Are Externalities an Intellectually Sound Bridge Between Us and Them?
When Princeton’s Roland Benabou visited GMU a couple weeks ago, he made an argument I’ve occasionally heard before: Non-economists would disagree with economists less, and respect our views more, if we put more emphasis on the concept of externalities. When economists talk about markets, the argument goes, we usually seem tone deaf to non-economists’ concerns. If we put more emphasis on the concept of externalities, non-economists could see that it is easy to translate their concerns into our language – and that we have every reason to take their concerns seriously.
As a rhetorical strategy, Benabou’s probably right. Non-economists are much more anti-market than economists. If we told them that the economic way of thinking is consistent with (or better yet, justifies!) their anti-market prejudices, we’d be more popular.
But is this an intellectually sound way to bridge the divide between economists and non-economists? I think not. If we explain the concept of externalities properly, non-economists will continue to give us the cold shoulder. Here’s why.
1. The concept of externalities relies entirely on economists’ standard notion of willingness to pay. If people are willing to pay to preserve a rare species of monkey, there may be an externality. If no one cares, there’s no externality. The upshot is that the concept continues to slight non-economists’ concerns about fairness, intrinsic value, equality, etc.
2. If an externality exists, the economically efficient solution is normally a tax or subsidy. That’s it. But non-economists are usually looking for an excuse for government to ban or nationalize. At minimum, non-economists want to use hands-on regulation – not just add a tax and say “OK, problem solved.”
Someone who uses an externalities argument to justify e.g. existing (or stricter!) EPA regulation doesn’t really understand the argument.
3. The concept of externalities focuses on non-excludable costs and benefits. The upshot is that we can go down the list of e.g. environmentalist causes and pick out a major subset that probably don’t qualify as externalities problems. Recycling? If people are paid the market value of what they recycle, it’s hard to see the externality. National parks? If user fees can’t sustain them, you have to fall back on a lame “existence value externality” story.
4. Most fundamentally, externalities can afflict any social institution – markets, governments, non-profits, etc. So there’s nothing inherently anti-market about the concept. You can use externalities arguments to complain about auto emissions. But you can just as easily use the concept to complain about voter irrationality. If the externalities of government decision-making are severe enough, externalities provide an efficiency argument for living with market failure rather than doing something about it.
Bottom line: If economists are upfront about all of this – and we should be – the concept of externalities is not going to make us many friends. Economics has a lot of unpalatable lessons to teach. Our job is to teach them nonetheless.
The post appeared first on Econlib.
Getting people to like economics is a favorite subject of mine.
I think the most attractive free market concept for non-economists is "comparative advantage."
It was for me, anyway. But I'd like to know if it was for other commenters here on Bryan's Blog. The example that did it for me was the boss who could type faster than his secretary, yet finding it profitable paying her to do that. Is there a way to show how "comparative advantage" enables individuals, countries (or ethnic enclaves) to all benefit with fewer transaction costs imposed by the government?
The externality that most concerns those who are least likely to be economists is inequality. It is a religion even for those who proclaim loudly they are atheists. The assistants profit less than the boss, in the "comparative advantage" example and that results in inequality. But at the same time, it can be seen that if the government forced him to pay more he would not employ as many assistants and that means a society where there are no specialists; everyone has to do everything. I think why an understanding of comparative advantage is of value is because of how natural it is for the boss not to do something. It would never occur to the boss to hire an assistant if the government made him pay the assistant as much as he pays himself. "It would never occur to the boss" leads to the concept of choice based on what advantage is it to the boss. Just as it would never occur to the boss to hire an assistant in one scenario, it "would" occur to him (in the absence of government force for equality) to find someone who could do what he can do even if not as well. That would help the non-economist to see the concept of "willingness to pay" as well as "living with" the externality of an inequality.
Ron Allan
PREAMBLE: The purpose of an externality charge is NOT to raise revenue (to compensate losers). It is to influence decision making. The decision maker faces the full social cost of his/her decision. Any revenue raised can be burnt! The social cost of burning the money would be the destruction of some slips of paper (or, more accurately, the cost of paper and ink to reprint).
Externality charges eliminate the externality. There is no longer an externality to be compensated.
MY SUBMISSION: I’m puzzled by the claim that the “concept of externalities relies entirely on economists’ standard notion of willingness to pay.” WTP is useful for valuing some externalities, but by no means all.
Take road collision externalities. A collision results in costs that can be quantified without resort to WTP. Emergency services. Vehicle recovery and repair. Loss of productive output for those injured.
Then there is loss of life. We do not value a “life”. Lives are not traded. We value risk reduction, using WTP to do so.
Suppose I would pay $10 more for a ticket on a airline because it has a better safety record than the alternative. The difference between my preferred airline and the next best option is 1 in 100,000 chance of a fatal crash. If, notionally, 100,000 people paid this premium the total paid would be $1M. The expected benefit would be the preservation of one life. Hence the sloppy statement “value of life is $1M”.
I drive a battering ram of a vehicle, which in a head-on collision favours me. My decision has external effects on other road users, such as you. You may elect to drive small car. Small cars are more collision-involved, so your decision increases my odds of being involved in a collision. I solved this conundrum 30 years ago using differential calculus to derive externality charges that internalise the externalities.
Out of interest, I showed (30 years ago) that New Zealand trucks should be levied a fee of 5 cents a kilometre. When I retire (I’m 83) I’ll get around to publishing this work.