Suppose you are a government that thinks some policy will be good for your populace in aggregate over the long-term (that is, it’s a Kaldor-Hicks improvement). For example, perhaps some tax reform you’re excited about.
But this reform (we assume) is quite unpopular with a few people who would suffer concentrated losses. You’re tempted to include in the policy a big cash transfer that makes those people happy (that is, making it closer to Pareto optimal). But you’re worried about levering up too much on your guess that this is a good policy.
Here’s one thing you can do. You auction securities (that is, tradeable assets) that pay off as follows: if you raise $X through auctioning off the securities, you are committed to the policy (including the big cash transfer) and the security converts into one that tracks something about how well your populace is doing (like a share of an index fund or something). If you raise less than that, the owner of the security gets back the money they spent on the asset.
Ignoring some annoying details like the operational costs of this scheme or the foregone interest while waiting for the security to activate a branch of the conditional, the value of that security (which should be equal to the price you paid for it, if you didn’t capture any surplus) is just the value of the security it converts to.
(Solve (Probability($X is raised)×Value of the security it converts to) + ((1−Probability($X is raised))×Price you paid for it) = Price you paid for it)
So this scheme lets you raise the cash for your policy under exactly the conditions when the auction “thinks” the value of the security increases sufficiently. Which is kind of neat.
Suppose you are a government that thinks some policy will be good for your populace in aggregate over the long-term (that is, it’s a Kaldor-Hicks improvement). For example, perhaps some tax reform you’re excited about.
But this reform (we assume) is quite unpopular with a few people who would suffer concentrated losses. You’re tempted to include in the policy a big cash transfer that makes those people happy (that is, making it closer to Pareto optimal). But you’re worried about levering up too much on your guess that this is a good policy.
Here’s one thing you can do. You auction securities (that is, tradeable assets) that pay off as follows: if you raise $X through auctioning off the securities, you are committed to the policy (including the big cash transfer) and the security converts into one that tracks something about how well your populace is doing (like a share of an index fund or something). If you raise less than that, the owner of the security gets back the money they spent on the asset.
Ignoring some annoying details like the operational costs of this scheme or the foregone interest while waiting for the security to activate a branch of the conditional, the value of that security (which should be equal to the price you paid for it, if you didn’t capture any surplus) is just the value of the security it converts to.
(Solve (Probability($X is raised)×Value of the security it converts to) + ((1−Probability($X is raised))×Price you paid for it) = Price you paid for it)
So this scheme lets you raise the cash for your policy under exactly the conditions when the auction “thinks” the value of the security increases sufficiently. Which is kind of neat.