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- [Alex] We've already looked at one
solution to the externality problem,

Pigouvian taxes and subsidies.

You might call that
the economist’s solution.

There's another solution,
however, which is very common

and quite popular to the man in the street

and that's command and control.

That's what we're going to look at now.

Command and control
is pretty much what it sounds like.

The government says,
"You cannot do this or you must do this."

For example, the Department of Energy

in an effort
to reduce the consumption of electricity,

recently said that it is illegal to sell
washing machines in the United States

if they consume more than
a certain amount of electricity.

The only washing machines
that it was legal to sell

had to consume
less than this amount of electricity.

So, what were the results
of this command and control program?

Well, here's Consumer Reports:

"Not so long ago
you could count on most washers

to get your clothes very clean.

Not anymore.
What happened?

As of January 2007,
the US Department of Energy

has required washers
to use 21% less energy...

but our tests have found
that traditional top-loaders--

those with the familiar
center-post agitators--

are having a tough time
wringing out those savings

without sacrificing cleaning ability..."

So the government said
you have to use 21% less energy,

but if things were that easy
everyone would do them.

There are trade-offs everywhere,

and by requiring the washing machines
to use less energy,

the trade-off
is they didn't clean so well.

Eventually, the technology
has gotten better and will get better,

and perhaps, this will be possible.

But one of the problems
with a command and control approach,

is that the government
is not always aware of the trade-offs.

They're not always able to choose
the least cost way of achieving a goal.

Let's take a closer look at this problem.

Command and control is rarely
an efficient way of achieving a goal.

Why not?

Well, there many ways
to achieve most goals.

For example, let's look at some of the ways
in which we could use less electricity.

We could turn down
our thermostat a little bit.

We could shut the lights off
when we leave a room.

We could turn off our computers
at night when we're not using them.

We could use more solar power.

Firms which use a lot of electricity

have many, many different ways to use less
by adjusting their production processes.

Now if we want to cut back
electricity consumption by, say, 10%,

we want to cut back
on the 10% of electricity uses

which are least valuable.

We want to reduce electricity use
in the way which is least costly.

The problem is,
out of all of the millions,

and perhaps,
billions of ways of reducing electricity,

is government going to choose
to command and control us

to reduce electricity
in the least cost way?

Probably not.

Government
simply does not have enough information

to order the least costly method
of reducing electricity consumption.

Now, let's compare our command and control

with an alternative method,
a tax on electricity.

A tax on electricity
would allow the users--

would give them flexibility--

to find the lowest cost ways
to reduce their use of electricity.

If a tax of, let's say,
a few percentage points

would reduce electricity consumption

by exactly the same amount
as the command and control approach.

The difference is,

is that each one of us would look
at the higher price of electricity

and would choose,

based upon our different circumstances
and knowledge and flexibility,

which ways we could reduce electricity
in the least cost.

Some of us would turn down lights,
some of us would turn down thermostats,

some firms would change
the production processes a lot,

others would change their production
processes just a little bit.

Each one of us
would access our own information,

and in this way with much,
much, much greater flexibility,

we could reduce electricity consumption

by exactly the same amount
as the command and control approach.

But we would do so at much lower cost

because each user of electricity

would have the flexibility
to choose the least cost ways of doing it.

Think about it--

how many people would choose
to reduce electricity

by paying a lot more for a washing machine
that doesn't clean very well?

Probably not too many.

That illustrates that when government
chose to reduce electricity consumption

by requiring washers
to be "more efficient"

that actually wasn't the least-cost way
of reducing electricity.

That was actually a very high-cost way
of reducing electricity,

because it meant that we had dirty clothes
and we really didn't want that.

Finally, let's remember that the goal
is not actually to use less electricity.

The goal is to reduce pollution.

That's why a Pigouvian tax

is really one of the most efficient ways
of reducing or controlling an externality,

because a Pigouvian tax
is targeted on the problem--

the pollution.

So, the closer we can get the tax

to the good which is actually
causing the problem--

which is not electricity
but instead which is pollution--

the more efficient,
the lower cost way we will have

of solving the externality problem,
of reducing pollution at least cost.

Is command and control
ever a good solution?

Yes, it can be precisely when
flexibility is not a virtue.

So, if the best approach
to the problem is well known--

we don't need experimentation
and innovation and new ideas--

we know the best approach,

and if success
requires very strong compliance--

that is when flexibility
is not a good thing--

then command and control
may be the best approach.

So for example, let's consider
the eradication of smallpox.

Now, smallpox is a terrible disease.

It has killed more people
in the history of the world,

billions of people,
than, perhaps, anything else,

except, perhaps, old age.

To get rid of smallpox
we had to isolate--

every single time
there was a new case of smallpox--

we had to isolate the people
with the smallpox

and vaccinate everyone
in the surrounding community.

And the World Health Organization
and other organizations

did this time and time again.

Wherever a case, anywhere in the world,
of smallpox appeared,

we isolated and vaccinated.

And over time smallpox
had fewer and fewer places to hide,

until by 1979,
there were no places to hide left.

Smallpox had been eradicated
from the face of the planet.

That was a tremendous boon to humanity,

but really the only way
it could have been done

was command and control.

If we'd subsidized vaccinations,
that would not have been enough,

because that inevitably would have led
to small pockets of people

who were not immunized
and they would've continued to be carriers

to spread it to other people in the world.

So, command and control
got us very strong compliance

and it eradicated smallpox
from the world--

and that was a tremendous thing.

Very briefly, let's just say
where we've been and where we're going.

We've been looking at solutions
to externality problems.

So far we've looked at two:
Pigouvian taxes and Pigouvian subsidies--

Pigouvian taxes for external cost

and Pigouvian subsidies
when there are external benefits--

and command and control.

The next thing we want to do
is to look at the Coase theorem

and private solutions
to externality problems.

It turns out that we've been
a little bit too pessimistic.

There can be some market
or private solutions

to externality problems
in certain circumstances,

and that's covered by the Coase theorem.

The last thing we're going to do
is look at tradable allowances.

These have been extremely important
in practice in reducing acid rain,

and may become more important
in the future

in dealing with global climate change.

Tradable allowances, as we'll see,

are a sort of combination
of command and control,

and ideas from Ronald Coase--

and it actually turns out

to be quite similar to Pigouvian taxes
and subsidies in the end as well.

So, that's where we're going--

Coase theorem and private solutions
and then tradable allowances.

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