NZIER has released an “Insight” on internalities – specifically stating that this is one way we could justify some of the costs in the BERL alcohol report as being policy relevant. Eric Crampton discussed the release here.
What are internalities? Internalities is the name for the cost associated with not being able to “commit” to the best set of actions over time (time inconsistency). For example, on a Friday morning you might think about your weekend and decide it would be best if you only drank 2 beers that night. However, once you started drinking you suddenly decided to have more – something you undoubtably regret the next day. In this case, the inability to commit to the “optimal plan” has costs – costs that are not external but ARE policy relevant (contrary to my slogan here).
Now, both the people from BERL and NZIER that raised the internality issue are correct, and both sets of economists have far more experience and knowledge in the area of time inconsistency (I am only a macroeconomist after all). However, there is one important point for me here – internalities matter because of commitment, and so mechanisms to aid commitment can be solutions.
Why is this so important? Well when we look at the impact of a persons action on themselves it is often easier to develop mechanisms to solve this than in the case of “externalities” (where someones action influences an unrelated party).
In the case of alcohol there are a number of “pre-commitment mechanisms” avaliable to improve outcomes. If we can figure out what the private cost of establishing these mechanisms is, and we see people not use these mechanisms, then we have an upper bound on the relevant “internality” associated with commitment issue!!!
So lets ask ourselves – how costly is it to commit to not drinking too much? Some mechanisms are:
- Leaving your wallet at home and only bringing in a limited amount of cash (when going to town).
- Buying smaller portions of alcohol (when staying home).
- Dressing badly (when going into town).
- Committing to do something the next day which sufficiently increases the cost of drinking during the “temptation” period.
I have seen all these mechanisms in action. They are costly, but not that costly. As a result, my impression is that the policy relevant loss associated with the “internality” will be quite small.