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Other economists are skeptical about industrial policy. Even if technology spillovers are common, the success of an industrial policy requires that the government be able to measure the size of the spillovers from different markets. This measurement problem is difficult at best. Moreover, without precise measurements, the political system may end up subsidizing industries with the most political clout rather than those that yield the largest positive externalities.Another way to deal with technology spillovers is patent protection. The patent laws protect the rights of inventors by giving them exclusive use of their inventions for a period of time. When a firm makes a technological breakthrough, it can patent the idea and capture much of the economic benefit for itself. The patent internalizes the externality by giving the firm a property right over its invention. If other firms want to use the new technology, they have to obtain permission from the inventing firm and pay it a royalty. Thus, the patent system gives firms a greater incentive to engage in research and other activities that advance technology.Quick QuizGive an example of a negative externality and a positive externality. Explain why market outcomes are inefficient in the presence of these externalities.10-2Public Policies Toward ExternalitiesWe have discussed why externalities lead markets to allocate resources inefficiently but have mentioned only briefly how this inefficiency can be remedied. In practice, both public policymakers and private individuals respond to externalities in various ways. All of the remedies share the goal of moving the allocation of resources closer to the social optimum.This section considers governmental solutions. As a general matter, the government can respond to externalities in one of two ways. Command-and-control policies regulate behavior directly. Market-based policiesprovide incentives so that private decision makers will choose to solve the problem on their own.10-2aCommand-And-Control Policies: RegulationThe government can remedy an externality by making certain behaviors either required or forbidden. For example, it is a crime to dump poisonous chemicals into the water supply. In this case, the external costs to society far exceed the benefits to the polluter. The government therefore institutes a command-and-control policy that prohibits this act altogether.
In most cases of pollution, however, the situation is not this simple. Despite the stated goals of some environmentalists, it would be impossible to prohibit all polluting activity. For example, virtually all forms of transportation—even the horse—produce