Pecuniary and Technological Externalities, and EQC

Recall that in standard micro, a pecuniary externality is one that affects you through your budget constraint, if you follow the standard Buchanan and Stubblebine definition, or one that is mediated through the market process, if you follow other texts. A technological externality is one that affects you through your utility function (Buchanan & Stubblebine) or operates outside the market process (others).

And standard theory says that pecuniary externalities are of no efficiency consequence. They don't result in sub-optimal decisions being made; further, we usually expect that they're offset elsewhere. If my bidding at auction forces you to pay more for your house, that's a loss to you but a gain to the seller and the house still goes to its most valued use. Technological externalities generate inefficiency. So we say that policy should generally ignore pecuniary externalities and focus on technological ones.

And in Friday's paper we read that New Zealand's Earthquake Commission withheld from neighbours information about dangers posed by neighbouring buildings. Why? Because of the potential pecuniary effects:

The Earthquake Commission (EQC) withheld information on a dangerous and ultimately deadly Christchurch building to protect privacy and property prices, a royal commission has been told.

Two women were killed in Wicks fish and chip shop in Worcester St after a brick wall from the neighbouring two-storey building collapsed into the shop during the February earthquake.

Natasha Hadfield, who owned the shop with husband Geoffrey, was serving Betty Dickson when they were both crushed by falling bricks.

The Canterbury earthquakes royal commission was told yesterday that on February 1 a commission inspection of the two-storey building found two walls were unstable and "in danger of collapse".

The EQC inspector urgently requested an engineering inspection of the building, but the request appears to have gone nowhere.

EQC chief executive Ian Simpson said yesterday the file had "gone into a hole", blaming a paper filing system that had since been replaced.

"I can't answer why an engineer was not contacted," he said.

After the September 2010 quake, the building sustained substantial damage. It had its eastern wall propped, and a hole in the roof was covered by a tarpaulin. It was cleared by at least one engineer as safe.

The western wall, which fell on to Wicks on February 22, was not braced.

EQC inspectors identified the western wall as dangerous, but the information was never passed on to neighbouring building owners or the Christchurch City Council.

Simpson said the policy had been to not release any information on inspections to third parties to preserve property prices and privacy.

"It was about bricks and mortar and property prices," he said.

The policy had reflected many residents' concerns that if information on quake damage was attached to their property, it could affect values, he said.

The policy was changed in October this year, largely because of the deaths at Wicks, he said.

The pecuniary effect is troubling enough; let's take that one first.

Let's start with the best case for EQC's information withholding being efficient. Suppose that a property's earthquake damage gets listed on the Land Information Memorandum (LIM) but the damage is fixed by the owner. If the subsequent repairs don't get noted on the LIM, or if buyers are irrationally risk averse, the owner may suffer a real loss despite having fixed all the damage. If buyers are rational, this only happens where property damage is a good indicator of likely damage in subsequent events despite the property's being repaired; in that case, we impose a cost on buyers if we fail to disclose. But if they're irrational, then we could perhaps view LIM listing as being akin to noting on the LIM that somebody was murdered on the property a few decades ago if everybody in town believes in ghosts. If ghosts don't exist, then both buyer and seller are better off by that the buyer never finds out that the property might have ghost-risk.

But earthquakes are real and ghosts aren't. Even if there aren't any technological effects, policy then effects a transfer that may not be desirable: buyers can't tell which properties are subject to greater earthquake risk and so we get a transfer to the owners of risky buildings from buyers and from the sellers of relatively safer buildings who then are pooled with the owners of risky buildings.

Bringing back the potential for technological externalities, things look worse. In order to avoid a pure transfer, EQC induced a technological externality.

It's not likely that different policy would have affected outcomes in the case noted in the paper; unless the inspector finding problems immediately went next door to warn people, the information would have been lost in the system until after the 22 February earthquake anyway. So it's wrong to blame this EQC policy for these two deaths. But that sure doesn't make it good policy to trade a pecuniary externality for a technological one.