Anyone who has lived with roommates has personally experienced what economists call externalities. Dirty dishes piling up in the sink, terrible music blasting at 2am, and a strange smell emanating from the door down the hall. These are externalities because your messy roommate only considers their own preferences for cleanliness, not the costs they impose on the rest of the people living there.

The argument for government intervention to correct externalities is strong. A West Virginia coal plant only considers the cost of fuel and electricity, not the cost of air pollution which accrues to people living in the surrounding mountain hollers. But both sides of this externality are under the same government. Since the government gets votes and tax revenue from both sides, they have the incentive and ability to internalize the externality and tax the coal plant in proportion to the costs they impose on their surroundings.

Government intervention makes sense for correcting externalities because it has skin in the game: it benefits when its constituents benefit, and suffers when they suffer. But this explanation for the effectiveness of government in some situations also predicts their failure in others: Governments don’t internalize all the costs and benefits of an action when they accrue across borders. Governments ignore many externalities when they aren’t constrained by popular vote or have large groups of disenfranchised subjects. Even liberal democracies are subject to biases which lead governments to prioritize emotional salience1 and transfers to small organized groups2 at the expense of everyone else.

But there is another caveat which is overlooked despite being possibly the most important: governments are better at internalizing externalities across space than across time.

Myopia in Government

The argument for why governments can’t be trusted to correct externalities across time is the same as why they can’t be trusted to correct them across borders: no one in the long-run future gets to vote in the next election. No one in government today will gain anything if they make the world better 50 years from now or lose anything if they make it worse. They have no skin in the game when it comes to the long-run future.

This model of government myopia has several predictions. The clearest prediction is about debt. Debt is a tool which directly transfers costs and benefits between the present and the future. Just like we should expect the West Virginia coal company to overproduce coal because the cost of air pollution doesn’t impact their executive bonuses, we should expect governments to overuse debt because the costs to long run growth and stability are not paid by the people deciding how much debt to take. Like coal, debt has some worthwhile uses so without more research we can’t say exactly how much the government use of debt exceeds the social optimum. But we can observe the massive obligations that governments impose on future generations and wonder.

Other predictions are more complicated because most externalities do not fit as cleanly as debt into the spatial vs temporal dichotomy. Take climate change for example. This has short-run spatial effects, some of which are internalized by governments, but many others are spread across hundreds of national borders. It also has very long term impacts that no one in government today answers for. Our theory of myopia predicts that these cross-border and temporal externalities would lead governments to underinvest in preventing climate change relative to the social optimum.

Climate change has huge cultural salience and it is something that world leaders talk about a lot, so it may seem that the prediction of our theory is wrong. Governments do spend time and resources passing legislation about climate change, but their approaches reveal that they don’t actually care about alleviating the long term effects.

The US doesn’t have a carbon tax. The German Green party shuts down its nuclear power plants in favor of coal. Environmental permitting regulations make it easier to frack for gas than geothermal and easier to set up offshore oil rigs than offshore wind farms. Europe and the US subsidize their fossil fuel industries. International law required cargo ships to remove sulfur from their airborne fuel emissions in 2020 even though sulfur’s reflectivity and cloud seeding actually decreases global temperatures. Climate change is something that governments care about, but not because they are trying to strike the socially optimal balance, taking the interests of foreigners and future people into account.

I am calculating in terms of the next generation, in terms of the next hundred years, in terms of eternity” - Lee Kuan Yew, Prime Minister of Singapore, the exception that proves the rule

Temporal Externalities in Markets

Externalities are usually framed as market failures which can be corrected by government intervention. But in the case of temporal externalities, markets have better incentives than governments do.

Consider an old farmer on a nice plot of land. Raising big harvests in quick succession damages the future productivity of the land. Our old farmer is retiring in a few seasons so he wouldn’t face this damage directly, the cost would accrue to someone else in the future. So you might think that in building up for retirement the farmer would run the land for all its worth, damaging its future prospects in exchange for immediate gains. But instead, our old farmer tends to the farm like normal, protecting the productivity for the next generation.

This isn’t just because he’s a nice guy, he is also following his self interest. When he retires, our old farmer can sell the land for its present discounted value. If the land has lots of productive years ahead of it, he can sell it for more than if it was an over-farmed husk.

If our farmer was in an elected position coming to the end of his term limit, things would be different. He doesn’t gain anything from handing off the farm in better condition to the next generation. It’s better to build political support in the short term by over farming the land and giving out extra food. Markets offer an inherent mechanism that incentivizes individuals to consider temporal externalities: future value influences the price of current assets. Unlike politicians, our old farmer captures the long-term benefits—or consequences—of his decisions when he sells his land, creating a natural motivation for sustainability.

You shouldn’t rely on your roommate to take your interests into account when they hydraulic-press the trash further down into the bin instead of taking it out. Similarly, you shouldn’t rely on governments to protect the long-run future when they don’t get any taxes or votes from them.

Next time you hear people call for government intervention to protect the future from climate change or AI apocalypse, be a little more suspicious. Governments have lots of reasons to accept short-term gains at the cost of future harm. If we call on government to intervene in the energy or matrix multiplication industry, how can we be sure they will use it to make us better off? Or to make our great-grandchildren better off? It is not impossible to guide and constrain governments to an optimal response, but it won’t happen without strict incentives to counteract government’s general tendency to sacrifice the long-term future for a better chance to win the next election.

1

Rational Irrationality leads voters to vote based on emotional preferences rather than even self-interested cost-benefit analysis of candidate’s policies. E.g Immigrants are a positive externality in labor markets and innovation but they are barred entry in large part due to salient examples of crime which are far more important to voters even though immigrant crime has less impact on them than immigrant’s economic effects.

2

E.g the sugar lobby. This is an example of a concentrated benefits-diffuse costs government failure. Taking $100 million from one group and giving $80 million to another is a clear net loss, but if the $100 million comes from taxing every American an extra 33 cents, no one will notice or be able to organize a campaign against the tax; the costs are diffuse. If you concentrate the benefits of the $80 million dollar transfer among a few hundred of your constituents you will gain their deep loyalty. Unlike the Americans who only stand to gain 33 cents by removing the tax, the group getting the transfer is willing to spend millions campaigning to keep it.

3

3 comments, sorted by Click to highlight new comments since: Today at 6:07 PM
New Comment

For something that is long term, but only effects the property of 1 person, like the field example, the market prices it in and it's not an externality.

No one is significantly incentivized to stop climate change, because no one person bears a significant fraction of the damage caused.

Politicians are far from perfect, but at least they have any incentive to tackle these big problems at all.

Well if it affects one plot of land that is currently the property of just 1 person it can still be an externality because lots of different people will own this land in the future.

It could be an externality, if the land was randomly reassigned a new owner every year or something. But if the land is sold, that is taken into account. It isn't an externality. Capitalism has priced this effect in.