Negative Externalities and the Public Domain

Magically bored on a quiet street corner
Free frustration in our minds and our toes
Quiet stormwater, m-m-my generation
Uppers and downers, either way blood flows
--The Who

In our previous discussion of externalities, we observed that negative externalities can be viewed as failures of government rather than as failures of free market operations. Government is the agency charged with enforcing individual property rights in free market systems. If individual property rights were enforced, then it would be difficult for negative externalities to persist in market systems.

Rather than the private sector, it is the public domain that seems a more likely breeding ground for negative externalities. In economic systems that have been socialized to some degree, ownership and control of some productive assets are moved from private to public hands. Private property rights have been outlawed to some extent.

Consider the case of public property. Suppose that chemical runoff from privately owned farms kills fish in a nearby river. The river is public property. Many individuals that use the river may be negatively affected--fishermen, boaters, etc. Since none of these people owns the river and its contents, however, they have no direct claim on the damages, and they are in no position to negotiate with the farmers for satisfactory resolution.

It is common for government to represent the collective in pursuing remedies in situations such as this. Unfortunately, the preferences of the individuals in legal negotiations are likely to be varied, while government is likely to pursue a monolithic objective. This implies that some individuals represented in the collective will not realize satisfactory resolution.

Moreover, since individual lack property rights to negotiate solutions that 'internalize' the externalities, the externalities are likely to persist in the face of costly bureaucratic regulatory processes. It is not at all clear that social welfare has been advanced in this case.

Note that this problem largely goes away if public property was privatized. Privatization would put negotiating power in the hands of individuals who could use local knowledge to permit adequate internalization of the negative externalities.

The public domain is also likely to foster negative externalities in public works projects. In the United States, the notion of public works can be traced at least as far back as the Whig's American System, which proposed government-sponsored 'internal improvements' to enhance general welfare. Canals, roads, dams, tree planting, space travel, green energy, et all have all been posited to benefit the general public.

If true, then the beneficial spillovers would make public works projects a case of positive, rather than negative, externalities. Naturally, government officials would like you to believe this to be the case for any program that government is involved with. Indeed, President Obama's state of the union speech last week was full of such claims (here is a critical review of one of these claims related to government and nat gas).

Unfortunately, it is difficult to reason in favor of positive externalities for public works. This is because public works projects are funded by resources forcefully taken from private hands. Obviously, private owners had other plans for those resources, otherwise no government programs would be necessary. While some individuals may certainly benefit from the government project, we know with certainty that other individuals--those who had their capital forcefully expropriated--were harmed.

Moreover, long run spillovers of public works projects may not be positive either. While public works infrastructure such as roads and dams may seem beneficial, what is unknowable is what might have happened if that capital had remained in private hands and been invested using risk/reward heuristics. Quoting Mises (1951):

"The gullible masses who cannot see beyond the immediate range of the physical eyes are enraptured by the marvelous accomplishments of their rulers. They fail to see that they themselves foot the bill and must consequently renounce many satisfactions which they would have enjoyed if the government had spent less for unprofitable projects. They have not the imagination to think of the possibilities that the government has not allowed to come into existence." (655)

There seems little difference between viewing public works projects as negative externalities and viewing those projects as applications of the Bastiat's broken window fallacy (Hazlitt, 1946).

References

Hazlitt, H. 1946. Economics in one lesson. New York: Harper & Brothers.

Mises, L. 1951. Human action. New Haven: Yale University Press.