Externalities and The Private Sector:

Traditionally the performance of the private sector in situations involving externalities is viewed with suspicion. In cases involving positive externalities the private sector does not produce much and in the presence of negative externalities it produces more than optimum. In the case of infrastructure where the rate is return is too low in the short run and it is not possible to

capture the spillovers the private does not venture usually. In order to control production of goods with negative externalities the government in traditional approach imposes restrictions of finns while it entered into production goods with positive externalities. In recent years, however. some changes are . observed in the sense that private sector has ventured into areas hitherto considered as the domain of the public sector. Moreover, situations involving negative externalities are viewed as a source of revenue.

Let us take the example of entry of private sector into development of infrastructure such as roads. We consider two situations: first related to short stretches in busy metropolitan cities, and second related to highways. Investment in short stretches of roads in busy metropolitan cities is now perceived as a profitable investment by the private sector. The private sector builds the road segment (e.g., a bridge over a river), and operates by charging a stipulated tool charge from users. As the traffic is too high. it is profitable for the investor. In some cases the builder pays a lump sum to the government as a license to operate on this road segment. Thus. what was considered earlier as expenditure by the government is now a source of revenue for the government. In the long distance road sector, the private sector is assured of a minimum rate of return on investment.

We consider another situation where the government used to impose uniform restrictions on private sector as it involved negative externalities. As an example let us consider the case of environmental pollution. Producers of a polluting good would dump the effluents to the river or the sea. As a result, the water downstream or on the seacoast would get polluted. The adverse effect of the polluting activities often prompted the government to impose restriction on production of polluting goods or shifting of polluting activities away from residential areas. Social buds such as pollution reduce the cost of production for the producer, which influences the producer to produce at a level higher than the social optimum. In recent years, there is a shift in policy from command and control measures to market based incentives. Thus instead of imposing a blanket ban on polluting activities, the government collects certain amount of pollution charge from the polluting units. The objective is to increase the cost of production so that polluting goods are produced at socially optimum level. In the process, however, the government generates revenue which can be used for pollution abatement or for other productive activities. Thus there is 'double divided' - reduction in pollution and generation of revenue - from such a policy.