Of car alarms, ugly facades & first aid courses – the wonderful world of ‘compound externalities’

Jargon is a nerd’s best friend

Economists love to talk about ‘externalities’. ‘Externality’ is a wonderfully complex-sounding word that makes you feel more intelligent just by saying it. It is especially useful when trying to pull the wool over the eyes of a non-economist, as in:

Community activist: “We’re outraged that our organisation has had its budget cut so the government can bail out irresponsible banks!”

Economist: “I understand completely your feelings, but your analysis of the cost of financial sector repair fails to take into account the growth-enhancing effects of the associated positive externalities resulting from the smooth operation of financial markets.”

Community activist: “I… well… uh… what?”

Economist: *smiles imperceptibly and adjusts knot on his silk tie*

Keep your market transaction to yourself, buddy

Yet the actual meaning of the word ‘externality’ is in fact quite simple. Here it is in a nutshell: For any transaction, there is a buyer and a seller. An ‘externality’ can be thought of as the effect of the transaction on someone who is not the buyer and not the seller.

Pollution is a classic externality – a cost on someone outside the market which occurs through the operation of the market

So for example, if John buys a car from Volkswagen, this transaction has effects on both John and Volkswagen (John gets a new Golf in exchange for €30,000; Volkswagen gets €30,000 in exchange for a Golf). Because the transaction was voluntary, we can assume both John and Volkswagen are both strictly better off from having made the trade (otherwise, they probably wouldn’t do it).

But what happens when John tools down the road in his new Golf, kicking carbon emissions and particulates into the air, taking up public space and potentially running over grannies and cats? In that case, there is a cost born by someone who was not party to that transaction, arising from the transaction (pollution, traffic congestion, increased risk of an accident). This cost is a ‘negative externality’. There are many examples of negative externalities, but pollution is perhaps the most common one. In general, economists accept that the government should sometimes intervene in markets in order to correct for these negative externalities (through regulation or taxation, for instance).

There’s no such thing as a free ride…or is there?

We can also think of ‘positive externalities’, i.e. when the operation of a market has a positive effect on someone outside it. The pleasant smell of freshly baked bread on a street outside a bakery can bring joy to passers-by, even if they do not actually enter and pay for the bread. And if a person with a contagious disease pays to have himself treated privately, this is a benefit to all the people he has protected from potential infection, even if he was only acting selfishly.

But don’t let the name deceive you: positive externalities are not always a good thing. Sometimes they can stop markets from operating effectively. For example, if I invent a brilliant new machine and try to sell it, the ‘idea’ can simply be copied by someone who does not actually pay for my machine, leaving me with only a small reward for all the midnight oil I burned while getting to my eureka moment. Without some kind of protection, this risk might prevent me from bothering to invent the machine in the first place. This is why, just as in the case of negative externalities, the risk which positive externalities pose to production is a justification for the government to intervene, by granting patents and other forms of intellectual property rights.

Compound externalities – where markets depend on failure in order to succeed

There is a certain class of externality which I find quite interesting and which, to my knowledge, has not been written about by economists yet. It is the ‘compound externality’, which can be defined as the effect on someone outside a market arising from the operation of a market which only has value to the buyer and seller because of this negative effect. This sounds confusing, but it’s quite simple when we break it down: As before, we have a transaction, so we have a buyer and a seller. In addition, there is an effect from the transaction on a third party AND – here’s the catch – the only reason the transaction is valuable to the buyer / seller is because of this effect on the third party.

The most obvious example of a compound externality is noisy alarms. In this case there is a negative cost imposed on you when your neighbour’s house alarm goes off at 3 in the morning, even though you didn’t sell him the alarm and you sure didn’t buy it. But here’s the catch: the only reason he wanted the alarm is so that it would annoy and wake you, his neighbour, up, so that you would then look out the window at his house and – in this way – spot the burglar breaking in through the window (hence deterring the burglar!). If it didn’t create the noise pollution, the alarm would have no value.

Another example is the ‘ugliest façade’ project. Imagine you live on a historic square full of old houses with lovely façades. Your obnoxious neighbour from the above example – not content with his cacophonous alarm – has torn down his house and is building anew. He has an incentive to build the façade as ugly as he possibly can. Why? Because by doing so, he destroys the perfect appearance of the square as viewed from your house and from every other building… every building that is, except his own. All of the sudden he possesses the only piece of real estate with an unsullied view of the historic old square!

Quick, is there a positive compound externality in the house?

What about positive ‘compound externalities’? Are there any examples of markets which, in order to operate, depend on a positive effect occurring on someone outside the market in order for the market to exist? The only one I can think of is the market for first-aid training. Here, the only value to you in paying for a first-aid training course is that, should the occasion arise, you will be able to apply the Heimlich Manoeuvre to dislodge a chicken dumpling from the oesophagus of a third party (while attending a party…).

I’ll stop now because I can’t think of any other examples. Perhaps someone else can?


Things aren’t so bad … so let’s not make them worse

The People think they want change

Ok, there is a lot of anger out there. Some are angry because they fear the ‘other’ taking away what they have; others are angry because they want more redistribution and fairness. Some blame benefit-scrounging immigrants, others blame the global elites. But while the grumbles might be diverse, there is a common sense that the system is somehow ‘broken’ in a way it wasn’t before. Whether it means Trump, Brexit or someone like Bernie Sanders, a large number of people who previously would have been moderates now want – or at very least expect – to see fundamental change to the societies and political systems they consider have failed. Alarmingly, they seem prepared to topple long-established systems and political traditions in order to see this change happen.

And maybe they’re right. Who knows? The consequences of disruptive change are hard to predict in the short run, and ultimately may take a very long time to play out fully. When Nixon visited Beijing in 1972, he asked the witty and influential Chinese mandarin Zhou Enlai his opinion on what impact the 1789 French Revolution had had on history, to which Enlai is said to have replied that it was “too early to say”.

Nature red in tooth and claw

But it seems to me the risks are very much on the downside. To paraphrase John Lennon, if disruptive change means destruction, you can count me out . Our system may not be perfect, but it is a hell of a lot better than nothing. To see how, consider what things would be like in the complete absence of society. Imagine an invisible hand picked any one of us up from his current desk, couch, bed, airplane seat … and carried him out of his man-made environment and place him, naked, in a

Without us around, Nature would reclaim cities within a few hundred years. Romantic? Or just plain brutal?
Without civilisation, Nature would reclaim cities within a few hundred years. Romantic? Or brutal and hostile?

theoretical primeval forest where other humans simply did not exist. This is the total absence of society. How well would he fare? He might last a week before getting eaten. A summer, perhaps, if he is particularly crafty and in good health. But come winter, he would freeze, starve or get eaten by wolves. The first major injury or illness would likely finish him off. And even if, by some miracle, he managed to carve out a niche (most likely literally) for himself, would his quality of life be even a fraction of what it is now? I remember an excellent article written by Alan Weisman in Discover Magazine back in 2005 which explored the world without humans. It was a romantic vision, full of evocative prose of species flourishing and cities crumbling. The descriptions made it clear a little bit of the author’s heart longed for such a thing to take place. Yet where is Mr Weisman now? Living in one of the few remaining wildernesses in Alaska or Russia which closely approximate his vision? I’m guessing not. Especially as he was sending pre-apocalyptic tweets as recently as 2014.

Creature comforts are better than creatures

This thought exercise is designed to remind us of just what a good job society does at shielding us from what is, in reality, a hostile physical environment. Such a good job, in fact, that we forget we are being shielded. Unlike the current political system, Nature isn’t just guilty of neglecting our interests and selling us a bit of Fake News. Nature actively wants us to die. It wants to dispatch predators to eat us, it wants to release diseases to sicken us, or else simply deny us food and watch us starve. The system, far from being broken, does an absolutely remarkable job of taming Nature and providing us with far more than what we could have on our own. What’s more, it is better at doing this now, than at any point in human history.

If we allow this system to be torn down, perhaps a better one will rise from the ashes and we will achieve some kind of Utopia. But that seems like a bad bet, given what we know from history and observing the physical world around us. Disruptive change is more likely to give Nature the opening she has been seeking for centuries. She might rub her hands in glee while we starve in our billions. Animals or bacteria could so easily overwhelm us, and in the ensuring mayhem we would likely turn on each other. Then, somewhere in the mud and mess, those among the living who were old enough to remember would regret that they so cheaply threw away a system they thought was broken, but in reality was only a little bit flawed.


Soooo many people died in 2016, right? Wrong.

Should old acquaintance be forgot…

New Year’s for most of us has been more a question of ringing out the Old Year, rather than ringing in the New. It’s more or less universally accepted that 2016 has been a crummy one, at least within my circle of acquaintances. One particular feature has been the remarkable number of deaths, with George Michael and Carrie Fischer being but the last in a long list of casualties claimed by that angry teenager, Not-so-sweet ’16.

However, in actual fact, as a proportion of the total population, fewer people died in 2016 than in 2015. What’s more: as a percentage of the population, fewer people died in 2016 than in any year in the history of humankind. That’s right: In 2016, 0.76% of humans on earth kicked the bucket. By contrast, back in the ‘good ol’ days’ of say, 1960, that number was a whopping 1.77%. If you went back a Century, when the Great War was raging, it might have been closer to 3 or 4%. So in fact 2016 was the safest year ever to be a living human being.

This was thanks to lower infant mortality rates, better access to medicine, improved diets and – despite what has happened in Syria and a few other places – overall a reduction in violent death.

Adieu to the former artist formerly known as the Artist Formerly Known as Prince.

But the good news doesn’t seem to apply if you were a celebrity. The BBC has a good article which tracks obituaries for 2016 compared to previous years and yes, we’re not all just imagining it: The hard data backs up the commonly held opinion that 2016 has been a grim year for the rich and famous.

According to the BBC's count of obituaries, 2016 has indeed killed lots of famous types.
…and this chart isn’t even counting the most significant death of all: That of Brad and Angelina’s marriage!

Which got me thinking about why we care so much. Why does it matter to us that someone – a singer or an actor – has passed away? Sure, they produced art which gave joy to our lives. But in almost all of these cases, the people in question were well past their artistic primes. And the art they gave us can still be enjoyed, even if they have now moved on to the Great Dressing Room in the Sky. Yet we seem to care, not just about their art, but about them, as people.

Which on the face of it is very weird. It hardly needs saying, but these people are strangers to us. We don’t know them personally, they certainly don’t know us or even want to know us, and even if by some freak chance we found ourselves snowed in to an alpine cabin in the company of a selection of Hollywood A-listers, we would quickly discover that they have nothing in common with us. So instead of cursing 2016 for the handful of complete strangers it has taken away, why don’t we choose to raise a glass of New Year’s bubbly and thank 2016 for sparing our friends and family?

Thou shall have no other gods before me, except perhaps the Kardashians

Of course we are grateful for our loved ones. But the fact is, celebs do matter to us. They fulfil a need which appears to be very human, that is, the role of the idol. This is nothing new to our age. The desire of the masses to look up to quasi-real demi-gods and follow their every movements is as old as mankind itself. Is our fascination with Angelina Jolie’s shocking decision to divorce Brad Pitt not the same kind as what the ancient Greeks must have felt about the decision by the mythological Jason, leader of the Argonauts, to divorce the powerful Witch-Princess Medea of Colchis, in order to tie the knot with the Corinthian princess Glauce? Did the plebs of Ancient Rome look upon Cleopatra any differently to the way the plebs of New York saw Marilyn Monroe? And the Hollywood Walk of Fame, can it not be seen upon the walls of any Catholic church, in the form of a star-studded line-up of Academy Award-winning saints?

In a sense, it is the decline in religion which has left a void in us; a void we seek to fill through celebrity culture. The image of callipygous Freya, the most beautiful female form imaginable, riding in a chariot pulled by two great cats through the Norse woods, together with her omnipotent husband Odin, is lost to us. But in its place we have bootylicious Kim and her theomaniac husband Kanye, riding in a sleek SUV along the highways of Los Angeles.

There’s one degree of separation between me and you: Kevin Bacon

And yet, while celebrity idolatry may always have served the purpose of setting a distant horizon to our plebeian ambitions, it seems that in recent years, the phenomenon has grown even more pervasive . I speculate that this is because, as cities become more vast and anonymous, and society more fragmented, we feel an ever larger yearning within ourselves to have something that connects us. With greater labour mobility and smaller families, more and more of us are moving about, lonely and disconnected. Shared references and common history are scarce, lost in the back of a rented U-Haul truck. Yet celebrities can restore that bond. We all know these beautiful super-humans from our one common altar – the TV screen. Taking an interest in their fate, becoming intimately acquainted with their ridiculously-named offspring and keeping track of their drug addictions and failed marriages becomes a vital source of shared reference. In the cold urban jungle, it is a comfort to me to think that while I may not know my neighbours, at least I know that they are watching the Oscars too. These saintly figures who float down the red carpets, in a mythological universe that seems planets away; they are the one true bond between us plebs.