Negative Externalities

I’ll give you an example:

Say you, for your own personal purposes, have a nice garden around your house and are very careful about your lawn so that everything looks real nice.  As a result, people who walk down your street, or live near you, benefit from it. That’s a good externality.

In contrast, say you are a hoarder who has saved every item and every piece of garbage that you ever laid your hands on.  As a result, your yard is a horrible mess and rats infest your house and the entire neighbourhood.  That’s a bad externality.

Surely we agree that there is a legitimate role for government, in so far as it can, to control and keep bad externalities in check?

Let me give you a broader example:

Suppose you sell me a car, and we both make a very good deal for ourselves and are both extremely happy about it.  Well, if you sell me a car, it increases gas prices, pollution, and congestion, and that extends very broadly from one car to one billion cars.  That’s a bad externality.

Externalities come in all shapes and sizes.

Second hand smoke is another example of a bad externality. As a result, most sensible governments have made smoking in public places illegal.

Surely we agree that there is a legitimate role for government, in so far as it can, to control and keep bad externalities in check?

In the financial institutions bad externalities are the worst of all. Financial institutions are in the business of taking risks. If they are well managed, they calculate the potential cost to themselves if there is a loss, but, the important words here are “to themselves.”  They don’t add what’s called “systemic risk” into their calculations. They don’t add the cost of what happens if they go bust. That can be a hugely bad externality where millions of lives are affected.

Surely, we agree that there is a legitimate role for government, in so far as it can, to control and keep bad externalities in check?

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