24 Mar 2016

Get prices right if you want a strong society

JB asks:
How is the regulation of scarcity surcharges for a public resource such as potable water[1] similar to a policy that could internalize the true social cost (e.g. medical externalities) into a consumer "good" such as Pepsi?[2] Both hypothetical policies in this question aim to represent the best-approximated true cost of something to affect market forces for the sake of sustainability and public health respectively.

The way I see it, a true cost makes sense either way as it puts the burden of explicit-and-hidden costs on the immediate actors of the economic exchange (and not some person/place/creature elsewhere who has no choice or nothing to do with the exchange), altogether fostering responsible economic relationships. But how might I be wrong? Would reflecting the true cost of something like Pepsi in its per-can-cost, in this example, not have any affect on the broken health system and subsidies of addiction in America, as someone like me would hope?[3] Lastly, another way to ask this is: are there any commodities in which reflecting or regulating the true cost of it is not ethical and efficient?[4]
I'll start by agreeing that it's helpful and important that people face the true social cost (or benefit from the true social value) of their actions. After that, it gets a little tricky:
  1. Scarcity surcharges on water supplies to your tap (or higher market prices for a farmer) are meant to help users understand, via paying more money, the scarcity of the thing they are using. These water sources are "private goods" (excludable from others, and rival -- i.e., depleted -- in consumption) according to economists, BUT they are often underpriced due to government regulations that allow water prices to reflect the cost of service but NOT the value/cost of the water itself. (For farmers, prices are "too low" because farmers get as much water as they want, via permits or pumping, or buy it at subsidized prices from the government). For more, see my (free) book.
  2. The negative externalties of Pepsi consumption (higher public health costs, not an individual's suffering from obeisity, which is "internalized") is not in the same category, since they fall on the (cross-subsidized) health system (more on THAT here). It's not that we want people to drink less Pepsi. It's that we don't want them to get sick -- and cost us money -- as a result of drinking too much. 
  3. That said, a "sugar tax" that paid for public health programs -- especially for diabetics -- might be effective at countering the harm from the overuse of that product. Using sugar taxes to subsidize the consumption of candy bars would be a bad idea, of course, but that's what "we" (Americans but other countries too) do by spending gasoline taxes on roads. Those taxes should be used for protecting forests and subsidizing bicycles, not encouraging MORE driving.*
  4. Should we subsidize some commodities? Sure -- education and public health should be provided at less than "full cost" to users if we believe that educated, healthy people are not just happier themselves (on the private good side), but ALSO because those people provide value to others, e.g., participating in community management, helping neighbors, raising better children, etc. All of those "positive externalities" contribute to public and common pool (shared, i.e., non-excludable) goods that define Society (as opposed to the educated, healthy individual stuck in the woods, alone, somewhere).
Bottom Line The price you pay may not reflect the true cost or benefit of your action. You should know why there's a difference and why it should be eliminated or kept.

Pigou writes about charging motorists for their use (see section II.IX.17), but notes that the funds are put into NEW roads, thereby expanding the benefit of driving. That's counterproductive!

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