In the free market economic model it’s generally assumed that prices of things, including wages, investment, accurately represent the value of what’s being produced. An ideal free market has everything about a product expressed in its price. In reality markets often misprice things. That is the price determined by the market for a product is lower or higher than it should be. There are many reasons for that and they’re considered market failure, because the market fails to price things correctly which then means it fails to allocate resources efficiently - one of its primary features. This means for example that something is too expensive and we produce too little of it as a result, or the other way around. Externalities are a type of mispricing where there’s negative or positive effects, or value, from a product which isn’t reflected in its price. For example, until recently the CO2 emitted by manufacturing of most things wasn’t factored in the prices of anything. As a result, say the price of shipping is lower than what it should be. As a result we ship more than what we otherwise would have. As a result there’s more wildfires. As a result populations near wildfires lose their homes and/or their insurance rates skyrocket. They’re paying costs that should have been part of the shipping prices which would have reduced the amount of shipping we do, or made the shipping industry invest in low carbon technology, etc. The market however failed to allocate this cost into the price of shipping, thus producing an externality. Since this externality is an additional cost compared to the price, it’s a negative externality. A positive externality is one where there’s additional benefit that’s not reflected in the price of a product. In the case of free open source software, a lot of it is priced at 0. At the same time there’s vast numbers of businesses built upon FOSS. Since the market prices FOSS at 0, most of them pay 0 and we end up with unmaintained OpenSSL libraries. Perhaps more importantly, we end up having less FOSS produced than what would be optimal for the economy. For example we end up having most firms pay Microsoft significant profit margins for their products instead of paying significantly lower prices for FOSS which would have generated the investment needed to develop better alternatives to MS’es products. And that’s the market failure that leads to underinvestment in FOSS.
Now I’m not in any way saying that the free market is a tool that is actually capable of allocating these resources efficiently and that “something is done to it” which causes it to fail. If anything, FOSS is a great example of the inherent inability for the free market to efficiently allocate resources in many cases. You know, in case the climate crisis wasn’t a good enough example. 😅
Excellent explanation (and disclaimer). I might just add another 2 cents…
It’s not just that “the market fails” to account for many “externalities”, but also that the market is systemically incapable of ever accounting for very many, very important externalities.
IE. The space of externalities >>> the market space. For example if the market priced in the suffering of labor (by paying living wages+, etc), that alone might make the market unaffordable. Similarly with climate justice, etc. The exploitation of these externalities is largely the basis of “profit”.
You know, as time passes I get the feeling that this “space of externalities >>> the market space” might indeed be the case, or otherwise put that the free market fails to allocate resources efficiently more often than it succeeds. I just don’t know if there’s any empirical evidence for it and therefore I didn’t want to add much of my opinion. Just the mainstream economic view of externalities coupled with a few obvious and massive examples like climate change paints a decent picture.
Do you know of any analysis that tries to compare the space of externalities vs the space of the market?
In the free market economic model it’s generally assumed that prices of things, including wages, investment, accurately represent the value of what’s being produced. An ideal free market has everything about a product expressed in its price. In reality markets often misprice things. That is the price determined by the market for a product is lower or higher than it should be. There are many reasons for that and they’re considered market failure, because the market fails to price things correctly which then means it fails to allocate resources efficiently - one of its primary features. This means for example that something is too expensive and we produce too little of it as a result, or the other way around. Externalities are a type of mispricing where there’s negative or positive effects, or value, from a product which isn’t reflected in its price. For example, until recently the CO2 emitted by manufacturing of most things wasn’t factored in the prices of anything. As a result, say the price of shipping is lower than what it should be. As a result we ship more than what we otherwise would have. As a result there’s more wildfires. As a result populations near wildfires lose their homes and/or their insurance rates skyrocket. They’re paying costs that should have been part of the shipping prices which would have reduced the amount of shipping we do, or made the shipping industry invest in low carbon technology, etc. The market however failed to allocate this cost into the price of shipping, thus producing an externality. Since this externality is an additional cost compared to the price, it’s a negative externality. A positive externality is one where there’s additional benefit that’s not reflected in the price of a product. In the case of free open source software, a lot of it is priced at 0. At the same time there’s vast numbers of businesses built upon FOSS. Since the market prices FOSS at 0, most of them pay 0 and we end up with unmaintained OpenSSL libraries. Perhaps more importantly, we end up having less FOSS produced than what would be optimal for the economy. For example we end up having most firms pay Microsoft significant profit margins for their products instead of paying significantly lower prices for FOSS which would have generated the investment needed to develop better alternatives to MS’es products. And that’s the market failure that leads to underinvestment in FOSS.
Now I’m not in any way saying that the free market is a tool that is actually capable of allocating these resources efficiently and that “something is done to it” which causes it to fail. If anything, FOSS is a great example of the inherent inability for the free market to efficiently allocate resources in many cases. You know, in case the climate crisis wasn’t a good enough example. 😅
Excellent explanation (and disclaimer). I might just add another 2 cents…
It’s not just that “the market fails” to account for many “externalities”, but also that the market is systemically incapable of ever accounting for very many, very important externalities.
IE. The space of externalities >>> the market space. For example if the market priced in the suffering of labor (by paying living wages+, etc), that alone might make the market unaffordable. Similarly with climate justice, etc. The exploitation of these externalities is largely the basis of “profit”.
You know, as time passes I get the feeling that this “space of externalities >>> the market space” might indeed be the case, or otherwise put that the free market fails to allocate resources efficiently more often than it succeeds. I just don’t know if there’s any empirical evidence for it and therefore I didn’t want to add much of my opinion. Just the mainstream economic view of externalities coupled with a few obvious and massive examples like climate change paints a decent picture.
Do you know of any analysis that tries to compare the space of externalities vs the space of the market?