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Surpassing the Jones’

May 29, 2008

Robert Frank, an economist whose books and editorials I’ve often enjoyed, recently published an editorial in the New York Times entitled “The Invisible Hand is Shaking.” It is a lucid piece, describing why it is necessary to tax gasoline in order to require consumers to pay the entire social costs of gasoline (production costs + pollution costs).  This is a typical example of what economists call an “externality,” which in a nutshell means that that the the market price of a particular item does not reflect its true cost to society. In such cases economists, regardless of their personal political leanings, advocate taxation as a way to bring price and social costs into balance and thereby enhance economic efficiency — almost always the holy grail of economic analysis.

My own background as a business school academic, and one who often teaches and does research in marketing, suggests that economists view externalities far too narrowly. Almost everything we buy and consume involves some amount externality, distortions between the market price and the total social costs. In some cases these externalities are generated from pollution or environmental degradation of some kind, but often they exist just because they affect the enjoyment of others consumption. What?

Marketers have known for a long time that what you consume impacts how I feel about what I consume. For example, I drive a Toyota with about 100K miles on it. Seems fine to me — that is until one of my friends recently bought a brand new Subaru Outback. Now my ride seems a bit shabby. Maybe I should take the millions I’m making on the book and go buy a new car. Or I could spend it on a flat screen TV, which everyone seems to have except for me. 

Let’s face it, this kind of thinking affects everyone. The enjoyment I get from the things I currently have are subject to others’ buying decisions — just like the air I breath is affected by others’ decisions to consume gasoline. Robert Frank makes similar sounding arguments in his books, but this kind of thinking has not found its way into mainstream economic analysis. The implications are enormous. Once you acknowledge that almost all consumption generates externalities taxing consumption becomes fair game, a reasonable thing to do in light of the analysis. In a future post I’ll talk about why I think taxing consumption would an exceptionally good public policy for increasing savings.  But for right now you should probably stop reading this and go get yourself a gourmet coffee from Starbucks or that ultra-cool local coffee shop near you. Everyone else is doing it.

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