Direct government provision
Direct provision of goods and services by the government
The existence of externalities provides an important argument for the common ownership, or nationalisation of a number of key industries.
The argument is that privately owned firms, in order to survive in a competitive world, necessarily have to put their own interests before those of society at large, for to do otherwise might be inconsistent with the goal of long run profit maximisation, or even survival. This harsh reality of the market is likely to manifest itself in the generation of negative externalities such as pollution, as the control of these externalities would involve higher costs and an adverse impact on profits; conversely, production activity which conferred net positive externalities on society might not be undertaken in sufficient quantities if the criterion of private profitability could not be met.
Nationalised industries, on the other hand, which, on account of being commonly owned, could be operated according to broad social criteria, rather than the narrow commercial one of private profitability, and this allows for the possibility of externalities to be fully incorporated into production decisions. Thus, for example, questions of workers' safety standards and atmospheric pollution could be accorded priority status, rather than being ignored on the grounds that to do otherwise would adversely affect profits and competitiveness; and activities such as the keeping open of 'uneconomic' coal mines and the provision of postal and transport services to remote outlying areas, could all be maintained on the grounds that they provide substantial positive externalities to society at large, although not necessarily being profitable in the sense that the private revenues from such activities exceed the private costs.
Similarly, an important argument for merit goods such as education and health being directly provided by the government rather than through the market, is that they not only confer private benefits on individuals but also significant positive externalities on society as a whole which individuals would tend to ignore when making their consumption decisions. As a result, left to the market, under-provision is likely to occur; for example, individuals would be prepared to buy education through the market if they had to, as substantial private benefits, such as higher life-time earnings, are likely to result. However, a case for a higher level of government provision can be made on the grounds that not all the benefits accrue solely to the individual - society gains from a more efficient and adaptable labour force and perhaps a more tolerant and more aware population. The topic of such merit goods will be considered in more detail.
The above arguments for direct government provision would of course be strongly contested by free market economists who would argue the case for privatisation, the desirability of using markets to provide merit goods and the extremely poor record of pollution control of the formerly centrally planned economies of Eastern Europe.