Responding to Cafe Hayek’s post “Externalities Unavoidable ,” David Henderson  sent the following e-mail. David is a Research Fellow at the Hoover Institution  (along with Cafe Hayek’s own Russ Roberts), editor of the wonderfully useful Concise Encyclopedia of Economics , author of the the highly recommended book The Joy of Freedom , and frequent contributor to the Wall Street Journal and other high-quality publications.
Don Boudreaux pointed out that government creates as well as eliminates externalities. He gave as an example the externality that is caused by aggressive foreign policies of the U.S. government. People who dislike those policies, he noted, may terrorize innocent Americans in response to those policies.
All of this is correct, and I don’t wish to dispute it. But there are even bigger examples (bigger meaning “more costly”) of externalities caused by government..Take Medicare. Please. Government has structured the incentives so that a Medicare patient who uses health care imposes a huge cost on us taxpayers that she (most Medicare users are women) doesn’t take account of. Every time someone uses Medicare, an externality is imposed. The size of that externality is tens of billions of dollars a year. And this is just one example. In fact, it wouldn’t be much of an exaggeration, and may be literally true, that the majority of what government does nowadays is create externalities.