Sunday, December 17, 2017

“To the highest bidder” As a Sneer

There is a ridiculous sneer that goes something like: "Under capitalism, everything goes to the highest bidder!" I was reminded of this trick when I saw a recent tweet by Bernie Sanders. The sneer makes it seem as though under capitalism "the rich" just get their way with everyone because they have more money. This is kind of absurd even when applied to consumer goods. Sure, the rich have a lot of disposable income, but it's limited. Their purchasing power is smaller than the combined purchasing power of the middle and lower classes. People set up shops and stock them with goods for poor people, too. It's not like "the rich" totally dominate them by buying all the stuff and leaving nothing behind. Besides, most rich people save a lot of their income. They don't consume, which leaves all that stuff for the other people to consume. It gets bid upon by lower-income individuals.

The "To the highest bidder!" sneer, nonsensical as it is when applied to consumer goods, makes less sense when applied to capital goods. "No fair! Under an auction system, radio spectrum will simply go to the highest bidder!" Well, I say, usually it's a good thing when something get allocated to its highest value use. If you don't really give it much thought, you might envision this world where a few rich moguls call all the shots. The Sumner Redstones and the Rupert Murdochs of the world just use their massive wealth to decide what the media looks like. And this naive view gets it exactly backwards. The "rich" part most likely came second. These men grew rich (or richer) by selling people what they wanted to buy. You or I may think their product is meretricious, but they make their fortunes by insightfully predicting what these unwashed masses want to see. And if they try too hard to "call the shots," someone else will create a product that is more in tune with consumer demand. Even if they are willing to squander a large sum of their fortunes producing the media that they think consumers should want, unless they sell a product that consumers actually want they will go out of business. Even if the media mogul is an incorrigible old coot bent on a social mission, s/he will eventually be voted out by the board of directors or compelled by their heirs to step aside. These kinds of people usually have partners, and these partners aren't willing to lose money forever on some rich guys vision of social engineering. Even the rich get outbid.

Imagine someone who says, "I'm willing to buy this plot and build a factory on it. I'll pay $1 million." A second bidder says, 'I'm willing to buy the same plot and build a factory on it. I'll pay $10 million." You shouldn't conclude that the second buyer simply has 10 times as much wealth backing him, and is just blowing his stash on frivolous new ventures. You'd probably conclude that the second bidder has a higher valued use for the property. Someone, perhaps the bidder himself bidding his own money, or perhaps a series of venture capitalists and other investors, did some due diligence on the proposed "new factory" project. They decided that the resulting revenues would justify a bid of up to $10 million. It's not that they start off richer. Rather it's that they expect to produce something that they can sell to consumers for lots of money. This isn't a case of "rich guys throwing their weight around." It would be more accurate to describe this as consumers hiring capitalists to build a factory and produce consumer goods for them. In reality, the consumers don't know about the factory builders' plans and don't even realize they want the factory's output. But the capitalists have market research, management experience, and some intangible je ne sais quoi business acumen for the next big thing. And they might be wrong. Maybe the $1 million dollar bidder's idea is better. But capitalism lets a million little flowers bloom. There may be cases where the better idea gets "outbid" by someone with inferior ideas but a superior bankroll. But this is unlikely to be the case consistently, for the millions of big and little auctions that happen in our vast economy. Over time and over a large enough sample size, the better ideas outbid the worse ones because they are better ideas.  Not simply because a few rich guys call the shots. The "rich people's ventures perpetually outbid the less-funded but more insightful and meritorious ventures" scenario is paranoid in the extreme.

The sneer makes even less sense when applied to non-rival goods. That is exactly the case with the Sanders tweet. There are times when bandwidth is scarce. If we're all trying to watch Netflix at 9:00 p.m., or we all want to binge-watch the new Punisher show the night it comes out (okay, sorry, enough about me), then bandwidth becomes scarce. My use of the internet slows down your use of the internet. If we're just reading text articles and stupid blogposts all day (okay, sorry, seriously, enough about me!) we have plenty of bandwidth and we aren't hogging network resources in any meaningful sense. This notion, that this marginal internet  user will be perpetually outbid by "rich people" in a way that makes the internet unusable, is nonsense.

(Thinking of my own internet consumption. I'm an actuary married to a physician. And yet we shopped for the best data plan. We basically picked the cheapest plan at 1 or 2 Gb a month, I don't remember which. We didn't just buy up as much data as we could get. The notion of throttling other users to dedicate bandwidth to our phones never even occurred to us. I seriously doubt that we're atypical, either. I know other doctors and actuaries, and they shop around for the best value, too. I seriously doubt that even corporate executives try to purchase the "throttle the network and send it all to me!" plan. I try to imagine the "rich people buy up everything and leave nothing for anyone else" scenario playing out, and when I try to picture it it just seems unbelievably paranoid.)

Very early on, economist Ronald Coase explicitly advocated allocating radio spectrum to the highest bidder. He had in mind a rationale similar to the one I give above. Basically, allocating to the highest bidder means allocating to the highest valued use. And historically that has worked out pretty well when tried. Things worked poorly when we've deviated from it. In an allocation-by-fiat rather than allocation-by-auction regime, spectrum gets allocated based on somebody's idea of what's socially beneficial, or it gets allocated by political favoritism (which is exactly how LBJ and his wife made their fortune). If someone has a novel idea for the use of spectrum, the bureaucrats who allocate it can simply scoff and say it will never work. So a new technology may take years or decades to get off the ground. (Again, read the Grumpy Economist piece.) This doesn't happen under a "to the highest bidder" regime. The upstart business with the hot new idea runs some numbers, figures out what are the likely revenue scenarios, and buys the spectrum if it can justify the cost. It doesn't have to plead with bureaucrats, beg politicians to change the relevant laws, or ask permission from its competitors to operate. In these kinds of auctions, it is ultimately the consumers who are bidding with their purchases, not the business owners themselves. There would be no money for them to bid with in the first place unless they can win over customers.

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