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Externalities and government intervention
December 12, 2011 5:06 AM   Subscribe

Do externalities (political or economic) necessarily constitute a market failure and thereby justify government intervention?
posted by espada0 to Law & Government (12 answers total) 1 user marked this as a favorite
 
No. They could be (1) inframarginal (2) optimal due to second best considerations or (3) the cure could be worse than the disease.
posted by hawthorne at 5:21 AM on December 12, 2011 [1 favorite]


Perhaps you have a particualr case in mind? Would it be helpful to present it here and see whether you might get advice as to whether the exceptions are applicable in a specific case?
posted by biffa at 5:40 AM on December 12, 2011


That was rather too terse, sorry.

1. Stench from rotting garbage from my house would cause damage to my neighbours, but my own demand for a nice-smelling house is sufficiently large to internalise the externality. There is an externality, but it's zero at the margin.

2. If there is some sub-optimality somewhere else in the system due to (say) monopoly, intervening to correct an externality may make things worse. Ideal policy might be to correct both market failures, of course.

3. Intervention is costly (real world taxes are distorting at the margin) and it is often very difficult to target the problem effectively.

It might also be mentioned that what seem like externailites can be dealt with (internalised) by markets in Coase-like bargaining, but I don't know whether you'd still call them externalities.
posted by hawthorne at 5:41 AM on December 12, 2011


You've assumed, without arguing for it, that "market failures" justify "government intervention." This is begging the question. One could, and people do, take the position that market failures don't justify government intervention, so externalities don't enter into it. You also haven't really defined "market failure," which is a loaded term to begin with, as one person's "market failure" is another person's creative destruction.

The correct answer is, therefore, "mu."
posted by valkyryn at 6:43 AM on December 12, 2011


It is my understanding that mainstream economics defines a market failure as resulting from one or more of a number of basic causes, one of which is the creation of an externality.

I don't think it's appropriate to reject the question's premise. A sufficiently large negative externality can certainly justify government intervention. I take this to be particularly the case given that efficient markets do not arise absent or prior to government intervention, so the question is more along the lines of, can the existence of (sufficiently large) externalities justify reforms or adjustments of existing rules relating to market activity?"

It's worth mentioning further that there are both positive and negative externalities. A positive externality is a condition such that the economic actors produce incidental benefits in third-parties which the actors themselves are unable to recoup.
posted by gauche at 7:17 AM on December 12, 2011


valkyryn and I are on different ends of the political spectrum, but I agree with his questioning of the premise-- not all market failures necessarily automatically justify government intervention. The more appropriate question is whether the externality (for whatever reason) imposes sufficient costs on the public that the public is justified in seeking redress through government intervention.

I don't think that the metric of "is this a market failure?" is the one we want to use when deciding whether government intervention is justified. It's more a question of whether the externalities can be properly accounted for and resolved through government intervention, and whether it's worthwhile.
posted by deanc at 7:27 AM on December 12, 2011


You also haven't really defined "market failure," which is a loaded term to begin with

It doesn't need definition any more than "water" does. It's a well-defined term. There are a couple of ways of stating it, but they really boil down to the same thing. One is that a market failure is any Pareto-inferior distribution of goods (and bads) that is created by market exchange (or something otherwise close to market exchange in the case of monopoly market failure). Another is any divergence between marginal private benefit and marginal social benefit, or marginal private cost and marginal social cost, either of which will act to create Pareto-inferior distributions.

One could, and people do, take the position that market failures don't justify government intervention, so externalities don't enter into it.

On the one hand, yes, there are such people. Their existence, however, doesn't mean that espada0 is assuming his conclusion in any realistic sense -- there are people who strenuously deny that anthropogenic climate change exists, too, but that doesn't mean that a question about "does my action increase global warming and is therefore bad" is assuming its conclusion in any useful way.

The idea that market failure at least in principle justifies government intervention is nearly universal within economics, a few crazy Austrians (who really are pretty close to global-warming-deniers) notwithstanding. The difference between the public-choice crowd and garden-variety neoclassicists is that while public choice implicitly agrees that an idealized intervention would be Pareto-improving, they argue that the slippage between idealized intervention and actual intervention is large enough that actual interventions may not be Pareto-improving.
posted by ROU_Xenophobe at 7:34 AM on December 12, 2011 [1 favorite]


(hawthorne actually answered the question dead-on)
posted by ROU_Xenophobe at 7:42 AM on December 12, 2011


In a democracy, the people take precedent over the "market," and it is their will that justifies government intervention. Ideally, anyway.
posted by yarly at 8:38 AM on December 12, 2011


Another good thing to remember is that positive externalities often end up getting captured in something that can be (but is hard to) recognized as property rights. For example, airwave TV gets funded by advertisers; the underlying property right is that others can't splice out the commercials. There's no general guarantee that something like that solution exists (if advertizing didn't work well, we would get insufficient supplies of airwave TV), but it can.
posted by a robot made out of meat at 10:47 AM on December 12, 2011


I don't think it's appropriate to reject the question's premise. A sufficiently large negative externality can certainly justify government intervention.

But that isn't actually the question. The question is not whether a "sufficiently large" externality is a market failure, or whether a "sufficiently large" market failure can justify government intervention. The question is whether the existence of an externality is by definition a market failure which always justifies government intervention.

Put that way, I'd say that the answer is fairly obviously "No," but that isn't really doing the subject justice. As I said, the way this is put begs a number of questions and requires one to insert the kind of qualifiers you and others have before a straight answer is even sensible.
posted by valkyryn at 11:06 AM on December 12, 2011


the way this is put begs a number of questions and requires one to insert the kind of qualifiers you and others have before a straight answer is even sensible.

No, it really doesn't.

Yes, any externality is a market failure. By definition.

No, not every externality merits government intervention. Some are just so small that no neoclassical economist would suggest that it would be worthwhile, in the same way that more generally some problems are so slight that any attempt to solve them, or even just stopping to think about how to solve them, is more costly than the problem itself.
posted by ROU_Xenophobe at 12:12 PM on December 12, 2011


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