In each of the last two weeks the IEA has hosted panel discussions in front of packed houses. Last week the topic was public sector pensions and this week it was the Third Heathrow Runway. Economics is not well regarded in today’s Conservative Party as a tool for approaching economic problems – many public statements have been made by leading figures in the Party to the effect that the 1980s was the decade when the economy had to be fixed but now other things have to be fixed. This takes a rather narrow view of economics and ignores the fact that most problems have their economic aspects even if, on the face of it, they are not fundamentally economic issues. With regard to public sector pensions and the Third Runway there is a lot of thrashing around by politicians (I don’t just refer to the Conservatives now) but a simple economic analysis can at least provide the basis for a solution in both cases.
With regard to public sector pensions all that needs to happen is for the Treasury to start charging public sector employers (schools, hospitals etc) the true cost rather than the supposed cost of pension benefits. Then there will be strong incentives for both employers and employees to sort the situation out. Employers will have the carrot of cutting costs; employees will have the carrot of cash replacing an expensive benefit in kind if pension benefits are changed. With the Third Runway why not do something radical along the following lines? Let’s accept that the right to cause current noise levels are a property right that belongs to BAA – after all most people have bought their houses near the airport knowing that they will be affected by noise. A way will have to be developed of determining who is affected and appropriately weighting noise at different times of day but that would not be difficult. If BAA wishes to create any more noise or affect new groups of people it should have to buy the right to do so from affected residents. An institutional mechanism would have to be found to facilitate this process – this could be through local councils or directly with representatives of local residents. If the compensation local residents demanded was higher than BAA was willing to pay then the Third Runway would not get built. If it was lower than BAA was willing to pay then the parties would have an incentive to settle. BAA could then charge airlines for slots according to how noisy their planes are, so the incentives then get passed all the way down the line to the engine makers.
Of course, this mechanism is not perfect (though it is difficult to see the problem of using economics to resolve public sector pension problems). The greatest difficulty would be that different local residents would put different values on noise reduction. However, at least the incentives would run in the right direction. We would have a well defined property right. BAA could buy more of that property (the right to make noise) but would have to purchase that right from local residents. The winner takes all approach to planning in this country is a disaster as far as large infrastructure projects are concerned – the Channel Tunnel Rail Link is another example. Defining property rights and charging prices provides incentives for these problems to be sorted out where the information is to be found – amongst businesses and the people – instead of in Whitehall. Three cheers for economics!