Thursday, August 12, 2010

Externalities, Calculation, and the Market

Trying to address externalities with policy is not the same as central planning. In central planning, the state does the task of economic calculation - an endeavor doomed to failure. In externality policy, the state improves the market's ability to do the task of economic calculation. There are certainly critiques to be leveled against these sorts of Pigovian policies but the economic calculation critique makes no sense, because Pigovian policy doesn't ask the state to do any economic calculation (as it is traditionally conceived in this debate at least).

Jonathan Chait, at The New Republic, makes the distinction in less technical terms when he points out the reaction of the light bulb industry to energy efficiency standards. He is right on target - it's Chait that understands the process of economic calculation, not Weekly Standard writer Andrew Ferguson (to give you a sense of the way Ferguson sees the world, his most recent piece was titled "Are Americans closet statists?").

This is the point I was trying to make when I highlighted the Chinese attempt to increase energy efficiency by centrally identifying a bunch of factories to simply shut down. That is the state doing the task of economic calculation. Policies to address externalities have the market do economic calculation. And when you don't do Chinese central planning and you don't do anything about externalities, you're just ignoring the requisite inputs for market calculation (namely, profit-and-loss prospects, well defined property rights, and internalized costs and benefits).
Some people who object to addressing externalities object on a practicality/public choice basis. That makes some sense but I think these points are usually considerably overblown (what kind of rent-seeking really went on in this Bush-era light bulb energy efficiency decision, for example??), but they do at least make sense. The argument against Pigovian policy from an economic calculation problem perspective, though, makes no sense at all. It completely misunderstands the issue at hand.


  1. Energy efficiency - despite all the folk wisdom about it in the political realm - does not lead to per capita or aggregate decreases in energy use. Energy use increases in new areas opened up by those efficiencies.

    Anyway, most Pigovian actions are basically in the realm of the sorts of moral panics that lead to nanny-statism. That's the inherent problem with Pigovian actions and efforts to fix externalities.

  2. "Anyway, most Pigovian actions are basically in the realm of the sorts of moral panics that lead to nanny-statism."

    I can always count on your for soap-box prognostications that are so vague and unsupported that one doesn't even know how to respond.

  3. btw - thanks Robert.

    There are some days I feel like my research agenda just oughta be this world of externalities.

    Ultimately it's way too micro for me, and often way too context-less. But I think they're hugely important and they complicate a lot of the fights that people always seem to want to pick, like the "Socialist Calculation Debate".

  4. Daniel,

    I can always count on you to support any and all things that the state does just because it is "efficient."

  5. Hey there's another one!

    Come now - "any and all things that the state does". That, unlike your previous statement, is entirely transparent and easily falsified.

  6. "Come now - "any and all things that the state does"."

    Just because it is "efficient"; like how you left out that qualifier.

  7. That didn't sound like a qualifier - that sounded like my justification.

    In other words, you didn't say "any and all efficient things that the state does" (that would be untrue too, but admittedly harder to demonstrate since for the most part the places where I see state action as legitimate are the places where there is some prospect of state efficiency).

  8. It is a qualifier and clearly is one!

    "but admittedly harder to demonstrate since for the most part the places where I see state action as legitimate are the places where there is some prospect of state efficiency"

    Hypothetically that is the case; in actual practice, not so much.

  9. I did a small amount of research and discovered that GE spent a fair amount of money lobbying for the outlawing incandescent light bulbs. Which also puts this all back into the "socialist calculation debate."

  10. Speaking of standards:

    So, not only are the standards useless - they don't lead to decreases in energy use - they also apparently are rife with error.

  11. Of course Pigou agreed with me:

    "It must be confessed, however, that we seldom know enough to decide in what fields and to what extent the State, on account of could interfere with individual choice."

    Drawing on this statement we can compare its humility with what the state actually does and come to the conclusion that the state does all sorts of things in Pigou's name that Pigou would not have approved of. Why does it do these things? Moral panics seems like a very reasonable conclusion.

  12. Xenophon -

    1. I don't think you understand what I'm saying about the SCD. I have no doubt lobbying went on for this and many other decisions. That's part of representative government. Sometimes its fine, sometimes it's very seedy. But regardless - this make public choice theory more relevant, not SCD. How are you thinking this makes SCD relevant?

    2. I agree with Pigou too on that. I don't think much of what the government does is done in Pigou's name. I also think that economists who invoke Pigou generally speaking don't support a lot of these things you're thinking of. And I agree - moral panic explains a lot of what the state does, and it probably explains electoral support for things that economists would consider a "Pigovian" solution. In other words - most of the stuff you're thinking of isn't done in Pigou's name, and the stuff that is justified on the basis of Pigou gets extra public support out of moral outrage and moralizing. Then again - a lot of the oomph that libertarianism gets comes from moral panic too.

  13. I tried to respond to this on my IPhone ... the text on the browser is just too small.

    (1) "Sometimes its fine, sometimes it's very seedy."

    Well, it is always seedy - the intensity of such varies.

    Because it is still planning. That's the point Pigou is making to me ... in most cases their is a calculation being made and a specific outcome being planned. It remains part of the calculation debate.

    Now certainly, businesses can respond to those incentives (though some will clear;y suffer and others will benefit), but the calculation isn't merely up to them.

    Then again - a lot of the oomph that libertarianism gets comes from moral panic too."

    Except the objects of our "moral panics" have a tendency or track record of coming true.

    In light of what we "panic" over and our earlier conversation on culture, books, etc., I thought I would pass this along:


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