep its brand alive as uniquely French. The success of this alliance is that Renault remained in business as a symbol of the French automobile.

There is ample evidence that Asian automobile firms are interested in acquiring the Big Three. In 2006, Renault-Nissan approached General Motors to create an alliance similar to the relationship they had developed in the 1990s. But it was quickly turned down by General Motors. In 2000, Mitsubishi and Daimler Chrysler tried to develop an alliance, but it failed due to both firms’ individual financial difficulties.  The Big Three no longer have the luxury of resisting foreign alliances without a coherent explanation to the American people.  By offering only two options of bailout or bankruptcy, the Big Three and Congress are misleading the American public into believing that successful compromises could not be achieved.  If the Big Three want to stay in business with the long-lasting support of the American people, they need to explain why they refuse to develop international alliances.

The Emergency Economic Stabilization Act of 2008, more commonly referred to as the “bailout plan,” has caused significant debate, suspicion, and anger among the American people.  As giant companies cried out for help in the face of imminent collapse, Congress wrote a $700 billion check ostensibly to rescue the economy from the alleged devastation that would otherwise have occurred.  The economy, however, continues to struggle.  The New York Times reports today that unemployment in the United States has reached a 14-year high, rising to 6.5 percent.  The stock market continues to bounce uncontrollably, which does nothing to help restore consumer confidence.  It has been widely reported that the bailout money is not being used to restore the economy, but rather, for executive bonuses.  Time magazine reported that executives of those firms receiving bailout funds can expect to earn bonuses worth about “15 times the income of the average American household.”  The American people, watching prices rise, job opportunities fall, and their retirement funds slip away, are asking themselves what went wrong.

One of the main arguments in favor of the bailout package was that the collapse of some companies, notably AIG, would have too much of a negative impact on the economy.  American citizens were cautioned that the economy would crumble if these companies weren’t propped up.  Perhaps that is true.  The question, however, is: Why were these companies allowed to become so singularly powerful in our economy? If a company has too much power in its own market, the government intervenes through antitrust law to rein it back from excessive power.  There is a vital, relevant market that appears to have been neglected by the antitrust movement:  The Public Market.

The United States government is familiar with protecting Americans from unfair and corrupt business practices, largely through antitrust law.  Antitrust law, initiated by the Sherman Act in 1890, protects American consumers and competitive firms from the harm that arises out of anti-competitive activities, such as price fixing, cartels, and predatory pricing.  The Act was supplemented by the 1914 Clayton Antitrust Act, which granted the government the authority to intervene earlier to prevent such illegal behavior. The spirit of the Sherman and Clayton Acts is rooted in the fact that consumers are often coerced into paying higher prices and competitive firms generally struggle to stay in business when monopolies exist.  The Antitrust Division of the U.S. Attorney General’s Office and the Federal Trade Commission (FTC) are responsible for monitoring signs and symptoms of anti-competition in the market.  One of the ways in which the Attorney General and the FTC have measured unfair business practices since 1985 is through a market share analysis:  If a company has too high a percentage of the relevant market, the Department of Justice is responsible for investigating its excessive power and punishing the company for it.

It is time for the United States government to enact similar legislation with its eye towards the Public Market, which we shall define as any market with significant public involvement.  Significant public involvement can be established in the following ways:  (1) significant financial investment by individuals, (2) significant repercussions to individual financial investment in the event of collapse, and/or (3) significant ties to other firms that have significant investment by individuals.  Significance should be understood as an unreasonably risky level.  The legislature should establish a threshold, past which significant public involvement is deemed unacceptable and must be hedged in.  If and when the FTC and Attorney General report significant public involvement, the accused firm must post bond to insure the public against any negative repercussions as it corrects itself.  An index, similar to the one used in antitrust law, must be established as a function of significant public involvement.  The index will be a function of the firm’s aggregate public involvement as a fraction of United States Gross Domestic Product.  The bond required for those firms with significant public involvement will be a function of each firm’s involvement.  The bonds will only be reimbursed if the firm reduces its public involvement without damage to the economy.  Through such legislature, the United States government would achieve both short-term and long-term goals necessary to revitalize the economy:

(1) Improve consumer confidence;

(2) Increase transparency;

(3) Increase firm responsibility for harming consumers; and

(4) Minimize the need for a similar bailout in the future.

Of course, there is some responsibility on the part of consumers for the economic crisis in which we find ourselves.  To minimize the future risk of poor individual credit decisions, we recommend Credit Licenses, similar to drivers’ licenses:  If a consumer wants a loan or a credit card, she must take a class and, later, a government-administered exam to demonstrate her competence at making significant financial decisions.  In particular, each consumer must be able to comprehend the details of any consumer credit agreement and must be able to calculate the financial effect of revolving credit.  If the consumer credit agreements are excessively complicated such that a consumer with a high school diploma cannot comprehend them, the government must enact regulation to improve transparency.

Financial analysts, politicians, and reporters have described the current crisis in such a complicated, complex fashion that American consumers may understandably feel disempowered.  It is important to remember, however, that the complexity of an industry must not protect it from inquisition.  Consider the case of the physician:  If a physician makes a mistake on a patient – no matter how technical or complex the procedure – he may be sued for malpractice and may pay damages.  In the case of the current economic crisis, there were, simply put, traders and analysts lacking the competency and wisdom to understand the repercussions of their mistakes.  When the economy was doing well, those mistakes were accepted or ignored.  But when the economy began to slip, the lacking abilities turned devastating.  The financial institutions have a responsibility to their shareholders and consumers to make appropriate staffing decisions.  At the end of the day, regardless of whether the financial institutions could accurately predict the damage they would cause the economy, economists and lawyers will be prepared to estimate the damages now.

This article was written by Dr. Sebastien Gay and Nadia Nasser-Ghodsi.  Nadia is a 2011 J.D. Candidate at the University of Chicago Law School.

Growing vegetables and fruits for fun, often called “agritainment”, has become a new leisure for rich Americans.  Overwhelmed with frantic city life and chaotic schedules, many professionals now turn to the peace and quiet of a farm for relief.  With the failing economy and the housing market plunge, there is an undeniable pleasure to see that we can still accomplish something, even if it is as simple as growing a perfect, bright red tomato.  In the wake of this trend, some people have taken the idea of agritainment beyond leisure and turned it into a lifestyle called “permaculture” with a mission to save the planet.  According to the co-founder of the so-called permaculture movement, “People and nature are both preserved and enhanced by thoughtful planning, the careful use of resources, mimicking the patterns found in nature (bio-mimicry) and a respectful approach to life.” (http://www.midwestpermaculture.com).  Permaculture communities, called transition towns, have sprouted across the country, providing a haven to those who want to live among environmentally-aware neighbors.  The name “transition town” is based on the idea that society must transition into a post-petroleum era.  The residents of the towns are coming together to prepare for the drastic, fundamental change they anticipate will jolt our global community.

It is understandable that permaculture followers may be attracted to the opportunity to have a stronger voice in support of the environment in their small community than they would if, say, they lived in Chicago or New York City.  They may appreciate seeing their friends and neighbors treat the environment with respect rather than watch garbage pile up on the streets of downtown San Francisco.  Furthermore, the anxiety rooted in the impending transition we face into a post-petroleum era is widespread and expected.

However noble the spirit of permaculture might be and however understandable their frustrations are with the current state of the environment, the question remains:  Are these communities effective?  In answering this question, a few factors need to be considered:  First, let’s recall the simple fact that the Earth itself is a limited resource.  Isolating oneself from the billions of people also sharing it does not mean he or she is suddenly living on a healthier planet.  Second, the development of environmentally-conscientious energy resources will be driven by demand for them.  If all the environmentally-conscientious people isolate themselves from domestic and global markets, the remaining aggregate voice will be less environmentally-conscientious for having lost them.  In the long run, if permaculture followers isolate themselves from the rest of us, they might actually contribute to a less healthy planet than had they stayed engaged.

I think that the “transition town” residents need to consider the driving economic forces behind oil in order to succeed in their endeavor:  Oil is a limited resource, which means that eventually we were going to run out of it.  As the remaining amounts of oil deplete, the price of it will continue to get higher and higher over time.  If we demand alternative forms of energy, inventors and scientists will, in theory, develop an energy source (or multiple energy sources) that is cheaper than the rising price of oil.  Therefore, in theory, oil should be replaced with a different source of energy before it is entirely eliminated.  I hope that calms those of you who are panicked about the depletion of oil.  The next order of business is to consider the extent to which our next energy source is environmentally-conscientious.  Whether or not we use environmentally-conscientious energy as our next energy source is based on a simple concept:  incentives.  The depletion of oil has provided the incentive for companies, inventors, and scientists to find a new source of energy.  The government can provide incentives for environmentally-conscientious energy sources with tax breaks or other rewards for new ideas.  Vitally important, however, are the incentives that consumers bring to the market.  We called for organic food products?  They now stock the aisles of the grocery stores.  We demanded hybrid cars?  You have plenty to choose from these days.  Do we want an environmentally-conscientious energy source to replace oil?  Then we need to establish the demand.  If permaculture followers disappear, the demand will be weakened because of them.

Too many people do not recycle.  It is not particularly difficult to put aside the paper or cardboard boxes in one bag, the cans in another one, and the rest of the waste in the trash can.  So why do people decide not to recycle?

The reason, I believe, is that they are not given enough incentives to do so.  Of course, we all want a healthy planet for our children’s children to inherit, but the fact remains that the results of our small recycling acts as individuals are hard to see.  Even if I diligently recycle for years, I will not notice a tangible effect on the atmosphere.  Given this problem, we need to use additional motivators beyond our love for Mother Nature to protect the environment.  For example, when the price of gasoline increases, drivers turn to public transportation more often.  When the price of organic food declines, shoppers are more inclined to buy these environmentally-friendly products.  Similar ideas can be applied to recycling to make a positive impact on the environment.

In simplest terms, when people do not recycle, they put recyclable products (milk cartons, newspapers) in the trash where they do not belong.  Most of us are guilty of participating in this overproduction of trash and, in doing so, are creating a market failure.  A market failure means that there currently exists an allocation of resources, in this case, trash, on the market is not socially optimal:  Real trash should be in the trash can; recyclable items should be in the recycling bin, but we lump them together and, in doing so, create much more trash than necessary.

To resolve the trash market failure, I offer two possible solutions:  (1) a trash (non-recycling) tax or (2) a trash (non-recycling) system of permits.  A trash tax would be put on those people who decide not to recycle.  For example, each city could start picking up only one bag of trash per household each week.  Recycling bins would be available free-of-charge for residents to put their recyclable items.  Extra trash bags would be available at a cost (this cost represents the tax).

Another solution is to create a set of “trash permits” that people would receive from the city.  Every household would be given a set amount of trash bags per month (based on the number of people in the household).  These official bags would be the only ones picked up by the waste management company.  People could then trade between each other to try to find the best allocation of trash bags they would need for a given week.  It would create a socially-efficient allocation of trash and recycling.

A small town in Massachusetts, Hamilton, has already implemented a plan similar to the trash tax I recommended.  On March 12, 2008, the residents of Hamilton implemented a plan under which they are allowed one bag of trash per household each week. Additional bags of trash must be put in a “town bag” for a price of $1.75 per 32-gallon bag; however, recycling bins are free and unlimited.  According to the Hamilton-Wenham Recycling Committee that advocated for the new plan, studies of similar programs in Massachusetts and across the United States demonstrate trash reductions between 25 and 45% in the first year.  Though it is too soon to release the first year results in Hamilton, when residents drive through the town these days, they can see more recycling bins at the end of driveways than trash cans.  Hamilton residents have told me stories about children being scolded by their parents for putting recyclable items in the trash.  A little less than $2 might sound like a small tax, but it is already having an effect.

It may be frustrating to realize (or embarrassing to admit) that people appear to be more driven by small taxes on trash bags than they are by an inherent respect and appreciation for our planet.  It is important, however, to remember that it can be discouraging for one person who puts effort into recycling to watch her neighbors, local businesses, and even local government neglect to do so.  Through the types of plans I outlined above, we can correct for trash market failures by aligning incentives to recycle.

Dr. Brian Wansink, well-known author of Mindless Eating, published an article on the effects of low-fat labeling on eating habits (“Can ‘Low-Fat’ Nutrition Labels Lead to Obesity?” Journal of Marketing Research, November 2006).  He argues that low-fat labeling increases consumption because the labels (1) suggest to us that the products have lower calorie density; (2) influence us to imagine that the serving sizes are larger than those of regular products; and (3) make us feel less guilty about eating the “low-fat” products.  The main source of support for his argument is a study conducted at a university open house in which incoming students and their families were invited to sample either regular or “low-fat” M&Ms (both samples were, in fact, regular M&Ms).  Dr. Wansink and his team measured how many M&Ms were consumed and how many calories the participants thought they consumed.  According to the results, participants who sampled the “low-fat” M&Ms consumed 28% more than those who ate the regular ones, suggesting that we over-consume “low-fat” labeled products.  The participants also grossly underestimated their calorie-intake by 48 percent; those participants who ate the “low-fat” M&Ms were worse at accurately measuring their consumption.

If we disregard the flaws in Dr. Wansink’s study (small sample size, self-reported weight, to name a couple), the results are quite troubling.  Are we really the clueless eating-machines that he makes us out to be?  I don’t think so.  Let’s consider an economic analysis of the eating choices available to Dr. Wansink’s participants who ate the “low-fat” M&Ms:  When consuming the “low-fat” M&Ms, the participants incurred a substitution effect by consuming a product that they believed had less fat density than the regular M&Ms.  When the participants realized the substitution, their guilt associated with eating the “low-fat” M&Ms decreased.  The decreased guilt led to increased consumption, otherwise known as a scale effect.  The decreased guilt also caused the “low-fat” M&M-eating participants to relax and, therefore, to pay less attention to their consumption levels.

A good way to understand the differing consumption levels of regular and “low-fat” M&Ms is to frame the participants as having lexicographic preferences.  A lexicographic preference structure means that, given a set of M&M characteristics (“low-fat”, calorie content, sugar content), the participants prefer them in an established order, where the first preference is preferred infinitely more than the second:  (1) “Low-Fat” (over regular), (2) Lower Calorie Content (over higher), and (3) Lower Sugar Content (over higher).   As long as the participants consider the decision to take “low-fat” over regular M&Ms as the first preference in their set, we can expect them to continue to consume excessive amounts of “low-fat” M&Ms.

Given the economic analysis above, the  solution to our over-consumption of “low-fat” products is simple:  We need to change the default M&M option from regular to “low-fat” if both options are available, thereby eliminating the first preference in our lexicographic preference set.  We are not irrational eaters, as Dr. Wansink describes us.  If we integrate healthier options into our preference structure, we can focus on the calorie content of our products and make better consumption choices.

Lee Andrew Macon, 49, and Jerome Jackson, 51, used to be next-door neighbors on a quiet street in Lauderdale Lakes, Florida.  They lived in modest pastel-shaded homes with well-groomed lawns out front.  Of course, like many neighbors, they had ongoing squabbles.  Macon and Jackson were known to often argue over the property lines on their adjoining lawn.  On the morning of February 7, 2008, Macon’s lawn service worker arrived to cut the grass.  Noticing the activity, Jackson came out of his house to argue over the contentious matter of property lines.  The argument got out of hand, and Macon pulled out a gun and shot at Jackson.  A brief skirmish ensued before Macon shot and killed his neighbor.

Had Jackson known his neighbor was dangerously unstable, he perhaps would have avoided their habitual heated arguments over the lawn.  Maybe Jackson saw hints of unreasonableness and instability in Macon, but clearly nothing that was sufficiently alarming to avoid their final fight.  It is unnerving to imagine that the people who live around us could be dangerous.  These are the same people who witness our daily actions:  when we pick up our morning paper, when we drive our children to school, when we come home from work each night.  We would like to imagine that the seemingly kind man next-door who waves when we head out for a walk is a mentally-sound person.  We hope that the parents of our children’s friends who live down the street are good people.  The hard and simple truth, unfortunately, is that we cannot know.  One neighbor could suddenly become violently angry over news of infidelity; another might become unstable over the loss of her job.   We just don’t know.

There is one piece of information, however, that we can know.  In 1994, the federal Jacob Wetterling Act mandated that states establish sex offender registries for law-enforcement use.  Two years later, Megan’s Law, a federal mandate, was passed to ensure that states provide public notification of local sex offenders to residents or “at risk” individuals.  Today, notification of sex offenders to local residents is available almost everywhere in the United States.  In addition, many states provide publicly accessible websites with information on each registered offender’s age, physical description, address, description of crime, and conviction date.

There has been much public debate over the effectiveness of notification of registered sex offenders.  Proponents of Megan’s Law argue that residents have a right to protect themselves and their children from dangerous neighbors.  Opponents counter that notification does little to help prevent crime; instead, it creates unnecessary anxiety and erects barriers between society and registered sex offenders who should be allowed back into the community.  According to some opponents, the isolation and harassment that some registered sex offenders experience increases the likelihood of repeat offenses.

Minimal empirical analysis has been conducted to test whether public notification helps prevent repeat offenses by registered offenders, or recidivism.  The available empirical analysis, however, suggests that the notification laws has no effect on preventing recidivism (Zevitz, 2006b; Welchans, 2005; Walker, Maddan, Vasquez, VanHouten, & Ervin-McLarty, 2005; Adkins, Huff, & Stageberg, 2000).  All these papers make a significant assumption that may be considered rather questionable:  The authors assume that accessibility of information is the same as information usage.  While pondering this point, ask yourself, “When was the last time I checked my local registry?”

The work by Tewksbury (2005) on registered sex offenders in Kentucky supports the criticism that variable information usage may be a problem.  He states, “The data here suggest that the registry may not be fulfilling its goal, as registrants with child victims are less likely to report most people in their lives knowing about their offenses and registration. Only 39.2% of registrants with child victims report that 90% or more of others in their lives know of their registration/offenses, compared with 59.6% of registrants without child victims…Evidently, registrants who have victimized children are more successful than other registered sexual offenders at hiding their status…” (Tewksbury 2005, p. 75).  If the information is publicly available on the Internet in Kentucky (http://kspsor.state.ky.us/), how do registered sex offenders who had child victims hide their status?  It would appear that residents may not be checking the registry.

From an economics standpoint, it is incumbent upon residents to review publicly available information on registered sex offenders in their area.  Given that the information on them is readily available, those registered sex offenders who are your neighborhood expect you to check.  They are aware of how easy it is to search their name in the online registry or to ask at the police station.  It is rational of registered sex offenders to interpret your behavior – friendliness, invitations over to your house, requests for babysitting – within the context of you knowing about their past.  Therefore, we must check.

Levenson, D’Amora, and Hern (2007) surveyed 239 registered sex offenders in Connecticut and Indiana to measure the impact of Megan’s Law on their lives.  One result stands out as rather shocking:  Only 20% of those surveyed agreed or strongly agreed that “I have less access to potential victims because neighbors keep children or others away.”  Perhaps, it is because we are not checking who are our neighbors.