At EconLog, Bryan Caplan writes:

When Princeton’s Roland Benabou visited GMU a couple weeks ago, he made an argument I’ve occasionally heard before: Non-economists would disagree with economists less, and respect our views more, if we put more emphasis on the concept of externalities. When economists talk about markets, the argument goes, we usually seem tone deaf to non-economists’ concerns. If we put more emphasis on the concept of externalities, non-economists could see that it is easy to translate their concerns into our language - and that we have every reason to take their concerns seriously.

As a rhetorical strategy, Benabou’s probably right. Non-economists are much more anti-market than economists. If we told them that the economic way of thinking is consistent with (or better yet, justifies!) their anti-market prejudices, we’d be more popular.

But is this an intellectually sound way to bridge the divide between economists and non-economists? I think not. If we explain the concept of externalities properly, non-economists will continue to give us the cold shoulder. Here’s why.

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… [There is more.]

I think Caplan and Benabou are both right. Caplan is right that the idea of "externalities" is often misused and doesn’t justify what many non-economists want it to justify.

But Benabou is right too. I have heard it said more than once that "economists have never heard of externalities", which is a little like saying that "mathematicians have never heard of subtraction" or "Catholics have never heard of sin". Non-economists are reassured simply by the discovery that economists understand that markets do not always function perfectly. In a world when economists are cariacatured as market fundamentalists, this is progress.

February 12th, 2008 in Grown up economics | Permalink