Theory Of Externalities, And Why We’ve Come To Hate Tech Companies

Google buses yuppifying San
Francisco. Facebook creepily profiling us. iCloud giving up our pubes to hacker
paparazzi. We poured our faith and money into these companies, and now we feel
like jilted lovers.

Apple once made “the computer for
the rest of us.” OK, we always knew Google wanted world domination, but we
thought it would be benevolent. Google even told its coders, “Don’t be evil.”
We placed the tech companies on a pedestal, in a new category. They were
different from the rapacious, polluting, high-handed businesses of yesteryear.

Tech oligopolies and game
theory

I like to think of this in terms
of the famous Prisoners’ Dilemma in game theory. You’re familiar with it: Two
suspects interrogated in separate rooms, the cops having only enough evidence
to send them to jail for a short time if neither one confesses. If both
confess, they’ll stay in the slammer longer. If one confesses and rats out the
other, he will go free – unless the other guy rats him out.

In repeated plays, it turns out
best for both prisoners if, in each play, each one mimics the tactic used by
the other guy the last time around. This is known as the tit for tat strategy.[1]

Let’s think about tit for tat
between giant corporations and their customers – that is, us. The companies
treat us well, we buy their products and wear their logos. They screw us (bad
customer service, poison our municipal water, etc.), they profit more in the short run, but we boycott them and use
yelp.com to warn off other potential patsies, er, customers.

Sounds simple, but the tit for tat
strategy fails in two ways. It portrays a dispassionate mutualism, with no
place for morals or emotions. (This is why it has been used to model the
evolution of parasitic, symbiotic, etc. behavior in non-sentient organisms.) In
our, hopefully sentient, situation, after a long period of cooperative behavior
from the other party (the tech giants, or our significant other), we do develop
feelings of trust. A subsequent betrayal is a real blow.

In other words, human players
don’t get terribly upset if we are betrayed on the second play of the game. We
do get seriously out of joint if the other player cooperates for nineteen plays
and betrays us on the twentieth.

This leads us to the second
failing of the prisoners’ dilemma: The only way it allows us to retaliate is to
not cooperate in the next rounds – on the 21st play and forward, in my example
above. Economists Avinash Dixit and Barry Nalebuff aptly note, a “stronger
punishment of a cheater would be a clear deterrent.” As we want the punishment
to be clear and swift, we need a bigger response on round 21. The Prisoners’
Dilemma game doesn’t provide the needed response escalation.

There are other models in game
theory that do allow this “escalation”. They are common in military planning.
See e.g., Warburton.[2]
Though they may come into play if and as the conflict between corporate and
public interests worsens, we won’t pursue them here. We’ll turn to a still
different game-theoretic idea of escalation at the end of this column.

Externalities

An externality is the effect a
transaction has on those who are not direct parties to the transaction.[3]
For instance, if you neither own the factory nor buy its products, but it
pollutes the stream behind your house, you suffer from a “negative
externality.” If you are in business and a competing firm locates near you, you
may find it easier to recruit well-prepared employees. This effect, sometimes
called “knowledge spillover,” is a positive externality. (Of course, being too near
to a competitor can have negative effects also.)

Cynics call modern corporations
“externality-generating machines,” because the corporations’ mission is to
internalize revenues while externalizing costs and risks. That is, the corporations
create all possible negative externalities, in order to keep growing their
stock price in a brutally globalized market. If it’s cheaper for them to
pollute than to clean their effluent, then they’ll pollute, leaving cleanup
costs and public health consequences to the taxpayers. If they can get a free
bailout from the government, their CEOs will get big bonuses, even as the same
CEOs rail against the taxation that funded the bailouts.

We adored the big tech companies,
especially those in software, for being non-polluters. They gave us all these
lovely devices, made our businesses more efficient, made it harder for
totalitarian governments to hide their atrocities, and made our workdays more
fulfilling. They offered clean, safe and healthful working environments –
especially compared to the mining and meatpacking industries of old – reducing
the load on public emergency rooms and disability pensions.

Forty years ago, economist Tibor
Scitovsky[4]
noted that “consumer” is an infantile role; adults produce. This year for the first
time, young people spent more money on tech (with all its potential for
producing[5])
than on fashion (consumption items). We might say, then, that the tech industry
helped us mature as a society, and maybe even as a species.

Bigtime positive externalities,
all.

Yet the negatives have started to
pile up. Tech companies cooperate with the NSA’s spying on the citizenry.
They’ve discovered lobbying, which threatens to position them on the side of
those who subvert representative government. And Apple keeps changing those
plug connectors....

The pressure of global
hyper-competition causes our formerly beloved tech companies to become just
like any other companies.

Because the tech companies have
been with us for decades but the negative externalities have only recently
become apparent, our sense of betrayal is extreme. We will, perhaps unfairly,
wish to punish them more severely than we would other kinds of companies. Did I
say “perhaps unfairly”? Apple isn’t Comcast! Despite its shortcomings, Apple
doesn’t deserve the kind of backlash Comcast does. But emotions will drive us
to treat Apple, which appears to have betrayed us after a long lovely romance,
more harshly than we treat Comcast, from whom we learned early on never to
expect much.

Corporate social responsibility
and the bigger picture

Corporations get their charters
from the States (often Delaware or Nevada), and in return the People expect the
corporations to obey the law, pay their taxes, and create jobs. This is
bare-minimum corporate social responsibility (CSR). The next CSR step beyond
this minimum would be for corporations to reduce their production of
negative externalities.

No, I haven’t suddenly changed the
subject; I’m tying the game/escalation/externality argument to a bigger
picture. Let’s look back with rose-colored glasses on a world that plausibly
existed before the first Earth Day. (That was in 1970, for history-impaired
readers.) Environmentalists thought corporations would engage in remedial
action if the harm they were doing – the negative environmental externalities,
a term they had never heard then – were simply pointed out to them. Executives
who had not read Silent Spring 
had no idea that the planet could not recover from the pollution levels of that
era.

In the event, they persisted in the post-WWII economic-growth-at-all-costs
mentality. Environmentalists raised the ante by blocking construction projects
that threatened obscure insects that (despite the undeniable virtue of
biodiversity) no one really wanted to defend. Corporations escalated, killing
public transit projects and pouring still more CO₂ into the
atmosphere. Environmentalists exaggerated and even fudged data on global warming,
which is real, and corporations then engaged in more vociferous climate change
denial.

We now see an outcome in which climate change denial is a result of both of the kinds of
escalation recognized by game theory: The 2-party escalation of hostilities analyzed
by Warburton and others, and the psychological self-escalation proven by Staw.[6]
Staw investigated people’s behavior vis a vis what operations research
people call the sunk cost fallacy, and what ordinary folks call throwing good
money after bad. Staw showed that people do it, and continue to do it, long
past the point of obvious irrationality, and past the point at which the loss
is irrecoverable.

In just this way, if polluters and
environmentalists could have cut through the crap earlier, it would have saved
a lot of grief. Now, neither side can back down. The cost of remediating the
damage done by some corporations, if assessed by a court, would exceed the book
value of the corporation. No CEO can afford to admit that.

I may fall into the same fallacy
as I contemplate abandoning my 30-year loyalty to the Apple brand and
converting to, well, not Windows, but Android. Yet I have all those programs
and accessories for the Mac and iPhone...

I even have an iPad, heaven knows
why. A machine suitable only for consuming content, never for creating content,
and Apple had the chutzpah to try to sell it into the educational market, where
we professors want our students to create. The iPad is a giant step back from
putting productive resources in hands of “consumers”. (It lets us consume
content more efficiently, I’ll give it that.)

Naturally, as environmental
problems worsen, new companies will sprout up to remediate. We’ll hail as
heroes any companies whose products reduce environmental damage. Tesla, anyone?
Time will pass, investor pressure will intensify, and those well-intentioned companies
will become... just companies. The corporate interest and the public interest
will remain at odds.

I’ve aimed in this column to
explain, via the theories of games and externalities, why this happens. Sorry
to say, I have no solution. I do hope analytic explanation will be, as it often
is, the first step toward making improvements possible and that many good
thinkers will take up the challenge.