Negative Externalities: It’s time to change our viewpoint (Part II)
Most of the time, externalities are seen as a mechanical sequel of a market’s operation, a small noise in a nearly perfect symphony. Most economists want the music to keep playing. Consequently, fixing minor technical collateral damage is considered a “nice-to-have”, argues North Star Transition co-founder Olivier Boutellis. In reality, it is a fundamental flaw that we need to fix before it hits us fatally. A century has not been enough to solve the externalities problem. We should urgently reconsider the way we conceive externalities, otherwise we may keep on trying to solve the wrong problem.
Negative externalities are mostly viewed as a macro-economic issue, but their poison percolates the entire economic system, including at micro-economic level, sending the wrong incentives to business executives and consumers. Catch up on Part 1 of this blog post here.
First, we tend to forget that, far from being a mysterious anomaly of some obscure mechanism, an externality is usually the outcome of a decision or a series of decisions: outsourcing to the other side of the world to exploit cheap labour, or use under-priced and over-polluting transport methods; moving to a less demanding jurisdiction to circumvent regulatory obligations; reducing cost by using lower quality, risky products; shifting production to a zone where energy is cheap and dirty; or freerider decisions to avoid taxes. Interestingly, some externalities emerge from decisions to lobby against policies aimed at internalising externalities, or pushing for subsidies of harmful fossil fuels over renewables.
There are many such decisions made on a daily basis, some small, others big, some made knowingly and cynically, others under the convenient banners of ignorance, concealment or insufficient evidence. But it is possible that the vast majority of these decisions are made in good faith. They are decisions that conform with what is assumed to be the social norm. They are common practice and in line with what has been learned at school or on the job. And the externalities they produce are usually unnoticed, hidden in plain sight or seen as unrelated. Worse, they often benefit the decision-maker, at least in the short term. Nonetheless, it appears increasingly clear that these externalities have turned markets into weapons of mass extinction. It is the narrative of normality that needs to change; the facts will not.
If most externalities result from human decisions, it stands to reason that other decisions could have been made. Decisions are made when people have different options, although, they may not always see or admit to those options. Even when decisions are made in some algorithmic black box, a human being has conceived or initiated the system and a human can unplug it. In the worst circumstances of human history, there have always been people who dared to differ, who made the right decision despite all sorts of pressure, even life-threatening pressure. We have, or can regain, agency, at least partially, and more often than we believe. Many of these decisions can be limited or stopped by regulatory intervention. This is not always true but when policymakers choose such a tack it is a decision to abstain.
Opposing action
It seems that even when action is taken, it doesn’t match the magnitude of the problem. For instance, carbon markets have not done the necessary job to reverse the continuous increase in our emissions. It is also interesting to observe that nearly all attempts to address markets externalities face harsh opposition and reactions – lobbying against such reform is a conscious decision made and executed by human beings. The assumptions and reasoning that underpin these lobbying decisions are rooted in a set of beliefs that are widespread and unchallenged today. History is full of theories and people who were once unchallenged but later forgotten, mocked or held responsible for perpetuating the wrong idea. Sadly, we just don’t have the 359 years it took to the Catholic Church to recognise that Galileo was right. We therefore need to better understand what makes these degenerative decisions unshakable obstacles to making regenerative decisions.
Even for those with critical minds, such decisions may be interpreted as unavoidable or dictated by the context, for example, competitive pressures. In that sense, externalities have a systemic nature and impact. We think that a business prepared to account for its externalities has also to be prepared to increase its costs and become less competitive. Similarly, a government that forces the internalisation of externalities through policy measures has to be prepared to face gilets jaune on the streets and lose future elections.
The recent experience in France of the convention citoyenne pour le climat demonstrated that these negative views about dealing with externalities may be more about prejudice than founded in evidence. Governmental elites often lag far behind citizens and businesses in terms of environmental awareness and readiness to act. The new president of the European Commission, Ursula von der Leyen, might be the exception but, contrary to what most people are encouraged to believe, the lion’s share of power in Europe continues to belong to national governments. Looking back over the past forty years, it seems that the pressure holding up governments from acting on externalities comes from within or from industry, not from the streets.
Of course, a government that would take commensurate action to internalise externalities would reduce the competitiveness of its industry and attract less foreign investment. This locks both business and governments into a typical prisoner’s dilemma, made even more difficult because it now covers all players and is woven around the entire globe.
Profit motive
At the end of the day, externalities are simply sources of profit. They are costs that are transferred to others, including society or future generations. A cost that is not borne goes straight to the bottom line - it is just additional profit. What is often presented as positive words such as “optimisation” and “efficiencies”, often hides negative externalities. In many industries, from fashion to car manufacturing, the opportunities from financial engineering and globalisation have created a race to benefit from externalities.
One of the key characteristics of negative externalities is that they often represent a burden for the majority and a significant source of profit for a minority. For the latter, the internalisation of negative externalities would eat up at least part of their margins. It is not often that people volunteer to or even accept earning less in order to reduce a collective cost. Still, in the longer term, we are all prisoners of the same planetary vessel (except perhaps the tycoon who manages to find a shelter on Mars, but he may feel pretty lonely and miserable too).
Ending externalities would be in everybody’s interest. The way markets function today creates individual benefits and collective losses that preclude change, even though in the longer term, today’s beneficiaries will also be losers. No individual lives outside the collective.
Externalities are also a way of reducing production costs; in other words, they are a way to ensure the affordability of the goods produced. Affordability helps maintaining social peace by indirectly increasing buying power. It also helps increasing sales volumes and profits. This duo, which appears virtuous, is in reality a vicious circle that locks the system into spiralling growth that is unsustainable in a world of finite resources and limited capacity. It is also a way of avoiding the question of income inequality, as slightly increased buying power can improve the situation for some. But this may be in appearance only, as the price is paid in other ways through impacts such as, say, diabetes or pollution. The relative gap between rich and poor has, in fact, continued to expand. Yet another way of looking at externalities would be as the theft of human, natural and social capital.
Rather than a mere mechanical consequence of markets, most externalities are the consequences of illegitimate, antisocial and damaging decisions. Such a change of perspective should lead at least some decision-makers to reconsider what they do and make radical intervention much more justified.
In democracies, the socialisation of costs should be a collective choice (in fact even dictatorships that are keen to last have to take such public interest elements into account). Beside economically and politically divisive debates, we need inclusive mechanisms to develop systemic and consensual solutions. These are not available in most nations and even less at global level. Reforming international Institutions (or rewriting the American Constitution…) will take time we don’t have at our disposal.
Given the urgency of the situation, the only option is that we all take responsibility for the decisions we make, or are asked to make. Moreover, we need to engage in multi-stakeholder, multi-disciplinary and multi-cultural collaborations to co-create and scale up new solutions that counter lingering externalities and accelerate systemic change. The philosopher Rabelais makes this statement, “science sans conscience n’est que ruine de l’âme,” (“science without conscience is but the ruin of the soul”, François Rabelais, Pantagruel, 1532) which appears to be of particular relevance to economic theory. This is not meant to imply that economics is a science, by the way. Interestingly, moral considerations seem to be banned from the field of economics (why is it so afraid?) as if the economy was disconnected from society and the natural environment in which it is embedded. Repeated social crises, the biosphere collapse and even the current pandemic are proof to the contrary. Changing the perspective on externalities make them look a lot less like a problem of economic theory or a mechanical side-effect. It’s not the economy, stupid! as an American president was wont to say. It’s an ethical and political question, and we can no longer side-step it.
Photo credit: Muhammad Numan on Unsplash
