Paternalism is a turn-off. We humans seem to have an innate desire for autonomy, a desire that generally leads us to resist efforts by elites to force us to make “wise” decisions. It’s rhetorically useful, then, for opponents of a proposed regulation to demonstrate that the rule at issue aims merely to save folks from their own improvident choices, not to protect the interests of others. Conversely, the proponents of a regulation will generally want to show that the proposed rule goes beyond paternalism to prevent or remedy a cost imposed on others — i.e., a negative externality.
Given their rhetorical power, externality-based justifications for proposed regulations are quite common and should be evaluated critically. First, one should ensure that a purported externality is a “technological” externality, not merely a “pecuniary” externality that is mitigated by the price mechanism. When I fail to care for my home, for example, my conduct in some sense imposes a cost on others (subsequent owners), but because of the intervention of the price mechanism (i.e., the price I can charge for the house will fall), I ultimately bear the cost of my harmful actions. Similarly, when a restaurant owner decides to permit smoking within his establishment, his decision may adversely impact some cigarette-averse patrons and employees, but the owner will ultimately bear the cost of his decision in reduced patronage, lower food prices, and higher wage demands. The externalities commonly invoked to justify smoking bans are thus pecuniary, not technological, and should not count.
It’s also important to remember that externalities are not a sufficient condition for a governmental fix. While unmitigated externalities may impose social costs, so may regulatory interventions. As I have elsewhere explained, government efforts to prevent and remedy externalities may make things worse if regulators lack the information needed to determine the socially optimal level of an activity or if the regulatory process becomes hijacked by interest groups that are able to extract restrictions that benefit them but leave society as a whole worse off. Even A.C. Pigou, the intellectual father of the externality rationale for government intervention, recognized that government interventions may misfire because of informational constraints and/or interest group wrangling. (Pigou acknowledged that regulators addressing externalities “are liable alike to ignorance, to sectional pressure and to personal corruption by private interest. A loud-voice part of their constituents, if organized for votes, may easily outweigh the whole.”)
A third point to keep in mind is that the externality concept is slippery indeed. For practically any activity, it’s possible to identify some person or group whose interests are harmed by the activity at issue. If a parent smokes or drinks or watches too much T.V. or sunbathes or consumes too many calories, his or her children may face adverse consequences associated with sick parents. Because no man is an island, even a childless soul like yours truly may adversely affect others with his ostensibly personal decisions. Every time I go skiing or rock climbing, I risk a debilitating injury that would raise my health insurer’s costs and could affect the premiums others have to pay.
In last Sunday’s New York Times, Greg Mankiw set forth (but did not endorse) an extreme expansion of the externality concept. In discussing so-called sin taxes on unhealthful but tasty products like sugary sodas, Mankiw observed that some economists have invoked an externality justification other than that related to increased public expenditures on health care. (As it turns out, many health and safety mandates can’t be justified on grounds that they reduce costs to the public fisc; healthy folks tend to live to an old age and therefore impose greater lifetime health costs on insurance systems than do the unhealthy hedonists who live it up and die early. See, e.g., here.) The novel externality rationale Mankiw highlights purports to prevent people from making decisions that harm their future selves. He explains:
There is, however, an altogether different argument for these taxes: that when someone consumes such goods, he does impose a negative externality — on the future version of himself. In other words, the person today enjoys the consumption, but the person tomorrow and every day after pays the price of increased risk of illness. …
[P]eople do not suddenly mature at the age of 18, when society deems us “adults.” There is always an adolescent lurking inside us, feeling the pull of instant gratification and too easily ignoring the long-run effects of our decisions. Taxes on items with short-run benefits and long-run costs tell our current selves to take into account the welfare of our future selves.
If regulators treat “future selves” as third parties who should be protected from externalities, then is there any activity that could not be banned or limited in the name of protecting “others”? The only prerequisite for restrictions on an activity would be that the behavior, when engaged in at some level, has the potential to cause regret — i.e., to injure a future self. Every form of conduct would be fair game for regulators. If the concept of an externality is to have any meaning whatsoever, then it should require an effect on a different individual, not a future self.