Externalities

Though largely unknown in the wider public discourse, externalities represent a key concept in economics, particularly as it concerns the environment. At its core, the term externalities captures a simple, basic idea: virtually every market transaction accrues either benefits or costs that are not directly involved in the initial transaction. Another way of stating this is that neither “positive externalities” nor “negative externalities” are “internal” to the transaction (they produce what economists call a “spillover effect”). A simple example for a beneficial externality: a consumer pays for, and receives, a flu shot. When they subsequently stay healthy, everyone around them benefits (even though they did not pay for the shot, nor in any other way were part of the original transaction). A simple example for a cost, or negative externality: a consumer buys a tomato from a farmer who uses toxic fertilizers that leak into the groundwater and end up killing fish and sickening water consumers at an adjacent lake; the expenses of water filtration, loss of fisheries, and healthcare costs are borne neither by you nor the farmer; the cost is effectively “externalized” to water consumers and the community. Economists frequently differentiate between “private costs” (those that are part of the transaction) and “social” or “socialized” costs (when society picks up the tab). A classic recent example for the latter distinction would be the government bailout of AIG or Goldman Sachs: as long as their creative financial dealings were profitable, the gains were private (kept by the company), but the subsequent huge self-inflicted losses were essentially externalized or socialized.

What we learn in grade school, namely that you fix what you break, in short, does not apply in our modern economy. Indeed, almost everything people generally associate with what is broken in the environment—resource depletion, pollution, waste, degradation—represents, in economic parlance, an externality, for it was, originally, a consequence external to the original economic transactions. The purchaser of the tomato, for instance, did not pay for (or even know about) the water contamination downstream. Similarly, a carpenter who buys lumber did not pay for the potential costs associated with clear-cutting, such as soil erosion, a decline in biodiversity, or the loss of biosequestration of carbon dioxide (CO2).

An example widely debated in a series of recent documentaries, books, and articles on fast food can serve to clarify the significance of externalities, as well as illuminate some of the most daunting conceptual questions occupying scholars, economists, and environmental activists alike. Today, the price of a hamburger at any major fast food franchise is less than $4.00. According to a variety of studies, however, the real cost is significantly higher—if the cattle were raised in pasture cleared from rainforest, according to the Indian Centre for Science and Environment, the cost could be considered as high as $200, that is, [Page 259]if all externalities were to be included in the price. While this may sound absurd, let us examine what went into the calculations. For one, fast food franchises each sell hundreds of millions of hamburgers a year in the United States, and the carbon footprint of the energy used to produce and cook these hamburgers, according to conservative estimates, runs up to at least 2.7 billion pounds of carbon dioxide emissions that would cost hundreds of millions to clean up.

...