Lesson 6 - Externality and Role of Government

The market economy cannot address all problems through the price system. Externality is a sign of market failure in which free riders of public goods may generate consequences with heavy social costs that the rest of the economy has to bear. But sometimes it is difficult to determine how best to utilize our resources for balancing different social goals such as economic development vs. environmental protection.

For Example, a public elementary school in New Territory with beautiful natural landscape and over 80 years of history has to be shutdown due to insufficient enrollment. There are alternative uses to the premise:
a. Demolish it and sell the land to developer to turn it into a resort
b. Preserve it and turn it into a museum
c. Preserve it and turn it into a private school
Which one would you pick? And why?

A new television broadcast license is going to be issued to increase competition. Here are some considerations:
a. Free TV with an advertising based revenue model
b. Paid TV with a subscription based revenue model
c. Free TV with a grant and donation revenue model
Which one would you pick? And why?

These decisions are tough and cannot be easily addressed by a pure profit maximization model. Is achieving profit maximization and sustainable economic development with social and environmental mission a contradiction? Recently, there is a growing advocacy of social innovation, which states that profit maximization should not be pursued in the expense of ignoring social and environmental impacts. An entrepreneur with social innovation in mind, a social entrepreneur, should strive for a balance to pursue economic, social, and environmental goals at the same time. For example, a renowned product design company, Alchemist, won the prestigious “Best of the Best” Red Dot Design Award just because of that. They received the award because of the watch they made out of aluminum can. Not only this watch is environmental in design, it also utilizes the staff from the St. James Settlement and the Christen Family Service Centre, two local NGOs, famous for their rehabilitation services. As a designer watch, the watch can also be sold at a higher price.

For the local economy to strive, there is a pressing need for the government to step up her role to regulate the market, protecting it against misuse by market power. Nevertheless, even with the best intent, the regulatory role can be perceived by various stakeholders differently. The minimum wage law is an example. Starting May last year, the hourly minimum wage has gone up from HK30 to HK$32.5 but neither employers nor workers are happy with the arrangement. This mounting cost pressure also reduce the competitiveness of our budding entrepreneurs. What can be done?

Hong Kong, often voted as the freest economy in the world, is facing tremendous pressure to control housing as well as rising labor costs. In other countries, some governments may have already intervened to protect local industries and young firms from powerful foreign competitors through subsidies or passing tougher trade measures. The Hong Kong government is relatively hands-free on this. But the rising Gini-coefficients of both household and individual income inequality have clearly demonstrated a widening poverty gap that the Hong Kong government cannot ignore.

Major points to recap

a. Externality exists because the market cannot easily address the free rider problem.
b. Unlike private good that can be priced through the market, public good cannot.
c. The limitation of the profit maximization model in pursuit of sustainable economic development requires more innovative business model to engage in social entrepreneurship.
d. The Gini-coefficient and government intervention.

Questions:
a. Uber claims to make the market more efficient by providing an online platform to facilitate transactions between drivers and passengers. However, they have been forbidden to operate in many cities. Is this kind of government intervention unfavorable for a market economy such as Hong Kong?
b. The incubation programmes at Science Parks and Cyberport are funded by Hong Kong Government to nurture young technology entrepreneurs. As part of the incubation package, there is usually one year of “free rent”. Is “free rent” considered as a subsidy to help the development of these young firms?