Market and externalities

Public goods and externalities are important concepts in economics. An externality defines an effect to a consumer/producer caused by another consumer/producer that is outside of the market logic (price system). It’s when you get a benefit that you didn’t pay for or when you get harmed without getting any compensation. Public good defines a good that is non-rivalrous (the use of someone doesn’t reduce the use of someone else) and non-excludable (people cannot be excluded from using it.) An example is the air. Public goods can be defined as a form of fixed externality: an externality that is not caused by someone: it is an externality as it is. For this reason, I consider public goods as a synonym of externalities.

Private property is what makes a public good private and it is what internalizes externalities. When an externality is internalized it enters the private property system, a price system. When it enters the price system it is not considered an externality anymore, but something people buy or compensate. The same is true for public goods, if the technology changes in such a way that you can set some boundaries, a private property, then it is not a public good anymore. An example is clean air. Air is a public good but clean air is not completely public anymore: now many companies are forced to compensate for pollution. Since the actual technology allows to measure the level of pollution, compensation is possible. When such technology didn’t exist, clean air was a public good too.

I make a supposition that public goods and externalities are the same thing, no difference between the two. Because they both are the opposite of private property. Externalities is just the whole Universe. The Universe is the sum of all the externalities: stars, galaxies, the Sun, planet Earth, its resources, everything. They’re public. Even your brain and your talents and abilities can be seen as a form of externalities. They’re not public, but they are not part of a market system neither. In this giant thing that we call the Universe there is something we call the market. Inside this big mess, we are able to exploit, to find ways to interact with each other in such a way that is profitable for everyone, we find ways to increase our well-being, by selling and buying things we serve and/or build. The market is a subset of the Universe, but it is not externalities, it’s the opposite of externalities. The process of allocating an externality inside a market system through ownership and a price system is called internalization.

Therefore, the market is a form of internalization of externalities.

A definition of the market from this point of view is:

MARKET = UNIVERSE – (PUBLIC GOODS + EXTERNALITIES)

Or, if we suppose: PUBLIC GOODS = EXTERNALITIES:

MARKET = UNIVERSE – EXTERNALITIES

How does the market become bigger? By market I intend the set of things that are part of a price system, that are exchangeable. This is a synonym for (measurable) wealth generation. How is wealth generated? How to increase the global GDP? It is obvious in the formula I wrote above. By increasing parameter Universe and/or by decreasing parameters public goods and externalities. Hence, by:

-        Making the world larger through imagination (the concept of increasing information entropy). In other words, by inventing new things.

-        Internalizing the externalities. (a synonym for reducing the externalities) and/or reducing the level of public goods by setting new ownership systems.

-        Doing either simultaneously.

How do you make the world larger? The world is something I define as the level of information that exists. If you increase the level of information, you are increasing the world. The only aspect of human beings that is infinite is imagination. Through applying your imagination into the outer world by inventing new things or creating new content you have increased the level of information. The other one is decrease the level externalities and public goods.

An example: suppose you are a pre-historical human, you have 1 externality, 1 public good and 1 possibility to increase information:

1.     Public good: The existence of apple trees

2.     Externality: The fact that apples are edible and likable

3.   Imagination:: One of the 2 facts above alone doesn’t make anything from the perspective of economics, but if you put the 2 together, through your imagination you can figure out that if you decide to set a private property where you plant apple trees, you can pick the apples and exchange them with other goods. So, by doing this, creating a market for apples, you have 1.privatized some space (reduced parameter public good maybe), 2.exploited the fact that people like apples (reduced parameter externalities), 3.by planting apple trees, picking up apples, and then exchange this good with other people, you have internalized the externalities of apple’s existence and the fact that humans like eating them. You have created the market for apples, you have increased the quantity of things that passes through a market system. You have made a small invention: the concept of making money through doing this kind of thing. Your imagination allowed you to make it.

Before human beings figured out private property and exchange, the level of wealth was something not measurable like it is now. The prehistorical human could think, but he could not imagine something like private good vs public good in the same way we can now.

Let’s consider public goods as just a form of externality (public good = externality), and take this famous tweet from Per Bylund:

What causes #poverty? Nothing. It's the original state, the default and starting point. The real question is, What causes #prosperity?

And change it in this:

What causes externalities? Nothing. It’s just the original state, the default and starting point. The real question is, what causes prosperity?

Conclusion: I’m always surprised when I see economists arguing about trivial things such as the importance of private property. But I understand when they don’t believe that through the application of our imagination all the public goods will be privatized and all the externalities will be internalized. Because the Universe is limitless and we are not that cynical, it is fine that some beautiful things in life are free.

Credits to my late Economics Professor Giacomo Vaciago