At Explaining Liberal Principles I include taking into account positive and negative externalities as necessary to overcome weaknesses in the "free market."

A libertarian, JW, sent me the commentary below. He and other libertarians hate the very idea that the free market might have flaws, and maintain, even if it does, doing anything about them creates more harm than good. His comment : "You may receive some benefit from this" with the subject line: "The value of individual choice vs collective choice." (See more from JW at There's No Collective or Social Reality.)

My responses to this commentary's assertions are indented below.

Politics Imposes External Harms by Linn and Ari Armstrong Published May 12, 2008, by Grand Junction's Free Press.

In our last article, we pointed out that a tax-funded recreation center unfairly charges people who don't use the center and pushes out competing voluntary services. We argued that, if a recreation center is a good idea, "then it will be profitable on a free market. Those who want the center can... pay for it all by charging their customers (or collecting voluntary donations)."

Keith J. Pritchard sent a reply to FreeColorado.com, your younger author's web page. Pritchard argued that we're "missing an important economic concept -- beneficial externalities." We supposedly aren't "considering the marginal social benefit. For example, it could provide a nurturing environment for youth who might otherwise be on the street experimenting with drugs. If the center kept these youth out of trouble with the law and out of prison (paid for by taxpayers), that is a beneficial externality."

How silly of us: we didn't realize that the only two choices in life are going to a tax-funded recreation center or doing drugs and going to prison.

There is a little problem with Pritchard's case: every recreational activity offers an external benefit. Children who attend Boy or Girl Scouts are not "on the street experimenting with drugs." Other alternatives include going to the movies, reading a book, joining 4H, dancing, martial arts, skiing, going out to eat, cooking a family meal at home, playing games, and so on. All the money forcibly redirected to the recreation center is not available for all the other goods and services that people otherwise would buy.

He writes, "every recreational activity offers an external benefit." This just plain wrong as I explain below. And, as to whether a tax-funded recreation center is a good idea, that's up to the voters if they see that many children in povery can't afford membership in a private club. Yes, it's silly to not understand that the alternative for many might be, and is, engaging in gang crime.

What is an externality? It is any benefit not funded by the beneficiaries or any harm not funded by the party causing the harm. The problem is that "beneficial externalities" are ubiquitous. If the government should subsidize every activity that offers external benefits, then the government should subsidize nearly everything.

This definition is lacking. Externality defined at Wikipedia:
In economics, an externality is an impact (positive or negative) on any party not involved in a given economic transaction. An externality occurs when a decision causes costs or benefits to third party stakeholders, often, although not necessarily, from the use of a public good. In other words, the participants in an economic transaction do not necessarily bear all of the costs or reap all of the benefits of the transaction. ...

Pritchard has no way of knowing that the external benefits of a recreation center exceed the external benefits of the recreational activities that would otherwise be funded. Thus, by his logic, government should also subsidize theaters, dance studios, restaurants, board games, camping stores, and so on. Not a single provider of recreation should be excluded from the tax trough.

"No way of knowing?" There can be estimates. And besides, it's up to the voters to decide which to subsidize.

That logic does not imply that government should subsidize every recreational activity. Not every transaction related to recreation has positive externalities. Some movies may have negative externalites (incite violence). 

But why stop with recreation? Children need good shoes so that they can walk to and around school. They need cool shoes so that they can have good self-esteem. Obviously, then, the government should subsidize all shoe makers and stores. Children need food so they can develop their minds and get good jobs, so perhaps Fruita should open up a tax-funded grocery store. Books provide all sorts of positive externalities, so clearly government needs to run the book stores.

The attack on "self-esteem" deliberately confuses self-esteem with with "pseudo self-esteem" from external, rather than internal, validation. From Wikipedia on Self-esteem: Nathaniel Branden labeled external validation as "pseudo self-esteem", arguing that "true self-esteem" comes from internal sources, such as self-responsibility, self-sufficiency and the knowledge of one's own competence and capability to deal with obstacles and adversity, regardless of what other people think.

Having "cool shoes" does not contribute to true self-esteem and is harmful when it leads to a false sense of self-worth.

That "children need food so they can develop their minds and get good jobs" is true; assuring they do has significant positive externalities. That's why, in a democracy, the public consensus is that subsidized meals at school are beneficial to society. While some would like them to go hungry because they chose poor or irresponsible parents, most of us think that blaming the child for choosing the wrong parents is just plain wrong does not contribute to equal opportunity in society.

And of course books have positive externalities. That's why we have public libraries.

It would be great if everyone had the means to buy books and nutricious food, but they don't because there are structures in our society that absolutely assure poverty. See There's no 'free market' for Labor, What does affect the wages of jobs?, U.S. Subsidies for Offshoring, What's the impact of Federal Reserve policy on wages?, and Wealth Happens. These policies have led to government providing food stamps to partially make up for these policies and dynamics.

But let's not stop with businesses! Attractive people walking down the street offer an external benefit to those who appreciate their appearance. What's needed, by Pritchard's logic, is a subsidy for good-looking people and a tax on ugly people. We also need an Attractiveness Index, so that the best looking people get the most tax subsidies while the ugliest pay the highest fees. (Your authors could be in trouble.)

With this discussion of the exernal benefit of personal attractiveness, the authors venture into the truly ridiculous. Personal views of attractiveness diverge greatly.

If the government is going to be in the business of subsidizing positive externalities and taxing negative ones, the government should control not only the entire economy but all of our personal choices. Pritchard cannot point to a single human activity for which we cannot show some externality.

There may or may not be some externality associated with "every human activity," but that is not the issue. The issue is whether government should subidize or tax them. That depends on whether the externalities are large or small. In a democracy the citizens of a country decide.

Libertarians, like conservatives, really do not believe in democracy because they consider democratic decisions to be a tyranny of the majority. The posibility of democratic abuse of the minority is why we have a Constitutionally-limited Republic in which representatives are democratically elected. There are some things government is not allowed to do (... even though conservative Republican rule has led to many violations of the Constitution).

Pritchard is "missing an important economic concept" himself, the concept of Public Choice, the branch of economics popularized by Gordon Tullock and James Buchanan (who won a Nobel for his efforts). One of the many interesting implications of Public Choice economics is that politics is a gigantic source of negative externalities.

It is true that public choice is exceeding difficult. This from the Wikipedia entry for Public Choice is exceedingly important:

The politician pays little to no cost to gain these benefits, as they are spending public tax money. Special interest lobbyists are also behaving rationally. They can gain government favors worth millions or billions for relatively small investments. They face a risk of losing out to their competitors if they don't seek these favors. The taxpayer is also behaving rationally. The cost of defeating any one government give-away is very high, while the benefits to the individual taxpayer are very small. Each citizen pays only a few pennies or a few dollars for any given government favor, while the costs of ending that favor would be many times higher. Everyone involved has rational incentives to do exactly what they're doing, even though the desire of the general constituency is opposite.

This is a prime example of how individually-logical actions can be collectively irrational. The consequences of not addressing this are enormous.

An example is urban growth (see the Growth Facts of Life). Much of the costs of growth are externalized onto the public, either through taxes for infrastructure or you being stuck in traffic. The cost to each individual may be hundreds or even thousands of dollars a year, but the cost for any individual to change public policy would vastly exceed that. On the other hand, growth industries (the growth machine) makes millions, even billions, in profits that allows them to relatively easily affect public policy as described above. As an indication of the cost to the public, consider the American Society of Civil Engineers "report card” on the nation’s infrastructure; it estimates a $1.6 trillion investment is required over the next five years. Much has been spent on new infrastructure (roads, bridges) to subsidize new growth and not enough on infrastructure mantenance and replacement.

Doing nothing about the negative externalities associated with growth has been short-sighted and irresponsible. At this point the U.S. is in a real mess. Now there are warnings of $12-$15 a gallon gas and rationing. It makes sense that prices could be driven this high because residential building and commuting patterns make demand for gas relatively inelastic. It will take many decades to change building patterns, but only weeks for the price of gasoline to soar.

Such a high price of gas would make so many jobs uneconomic that it would surely lead to economic collapse and a hyperinflationary depression. Inflation due to increased transportation costs is already showing up in rising food prices. The U.S. economy is already headed to collapse because of a sinking dollar and resulting inflation thanks to the enormous and growing U.S. trade debt (accumulated deficit) and excess dollars in foreign hands.

Supply being controlled by OPEC and an oligopoly of five major oil companies practically assures restricted supply and high prices. Once the economy crashes, the price will go down again. So, not to worry, the "invisible hand" will take care of it. Only "the invisible hand shakes with such violent tremors" that it's going to be a really rough ride.

Our current political system is definitely imperfect. Having publicly-financed elections would help significantly reducing the ability of "special interest lobbyists [ability to] gain government favors worth millions or billions for relatively small investments." The challenge as described at Public Choice:

(1) how to hire competent and trustworthy individuals to whom day-to-day decision-making can be delegated and
(2) how to set up an effective system of oversight and sanctions for such individuals.
... voters have no reason to expect that, short of dictatorship, even the best rules for making collective decisions will lead to the kind of consistency attributed to individual choice.

This is because groups have what I call "group multiple-personality disorder." Group decision-making is extremely difficult and we do it poorly; see Facilitating Group Action.

That said, individual decision-making isn't all that hot either because we humans are boundedly rational. Free market fundamentalists grossly exagerate the ability of humans to make decisions. From Sterman, Business Dynamics, Systems Thinking and Modeling in a Complex World (2000):

Bounded rationality results from limitations on our knowledge, cognitive capabilities, and time. Our perceptions are selective, our knowledge of the real world is incomplete, our mental models are grossly simplified and imperfect, and our powers of dedeuction and inference are weak and fallible. Emotional, subconscious, and other nonrational factors affect our behavior. Deliberation takes time and we must often make decisions before we are ready.

Libertarian logic relies on the myth that humans are capable of perfect decision-making and ignores the Fallacy of Composition.

In the name of "fixing" externalities, politicians impose high taxes, slow the rate of economic growth, hamper the flow of economic information by distorting market prices, create tax-sucking bureaucracies and commissions, impose protectionism, waste funds, and subject our paychecks to special-interest warfare.

Taxes do not necessarily slow the rate of economic growth. For example, taxes can be too low and lead to inadequate investments in infrastructure. Too low taxes (impact fees) on developers and home builders lead to uneconomic decisions because the pubic subsidizes their ability to sell their product (see the Growth Facts of Life).

This externalization of costs onto the public leads to major distortions of market prices. Unless prices fully capture the full costs of growth, that is, unless the costs are fully internalized, the market cannot correctly value the choices and work properly. We'll know when costs are fully internalized when infrastructure backlogs stop growing without taxes to pay for them (and pays only for maintenance and replacement).

And who says there should be "economic growth", instead of "economic development"? After all, nothing can grow forever.

We have less of a problem with "tax-sucking bureaucracies and commissions" than we do with privatized government taking the public to the cleaners ... corporations feeding at the aforementioned trough. See The Rise of Disaster Capitalism, Serving the Corporatocracy and The NAFTA Nemesis. Treasonous war profiteering from a privatized occupation of Iraq is a prime example.

The alternative is a free market in which government's only role is to protect individual rights by preventing violence and preserving private property. With rights consistently protected, people are best able to apply their reason to the problems of living and enter into voluntary, mutually-beneficial exchanges.

This is the libertarian utopian fantasy that's created a dystopian nightmare. Yes, there is Government Dysfunction, but that's largely due to this thinking that the "government's only role is to protect individual rights." We can do better when we realize that problems are both a society's and an individual's.

A system of individual rights is best able to handle externalities. Negative externalities such as pollution of specific properties are resolved through the courts. Social negative externalities, such as rudeness and body odor, are solved by such measures as social pressure, the property holder's right of invitation, and soap commercials. Positive externalities are captured by private businesses and philanthropies.

The idea that it's best that "negative externalities such as pollution of specific properties are resolved through the courts" is dysfunctional and evil. When remedies are retroactive through the courts, the damage is already done. The person is already injured or dead. Even when pursuing remedies after the fact, the cost to the individual, or the family of the deceased, to fight a lawsuit against a corporation that has done harm is enormous, which makes it very difficult to prevail. The problem isn't "frivolous lawsuits", it's "frivolous appeals" that delay payment, often until the individual runs out of resources or dies. Thanks, but no thanks. Prevention through regulation is needed.

Those who invoke the theory of externalities to rationalize tax subsidies for their pet projects in fact sanction the greatest contributer of negative externalities, the political process of robbing Peter to pay Paul. The system of individual rights provides justice as well as the best framework for solving economic problems.

It's not "justice" when a person is injured and killed; even if the person or family prevails in court, money is not just compensation for injury or death. This idea that a "system of individual rights" will suffice is exactly why so many of our social problems seem intractible.