Larry Summers once began a famous paper* about the rationality of financial markets by quipping “THERE ARE IDIOTS. Look around.” Everybody appreciates this quote because so neatly demonstrates the limits of any argument that relies on the premise that masses of ordinary people will individually make decisions based on a full appraisal of costs and benefits. It’s not just that people can be uncertain, or that information can be incomplete. It’s that many people routinely make bad (in the sense of biased, erroneous, suboptimal, or regret-maximizing) decisions in ways that prevent financial markets from approximating an efficient system.
COVID-19 does the same for externalities. Most everybody now understands that individual decisions about health behavior have broader consequences for society. I cannot choose for you not to go outside. And if you do so, you raise the probability that I will get sick. The costs of me getting sick are infinitesimal to you, but high for me. Your choices create externalities on my health. Multiply that by all people making individual decisions about their health behavior and we have the problem of how to protect community health, which comes down to large numbers of people jointly deciding to take costly actions like staying inside.
What is remarkable—truly remarkable: ask yourself if you would have thought any of this would be possible on March 1—is that, generally, this is working. People get it. Many Americans may not like it, but most seem to understand the concept of social distancing and the importance of taking steps to slow the spread of COVID-19. The costs of refusing to comply with social distancing fall on all of us.
The big question right now is whether these lessons will endure. How long will people accept these costly actions that have positive externalities for all of us by protecting public health? But a related question, which is nearly as important, is whether these lessons will transfer? There are externalities, positive and negative, everywhere in modern economic life. This point is well-understood even by strong free-market economists and provides one useful argument for government intervention. But those economic treatments of externalities generally focus on “big” topics like pollution or research and development.
It would be useful to broaden our understanding of externalities to the individual and collective consequences of individual economic choices and collective economic conditions as well.** For example, one consequence of the local restaurant industry in my small town going through a massive contraction is that restaurants that I enjoy may not be around in a year. I cannot take an individual action to keep these restaurants in business: I can help, but only as part of a collective effort.
Or consider unemployment. No one doubts that the negative effects of being unemployed fall primarily on those who experience it. But there are social costs as well, which means that schemes that unemployment insurance may have positive externalities more broadly. I am wary of the epidemiological metaphor—unemployment is not an ailment, the unemployed are not “sick,” and they do not “infect” others—but we do know that employment rates are hysteretic and that unemployment makes us sick.
These are observations that recognize that individual economic choices are embedded in economic systems. There is, after all, a macroeconomy, and it is bound to seem weird if you’re used to thinking about individual economic choices in an idealized market transaction setting. COVID-19 may help people to understand that externalities matter and that the macroeconomy does indeed exist. After all, COVID-19 has created a recession that was nobody’s individual fault, and we are seeing the interconnectedness of economic life very clearly.
We also have bipartisan consensus in Washington that the government not only can help to ease the coming crisis, but that nothing else can help the way that the government can. It is not surprising to find that there are no libertarians in financial crises, as we learned in 2008. Today, we are also learning that shareholder value is secondary to stakeholder interests during pandemics.
Of course, when COVID-19 finally passes there will be policy voices and political movements that forget about the externalities that we all agreed were important during a pandemic that was nobody’s fault. But if COVID-19 proves to be the sea-change in how we relate to one another that many people believe it will be, it may also change how we manage our interconnected economy in normal times as well.
* The story of this paper may be apocryphal. I’ve never seen the paper and no one seems to have a link to it. But it’s a good story and there are idiots (look around).
** Starting here, I will be abusing terminology by talking about externalities a bit imprecisely. Suffice it to say that for each of these examples, there is an externality.