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3 Mins
January 25, 2011

Question: Please explain the meaning and significance of externalities, how they arise and to what extent they can be corrected by government intervention.

Answer: “Externalities,” in economic terms, are costs or benefits imposed on third parties during the normal course of economic activity. So, if a developer built a golf course across the street and your house became more valuable as a result, that would be a positive externality. On the other hand, a negative externality might arise if you lived near an airport and woke up a few times every night to the sound of jets flying low overhead.

The issue at stake here is property rights: should economic activity be allowed to continue if it imposes costs on others? Do you owe someone payment if his action benefits you in ways you did not request or foresee? Objectivism contends that the only act that warrants a response from the government is an initiation of physical force. The question, then, is whether externalities fall under this heading.

Positive externalities obviously do not. If someone happens to benefit as a result of an economic transaction in which he had no part, it is certainly no fault of his own. He has not stolen from anyone, and didn’t even take part in the exchange in question. That some third party may benefit from an economic activity is a concern of the people directly involved, and they are free to act or not to act based on that fact.

Objectivism contends that the only act that warrants a response from the government is an initiation of physical force.

Negative externalities, on the other hand, are a bit more complicated. If your actions erode the value of someone else’s property, have you violated his rights? Some cases are obvious; dumping toxic waste on a neighbor’s lawn is flagrant destruction of his property and probably poses a risk of serious physical harm. But what about driving a car that emits some small amount of carbon monoxide that, combined with the emissions of the millions of other drivers in a city, produces smog?

The sorts of force Objectivism is concerned with are direct and physical. These are the sorts of harms you would be expected to prove if you brought a tort lawsuit against those who had destroyed or degraded your property. In fact, under the laissez-faire state advocated by Objectivists, tort lawsuits would be the preferred method for resolving the vast majority of these kinds of disputes. On the other hand, Objectivism does not regard hurting someone’s feelings, or wearing clothes that are an offense to his esthetic sensibilities, to be a form of force to be resolved through government response. These kinds of “costs” cannot really even be objectively calculated, which is one of the problems with trying to even out every single imbalance arising from externalities.

Trying to resolve every diffuse or minor negative externality would have some rather tyrannical—and economically destructive—consequences. Homeowners cannot be permitted to stall airline travel just because they dislike the appearance of jet contrails in the sky above their homes. To use a more common example, one’s appreciation of “open spaces” does not give one the right to prevent a farmer from selling his land to a developer looking to build a subdivision. It would be exceedingly difficult, in a court of law, to prove that these minor inconveniences had resulted in any significant physical or economic damage. When properly defined, property rights are not a blanket right to dictate what sorts of activities may take place within eyesight, earshot, or driving distance of one’s land.

One factor that always acts to widen the degree of negative externalities is public ownership of land. When a river or stand of trees is owned by everyone, no one feels a particularly acute financial concern to maintain it. In economics, this is known as the “tragedy of the commons,” the fact that bodies of water and land are much more likely to become polluted when they are held in the public domain. Capitalism minimizes these harmful effects by privatizing the commons as much as possible. For instance, radio frequencies—which could easily become chaotic and “polluted” if many stations operated on the same frequencies—have been made into a kind of property through the use of broadcast licenses. The unsettled American West, one of the largest commons that has ever existed, was privatized through homesteading and land grants.

In the case of externalities, the relevant issue is property rights, and the corresponding principle is non-initiation of force. Externalities will naturally arise as part of the ongoing process of economic activity. Usually, their costs are small and transitory. But exceptions will arise, and when the harm caused by an externality is specific and acute (so much so that it could be established as part of a tort), it is a violation of property rights, a kind of initiation of force, and a matter for lawsuits and perhaps even government action according to criminal laws.

Andrew Bissell
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Andrew Bissell