(An epiphany about economics, not an affordable epiphany.)

As I was thinking about some of the discussions I have about government, markets and utility with Lee, Max and others of my libertarian friends, I was trying to resolve in my head how I believe systems built on top of people should handle externalities. This led me to thinking, “what is an externality, exactly?”

I think of externalities as side-effects of otherwise normal transactions. If you and I make a deal about something, generally speaking we affect each other and probably the good/service in question (since we transacting about it). But many times, as an unexpected, unintended or ignored consequence, others not involved in our deal become affected. Generally speaking, you are I aren’t concerned with those people – we are making the deal for ourselves. Even if I’m particularly magnanimous and include other people’s happiness in assessments of my wants and needs (i.e. what I would be making deals about), there will potentially be folk affected I didn’t include.

The core problem is not that “external” parties are affected, but that we don’t factor that into our calculations. And that led me to these parallel conclusions – what libertarians see wrong with government and what I (and many other liberals/government-supporters) see wrong with regulation-free market agents is actually very close to the same probem!

  • Government folk who represent folk are insulated from those folk. They are not incentivized to care about those folk, and therefore (by default) they act in accordance with their own regular interests (power/happiness/what-have-you), or those interests who do properly incentivize them (lobbyists, reelection donors, etc.)
  • Free market folk who provide products/service to those who want them and can pay are insulated from the folk who the product/service could impact as a side-effect. They are not incentivized to care about those folk, and therefore (by default) they act in accordance with their own regular interests (profit), or those interests who do properly incentive them (one could argue the customers who are not affected by these externality costs, because they are deriving benefit without paying as many costs themselves, and so it’s a good deal for them, naturally incentivizing them to incentivize the provider and so on).

I hope I communicated my thoughts here in a way that makes sense. They aren’t the same, clearly, but they seem more parallel than I had originally expected.

It’s interesting (as a psychological quirk, or indicative of my mindspace) that I basically extended this idea to game design immediately in terms of designing the right incentives: games are in essence structures that incentivize potential players to take into account indirect consequences (effects on a game board, as opposed to e.g. dollars or happiness) for their direct actions (their own interaction with the game) that in turn leads to direct reward (fun) – a method that directs them to incorporate “externalities” into their mind-model.