Economics / Policy

Patents for institutional innovation: Drug reform… sharing economy too?

Sometimes special interest groups are blocks to policy reform. Other times they can unlock an institutional innovation, but for a cost. This is a kind of Faustian bargain. The deliverers of efficient policy reform simultaneously benefit from an inefficient policy kickback. Think of it as a patent for institutional innovation.

Recently over at Organizations and Markets Dick Langlois has looked at the latest attempt at legalising marijuana in the United States, this time a ballot proposal in Ohio:

The unusual aspect of the proposal was that it would have come with a grant of a monopoly in commercial marijuana production to specific investors who owned suitable land. Because they stood to gain considerably from passing the proposal, these investors devoted resources to getting it passed, including professional canvassers, political strategists, and even a mascot with a head shaped like a marijuana bud. Basic Public Choice teaches that legislation benefiting many diffuse constituents is hard to pass because of transaction costs. In effect, the monopoly aspect of the Ohio proposal would have granted a patent to the investors, thus giving them the incentive to overcome the transaction costs of collective action.

Public choice theory is often used to explain how political decision-making results in outcomes that conflict with the preferences of the general public. The usual story goes that efficient policy change is stifled (or conversely inefficient policy is enacted) because the transaction costs of collective action for the large portion of society that would benefit from better policy are proportionately large, and the costs of collective action for small, special interest groups that would benefit from bad policy (at the expense of others) are small. On the other side of the equation, the benefits to special interests are large and the share of this borne by an individual citizen is small.

The Ohio proposal is a curious case, however, because of the monopoly aspect of the would-be new industry. What exactly is the correct policy measure? The economic case for marijuana legalisation is fairly lock-tight, and the evidence from the first year of legalisation in Colorado is supportive. So it’s no surprise a majority of Ohio voters supported legalisation. On the other hand, monopolism is difficult to justify economically, which explains why legal marijuana entrepreneurs are happy that Ohio voters rejected the proposal. It seems that voters rejected the notion of legislating a monopoly, not marijuana legalisation.

To return to public choice, we need to identify just who are the special interests. Is it the minority group of prohibitionists that would see their political preferences privileged over those of the general public? If you have strong preferences against legalisation and there isn’t many of you, then it seems you are in good position to form a distributional coalition and get your way. Or is the group of would-be monopolists—the 10 pre-selected company farms known as ‘ResponsibleOhio‘—the real special interest group? Again, this is a classic formulation of diffuse costs and concentrated benefits.

I believe it is both, which is what muddies the waters here. As Dick points out, if the proposal was accepted an economist might have argued that a de facto patent had been granted to the ResponsibleOhio drug cartel, as reward for delivering the institutional innovation of marijuana legalisation (and as compensation for the fixed costs of lobbying incurred in doing so).

This is really interesting, as it suggests a counter-intuitive model for overcoming special interests and introducing efficient policy changes—create countervailing special interests with a favourable collective action calculus, and bundle the efficient new policy with temporary (inefficient) market power for their troubles.

Although I’m not going to endorse such a move, because it would likely be plagued by public choice issues as well, at least in principle we should be able to concede there could be some scope for mutually beneficial exchange here. It’s not unreasonable to suggest some small, temporary market power (inefficiency) could be exchanged for the long-lasting, more efficient institutional innovation that removes political barriers to the creation of that very market in the first place.

We see this dynamic playing out for other institutional innovations too. As Darcy Allen writes in the latest IPA Review, it is sharing economy companies like Uber and airbnb that are pressuring governments to permit new, more efficient markets to emerge and supercede inefficient, protected old market models:

Yet while their actions firmly sit in their own private interest, they are more broadly providing a service that all Australians can enjoy—they are breaking up the incumbent industries-government relationship. This locking of horns between the incumbents and the innovators is a good thing. Each new user of the sharing economy is a vote for the free market, and is additional power on the side of the free market political entrepreneurs.

But, lest we forget that today’s free market political entrepreneurs too often become tomorrow’s special interest political pleaders. Such is politics. To echo Langlois,

it is interesting nonetheless to think about the economics of such “patents” for institutional innovation.

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One thought on “Patents for institutional innovation: Drug reform… sharing economy too?

  1. Pingback: Regulatory capture Uber alles | Meso Soup

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