[extropy-chat] Externalities

[Hal Finney]

Seems like a lot of the problems we face could be solved if there were
some reasonable scheme to compensate people for negative externalities.

In economics, an externality is a cost or benefit conferred/imposed on
a third party to a transaction, which is not considered by the parties
engaging in the transaction.  A classic negative externality is pollution;
the factory making products and the people buying the products don't care
that the factory is adding pollutants to the air or water.  People living
near the factory do care but the costs this imposes on them are not
reflected in the transactions between the factory and its customers.

The classic positive externality is beekeeping, which may benefit
neighboring farmers by adding pollinators for their crops.  But this
benefit is not considered by the beekeeper or the people who buy his
honey.

Negative externalities are often a cause for opposition to various
proposals that might well have a net positive effect.  This manifests
in the classic NIMBY syndrome, "not in my back yard".

I live in Santa Barbara, California, an oil producing region.  But it is
also a center of the environmental movement and there is considerable
local opposition to oil operations.  Santa Barbara was the site of a
major oil spill in 1969 after an accident at an offshore oil platform.
It fouled the beaches for months and killed many birds and sea animals.

Recently there has been a proposal to build an offshore LNG (liquified
natural gas) unloading terminal 40 miles south, off of Oxnard.  There are
only a few LNG terminals in the whole U.S. and we are definitely going
to need more.  This too is causing strong local opposition due to fears
that the flammable gas could cause disastrous accidents or even be a
focus of terrorism.

A simpler story happened locally, when a lady tried to get a permit to
run a day care operation out of her home.  There is a strong shortage of
day care in the area with many businesses having waiting lists of five
years or longer.  (By that time your kid doesn't need day care any more.)
She passed all the inspections, but the neighbors are fighting it.
They live on a quiet residential street and having a business operating
next door will negatively impact them due to the extra traffic and noise.

It's the same thing in each case - negative externalities.  And these are
legitimate complaints.  Why should neighbors have to bear uncompensated
costs when the larger community benefits?

Ideally, those who receive the negative externalities could be compensated
for them, out of the benefits and profits from the activity.  If the
positives don't outweigh the negatives, then the activity shouldn't go on,
because it is a net negative.  But if the activity is a net positive,
the profits will more than pay for the externality costs and the whole
thing makes economic sense.

This means that charging for externalities is actually an economic
improvement, as it insures that only projects go forward which are
economically rational.  But it also means that if externalities are not
paid for, excess benefits appear and go into the pockets of the people
engaging in the activity; so of course they will oppose proposals to
compensate for externalities.

One of the problems with compensation is that it is difficult to come up
with a formula for a fair compensation level.  Once the possibility is
opened, of course each person has an incentive to exaggerate the negative
impact he feels in order to negotiate a higher level of compensation.
And meanwhile the proponents of the activity are lobbying to reduce
or eliminate compensation.  In the face of these opposing forces the
political process is unlikely to hit upon an economically optimal level
of compensation.

There are various other ideas which have been proposed.  Economists have
identified what are called "incentive compatible" mechanisms for these
kinds of issues, where people have an incentive to tell the truth.
For example, perhaps the community could vote between two alternatives,
either don't start the activity, or else start it up and use a given
compensation schedule.  Multiple votes could be held with different
compensation schedules and the one which caused people in all areas to
split 50-50 on the two options would be the fairest one.

There was a seminal paper by Groves and Ledyard for allocating public
goods that could probably also work with negative externalities (which
are like negative public goods).  There has been more work on this and
it is a somewhat active area of research.

It's also possible that a futures market could work, similar to Idea
Futures.  People could buy real estate futures that were conditional on
either the activity being started or not.  Then the price differential
between the futures contracts would be an objective measure of the
loss in property values due to the activity, which would then determine
compensation levels.

These are all rather esoteric ideas, but even a simpler and cruder
approach would seem to be a step forward over the present method, which
is basically for the two sides to yell at each other until somebody
backs down.  We're going to need offshore oil drilling and many other
measures as well in order to satisfy our energy needs.  It seems obvious
that paying the communities which are impacted by the wells should go
a long way towards quelling the opposition which will otherwise hold
these efforts up for years, until we hit some kind of crisis.  It's
the same way with other NIMBY problems.

The truth is, the NIMBYs have a point.  They should be compensated,
when all the rest of us gain an advantage by doing harm to them.
Doing this will be more fair, it will improve economic efficiency,
and it will reduce resistance to much needed development projects.

Hal