Monday, May 08, 2006


Externalize the internalities

I was thinking that perhaps an alternative approach that should be taken in modern public economics is not to equate each and every MSC to MSB, but rather to look at the aggregate of all positive and negative externalities, and only look at the distributional effects to see if the "net out" on the whole.

The reason, I am wondering this is because of the problematic pigovian tax approach. It could be that I am mostly, just not a fan of taxes, but it might seem that artificially influencing the price of a good may have more negative effects than positive (on the whole). Especially, since new science comes out and tells us that everything (literally...everything) is bad for you. So, as easily as that is recognized, the notion and ability for governmental interference in the pricing signals of a good and/or service is not all that appealing to me. It also, presumes that some "Economist General" has more information than others actively participating in a market.

The whole approach, at least to me, is problematic and reeks of paternalism.

What do you think?

I think it depends on what one is trying to do. If you’re trying to measure over all welfare, then a positive externality won’t net out a negative externality. Think of it this way. Your smoking imposes costs on everyone around you that you don’t take into account (negative externalities), but the benefit everyone receives from your beaming personality exceeds the private benefit you receive. While your personality may make everyone around you better off than if it wasn’t there and you only smoked, it wouldn’t make everyone as well of as if you smoked less and beamed more. So, if our goal was to maximize social welfare, we would charge you for smoking and pay you for beaming.

But I would have to agree that Pigouvian taxes make me nervous. I prefer institutional solutions like Coase would suggest over direct tax and subsidize solutions Pigou would suggest. But, I believe there are places where these externality problems warrant pigouvian solutions. For example, with Air Pollution or Global Warming (if it is a problem), transaction costs are most likely so high that a tax on emissions might be the best route for solving these problems.
If particular activities have roughly the same distributional consequences, then we could see a netting out of these externalities. In public economics, I am sure that there are well known positive externalities and negative externalities that have similar distributional effects. If they are of similar magnitude, wouldn't an appropriate policy be to just "let 'em ride" and then focus on some of the others?
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