Turning towards policy, I wanted to detail some of the issues surrounding negative externalities and how much better off society could be if they were dealt with effectively. First, a negative externality is situation where an individual benefits at the public’s expense. And these situations are all over the place. For example, if I drive to work, I benefit, but the public loses. The public loses because the air is dirtier, there is more congestion, the despots around the world selling the oil are a little richer, and the economy is that much more sensitive to oil price shocks. But the problem is that none of these problems are passed on to me directly in terms of charging me for the use of my car.
Well, how could this be solved by harnessing the power of the markets? Well, think of a problem that almost everyone deals with, i.e., traffic congestion. When legislatures hear about traffic problems what is their usual solution? It’s almost always to build more roads (and increase supply), but that’s only thinking about half of the equation. What if we worked to decrease demand? How could we do that? Well, various cities around the world (London and Singapore, for starters) have been experimenting with congestion pricing. Just as with everything else, if a higher price is put on the good of driving into a congested area, the demand goes down.
While no one wants to pay more to drive, the truth is that we’re paying for these negative externalities anyway (as mentioned) , it’s only that the costs are hidden. What costs? Well, with congestion, one is losing hours of productivity and the cost of idling your vehicle (or just creeping along,); vehicles get the best mileage around 55mph. Yet another concern are the health care costs associated with having to breath the dirtier air that traffic creates. What about the cost of not being able to get somewhere when you need to? In a certain situation, that could be priceless. Suddenly a $5 charge to enter the city-center doesn’t seem so bad.
The congestion pricing schemes work by various ways, but the gist of it is that one is charged for entering a specific area at a certain time of the day. The logistics of it have been honed to the point where all one would need it a transmitter on the car somewhere, and the fees are electronically sent to your accounts (no fuss no muss).
One of the key benefits is that the people who can easily avoid the fee will do so, capturing some of the painless low-hanging fruit. The money collected from the pricing could go to increasing public transportation options, thus increasing the amount of low-hanging fruit (with increased fees if traffic is still a problem) and so on in a continuous cycle. Demand side solutions (such as this) are often overlooked to our detriment.