Abstract painting of subject, generated by DALL-E 2

More from Mark "externalities are internal" Wadsworth

20 Apr 2009 - Bruno Prior

Further to the earlier post about the dumbest economic argument in the world, the perpetrator (Mark) has now published the results of his poll, which asked "-Who is best placed to decide what to build on any particular plot of land?-" He has discovered that most people think that the owner is. Well, knock me down with a feather. Of course they do. So do I.

But in Mark's strange world, dreamt up to justify his devotion to LVT, this somehow means that whatever use gets the best value for the landowner also is most beneficial for the neighbours. Gems from his analysis include:

-"Interestingly, even though each of these uses must have some 'external costs', it must also have 'external benefits', and the rental value of each shop reflects the profit value to the owner/occupier, plus the external benefits and minus the external costs of the neighbouring businesses."-

-"as the rental values of premises in the same street are going to be broadly the same, the external benefits generated by each occupant must exceed the external costs (or else rental values would tend to nil rather than skywards)."-

-"So the 'location value' of any site, being a positive figure, consists to a large extent (I can't quantify this as a fraction of the total rental value, but it it- -very significant) of the external benefits created by neighbouring occupants"-

Notice how Mark is rather casual about the direction and extent of externality. So long as there are some external costs and benefits floating around, it doesn't much matter in Mark's world whether you are the inflicter or the inflictee. Somehow, this has all magically coalesced into fair value for all.

To take that first quote, the first two pairs of externalities mentioned are inflicted by the landowner or tenant on the neighbours. The second pair are inflicted by the neighbours on the landowner/tenant. Somehow, these are assumed to balance out so that the rent is a fair reflection of the use-value plus the (zero) net external value (costs and benefits inflicted -by- the landowner/tenant netted off against costs and benefits inflicted -on- the landowner/tenant). Or they are not assumed to balance out, and Mark thinks it is fair that the costs of externalities should be incurred by neighbours, without recompense, other than the "benefit" of having a lower value (and therefore lower LVT, in his model).

Of course external costs and benefits fall on someone. If they didn't, they wouldn't be costs and benefits. The question is whether they fall on the person who causes the externality, or the person who is affected by it. In other words, whether they are internalized to the the person causing the externality (no) or borne by the people on whom it is inflicted (yes). Mark's whole rationale, without which his justification of LVT falls apart, is that either it is fair for us to incur the costs of others' externalities netted off against the externalities they inflict on us, or that somehow there is a magical balance between my external impact on my neighbours and their external impact on me.

In fact, Mark almost recognises this, before finding a feeble excuse to ignore it. Taking one of the classic examples of externalities, he acknowledges that some of his readers may not agree:

-"I know that a couple of regular commenters (Dearieme and Lola) aren't too happy with the thought of new housing blocking the view over somebody else's land that they currently enjoy"-

Duh! You think?

-"but taking society as a whole, their loss is somebody else's gain"-

Yes. That's what is called an E X T E R N A L I T Y. Perhaps they are supposed to bank the spiritual satisfaction of knowing that "their loss is somebody else's gain"? The whole point of externalities - the point that Mark seems determined to ignore - is that it matters whose gain and whose loss it is. That's what property rights are about. Ignoring this distinction is the basis of socialism. How many miseries have been inflicted on people for the benefit of "the greater good"? 

Now, I actually agree with his last point:

-"if they don't want neighbouring land to be developed, the free market solution is not planning restrictions but the farmer offering to sell them the land for the same price that a property developer would offer."-

That's because his readers have failed to understand the nature of this externality. "Loss of view" is not an external cost inflicted by the farmer on the neighbours. On a property-rights basis, the neighbours never had a right to a view across the farmer's land. If neighbours valued the view, they gained an external benefit. They could have chosen to pay (if a price could be agreed) for the continuation of that benefit. And incidentally, it doesn't have to be sale of the land; the farmer and his neighbours could contract, at some value less than the potential development value, for the farmer not to develop it, because the farmer would then have the value of the pre-existing use plus the contract value. The farmer may also prefer not to develop his land, if he can get enough to justify keeping it in farming use, and might contract with the neighbours for less than the difference between the current-use value and development value. Because: value is subjective, and every transaction is unique. We cannot assume that the farmer's (or anyone else's) priority is maximising monetary return from individual transactions.

But the fact that the nature of this externality has been misunderstood, does not mean that externalities do not exist, nor that they cannot be asymmetric (i.e. that I cause more harm to you than you cause to me).

It is perfectly conceivable, and indeed commonplace in real life, that the use planned for the farmer's land could have caused a genuine external cost to the neighbours, rather than loss of an uncontracted external benefit. It might be that the highest value that the farmer could get was an industrial process that caused noxious fumes, noise pollution, vermin, etc. to intrude on the neighbours' properties. In this case, the use is genuinely interfering with property-owners' rights to enjoy their property unmolested. The value of the land put to industrial use goes up and the value of the neighbours' land goes down. It isn't good enough that the LVT of the former also goes up and the LVT of the latter goes down. The neighbours are still out of pocket, and moreover might not have chosen to agree to this at any price.

Mark will probably say that's what planning is for. But most cases are not black-and-white, yes-and-no situations, which are the only two options available in the current planning system. In the above case, there will often be different degrees of clean-up/attenuation that could be applied to the process to make it more or less acceptable. Those different degrees will have different costs. There is a trade-off to be made, and it could be made in two directions. The industrial developer could install more clean-up/attenuation, or he could pay more to the neighbours to compensate them for the impact. It would be a good idea if the planning system could take account of this by having the freedom to set the rateable value as part of the trade-off. 

So we need a system that allows negotiation over how much clean-up/attenuation should be installed to be acceptable, and how much money should be paid annually in recompense for any residual impact. A system like that should result in smaller losses to the values of neighbours' properties (because the planning authority will demand a prohibitively high rateable value or refuse permission altogether if the impacts are beyond health limits or what the neighbours would accept at any price). And within those constraints, it should result in the best value to the community and to the industrial developer, who will be willing to pay more for the avoidance of marginal attenuative measures, so long as the cost of the additional rates is less than the cost of installing the measures. This is an imperfect but practical application of basic Coasean theory.

Compare that with the model where externalities are assumed to be either included within the land-value, or taken account of within the LVT, or within planning decisions (without flexibility to vary the amount of local tax that must be paid for the developed use). There is no way of knowing whether the increase in LVT from the developed land, and the falling LVT from the affected properties will adequately compensate those who have incurred the externality. Probably not, because they are still out of pocket (because LVT is assumed to be a fixed proportion of value) and incurring the externality. Or, if permission is refused unless there is no material externality incurred (which may mean installing very expensive attenuative measures of marginal benefit), there is no way of knowing whether that is the best deal for community and developer. Probably not, because at some point, the community would have accepted minor external impositions if it had been balanced by payments by the industrial user that kept the community's domestic local tax bills low.

In the former approach, we have internalized the externality to the externality-producer, imperfectly but not unreasonably (otherwise, the imperfect recourse is the ballot box). In the latter approach, there is no realistic effort made to internalize the externality - it is either inflicted (is permitted) or is not (is refused). If inflicted the victims must be satisfied with the reduction in their LVT as a result of the reduction in the value of their properties. If refused, or if permitted only on the basis of attenuating marginal impacts at uneconomic cost, all (landowner, industrial user and community) may be worse off than if the planning authorities had had scope to negotiate.


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