Sunday, May 07, 2006

cost, worth, and externalities

The Daily Kos has an op-ed (they call them diaries) by VetGrl that discusses the concept of cost versus worth. It tries to distinguish between the market price of an item and its intrinsic worth.
Unless they're buying or selling, and assuming no financial calamity has struck, the value many people attribute to their homes has more to do with neighbors and community than with market value.
While it might give economists headaches and make modeling the process a real pain, there doesn't seem anything intrinsically wrong with saying the subjective valuation of an item can vary depending on circumstances. Certainly it can vary with new information, as we can see every day on the stock and commodities markets: if there's sabre rattling in Iran, the price of oil jumps up a notch. It's the same oil, but information regarding how available the next barrel of oil will be affects its valuation and therefore its price. An example closer to home might be the value you place on a piece of paper with a crayon drawing on it, which could vary depending on whether or not you believed your child was the one who created it.

The op-ed then goes on to consider valuations that change, not over time, but with the price of the item being valued.
The problem is that not enough people consider the worth of much more mundane goods, like cookware, clothing or linens. For these things, the consideration is no different than the environment to the GOP: What does it cost?
Here the opinion piece starts moving into something that sounds a lot like externalities. Take a cotton towel as an example. The market price of the towel might not accurately reflect the true cost to society of creating that towel, if you take into account the impact of the pesticides used to grow the cotton entering the food web, whether the land on which the cotton was grown is pulling more or less carbon dioxide out of the atmosphere, and whether the people involved in harvesting the cotton or manufacturing the towel would be better off if the towel had not been made, or created in a different way. An external cost is a cost whoever's making the go/no-go decision does not have to bear, a cost they can transfer to someone else, so that it never factors into that decision.

The interesting thing about recasting the language in terms of externalities is that it should open a fair bit of common ground across the political spectrum. If we assume the free market functions to maximize overall social benefit, then externalities get in the way of that function by distorting the go/no-go decisions. If the cost of gas at the pump is too low to adequately reflect its impact on the city's air quality (and therefore health care issues) or the cost to keep the roads in repair, I might take the car when the real cost, that takes those things into account, would normally convince me to bicycle. The market mechanics are working just fine, but they're maximizing the wrong thing because they're working from faulty premises, and free market advocates should have a problem with that.

Now, the language of externalities won't reconcile all relations across the political spectrum. A purely utilitarian approach says maximizing overall social wealth is good, but it doesn't care about the distribution of that wealth within society except as it affects wealth maximization. (Under that view, one Bill Gates plus a million people in hovels is the same as a million and one people with $50,000 each unless having money lets the million people build a secondary market and increase overall wealth even further.) In contrast, many folks on the left have an issue in principle with a system where a lot of people live in hovels. Still, it's a good starting point for finding common ground on many problems such as carbon and pollutant emissions and energy and transportation infrastructure.

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