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Wednesday, February 29, 2012

Conceptual errors lead to externality abuse

In class, we discuss how there is a lot of externality abuse in politics, as well as things being called public goods that are not actually public goods from an economic standpoint. Conceptual errors are a big part of why these abuses occur: People do not understand what an externality, market failure, or public good is from an economic standpoint, yet try to analyze it through economics.
For example, people often consider the government a market, rather than a force used on the market, and then consider externalities created by the government an externality, and a source of market failure. But the government isn’t a market; it’s a force. It’s a failure of the government if something they do creates an externality. For example, in a blog I read they talked about how taxing sodas is a good idea because they create a negative externality, because they are unhealthy and can increase medical costs for the person drinking them. They claim it’s a negative externality because taxpayers pay the cost through Medicare/Medicaid. However, these programs are created by the government, and only because of these programs, is there a 3rd party that is affected. However, Medicare/Medicaid are government created programs, and if they didn’t exist, there would be no externality; if someone was unhealthier and paid higher medical costs because of all the soda they drank, they would pay the costs themselves. This is a government failure, not the market failure; plus, the government intentionally involves the 3rd party through taxes, so it does not meet the definition for an externality.
Another example of this conceptual error is health insurance, and how it’s getting more expensive and less people can afford it. There is a lot of regulation in place limiting competition between healthcare insurance companies, which plays a role (among other things) in increasing healthcare costs. However, these regulations are in place by the government, not the market, and therefore that is a government failure, not the market.
Another example of a conceptual error is in public goods. Public goods must be both nonrival and nonexcludable to be true public goods. Some examples in class we talked about were highways and roads, and how these are club goods, not public goods. Another example is parks; they are congestible, and so have a limit of nonrivalry. Also, they are excludable, because you could charge a fee to use the park rather than have them open to the public. The government uses taxes to build parks because they consider them a public good: trees are good for our air and environment, they are good for activity of the people who use them, but these are not third parties that are benefiting unintentionally. They pay taxes for these parks, the government intends to make things better for the society as a whole, therefore intentionally involving the third party (even if they don’t pay taxes), and so it does not fit the economic definition. Just because the park does positive things for people (therefore it is good for the public) does not make it a public good; the government uses force to by choice provide them free of charge. Technically, parks, highways, education systems, and many more things are actually club goods, and club goods can be provided by the market, providing they can get efficient membership, provision, and utilization over time.
By assuming government failure is market failure, many people see externalities or other sources of market failure everywhere, and say that this is cause for government action. Whether the externality is negative or positive, if it is created by the government, it is not a market failure. By economic definition, if it is not a market failure, the government should do nothing; so in the case of externalities caused by governments, governments should stop acting. 

Danielle Pierson

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