In his post from Friday, Michael discusses Baumol’s thesis that some industries respond less to capital augmentation and high cost of labor than others do. He suggests as an example health care, which is very labor intensive and will most likely remain labor intensive because a significant part of the service itself is human interaction (unlike haircuts maybe).
Michael explains that because of the existence of such goods, he is not comfortable with the argument that high cost of labor, or high opportunity cost generally, provide a sufficient incentive for innovation. Michael’s main concern is not with health care, though, but instead with oil and specifically transportation fuel. Basically, the question is, what happens if the high opportunity cost of using oil are not sufficient to generate innovation that will lead us away from a dependence on oil? Oil is getting more expensive and it will most likely continue to get more expensive for the near future (note that this does not really have anything to do with capital augmentation). We have not yet come up with a good alternative transportation fuel, however, or for that matter with a good alternative substance to make plastic with (corn based plastics* excluded). Therefore, my interpretation of the implication is that we might need to intervene somehow (Note: this is not Michael’s claim!) to bring about innovation and the development of substitute energy sources.
So, here is my shot at a defense of the market advocates against intervention: I thought about it for a little bit but I could not think of an example of the destruction of a civilization that was caused by the high cost of a product or raw material. I might just be oblivious though, so I would very much appreciate any examples you know of. Most of the time, when a civilization declined, it is pretty easy to trace the causes of the decline back to political institutional factors, not the depletion of a resource (I am thinking Rome, the Dutch Republic, Ancient Venice …). That leads me to believe that market advocates might not be so wrong after all, when they argue that innovation in the market place is a function of increasing opportunity cost. We humans are great at finding substitutes for things because we are really entrepreneurial, especially in the face of high opportunity cost. So we will find an alternative transportation fuel and we will reduce our dependence on oil, because higher prices are a sufficient incentive for entrepreneurial innovation. And because we have always been able to do so in the past.
You might ask why we do not respond the same way to institutional failure, i.e. why do we not innovate and find a substitute for a political institution when it is set to ruin us? Well, Mises and Kirzner would probably say that it is because there are no price signals in politics. Without price signals, it is impossible to fully internalize the costs and benefits of any action. When you do not fully internalize the cost of your action, you are a lot less sensitive to the high cost consequences of your actions. One of our neighbors has a dog, which runs around by itself all the time and does its business in the yards of the entire neighborhood. The dog’s owner does only bear the full cost of his dog’s business, if it is done in his yard. He therefore does not care to keep a tighter leash on his dog. Similarly, when you cannot fully internalize the benefits of your action, you are less likely to innovate. If I do not expect to have full property rights over a cure for cancer and the proceeds from its sale, I will not look for one. In politics, entrepreneurs who come up with institutional designs that could safe us all are not systematically rewarded (other than with fame maybe). Therefore, they are less likely. Entrepreneurship is absent, or at best unsystematic.
Given this understanding of the relative likelihood of entrepreneurial solutions to problems in markets vs. politics, I am lead to believe that we are much more likely to find a substitute for oil and a cure for all of our environmental problems in the context of the market than we would be in the context of regulation or politics generally. Therefore, my response to the argument that some production processes are less likely to experience capital augmentation is “So what?” and “It has not hurt us in the past.” We will find a substitute for oil and we will be fine. In short, I am with Julian Simon.
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* As an aside, we have had a spoon made of the plastic alternative stuck in our front yard for about 7 months now and it has not bio-degraded as advertised.
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