Peruvian Wonder Retains Beauty Despite Destructors

I dream of one day visiting every single wonder of the world. Last December, I was able to cross Machu Picchu off my list. It was remarkable.

But in the process of arranging the trip, I was surprised to see the immense amount of regulation placed on the historical site and the city it resides in. Machu Picchu is in a city called Aguas Calientes in Peru. As tourism has begun to increase at an exponential rate, the country has taken precautions to mitigate its effects. While these regulations can be annoying at times, it’s important to understand why they exist, why they continue to become more stringent, and how they contribute to economic efficiency. This understanding comes first from recognizing the effect that the business of tourism at Machu Picchu has on the site itself. Tourism can present huge negative externalities on the site of Machu Picchu and the village its entrance resides in. These externalities are driven by tourist consumption. Therefore, I argue that the massive crowds at Machu Picchu present a negative consumption externality. The thousands of tourists who enter the ruins of the ancient Incan civilization can be somewhat unsurprisingly, extremely destructive: they climb structures, erode the land, take stones, and damage the area. (Not to mention that it's virtually impossible to get a photo without these tourist hoardes in it.) Which, in turn can hinder the experience for future visitors. But that’s not where their impact stops. The thousands of tourists that flood the village of Aguas Calientes everyday make life for those who reside there permanently difficult. While tourism accounts for a huge portion of revenue for the village, it also causes massive overcrowding.

But the concept of this negative consumption externality at Machu Picchu isn’t a new one. Peru has been trying to mitigate it for decades and continues to do so through both regulation and price hikes. For instance, in addition to regulating the number of people allowed to enter Machu Picchu, Peru also controls when they may enter/leave, how long they may stay, and how quickly they must complete their hikes of Huayna/Machu Picchu mountain. These regulations literally limit the number potential destructors of the citadel by putting a cap on consumption. What makes these regulations even more effective are the high prices that come along with them. To get to Aguas Calientes, you often must take a plane, bus, and a train—all with individual ticket prices. After you get there, a single bus ticket to get up and down from Machu Picchu can cost anywhere from $50-$75. Once you get to the top, entering the ruins costs another ~$50. If you want to do any of guided hikes, that costs ~$100 and needs to be completed in under 4 hours. These price hikes partnered with stringent regulation limit the number of people who can afford to travel to Machu Picchu and thus limit consumption of the area, thereby mitigating some of the negative externalities it imposes and preserving the beauty of the Machu Picchu ruins for a little longer. Hopefully long enough for the next one of us wandering wahoos to visit.

Machu Picchu (2017), Wandering Wahoo Collection; Sabrina Grandhi

Cattle and Methane

Our discussion on externalities and Robert Coase’s analysis of the interaction between a cattle-producer and a farmer reminded me of a similar issue regarding global warming that I studied in high school. For meat-lovers, including myself, a nice 12-oz New York Strip steak is a delicacy. However, the production of livestock, like cattle, to feed the large community of meat-lovers results in a strong example of a negative production externality. Cows produce methane, a powerful greenhouse gas that contributes to the rise of global temperatures. Clearly, then, the social marginal cost (SMC) of raising cattle for human consumption equals the private marginal cost (PMC) that the producer of the cattle is responsible for when raising livestock plus the additional marginal damage (MD) that the release of methane places on the environment and our wellbeing. If no action is taken, there will be an overproduction of cattle and even greater amount of the greenhouse gas being released (Q_{AE <} Q*). To fix this problem, what should be done?

If we lived in a world where everyone loved a good New York Strip, then the social marginal benefit of producing cows for consumption would certainly outweigh the social marginal cost of the methane being released into the atmosphere. Unfortunately, for all meat-lovers, this is not the case. A bargaining solution would not be feasible in this situation because it would lead to both a free-rider and a holdout problem- there are just way too many people that are either liable or not liable to find any clear consensus. Hence, there needs to be government intervention beyond assigning property rights, in the form of taxes, regulations, and subsides. The article Meat Is Horrible articulates government intervention in the form of a “meat tax”. Another solution could be regulations aimed at capping the number of cows a farm can grow in order to control the levels of methane being released. Finally, subsidies could be used to incentivize farmers to use a certain type of feed that will reduce the amount of methane released by the cattle.

Meat is not horrible, but a solution needs to be found to alleviate the effects of the negative production externality caused by the growing of cattle for consumption.  

Application of Coasian Theory in India

This summer, I was able to listen to a presentation by Shruti Rajagopalan, an economist whose primary interests include public choice and development economics. In her presentation, she discussed Gurgaon, a city in India with a population of approximately 2 million. Gurgaon, unlike typical cities in India or around the world, has developed over the past thirty years through the private provision of goods that are typically funded by the government, such as infrastructure, transportation, and security. Rajagopalan’s paper with George Mason economist Alex Tabarrok about the topic can be found here.

This city, where private firms fund public goods based on their individual demand curves, gives us an interesting scenario with which to study externalities. Without government intervention to solve market failures through taxes and government regulation, they are left to Coasian solutions to solve market inefficiencies. These inefficiencies will persist if the Coasian theorem of ‘internalizing the externality’ fails. If we assume that property rights are well defined within the city (not an entirely accurate assumption but reasonable enough to tell the story), then Coase’s theory suggests that bargaining will bring about the socially optimum quantity of desired goods. This may work in certain markets, but Rajagopalan and Tabarrok’s paper suggests that large-scale infrastructure such as sewage and electricity are lacking. This is likely due to the free-rider problem, because there are a large number of individuals in the city, each of whom shares the responsibility of funding the public goods. Therefore, large-scale goods such as sewage will see underinvestment, and waste treatment plants will be operating below the allocatively efficient quantity.

Gurgaon has grown faster and seen relatively more corporate success than most other areas of India, but its private model still has issues such as that which I discussed above. I think that this topic of private provision vs. government solutions is quite interesting, and you may see me bring up this example again if it relates to any future posts about public choice.

The Negative Externalities of Corporate Culture

In our class these past two weeks, as well as in the 2010 discussion sections I am teaching, we have discussed the classic examples of externalities - pollution, parks, smoking, etc. However, another interesting (and relevant) market failure is that of companies with sub-optimal levels of cultural capital. In “The Economics of Why Companies Don’t Fix Their Toxic Cultures,” Kevin Stiroh defines cultural capital as a form of investment subject to market failures that explain why companies often fail to address poor corporate cultures. Investing in cultural capital reduces employee misconduct risk, just as investing in physical and human capital reduces liquidity risk and operational risk. The higher the cultural capital, the lower the misconduct risk and the greater alignment between a company's business outcomes and stated values. On the other hand, stated values and employee behavior differ in firms with low levels of cultural capital, yet many companies (like Uber until 2017) do not invest in cultural capital to mitigate this misconduct risk.

Firms do not invest in cultural capital for a variety of economic reasons relating to market failures. Externalities is one of them - employee misconduct creates externalities like lost consumer confidence in the firm and in the entire industry. This requires the assumption that consumers lose confidence both in firms with negative corporate cultures and in the overall sectors of these misbehaving firms. For example, a few powerful financial institutions made consumers lose trust in the entire financial sector during and after the Great Recession, and a few high-profile tech companies have led many people to question the values of the tech industry as a whole. Therefore, individual firms do not always incur all of the costs of their own misconduct. This leads to a negative production externality - firms with low cultural capital impose a negative externality on third parties, like other companies in the industry that have high cultural capital. Since these firms do not bear all of the costs of their negative corporate cultures, they do not take appropriate action to reduce their misconduct risk.

Market failures have implications for many business decisions beyond our typical examples of farmers and cattle-raisers. Negative corporate cultures, from financial irresponsibility to sexism, and companies’ unwillingness to improve them can be explained in part by uncorrected negative externalities.

Engaging in political activity and the free rider problem

This past week, I spent some time volunteering for a local political campaign in Charlottesville. It strikes me that the efforts of anyone volunteering for a political campaign may in fact have positive externalities, a perspective I hadn’t yet considered. Assuming one is volunteering for a candidate who supports policies that are socially optimal – or at least more socially beneficial than those of their opponents (very big assumptions, to be sure) – a volunteer’s work on behalf of a campaign can create benefits for society. As a volunteer puts in more work, they may sway more voters, and increase the likelihood that their candidate gets elected. The benefit from each additional hour of of unpaid work from a volunteer is shared by all of a candidate’s constituents who benefit from the policies they might implement once elected. In other words, that extra hour of work has a greater social benefit than the private benefit which the volunteer alone receives by volunteering.

An implication of this is that volunteering on political campaigns will be underproduced, because many people would have an incentive to “free ride,” benefitting from the volunteer work of others who help elect the preferred candidate. Of course, this implication comes from assumptions in an ideal world: the assumption that one candidate has consistently socially optimal policies; the assumption that those policies benefit a large proportion of their constituents; the assumption that more volunteer hours consumed leads to a higher likelihood of the candidate winning; and the assumption of perfect information availability about the impacts of a candidate’s policies. In the real world, many of these assumptions don’t hold, and individuals’ policy preferences are highly subjective. This is the difficulty with social benefits and costs: they are very difficult to measure and to account for differences.