Friday, April 9, 2010

Keep your carbon off my property: Paul Krugman explains externalities

To hear some commentators, "free market" means the same thing as "small government." According to this mindset, government and freedom are zero sum. If you want to make the market more free, it always means reducing government interference in the market. And by the same token, any increase in government control over economic activity reduces economic liberty.

But market exchanges don't happen in a vacuum, and they often produce side effects. That's what we call an externality, and it's the classic Econ 101 example of how government interference in markets can make them more free. In an excellent piece on climate change economics, Paul Krugman gives a great intro lesson in externalities for the non-economics student:

But what if a deal between consenting adults imposes costs on people who are not part of the exchange? What if you manufacture a widget and I buy it, to our mutual benefit, but the process of producing that widget involves dumping toxic sludge into other people’s drinking water? When there are “negative externalities” — costs that economic actors impose on others without paying a price for their actions — any presumption that the market economy, left to its own devices, will do the right thing goes out the window. So what should we do? Environmental economics is all about answering that question.

In other words, it's totally simplistic to talk of cap-and-trade as a restriction on freedom. Whose freedom - factories' and coal companies'? And what kind of freedom - the freedom to pollute? The freedom to waste? The freedom to emit dangerous gases into an atmosphere shared by all, even if other people don't want you polluting their atmosphere?

Surely anyone who lives in democratic society lives by the precept that "you can do whatever you want - but not if it affects somebody else." And surely anyone who believes in capitalism and property rights believes in my right to keep other people's carbon pollution off my property.

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