Externalities August 2019 • 8 minutes

People seem to routinely misprice externalities into their decision making. Consuming gas for it’s transportation benefits without pricing in the environmental impact is the obvious one. Doing something that wastes time but saves money would be a less obvious version: by accounting your own time with a value of zero, you create a significant distortion of economic and practical reality. Much like gas and the environment, the consequences are serious if routinely mistaken.

It would be interesting to explore what would happen if all known (knowable?) externalities were to be priced into consumption overnight. Gas would be more expensive: it’s clear that the negative externalities are not accounted for properly. Some things would be cheaper: it seems like vegetable eating would save a great deal of health care dollars, and so perhaps allow for zero or negative rates of taxation to account for their relatively positive impact on people’s functioning. Smoking, sugar and other lifestyle factors would be more expensive: those things end up costing the healthcare system much more than the cost of consuming them.

It seems like you can start to establish categories of externalization based on the subject of the impact. Does it harm: you, your kids, your country, your health, your business, your wallet? Considering these things is a pretty good basis for more rational decision making. It can be a challenge to try and price in your own externalities (ie. going zero waste, cycling to work instead of driving) because the economy really doesn’t work in favour of those things today. It’s pretty clear that income tax is a pretty crude and harmful mob-ish way to go about shifting resources from areas of low yield to areas of high yield. If the government considered itself the system whose job was to price in externalities accurately, everyone would be better off. It’s interesting to consider how market failure problems (ie. vaccines) could actually become market successes if you change how the externalities are priced in (ie. no taxes for companies that make vaccines for a profit, instead of non-profit status for predatory universities that create no value).

The interesting thing about externalities is that simply knowing they exist can be a weapon. The overton window (things you are culturally allowed to debate) controls the externalities one is allowed to talk about. One externality that is starting to be rationally priced in is the concept of the value of women’s time as it relates to working inside the home. That was never economically priced in to decision making, the concept that someone’s time had value, which creates all kinds of weird distortions (ie. aggressive use of couponing and discounts). If you start to price that externality in (ie. what is my time worth) it would rewire a lot about how the economy functions (but also, more specifically, eventually improve how it functions).

If you were to make a survival guide for the rational person, what would that look like? I imagine it would start with knowing: learn about the second and third order consequences of the things we do or don’t do. Consider what externalities exist (ie. the consequences) when you do or do not do those things. Consider whether there is a path that results in more wealth for you (ie. more of the things you want) and less of the harmful kind of externalities (ie. less of the things we don’t want). Consider whether it is practical to lead by example and engage in the high benefit/low externality option. If so, do that. If asked why, explain the concept of externalities as it relates to that thing, and let the people decide.

I’ve talked in the past about the concept of a consumption tax, which would attempt to price in externalities to consumption activities as a way of curbing harmful consumption and incentivizing the right kind of consumption (ie. learning, vegetables). I think as time goes on it gets more clear to me that this is an important moral quest to fight against the concept of income tax. People would be much better off (in theory, who knows what would happen in practice) in a system where the right things were subsidized and the wrong things were made more expensive. At a certain point everyone would do the right thing. Could it be then that the problem is that we disagree on the wrong things? Is it possible that there are people who think it makes sense to subsidize gas drilling and not electric cars? My guess is that the answer to those questions is yes, but not from a scientific perspective. From a scientific perspective, the right thing is clear. So we return to this question of convincing both sides of the political bifurcation of the importance of issues involving science.

The best way to price in externalities might just be to develop your own family wealth to the point where you can do it in spite of the lack of economic reason for doing so. If there’s one thing more constant than political disagreement, it’s people having a strong desire to copy what rich people do. At a certain level, all you have to do is become right, and then do the right thing. Eventually, that will make waves. It seems like that is the crux of the Elon Musk or Jeff Bezos plans. Perhaps that is essentially the highest agency way to deal with this problem.

The first and most obvious counter argument would most certainly be that an externality pricing tax would slow economic growth. The second and correlated argument would be that it would be regressive, as in it would hurt people with less wealth in particular relative to those with more wealth. Both are interesting, and wrong, but taken on a short enough time scale they are both true and scary to those who can’t see around the corner.

The first counter argument was that by implementing a tax of this nature, we would slow economic growth. The rebuttal comes down to dismantling the highly irrational way that we currently measure economic growth. The purpose of an externality pricing exercise is to produce, over time but also in the short term, more of the outcomes we want and less of the ones we don’t. In that sense, regardless of what the GDP figures say, we should be moving towards something that is better than the current approach. If it requires slower growth in order to price externalities in, we should do that. The problem there is a ponzi scheme like way on which we have built the economy: where all the important learning and social institutions build future inflation and money supply increases into their current planning. If GDP growth were to slow further than it already has, it would place enormous stress on those systems. In a sense, there’s a sort of one way door that we already walked through involving how we approach creating economic incentives. If you’re already on a “grow or die” path, a sort of VC backed society, it is hard to justify switching to a “carefully consider things and price in all the bad stuff” path. But that’s probably the only way to appropriately account for externalities. So at a certain point, we have to run the numbers and decide how we’re going to move forward. Hopefully this doesn’t create some kind of partisan issue, because “getting what you want” is not zero sum in an appropriately externalized world. All sides of the political spectrum should be able to increase their wealth without having to battle in a zero sum contest for pieces of a fixed sum pie. We more or less painted ourselves into this zero sum corner by offering the wrong incentives.

The second counter argument involves the regressive nature of externality taxes. “If we raise gas prices, that’s going to make it hard for hard working, tax paying (geography) citizens to get to work, drive their kids to school, do (middle class thing).”. This one is harder. The reason it’s hard for (geography) citizens to afford to live now is terrible economic incentives and management. If we start to price those things in, “good things” like renewable energy will boom. That boom will eventually result in higher net wealth, more growth and “good things” like inexpensive commuting. Can people weather the storm to get from Point A to Point B? Maybe not. In cases like that, you have to consider that vulnerable people who can’t afford price shock might be another externality to consider when you design the system. In theory, people who don’t have good cash flow now aren’t necessarily going to be able to change that in a different system. They might be able to have more of what they want, and less of what they don’t want, though. And so you would just need to factor the cash flow issue in as yet another externality. The obvious approach would be to further reduce their income tax so they can absorb the pricing shock. The economics are the same for those individuals, but the externalities are priced in where others are priced out.

I think we can all agree that the goal is to get more of what we want with less of what we don’t want in the world. The only way to mass change people’s behavior is through a combination of cultural change and incentives. We could all afford to spend more time building an understanding of the externalities of our actions or lack of them and considering how we could improve our situation by doing a more considered job. Ignoring an externality does not make it go away, it increases it’s impact.