Spillover Effect

What is Spillover Effect?

Spillover effect can refer to a positive or a negative economic, social or political impact, but more often negative, that is experienced in one region or across the world due to an independent event occurring from a seemingly unrelated event. More often, the event occurs in a specific country, which leads to the positive or negative impact spreading to the rest of the world. In return, it creates a social crisis or a shock in the market like booms or crashes.

Understanding the Spillover Effect

The spillover effect typically emanates from a single source, and its impact leads to other non-participants experiencing negative or positive social, political, or economic interference. The Great Depression that began in 1929 serves as a great example to demonstrate the spillover effect.

As history records it, it was a severe depression that originated from the United States and spread to the rest of the world. The depression led to a reduction in outputs, which resulted in unemployment and severe deflation of markets around the world.

A more recent spillover effect event has been the COVID-19 pandemic. A single event arising from Wuhan, China, spread to the whole world to become a 21stcentury disaster. During the lockdown period, trans-border trades were limited, stocks plunged, cross-country borders were shut down, etc. It became another disaster similar to the 1918 Spanish Flu pandemic.

At the same time, the COVID-19 pandemic caused some positive spillover effects. In early 2020, when China and the rest of the world continued to enforce lockdown measures, it was reported that pollution fell significantly due to the reduction of human activities. In China, the sun could be seen over the skyline. In India, New Delhi’s India Gate could be seen without the typical smog blocking the views.

Types of Spillover Effects

The main types of spillover effects include:

1. Social interaction spillover effect

It refers to spillover effects where a person or community benefits from a program indirectly through interacting with a target program. An example is free public education offered by the government. The community benefits from it by interacting with well-mannered and educated students. Crime rates go down. The economy, too, will include more elite members who are likely to impact it positively.

2. Context equilibrium effect

It arises from interventions affecting social norms or behaviors within a context, such as a locality in which the interactions originate.

3. General equilibrium effect

It is a type of spillover effect that arises from an intervention that affects equilibrium prices through shifts in the supply and demand of particular products in the market.

4. Externalities spillover effects

Externalities refer to activities that affect third parties who didn’t choose to provoke such benefits or costs.

Positive and Negative Spillover Effects

In most cases, the spillover effect causes more negative effects than positives. Here is how both impacts compare:

Positive Spillovers

Positive spillover effects occur when an action in the environment leads to an increase in one or more pro-environment behavior. Its occurrence minimizes the negative effects. A good example is a free public education offered by the government.

The students benefit from the program directly by gaining free knowledge, learning materials, and good morals; general society profits indirectly from a better educated and developed population. The economy, on the other hand, benefits from a higher educated workforce. The workforce can also be shipped overseas to extend the positive effect.

Negative Spillovers

Negative spillover is the opposite of positive spillover. Its occurrence in the environment elevates unwanted social, political, and economic behaviors. An example is when an industrial plant releases smoke, carbon dioxide gas (CO₂), oil, wastewater, and other harmful waste materials into the atmosphere.

The accumulation of CO₂ and CFCs in the air with other air pollutant gases cause global warming. Consequently, the melting of ice in polar regions raises sea levels, eating away the world’s shoreline. Even worse, the accumulated CO2 in seas and oceans leads to acidic water endangering aquatic survival if not causing deaths. The negative impact of a filthy oozing environment weighs heavily on both the participants and non-participants.

Why Do Spillover Effects Cause Market Failure?

Market failures occur when goods and services are not well distributed. In other words, no price is accounted for in all the benefits and costs involved while consuming or providing the products. When such a scenario happens, the market responds by either over- or under-producing such products. The oversupply or undersupply of products is due to the externalities’ spillover effects.

Learn More

CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

• Black Swan Event
• Negative Externalities
• The Economic Crash of 2020
• Unemployment
• See all economics resources