Wednesday, October 17, 2012

Failures in Romney's Economic Proposals - Negative Externalities

The topic of negative externalities identifies a place where the Republican Party completely abandons its own morality.

Free market economics calls for defending certain rights to life, liberty, and property. It condemns violations of those rights. However, within the topic of negative externalities, the accepted position of most Republicans (though not all - an important minority on this point can still sometimes be heard) is that the owners of capital shall be free to kill, maim, and poison people and to destroy their party - even to destroy whole cities and wipe out whole nations - when it profits them to do so.

The first reaction many are likely to have to this statement is that it is an example of politically motivated exaggeration that is common this time of year.

Actually, it is not. It is quite literally true exactly as written. Though you do have to take care to note that "as written" includes the phrase "within the topic of negative externalities". Failure to note this clause could lead to misinterpretations of what I wrote.

What follows is a demonstration of this fact, as well as an explanation of how it stands in direct violation of the principles of rights and free markets that Republicans claim to support.

What are negative externalities?

Negative externalities are costs created by some activity that are forced on other people.

For example, let's say that I begin to tan hides on my back porch so that I can sell these hides. This produces a horrible stench. You live next door. Even with your windows closed, the stench seeps into you house. It is nearly enough to make you vomit.

How much would it be worth to you to avoid that smell? How much do you think you would have to knock off of the price of your house to get others to buy it if you put it up for sale?

These are costs. They are costs that are created by my act of tanning hides in my back yard. However, they are not costs that I have to pay. These costs are being forced on you - against your will. You get no compensation. You do not even get a share of the profits that I receive when I sell my hides.

These types of costs are negative externalities. We find them when companies produce obnoxious noises and smells, poison the air and water, and even when they contribute to climate change that - in turn - spreads disease, destroys property due to sea-level rise and extreme weather events, promotes drought, and inflicts similar harms on others.

Free markets abhor negative externalities. They prevent markets from being free, actually. They represent a form of forced transfer of wealth from those who suffer the costs of negative externalities to those who are making a profit without offering any form of compensation. If you are truly a supporter of free markets, then you too must abhor negative externalities and be seeking ways, where possible, to internalize these costs.

Let us add some sample numbers that illustrate the costs of negative externalities - how they violate free-market principles - and why these costs must be internalized for free markets to work as they should.

How much would you be willing to take, in the form of compensation, to put up with the stench. We can assume that you would do so for $10 million, but not for $1. There is some amount in the middle where "the stench and the money" is equal in value to "no stench and no money". Let us say, for the sake of this example, that this amount is $500 per month.

I am profiting from an activity that is costing you $500 per month. In economic terms, this is no different than me gaining access to your bank account and simply subtracting $500 from your bank account as a part of running my business. I am not taking the money - or the value - per se. I am simply destroying it. If it was my own $500 per month being destroyed, I would have an incentive to do something about it - to stop it. However, because it is your $500 being destroyed, I have no incentive to prevent it, and I allow it to continue.

Internalizing the costs - which is what the free market demands - means that if I create a cost for others, that cost must come out of my own pocket. I must compensate people for the harms done at least to the point that "harm plus money" is of equal value to the person being harmed as "no harm plus no money". If I do not, the market is not free nor is it running efficiently.

Let us say that I cannot afford the $500 per month it would take to compensate you for the harms done. My business only brings in an extra $400 per month. According to free-market economics, this business should not exist. Its costs to society are greater than its benefits. It is a business that makes people - all things considered - worse off rather than better off.

Now, let us assume that there is a process I could use costing $200 per month more that has no smell. If costs are internalized - if I have to pay you $500 per month as compensation for the smell - I now have an incentive to adopt this $200 alternative. I spend $200 per month, I save $500 per month, so I benefit. Free market principles where costs have been internalized give people an incentive to do things that benefit the community.

However, if I am free to impose these negative external costs on you with impunity, then why should I spend $200 for a procedure that would reduce the smell? I get nothing out of it. You are paying the costs of the smell, not me. Perhaps you want to pay me $200 to adopt the procedure. Personally, I am going to charge you $495. You still get at $5 benefit. Or, better yet, I might threaten to produce a smell so bad you would pay me $1000 to get rid of it - and then charge you $995 not to use it.

There is also a right's based moral argument that generates the same conclusion.

Let us assume that you bake a pie. It is your pie. If I want any of it, I must offer you enough in exchange to get you to voluntarily give up a slice of pie. If I take the pie without just compensation, I am a thief. If I spit on the pie, or I pour a cup of motor oil on it - in other words, if I pollute the pie - I have destroyed or diminished its value. I owe you a pie. Rights-based morality demands this. Nobody can claim to be a consistent defender of rights-based morality and hold that I can destroy the value of your pie by polluting it without owing you compensation for harms done.

However, the Republican position on these things is that, while a common citizen may not destroy another person's pie, a factory owner can destroy her health, poison the water she drinks and the air she breathes, even destroy her property, and not owe her a dime in compensation. Environmental regulations that would prohibit these activities, or that would require that the owner pay some sort of fee that can go to compensating victims for their costs - represent "excessive government intrusion" and is to be condemned. The Republican position is that those who own factories or other means of production must be permitted to kill, maim, and poison people - and destroy their property - with impunity.

If anybody has to pay for these harms done, it is the government, not the people who do the harm. And having the government pay for these harms itself represents an unacceptable "growth of government" that ought not to take the place of these people suffering the costs themselves.

So far, I have been talking about pies and a $500 stench. This may give the illusion that these cases are trivial - and as such they really do not matter.

However, these examples only illustrate the principles. Climate change provides a prime example of a real-life application of these principles. Here, the Republican position is to permit people to engage in activities that threaten to destroy whole cities, wipe out whole nations, decimate whole populations, submerge tens of thousands of square miles of property under sea-level rise, promote the spread of disease that will kill millions, prematurely kill countless elderly with heat stress - without paying one single dime in compensation to the victims.

The rich get to pocket their profits - the poor get the bills.

In principle, it is no different than the hide-tanner forcing a $500 cost on his neighbor or the person destroying the pie. In fact, greenhouse gas emitters are forcing death on hundrends of millions of people and the complete destruction of vast amounts of property.

This is not a mere academic exercise. This is not something that one should be able to read and shrug and say, "I don't care" - any more than one should shrug one's shoulders with indifference to setting of a nuclear warhead in a major city. This is a moral wrong of tremendous proportion - not by some outside standard that Republicans reject anyway, but by its own standards.

To preserve their egos, they simply ignore the evil they defend. "These things are wrong and those who do or defend these things" go in one mental compartment. "I do or defend these things" go into another, and they are kept far apart in the Republican brain.

Romney's economic package could work in a fantasy world where negative externalities do not exist. In the real world where negative externalities are common, and in some cases massively destructive. A Republican true to his moral principles will be telling the world his plans to internalize these costs and to prevent the forced transfers of wealth from those who do harm to those harmed. However, the official Republican position is that those with capital must be free to kill, maim, and poison others - and destroy their property - whenever it is profitable to do so, as long as the method for doing so is the production of "negative externalities."


noahluck said...

I was going to share this with friends and ask for their comments -- until I got to the end. No matter how accurate the comparison and contrast versus child molesters is, I expect that it's so inflammatory that it will overwhelm any thoughtful responses to the material preceding it. :(

Alonzo Fyfe said...

I had second thoughts about that, too. So, I've removed it. In this context, it does not say what I want it to say. It requires a fuller discussion of the techniques of rationalizing - convincing oneself that, in spite of strong evidence to the contrary - the things one (wants to do) are not bad so as to not feel guilty about doing them. However, this article does not focus on rationalization techniques, so I shouldn't bring them up at the last minute.

Ryan said...

"However, the official Republican position is that those with capital must be free to kill, maim, and poison others - and destroy their property - whenever it is profitable to do so, as long as the method for doing so is the production of "negative externalities."

There are two ways for a Republican to avoid your charge of hypocrisy:

1.) Deny that these externalities are real

2.) Argue that these externalities are a necessary evil because they are produced by necessary businesses and cannot be eliminated without significant spending that (1) no one can afford and (2) greatly exceeds the costs of the externalities

In fact, Republicans do both. Whether or not they are correct is one question; whether or not they believe that they are correct, such that they can avoid the charge of hypocrisy, is another.

Alonzo Fyfe said...


In some cases, these claims are even accurate. People make false claims of negative externalities, and if the costs of negative externalities are sufficiently low then the most efficient option is to let society absorb them.

However, the denial response can only apply to specific claims of externalities - and the denial has to be plausible. Pouring motor oil on your apple pie while denying that I ruined it is either a sign of insanity, a lie, or a morally culpable example of rationalization.

As for the "necessary evil" argument, the claim is not necessarily that the negative externalities should be eliminated but that some sort of compensation should be made. One possible compensation is to simply have the company pay a fee to the government according to an estimate of the value of negative externalities produced, and have the government earmark the money for projects that benefit those most strongly impacted.

For example, a tax of tires that goes into covering respiratory illnesses in urban hospitals would be a simple way to deal with pm2.5 residue from tires - the small pieces of rubber that get into the air when people drive.

Mostly, this article is an objection to an economic plan that does not even mention negative externalities or discuss any way of internalizing costs - a significant oversight given the facts of the matter.

Alex Strinka said...

"Free markets abhor negative externalities." Is that standard usage of the term? Generally when I see the term "free market" used it refers to something more like laissez-faire, which isn't opposed to externalities (or monopolies or other sources of inefficiency).

Alonzo Fyfe said...

Alex Strinka

It is a standard usage in economics. A free market is one in which economic transactions are free of force or fraud. Where force or fraud is used, markets are not free. Negative externalities represent a type of force - imposing costs on others without their consent.

Chris Langston said...

Most of the conservatives I know downplay negative externalities by pointing to the Coase theorem, which shows that you can internalize externalities with a more complete system of property rights (e.g. eliminate air pollution by privatizing the air). They suggest that conservative politicians don't push these internalizing policies because they are so unlikely to pass the congress, but that the politicians would like to do so if they could. Is this disingenuous? I don't know.

Alonzo Fyfe said...

Chris Langston

Yes, you can internalize negative and positive externalities both with a more complete system of property rights.

So, Romney should be presenting a more complete system of property rights.

Instead, he ignores the problem. Ignoring negative and positive externalities will not solve the problem. It's like ignoring the fact that your boat is sinking.

The White Man said...

Thanks for the analogies. Apparently no free market exists in the world, or ever has. The best we can hope for is to live upwind.

Kris said...

I enjoyed this more than I can say--it's fun to delve deeper into matters and come away with a better understanding. You're an excellent teacher.