Externalities and the free market

Readers Question: I understand “externalities” and why certain economic actors will tend to dispute the scale/existence of them. What about the complementary idea, of benefits conferred by many societies which are centrally planned and financed (roads, defence etc.)? Libertarians of any political stripe may downplay/deny their importance though benefitting. My question: is there a technical term for all this? “Internalities” would be logical. Some of these are easier to perceive and defend than others. Roads are “good”. NHS more controversial. Hardest to define, benefits of a society which is liberal, promotes trust, provides robust safety net etc. Thanks, Mark

I’m sure most economists would accept the existence of externalities, both negative and positive. If there are negative and positive externalities, there is a clear argument that this will lead to market failure. For example:

I would argue that health care is a clear case of a service which has a strong positive externality. If you look at standards of public health in the Ninenteenth Century, death rates were much higher. It is in everyone’s interest to provide a minimum level of public health because everyone benefits. If you have a situation where people catch infectious disease because the free market has failed to provide decent sewage or vaccination, everyone is more susceptible to catching infection too.

Solution to Externalities

The solution to externalities may differ. I’m not too aware of extreme Libertarian ideas because I find it difficult to take them too seriously. I know the presidential candidate Ron Paul argued there was no need for public health care because in the absence of government, local communities would chip together to offer local charitable provision.

A libertarian may also argue, that even if there is a theoretical case for government intervention to overcome market failure, the government should still nothing. The argument is that the costs of government intervention (such as incentive reducing income taxes), poor information, and the ‘inevitable’ government corruption will always outweigh the benefit.

Personally, I don’t accept this idea. Health care workers, such as nurses and doctors don’t become inefficient because they are working for the government NHS rather than a profit making health firm. In fact, perhaps the opposite.

Nor do I accept that the free market will magically provide these public goods. If you leave it to the free market, there will always be a huge inequality in provision and quality of the product. Victorian society, shows that the free market will provide some health care and some education, but, this was a very limited. Whatever failings of government health care and public education, I’d take it over a libertarian society.

Nor do I accept that government intervention has to be inefficient, corrupt and all the other ‘evil’ practises that libertarians project onto government. If you have government of the people, there is no reason why government public services can’t be run in the public interest.

It is worth bearing in mind even ‘right wing’ ‘free market’ economists like Greg Mankiw, who worked for George Bush, is a strong advocate of the Pigou club – taxing goods to make people pay the full social cost. Pigou club


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