Michael Munger on Subsidies and Externalities

Episode Summary

Executive Summary: Russ Roberts and Mike Munger examine why governments subsidize activities, contrasting the textbook case of correcting positive externalities with political and cultural motives. Examples from farms, sports stadiums, cultural industries and urban development show how subsidies can hide opportunity costs and benefit organized interests. The beekeeping example illustrates Coase’s insight that people often negotiate around externalities when transaction costs are low; policy should therefore compare alternatives and account for transaction costs.

Main Topics: Economic rationale for subsidies and externalities: The Pigovian case for subsidies is to encourage activities whose benefits spill over to others and are not fully reflected in market prices. The speakers distinguish this ideal from the political reality of who receives public support. Farm subsidies and political coalitions: Munger describes receiving North Carolina tax advantages and cost-sharing for tree farming despite being a well-paid professor, illustrating how support framed as helping struggling farmers can benefit people who do not fit that image. Roberts connects such policies to a coalition of cultural sentiment and beneficiaries’ self-interest—the ‘Baptists and bootleggers’ dynamic. Sports stadiums, culture and opportunity cost: The Cardinals stadium may provide cultural benefits that teams cannot capture through ticket sales, but those benefits do not establish that public financing is worthwhile. Costs include taxes, land, traffic and facilities used only part of the year; consultants’ projected benefits may overlook alternative uses of public resources. Cultural preservation and directed urban development: The discussion considers agricultural protection, domestic film quotas, downtown art galleries, farmer’s markets and attempts to create regional industries. The speakers question whether preserving a preferred aesthetic or copying a successful region justifies coercive spending, emphasizing uncertainty, political incentives and unseen alternatives. Beekeeping, Coase and private solutions: Bees benefit both beekeepers and orchard owners, and the speakers describe markets, contracts and the ‘custom of the orchard’ as ways people coordinate pollination without government direction. Coase’s central lesson is to examine transaction costs and real institutional arrangements rather than assume a subsidy is necessary. Carbon policy, transportation and transaction costs: The speakers question subsidies for roads and mass transit and note that new roads can induce location choices and later congestion. For carbon emissions, they argue that taxes are one possible response, but tradable credits or other lower-cost arrangements may reduce transaction costs and achieve reductions more efficiently.

Key Arguments: A subsidy can address a positive externality when people who create a benefit cannot capture enough of its value to justify providing it; however, identifying a spillover does not by itself prove that government intervention improves outcomes. Subsidies often combine broadly appealing cultural or moral claims with direct benefits to organized interests. Munger’s tree-farm support, despite his personal circumstances, illustrates how a program’s public rationale can differ from who benefits. Consumer surplus and non-paying beneficiaries do not automatically justify public funding. Stadium proposals must be judged against full costs and opportunity costs, including land, taxes, traffic and alternative public or private uses. Governments can mistake correlation for causation when trying to reproduce successful places or industries. Research Triangle Park’s success does not show that building a large airport elsewhere will create growth without comparable universities, skills, infrastructure and demand. The beekeeping example challenges the assumption that a positive externality necessarily requires a subsidy: recurring relationships and local customs can coordinate beneficiaries and providers when transaction costs are manageable. Coase’s insight is not that externalities never matter, but that policy analysis should consider transaction costs, property rights and feasible alternatives. Where bargaining is costly, institutional design—including tradable credits—may work better than a uniform rule or tax. Public projects and subsidies should be evaluated against what resources would otherwise have produced; visible improvements do not reveal the less visible activities or neighborhoods that may have lost funding.

Data Points: Munger’s tree-farm area: 35 acres - He describes owning forest land in North Carolina and growing pine trees. Annual property tax on the farm: About $600 - Munger says the farm-use tax treatment leaves his bill at roughly this amount. Tree-farm fertilizer assistance: Half the cost - The state offered to pay half the cost of fertilizer; Munger says he benefited by about $6,000 from state support last year. Prescribed-burn cost and state share: About $12,000; state paid three-quarters - Munger says the state funded most of a burn to clear undergrowth on his property. Munger’s estimated annual benefit from subsidies: Close to $20,000 - His estimate of the combined value of the farm-related support described. Time until pine trees are ready to harvest: 22 more years - Munger’s estimate of the remaining growth period for the trees. Stadium use: 81 days per year - Roberts cites the number of days a baseball stadium is used for home games when discussing opportunity costs. U.S. farm population and farms in the 1930s: About 25% of the population; 6 million small farms - Munger contrasts the era’s farming culture with later agricultural concentration. U.S. agriculture around the 2000 census: About 150,000 large farms; 2% of the population on farms; three-quarters of food supplied - Munger uses these figures to question the persistence of broad farm subsidies. Japanese rice price compared with world price: Five or six times higher - Munger cites this as an example of protection justified partly by cultural preservation. Illustrative emissions reduction target: 10% - Munger contrasts requiring each emitter to reduce emissions by 10% with an aggregate target that allows trading.

Pivotal Quotes: "there is no we. The state doesn't have desires." — Russ Roberts: Roberts challenges language that treats government as a single entity with its own preferences, before offering political incentives as an alternative explanation for farm subsidies. "when transaction costs are small, we can often ignore these externalities because the parties involved have a very strong incentive to find a way to make the wise decision." — Russ Roberts: Roberts summarizes the Coasean lesson illustrated by arrangements between beekeepers and orchard owners. "We can just create some institutions that reduce transactions cost, and then some of the externality will be ameliorated." — Mike Munger: Munger explains how policies such as tradable credits can facilitate decentralized responses to externalities.

Implications: Treat subsidies as proposals to be tested, not automatic fixes for externalities or cultural concerns. Compare full opportunity costs, identify who benefits, and look for private coordination or institutions that lower transaction costs before choosing taxes, subsidies or direct regulation.