Market-Based Budgets

We arrived at a prison camp in Italy after capture and each received a Red Cross food parcel. At once exchanges, already established, multiplied in volume. Starting with simple direct barter, such as a non‑smoker giving a smoker friend his cigarettes in exchange for chocolate, more complex exchanges soon appeared.

Stories circulated of a priest who started off round the camp with a tin of cheese and five cigarettes and returned to his bed with a complete parcel in addition to his original cheese and cigarettes.

It’s a bit of a puzzle how a priest, presumably an honest agent, can engage in trade and end up with more of not just one foodstuff by trading for it, but more of everything. How did he manage this through voluntary exchange? In fact, he managed to make everyone he traded with better off. – Munger on Middlemen 

Contents

  1. Market-Based Budgets
  2. Lessons
  3. Price
  4. Mechanics
  5. Benefits
  6. Q&A
  7. Proposal

Lessons

Within a week or two, as the volume of trade grew, rough scales of exchange values emerged. Sikhs, who had at first exchanged tinned beef for practically any other foodstuff, began to insist on jam and margarine. It was realized a tin of jam was worth 1/2 lb. of margarine plus something else; a cigarette issue was worth several chocolate issues, and a tin of diced carrots was worth practically nothing.

The cigarette became the de facto unit of exchange due to its fungibility and divisibility.

* * * * *

The total inventory was fixed; the total number and variety of food stuffs across all the Red Cross parcels didn’t change. Trading maximized the satisfaction for all prisoners by allocating a fixed inventory to those who most valued each type of foodstuff.

How much of each foodstuff should the Red Cross send so even greater satisfaction can be achieved across the prison camp at no additional cost (e.g., fewer diced carrots)?

Price

We set a price on services received from charities and/or governments.

Each of the 100 Senators (Officers) gets 432 chits and each of the 432 Representatives (Enlisted Men) gets 100 chits for a total of 86,400 chits (100 * 432 + 432 * 100). Their job is to purchase units of charity / government service with those chits within an overall fixed spending limit. The Red Cross only has so much money.

Hint: chits are the cigarettes in our story.

Here are the rules for setting prices in our charity economy. At first glance they may seem counter-intuitive.[1]

If many legislators want a service then it’s cheaper. It costs fewer chits per unit of service (e.g., $1 billion in defense spending). Popularity across legislators is assumed to show the service more fully represents the collective will of the nation that voted for the legislators and we discount its unit price accordingly.[2]

If few legislators want a service then it’s expensive. Legislators may have to spend their entire purse of chits just to acquire a single unit of this service. It less fully represents the will of the people and therefore should cost legislators dear so there is less of it in the common inventory.

Let’s show an example.

Assume we have four government services: guns, butter, debt reduction and municipal grants. The outcome of an illustrative budget session is shown below:
Budget_Illustration
For simplicity each unit represents $1 billion in budget allocated to each category of spend. Representative 1 bought $2.7 billion in guns for 50 chits.

Price per unit in chits emerges from legislator bidding, enforces the ~$40 billion spending limit across all 864 chits, and determines the units bought for each category of spend (e.g., 300 / 18.49 = 16.2 units of Guns).

Most legislators want guns and butter so these end up with a low price per unit. About half as many want debt reduction, so its price per unit is about double that of guns and butter. Almost no one wants to provide grants to municipalities, making this item relatively expensive.

The Red Cross now knows precisely how much of each foodstuff to send.

Mechanics

Spoiler alert! I don’t know the mechanics.

The illustration above uses a linear relationship between number of chits bid and unit prices. This is not realistic. We want prices to emerge as a result of dynamic buying and selling patterns among legislators. We want to simulate private markets with legislators as buyers constrained by a limited spending authority.

The more legislators want of an item the less it costs per unit, analogous to economies of scale. But how much less? For example if all legislators except one pick guns, the lone legislator should find the price of their unique choice prohibitively expensive. It costs way too much to manufacture and pack just one item for a lone legislator.[3]

Our market must factor in changes to an item’s value that arise as part of the buying process. If legislators find an assumed unpopular service to have high popularity they may change their mind. If a service seems neglected they may decide to buy it despite its high unit cost.

Our market must correct for Free Riders, Defectors, Shills, Collusion and Regrets[4]. It must allow for rewards and punishments based on altruistic or selfish behaviors. We must correct for having two or three highly polarized groups competing in our marketplace. Signals of intentions (e.g., limit bids , bid good-till dates, conditional bids[5]).

Mathematicians have solved the problem of slicing a many-flavored cake and equitably sharing the slices across many kids each with different tastes.[6] We know precisely how to divide up a fixed heterogeneous Red Cross inventory into envy-free packages for each prisoner.

We unleash the academicians to know precisely how to populate the inventory.

My bet is on a market solution with pricing as the clearing mechanism. It works great in the private sector.

Benefits

Market-Based Budgets establish a price for government services emergent from the collective values of all legislators. We learn from the collective how much guns are worth relative to butter relative to municipal grants, etc. We see how the relative value of services adjusts after legislators have purchased ‘their necessities’.

Market-Based Budgets construct a Federal budget as the collective will of the legislators. Each legislator purchases the government services they personally feel best meets the needs of the nation. We add them all up for the total Federal budget.

We turn the academics loose on the market data. Let them theorize and experimentally test ways to increase altruistic (or decrease selfish) behaviors on the part of legislators. At a very granular level.

What are the dozens or hundreds of tiny tweaks to the trading process that can be shown to nudge legislators to better serve the public interest rather than their own?[7] How do we leverage an ever‑growing body of behavioral insights from the sciences to improve the national budgeting process? How do we constantly update the budget process as legislators learn new and improved ways to game the system?

We can’t do these experiments within today’s chaotic, power-hungry, one-size-fits-all approach. Within the market arena there’s a chance to finally fix the government budgeting process. To make it truly responsive to the collective will of the taxpayers.

Q&A

Q. I look upon this as a classical economist and see the demand curve but not the supply curve. It’s hard to see how you’ll come up with anything but an arbitrary pricing mechanism (like in your illustration)?

Don’t know. But I suspect prisoners in the POW camp can somehow come to an agreement that almost any amount of additional chocolate would be better than the diced carrots. At the margin there must be choices that can be made to improve the overall inventory. The solution is probably iterative. We may need to get carrots to realize we can live without them. Or chocolate to realize we really want more.

My guess is we will end up with heavy discounting of unit prices for highly demanded services, heavy penalties on little demanded services, with everything between at fairly constant unit prices.

I would insist price setting be formulaic based on trading patterns. I wouldn’t favor unit prices set as a political calculation (e.g., favoring labor unions, trial lawyers, defense contractors). I wouldn’t favor Rawlsian pricing with a preference for the poor at the expense of political accountability.

Q. Why all this pricing and chits hocus pocus? Just have each legislator take their share of the total budget and allocate it to services as they please.

A pricing mechanism discourages self-serving legislators from spending their share of the budget on themselves by making selfish spending very expensive. It’s hoped voters will punish a legislator who spends their entire purse on a bridge to nowhere instead of buying much more of anything else.

Once you get beyond the necessities of life (coffee, chocolate & cigarettes) prisoners watch others for signals of the worth of a foodstuff. Indeed, these signals can change the mouthfeel of a foodstuff. Trading is a valuable means by which prisoners uncover the worth of secondary foodstuffs, something you don’t get with a simple summation of independent choices.

Notice in the above illustration each legislator does not allocate the same dollar amounts to the final inventory (e.g., Representative 2 allocates $3.1 Billion compared to $4.9 Billion for Representative 1), but each legislator achieves the same level of ‘satisfaction’. Each has spent their chits in a manner they deemed best. Some feel the nation is best served by having a few expensive items while others feel having many inexpensive items is a better purchase.

Should each legislator be allowed to spend the same dollar amount they would end up with a lower total satisfaction. Representative 2 would be happier but not enough to make up for the lower happiness of Representative 1.

Q. Budgeting isn’t about fairness, sharing, or the good-of-the-nation. It’s about wielding power. This proposal is a pipe dream.

Agreed. It’s hard to see how any legislator in a position of power would embrace even my modest proposal to fund a study of the question. They would rather spend the money on their contributors or constituencies. But it’s good to have these proposals in the mix for when a crisis looms and people go grasping for new ideas. At some point there may be a visionary leader who wants to stop the madness and we have here a ready-made fix. We can always start this budget process with a linear relationship between the number of chits bid and unit prices, as per my illustration, and adjust as we gain experience.

Q. Will legislators make purchasing decisions on all million individual line items in the budget?

Might be possible with technology, but probably best we stick with broader categories. Perhaps one or two layers deeper than guns, butter, etc. At the level of Federal Agencies? Details underneath each broad spending category can then be worked out in committee, or in subsequent bid / purchase sessions.

Q. The president will veto the budget?

Since the budget represents the express intent and values of all legislators it should be easy to muster a super majority to override any veto. If the veto cannot be overridden resolution will not be much different than today: backroom negotiations and arm-twisting to convince legislators to trade some of their choices for the president’s choices.

Q. What about Social Security and Medicare?

Social Security is currently off-budget. The Federal Reserve System and various government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac, have historically been off-budget. Off-budget items are currently 66% of total spend. Once a spending limit is in place legislators will likely rethink the wisdom of having this much of the budget off-limit. Especially when social security and interest payments skyrocket leaving no money for anything else.

Q. How does this help manage the debt?

We provide a line item for debt reduction. If a legislator buys debt reduction and this increases overall spending authority (under a spending limit enforcement like 4 x GDP / Debt) then we can reward additional chits to the legislator who purchased the debt reduction. We essentially decrease the unit price of this government service owing to its increase in spending authority.

Proposal

The Market-Based Budget Act of 2014. Fund research into workable solutions for market-based budgeting, with the promise of funding and piloting top solutions in the U.S. Congress.

We want each legislator to deliver to their constituencies a custom parcel of services taken out of an inventory of services that has already factored in the collective preferences of all legislators. The inventory is optimized. If the Red Cross switches any item in the inventory then the prisoners, we the people, are collectively worse off.


1. You might think the more people want a product the more expensive it should be so as to ration the good. But with government services we want the greatest good for the greatest number of people from a fixed amount of spend. So if many people want an item we set its price low to further encourage its inclusion in our Red Cross inventory. We have more of the item to spread around when the inventory gets parceled out. Also note for simplicity we package each foodstuff in quantities so each unit of foodstuff costs the Red Cross the same (e.g., a 6 oz. candy bar costs them the same as an 12 oz. tin of carrots). The unit cost is the same; the unit ‘price’ reflects how much each buyer values the unit.

2. Yes I know for any given social concern the most knowledgeable decision-maker always comes up with a better solution than the hoards. Group Think is often worse than the smartest person in the room. But we live in a democracy and Group Think is the price we pay for this democracy.

3. One approach that gives this decreasing cost relationship (i.e., higher demand means lower unit cost) is to have legislators bid for government services packaged as a percentage of total spend. The higher the percentage on one government service the lower on the others. Unfortunately this approach is highly vulnerable to collusion (e.g., 51% of legislators bid 100% spend for a single government service).

4. My local True Value hardware store is expensive, at times 30-40% higher than the distant Big Box stores. But it’s only 2 minutes from my house. When I’m in the middle of a fix-it project and am missing just one little screw it’s so convenient to drop by True Value. But True Value won’t survive on just an occasional screw purchase. So I buy other items there just to make sure they’re in business next time I’m in a rush and I need them. I know to avoid future regrets with today’s purchasing decisions.

5. If the total budget for Guns falls below $10 billion then move up to 25 of my chits from Butter to Guns not to exceed $10 billion total spend on Guns.

6. With two kids it’s easy. The kids talk to each other about preferences. One cuts and the other gets first pick. With more than two it gets complicated. Here’s the answer for four kids. First Bob divides the cake into five equal-looking pieces. He passes them to Carol, who trims two at most to create a three-way tie for largest in her eyes. She sets the trimmings aside and gives the five pieces to Ted, who trims one at most to create a two-way tie for largest in his eyes. Alice, the fourth player, now chooses the piece she likes best. Choosing proceeds in the reverse order from cutting, with the proviso that anyone who trimmed one or more pieces must take one of them if any are still available when it’s his or her turn to choose. Discover Magazine – Dividing the Spoils .

7. For example, does anonymized bidding help or hinder. Once the budget has been finalized do we allow legislators to burnish their image for their core constituencies, setting up a brief anonymous post approval trading session to adjust a legislator’s purchase choices for public consumption? Swearing on a bible before the purchase session? Wildcard buyers? Dry runs?

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s