Environmental Law, Economics Of

From the perspective of economics, the fundamental role of environmental law is to internalize externalities. Environmental problems are a case of market failure caused by negative externalities. A negative externality is a consequence of an economic activity of one agent decreasing the welfare of another agent if the market mechanism does not mediate this connection between the two individuals. The emissions of airborne pollutants generated by a production process and reducing the air quality in the neighborhood of the plant are among the many environmental examples.

Externalities destroy the ability of markets to provide for optimal allocation of scarce resources. The reason is that environmental resources are used free of charge by the generator of the externality. Thereby, rational agents do not appropriately consider resource scarcity when deciding on the quantity and quality of their economic activities. Compared with optimal resource use, people use too many environmental resources if they are free goods. The idea of internalizing externalities is to make polluters pay for the environmental resources they use. Ideally, the level of the prices paid should reflect the scarcity of these resources for society. An example for the possible legal strategies of internalization is environmental liability law. If polluters must fully compensate for any environmental damage they cause, they are induced to take the value of environmental resources used in their economic activities into account, just as they do with any scarce resource that has to be bought within the market system. With full internalization, the ability of perfect markets to provide for optimal resource allocation is restored. Consequently, environmental law may be considered to serve as an internalization strategy.