Tax Investment
Michael Blume recently reminded me of a point I made eleven years ago. At the time it seemed too obvious to be original, but now I’m not so sure. So let me point out an important negative investment externality:
Raising the long term real interest rate results not only in dropping poor investment projects, whose rates of return are lower than the new rate, it also causally increases the long term rate of return of all better investments, those that would have been undertaken anyway.
This is a huge market failure, due to a lack of property rights in long term investment prospects, as I explain below. If it were the only investment externality, then free market interest rates would be too low. This externality is countered, [edit: complicated] however, by a legal failure due to our choosing not to enforce all feasible long term contracts, especially with the dead:
Large legal barriers now hinder us from making deals with the far future, and from saving today to benefit them. We do not enforce many kinds of terms in wills, and charities are required to spend a certain fraction of their capital each year, to prevent their endowments from growing large.
Given this overall situation, the obvious policy prescription is:
Enforce all feasible long term contracts, and
Artificially raise global interest rates, e.g., tax investment.
The first policy can be implemented locally, but second seems to require global coordination – an extra local tax may on net hurt that locality. So without a world government we may never implement this second policy.
Regarding the source of the problem, here is my old argument:
A lack of long-term property rights in most investment projects means that returns above the market rate are burned up an a race to be first.
There are, in fact, very few long-term property rights regarding the right to undertake investment projects. Think of developing a new kind of car, colonizing the moon, developing specialized CAD software, or making a movie with a certain kind of gimmick. Each such project requires various forms of capital, such as machines or skilled labor. While in the short term only one investor may have the rights to tackle a given project, in the long term many competing investors could have positioned themselves to have this short-term opportunity.
For example, Microsoft’s dominant position in PC operating systems now gives it the right to many very attractive investments. But there was once an open race to become the dominant operating system, and competitors then tried harder because of the prospect of later high returns. And when deciding whether to enter this earlier race and how hard to try, investors mainly wondered if they could get a competitive rate of return. Similarly, while one group now has the right to make the next Batman movie sequel, there have long been open contests to create popular movie series, and popular comic strips.
Consider a typical as-yet-untried investment project, becoming more and more attractive with time as technology improves and the world market grows larger. If there wasn’t much point in attempting such a project very long after other teams tried, then a race to be first should make sure the project is attempted near when investors first expect such attempts to produce a competitive rate of return. This should happen even if the project returns would be much greater if everyone waited longer. The extra value the project would have if everyone waited is burned up in the race to do it first.
Thus most of the return above the market return … should be burned up, leaving the average return at about the market return.
Of course some of the wasted effort to invest too early will produce positive innovation externalities. But it seems wishful thinking to expect this to completely negate the earliness waste.
On your point 1, it is exactly like why a monopolist wants to raise prices above the competitive level; he loses marginal customers and gains on all infra-marginal customers.
So, it makes more sense if I think of the long-term rights that solve the problem not as extended patents -- because the problem is the race to be patentable. What you want is a lower barrier to lock up research toward a particular patentable item early on in the dev process. So you could apply for a pre-patent right to deliverable a patentable item in N years. This would then be made public and bid on. Like other patent rights it should be tradeable. What the winner (holder) gets is basically the sole right to patent this item if they produce it within the term. If anyone else wants to beat them out, they have to buy the pre-patent or hope the holder can't produce a patentable product within the term so that it expires.
If this is the kind of right Robin imagines, that would make sense (at least in the patent space). There is still the social cost of the year wait, and while there's no reason to think it's as much as 100 million, it's still significant (probably on the order of 20M if the net benefit over the patent term is 200M).
Plus we haven't considered how much of the extra 100M in spending is dead-weight loss versus mere utility transfers. In your contrived hypothetical, it's easy to imagine dead-weight loss being more than 20%, so that probably represents a net social cost, that some kind of pre-patent right would eliminate or at least drastically reduce.
I'd love to have a real world example to chew on, though. I'm not aware of any races to be first where the cost ratio was that dramatic (10 x cost for 10% time savings). With less extreme numbers and a small percentage of dead-weight loss on the extra spending, a race to be first in innovations could end up being a net social positive, even if it is negative for all the entrants in the race.
The social benefit is less obvious for something like homesteading.
I've thought some more on the interest rate issue, and if there is no economic profit (due to efficient competition), then it makes sense that all investments would earn the market rate plus something the investor brings to the table. But the difference is still just transfers except at the investment margin which, as Jordan Amdahl notes, is an unclear (to me anyway) trade off between delayed now profitable investments (social good) and scrapped no-longer profitable investments (social bad).