The EPA and Externalities

Using the analogy of lemonade stands, this post looks at the chief argument against the EPA’s regulation of carbon pollution.

With the Environmental Protection Agency (EPA) announcing their Carbon Pollution Standards, a lot of worry (mostly from paid interests) has been voiced about how the standards will result in higher energy costs.

That’s false. The standards may result in higher short-term nominal costs. That is, you and I and everyone else may pay more for our energy as the standards are implemented. But the real costs are already much higher, as warming the planet is not free.

Global warming via pollution is an inefficiency and external cost for many forms of electricity generation, including coal-fire power generation. These externalities result in anti-capitalist behavior among the purveyors of power that produce external costs. An example will be useful.

Let’s say that Team Clean and Team Dirty open lemonade stands. Team Clean buys their lemons at the store. Team Dirty steals their lemons. Over time, Team Clean cannot compete on price with Team Dirty, and most people say, “I don’t care if they steal their lemons; it’s cheaper.”

While pollution is not direct theft, it remains a false economy. The less expensive, pollution ridden energy generation methods cause real harm and keep their costs hidden because we do not see the copious amounts of pollution directly.

The EPA is telling Team Dirty, “you have to reduce your lemon theft to 70% of your lemon theft nine years ago, over the next 16 years.” So of course Team Dirty’s prices will go up as they implement the change, and given they have a substantial market share, so will everyone’s bills.

But what happens then? Team Clean’s prices start to look better as Team Dirty’s approach parity. Team Clean is then able to use the increase in customers to invest in improving their efficiencies. Over time, Team Clean’s technologies may surpass Team Dirty’s technology. Or maybe Team Dirty can cope with the change and make their lemonade cheaper without stealing.

On the whole, internalizing externalities is very positive for capitalism. The fact that you don’t hear politicians continually railing against externalities, passing laws to internalize them, etc. may be puzzling. The problem is that politicians often do not understand economics any more than their constituents do.

Opponents cite a weak economy, and that without cheap lemonade the economy will grind to a halt. Yet if the economy were humming along, they would still oppose stopping lemon theft. They would then say, “no, we’re running too good to undermine it now.” Both positions (well, they are really just one position: that we ca never enact regulations because of economic impacts) miss the fact that the externalities are the economic impacts.

Stealing lemons is not an economically viable business practice. While it may work for awhile, at some point (and when we’re looking at global scales, 100 years or 200 years is not a long time) the practice fails spectacularly. With the status quo ante we would eventually see prices go up to reflect the supply chain and infrastructure disruptions associated with global warming.

The main problem with the proposal is simply that it does not go far enough. Lamentable as that is, that is a product of the current of legislative obstruction caused by the newly-wealthy with both political aspirations and the inability to see the long-term.


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