In economics a spillover is an economic event in one context that occurs because of something else in a seemingly unrelated context. For example, externalities of economic activity are non-monetary spillover effects upon non-participants. Odors from a rendering plant are negative spillover effects upon its neighbors; the beauty of a homeowner's flower garden is a positive spillover effect upon neighbors. The concept of spillover in economics could be replaced by terminations of technology spillover, R&D spillover and/or knowledge spillover when the concept is specific to technology mamagement and innovation economics.
In the same way, the economic benefits of increased trade are the spillover effects anticipated in the formation of multilateral alliances of many of the regional nation states: e.g. SAARC (South Asian Association for Regional Cooperation), ASEAN (Association of South East Asian Nations).
In an economy in which some markets fail to clear, such failure can influence the demand or supply behavior of affected participants in other markets, causing their effective demand or effective supply to differ from their notional (unconstrained) demand or supply.
Another kind of spillover is generated by information. For example, when more information about someone generates more information about people related to her, and that information helps to eliminate asymmetries in information, then the spillover effects are positive (this issue has been found constantly in the economics and finance literature, see for instance the case of local banking markets).
History of the concept
19th century economists John Stuart Mill and Henry Sidgwick are credited with founding the early concepts related to spillover effects. These ideas extend upon Adam Smith's famous ‘Invisible Hand’ theory which is a price that suggests prices can be naturally determined by the forces of supply and demand to form a market price and market quantity where buyers and sellers are willing to make a transaction. Spillover effects, also known as externalities in market theory are the costs associated with a transaction borne upon a party/parties that are non participants in the transaction (i.e., Production costs do not consider the cost of pollution on society at large). Furthermore, Mill argues that Government intervention in the market can be a useful tool when necessary to prevent or mitigate spillover effects when necessary as opposed to Adam Smith who believed a competitive market with little to no intervention provides the most adequate outcome.
These ideas on spillover effects later became extended upon further by other economists, notably Arthur Pigou. Pigou developed the concept of externalities in 1920 through ‘The Economics of Welfare’. Essentially, Pigou argued negative externalities (spillover) of an activity should incur an extra cost or tax while activities that produce a positive externalities (spillover) should be subsidized to further encourage this activity. Taxes on these activities that create negative externalities are used commonly in the 21st century through taxes including excise tax on purchasing alcohol and cigarettes which can cause damages to the health and wellbeing of citizens.
Types of spillover effects
There are different types of spillover effects which can take place. According to the Corporate Finance Institute, spillover effects can be categorised in the following ways: 1. Social Interaction Spillover Effect 2. General Equilibrium Effect 3. Externalities Spillover Effect
Social interaction spillover effect
Social interaction spillover effect occurs when community programs and initiatives have the effect of benefiting the welfare of people and in turn the community at large. For example, free education, social welfare payments and other public goods are designed to improve the social behaviour, education and employability of citizens which in turn could lower crime rates and poverty in the community in theory.