Substack

Friday, June 22, 2007

Encouraging Positive Externalities

I have already written about externalities in previous posts. Externalities are outputs or outcomes which are borne by the system external to the agent doing the activity. These external impacts can be either detrimental or beneficial to the society at large. Those which impose a cost on the external environment is called a negative externality and those which confer benefits on it are called positive externality. Positive externalities are good for the society and have to be therefore encouraged. However, since it does not confer any benefit on the generator of the activity, positive externalities will be under supplied, if left to the market.

Therefore, just as negative externalities have to be penalised and taxed, positive externalities have to be incentivised or subsidised. When your actions make strangers better off, you should be encouraged to do more of the same and maybe even given tax relief. The Marginal Social Cost (MSC) of positive externalities is less than the Marginal Private Cost (MPC), and the Marginal Private Benefit (MPB) is less than the Marginal Social Benefit (MSB). Under any circumstances, the private individual bears greater cost and gets lesser share of the benefit than the society at large. Positive externalities confer benefits to the society, while incurring little or no cost. In short, it is a free lunch! But in the absence of clearly defined property rights, the agent doing the activity cannot capture the financial benefits of the externality.

What are the examples of positive externalities in urban areas? Health Care, Education, gardens and green belts, keeping surroundings clean, maintaining pet dogs (pet dogs deter crime in the neighbourhood), parking lots etc.

Education and health care are popular and standard examples of positive externalities. Vaccination taken by an individual not only helps the individual, but also reduces the chances of the neighbour contracting the disease. An unhealthy individual inflicts a negative externality on the environment, in so far as he is a health risk for his neighbours. Education helps in building up the knowledge base of the population and development of its citizens. An uneducated person causes negative externality, by being a burden on the society and a potential recruit or prey for some anti-social activity. We need to encourage private agencies coming forward to provide health care and education, especially in the slums and other poor localities, by incentivizing them.

Residents Welfare Associations (RWAs) who keep their areas clean are generating a positive externality, in so far as they are not only directly enjoying its benefits, they are also passing on the benefits to the neighbouring areas. They also end up fostering a healthy competition, by encouraging the neighbouring and other RWAs to keep their surroundings clean. It may be appropriate to reward such RWAs by taking up civil works or trying to solve their long standing problems on priority.

Green belts and parks are evidently good for the environment, and people who adopt them need to be encouraged. In fact, we need to encourage residents to plant trees in their areas, and shops to adopt trees in fron of their shops, wherever possible. These shops should be incentivized by giving, say, Property Tax relief to the extent of trees planted and maintained. Given the massive parking problem facing our cities, any development of private parking lots would have benefits beyond that accruing to the individual, and hence should be encouraged.

We can even add philanthropy as an example of positive externality. Philanthropic donations confer huge social benefits and hence ought to be ecouraged. In fact, our Income Tax Act confers certain tax exemptions on donations for certain causes. Extending this, local bodies may be given the freedom to accord privileged status to such individuals or provide them certain tax or other concessions.

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