markets, externalitiesA company (typically) does not set out to produce waste or harm in the production of their products or services; it is a by-product. Where that by-product is of neutral or positive benefit, no-one pays any attention (a bit like people turning up at their local restaurants to get the used cooking oil to turn into biofuel). Where that by-product is of negative consequence then it is essential that it be priced, or have some measurable and reducable impact which causes a market response … if our intention is to do away with that negative externality.
My initial premise is that, if that by-product has no financial value to anyone, but a negative impact on society, then it is up to regulators to impose a market on that good.
Many column inches have been dedicated to the notion that a carbon tax is not necessary because free markets will price in any externalities.
I can see how, for instance, high rates of crime in a particular area enters the price mechanism by reducing property and investment returns in that area. This can, eventually, lead to a point where the cost of acquisition of those assets is sufficiently low, and the returns from investment in safety and security are sufficiently high, that such investment takes place. This assumes, however, that there is a “better” place where investment has been protected to flow down into the now cheaper market.
With a ubiquitous negative externality there is no somewhere else to ride out the impact.
My question: has there been research to show that, in the absence of regulatory intervention, a negative externality imposed universally on a captive market is ameliorated by that market. More importantly, how “bad” (as quantitatively as is possible for such a normative judgement) does it get before the market responds?
If a for-profit company does generate positive externalities, it will do its best to internalise them and capture them as higher profits, as far as it is able.
There are at least two millennia of examples that the market does not always price in negative externalities: and indeed, for a for-profit operator, the incentive is to externalise any costs that it can, to reduce the costs it has to pay directly itself, and thus increase its profits.
For areas with sinking property prices and rising crime: this tends to become a self-reinforcing cycle. And in some areas, investors do step in. But in other areas, urban decline goes unarrested, possibly for decades, and we end up with ghost towns.
And now to ubiquitous negative externalities. An article of mine published in INFO magazine explored these, in a section on the Tragedy of the Commons:
The economic imperatives that lead to the spiralling of negative externalities into an environmental crisis is well-documented: back in 1968, the inevitable tragedy of the commons was first written of in scientific journals: that a resource used by all but owned by none, would inevitably be over-used until it turned to dust.
That paper was "The Tragedy of the Commons," by Garrett Hardin, published in Science, 162(1968):1243-1248. However, Aristotle had written about the same phenomenon two millennia previously.
Returning to my article:
The inevitability of the tragedy of the commons became economic orthodoxy. However, more recently, Elinor Ostrom has documented several cases showing that the tragedy of the commons was not inevitable.
Ostrom went on, in her Nobel-winning research, to document the circumstances in the commons were protected, and negative externalities curbed. From the same article as above:
In many cases, communities had formed joint-stewardship agreements to sustainably manage common resources, such as fishing grounds, groundwater supplies, and grazing commons. They used frequent mutual monitoring and discussions between themselves to ensure that agreements were kept, and offenders were sanctioned with penalties determined and agreed in advance by all.
And here is as far as we can get in answering the question:
how "bad" (as quantitatively as is possible for such a normative judgement) does it get before the market responds?
From experience, some times the market simply does not respond, until the marginal damage cost gets so high as to equal a market participant's mitigation costs: that is, the point at which the commons have deteriorated so far that it's profitable for individuals to intervene. Joint-stewardship agreements can prevent things getting that bad, but only if specific structures and circumstances are in place to enable those agreements to form. In many cases they are not there, and hence the destruction of the commons documented by Hardin, Aristotle and others. In other words, sometimes market failure is terminal.
These joint-stewardship agreements have also been done at the global level - for example the Montreal Protocol protecting the ozone layer. Such agreements can combine regulation and market mechanisms: for example, proscribing certain goods or acts, and enforcing a quota on others; together with Pigouvian taxes to price in the negative externalities.
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