Tuesday, March 28, 2006

Thoughts on externalities

An interesting idea hit me. Negative externalities of some marginal amount are present in all capitalist transactions, and indeed in all industrial production, but rightly of course the general consensus is that on average the private gains outweight the (average) social cost.

Or restated, though making a TV causes pollution, we'd rather have a TV than no pollution.

What struck me though, is to use the classical/neo-classical emphasis on the long run. Though the gains made from the short run production of widget X outweigh its short-run externalities, if externalities are the rule rather than the exception, then the long run consequences are disasterous.

Just an interesting thought, perhaps to bring up the next time I hear someone say "Yes but the long run equilibrium..."

Another thought struck me about classical labor pricing models, and how they don't seem to make much sense. The classic model basically posits marginal productivity * market rate, with emphasis on short run costs, and productivity. Yet what this implicitly states is that it is not primarily the market rate that sets labor pricing, but the capital of the employer. Whenever the employer improves his capital the marginal productivity of all employees increases. This also sets up an interesting conflict whereby you'd expect an employer to increase wages every time he purchased a new piece of machinery, which is pretty much false on the face of it. Also you'd expect an employer with ever increasing capital intensive production to hire ever more labor, while at the same time raising wages, to compound the marginal productivity. This conflicts with the fact that capital intensive production lowers concentration (and indeed sometimes the total amount) of labor. Macro-case in point: France has some of the most capital intensive production in the world, and 12%+ unemployment, though if you only count those that work they are the most productive workers in the world.

The key insight here is that employers pocket some portion of the extra marginal productivity difference when they utilize new capital, and that often new capital is used to replace labor.

But still, this basically says that wages are set by the capital investment of the employer, as ultimately that will reflect both how much labor they will use, how much they will pay, and the marginal productivity of the workers themselves.


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