Bryan Caplan  

Are Externalities an Intellectually Sound Bridge Between Us and Them?

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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.


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The author at The Undercover Economist in a related article titled Market failures - and making economics loveable writes:
    At EconLog, Bryan Caplan writes: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 ... [Tracked on February 12, 2008 1:54 AM]
COMMENTS (21 to date)
John V writes:

Bravo. I agree.

I wonder your typical left of center economist would say to all this? Or is it that they know and talk around it?

John V writes:

I wonder what your typical left of center economist would say to all this.

Do they agree with your assessment but simply talk around it?

Johan Eriksson writes:

I certainly agree with your conclusion, but that leaves the underlying problem unsolved. How should those lessons be taught to the average voter, in a way that allows the voter to accept them in spite of prior preferences, while not altering the fundamental points? This is a tough question, but an important one.

Jim writes:

Doesn't the concept of externality mean a positive or negative impact (economic impact?) on a 3rd party?

How does whether anybody cares matter? If you do something economic with another party and somehow that shortens my productive life in the economic system but I don't care isn't it still an externality?

Eric Crampton writes:

A little knowledge can be a destructive thing. Check all the "econ" justifications of fat taxes and such based on fiscal externalities generated by the presence of a public health system.

Give them a bit about externalities, they'll turn it into "tax anything I don't like 'cause me not liking it means it's an externality."

Jody writes:

but I don't care isn't it still an externality

That's the point. If you're indifferent to it either being there or not being there, then there's no economic externality to you, positive or negative.

Alex J. writes:

Getting people to understand (and accept) externalities in palatable cases sets them up to understand and accept them in unpalatable cases later.

Also, when people misuse externality arguments, but rely upon them for their economic respectability, that sets them up to accept the actual economic concept of externalities.

Nathan Smith writes:

Differing with Bryan, I am inclined to think that externalities do offer a "sound bridge" between economics and what some people regard as common sense. Take two examples: (a) narcotics, and (b) prostitution. In both cases, an economist's first instinct is to say "A-OK." Then think about externalities. A drug obsession can destroy a personality, harming not only the person himself, but family members and friends of whose lives the person is a part. Prostitution creates temptations to infidelity for husbands and boyfriends, harming wives and girlfriends.

But economists might want to be wary of talking about externalities, because when you start to think about it, they provide a rationale for too much government intervention. Since people value status, any kind of accomplishment may have negative externalities, because your excellence prevents me from being #1. And the most basic freedoms, like free speech and freedom of religion, can disrupt families and communities, having externalities far worse than ambient smoke. What would be a Catholic mother's willingness-to-pay to force her son to stay in the Church?

And yes, government solutions are prone to nasty public choice problems so that the cure is usually worse than the disease; but that's a different argument, a subtler one, and easy for a biased party to reject.

So economists should be aware of just how big a problem externalities really are, but I'm not sure it would be wise to play them up rhetorically.

On a tangent, my post "What is property? The troubled marriage of Locke and Coase" deals with the challenges at the level of principle and of public choice of (externalities and) defining property rights.

wintercow20 writes:

Right on to what Eric C. said.

It seems that those with an anti-market leaning have already embraced the externality language. Everything causes an externality, and the problem with understanding only a little theory is that casual obsveration lends folks to believe that all externalities CAN be fixed, or worse, that all should be fixed. If we are going to emphasize externalities then, whu don't we also emphasize the Quis custodiet ipsos custodes problem. Or even better, why is it that governments are the correct 3rd party to deal with the externality. A large literature exists on how super-demanders overcome externality problems, have innovative competitive enterprises have arisen to deal with them, and so forth. This is not to say of course that they are are solvable this way.

Economists would do better to put externalities in a better context. For example, I am a rather annoying, high energy guy. No doubt that bugs people. But that I have managed to get along rather well with most people indicates that non-coercive mechanisms have done quite well to deal with this externality.

Good post.

Michael Sullivan writes:

Recycling? If people are paid the market value of what they recycle, it's hard to see the externality.

The externality for recycling is in what you *don't* do which is to dump garbage instead. I'm certainly willing to pay something not to live next to a garbage dump, or to keep garbage out of the sea, so there's an externality there. Whether it's enough to justify most common forms of recycling is another question that's harder to answer.

Mason writes:

"Economics has a lot of unpalatable lessons to teach. Our job is to teach them nonetheless."

"How should those lessons be taught to the average voter?"

Take econ at Mason until the message sinks in. As many with Caplan as possible, although you probably don't want to start with labor relations.

Thank you Bryan and all my other Mason profs. for showing me the light.

N. writes:

...I can't help but feel that an emphasis on externalities might still win some hearts and minds on the margin. In my experience, too many people seem to believe that an economist's answer to any 'social problem' is simply to run roughshod over any consideration in pursuit of 'market growth' or 'market efficiency' with no regard -- indeed, no professional vocabulary -- for dealing with any human element. This, I think we can all agree, is a false characterization. Putting more emphasis on the concept of externalities might go a long way towards correcting this perception.

The masses may be asses, but I think they are less monolithic than they appear. There may not be a universal panacea, but I think it is possible to chip, chip, chip away at economic ignorance with as many different arguments and strategies as we can muster. Remember the margin, my friends! All the important action is at the margin!

duus writes:

I found the tone of this article insulting, arrogant, and stupid.

Lord writes:

This quickly shows the shortcomings of economics. Many distinctions have moral components behind them. Moral components usually end up with bans and regulations. Should someone be allowed to speed if they can pay the fine? Should the fine be fixed or based on income? Who should the fine be paid to? Should repeat offenses escalate? Should the punishment for murder be a fine? What value should we place on it? What becomes of justice or other social values? Attempting to monetize life frequently end up undermining both life and money.

TGGP writes:

Lord, privatize the road and the company that owns it will decide all that.

Tom West writes:

I'm afraid that Lord has put his finger on it. The public doesn't widely accept economic wisdom because "pure" economic wisdom leads to results that are, in a human context, simply wrong.

As I understand it, the death of indigent human as a side effect of some other activity is no externality because there's no-one (including the deceased), who both had the means and was willing to pay to prevent the death. However, the human within (most of) us knows that a wrong has been done.

Economics dictates that we judge what is valued by our willingness and ability to pay for them, which intrinsically means that what the wealthy value is more valuable. Again, this goes against what most of humanity feels.

Economics has a lot of unpalatable lessons to teach. Our job is to teach them nonetheless.

Exactly what lessons do you mean? I have no trouble with clearly itemizing the benefits of the markets and I think a lot of people could benefit from understanding what they are. But the fact that it has benefits is no excuse for ignoring the fact that many (if not most) aren't willing to pay the full price of the maximum benefits - an unfettered market. And in the end, the purpose of the market (and indeed the whole study of economics) is to serve us, not for us to serve the market.

[As for anti-market bias by the uneducated, I strongly suspect that many such people don't like the policy and come up with an (incorrect) excuse as to why it's bad. Better education may gain a few extra converts, but if the problem is the policy itself, and not the outcome from the policy, then education will not change anti-market bias all that much.]

John V writes:

Funny, Bryan

I asked an unanswered question in the first post on this thread and I got my answer from Mark Thoma.

Why don't you and others ever engage this stuff with these guys??

John V writes:

BTW, Bryan,

Forgive me, I gave your post here a plug over at that Thoma link:

CLICK.

Jim writes:

Bryan mentions taxes and subsidies, but a third way of resolving externalities issues usually suggested is Coasean bargaining. Of course Coase's work mainly shows us why such bargaining usually doesn't happen (information, transaction costs) which can make a case for regulation.

But assuming for a moment that economists have no problems clearly identifying and pricing all externalities, the question of who pays the cost necessarily raises questions of distribution, justice and political economy, and therefore ethics and morality come into play. Economists are often pretty poor at dealing with these kind of issues, and Bryan's blinkered aggression towards 'environmentalists' as a whole suggests he's even worse than average, so he shouldn't be surprised when he gets criticised on this score.

The assumption that externalities can be clearly identified and costed is clearly a whopper too. Bryan can pretend it's a simple matter all he likes, but more than most he should know it isn't. To take the most obvious example of climate change: human actions are clearly having some sort of effect, but even when when the overwhelming majority of qualified scientists agree on the direction and rough magnitude of it, you still get people like Bryan and Arnold preferring to ignore the evidence or disassemble, apparently on ideological or pseudo-methodological grounds. When you view the concept of environmental externalities as some sort of assault on your profession, as Bryan seems to, it's no wonder your theoretical response is inadequate.

lgroner writes:

For an individual calculating the value or harm caused by an externality is very difficult. The value of a park as a place to visit is easily discerned by the fee people are willing to pay to visit. However its value in terms of preserving endangered species, keeping neighborhood youths off my street corner, buffering air and water pollution, or preventing floods, ..., is not one that an individual can easily estimate. Thus the fees the park collects maybe extremely inaccurate in estimating the value of the park.

The state has the expertise to estimate the likelihood and magnitude of the park's external effects and, via the political system, assess the collective price people are willing to pay for them.

Holly writes:

Open mind economics whether it is a positive or negative impact to any thrid party needs to always be considered. Things have to bee seen from all sides!

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