How rational choice makes some markets fail

The Tragedy of the Commons is a situation where players cooperate or everyone loses, yet each individual has incentive not to cooperate. Also known as the “Prisoner’s Dilemma,” here’s a sample Tragedy of the Commons: farmers graze their cows on a shared grassy area called the Commons. The Commons can support 100 cows. One hundred farmers each bring a cow, and the eatin’s good. But each farmer thinks, “If I bring one extra cow, it doubles my entire income and only puts a 1% drain on the Commons.” All 100 farmers think this, all bring one extra cow, and 200 cows quickly overgraze the Commons. It dies completely, and then, so do the cows, followed by the farmers.

Pollution fits this structure. The Commons is nature’s ability to absorb the pollution. The benefit of polluting to any one polluter is great–they save clean-up costs. But when every producer does this calculation, rivers and landscapes quickly become clogged with pollution.

Energy usage fits this structure. The Commons is energy. The benefit to living in a suburb and driving to work is huge–I get lots of land, a nice yard, and a big house, and pay relatively little for a car and gas. But when 350 million Americans all make this trade-off, we’re suddenly using 40% of the world’s oil driving prices up. We don’t know how this one plays out, yet, but it will be interesting, since our physical sprawl makes cars a survival necessity, not a choice, for almost everyone.

Advertising fits this structure. Any one advertiser can get great returns by sending you junk mail, putting ads on your favorite TV shows, and putting up billboards on your roads. When all advertisers do this, you get so overloaded with messages than now it takes 20 ad impressions for you to pick a product out of the crowd. So now all advertisers must advertise so much that they spend a fortune, and you get overloaded. I no longer even look at my paper mail, and I get around 6-10 pieces a day. A one-week trip brings me back to a stack of 60-100 items. It goes straight into the trash. So now, it’s not clear advertisers can reach me at all.

Littering fits this structure. Any one person finds it convenient to dump their trash on the ground, leaving it for someone else (mom?) to pick up. When everyone in a neighborhood does this, they end up living in a garbage heap. Eventually, no one even sees a point in using the trash can any more and the litter accelerates.

I also think social networking sites are a Tragedy of the Commons. I’m not yet completely sure, though. Time will tell.

The “Tragedy” Can Be Used for Good

The Tragedy works in reverse, too. There are times when no one person has incentive to do a good thing, yet a small contribution by every person adds up to a huge Good Thing. Consider building an interstate highway system. No one person could pay for it, and even if they could, they could never collect enough in revenue to maintain it and make it worthwhile. Yet building it brings great benefit to everyone. The neat thing is that if every person pays just a little bit, we collect enough in total to take on the project. That’s where taxes really shine as a financing device; they’re one of the few good ways to finance building shared resources. Everyone pays a relatively small amount, and we get services that give far more benefit.

Public schools are another example. It’s cheaper for us all to pay a little in taxes and end up with schools for everyone. (Yes, you can complain about the quality of our existing school system, but the quality problems have less to do with the funding and more to do with our model of education.)

Fire protection is another example. While typing this, I received a call from the Volunteer Fireman’s Committee asking for donations. It’s a scary request, as it implies I won’t get fire protection without paying. Yet I’m happy to pay for firemen through my taxes. That way, we all contribute, and we have a fire prevention infrastructure that benefits us all.

Managing the Tragedy is a Fundamental Role of Government

I believe Governments are the only players in our world who can manage the Tragedy of the Commons. Our markets are built on the assumption that each customer/supplier should be free to pursue their maximum self-interest. The Government introduces regulation, tariffs, etc. designed to spread the Commons risk among market players, so the market can function and produce what’s best for civilization overall.

Sadly, I don’t think politicians or voters consider this, so the mechanism fails. Regulation isn’t inherently good or bad; it’s simply the only way to avert certain Tragedies of the Commons. Taxes aren’t inherently good or bad (though many would like you to believe that for their own political agendas); they’re simply one way to raise funds for projects that would otherwise never happen due to Tragedies.

The Tragedy of the Commons explained

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