Tragedy of the Commons

Note from Chris:

I got to thinking last night that the current fiscal crisis that has the nation in an uproar is a variation of Tragedy of the Commons that many of us learned about in Economics 101.
 
A refresher from Wikipedia:
 
The Tragedy of the Commons is the title of an influential article written by Garrett Hardin, first published in the journal Science in 1968.[1] The article describes a dilemma in which multiple individuals acting independently in their own self-interest can ultimately destroy a shared resource even where it is clear that it is not in anyone's long term interest for this to happen.

Central to Hardin's article is a metaphor of herders sharing a common parcel of land (the commons) on which they are all entitled to let their cows graze. In Hardin's view it is in each herder’s interest to put as many cows as possible onto the land even if the commons is damaged as a result. The herder receives all the benefits from the additional cows but the damage to the commons is shared by the entire group. If all herders make this individually rational decision, however, the commons is destroyed and all herders suffer.

This one might be called the Irresponsible Forest Owner.  If I live in the forest together with my neighbor and he is very careless about fire – what is my response when he sets fire to his property?  My instincts are “You need to live and learn from your own mistakes.  If your house burns to the ground, perhaps you will be more careful next time.  This is the natural consequence of your actions.”
 
But then I watch the fire getting ready to spread into the rest of the forest including my property and so I reluctantly go to his rescue.  I am angry, I have violated my principles of self responsibility but my only other choice was to watch the entire forest go up in flames.   Grrrrrrrr.
 
I sense the great majority of Americans are against the bail-out.  But I also sense that the great majority of Americans don’t believe that the “fire” has any possibility of spreading to them.
 
So ultimately it gets down to whether a person believes credit will dry up because of the fear created by this sleazy affair.  Let me relate a conversation I had the other day with our local banker who chaired my advisory committee.  He said simply--people are pulling their money out and taking it home.  He is a profitable bank but now he is less liquid and less able to meet his legal requirements.  He doesn’t want to but now he cannot make as many future loans and is starting to call in current loans.  Did the far away fire on Wall Street spread to his property simply through fear?
 
So here’s how it could play out.  The bank’s got less cash in it.  The local business person last week was profitable… but that depended upon the credit of the bank.  He now has less wiggle room and starts to shorten his net terms from 45 to 30 days or less.  He needs the money to make payroll and pay his own expenses.  This then backs into his customers who either buy less or start to stow more money in the safe deposit box.
 
It’s exactly the same issue FDR faced when he said “The only thing we have to fear is fear itself.”
 
And so it spreads…everyone profitable under the existing conditions, no one wanting to dry up credit, but everyone forced to do it to stay alive, simply because of fear.  The individual rational decisions of each business person and customer (regardless of their opinions about the crisis), just keep tripping down the system like falling dominoes.  This is similar to an electrical blackout when a single failure causes each inter-related network to go into a defensive mode to protect itself, further exacerbating the problem down the line.
 
When the entire economy gets turned upside down by fear, its really hard to get it upright again.  Each person in the chain has to again loosen up credit but no one person can do it on his own…otherwise he goes under.  Getting everyone to agree to loosen up at the same time is nearly impossible—it took the overwhelming forced production of WWII to get us free from the Great Depression of 1929-1941.
 
So here’s the big question --  Has the fire spread beyond irresponsible Wall Street? Has fear been turned loose in the land?  A whole bunch of people in Congress are debating that question today.
 
Frustrating when you have to swallow your principles because of systemic characteristics.
 
At least I think that’s the way it works.
 
Chris Gibbons
Littleton, Colorado