Frequently, when I’m driving to work, I see what I think is one of the clearest examples of an economic externality: big gravel trucks with lousy covers and a shower of greater or lesser extent of little bits of gravel flying off, threatening the windshields of all who would come near.
On the mud flaps, a sign: “Warning: Stay back 200 feet. Not responsible for cracked or broken windshields.” There’s a half-assed cloth cover on these trucks that appears comically intended to reduce the windshield-threatening shower, to little effect.
This is a case where the damage caused by an economic activity is borne by party “A” (me in my little Honda Civic), while the cost of preventing that damage is borne b party “B” (the guy who owns the big gravel truck). What economic incentive might Big Gravel Truck Guy have to spend the money for a decent cover that doesn’t comically flap in the wind and let all the gravel shower down on other drivers? Maybe a little, if I go to the trouble to sue him for the $150 it costs to get the windshield replaced. But how many people do that? It’ll cost me far more than $150 in trouble to chase down the truck, get the license number, go to small claims court. So most people don’t. The result is that Big Gravel Truck Guy’s costs in this case are shifted to others.
This example also illustrates a couple of issues involved with policies that might be adopted to address this market failure.
One approach involves transaction costs. If we could make it easy for me to make Big Gravel Truck Guy pay for my windshield, he would have an economically efficient choice. He could either get a better cover, or simply pay for the windshields, whichever is cheaper. But transaction costs can be really high in this sort of case, where the burden is placed on a whole lot of individuals who are harmed. The other approach in a case like this is regulation. We could have government rules mandating really good gravel truck covers to prevent the gravel shower. But economics suggests why this also is not likely to happen. The benefit here, to all the people in cars, is diffuse. Few individuals have the economic incentive to be politically active on an issue like this, lobbying for legislative reform. The Big Gravel Truck Industry, meanwhile, has a focused economic incentive to hire Big Gravel Truck Industry Lobbyists to fight such rules.
Bottom line: We’re likely to have to just suck it up and live with externalities like this.
* updated with new title to reflect amusing blogoreference I thought of in the car on the way to work