Pecuniary externalities

Samson, a loyal MR reader, requests:

What do you think about pecuniary externalities? What would be a good definition of such externalities, if you find them to be plausible? Without the fiction of an infinite number of buyers and sellers, why isn't it the case that any transaction through the price system, through an impact on price, causes an externality, and might one call such an externality a pecuniary externality? I cannot find much on this subject.

Economists try to make a distinction between pecuniary externalities — changes in price which merely redistribute wealth — and non-pecuniary externalities, which involve a real good or service being provided or denied at the margin.  If the price of wheat rises, wheat consumers suffer a pecuniary externality.  If you dump garbage on my lawn, that's a non-pecuniary externality, although it may be accompanied by a pecuniary externality, namely a decline in the value of the house.  In the meantime, the lawn stinks.

The distinction is often a tricky one, especially in the absence of perfect markets.  A lot of the complaints about health care markets are actually complaints about pecuniary externalities, namely that some people get priced out of the market.  Alternatively, the risk of facing high prices for cancer treatment may make people nervous and insecure.  The notion of "risk" often bundles together pecuniary and non-pecuniary externalities in a not-too-easy-to-separate form.

Efficiency and distribution are not always possible to separate, no matter what the first and second welfare theorems seem to imply. 

What about people near subsistence?  Say you redistribute $500 from a poor Haitian to a somewhat less poor Mexican, and the Haitian dies and the Mexican buys a used motorbike.  Is that "just a transfer"?  Or is it "a real resource loss"?  I say it's the latter, but then virtually any redistribution will destroy some complementary value from the portfolio of the individual losing the money.  What is then left to count as a pure transfer?

There is also no such thing as a pure lump-sum transfer when population is endogenous, either through child-bearing decisions or through taking risks with one's life.

The distinction between pecuniary and non-pecuniary externalities is useful, and hard to do without, but its foundations are shaky.  In practical terms the weakness of the foundations matters most when we are doing health care economics or analyzing food subsidies (or comparable forms of aid) in poor countries.  The richer and healthier the people are, the more likely the distinction can be invoked without much trouble.

And Samson is correct to think that large numbers of transactions involve pecuniary externalities, at least whenever the particular actions of a buyer or seller influence market price.


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