Thursday, February 3, 2011

Externalities, LGA & Paul Wellstone

The readings and class discussion this week focused on the conditions that, from an economic perspective, require government intervention or service provision. The issue of "externalities" is particularly interesting in the context of the current budget debate here in Minnesota and the Local Government Aid (LGA) program.

Chapter two from Fisher's text states, "If consumption or production generates benefits for others that are not considered, then the consumer or producer underestimates social benefits and chooses too little of that economic activity." In my view, there is currently a severe underestimation of the social benefits Minnesotans derive from their own city's services, and this is even more true when it comes to services provided by cities hundreds of miles away.

Why should someone who lives in Eden Prairie care about the livability and tax burden in Minneapolis? The reasons primarily relate to externalities.

One reason is that the odds are very good that an Eden Prairie resident will travel into Minneapolis for work or for entertainment and expects a certain level of street maintenance and public safety services along the way. This is why "commuter burden" is an externality accounted for within Minnesota's Local Government Aid formula (the "accidents per capita" factor).

A more removed yet often cited rationale is public safety -- that if large metropolitan core cities are allowed to deteriorate and crime rates rise, the crime rates of surrounding first- and second-tier suburbs are likely to rise as well.

But why should that Eden Prairie resident care about the livability and tax burden in Hallock -- a very small city in the far northern reaches of the state? Especially if they've never been there and don't see any reason why they ever would?

The externalities are more...external...but still very much exist. A good quality of life in small cities means families with children will still live there. Small businesses will remain there and generate revenue utilized in their local community, their region, and the state.

The alternative (and an increasing likelihood for small LGA-dependent cities) is a deteriorated quality of life. If left unrectified, low quality of life leads to shuttered main streets and ripple effects to the other businesses that once supplied them. Neighborhoods filled with vacant housing, attracting crime and drug activity that spills over to nearby regional centers.

The fact that Minnesotans rarely stop to think about their interdependence allows state officials to underestimate the value of intergovernmental revenue sharing without substantial political consequence -- at least in many parts of the state.

And unlike state funding for K-12 education, which nearly everyone has had direct experience with and understands the value of, programs like Local Government Aid are not well understood by the general public and are therefore easily mischaracterized and maligned -- and with a $6.2 billion state budget hole to fix, more easily cut. Just today, the State Senate voted on its first budget-balancing bill of the session and it includes a massive reduction in Local Government Aid. The underestimated social benefits of this program have led to a choice to reduce this particular economic activity.

The interconnection among Minnesotans is more real and more impactful than any of us can really get our heads around. But the underlying concept is simple and perhaps best summed up by the quote often attributed to Paul Wellstone, "We all do well, when we all do well."


  1. Amen. Additionally, cuts to aid for cities and counties has also resulted in increased property taxes.

  2. Excellent point!

    The interconnection and interdependence among localities in the same metropolitan area, such the Twin Cities, are especially significant ... although I am not sure what would be the best way to internalize those externalities -- state coordination, regional collaboration, or else?