How To Think About Hidden Costs in the Pandemic

September 9, 2020

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How To Think About Hidden Costs in the Pandemic

Posted Sep 9, 2020

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?

Increasing Negative Externalities

Environmental groups have already noticed an increase in waste as people shift to using more disposable products due to health concerns. Face masks have become ubiquitous as an effective way to control the spread of the coronavirus, yet many people rely on single-use disposable masks thrown away at the end of the day. Even reusable masks often rely on disposable filters. People are also using more disposable PPE, such as gloves and goggles, in an effort to protect themselves. Storeowners are also reporting an increase in the use of disposable plastic bags, again in an effort by shoppers to protect themselves.

Also, with restaurant closures and a shift to work-from-home, people have turned to e-commerce and food delivery, which has led to a massive increase in plastic packaging waste, especially from food delivery containers.

Waste creates externalities. It degrades land quality: they require the use of landfills, which affects quality of life for those nearby. Chemicals leech into the surrounding environment, with health effects. And as plastics break down, microplastics enter the air and water, where they affect both wildlife and human beings.

Another negative externality is the increase in the use of sanitising chemicals. From hand soap to chemical sprays, society has drastically increased its use of these chemicals, but we have yet to see how this will affect the environment. Chemical pollution has, in the past, had clear effects on both wildlife and human health.

Some of these actions are necessary from a health standpoint: we do need to wear facemasks, and we do need to sanitise areas frequented by lots of people. But just because an action is necessary does not mean society can ignore the external costs caused by it.

Decreasing Negative Externalities

However, the pandemic has also reduced some of the externalities of “business-as-usual”. As business activity was reduced, cities around the world saw vastly improved air quality as people stayed home, factories reduced production and cars stayed in garages. Air pollution is one of the greatest public health risks, judged responsible for over four million premature deaths worldwide.

The collapse in international travel has also had some positive side-effects. There were growing concerns about “over-tourism”, where tourist populations had grown beyond the ability of tourist destinations to manage their numbers and their impact on local communities and the environment. Tourism also has a tendency to distort the economy in favour of luxury retail and hospitality, without necessarily supporting the wider economy.

Destinations as far afield as Angkor Wat and Venice are realising some of the benefits of limited tourist arrivals, and are perhaps evaluating what a more sustainable tourist industry might look like, even as they currently try to grapple with the short-term lost revenue from closed borders.

More generally, urban residents have noted some of the silver linings of lockdowns: quieter and more pedestrian-friendly streets; a re-emergence of nature and wildlife.

These externalities are a product of our current period of lockdowns and social distancing, and so they may not persist as the pandemic ends. There’s already some evidence that countries emerging from lockdowns, such as China, are ramping up their use of dirty fuels like coal as a mechanism to recover from low growth earlier in the year. Nor is it clear that societies can accept extended months-long lockdowns, making these “silver linings” untenable in the long-term.

These externalities may not endure beyond the period of social distancing. But they are a reminder of the external impacts of our modern way of life. These trade-offs are what we must consider as we return to "business-as-usual".

Encouraging Positive Externalities

Finally, the renewed focus on public health is a case-study on how governments and authorities can encourage pro-social behaviour — or, in other words, encouraging behaviours and actions that are positive externalities, and thus under-consumed compared to the social optimum.

Take something as simple as the face mask. The private benefit of wearing a face mask is clear: it helps lower the risk of catching a disease from those around you. Yet masks also have a clear external benefit: it helps lower the risk that others may catch a disease from the one wearing the mask.

A “rational” person would thus not wear masks as often as they should, as they don’t necessarily benefit from preventing others around them from getting sick. Yet we’ve seen mask wearing become commonplace in most global societies during the COVID-19 pandemic, even in places that didn’t normally have a culture of mask-wearing.

This behavioural change has arisen through a combination of firm government regulation (e.g. a mandate requiring mask-wearing on public transportation), clear public messaging from trusted authorities, and “word-of-mouth” within society.

There are still significant minorities of people who resist wearing masks, but it’s important to realise just how quickly behaviour has changed: experts have noted that societies rarely change their minds so quickly and so universally.

This is an important lesson because there are other pro-social behaviours that governments may want to encourage. Staying within the realm of public health: governments have sometimes struggled with encouraging mass adoption of the flu vaccination. The lessons learned from encouraging mask use could be applied to encouraging everyone to get their flu shot.