Let's look at a real-life example of how markets can solve problems and increase efficiency in a context you might not expect it. Food banks. We've talked about how economics is everywhere, about people following their incentives, rationally, doing the best they can do to make themselves as well-off as possible. And that's true even when talking about charities and helping others. This lecture is based off of a recent paper by Kennis...
Prendergast, an economist at the University of Chicago, that talks about his work with Feeding America, which is not only the largest food bank network in the country, but the third largest charity overall. Now, before 2005, Feeding America assigned supplies to individual food banks through central planning. Donations of food would come in, generally from manufacturers or retailers, and the staff would use an algorithm to decide how it would be distributed among the roughly 200 local food banks.
Pounds of food would be allocated based on measures of poverty and population, over 200 million pounds of food a year. When a load of food came in, Feeding America would tell the food bank to which it had been assigned by the algorithm that they had it, and the food bank could either accept or reject it. If they refused it, it would still count as having fulfilled part of their need.
So food banks had incentives to accept loads that they didn't want or need. Was this centrally planned system a good way to allocate food? You'll notice that what the food bank actually wanted wasn't factored into Feeding America's decision at all.
Feeding America decided what was best without knowing what the food bank wanted or needed. So you ended up with a food bank in Idaho being offered potatoes, or ones with insufficient freezer space being sent a large load of frozen meals. Also, all food was treated equally. A pound of chips was the same as a pound of chicken. Transportation costs, nutritional value, and local preferences didn't play any role.
So what did Prendergast and his colleagues do? They went back to the principles of economics. Consumer choice is all about willingness to pay. And rational people will optimize using all of their available information to get the best allocation they can.
But in the world of food banks and charities, you can't really just slap prices on food and let the market sort it out. Or can you? They designed a system in which food banks were allocated a currency called shares that they could use to bid in an eBay-like system on loads of food. Feeding America assigned the shares to food banks based on their need to avoid the danger that the most needy areas wouldn't have enough purchasing power.
and they adjusted the number of shares over time in response to changes in needs. Food banks could bid on loads of food, as you can see in this image, and decide whether or not to bid. Shares could be saved up to purchase more desirable products, and food banks can even borrow against their future shares to purchase more now.
And shares that were spent on a given day were distributed back to the food banks based, again, on their need. Food banks could even bid negative amounts for undesirable loads, basically being paid to take it off feeding America's hands. Now, of course, in reality, the system is more complicated than I'm describing, but this pretty much covers it. This system had the potential to solve the problems of central planning.
A food bank that wouldn't be able to use or didn't need a particular load didn't have to take it. In fact, they benefited from being able to save their shares for a future purchase. And prices could adjust to reflect the fact that some types of food are much more valuable than others. Did it work? Yes, incredibly well.
Prendergast shows in his academic research that food banks got more and higher quality food than they did under the old system, and that the allocations were much more efficient in terms of whether food went to places with high need. But not only was the demand curve from food banks helped by the system, the supply curve of donations was affected too. Because Feeding America could distribute food more efficiently, They were able to accept more donations, where previously they might have had to refuse some.
Overall, it looks like there was an increase in the supply of food by enough to feed an additional 100,000 people per day, every day, compared to the old system. Prices are important. They serve as signals and as incentives.
Under the old system, the price of a pound of food was the same, irrespective of how desirable the food was. Allocations were based on what Feeding America thought a food bank needed, not what they thought they needed. Under the new system, we know that peanut butter and cereal are much more valuable than potatoes and pickles. Loads are allocated to the highest value consumer, creating the most surplus possible.
Central planners suffer from what Nobel laureate Friedrich Hayek called the knowledge problem. A central planner or a committee of planners can't ever possibly have all of the information necessary to make decisions about how many pounds of frozen peas should go to a food bank in central Texas. Does that food bank have space in their freezer? Do they have a lot of close substitutes like canned peas in their pantry? Do their clients even like frozen peas?
Multiply the amount of necessary information for each transaction by the entire economy. and you can quickly see how impossible it is for central planning to be efficient. Markets work because people are following their self-interest.
If that central Texas food bank wants frozen peas, they can bid for them. If lots of other food banks also want those frozen peas, then their price in terms of shares will go up, and the food bank that values the most will bid the most shares. There's a great quote in Prendergast's paper from the head of one of the major organizations working with Feeding America, John Arnold.
Arnold was skeptical about the choice system, though once he saw it in action, he became one of its biggest supporters. And he said, quote, I am a socialist. That's why I run a food bank. I don't believe in markets.
But the great thing is that you don't have to believe in markets for them to work anyway.