Solutions to COVID 19 Economic Damage

Solutions to Externalities of the COVID-19 Pandemic

by Anirudh Goel

As a response to the COVID-19 Pandemic, governments across the world have shut down economic activity in view of the policy of social distancing to contain the spread of the virus. From an economic perspective, the pandemic is an externalities problem impacting unrelated third parties. Externalities refer to situations where individuals affect each other in ways that are not negotiated or intermediated between them through voluntary agreements. An externality may either be positive or negative depending upon the nature of its effect on these individuals. An industry emitting pollution upon residents of its neighbourhood without their consent is a classical example of a negative externality. On the other hand, an investment in research and development that produces new knowledge or innovation could be regarded as a positive externality. The COVID – 19 Pandemic has created a situation of several negative externalities, one of them being the risk of infected individuals coming in contact with healthy, thereby spreading the disease. Another example can be the voluntary decision of individuals to self-isolate themselves so that they do not contract the virus. Besides this, there are tremendous costs associated with a complete shutdown of the economy itself. As governments look forward to the resumption of economic activity in a phased manner, alternate solutions will have to be devised until the preparation of a vaccine for mass immunization (which in itself would be a positive externality). Through this article, some of these possible economic solutions, both Pigovian and Coasean, have been discussed.

Pigouvian Taxes & Subsidies

A Pigovian tax is a tax imposed on any such market activity which engenders negative externalities. Its object is to internalize the cost of externality by raising the private marginal cost of production to the social marginal cost of production. It is most commonly cited in cases of environmental pollution. It can be said that the mandatory shutdown of economic activity by the government on account of the COVID-19 Pandemic is equivalent of a hundred per cent Pigouvian taxation on that activity. With gradual relaxation of social distancing norms and an intent to restart economic activity, the government may have to devise simpler Pigovian taxes that are targeted specifically towards those activities which run a greater risk of transmission and infection.

For example, a higher indirect tax may be imposed on individuals visiting theatres or pubs where there is a risk of mass transmission due to community gathering. Similarly, policymakers may devise a mechanism of high taxation for those airline passengers who travel to and from countries that have a high number of infections, hence bearing a higher risk as a carrier.

On the other side, corresponding subsidies can be devised in a manner such that they incentivize people to practice norms that engender positive externalities. For example, revenue raised from the kind of taxes discussed above may be used to create subsidies in favour of increased production of face masks and hand sanitizers, and to ensure their better availability at public places such as airports, railway stations, etc. Recently, serious concerns have been raised with respect to online education in developing countries as many households do not have the internet infrastructure available for the same. Direct internet subsidy schemes and indirect ones channelled through schools and universities can help address this problem to some extent for the time being.

Coasean Solutions

The Coase Theorem approaches the problem of negative externalities in a different manner. Before Ronald Coase, externalities were looked at as perpetrator-victim or benefactor-beneficiary stories. Coase argued that if property rights are well defined and transaction costs are not prohibitively high, it may be possible for private individuals to enter into contracts that internalize the externality. A recognized example is that of a factory emitting pollutants and imposing a negative externality upon a fishery. If given an opportunity to negotiate, the factory and the fishery would enter into a voluntary arrangement wherein either the factory will pay the fishery to emit more pollutants or the fishery would pay the factory to emit reduced pollutants. They shall make an optimal choice by weighing their interests against the cost of compromise.

Coasean solutions in their classical sense may not be possible in the case of infected individuals bearing the threat of infecting healthy ones in public places where transaction costs are prohibitively high. However, they can be applied in the context of allowing travel or reopening of private establishments. For example, trading in permit systems may be devised wherein airline companies are required to purchase permits for air operations and be penalized if they operate beyond the purchased limit.

In a market for permits, airline companies can weigh the cost of purchasing permits against the cost of suspending operations and make an optimal choice. Similar systems may be devised to cap the number of employees allowed in the workplace based on area availability. Here, firms can make a choice between hosting more employees in the office or mandating them to work from home. Further, Coasean bargains can privately take place between employers and employees. Some employees may be willing to take the risk of infection by coming to the office in exchange for a higher salary. Others would settle for a lower salary and prefer working from home. At the same time, employers would also offer salaries based on an estimation of the possible gains if employees come to the workplace or the amount of losses if they are made to work from home.


A pandemic involves the entire population and it is impossible to bring them to a negotiation table. In such situations, principles of public economics do hold true and it becomes necessary for the state to use its conventional machinery and regulate individual behaviour through taxation or subsidies. Moreover, Coasean solutions require adequate state capacity in clearly defining property rights and building the necessary judicial infrastructure to enforce contracts and compensate in cases of torts. In states with low capacity, solutions to many of these externalities would have to come from the conventional state measures of financing and regulation. However, restarting the economy would also require the government to place trust on private individuals and encourage them to enter into private Coasean bargains at the workplace and other possible areas.

Views are personal.

Image credits: Provided by the author (Financial Express).


Anirudh Goel is currently pursuing law from West Bengal National University of Juridical Sciences, Kolkata.

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