Wednesday, December 9, 2009

Why Positive Externalities Are Bad

A.K.A. The Tragedy of the Commons

A negative externality is when someone who is doing some activity doesn't bear all of the costs of that activity. Instead, some or all of the costs are imposed on somebody else. This is bad not only because it's unfair, but also because it means that too much of that activity happens, like in the example from yesterday's post where gold mining in California was probably a net economic loss to the state. If the gold miners had to pay for the damage they were doing, they would have only mined the gold that they could get out without causing a lot of damage.

A positive externality is when someone who is doing some activity doesn't capture all of the benefit of that activity, and instead some of the benefit is captured by other people. It sounds like a good thing, like a service to society, right? Actually, positive externalities are also bad, because they mean that too little of that activity will happen.

In the digital age positive externalities are becoming much more noticeable, and having much more powerful effects on society. These effects are good! Google and Wikipedia (just two prominent examples) have provided enormous value to hundreds of millions of people. Though Google has made piles of money for its founders, it is still the case that the the value to society of Google's services is at least many times greater than all of the ad revenues the company has ever collected. How do I know that? Because I've already used Google more than 10 times this morning at no cost to myself, AND I didn't click on, or even notice, any ads. In fact I've hardly ever clicked on any Google ads. I am quite clearly free riding on Google's service, and have done so for years. Google is even subsidizing the wealthy, multinational corporation I work for by allowing my company to do research, for free, with its powerful tools.

So, why are positive externalities a bad thing? Oh right, because where positive externalities exist, not enough of a valuable activity is occurring. Can this be true? Do we really not have enough Google? Has society left money on the table in the form of investment that hasn't been made, but that could be making us all much, much better off?

Yes. Absolutely.

It's a hard thing to prove, because value that hasn't appeared is difficult to visualize, and even harder to quantify. but basic economics tells us that, yes, we are not getting an optimal amount of Google (and similar products/services). In fact, we are over-investing in something, maybe cars or houses or something, and under-investing in other things like information technology where it's hard to capture the benefit, and instead the benefit leaks out to the rest of society.

Just one quick example before this post gets long: Would the internet be what it is today if it hadn't been sponsored by the government? My guess is, no.


  1. Robert, where have you been learning these economic principles? These are not just intuitive to you are they? I have not met a single person for whom these ideas (this and your previous posts) come naturally, although when you think about them they make complete intuitive sense. I have heard that such people exist, but I have not witnessed one myself.

    I always enjoy pondering ways to solve externality problems. The first place I always look is property rights. Some extreme libertarians believe all externality problems are nothing more than problems with the definition of property rights. I am not convinced, and I think there are cases where government intervention is the best solution.

  2. Justin,

    Thank you for your kind words.

    I like to tell people that I was an economics major before I switched to engineering, and while that's technically true it's misleading because I only ever took a couple of lower division econ classes. I do LOVE economics though, even though I have occasionally doubted it (parts of it) as a hard science. I read and think econ every day.

    I'm really persuaded by the idea that property rights can be reformulated to fix a lot of problems. I don't think it's a simple thing to do that, but I do think it's possible. Lots of smart people have worked hard for centuries to develop regulatory solutions to these same problems. Many things have been tried, and the results are at least workable in most cases. I think it will require a similarly large investment in thought, trial, and error to develop high quality property rights solutions to these problems, but I think the long term results will likely be much more efficient, and probably more satisfactory.

    At the same time, I agree with you that government intervention has a legitimate role. I just think that right now it's the only tool in the box that is being utilized.

  3. Robert,
    I understand what you are saying, but can you tell me in a case of the Mclibel case are there both positive and negative externalities that came out of it. Or only negative?

  4. Anonymous,

    I guess I don't really understand your question. Are you asking about reputation as a property right?

    Possibly I could refer you to:

  5. I am new to economics and I saw as an example that the Mclibel 1997 case in England was a negative externalities. I was not sure in what way it can be categorized as such.

    I just need confirmation that is can be used as an example

  6. I'm not sure I can be a lot of help to you. The best I can suggest is that if you consider reputation to be a property right, then libelous speech produces an externality - an uncompensated impact on another person's (or company's) reputation.

    Can you tell more about the example you saw where negative externalities were discussed in terms of the Mclibel case?


    thats the link that i saw

  8. Oh, OK. So Prof. Folbre says that both McDonalds and their opponents were complaining about externalities. McDonalds argued (as I suggested above) that the political speech of the 'leafletters' (I assume she means leafleteers) was producing a negative externality on the reputation of the McDonalds corporation. In other words, uncompensated harm was being done to McDonalds. Put another way, the 'leafletters' were not bearing the full costs of their activities. Instead some of those costs were being forced onto a third party - the McDonalds corporation.

    On the other hand, the 'leafletters' were complaining that the McDonalds business model was producing negative externalities in the forms of environmental damage and corrosive effects on culture (poor nutrition, child labor).

    Whether any of these are true externalities in the economic sense is debatable. Certainly, if the claims of the 'leafletters' about the McDonalds corporation are true, then one can argue that any reputational damage done is the result of the actions of the McDonalds corporation, not the result of actions by the 'leafletters'. I might make a similar argument about influence on culture. Environmental damage, however, is a likely example of an externality, simply because such damage is usually not priced according to the inputs of future stakeholders.

  9. Ok Thank You very much , it makes much more sense now.
    Keep up your excellent work :)