What does it mean? When a party externalizes or internalizes? Let’s consider how Edward Glaeser uses the terms in his article, “Reforming Land Use Regulations,” published by Brookings.
Theoretically, it is at least conceivable that America’s web of locally-constructed zoning codes have worked out to be a finely tuned system that functions like a perfect Pigouvian tax internalizing all the offsetting externalities of all new construction.
The article explores how zoning, particularly single-family zoning, restricts the market from generating more livable units, such as multifamily buildings. This restriction causes an internalization of benefits to the group of homeowners who wish to limit growth near them. And this is indeed how it works. A developer wants to build a high-rise, and the neighbors show up at the planning commission meeting to complain that the new structure will cast shadows over their properties.
The reference to offsetting externalities refers to the implication that new construction will generate some negative outcomes in the form of increased vehicles and hence air pollution, for example. Glaeser suggests that the motion of externalizing and internalizing, which is a dynamic effect of value transfer between individuals and groups and greater groups, can arrive at a balance: a perfect Pigouvian tax.
Here’s another observation about externalities.
Our attempt to assess the total externalities generated by building in Manhattan found that they were tiny relative to the implicit tax on building created by land use controls (Glaeser, Gyourko and Saks, 2005).
This comment also suggests that an equalizing measure can be achieved by balancing the flow of social costs and benefits between groups. Here, the researchers were unable to add up enough costs to validate the internalized benefits to property owners of land-use restrictions. However, perhaps this is a framing issue. Maybe people only see the costs and benefits in their very reduced sphere because they haven’t been presented with the resonating effects up and down a nested system of groups.
Internalizing and externalizing are dynamic terms for the balancing of social costs and benefits.
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