Post No.: 0476
‘Negative externalities’ occur when the production or consumption of something causes any kind of cost to be passed onto a third-party. A classic example is air, water, land, noise or light pollution. Meanwhile, ‘positive externalities’ occur when the production or consumption of something causes any kind of benefit to be passed onto a third-party. Herd immunity through the process of vaccinations is a classic example here.
We would say that these third parties don’t deserve these costs, or benefits, to be passed onto them because they didn’t benefit from what produced those costs nor asked for them, or they didn’t pay for what produced those benefits they received, respectively. People aren’t fully and only getting what they pay for or deserve, hence externalities lead to market failures. Because of this, the market won’t optimise to produce a fair outcome on its own.
Negative externalities will lead to an oversupply of something in a market because if someone else is paying for at least some of the costs of our own choices and activities then we’re essentially, from our own rational individualistic perspective, getting them fulfilled on the cheap (e.g. you, or your family, alone benefit from you getting to drive your car to where you want but everyone, essentially in the world, is sharing in paying for the costs of the pollution on their health that your journey produces, whether it’s exhaust emissions, noise, tyre and brake wear particles, etc.). And positive externalities will lead to an undersupply of something in a market because if someone else is gaining from at least some of the benefits of our own efforts then we’re essentially being altruistic to them even though, from our own rational individualistic perspective, we might not want to be (e.g. having enough other people around someone getting vaccinated, which will produce a herd immunity that this person would benefit from too even if they don’t personally get inoculated against an infectious disease themselves).
So a negative eternality generates an external cost – an agent engages in an activity that changes the furry welfare of another agent, and that change goes uncompensated. But what is the value of life, or a beautiful vista? Most say priceless. Thus some will argue that lives and vistas cannot be traded in the market to know their ‘market price’. What amount of money can compensate a community because a factory is leaching hazardous waste or causing an eyesore, for example?
Polluters, in a free market, aren’t incentivised to give any compensation to those they externally harm anyway – thus it’s something that governments have to intervene with to do something about, such as via regulations and taxing the polluters to pay for things that will benefit those who are harmed. We must rationally make use of governments, laws and taxes to (somewhat) correct such market failures. Tax dollars are therefore not just for taxpayers but for anyone and everyone who needs to be compensated for suffering from the costs of other people’s actions.
The free market is inefficient at reaching the true market prices and costs of things that produce externalities. If the market doesn’t take into account external costs (e.g. companies acting selfishly because they aren’t the ones suffering from their own actions, such as a factory dumping waste in a river that’ll only affect those downstream from it) then it’ll never distribute the resource in question efficiently, thus the market itself creates the problem. It’ll send the wrong signals to the market (e.g. for not including these external costs, gas and electricity would appear cheaper than they really are for society, thus people will consume them more, and thus pollute more and create too much of a bad thing… often not knowing that there are long-term environmental costs that’ll bite them, or future generations of people, but only in the far future). If we only want the strong to survive then negative externalities ‘take the genes of innocent lives out of the gene pool too’, or at least unfairly harms them, as it were. The ‘cream’ doesn’t always rise to the top.
Whereas a negative externality will create too much of a bad thing, a positive externality will create a low quantity of a good thing because if people aren’t being properly compensated for what they actually positively contribute then they won’t be incentivised to provide it – hence again, the need for external incentives such as enforced laws or a government-led drive to vaccinate enough people within a country.
Vaccinations don’t work 100% of the time because different people produce antibodies with different degrees of effectiveness (e.g. people with cancer or autoimmune diseases, or young infants who cannot yet produce all types of antibodies). But if enough individuals (~70-90% is usually the target) have the vaccine against a particular communicable disease, that disease can be stopped dead in its tracks before it spreads far and wide. Not every individual within a group needs to be individually 100% immune from a disease for 100% of the people in this group to be protected from it.
Being in the vaccine-development business is an unattractive one though because of these positive externalities (the more customers get it, the less other potential customers will need it) and because there might be no/little repeat custom (once someone is vaccinated, they might not need to come back for booster doses or will only need to come back once every several years). Developing drugs that are thoroughly tested for safety is expensive too.
Yet of course vaccines are massively beneficial to society, and this is why vaccination programs are perfect for governments to carry out. They’re subsidised using taxpayers’ money to do what’s best for society as a whole. (But this is a reason why some anti-vaxxers think vaccines are really about governments injecting us with stuff to control us(!) Some parents in the 2000s, who understood a little but not enough, also exploited the ‘personal belief exemption’ by intentionally choosing not to vaccinate their children from MMR (measles, mumps and rubella), and these people noticeably increased the prevalence of these preventable diseases. Even a small decrease in inoculation rates can have dramatic detrimental effects on society. So get your COVID-19 vaccine jabs!) In other kinds of contexts too, solutions that aren’t profitable aren’t going to get produced or distributed by for-profit corporations without subsidisation, even though they could be hugely beneficial to society.
Owning a toilet also creates a positive externality – or did in the old days – because excreting on the streets or public grounds used to be free, whilst installing and maintaining a toilet cost oneself money and time. But you do yourself as well as other people (without them paying for any of the benefits) a favour by you owning a toilet. Lots of places across the world still don’t have flushing toilets because of the under-demand effect regarding positive externalities. On the other paw, the sewage system is shared so when some individuals throw things like wet wipes that don’t break down into them, this causes blockages that affect everyone along that system.
Externalities are present when tax-avoiding/evading companies rely on other people (fair taxpayers in this case) to pay for the road infrastructure, defence, police services, etc. these companies also take advantage of – anything where they benefit from something they don’t fairly pay for; or destroy, plunder or deplete something they don’t fairly compensate for, or even ask permission from others to pay for on their behalf.
Many people wonder why certain products are specially taxed highly, such as cigarettes, petrol and diesel. It’s because they produce significant negative externalities such as second-hand smoke, greenhouse gases, soot and aerosols. This extra tax revenue isn’t (or shouldn’t be) to pay for projects that benefit smokers or road users but for trying to compensate the wider public for bearing those passed-on costs (well if damage to health caused by others can ever truly be compensated with money). It’s to reduce the demand for such things. So taxing petrol and diesel highly should be to address the negative externalities of the pollution from vehicles, as well as the congestion they contribute – and such collected taxes should really be spent for the benefit of people such as pedestrians and cyclists (absent of voter pressures to spend this revenue elsewhere, such as on car users!)
Many taxes that seem to restrict our liberties and pursuits of pleasures are understandable once we learn about externalities. Alcohol can lead to people bearing the burden of other people’s consumption (e.g. assaults, vandalism, vehicular accidents, family problems) hence the production and/or consumption of alcohol is taxed and enforced with laws more highly to reduce these societal costs.
The free market only functions well if people get out only what they put in, and no more and no less, hence if someone can get all the benefits without paying all the costs (i.e. they get more out than what they put in) then the best won’t necessarily rise to the top and the worst won’t necessarily fall to the bottom, and people won’t get what they deserve. It’s not fair for you to walk down a street while breathing in some of the life-shortening toxic fumes of another person who’s driving a car journey that you’re not benefiting from. Things in advanced democracies aren’t restricted without good reason. (Regulations also aren’t usually proactive but reactive i.e. after a scandal or tragedy happens, but even then the political will might not be there if lobby groups are too powerful.)
The costs of externalities need to be weighed out with any benefits a product brings to society though (e.g. non-renewable-energy-powered cars and homes are still currently important for the economy and people’s lives despite the harms they contribute). This balance is now being tested in areas such as sugar and fat consumption because moderate consumption is fine but excessive consumption is not. When viewed as more of a fuzzy lifestyle choice instead of a person’s medical condition, some people controversially argue that obese people burden everyone else – not just when it comes to requiring more healthcare services, but they take up more space on seats and weigh more on aeroplanes, for instance.
Taxes are for the common pool and should get sensibly redistributed amongst society hence are an efficient way to at least try to readdress some of these market failures. Yet there’s no slippery slope to highly tax everything that brings people pleasure (condoms are even currently taxed at a reduced VAT rate in the UK). Learning about why things are the way they are helps us to stay more level-headed and helps us to make better-informed and reasoned arguments.
So rational governments increase taxes for things that aren’t healthy, aren’t fair for they cause negative externalities or otherwise would benefit from lower demand; and decrease taxes (or even offer subsidies) for things that are healthy, are good for they cause positive externalities or otherwise would benefit from higher demand. Sensible governments are also adaptable (e.g. in England and Wales, the window tax was repealed in 1851 after it was understood that windows offered health benefits like letting light and fresh air into a building. Tampon VAT has also gone). Governments should be scrutinised and then criticised if they step too far, but in many cases the free market needs governmental intervention to function more optimally. And if we want governments to keep doing good things then we should praise them whenever they do good things.
Woof! Through more education and thought, we begin to realise that everybody’s lives are interconnected in highly complex ways. Our choices and actions don’t just affect ourselves. So how can we make sure we all get, and only get, what we each deserve? Or would it be simply more pragmatically efficient, and thus perhaps rational, to be just a bit more egalitarian? Tell us what you think via the Twitter comment button below.