Externalities are benefits received or damages inflicted outside the market. They exist even if no market exists. There may be a legal framework or customary conflict resolution mechanism such that 'torts'- i.e. harmful actions by another- or benefits received from another but not properly reciprocated- give rise to some sort of sanction or mandatory transfer of assets.
Equally, when exchanges occur on the basis of presumed reciprocity or equity, one party who feels aggrieved that the other gained much more benefit may be able to gain compensation. Since, in Life, most 'contracts'- other than open market transactions- are 'incomplete', even the stupidest Economist now understands that 'relationships'- which is what you actually end up having with those you only wanted sexual relations with- are what actually binds our Lebenswelts together such that such a thing as Society exists.
Open markets- i.e. one's where no one has 'market power'; everybody is a 'price taker'- are situations where you can't complain that the seller gained more than you, the buyer, because the seller could have been anybody and the buyer could have been anybody. There is no real 'relationship'. There is only a transaction. But, though 'transactions' have burgeoned- I buy and sell a lot of goods and services off the internet now whereas, though I was richer forty years ago, most of my significant transactions were relationship based. That's why I used to talk with a posh accent back then and took some little trouble not to look like a big fat loser of a slob.
Tyler Cowen doesn't get this- essentially 'Old World' Oikumene aspect of the notion of externality. This is because, as Ronald Coase pointed out, Americans also don't understand the global nature of the concept of opportunity cost.
Thus Cowen writes-
Externalities occur when one person's actions affect another person's well-being and the relevant costs and benefits are not reflected in market prices.
Relevant costs and benefits are never reflected in market prices because Knightian Uncertainty is pervasive. If it weren't, we would never have evolved into Language speakers. An Arrow Debreu world is one where all possible future states of the world are known and agents are either in a Leibnizian Occasionalist monads synchronised in a pre-established harmony, or else the elementary particles of the ultimate Grand Unified Theory whose 'atomic propositions' have the property of 'carving up the world along its joints'.
This is Theology. Americans may be better Christians, or Taoists, or Hindus than yours truly, but they don't get that a non-dissipative Economia- or Artha Shastra- must concern itself exclusively with what is Secular about Relationships- that is Society- not Theological or Teleological.
A positive externality arises when my neighbors benefit from my cleaning up my yard.
This may be reflected in market prices if there are restrictive covenants or else well enforced local by-laws. People may pay more to live in such areas.
If I cannot charge them for these benefits,
They may be entitled to them. That is a justiciable matter. The law may say that your neighbour has a legal right to enjoying a salubrious neighbourhood. Your backyard is not salubrious. The Court forces you to clean it up. Suppose your neighbour does not bother to complain about your dirty backyard. Then you have a situation analogous to petty theft. The neighbour has been deprived of something illegally but can't be bothered to go to law over the matter.
Contract enforcement is a service which costs money. No externality is involved if you choose not to pay for that service. This is not an externality because if the cost of gaining redressal was low enough, people would avail of that service.
I will not clean the yard as often as they would like.
It is a separate matter that other people may want me to change my behaviour but are unable to do so because I have a Hohfeldian immunity in that respect. But they can offer me money to do what they want me to do. There is no externality here.
(Note that the free-rider problem and positive externalities are two sides of the same coin.)
Not if there are Hohfledian entitlements which are not being asserted because it is too costly to do so. In that case, there is no externality though there may be a case for finding ways to lower the cost involved.
A negative externality arises when one person's actions harm another.
Not if that harm is done through the market. I am harmed if a guy who owns a dog moves in next door because I have a deathly fear of dogs. But the law permits him to own a dog. Indeed, most people like dogs and become friendly to the neighbour dogs or cats. This is a case of bad luck, not market failure. I suppose I could move to a place where no pets are allowed. There may be a premium on such properties.
When polluting, factory owners may not consider the costs that pollution imposes on others.
Just as thieves may not consider the costs that theft imposes on the victims of robbery. Either you have bought the right to pollute- which may involve paying a premium or moving to a place which is already extremely shitty- or else what you are doing is analogous to theft.
Policy debates usually focus on free-rider and externalities problems, which are considered more serious problems than nonrivalrous consumption.
This is because policy debates are stupid. Courts, as well as Legislatures, can create remedies and public policy can lower the cost of making those remedies cheaper and more accessible Sadly, such interventions may be counterproductive.
The notion of externality becomes empty if any and every thing you don't like is described as a negative externality. The fact is, if a market for a remedy to the nuisance you are complaining of exists, then the problem is that its price is too high or your real income is too low, or you simply can't be arsed to get the remedy because you enjoy complaining about it.
Consider the notion of a 'pecuniary externality' which is merely the Slutsky 'Income effect' of a price change. But if substitutability is high then this should not matter. If wheat becomes more expensive but potatoes remain at the same price, then people aren't really any worse off. Being flexible in these matters is itself a good thing.
Cowen writes-
Economists try to make a distinction between pecuniary externalities — changes in price which merely redistribute wealth
in the short term when demand is inelastic- sure. But medium to long-term, demand is elastic because substitutes become available or relatively attractive. So the 'economic rent' accruing to the producer vanishes.
If people are changing their behaviour on the basis of price changes, that is actually a good thing. The question of the illicit use of market power, however, is a separate matter.
— and non-pecuniary externalities, which involve a real good or service being provided or denied at the margin. If the price of wheat rises, wheat consumers suffer a pecuniary externality.
No. There is no external effect. There is merely an 'Income effect' which, however, disappears as people switch to potatoes or rice etc. They may come to prefer their new staple foodstuff.
If you dump garbage on my lawn,
you have committed a crime.
that's a non-pecuniary externality,
No. It is a crime. Similarly, if you are sodomized and decapitated by a maniac you have not suffered a non-pecuniary externality. You have been the victim of a horrible crime.
although it may be accompanied by a pecuniary externality, namely a decline in the value of the house. In the meantime, the lawn stinks.
Which won't matter to you if your neighbour has sodomized and decapitated you.
The distinction is often a tricky one, especially in the absence of perfect markets.
It is utterly foolish.
A lot of the complaints about health care markets are actually complaints about pecuniary externalities, namely that some people get priced out of the market
No. These are complaints about market power more particularly where the marginal cost is low. Being priced out of a market doesn't matter if there is a good enough substitute. I might whine about not being able to attend the Opera, but watching it on TV is good enough for my purposes.
. Alternatively, the risk of facing high prices for cancer treatment may
as opposed the risk of dying of cancer
make people nervous and insecure. The notion of "risk"
relates to possible states of the world.
often bundles together pecuniary and non-pecuniary externalities in a not-too-easy-to-separate form.
There is no externality here. Either cancer treatment is being provided by the market, in which case it is rationed by price; or, it is provided by the State, in which case it is rationed in some other way.
Efficiency and distribution are not always possible to separate, no matter what the first and second welfare theorems seem to imply.
Pareto efficiency depends on information availability and the cost of transactions. The internet has increased the one and reduced the other. That's why I can sell stuff I no longer use and buy stuff some other guy half way around the world wants to get rid off. Distribution depends on mobility which determines elasticity. If you have perfect substitutes, nobody can extract rent from you. The message here is simple. Encourage things which
1) improve information availablity
2) lower transactions costs
3) increase elasticity of supply and demand thus eliminating 'rent extaction' or 'Marxian exploitation'.
Babbling about 'externalities' is fine provided you are finding Coasian 'mechanism design' type solutions. But that's not what Cowen is doing.
What about people near subsistence? Say you redistribute $500 from a poor Haitian
Try it, and she will kick your head in. Haitians threw out the French. They are not weak or cowardly.
to a somewhat less poor Mexican, and the Haitian dies and the Mexican buys a used motorbike. Is that "just a transfer"?
No. It is theft. But the Haitians will track you down and kill you or, at the very least, set Baron Samedi on your trail.
Or is it "a real resource loss"? I say it's the latter, but then virtually any redistribution will destroy some complementary value from the portfolio of the individual losing the money. What is then left to count as a pure transfer?
A pure transfer is the poor Haitian gratuitously sending money to the Mexican- perhaps for an altruistic reason.
There is also no such thing as a pure lump-sum transfer when population is endogenous, either through child-bearing decisions or through taking risks with one's life.
Nonsense! Anybody is welcome to make a pure lump-sum transfer to anybody else.
The distinction between pecuniary and non-pecuniary externalities is useful,
only if you also like talking about your experience of being beaten and sodomized as a 'negative externality' you received.
and hard to do without, but its foundations are shaky. In practical terms the weakness of the foundations matters most when we are doing health care economics or analyzing food subsidies (or comparable forms of aid) in poor countries.
In other words, this shite is only used by people paid a little money to say 'other-people's-money' is being appropriately wasted by some bunch of bureaucratic shitheads.
The richer and healthier the people are, the more likely the distinction can be invoked without much trouble.
Because talking stupid shite doesn't affect rich, healthy, people.
And Samson is correct to think that large numbers of transactions involve pecuniary externalities,
only if 'market power' exists. Where everybody is a 'price taker' there are no externalities though, in the short run, there may be 'income effects' because of low mobility/ elasticity. BTW a free-rider is, by definition, not a 'price taker'. Some additional mechanism may be needed to ensure that he is. Thus, a Cinema may employ people to check that customers have tickets. This stuff aint rocket science.
at least whenever the particular actions of a buyer or seller influence market price.
In which case there is 'market power' and thus comes under the rubric of competition policy. The Coase Posner Law & Econ tradition can take account of external effects while a 'deontological'- i.e. rule based- competition policy may treat any instance of 'market power' as prima facie illegal.
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