Dissipation of Economic Rents: when money is wasted chasing money

Much of economics is both esoteric and vital, meaning you need to understand it, but it's hard sledding. Today, economist Tim Harford does us the service of explaining "dissipation of economic rents" -- inefficient systems in which the effort expended by everyone chasing value wipes out the value they're chasing.

Harford draws on an example from Who Gets What and Why, Alvin Roth's 2015 book on game theory, which has a section on Stanford economist Mike Ostrovsky. Ostrovsky asks us to imagine an airfield next to a Treasury Department money-press, where planes take off filled with money, some of which flutters to the ground -- $1 million/day.

The airfield quickly fills up with treasure-hunters armed with nets, drones, and other bill-catchers. Before long, economics predicts that the money-chasers would be spending about $1m/day on bill-catching strategies, wiping out all the value that was fluttering down from the sky.

This analogy is a useful way to think of high-speed traders, who spend tens of millions trying to make their stock-market-bots a little bit faster than the competition's.

Harford proposes that the best answer to this is a series of periodic auctions, which would be cheaper overall for the participants, leaving more value on the table for those who succeed.

Can anything be done about such rent-dissipating behaviour? One approach is to tax it. We could levy a fee on standing in queues, or on microwave transmitters, or on stock market transactions themselves. If people who queue for scarce concert tickets are all taxed $5 an hour while they queue, then the lines will be shorter. The cost of the tax should roughly be offset by the reduced waiting time, so the queueing crowd is no worse off; the government, on the other hand, has acquired revenue from nowhere. This is a rare free lunch.

Taxing transactions is also a possibility, although a more problematic one. Much of the difficulty comes not from transactions themselves but from “quote stuffing”, where high-frequency traders make and withdraw thousands of bids, probing for information without actually making transactions. And charging for quote-stuffing might not help either. Three Canadian researchers (Katya Malinova, Andreas Park and Ryan Riordan) studied the impact of a regulatory change where traders were charged for quotes, not just trades; they found that quote volume fell sharply. But the bid-ask spread, a measure of market inefficiency, rose nearly 10 per cent. And while a transaction tax or quote tax would discourage some forms of high-frequency trading, it seems to me that the incentive to build microwave links between Chicago and New York would still exist.

How fighting for a prize knocks down its value
[Tim Harford]

(Image: Slow Motion Falling Money [Travel Links Directory/Youtube]