Negative Externalities
In my free time I play a game called “World of Warcraft” it’s your typical massive multiplayer online (MMO) game. MMOs (as they’re commonly referred to) are centered on providing an expansive gaming experience predicated around playing a game with thousands of other players. This provides many advantages over the traditional gaming experiences but has many drawbacks.
Almost every drawback in an MMO comes down to one economic principle: negative externalities.
Definition: An externality is an effect of a purchase or use decision by one set of parties on others who did not have a choice and whose interests were not taken into account. ~ Provided by About.com
The Warcraft Example
In the game there are 3 types of play which comprise the product offering.
World: Just the run of the mill environment generally geared more towards single player and leveling up of the character.
Instance: Typically used to gain the character some additional gear, interaction between 5 players, not terribly useful once the character has progressed to the raiding category.
Raid: Support for 10 to 25 players “end game content”. This is where the majority of players fall currently in the game.
Blizzard the company that was running the game decided they wanted to change the dynamics of where people devoted their time as the instances were being under-utilized. So they added a new purchasing option wherein people could run the instances and use tokens to buy the Raid gear.
On my server and many others there was already a problem with getting into instance servers as there are just too many players to be accommodated by the server hardware. Once this change went into place every player made the same decision that they should run more instances, and you guessed it no one accounted for how the increase in utilization would impact everyone else.
Waiting over 20 minutes to get into an instance was not uncommon after it, during the first few weeks. This obviously has a business impact on the company either through customer satisfaction or lost subscribers.
Just not a great experience.....
Real World Example
When George W. Bush came into office he created legislation to remove capital gains taxes from dividends. Due to this there was a strong outpouring of cash to investors from companies. The most egregious example of this was probably WAMU, Bear Stearns, and AIG all of who gave out nearly $90 Billion dollars in dividends and stock buy backs in the 12 months preceding their collapse.
In addition to the legislation impact the banks also were falling prey to other negative externalities due to over utilization of sub-prime mortgages. With each additional house foreclosure, or drop in a home price they saw their entire fleet of home loans reduced asset value.
Take-Away: I’ve only covered what a negative externality is in this post but all businesses should be considering externalities in business planning and decision making. When making a change ask yourself how stakeholders will interpret it, try and predict changes in behaviors and incentives. Additionally look at your traditional offering and determine if there is an incentive structure you can change to address externalities in your business.
In Blizzard’s case they incentivized an area with a known negative externality, they could have incentivized players to utilize the world content by rewarding tokens there and it wouldn’t have had a negative impact.
You are not going back far enough. The financial restrictions were relaxed during Clinton’s second term. Some of it was even included in the Nafta legistation (again a Clinton product). These failures that caused the global financial crisis can be traced to a bi-partisan failure. Also, you cannot just focus on dividends. Let’s discuss the bankruptcy rules that were changed during this time. The government put the interests of private corporations before the interests of society in general. While it was sold as a deal to make it harder for deadbeats to get out of their debts, what it actually did was remove control on these financial institutions. The financial instruments were confusing, the laws were favoring the corporations ability to make these risky investments, and the auditors were asleep at the wheel. It is a multi-faceted failure that we will be studying for years to come.
There is a much bigger problem. Another crisis is looming, and not many people are willing to talk about it. We had the internet dot com bubble, followed by the mortgage crisis… but these will pale in comparison to the disaster of the credit card market failure. Insiders studying economics agree that the culture has gotten too far into debt, and banking institutions have had little accountability. While additional focus has resulted out of the mortgage issue, very little has come back to the organizational design of the credit markets. It may be five years or seven years out, but it is coming.
How do you get out of it? The Democrats will buy banks and the Republicans will give you a tax break, all in hopes that you will pay off your credit card debt. With reported unemployment at 10% (and unreported figures estimated much closer to 20%) there is no way that will happen. We need fundamental change (not just Obama lip-service) from the top down. I pray that the Republicans can find something better than Sarah Palin to address this need.
I’ll conceed since I don’t have an accounting degree and quite honestly wasn’t as interested in fiscal policies in my formative years.
I definately think your perspective is solid. I too am very concerned by how we get out of this crisis.
My defacto position since before Bush’s second term was we needed a Jimmy Carter as our new president. We need a do nothing president to allow time for these wounds to heal. I dont see buying banks or reducing taxes as solid answers.
My thought lies more in growing out of this problem, and taking a tough love approach. Was I ok with bank bailouts last year? No, because I felt if tax payers money should go into it then every single loan that was in jeopardy at the banks should be eligible for refinance at a prime + nominal amount. Instead we got JP Morgan Chase, and Wells Fargo earning billions in profits just a couple quarters after they were in “crisis”.
Anyways I like you pray for answers, even if I pray to a different party to find them lol.