Dworczak: Between the market and the state

Dworczak: Between the market and the state

Justyna Orłowska: Greater awareness of inequalities seems to be something of a new trend in economics nowadays – is that right?

Piotr Dworczak: We are certainly seeing a surge of interest in this topic. Until recently, inequalities – especially in my field, which is microeconomic the- ory – remained on the fringes of scientific consideration. Today, more and more scientific fields are paying attention to this important issue.

The question we address in our ERC-funded research is this: How should markets be organized and how should valuable social resources be distributed, given the systematic inequalities between market participants? Classical economic theory, of course, deals with the problem of resource allocation, but it often implicitly assumes utilitarianism – the idea that we should be striving to maximize the sum of the utility of all members of society. Therefore, it does not distinguish any particular group that we are most concerned about: everyone carries the same social weight. It does not consider who is important from the perspective of a particular social goal. In practice, however, the point of many social policies is specifically to reach out to marginalized individuals, those most in need of assistance. If we take the goal of improving their material situation seriously, the conclusions reached by classical economics must be modified. One of them, for example, is the conclusion that a free market is the best way to allocate resources. We show that this is not always the case – that under certain conditions, the way the market operates can be designed to better serve those who are marginalized.

And what methods do you use?

We use mathematical modeling in our research. We try to formalize these considerations with mathematics, essentially focusing on solving an optimization problem. We examine how resource allocation should be optimized, under the assumption that we care more about the welfare of the poor than that of the rich. A good example of a problem where such mathematical modeling is applicable is the current steep rise in energy prices in Europe. After Russia’s invasion of Ukraine, electricity prices soared and it became apparent that the poorest households might find themselves unable to pay their bills. In response, most European countries introduced various types of interventions based on artificial price reductions. This runs against classical economic theory, where natural market processes should not be tampered with. However, in our theory, the primary focus is on the social goal of protecting the poorest people. This makes it possible for different types of political solutions and tools (such as price controls or subsidies) to be better differentiated and understood, and we can also test out which ones are most effective.

As for subsidizing energy prices, it turns out that lowering energy prices without properly considering consumption levels is a bad idea. A much better solution is to offer price discounts up to a certain level of energy consumption (which can be determined in a mathematical model) and apply price increases after that level is exceeded. If the levels are correctly calibrated, poorer individuals have the option to slightly reduce their consumption and pay lower bills. On the other hand, wealthier individuals, who might not even pay attention to how high their bills are, will pay more, effectively financing discounts for poorer individuals. With such an approach, it becomes possible to genuinely help the poorest individuals while not excessively disrupting the market system.

Where else does the problem of resource allocation appear?

Another example is the distribution of vaccines during COVID-19. Facing the pandemic, the world’s governments completely abandoned market mechanisms. Most countries decided to distribute vaccines for free – but distributed them to people in an order that raised certain questions. The paradox was that the allocation of vaccines between countries was still determined by a classic “wild” market, which resulted in poor countries getting them very late or not at all. The criteria adopted in Poland, for instance, to determine who would receive vaccines first were very coarse. A few priority groups were identified, but within those groups, the order of access to vaccinations was more or less random, based on who happened to show up at a particular time, who happened to know where vaccines are available without queueing, etc. This was neither fair nor socially useful.

The first example we have discussed, involving energy prices, is an example of gentle interference with the market system. The second, involving vaccines, is the complete circumventing of markets. But these are not the only possible approaches. It is possible to find a compromise between these two approaches, which may make the most sense. Continuing with the COVID-19 example, we might all have agreed that doctors need to be vaccinated right away, because they are crucial and at the same time the most vulnerable. For the rest of the population, on the other hand, some sort of not-too-high price could have been set, which would have gradually declined over time. Then people who really wanted to get vaccinated for various reasons could have been the first to do so, while those who cared less would wait until prices come down.

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