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Can Society Ever Invest Too Much in Technology?

December 1, 1996


Ron J. Feldman Senior Financial Specialist
Can Society Ever Invest Too Much in Technology?

It may seem almost impossible to overinvest in technology such as automated mortgage underwriting given the advancements brought by computerized information processing. But there is no intrinsic value to society in automating the various stages of making a mortgage. Rather, such technological innovation is only worthwhile if it improves society's well-being more than alternative uses of our resources. Normally, American society relies on market signals to determine how to allocate resources among competing uses.

The market allocation process is undercut when the government decides to subsidize a particular input of the production process. Consider, for example, what would happen if the government decided to provide free steel to all car makers. Auto makers would increase production to meet the demand for their lower-priced cars. Moreover, the cars created in the free steel world would have more steel in them then they had before. Car manufacturers would have reason to figure out how to replace a variety of more costly parts with steel. Out of this incentive could come technically impressive uses of steel. Free steel, for example, could make it financially feasible for car makers to produce a machine that makes steel tires that last longer than rubber tires.

But these great innovations in steel technology would not represent better uses of our resources. In fact, the subsidy would increase the use of steel more than could be justified by the true benefits and costs of its use. Indeed, the reason why steel tires did not exist before the subsidy was because other products provided more net benefits. While the case of steel tires is a hypothetical example, we, as consumers, come across many ideas or products that are technologically impressive but simply not worth the cost. When enough consumers have that reaction, the product or idea fails the market test and resources get allocated to projects with greater net benefits.

The warping of the allocation process described in the free steel example occurs in the case of the automated underwriting (AU) investments made by Fannie and Freddie. Fannie and Freddie's cost of raising money is reduced by the federal government's implied guarantee of their obligations. Because of the indirect cost-of-funds subsidy, Fannie and Freddie are able to raise more money to invest in products than they would be able to do otherwise. Thus, we should expect them to invest more in mortgage technology than is socially optimal. The subsidized investments in Fannie and Freddie's particular mortgage underwriting technology means that other investments that markets might judge more beneficial lose out.

This conclusion is supported by the fact that other firms that do not get the special and indirect subsidies that Fannie and Freddie receive are willing to produce AU systems. The subsidies that benefit Fannie and Freddie's AU do not ensure that AU systems are produced. Instead, these subsidies inefficiently reallocate resources from the distribution that the market would have produced.