Strategic Spillovers

Daniel B. Kelly (University of Notre Dame)

Abstract: The traditional problem with externalities is well known: self-interested individuals and profit-maximizing firms often generate harm as an unintended byproduct of their use of property. I examine situations in which individuals and firms purposely seek to generate harm, in order to extract payments in exchange for desisting. Situations involving such “strategic spillovers” have received relatively little systematic attention, but the underlying problem is a perennial one. From the “livery stable scam” in Chicago during the nineteenth century to “pollution entrepreneurs” in China in the twenty-first century, various parties have an incentive to engage in externality-generating activities they otherwise would not have undertaken, or increase the level of harm given that they are engaging in such activities, to profit through subsequent bargaining or subsidies. I investigate the costs of strategic spillovers, the circumstances in which threats to engage in these spillovers are credible, and solutions for eliminating, or at least mitigating, this type of opportunism through externalities.

Download the paper