Externality, Conflict, and Decision

Collective decisionmaking and enforcing institutions do not always seem to deal very successfully with regional conflicts over resources or the environment. Indeed, in some cases the institutions may create or be the problem. Perhaps the institutions need to be changed, or at least reappraised. But we should first try to be clearer about the nature of the conflicts we observe and about whether collective decisions and actions are necessary, or even desirable, as part of "solutions" to those conflicts.

Resource and environmental conflicts might be categorized in any number of ways—by the resource commodity or environmental medium involved, for example, the forum(s) in which the issue is using fought, the number of parties, or homogeneity of the regional interests at stake. I propose to adopt and extend a categorization based on the notion of externality, a jargon word of economics.

Three kinds of externality

The term externality applies generally to situations in which firm (or individual) A creates through its activities a cost or a benefit for firm (or individual) B but does not take this cost or benefit into account in making its decisions about its own production or consumption. Two sorts of externalities and thus, by implication, two sources of conflict, usually are distinguished. Pecuniary externalities involve market interactions, as when the advent of a competing source of supply drives down the price an existing firm can charge for its product. Of course, such effects are the stuff of economic growth and change. (Thus it is that economists often prefix "mere" to pecuniary.) Real externalities involve direct interactions, through competition for a common property resource such as an oilfield, for example, or through upstream water pollution and downstream water supply withdrawals.

To these two sources of conflict I propose to add a third, which I call political externalities. I apply this term both to situations in which the design (constitution) of our political institutions creates conflicts by excluding from collective decisions the voices of legitimately interested parties, and to situations in which the decisions or actions themselves prevent the resolution of conflicts arising from another type of externality. For example, a political externality would arise if a state decided to develop a resource and in the process to scar a wilderness or scenic area valued by residents of other states. The design of jurisdictions and decision processes based on residence means that the resulting conflict is not just between groups of individuals, but also between excluded groups and a state or states. A slightly different form of political externality arises when political acts place barriers in the way of bargaining and compensation that might have allowed resolution of actual or potential conflicts, as when a state closes its radioactive waste disposal sites rather than bargaining over terms on which it will accept waste from other states.

By way of further clarification, consider what types of externality potentially are involved in extreme state decisions about environmental quality or resource use. (The possibility of extreme decisions often is cited as a reason for uniform national laws. Existing laws strictly limit the scope for such contrasting policies, but the examples still are valuable, if hypothetical.) First consider a decision by a state to opt for very low environmental quality and, one assumes, high employment and money incomes. Assuming the state to be the decision unit, what types of externalities, and what sources of conflict are involved?

• A (negative) pecuniary externality is created because the state will lower the costs of polluting firms operating within its borders. This will raise their profits relative to firms operating elsewhere and will in the longer run encourage firms to migrate to it.
• A new or increased (and negative) real externality will exist if the increase in pollution spills over into other states.
• A (negative) political externality is created if residents of other states directly value the environmental quality within the deciding state.

The opposite extreme decision—to opt for very high environmental quality—creates the opposite signed externalities. In the book from which this article is excerpted I discuss each of these externalities and attached conflicts as collective decision problems—whether they are such problems and, if so, what has been tried in dealing with them. For the present purpose, however, I confine the discussion to the pecuniary variety.

First let me dispose of the idea that there is something intrinsically wrong with a system that allows externality-creating decisions to be made. There is no perfect system of geographic jurisdictional lines; that is, no system exists that prevents all negative externalities while giving to well-defined local majorities the right to have their preferences honored. A unitary or completely centralized and uniform system eliminates local choices in the interests of eliminating externalities. A system of complete "states' rights" emphasizes local choice while risking externalities and conflict.

Given that any real system has to balance these competing ends, what institutions are—or, in theory, should be—available for deciding matters of conflict?

Pecuniary externalities

We should be wary of assuming that a collective decision problem is involved at all in cases of pecuniary externality. As noted, these external effects are the signals that drive the continuous adjustment process that is a market economy. They most often are thought of as transmitting changes in tastes, technology, or resource availability, but a state government's decision to change its policy on resource exploitation or on environmental quality certainly can be ranked with these other items as an "exogenous shock" to the system. To the extent that we try to stop a signal by stopping a pecuniary externality we block adjustments to changes in reality.

In fact, adjustments to pecuniary externalities in the U.S. economy are made by mobile firms and individuals. While a few caveats are set out below, the general proposition is that pecuniary externalities take care of themselves as these firms and individuals shift locations and types of activities in response to changing wages, prices, and profit potential. When the ability of economic agents to move about and change industries, production processes, and so forth, is seen to be inextricably combined with the movement of political actors (voters), the range of possible adjustments to state decisions imposing pecuniary externalities appears formidable. Thus, individuals can choose the balance of environmental quality and money income they want from among those "on offer" by the several states.

But this is not the only point: when a state changes the balance it offers, it invites shifts in population and economic activity that both take advantage of the new opportunity and tend to reduce the differences, at least in money income, be-tween that state and the others. For example, if a policy of maintaining low environmental quality really does raise wages for workers and profits for the firms of state A, the following reactions can be expected.

• Some out-of-state firms will move in, bidding up the price of labor, land, and perhaps other inputs and thus eating into differential profits.
• Some citizens of other states will move in to pick up higher wages and in the process will put downward pressure on those wage rates.
• Some citizens of state A will emigrate to seek a balance of environmental quality and money incomes more to their liking.
• Some firms located in state A may move out because the higher pollution levels affect their costs of production or because their labor force is disproportionately (in numbers or power) represented in the emigrants.

In short, pecuniary externalities created by state resource and environmental policies impose costs internally as well as externally. And the gains they apparently create can neither be confined to the state's citizens at the time of the policy change nor, indeed, guaranteed in the longer run in the face of individual adjustments.

How about severance taxes?

Similar reasoning should carry us beyond the notion that a western state's severance tax on energy resources somehow is a momentous public problem. How can this be? What about the residents of, say, Massachusetts, who have to pay higher electricity rates because of Montana coal tax?

If, as is likely, the tax represents a capture of rents accruing to high-quality and low-cost deposits (relative to the marginal supplier of coal), the existence of the tax actually means nothing to the price. Montana coal would cost the same if the state tax went to zero (or, more realistically, to the level of the lowest state severance tax). Only the recipients of the rent would be different.

Also, no one is forced to live in Massachusetts or any part of the Northeast for that matter. But many of us who have done so consider that the cost, in terms of cold winters and high energy prices, is balanced by cooler summers, wonderful scenery, and other amenities both physical and cultural. Those who disagree can and do move to Montana or New Mexico or Florida.

Moreover, the citizens of Massachusetts can and do collectively capture a portion of the rents generated by their unique immobile resources—the beaches of Cape Cod, the forests of the Berkshires, and so forth. Montanans who want to enjoy the resources pay for the privilege, not only to private owners, innkeepers, and service stations, but to the state at large through sales, lodging, and entertainment taxes.

Finally, coal production is immobile only in the short or intermediate run. If, in fact, the state's taxes reduce the rents accruing to owners to unacceptably low levels, exploration, development, and mining activities will shift elsewhere. Only if all the out-of-state coal deposits already have been discovered is exploration relevant. And even if that were true, the balancing of total costs—including price transportation, and cost of use in power plants—still would assure significant potential competition for western coal.

Dealing with objections

Many of the caveats promised above already will have occurred to the reader as objections to this sanguine view of a flexible and changing economy. Consider only four.

Most important, this is a long-run view and ignores the painful disruptions of the short run. To combine two aphorisms: the short run always is with us, and in the long run we all are dead. What good, then, is a long-run view? The point is that we could apply our collective ingenuity to ameliorating the short-run problems and smoothing the path of adjustment, rather than struggling to stop or forbid the changes themselves. The version of this problem discussed here probably is much less important than the version posed as technology changes and entire industries die as new ones are born. But the Luddite response is no less inappropriate.

A second caveat or objection—and a good one—is that I have ignored the possibility of state monopoly or strong oligopoly position. A state that has a monopoly position in a resource indeed should not be allowed to exploit it without limit. But as a practical matter this is very seldom, if ever, the case. It certainly is not the case for Montana coal. (It might be the case that there are only a very few states with naturally occurring very deep harbors, but even here, substitutes such as dredged channels and offshore "ports" are available at finite cost.) We should try to avoid seeing a monopolist behind every price increase.

Third, states may create barriers to entry by firms or individuals and thus complicate and brake the adjustment process. It is true, for example, that Alaska law requires certain residency periods before an individual can share in its oil wealth through tax reductions. On the other side, Oregon and Washington seem to have at least semiofficial policies of discouraging immigration by those who would share in the high environmental quality of the Pacific Northwest. As an economist, I am not equipped to address whether serious efforts to interfere with migration of people and businesses ever can be constitutional, but it seems unlikely.

Finally, consider three more specific objections arising from concerns about equity,

• Poor people cannot afford to move, and thus policies of the sort I blithely have accepted will lead to a widening of regional income differentials and, at the extreme, to a Northeast entirely populated by welfare families. This argument simply is not valid, however much it may appeal to our egalitarian instincts. Many of the existing welfare families in the Northeast moved from the South and Puerto Rico in response to income signals. In fact, it may be easier for people without home ownership worries to move.
• New England, say, offers a unique lifestyle and people should not be forced (or even expected) to leave it for mere money income. But no one is forced to do anything, and neither should the nation at large be forced to subsidize a style of life in the face of fundamental changes that make it more expensive to maintain.
• What about interest rates and housing prices? Briefly, it would be remarkable if the current situation, with real short-term interest rates of around 9 or 10 percent, lasted very long. Again, it seems short-sighted to make policy to accommodate a particular aberration.

Let me reassure those to whom the thrust of my remarks may seem cavalier that I hold no brief for a purely laissez-faire approach. Indeed, it seems to me essential that the nation develop better ways of dealing with the short-run dislocations that follow from pecuniary externalities. Making long-run policy to protect short-run interest is not an especially promising way to greet the future. While transfer payments and related programs are currently much in disfavor, the nation might well find the real cost of even modestly inefficient transfers is less than that of maintaining inefficient pricing or pollution control or fisheries management policies into the indefinite future.

No guarantees

No government can guarantee happiness. It is enough—and decidedly more realistic—that ours enshrines its pursuit. Thus, a burden of my argument is that Americans stop trying to hold back the tide of most pecuniary externalities when the struggle involves disproportionate costs. Besides, not all such externalities are negative. Some are positive to start with and many seeming unpleasantries represent positive changes over the long run; still others tend to balance each other. We should do what we can to ease transitions when action does not make matters worse, but to do more is both futile and needlessly costly. In any event, change is both natural and inevitable. And adaptive change is a hallmark of the American experience.