Hi, welcome back. This is the second video lecture on market failures. In the previous lecture we talked about externalities. Those were the third party effects, certain types of economic transactions produce, like pollution. We ended that lecture with the question, why did externalities occur? I want to return to that question and try to answer for you. Remember, that externalities are things like air pollution, water pollution, traffic, noise. The thing that all of these have in common is that they take place in a public or an open access resource. Nobody owns the air, so companies are free to send emissions into the atmosphere. Nobody owns rivers, so people can dump stuff in them. Resources like these are called open access or common access resources. Everybody can use them almost as much as they'd like to. In the most extreme situations, what can happen is something called the tragedy of the commons. This is a title of a famous economic paper by a biologist named Garrett Hardin. I'm going to summarize what Professor Hardin talked about in this paper. During colonial times, lots of towns had a commons, this an area where people can graze their animals. Suppose you have a commons that could support 15 cows. That's its carrying capacity. And suppose you have five farmers, and they each have three cows on the commons. Everything is fine and they can go on doing this indefinitely. Then one of the farmers gets a bright idea. He wants to make a little bit more money, and realizes that he can sneak another cow onto the commons to graze. This first extra cow doesn't have a huge impact, but it does mean that the commons is degraded a little bit. Now, if other farmers realize what's happening, they're going to do the same thing. Pretty soon, instead of 15 cows, maybe you have 25 cows or 30 cows. Remember that the carrying capacity is only 15. Now what we have, is 30 skinny cows and the commons is overgrazed. So next season, maybe the caring capacity is only one or two animals, or maybe none. This is the tragedy of the commons, the desire for more wealth drives people to overuse the common access resource until it's ruined. Does this still happen? You bet it does. Here are two examples. If we divide the world's oceans into 15 sections, the Pacific and the Atlantic are divided into six regions, east/west by north, central and south, and the Indian Ocean into three region. It turns out that in all but about four of these 15 regions, overfishing is depleting fish populations. Today, the annual harvest in those 11 overfished areas is well below the area's peak harvest and that's despite more ships and better technology. if it takes more effort to catch the same number of fish, that's a pretty strong signal that fish populations are going down. Overfishing happens because beyond 200 miles of coastlines, the ocean is an open access resource. That is, anyone can go out and fish. Many countries subsidize fishing fleets in order to cash in on that free resource. Initially, when fish populations are healthy, everything works well but as fishing fleets get bigger, the total catch exceeds the reproduction rate and the population falls. Eventually, the catch begins to go down but people have invested in ships that are only good for fishing so they keep going out and fishing. Finally, the catch is so small, it doesn't even make sense to take the boats out anymore. Here's some graphs that show how fish harvests have crashed. Here's the data for Peruvian anchovies, which was a huge portion of Peru's export income. The next slide shows the California Sardine industry. Here is North Sea Herring. I don't have a graph of cod off the New England coast, but that fishery was completely closed for a number of years. So the tragedy of the commons is occurring and it's serious because more than a billion people live close to the ocean and depend on seafood as their primary source of protein. Here's another example. Industrial meat production has animals living close together. If one gets sick, there's a very high probability that the entire herd will get sick, which costs the producer lots of money. So these intense production facilities constantly give their animals antibiotics. This keeps the animals healthy so they grow faster and can be sold sooner. The antibiotics helps the farmers, but using so much antibiotics means that there is a growing problem with drug resistant bacteria. This means that people who have serious bacterial infections may not have an effective drug to help them get well. So financial gain by one group has eliminated a valuable resource for the rest of us, powerful antibiotics to treat infections. Let me shift to the third market failure that I want to talk about. This has to do with information. For people to make good economic decisions, they have to have good information. One of the primary measures of economic performance is a country's GDP, gross domestic product. We're happy when GDP goes up. That means the country's richer and hopefully, people are better off. But even as the GDP metric was being developed by Simon Kuznets in the 1930s and the 1940s, he warned that it had problems. Here's a short film of a speech that Robert Kennedy gave about GDP when he was running for president. In case you aren't familiar with him, he was John F. Kennedy's brother and like his brother, he was assassinated [MUSIC] >> Too much and for too long, we seem to have surrendered personal excellence and community value in the mere accumulation of material things. Our gross national product now is over $800 billion a year. But that gross national product, if we judge the United States of America by that, that gross national product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break in. It counts for the destruction of the Red Wood and the loss of our natural wonder in chaotic sprawl. It counts napalm and it counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts weapons, rifles and and the television programs which glorify violence in order to sell toys to our children. But the gross national product does not allow for the health of our children, equality of their education or the joy of their play. It does not include the beauty of our poetry, or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit, nor our courage, neither our wisdom, nor our learning, neither our compassion, nor our devotion to our country. It measures everything in short, except that which makes life worthwhile and it can tell us everything about America, except why we are proud that we are American. [MUSIC] Robert Kennedy pretty dramatically explained many problems with GDP. But we still use it as a measure of economic performance. There have been many attempts to design a better measure. One of my professors in graduate school worked on one, but none has ever been accepted as a good substitute. How can we manage an economy if the key performance metric is flawed? This flaw in GDP, not considering the loss of natural resources or valuing important family work or community work, helps explain why our economy works like it does and rewards some things and doesn't reward others. Like caring for the environment, and communities, and being sustainable. This type of information failure can occur in a couple of ways. It can be mismeasurement, like the GDP example, or it can be a lack of information that keeps us from being able to make good decisions. These market failures means that an unfettered economy won't produce the perfect world. We have to recognize that there serious problems that arise in the economy. Externalities, the depletion of common access resources and information problems. Government involvement is mandatory to solve some of these, but business can also play a big role. Sustainable businesses can try to address some of these deficits by reducing emissions or internalizing external costs or caring for resources over the long-term. In developing metrics, like science-based sustainability targets, that we'll introduce in the next class, that are better measures of performance than profits or other GDP like metrics. Our economy is an amazing machine for innovation and production, it's given us an unbelievably high quality of life. But it has weaknesses, so it needs to be monitored and improved. Sustainable business is a way to take the best that our economy gives us and make it even better. As you steer your company towards sustainability, you'll help improve life for people and make the economy work better by reducing some of these market failures. Thanks.
