Predrag Rajsic looks at the economic case for governments to address externalities:
Some theorists claim that externalities are probably the most legitimate reason for state intervention in human interactions. The ethical case for intervention is that it can presumably increase overall economic efficiency. This article demonstrates that, even if one accepts this ethical principle, the usual choice of externality-generating actions that are believed to justify state intervention is purely arbitrary.
In fact, according to the definition of actions with external effects, any human action in a multi-individual society would qualify for regulation under the banner of improving economic efficiency (i.e., internalizing externalities). However, the nature of human existence renders this internalization impossible. Thus, we end up with a paradoxical situation where every action inevitably fails the ethical criterion we have put in front of ourselves.
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Government intervention is commonly believed to be the correcting mechanism. In the cases where too much of an action is being performed, the government should coercively limit the externality-creating action (regulations, taxes, penalties, quotas, etc.) Alternatively, actions that result in positive externalities should be encouraged using the means available to the government (i.e., subsidies).
These government interventions are supposed to move the economy to the output mix as close as possible to the mix supposedly predicated by the model of perfect competition. In this sense, the model of perfect competition is adopted as a measuring stick for determining the ethical validity of individual action. According to this principle, one ought not act without taking into account the effect of his or her actions on all other individuals within the economy.
