Our Word is Our Weapon

I’ve been meaning for a while to come back to this post of Bryan Caplan’s on externalities. He writes:

[…] 1. The concept of externalities relies entirely on economists’ standard notion of willingness to pay. If people are willing to pay to preserve a rare species of monkey, there may be an externality. If no one cares, there’s no externality. The upshot is that the concept continues to slight non-economists’ concerns about fairness, intrinsic value, equality, etc.

2. If an externality exists, the economically efficient solution is normally a tax or subsidy. That’s it. But non-economists are usually looking for an excuse for government to ban or nationalize. At minimum, non-economists want to use hands-on regulation - not just add a tax and say “OK, problem solved.”

Someone who uses an externalities argument to justify e.g. existing (or stricter!) EPA regulation doesn’t really understand the argument.

3. The concept of externalities focuses on non-excludable costs and benefits. The upshot is that we can go down the list of e.g. environmentalist causes and pick out a major subset that probably don’t qualify as externalities problems. Recycling? If people are paid the market value of what they recycle, it’s hard to see the externality. National parks? If user fees can’t sustain them, you have to fall back on a lame “existence value externality” story. […]

There’s a few obvious things wrong with this. Bryan contradicts himself when dismisses ‘existence value’ externalities as ‘lame’, having earlier argued that there’s an externality if someone is willing to pay. So if people are willing to pay to preserve a national park but never get around to visiting it, that’s still an externality. What’s more, economic value can be assessed on the basis of willingness to accept compensation as an alternative to willingness to pay.

More fundamentally, it is simply not true that taxes or subsidies are the sole or even default solution to externalities, since as any good textbook of environmental or urban economics will tell you there are sound theoretical reasons for favouring regulation in some cases. ‘City Economics‘ by Brendan O’Flaherty, for example, has a good discussion of ‘When Rules Work Better Than Prices’. The first such case, says O’Flaherty, has to do with the information available for making policy. He uses two examples; a cruise ship which will run out of lifeboats if it takes on more than 80 passengers, and customers using the photocopier at a library:

Rules work better than prices when the marginal external cost of what the public is doing is very sensitive to the quantity of what the public is doing, and when the marginal private benefit is not very sensitive to the quantity … when you know what the marginal social cost is going to be, as at the library, set a price. When you don’t know what marginal social cost is going to be but do know where it changes, as on the cruise ship, use a rule

A second argument for using rules rather than Pigouvian taxes, says O’Flaherty, concentrates on enforcement costs, ie how hard it is to find out what people have done in order to tax or punish them appropriately. Here, when official monitoring is difficult or unlikely, ‘community reporting’ may be superior, and “it’s much easier for neighbors and the community in general to know whether someone is breaking a rule than whether she has paid appropriate taxes” (see Glaeser and Sheifer’s ‘A Case for Quantity Regulation‘).

There are also extreme cases in which rules are preferable, such as when collecting money is simply infeasible, eg at a traffic intersection (so rather than setting a price for going through access is determined by rights of way or traffic lights) or when “the external harm of an act is so great that the optimal number of times for the act to be committed is clearly zero”, such as arson or murder.

Finally, O’Flaherty makes a good general point about information:

if a government (or a firm) has the superb information it needs to set precisely the right prices, then it can set rules that work just as wel as prices: it can permit those instances in which benefits exceed costs, and prohibit the others. When information is very good, rules work just as well as prices.

In other words, environmental economics tells us that regulation can be a more appropriate response to externalities in a variety of cases. So when Bryan complains that environmentalists harbour unfair suspicions about economists, he’s not really helping his case by misrepresenting the field.

To follow up yesterday’s post on Baltimore, here’s Ryan Avent on what I think was a key mechanism in the precipitous decline of many American cities:

During the great suburbanization wave of the postwar era, policies discouraged or prevented black suburban homeownership at every turn. Whites moved into appreciating assets in the suburbs, building wealth while they constructed a segregated and elite system of services for themselves–especially schools–constituting an upward-mobility engine. Blacks were relegated to the cash-strapped center, denied the ability to build wealth through homeownership, stuck in failing schools, plagued by crime. You want to find the root of differences in racial mobility, suburbanization and residential segregation is a good place to start.

This is a complex story, combining free movement, distorting government policies on transport and land use, the consequences of decentralised local government financing, and old-fashioned racism. On a similar note, here’s Patrick Sharkey on how government policy implicitly discriminated against predominantly black neighbourhoods:

Federally subsidized mortgage programs, run through the Federal Housing Administration and the Veterans Administration, made home ownership available on a broad basis for the first time in the post-war years. However, because the official guidelines of these programs used the racial composition of neighborhoods to determine the risk of a loan, neighborhoods in cities with large non-white populations were largely excluded from opportunity offered by government-backed mortgages.

Again, you have to wonder how much of this was really an unintended consequence and how much was deliberate racial discrimination.

• Embrace Economic Change « Consider the Evidence
  (tags: economics inequality redistribution)

The Wire is brilliant television, but there’s something I keep asking myself when watching it, though particularly the unremittingly bleak fourth season: Is Baltimore really this bad? Here are a few stats, with a comparison to London thrown in:

• Baltimore lost 3% of its population between 2000 and 2006, while London gained about the same proportion.
• 14% of Baltimore’s housing units are vacant compared to about 3% of London’s.
• On any given day, there are over 28,000 residents of Baltimore City who are incarcerated or under the supervision of probation or parole. That appears to be more than 4% of the total population. There aren’t any directly comparable figures for London but the total official capacity of its nine prisons is about 7,500, in a city more than ten times as large.
• Baltimore’s homicide rate in 2007 was 44 per 100,000 residents, compared to about two per 100,000 in London.

I’m not just trying to make Baltimore or the US as a whole look bad. I’ve picked London as a comparator partly because its the easiest British city to find figures for and partly because the rest of the country generally tends to see it as Crime Central. There are more stats on a wider range of English cities here and of course you can look at other American cities but I think the general pattern will hold - it’s not like Baltimore is even the worst city in the US, at least for murders. You might argue that there are pockets of English cities that are just as bad as Baltimore - to be honest I doubt it, but even so I don’t think there’s anything on the same scale.

We could argue all day about the factors that brought Baltimore to its present predicament - industrial decline, corrupt governance, etc - but it’s hard to believe that urban decline would have been allowed to go so catastrophically far in England, which has a history of centrally-led interventions in deprived urban areas under both Conservative and Labour governments. Whether that difference reflects the legacy of racism in America, a more de-centralised and laissez-faire approach to urban governance and spatial inequalities, or something else altogether is another question.

• The Bellows » History Will Not Look Kindly on the Bush White House
  (tags: environment politics)
• Clogged Arteries
  “To power our metropolitan engines, we need to make big, well-targeted investments that improve transportation within and around them. Above all else, that means taking a less egalitarian approach to our infrastructure”
  (tags: cities transport geography)

This from Robert Reich is along similar lines to what I’ve said before:

Even though the winners from free trade could theoretically compensate the losers and still come out ahead, they don’t. America doesn’t have a system for helping job losers find new jobs that pay about the same as the ones they’ve lost – regardless of whether the loss was because of trade or automation. There’s no national retraining system. Unemployment insurance reaches fewer than 40 percent of people who lose their jobs – a smaller percentage than when the unemployment system was designed seventy years ago. We have no national health care system to cover job losers and their families. There’s no wage insurance. Nothing. And unless or until America finds a way to help the losers, the backlash against trade is only going to grow.

In other words, free trade demands ‘big government‘. This, of course, is strenuously opposed by those who are doing so nicely out of the current arrangements.