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Externalities, Reconsidered
August 11, 2011 Economic Illiteracy

When folks stumbled upon the idea that “externalities” constituted a “market failure” it really breathed new life into the forces of economic interventionism. A quick review, sulfur dioxide emissions/pollution is a classic externality. Why? Energy companies (profit seeking of course) burn coal to produce electricity, which they sell to customers to make a profit. As part of the combustion of the coal, sulfur dioxide is emitted into the air – which is harmful (really, it is, it’s not like some other “pollutants”). The sulfur dioxide causes lung disease, eye disease, ashtma, smog, or even acid rain. Since no one owns the air, there is little to “force” our coal company to consider the costs that emitting the SO2 into the air imposes on society. And since the costs to society are borne by everyone other than the coal company (I guess they are not human), then we get “too much” coal burning.

Zebra, not the lion food

We’ve written dozens of posts on this, so I don’t want to rehash it here. But what I do want to emphasize in this post is that an ‘externality’ is not something that is germane to market transactions. If you sit on an economics class or read the New York Times OpEd pages you might be led to believe otherwise. But anytime an individual makes a choice, or two individuals (or churches, or firms, or political actors, or fundraisers, etc.) engage in any sort of interaction, there is a chance (a very good one) that their actions will impose costs and/or benefits on others. And there is a very good chance that these costs and benefits will not ever be considered by the actors.¬†Instead of calling an externality an example of a market failure, it is better to think of it as a social failure, and even that is not exactly the right term.

I got to thinking about this again the other day when I read a piece talking about how yet another mollusk was beginning to wreak havoc in the waterways that I love (zebra mussels have been the major problem since the late 1980s).* In this case, Seneca Lake, Cayuga Lake and Owasco Lake are all suffering from infestations of Asian Clams. What is the problem with these little buggers? Well, they reproduce rapidly, and so quickly can take up hundreds of acres of lake bottom. The most serious damage from them is that their waste products contribute to ugly and harmful algal blooms in lakes. These blooms have shut down parts of Lake Ontario in each of the last two summers – both on days we planned on paddling or swimming nearby. So, how do these clams end up in the waterways and expanding? They usually end up in waterways because people use them as bait and some people use them in small aquariums and then dump them into the water.

Now, what part of using Asian clams as bait or dumping an aquarium into the water has much if anything to do with corporations making profits? Or a market transaction of any kind? I guess someone will try to tell me that someone, somewhere, sold an Asian clam. But is that any different than a car door ending up in the bottom of a lake? So, what is the source of the problem here, and what does it say about proposed solutions? The problem is that individuals in whatever setting they are in, do not (typically or always) take into account the costs they impose on others. A tired fisherman finds it easier to dump his extra bait than to take it home and dispose of it properly. He may not even know that dumping Asian clams may result in algal blooms that may end up killing the very fish he is trying to catch. Is the solution to this problem a tax of some sort? It’s hard to think of how a tax could be constructed and enforced. Is the solution here an expanded EPA? It’s hard to think that they could do much to prevent it. Is the solution here a sharp reduction in commercial activity? I would argue this may make many environmental problems worse?

There are a whole host of things we might do about it, but these are typically not at the top of the list of favorite things to do by economic interventionists. For example, it is plausible that extreme versions of private resource ownership would do a better job preventing these sorts of things than the current situation (of course, what if the owner really got pleasure from dropping Asian clams in the lake? The Coase Theorem suggests this would not be a concern so long as folks like me figured out who owned the lake). I’d argue that emerged social norms could handle problems like this. Pressure from fishing organizations and other interest groups could form community watch and clean-up organizations to do something about it. There’s lots more to think about. My point again, which is one I have made elsewhere, is that there is nothing unique to market transactions that makes particularly amenable to externalities – indeed, the ultimate feedback processes and the chance to profit when an externality is present perhaps puts more pressure on externalities to go away than in other settings. Conversely, there is nothing unique to non-market transactions or choices that excludes them from causing the same problems that markets are accused of causing – and without the same powerful feedback mechanisms of the market, you could argue they are worse settings.

* Note it is not clear that something which is thought to be a “negative” always is. For all the damage done by the zebra mussels, they also clean the water in inland waterways. This clear water helps certain species of fish thrive, such as the smallmouth bass.

"2" Comments
  1. Haha, wintercow. It has been some time since I thought of zebra mussels. Maybe Obama can get Dave Axelrod working on that problem.
    As far as zebra mussels, kudzu, and pythons, I expect the Princeton faculty will provide answers.

    Hoping wintercow has shale gas under his yard, best wishes to the herd.

  2. Massachusetts has hired kid to sit all day at the boat ramp at Laurel Lake, the first lake in the county to host the wee buggers. Before you put your boat in he makes you sign a statement attesting to where you have had your boat in the last 3 weeks. Kinda weird, because I am putting my boat IN the lake that already HAS the mussels. I’m always too psyched to fish to argue with him…….Now the state is paying for a boat washing facility in the parking lot (which tied up traffic on Rte 7 during the summer), so they don’t spread. Good luck fellas.

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