Public Externalities, Private Solutions – EconLib

I live in Asheville, North Carolina. Asheville is a major center for craft beer production, which I enjoy very much. I like to go to the pizza place down the street from mine, order a pizza to go, sit at the bar, and enjoy the different brews on tap. Normally, I don’t pay much attention to bills. The beer prices are all the same, and my pizza order doesn’t vary much, so I know what the bill will be.

However, my last trip was different. While I was waiting for them to run my card, I was looking at the receipt they gave me and noticed a charge at the bottom for the pizza: “Take-out container fee.” I paid my tab and went home and explored a bit. I wanted to see if this fee was something imposed by the city or county or something the restaurant wanted to do to discourage food and waste intake. Turns out, it was the latter: the restaurant imposed the fee to discourage people from using take-out containers that would only end up in landfills or as trash on the side of the road.

Pizza Place’s actions demonstrate the economic solution to the externality An externality is a cost imposed on individuals external to (i.e. not participating in) a commercial transaction. The solution is to internalize (i.e. participate in) people in commercial transactions to take these external costs into account. In technical terms, the solution is to internalize the externality.

Most economics textbooks will discuss various government solutions to internalize externalities: cap and trade, taxes and regulation are the most frequently discussed. In his famous 1960 article The problem of social costs, Ronald Coase points out that government solutions need not be the only or even the primary way to solve external problems. Coase points out that property rights evolved so that people could negotiate and internalize externalities in a similar way to my story above. Coase notes that transaction costs can prevent these negotiations from taking place, and that governments can act as “super-firms” to reduce transaction costs. Many textbooks will touch on Coase, but then some variety dismisses him gleefully as “but transaction costs are high and so the government must step in.”

but is Transaction costs as high as one might think? Transaction costs are generally asserted, taken as self-evident, and rarely (if ever) substantiated. One thing that usually no Taken into account is a parallel set of virtues that developed with property rights: social virtues (or what we learn about how to live in society).

Simple externality analysis assumes that transactional insiders do not care about anyone but themselves; The candymakers and their patrons do not notice that the noise of their machines prevents the doctor next door from being able to hear his patients (to use Coase’s example). But people don’t live in such a world. Adam Smith and other moral philosophers discuss at length how we learn about and care for one another. We both want to be loved (meaning we want people to like us) and beautiful (meaning we want to be likable). As a result, we consider at least some of the external costs of our operations. We want to be good neighbors, good stewards, good people. Even abstractly, we consider “other people” in our decision-making processes. I should note that this topic is not entirely original to me: I read James Buchanan’s discussion in Chapter 5 Cost and choice As a foundation of this point.

Asheville’s pizza restaurant is trying to do what feels like “the right thing.” And they are using economics to accomplish this. Their behavior, as well as the common moral sensibilities we all exhibit, suggests to me that the transaction costs of internalizing an externality are not as great as interventionists assume. As a result, taxes or other interventions are discussed At first glance Premature. Even in the face of highly complex issues like global warming, we should not assume high transaction costs. Just as property and property rights evolved to solve the highly complex (and high transaction cost!) problem of dealing with other people, so did other virtues to deal with other externalities.

A Pigouvian tax is probably not an optimal (or even a welfare-enhancing) solution to externalities. Given moral sentiments and already existing internal influences on their development, already existing implicit taxes, and public choice issues, taxation would likely be useful. The burden of proof is on the intervener to show that their solution will work, not just assume.


John Murphy received his PhD in economics from George Mason University and is an instructor at Western Carolina University.

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