Exernalities and Products

Externalities are costs in a market not borne by the consumers of the products or services. Pollution is the common example. Waste management (be it unused excess or things like packaging) is another. Anti-competitive practices are a third. In general, they are marked by market distortion.

For example, take waste management rather than some system where corporations have to directly account for product waste. Call a company LeafRing Inc. They manufacture decorative jewelry for you to put on your trees’ leaves. Each piece is sold for $1 and comes in a throw-away wrapper.

Let’s say that suddenly LeafRing had to pay for the waste, all those wrappers, plus damaged LeafRings, plus ones that people quit using. That might raise their unit price to $2, but people will only pay $1. They can’t sell LeafRings, so they go bust.

Instead, we have the externality system, where the true cost is still $2, but LeafRing only cares about the first dollar. The other dollar is up to the whole system (which, it isn’t, due to the way certain government and business funding actually works) to bear.

Basically, the system is designed such that a product that might otherwise be unviable can exist by everyone else paying for certain costs.

Now, that’s not to say society isn’t better off for having LeafRing. Nor to say it is. It’s a tradeoff people can disagree about. And they might choose to call it an effective subsidy instead of an externality.

The problem comes when, in response to externalities, people expect the solution to be free or profit-making.

Take public transportation, for example. The semi-private automobile system is too expensive or otherwise exclusive for some people, and so they need alternative transportation. But enough people get past the velvet rope that public transport is underutilized (a form of de facto segregation, though not entirely along racial lines). The fact that some people are not able to use the dominant transportation is an externality caused by high prices of cars and fuel, plus the demands placed upon operators.

Public transport is effectively the cost of the system we have, but critics often pretend that it should pay for itself. They want a free lunch: cars not having to account for the costs they impose on society, plus the therapy coming at no cost. Indeed, there are car drivers who look at a bus and think they’re paying for transportation twice: once for the car, and once when they pay taxes that support the busline.

In fact, the latter is just paying the hidden costs in the former. And the fact that’s not made clear, that politicians and media portray costs of externalities as though they’re facts of life, rather than as a problem of market distortion, only distorts the political system further.


The EPA and Externalities

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.