mercoledì 14 giugno 2017


Making Markets Work Better: Dominant Assurance Contracts and Some Other Helpful Ideas  By Alex Tabarrok

Public goods are one of the big challenges to markets.[1] Indeed, it was long thought that the free rider problem prevented public goods from being provided voluntarily. David Hume (1739), for example, wrote that such provision was impossible… “Two neighbours may agree to drain a meadow, which they possess in common: because it is easy for them to know each other’s mind; and each must perceive, that the immediate consequence of his failing in his part, is the abandoning of the whole project. But it is very difficult, and indeed impossible, that a thousand persons should agree in any such action; it being difficult for them to concert so complicated a design, and still more difficult for them to execute it; while each seeks a pretext to free himself of the trouble and expense, and would lay the whole burden on others. Political society easily remedies both these inconveniences…Thus, bridges are built, harbours opened, ramparts raised, canals formed, fleets equipped, and armies disciplined, everywhere, by the care of government… “
In a standard crowdfunding contract, entrepreneurs seek voluntary donations, but they commit to use those donations if and only if the total meets or exceeds a critical threshold. If total donations are less than the threshold, the donor’s funds are returned. Billions of dollars have been raised using crowdfunding contracts, but much more may be possible…
The dominant assurance contract adds a simple twist to the crowdfunding contract. An entrepreneur commits to produce a valuable public good if and only if enough people donate, but if not enough donate, the entrepreneur commits not just to return the donor’s funds but to give each donor a refund bonus. To see how this solves the public good problem consider the simplest case.
Suppose that there is a public good worth $100 to each of 10 people. The cost of the public good is $800. If each person paid $80, they all would be better off. Each person, however, may choose not to donate, perhaps because they think others will not donate, or perhaps because they think that they can free ride… Now consider a dominant assurance contract. An entrepreneur agrees to produce the public good if and only if each of 10 people pay $80. If fewer than 10 people donate, the contract is said to fail and the entrepreneur agrees to give a refund bonus of $5 to each of the donors. Now imagine that potential donor A thinks that potential donor B will not donate. In that case, it makes sense for A to donate, because by doing so he will earn $5 at no cost. Thus any donor who thinks that the contract will fail has an incentive to donate. Doing so earns free money. As a result, it cannot be an equilibrium for more than one person to fail to donate.
We have only one more point to consider. What if donor A thinks that every other donor will donate? In this case, A knows that if he donates he won’t get the refund bonus, since the contract will succeed. But he also knows that if he doesn’t donate he won’t get anything, but if does donate he will pay $80 and get a public good which is worth $100 to him, for a net gain of $20. Thus, A always has an incentive to donate. If others do not donate, he earns free money. If others do donate, he gets the value of the public good. Thus donating is a win-win, and the public good problem is solved…
Cason and Zubrickas (2017) recently tested dominant assurance contracts in an experiment and found that they do increase the provision of public goods.
there are advantages to the private method of provision over “political society.” Political society avoids the problem of free riders at the expense of creating forced riders, people who are forced to pay for a public good that they value at less than their cost. More generally, how do we know that a bridge is truly worth more than its cost? Hume takes the value of the bridge as given, but we need a discovery process for public goods just as for other goods.
Dominant assurance contracts open the provision of public goods to entrepreneurship, innovation, and the market discovery process.
t’s long been thought, for example, that unemployment insurance can’t be provided privately because of the risk of adverse selection and moral hazard. But although it may be difficult to create an unemployment insurance contract that pays out when you are unemployed, what about one that pays out only when you are unemployed and there is unusually high national unemployment, or unusually high unemployment in your industry or city? Conditioning payouts at least partially on things that the worker does not control could alleviate problems of asymmetric information and still allow the market provision of unemployment insurance.
Cochrane’s Time Consistent Insurance (1995, 2009) improves the market provision of health insurance (see also Tabarrok 1994, 2002b for “Gene Insurance”, an early precursor). Similarly, Robert Schiller’s (2003) macro markets in housing and GDP reduce the risk from housing bubbles and business cycles.[3] The better the market can insure against risk, the less will be the demand for coercive solutions.
New technologies such as smart contracts and the rise of ubiquitous and massive computing power, including all manner of sensors and location technologies, may make these ideas implementable at lower cost and in better ways than ever before