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Should Economists Spend More Time Discussing Externalities?

By February 10, 2008

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I think they should, so I don't entirely agree with Bryan Caplan's viewpoint:
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...

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."...
The Benabou position is more in line with my own thinking. I believe economists are tone-deaf to the general public, and we should take their concerns more seriously - instead of just talking about the merits of the free market in general or shouting COASE THEOREM whenver someone brings up the concept of extrernalities. Too many intelligent people write off economics as being libertarian (or conservative) ideology masquerading as a science.

Caplan states that "non-economists are usually looking for an excuse for government to ban or nationalize". But often this might be the most efficient case.

Take a stylized example from my own life. I am trying to grow organic tomatoes in my backyard, and I live at the bottom of a hill. Some of my neighbours, at the top of the hill, use pesticides and herbicides to keep a picture perfect lawn. Whenever it rains, pesticides are washed away from their lawn and end up in my backyard and on my tomatoes, because I live at the bottom of the hill.

Environmental groups are calling for a ban on the use of pesticides for residential use on lawns. I would naturally prefer some kind of tax/subsidy arrangement, but given collection and enforcement costs (and the natural Pigovian problem of what to set the rate at), is it reasonable to suggest that, in this case, a Pigovian solution makes more sense than a legislative one?

I think the disconnect between economists and non-economists isn't that non-economists are anti-market. Rather it's that academic economists have this habit of assuming away a lot of the facts, such as transaction costs, enforcement costs, collection costs, less than full information, etc. that make real life problems less black-and-white so much more difficult. First, we must assume that we have a can opener, indeed.


February 11, 2008 at 10:37 am
(1) Pat says:

“If no one cares, there’s no externality” is IMHO not a very good argument for that non-economists won’t accept the notion of externalities. As ethics is pretty much a social construct, and the product of our own values, what we define as a external cost must be related to our set of values, whether the be selfish or altruistic. The real problem is that many externalities are closely tied to freeriders and the tragedy of the commons.

With regard to the second argument, I think that in many cases taxing simply is not sufficient, as there is not as many economists assume no linear cost function, so that one might make simple weighing of marginal costs. I am especially thinking here of the question of global warming, where the costs to many societies (not necessarily those who cause the problem) might very well explode, but the uncertainty of this makes it impossible to know the “marginal cost”.

February 11, 2008 at 5:50 pm
(2) Jon says:

My primary advice to economists is to take their assumptions seriously. For instance, the Coase Theorem is predicated on clear assumptions. If those assumptions are met, the theorem is valid, if they are not then we need to consider other options. Unfortunately, (well-known) economists seem to take ideas like externalities and the Coase Theorem as evidence for their own ideological beliefs, rather than acknowledging the need for case-by-case problem solving in the real world of economics.

February 14, 2008 at 5:29 am
(3) Jon says:

I mean to include another point. I think it is important for economists to be careful when speaking of “solutions” to the world’s problems. The economically optimal policy for dealing with a problem will generally not erase any negative effects of that problem and I think politicians, the public, and some economists forget that. The best possible plan for dealing with global warming would almost certainly let some climate change happen. The best possible policy on Social Security would require a great many people to make sacrifices that they would resist. Economics is about tradeoffs. Sensible policy balances gains against gains and losses against losses. When there is a crisis, people will be hurt. The best course of action is the one that minimizes the pain on “average”, not the one that makes the pain disappear.

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