Negative externalities - It’s time to Change our Viewpoint (Part I)

Markets have been a fantastic driver of wealth and wellbeing… but for the small problem of negative externalities. Scientists worry that negative externalities threaten life on earth - yet we have not resolved the problem. In the first of a two part series, Olivier Boutellis asks why a hundred years of debate on externalities has not changed anything.

A lot of what we, westerners, enjoy daily is brought to us by markets: products, services, food, travel, entertainment, and now increasingly education, healthcare, warfare, dating and sex…  There are a few exceptions here and there, like large parts of spirituality, access to air (but less and less to water), connection to nature and still some areas of culture. The general assumption is that markets provide nearly all we need in the most effective manner.  We have not found a more effective way to organise production and supply, or to allocate resources and income. While some infer that there is no better way, it simply means that we have not found one yet.   We tend to easily overlook that history is in constant flux. In historical terms, the dominance of markets as we know them today can be seen as a mere epiphenomenon covering less than 10% of time since the invention of writing. In geological time however, markets seem to be a major spike as their growth runs parallel to the emergence of the Anthropocene, an era where 0.01% of biomass (us humans) drastically affect the other 99,99%.

Getting to grips

The negative impact of markets is largely attributed to what economic jargon calls “externalities”.  Briefly, there is an externality every time the price does not reflect the cost.  Unfortunately, this is quite frequent in practice, as a massive share of the environmental and social costs damaging human life and the ecosystems supporting it are not fully included in market prices.

If prices and costs are disconnected, the whole system of perfect knowledge goes wrong.  And it goes awfully wrong, as we can see with depletion of many essential natural resources, climate disruptions, biodiversity loss, soil exhaustion, pollution, ocean acidification and plastic saturation to take a few well-known examples. If some continue believing that the climate crisis is unrelated to human activity, it is difficult to hold that market impacts are not core to the other examples in this list (and this despite voluntarily leaving out social aspects that are usually seen as more ideologically tainted or politically debatable).

Yet, price is the cornerstone of markets, it is their prime information vehicle and remains the main determinant of most economic decisions.   There’s nothing new here.  The economic concept of externality was developed by Professor Arthur Cecil Pigou... in the 1920s.  A hundred years have passed since Pigou identified that certain costs (or benefits) were being passed on to other market players without being accounted for by those who created them.  The solution he proposed is still know as a “Pigouvian tax”, a tax aimed at “re-internalising” the cost of the externality to minimise its negative impact.  Pigou was a highly influential economist in his day (he led the development of the School of Economics at the University of Cambridge), but his influence was of no help in resolving the plight of negative externalities.  

Since Pigou, a few other solutions have been debated, and all fall into one of three categories: (i) market-based approaches, such as cap-and-trade mechanisms, (ii) standards & regulation and … (iii) taxes.  Homo Sapiens has accumulated ample experience putting these various solutions at work and none are particularly novel or complex, or harbour any secrets for corporate or government technocrats.  Surprisingly, all our knowledge, expertise and endless debates have contributed very little to practical outcomes.  It has been suggested that corporate disclosures could help, but the evidence that measuring and reporting would reduce externalities to the necessary level is still missing.  However, for policymakers, defaulting to new disclosure requirements is much easier than setting up a compensatory tax or strict standards.  Measuring impacts is indispensable – but it is not sufficient to drive change at the required level.  

Nobody has ever thought that disclosures would be an effective approach to reducing homicides, and let’s be clear, certain externalities do kill.  Air pollution kills five million people every year in the world and despite the “polluter pays” principle, no murderer has been tried for these deaths. Sources differ on how many as they do not count the same things in the same way at the same time and it is a difficult measurement anyway.

We can invest massive intellectual and technological resources into pricing carbon, monetising eco-services or costing human capital, but unless the price system changes and hurts those who cause externalities, they will simply be stimulating intellectual endeavours or awareness raising tools that vanish when it is time for a decision.  This is not an opinion: it is our experience in the past century – if we even dare consider it. 

Carbon markets are another topical example of how ineffective, if not deceptive, are the attempts to take externalities into account.  In fact, they illustrate how political intervention that only goes half-way (by not fixing a proper carbon price) can be useless or even counterproductive.  It also reminds us that the internalisation of externalities and the creation of a level playing field are a primary responsibility of governments: these have not been and cannot be achieved from inside the system by its players.

Nothing new under the sun

The irony is that we continue studying and debating negative externalities with great fervour even if is difficult to add anything new to the debate.  It is the same with GDP where criticism and research for alternatives are only exceeded by the stubbornness of governments, mainstream economists and journalists to continue using a grossly deficient tool.  Even Simon Kuznets, the economist considered to be the father of GDP, cautioned against equating GDP with well-being in 1934, but we have continued to do that anyway.

We have accumulated plenty of evidence that market externalities play a huge role in the destruction of our biosphere and societies.  Yet, there is little action and even less progress.  The real mystery is how it is still possible that such a fundamental market flaw remains unaddressed, in spite of decades of scientists’ alarms and now the unfolding of dramatic consequences.  Since Pigou we have had a hundred years to debate, experiment, implement and perfect ... if we wanted to.  We have reached a point where continuing the same discussion and questing for that magic bullet is pure procrastination, if not deliberate obstruction.  

We need to shift from debate to action… and results. But we are stuck in the same narratives and approaches.  What needs to change first is our way of thinking.  To get started, in Part II of this blog post, we will explore alternative narratives around externalities. What is sure is that more of the same will only produce more of the same.  Unless we rapidly walk the talk, we will not be able to walk the Earth anymore. 

Picture credit: Chris LeBoutillier from Pexels