Externalities are one of the core concepts that underpins GIFT’s analysis of the world.
Managing externalities will be the greatest challenge for economic policymakers over the next several decades. From the pandemic to climate change, policymakers need to find the right balance between collective welfare and individual benefit.
The COVID-19 pandemic is no exception, with implications for many of the major externalities of everyday life.
First, what is an externality?
An externality is any impact — positive or negative — that is not borne by the producer or consumer of a good or service. Thus, these impacts are not reflected in the market price of that good or service.
Most discussion resolves around “negative” externalities: a cost incurred by a third party. Second-hand smoke is the archetypical example of a negative externality: neither the smoker nor the cigarette producer pays the health cost of someone sickened by second-hand smoke. When goods or services have negative externalities, they are “under-priced”: the market optimum is greater than the social optimum.Other normal examples include air pollution, plastic waste, and noise.
However, externalities can also be positive, though these can be harder to determine. These are goods, services and behaviours that provide benefits to third parties. Thus, these are underproduced and underconsumed: the market optimum is lower than the social optimum.
Externalities are often used to justify government intervention in the market.
Taxes or subsidies help nudge prices to their social optimum. Regulations limit the vectors through which externalities can harm people. And, finally, court systems, legal liability, and government programmes can help restore communities harmed by negative externalities.
So how has the COVID-19 pandemic affected externalities?