Externalities and Valuing Non-Market Goods

by Joshua on September 29, 2009 · 2 comments


Externalities With Value

Externalities With Value

Our accepted model provides us with a free market – one that is omniscient and omnipresent – that allocates resources, goods and services. Neoclassical economists generally assume that when a consumer (that’s you – got to love that label, huh?) makes a decision, he/she does so with all the information required.

When you buy those pants, neoclassical economists assume that you take into account not only the price, but the material the pants are made from, its scarcity, environmental damage, labor associated with its creation, et cetera when you decide to purchase them. In this way the market is perfect at managing scarcity. We all know that reality is far from this picture, however; consumers make decisions with limited information and often without consideration of the far-reaching effects and “externalities.”

Externalities Are, Well, External…

An externality is a unintended by-product that occurs in a market from another process. These side effects could be negative or positive. For instance, say I am a bee-keeper and I come to your neighbor’s property to pollinate his orchard. There is a good chance that some of my bees will pollinate your plants as well. You didn’t pay for my service, but you are inadvertently receiving benefit of it. That is a positive externality.

On the flip side, say there is a city water plant and upstream a new coal power plant is built. When that coal power plant starts leeching mercury into the river the city water planet takes it in (coal accounts for most of the mercury in our waterways). The coal power plant is not paying to filter this mercury out, nor is it paying for all the damage that could occur from the toxin leeching into the ecosystems. Unchecked, this could be a very negative externality.

Unfortunately, because the producer does not pay for the negative, or receive funds for the positive, externalities these are often left out of the decision of whether or not to pursue the activity in question. If these externalities are eliminated by charging or compensating for activities, then they become factors in the decision making process. This is especially important for the negative externalities – all too often these become costs placed upon the society instead of the producer (e.g. the city water plant in the above example has to filter out the mercury from its water source). If these prices were quantified in some way they would eventually make coal production to costly to be worthwhile.

The Coase Theorem has some economists believing that externalities can be fixed by assigning property rights to either involved party. Take my previous example for instance, you could assign the right for the city to have a clean source of water or, conversely, you could assign the coal plant to have the right to pollute. According to the Coase Theorem, either would solve the problem and be balanced in the almighty market. The problem arises when trying to assign values to these properties and rights.

Making Externalities “Internalities” and Valuing Non-Market Goods and Services

The difficult job of assigning value to our forests, bees, waterways, and other natural services must be done to a certain extent. We must decide how much value to assign, whether it is an actual market price or legislation to limit the extraction, pollution, destruction, consumption, et cetera. While the latter is more feasible, the former has some merits as well in many circumstances.

There are numerical estimates to the services provide by our natural systems. To build off the previous example, the services of our pollinators is estimated to be a $57 billion dollars a year in savings. That number relates the service provided for free by nature in terms of the approximate cost of us doing it ourselves.

Of course, there are externalities even in this valuing: the cost to the food production upon the collapse of honey bee pollination and the increased cost in food world wide are not taken into account. There are values to every ecological service, from CO2 sequestration by forests to water filtration by soil. The total value of Mother Nature’s ecological services is estimated at upwards of $71 trillion (with a T) a year.

The reality is we will forever be chasing externalities and attempting to value non-market goods (natural services, value of human lives, et cetera), trying to get them to fit into a model that fundamentally doesn’t align. Similar to the diamond and water paradox, we will need to realize some values are based on use and not monetary exchange. That is to say, some things have value that cannot be quantified in terms of dollars and cents. These things (our lives, our environment, our freedoms, and so forth) should then be protected by legislation not entrusted in the almighty market.

In a Steady State Economy

A Steady State Economy will need for us to value our externalities as best we can in order to take into account every impact we have and move towards a sustainable scale. It will also require us to create policies that protect us when these externalities cannot, or should not, be factored into market forces. What do these policies look like? Well, we might decide that only human beings are endowed with unalienable rights and strip corporations of the rights of people. We might also decide that we value the ability to sustain our renewable sources like forests and mandate sustainable forestry practices.

The most important policies in the coming decade will be the ones we decide about pollution and climate. Allowing a privileged few (industrialized nations) to poison the environment of a poverty-stricken many (developing nations) is an externality the world as a whole can no longer afford to ignore.

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