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Externality as a coordination problem

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Abstract

Although externality is one of the basic concepts in economics, its rigorous definition remains elusive. This paper reconceptualizes externality as an instance of a broader phenomenon of incompatibility of plans—a situation where plans of different individuals cannot be materialized simultaneously because they compete for resources that are scarce. The plan incompatibility can be addressed by institutional arrangements involving mechanisms that determine which plans will be realized. Various institutional arrangements can be compared from the perspective of efficiency, operational costs, distributional effects, and other criteria. Regardless of the institutional arrangement, the spillover effects are unavoidable, as they are implied by scarcity. Therefore, the analysis of externalities should shift its focus from spillover effects to the mechanisms for allocating scarce resources among competing plans.

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Notes

  1. Hudik (2020) distinguishes between mutual compatibility of plans and compatibility of plans with nature. For the purpose of the present paper, this distinction is unnecessary.

  2. For other norms of ownership allocation, see, e.g., Heller & Salzman (2021).

  3. The literature on the political Coase theorem examines the possibilities of winners compensating losers. See, e.g., Acemoglu (2003), Parisi (2003), and Munger (2019).

  4. Nonetheless, idealized benchmarks may be relevant for activists and entrepreneurs as a motivation for change. Hudik (2021) presents a framework, where such benchmarks serve as the “pull” factors of institutional change.

  5. As pointed out by Sun and Daniels (2014), negative spillovers and positive spillovers are mirror reflections of each other: if an activity is associated with a negative effect on others, restricting this activity has a positive effect on others.

  6. This broad definition is in line with the definition of Buchanan & Stubblebine (1962), although they are rather apathetic regarding the inclusion of pecuniary externalities in the definition. They also develop their analysis in a different direction than the present paper focusing on various types of externalities rather than on their microfoundations.

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Acknowledgements

I thank Petr Špecián and Shahab Sharfaei for help in preparing the manuscript. I also thank two anonymous referees whose comments significantly improved the manuscript.

Funding

The work was supported by the Excellent Teams Project of the Faculty of Business Administration, Prague University of Economics and Business (IP310031).

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  1. Faculty of Business Administration, Prague University of Economics and Business, W. Churchill Sq. 4, 13067, Prague 3, Czech Republic

    Marek Hudik

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Hudik, M. Externality as a coordination problem. Public Choice (2024). https://doi.org/10.1007/s11127-023-01122-4

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