Positive Externalities in Today’s Economy

A technology spillover is an external benefit that results when knowledge spreads among individuals and firms.

In the overall U.S. economy, the most important single source of external benefits is the creation of knowledge. In high-tech industries such as semiconductors, software design, green technology, and bioengineering, innovations by one firm are quickly emulated and improved upon by rival firms. Such spreading of knowledge across individuals and firms is known as a technology spillover. In today’s economy, the greatest sources of technology spillovers are major universities and research institutes.

In technologically advanced countries such as the United States, Japan, the United Kingdom, Germany, France, and Israel, there is an ongoing exchange of people and ideas among private industries, major universities, and research institutes located in close proximity. The dynamic interplay that occurs in these research clusters spurs innovation and competition, theoretical advances, and practical applications.

One of the best known and most successful research clusters is the Research Triangle in North Carolina, anchored by Duke University and the University of North Carolina, several other universities and hospitals, and companies such as IBM, Pfizer, and Qualcomm. Ultimately, these areas of technology spillover increase the economy’s productivity and raise living standards.

But research clusters don’t appear out of thin air. Except in a few instances in which firms have funded basic research on a long-term basis, research clusters have grown up around major universities. And like farmland preservation in New Jersey, major universities and their research activities are subsidized by government. In fact, government policy makers in advanced countries have long understood that the external benefits generated by knowledge, stemming from basic education to high-tech research, are key to the economy’s growth over time.

ECONOMICS in Action: The Impeccable Economic Logic of Early-Childhood Intervention Programs

The Impeccable Economic Logic of Early-Childhood Intervention Programs

Early-childhood intervention programs focusing on education and health offer many external benefits to society.
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One of the most vexing problems facing any society is how to break what researchers call the “cycle of poverty”: children who grow up in disadvantaged socioeconomic circumstances are far more likely to remain trapped in poverty as adults, even after we account for differences in ability. They are more likely to be unemployed or underemployed, to engage in crime, and to suffer chronic health problems.

Early-childhood intervention has offered some hope of breaking the cycle. A study by the RAND Corporation found that high-quality early-childhood programs that focus on education and health care lead to significant social, intellectual, and financial advantages for kids who would otherwise be at risk of dropping out of high school and of engaging in criminal behavior. Children in programs like Head Start were less likely to engage in such destructive behaviors and more likely to end up with a job and to earn a high salary later in life.

Another study by researchers at the University of Pittsburgh looked at early-childhood intervention programs from a dollars-and-cents perspective, finding from $4 to $7 in benefits for every $1 spent on early-childhood intervention programs, while a Rand study put the figure as high as $17 per $1 spent. The Pittsburgh study also pointed to one program whose participants, by age 20, were 26% more likely to have finished high school, 35% less likely to have been charged in juvenile court, and 40% less likely to have repeated a grade compared to individuals of similar socioeconomic background who did not attend preschool.

The observed external benefits to society of these programs are so large that the Brookings Institution predicts that providing high-quality preschool education to every American child would result in an increase in GDP, the total value of a country’s domestic output, by almost 2%, representing over 3 million more jobs.

Quick Review

  • When there are positive externalities, or external benefits, a market economy, left to itself, will typically produce too little of the good or activity. The socially optimal quantity of the good or activity can be achieved by an optimal Pigouvian subsidy.

  • The most important example of external benefits in the economy is the creation of knowledge through technology spillover.

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  1. Question 16.5

    In 2013, the U.S. Department of Education spent almost $36 billion on college student aid. Explain why this can be an optimal policy to encourage the creation of knowledge.

  2. Question 16.6

    In each of the following cases, determine whether an external cost or an external benefit is imposed and what an appropriate policy response would be.

    1. Trees planted in urban areas improve air quality and lower summer temperatures.

    2. Water-saving toilets reduce the need to pump water from rivers and aquifers. The cost of a gallon of water to homeowners is virtually zero.

    3. Old computer monitors contain toxic materials that pollute the environment when improperly disposed of.

Solutions appear at back of book.