Tuesday, June 16, 2009

Ross: Why Government Should Have Regulatory Powers II

First Post Here. In it, I play the Devil's Advocate and argue some regulations are ex-ante forms of protection of property rights. Two examples I use are mandating liability auto insurance and not regulating against the construction of private nuclear reactors.

Matt provides a good response here.

My response to Justin Ross the Devil's Advocate (JRDA) of regulation is "with all the concern over property rights, you forgot the economics!" Let's start with the example of mandating auto liability insurance as a form of ex-ante property right enforcement. In a world without such a mandate, what are the incentives? What are the trade-offs?

Put yourselves in the shoes of just such a person, who understands that he may not be compensated for damage in collisions where the other party is at fault. Their incentive is…to voluntarily buy insurance against it. Compared to a world of mandatory liability insurance, we will have a greater amount of full coverage purchased. Now, you would implicitly be selling your possible future claim against the perpetrator to the insurance company in exchange for guaranteed compensation.

JRDA: "But wait, you haven't corrected the externality! Uninsured drivers are shifting their costs onto the more responsible drivers, incentivizing them to buy more insurance than they otherwise would."

Okay, but this is simply a transfer, is it not? Instead of him buying liability you are now buying protection, and this is only as true to the extent at which they would buy more protection insurance than they would in the mandated world. After all, the world where liability insurance is mandated does not ensure 100% compliance, so there will still be uninsured drivers incentivizing the more risk-averse drivers to buy protection insurance against them. All we have done by dropping the mandate is affect the perception of risk in exchange for the opportunity for everyone involved to choose their own risk-reward structure. As Matt pointed out, the mandated world changes the drivers who run the risk of large property damages to a certainty of some smaller property damage, coercing some in the process.

Now, the private nuclear reactor example.

In one sense this is easier to defuse on the grounds of reality (why would anyone ever do that?) but harder to do in principle. In reality, people build nuclear reactors for the benefit of others, which entail large fixed costs. The only way to recover that cost is to build a reactor that will operate safely and long enough for you to recover those costs. In principle though, what if someone wanted to build a private nuclear reactor? My imagination can only see this playing out in a handful of ways.

One of the observable consequences of a person building their own personal nuclear reactor would be a swift decrease in the value of property. If this did not happen, then it would be because nobody would have issues with private nuclear reactors and hence there would be no reason to regulate it. Most likely, it would decrease the value of property, significantly.

I think that it would most likely be viewed by the legal system as a form of coercion. What is your neighbor the reactor owner doing? He is discouraging others from trading (property) with you out of fear for their safety. If you discourage others from trading by encouraging them to trade with you via competition, there is no problem. If you discourage others from trading by threatening them with physical harm, it is coercion. That form of coercion is reserved for government use only, so due compensation or restraint is in order. The private owner could probably get those reduced if they submitted to providing some proof that they were being sufficiently safe.

Ultimately, the private nuclear reactor forces us to think carefully about what constitutes theft and violence toward property, i.e. that we clearly define property rights.

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