Economics Policy Brief Assignment

September 30, 2011, 10:38 AM 116 Comments

Markets Can Be Very, Very Wrong Muller, Mendelsohn, and Nordhaus have a new paper in the American Economic Review that should

be a major factor in how we discuss economic ideology. It won’t, of course, but let me lay out the case

anyway.

What MMN do is estimate the cost imposed on society by air pollution, and allocate it across

industries. The costs being calculated, by the way, don’t include the long-run threat of climate

change; they’re focused on measurable impacts of pollution on health and productivity, with the

most important effects involving how pollutants — especially small particulates — affect human

health, and use standard valuations on mortality and morbidity to turn these into dollars.

Even with this restricted vision of costs, they find that the costs of air pollution are big, and heavily

concentrated in a few industries. In fact, there are a number of industries that inflict more damage in

the form of air pollution than the value-added by these industries at market prices.

It’s important to be clear about what this means. It does not necessarily say that we should end the

use of coal-generated electricity. What it says, instead, is that consumers are paying much too low a

price for coal-generated electricity, because the price they pay does not take account of the very large

external costs associated with generation. If consumers did have to pay the full cost, they would use

much less electricity from coal — maybe none, but that would depend on the alternatives.

At one level, this is all textbook economics. Externalities like pollution are one of the classic forms of

market failure, and Econ 101 says that this failure should be remedied through pollution taxes or

tradable emissions permits that get the price right. What Muller et al are doing is putting numbers to

this basic proposition — and the numbers turn out to be big. So if you really believed in the logic of

free markets, you’d be all in favor of pollution taxes, right?

Hahahahaha. Today’s American right doesn’t believe in externalities, or correcting market failures; it

believes that there are no market failures, that capitalism unregulated is always right. Faced with

evidence that market prices are in fact wrong, they simply attack the science.

What this tells us is that we are not actually having a debate about economics. Our free-market

advocates aren’t actually operating from a model of how the economy works; they’re operating from

some combination of knee-jerk defense of the haves against the rest and mystical faith that self-

interest always leads to the common good.

And they’re wrong, with every breath we take.