Melberg, Hans O. (1996), Externalities, bureaucracies and tradable budgets

_{[Note for bibliographic reference: Melberg, Hans O. (1996), Externalities,
bureaucracies and tradable budgets, http://www.oocities.org/hmelberg/papers/960429.htm]

Externalities, bureaucracies and tradable budgets

Introduction

The starting point for this observation is an article in a newspaper about a person who
had to wait several months for hospital treatment (because of capacity problems and long
waiting lists in the public hospitals). His problem was not urgent, but it was serious
enough since he could not go back to work until he had been operated. While he was waiting
he received money (health insurance) from another state agency. The interesting fact was
this: The amount of money he received while he was sick was larger than the costs of the
operation. My immediate thought was: Would it not be better for society - and the person -
if he had received his treatment at once, thus avoiding the need for income support while
he was waiting for the operation?

There are three questions which should be discussed. What is the cause of this phenomenon?
Are there any solutions? What are the potential problems with the solutions?

The cause of the phenomenon

By necessity the modern state is divided into several branches which each are responsible
for one policy area. The health department deals with health policy, the department of
defense with defense policy etc. Below these large departments there are lower level
division of responsibilities, such as between various agencies within the departments. The
problem with this kind of organization is the externalities that arise when a small unit
makes a decision without considering the effects of this decision for the other units. For
example, when deciding who to operate first the hospitals do not consider the money lost
in insurance payment to those who wait for an operation. The most fundamental cause of the
problem is thus the division of responsibilities which leads to uncoordinated decisions.

Are there any solutions?

One solution could be to allow the departments to "trade" budgets. The agency
responsible for sick insurance payments may be allowed to use its budget to pay for
hospital treatment - even in a private hospital. An alternative solution could be changing
the hospital rules for deciding who to operate first.

What are the problems with these solutions?

At first sight the solution seems perfect (i.e. a Pareto improvement). The state saves
money (and thus needs less tax income) and - if the treatment is bought in a private
hospital - the waiting lists in the hospitals become shorter.

Yet, there are problems. One problem is related to considerations of justice. Why should a
person with a job receive hospital treatment before an unemployed person? I admit that
this may be unjust, but one should also note that the unemployed person could in fact get
treatment earlier with the new system compered to the old (since if the other
person gets treated in a private hospital there is one less to operate for the public
hospital i.e. the waiting line gets shorter). One must then ask whether the consideration
of justice is simply disguised envy. Even if it is not we may be willing to sacrifice some
justice to gain material wealth.

Another problem is that the new system may create an incentive structure which has bad
results. The following example illustrates how this could happen: Imagine that the people
who feel distracted by loud music in a student building are allowed to claim compensation.
In other words we have internalized an externality: The people playing music must take
into account all the costs of doing so (i.e. for their neighbours), not only their private
gains. This may seem like a good think until you realize that the new system creates an
incentive to appear more sensitive to loud music than what is true. You might be willing
to tolerate the music for $1 per hour, but - knowing that you neighbour would be willing
to pay $3 - you claim $3. This is only one example of a problematic incentive structure as
a result of the new system. There are other problems: What about the effects on the
relationship between you and your neighbour? What about the effects for bargaining between
the two agencies? (Changing the set of feasible options may change the outcome of a
bargaining process) There may be many problems, some of which I have though of.

Lastly I would like to add a note about which of the two solutions the best. The first
solution - allowing trade between agencies - is probably the best because it may solve
more problems (future and unknown) of a similar type. The second - than of changing the
rules in the hospital - is bureaucratic and it does not solve other problems of similar
kind - in which case the process of changing the rules would have to be started again. The
only advantage of the second solution is that it may avoid some of the problems of a more
generalized trade system.

In conclusion this seems like an area worth studying closer. The phenomenon is probably
widespread since all bureaucratic structures by necessity must divide responsibility
between several isolated units. We then need to develop methods on how to integrate the
isolated units to avoid externalities. Lastly we must ask whether the remedies (the system
of integration) is better or worse than the disease.

_{[Note for bibliographic reference: Melberg, Hans O. (1996), Externalities,
bureaucracies and tradable budgets, http://www.oocities.org/hmelberg/papers/960429.htm]}}