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Apr 13, 2010


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When a place of business (cafe, hardware store, bank, etc) becomes a "3rd Place" would that be considered a positive externality?
And on the flip side when a community loses those due to a Walmart or the local bank becoming a branch of a national bank that doesn't allow a "community coffee pot" in it's lobbies would those be negative externalities?

Michael W. Kruse

I see what you're getting at but not certain it is entirely the same.

Just because someone experiences negative consequences (based on whatever criteria) doesn't mean there is an externality. The parties need to essentially be "using" something that belongs to someone else. With pollution, the polluter is appropriating the air, water, or whatever, of the victim for his own uses. This is in part why some readily agree that while a factory dumping chemicals into a stream that affects neighbors is an externality, they question whether climate change pollution can correctly be seen as an externality. Can we really identify who are the victims and what property rights have been violated?

Business competition means there are always going to winners and losers. Businesses compete in one of two ways:

1. They become the low cost provider.

2. They offer a premium over the low cost provider (i.e. quality, convenience, service, style, etc.)

Walmart seeks to become the low-cost provider. Many businesses end up surviving and thriving in a Walmart market because they are able to identify and articulate the premium they sell over and above Walmart's low prices. Maybe it is in being that "3rd Place." The stores that fail are those that are neither the low-cost provider nor have a clear sense of what premium they have that justifies a higher price.

In a free market, Walmart has not closed these stores and customers were not compelled to shop at Walmart. The small businesses were simply not able to offer a compelling reason for why customers should shop at their stores. They failed to give customers what they want.

As to the local bank example, what prevents someone from opening up a new bank that provides the kind atmosphere that is purported to be so widely desired?

There are always going to be losers in the market place and people who are negatively impacted. That isn't an externality. No resources of theirs were appropriated by someone else.



I'm looking forward to reading more. I believe I'm getting a feel for the neg & pos externalities. I'm really interested in the what you have to say about Govt getting involved to make pos spillovers more effective. Can you give a good example...? would the recent bailouts be a type of spill over as many did benifit indirectly with the stock market upturn..? I still also wonder how ethics and morals play into this.

Michael W. Kruse

Thanks David.

There is a certain interrelatedness to almost every economic transaction we make so that to seem degree most transactions involve some amount of negative and positive externalities. In fact, some economists talk about the markets be "leaky" in that the do not capture call the costs or all the benefits to the parties in the transaction. The point is that most externalities are so negligible as to be irrelevant.

The issue here is when there are significant positive externalities. I've identified strom-warning systems, police and fire protection, and garbage collection as good examples.

But note a difference by comparison, If I landscape my yard, then it increases the property value of my house. And because my house is in your view, my neighbor, my landscaping work (for which you paid nothing) increases your property values as well. We pass city codes and have neighborhood associations to prevent people doing things that would have adverse impact on neighbors but we don't try to capture external benefits our neighbors receive from our landscaping transactions. We just accept it as part of what happens.

However, if we are talking about running a sewer line into the neighborhood a different picture emerges. No one household is going to pay to have a sewer line run into their neighborhood. Whoever does will have enormous costs, from which they will clearly have a benefit, but the neighbors will all benefit greatly at no cost. Everyone will wait around for someone else to act because they don't want to be out all that money themselves. These are the quintessential circumstances for government involvement.

The education scenario is a little different. People probably capture most of the benefit of a primary and secondary education to themselves but education is costly. Without public education you would either have to pay tuition or forgo the salary of at least one parent to teach children. Many might choose to forgo the education for economic reasons. The benefit of an educated citizenry would suffer. While maybe not like the sewer line scenario, the spillover is significant enough to warrant government support spread across the entire tax base ... not just parents of kids.

The real challenge anytime government gets involved, is a meaningful feedback loop. The market is dynamic information system communicating supply and demand with each purchase. In situations without the market, like government, it becomes significantly harder to measure how effectively resources are being used. More on that later.

I don't think the bailouts would qualify as addressing an externality. With the banks you had an economic institution that failed and government's attempt to restore it. More on that later as well.

I'm also coming to some moral ethical issues toward the end of the series.


Just now getting back. Sometimes the blog world moves to fast.

so..... Externality is a technical economic term (like scarcity) with a specific definition for economists. In this case ii does not refer to all consequences of an activity.

But some continued thinking about the relationship between a business and it's host community.

A while back you noted the difference between an employee/employer and client/patron relationships. You presented it as a choice between the two. Is it possible that what actually exists is a continuum between 2 poles at the extreme.

And perhaps there is a similar continuum that describes the relationship between business and host communities.

Since I used to live in Indy, the Eli Lily company is the one that comes to mind. As of the late 80's Lily had never laid off an employee, even during the depression. The company had never unionized in a city filled with other unionized companies.

The company provided a lot of amenities for employees and the community. The CEO of Lily and the CEO of the separate but related (since the sole source of it's funds was Lily stock) foundation were perhaps the most powerful folks in the city. The mayor and council followed their lead. And Lily funds meant that they could keep the tax rate low.

For example, as I understand the reason that there was a stadium for the colts to move to from Baltimore in 1984 was because Lily decided in the late 70's Indy needed to be an NFL city and provided a big chunk of funding for the old Hoosier/RCA Dome.

When I left Indy in 1987 Lily was turning it's attention to the development of a major park on the White River. World Class Zoo and lots of other stuff. I am not sure how that turned out.

So was/is Lily an employer, a patron, or something in between.

Michael W. Kruse

Ceemac, Hallmark has played a similar, but less prominent role, in Kansas City. I get the general picture.

I get your point but I think there are still profound differences. Yes, we get the word "patron" from Greco-Roman culture. But in that culture nearly everything was done through these pyramidal relationships. A Patron would do something on behalf of another who could not possibly repay the debt. That person became the patron's client owing complete allegiance. Any clients that the client could develop the then fed into that patronage pyramid. Patron's looked after clients and clients did the bidding of their patrons. If a patron was unable to provide something from his own means for his clients he might make use of a broker to negotiate an exchange with another patron of parallel status. There were market places where some goods were exchanged but even here, exchanges were heavily influenced by the patronage structure.

The idea of an employer hiring an employee purely on market exchange terms, where the employee shops around for positions looking for the best wage, was probably only common for the day laborers who had lost their land and had not become attached to a patron.

Certainly philanthropy is expected from people who make it to the top of the business environment in our culture. But the philanthropy is seen as a supplement to the contractual agreement of employers and employees. In fact, if a company were to give gifts and expect from government or others a response as in the Greco-Roman patron-client world, the would probably go to jail.



So Patron/Client is another set of technical terms that I was not using correctly.

But I am still pondering and I hope this is not too far off topic. But I think it does deal with the allocation of limited resources. What is the econ language for the different relationships that companies have with:

A. The people who work at the companies
B. The communities that host the company

How do economists evaluate those relationships.

And those relationships vary drastically.

At roughly the same time during the depression the Lily family was figuring out ways to keep everyone employed at Eli Lily while Henry Ford was having battles in the streets of Detroit with his employees.

Or a current example from my current neck of the woods. Southwest and American are both airlines with HQ's only a few miles a part. But they are worlds when it comes to relationships with employees. From my observation people work for AA but they are a part of SW.

Some companies seem to view workers as a necessary evil while others try to have the feel of an extended family.

As to location some companies seem to be tied or connected to a home community in some sort "organic" or even emotional way. Others are not committed to a place and move around at the drop of a hat or the lure of incentives like tax breaks.

So what sort of language do econ types use to talk about this stuff.

Michael W. Kruse

This actually brings up a dynamic. When a corporation hires someone, we have laws that say you aren't supposed to discriminate on race, gender, creed, age, marital status, and a host of other personal characteristics. You are to hire only on the basis the skills someone has to do the job. The employer, in most cases, can fire at will and the employee can quite whenever she likes. This contractual arrangement forms the foundation for everything else.

But human beings aren't so many cogs in a machine. The employees' sense of solidarity with the business and ability to work cooperatively with others has important implications for businesses. Some firms don't really care about employee retention. They hire people in and chew them up fast. All but a few burnout within a few years and they just keep hiring more as they need. Some businesses are more amenable to this than others.

However, most businesses like to keep turnover low and have a relatively stable environment, where there is some sense of team work. Depending on the business, the process of a having to constantly train new people can be very costly and disruptive to the business culture. Therefore, businesses try to create an atmosphere where employees develop a loyalty to the business. Perquisites are part of this effort. Greater solidarity means less turnover, less absenteeism, less lawsuits and usually more productivity. Apart from purely moral or altruistic motivations (and I don't want to dismiss those because I think they are frequently a significant mix in the picture) there are sound economic reasons for benevolence.

It is probably an overstatement but I think you are likely talking about a trade off in costs. One firm offers a decent pay (and sometimes very high pay) for a stressful workaholic environment with little cost for fringe benefits but high cost in turnover, absenteeism, theft, and so on. Another firm offers decent pay with a more reasonable work load and higher costs in perquisites, but lower cost in terms of turnover and so on.

As to benevolence to the community, a competitive advantage a firm can have within the industry is the good will of customers and the public. Furthermore, having things like professional sports teams, symphonies, well equipped schools, and so on, creates a more attractive living environment for employees and local suppliers to the firm. That contributes to the retention of employees by creating a good environment in which to live. Corporations usually join with other firms because the one thing they have in common is a desire to have attractive place for people to live and work.

I think I could say much more ... like seeing a corporations name over and over at sponsored events or donated goods develops good will with public too. And again, I don't want to be cynically dismissive of altruistic motives by many firms because I think those are frequently part of the mix. But is this getting at what you are asking about?

I'd just close by pointing back to what I started with. In our culture, it all begins with that employment contract. All the other stuff is layered on. In biblical times, "employment" was most typically a byproduct of having entered a much more encompassing patron/client relationship with a patron.

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