Wednesday, January 26, 2005

Dr. Henochowicz wrote, regarding this post:

Thanks for reading the blog. Externalities are thought of as "market failures" in economics textbooks. When externalities are positive, such as when a person benefits from the activity of others without having to contribute to that activity, there is no incentive on the part of the passive, unintended beneficiary to change. Why would there be? The benefiting person is a "free rider". As regards to government involvement, what other organization could have the authority and universal representatation to correct the externality? The remedy need not be with taxation. For example, companies are given pollution credits based on the amount they pollute. Those that pollute more can purchase credits from less polluting companies. The polluting companies don't need to retool if they don't want to, and the "cleaner" companies make some extra cash from selling the credits. Economists also increasingly feel that incentives are preferable in correcting externalities as compared to taxation (the honey/vinegar thing).

Stuart, I appreciate your response and am enjoying this conversation.

Why would an externality be defined as a "failure" of the market, as opposed to a result of the market that doesn't have a quality of success or failure independent of the opinion of each viewer? I think this consistent with definitions I have found of externality, here and here.

Look at the internet. The existence of the internet as we view it is an externality of the creation of ARPANET by the Defense Department. I don't know of anyone who would be seriously regarded if they felt this was a "market failure."

Your example of pollution, for one. One may view industrial pollution as undesirable, fair enough (and a view with which I agree.) Most would recognize that the industrial activity, and as a result the pollution, is an effect of the marketplace. A factory making cars pollutes as a result of the marketplace desire for the cars. If the buyers viewed the pollution as more undesirable than the car made at Factory A, they could switch to cars produced at Factory B, a factory producing less pollution. This would be the market in action.

Free market results are not, in and of themselves, "failures" or "successes." These are value qualifications place on the results by an interested party, biased by the opinions of that party. Different parties, with different values, may view the exact same result with different resulting opinions regarding failure or success.

When a concrete truck company washes out their trucks in an open field, this results in a large area of flat concrete. John, a very adamant naturist, views this externality as a failure. He would prefer the open field in its natural condition. Bob, OTOH, is a skateboarder. He views this new skating area as a success.

Same externality, or result of activity that is external to the primary result benefiting the company (clean trucks), different opinions. Failure or success is in the eye of the beholder. But if a large enough proportion of the concrete truck companies customers could be persuaded to agree with John, the resulting market forces would cause the trucking company to change their practices. If the government became involved, a very few Johns might cause the passage of a regulation prohibiting what the majority of community members felt was a success.

Thomas Sowell writes extensively about the results of housing regulation in California, and San Francisco in specific. The activities of a minority, interested in protecting the environment, have created a housing shortage that has impacted thousands. This shortage has resulted in greater commuting distances, causing greater pollution. If the free market were allowed to dictate results, it is reasonable that more housing would be built closer to where the people wanted. This might destroy some amount of ecology, but the resulting decrease in needed highway construction and the decreased commuting might well create ecological savings to a greater degree.

This is an example of a few with control over governmental processes creating a situation that is undesirable to the majority and creating its own externality, that of a housing shortage and, ironically, increased pollution and ecological damage.