Abstract
Suppose the production of x by agent i causes an externality to the production of y by agent j. A prerequisite for the existence of an externality problem is that i and j are not far apart and are separate agents. But an externality-corrective government policy may make j integrate with i, or move away and start producing both x and y. The above reactions by j essentially change the institutional structure and division of labor, and alter the boundary which differentiates what is internal and what is external. Previous analysis has neglected this aspect for which this paper provides a pioneering analysis.