Efficiency and Friction

Psychologist Barry Schwartz has an OpEd in the NYT calling for more economic “friction” in our lives. It is certainly not completely stupid. Inserting friction into the foreign exchange markets was the original purpose of the Tobin tax. The goals was to reduce volatility and so give a more reasonable view of the relative values of each country’s currency and so facilitate trade.

And there are relatively few economists who would disagree with the need to regulate negative externalities although they may disagree about which markets have these externalities and how best to regulate them. The standard economic solution is with a Pigovian tax so that market players see the “correct” price of their actions. That’s why a carbon tax is probably the best way to reduce emission of carbon dioxide. If we each face the real cost of consuming carbon, we will only consume that amount which is optimal.

The straw man of the importance of efficiency that is set up by Professor Schwartz is a little over the top. Does he even know how a leveraged buyout works? Sucking the profits out of a company and saddling it with debt is not exactly a negative externality.  And he seems to ignore (or be ignorant of the fact) that while American companies continue to create value (with a few exceptions, GDP per capita has been growing fairly steadily since the end of WWII), the split between workers, executives, and shareholders has changed dramatically.

I’m also not clear on his proposed solution. Should we regulate how people feel about their house and how companies behave toward their communities? I really don’t understand how we would do that. On the other hand, if the negative externality is inequality itself, then a high marginal tax rate becomes a Pigovian tax (think we can get Mankiw to endorse the idea? I doubt it). If those at the top have less of an incentive to take as much as they can, maybe there will be more for those in the middle.

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