September 22, 2005

Dr. Shawn Knabb, my Macroeconomics instructor, remarked yesterday that most economists agree on the basic principles and models of economics, and therefore almost any macroeconomics class (and I suspect microeconomics class) will cover virtually the same material regardless of who teaches them. What economists disagree on is how well markets (and by that, I suspect he means the market model) work and thus what the appropriate policy conclusions are, and that the reasons for this are related to assumptions and views beyond economics. In other words, economists generally agree on the market model. What they disagree on, for reasons external to economics, is the accuracy of the model.

This is doubtless an over-simplification, but in some ways it is likely true. For example, in reading the textbook (which was a grossly over-priced $98) they covered externalities (something we covered in micro as well). The basic ideas of externalities is that a product may have costs or benefits not accounted for in the price. For example, a steel plant which takes in clean air for free and releases dirty air for free costs the surrounding area by increasing respiratory irritants, dirt settling on property, etc. Another example, such as a vaccine, can be seen to have an externality benefit. Those who do not receive the vaccine pay nothing, but receive a decreased risk of getting sick because possible carriers of the disease to them are reduced. In other words, they become freeriders, receiving a benefit from a product without paying for it.

Both examples make some sense and seem like something most people would agree on. The disagreement, however, is in how to deal with the externalities. The first, externality cost, seem easier to deal with. As the actions of the steel mill damages the property of others, it owes them some kind of compensation through the legal system (although, determining the appropriate method of compensation is much more difficult to determine). However, the issue of externality benefits is much stickier. While it would seem on first glance that something should be done, the government has only several options available to correct this "problem". For example, subsidies, public distribution, etc. Unfortunately, all government options essentially involve forcing "free-riders" (those who receive a benefit they did not pay for) to pay for that benefit whether they want to or not. Such forced payment rests upon the idea that a provided service inherently demands a fee.

In other words, if I provide a service for you, you owe me regardless of any agreement between us. The classic argument demonstrating the absurdity of this idea involves the mowing of lawns. Assume that I come to your house and mow your lawn, without your permission or a previous agreement between us. Then, I come to your door and demand $20 in payment. Should you be required to pay? Do you really owe me anything? Certainly, I have provided a service for you. You have benefited without payment. You have received an externality benefit from my efforts and therefore owe me money. The clear answer is no. There is no agreement between us, and therefore you have no right to demand compensation for services rendered.

Some may object that the above example is not a good example of an externality benefit because it is a direct benefit to you, not an indirect benefit of a legitimate transaction between two people. However, consider this variation on the theme.

Your neighbor hires me to clean up his lawn, which is a complete mess. It is so ugly that it has a negative affect on its own property value and on your property value. I clean up the property and receive the agreed compensation from him. However, you have received an externality benefit of increased property value because I have corrected the negative influence of the neighbors mess. Thus, the real "value" of my labor is greater than the compensation received from the neighbor, whose payment represents only the value of the benefit received by him. Acting upon this reasoning, I continue on to your house and demand $40 for my services.

In the above, I put value in quotation marks because I believe that is where the core of the issue lies. The principle of externalities, when applied to public policy involves the pre-empting of personal freedom regarding determination of value. An individual (A) who agrees to pay a vaccination fee of $20 values his personal benefit at $20 or more and therefore freely agrees to pay $20. However, the government decides that the real value of the vaccine is $30 because the chances that another individual (B) will become sick is decreased. Thus, the value of the vaccine is $30 and to correct the production generated by supply and demand by the lower price does is less than the real value to society. To correct this, B is fined $10, which is then given to the provider of the vaccine, signaling increased demand and therefore increased production, allegedly correcting the "underproduction".

When viewed from a "societal" perspective, this appears to make sense. However, when viewed from the perspective of individuals, it makes little to no sense and adheres to the lawn mower counterexamples. The issue then, is one of determination of value. Does society (which inevitably translates into government) determine value or does the individual? This is not limited to a single product. This is really a question regarding the value of any product.

The book attempts to argue that their are products that have no externalities, such as burgers, due to exclusivity of consumption. My consumption of a burger does not in any way harm or benefit you, right? However, while most people would probably agree that this is generally true, it is not necessarily true. Consider this. A burger is generally considered to be a relatively unhealthy food. Thus, consumption could be argue to decrease your value to society, decreasing your output, making you sick, shortening your life, etc. The externality cost then, is decreased benefit to society. Thus, government should step in and "correct" this externality cost with a "fat tax". You may laugh, but the above argument in various forms and arguments of a similar nature have already been advanced for the "fat taxes".

Thus, the real question is not regarding a few commodities, but ALL of them. Logically, if we accept the argument of externality benefits demanding government intervention, a criteria of societal value is implicitly accepted. Thus, the individual loses the freedom to determine his own actions. What he would choose to do is limited by governmental skewing of prices and coerced distribution of resources (your own resources).

Therefore, in this case, it seems to me that my professor was correct. Most people agree on the model. The question is how well the market model works without government intervention, and model evaluation depends upon one's perspective or adopted criteria (in this case, the perspective and criteria of determining value). Thus, the real question here is one of socialism or laissez-faire, public control or private (individual control), communism or property rights. Essentially, to accept government interventions on an argumentation of externality effects is to accept a criteria of social rather than individual valuing of products based on majority decisions and enforcing that choice on all of society.

Clearly, I fall on the side of laissez-faire, private control, and property rights. My reasons for this are 2 fold. First, I believe freedom and property rights are important rights of individuals granted by our Creator, as stated essentially stated by the Declaration of Independence. Second, I believe that both market history and the clarity of the market model do (in contradiction of my professors initial premise) demonstrate that a free market based on property rights and individuals acting in their own interest leads to a much productive and richer economy than a socialist or communist system of "social" (ie. government ownership and control of everything) control.

In closing, one might be wondering what I would recommend we do with externality. The first, external costs, are clear. External costs represent a real cost to individuals, damaging their property and thereby violating their property rights. A free, rights based legal system has built in handling of externality costs, which are more than just externality issues, but issues of property rights as well. However, externality benefits are not property rights issues and therefore not really governments business. If a group of citizens believe the societal value of a product is greater than the current price indicates, they have two options. First, they can convince more people to freely purchase the product based on the social benefits. Second, they can personal contribute private subsidies or extra incentives for the production or consumption of the product.

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