Posts tagged negative externality

Negative Externalities: There is no such thing as free lunch.

I’ve lived most of my life never knowing the concept of negative externalities……but I’ve been affected by them all along.  I need to clearly understand this concept, learn to see negative externalities in my own life choices and in larger issues, and learn alternate approaches that minimize or eliminate them.  I learned long ago that I cannot optimize a manufacturing process until I can first SEE the process as it currently exists.  I have to make the process VISIBLE.  So, I’m taking the first step to make negative externalities more visible in my life.

First, a definition:  “A negative externality occurs when an individual or firm making a decision does not have to pay the full cost of the decision.” (1)   “For example, manufacturing activities that cause air pollution impose health and clean-up costs on the whole of society” (2)  So, in a transaction that has negative externalities, some party is benefiting from costs ultimately borne by other parties.   Another way to think of this is that someone is getting a “free lunch”.   And really, there is no such thing as a free lunch…..so who is really bearing the costs, and how can this unfair situation be rebalanced?

I’m not wise or informed enough to understand all the aspects of the examples I’ll be citing.  Again, my purpose isn’t to persuade…yet.  It is only to learn to see negative externalities and their consequences.  Many examples happen to be environmental or health examples…..but this negative externality concept shows up in many aspects of life.  I’ll talk about this at the end of the blog.

Wild Rice (http://www.startribune.com/opinion/commentaries/291592851.html)

This morning, there was an opinion piece about Minnesota wild rice and state limits on sulfate pollution.  There seem to be many negative externalities in this situation:

  • Sulfate pollution drives increased sulfide pollution which in turn is toxic to wild rice.
  • Harm to wild rice harms an important tribal resource and a vital plant to support aquatic life, ducks and mammals.

The costs to remedy these harms are not built into the manufacturing system which generates the sulfates.  So, the products produced by that manufacturing system have falsely low prices.   The total economic system would likely rebalance to some other optimum if these costs were fully recognized.  I realize this is a complicated proposition that requires assigning value to many transactions that don’t currently have assigned value, such as habitat loss.

Pineland to Potatoes  (http://www.startribune.com/local/290946331.html)

A few weeks ago, there was an article about conversion of pineland to irrigated farmland.  Again, there seems to be many negative externalities in a move that partly motivated by the positive goal of increasing crop rotation intervals.  A few of these include

  • Impact on quality of drinking water and later on quantity available from the aquifer.
  • Eventual health and other costs related to reduced drinking water quality .
  • Loss of habitat
  • Increased pollution in watersheds affected by these changes.

The price for the “pine forest to potato farmland” transaction needs to be adjusted in some appropriate way to fully reflect all the external costs.  If that were the case, it is possible that the farming company would have the economic justification to make some other decisions.

The Everglades and South Florida Water Management (http://www.news-press.com/story/life/outdoors/2015/02/10/water-storage-project-expected-help-caloosahatchee/23186239/)

The story of Everglades changes and restoration began 150+ years when man first began to “improve” the area by constructing roads across it, and attempting to drain it to make the land available for other uses.  The Everglades is an incredibly complicated and subtle system of natural water management that stretches from near Orlando all the way to the south end of the Florida mainland.  Changes in water flow in this total system affect many things including:

  • Land, fresh and salt water habitats  all over the southern half of the state
  • Water quality for drinking and agricultural use
  • Algae blooms in the Gulf
  • Fishing
  • Tourism
  • and so many other systems.

We’re gradually learning how this complicated system works.  That teaches us what we need to diligently preserve and how we might most effectively restore critical functionality.  But we struggle to pay for these restorations…..should we do them, who should bear the costs, what are the best and most cost effective approaches?  As you can imagine, the political and economic concerns are significant.  We need to repair the damage done, and also prevent future damage by making more holistic economic decisions BEFORE we embark on new projects.  These holistic decisions will necessarily take the negative externalities fully into account.

Smoking

What if the full costs of smoking were built into the cost of a pack of cigarettes?  The costs of healthcare due to primary and secondary smoke, the loss of productivity due to illnesses resulting from smoking, etc?  Lawsuits provide some equalization on these costs, but that system is inherently inefficient and doesn’t equalize the costs across all affected.  What if we could devise some system which built those costs in upfront, as the negative externalities were identified?

Super Sized Meals, Drinks and Portions

Super sized meals and drinks are an effective marketing tool to convey value.  But there are substantial negative externalities with this approach.  Contributions of excess calories and certain nutrients in these purchases, especially when they are sold in a manner that facilitates consumption by a single person in a single eating occasion, facilitate the issues of obesity, diabetes, heart disease, etc.  If the costs of these externalities were built into the price of the super sized meal or item, they would likely no longer be a “value”.

Yes, I have the option to not buy these meals.  Yes, I have the option to not eat the whole thing.  But, the value which persuades me actually doesn’t exist if all the costs were included in the price.  So I would make another economic (and health) decision if all of the costs were considered and built in.

Sub therapeutic antibiotic use in animals

Here is a practice which reduces the cost of meat, but is increasing the cost of healthcare by participating in a system of exposure to antibiotics which is resulting in resistant strains. People are sickened at enormous cost to our healthcare system, lost productivity and quality of life. Drug companies must focus research efforts towards replacement drugs which costs us the opportunity of other drugs they could be developing if this situation didn’t exist, and so on.  Again, what if the cost of the meat reflected these external costs?  Would other meat raising techniques become more economically viable if these external costs were built into the price?

Sub-living wages

There is a better title for this section, but I don’t know what it is.  Here’s the idea.  Let’s say a company has 50 employees who are part time, and thus not eligible for benefits.  Those employees may well need two jobs to make a basic living, and they likely don’t get benefits from either company.  Those benefits may be provided by other external means, such as Medicaid, public assistance, food shelves, etc.  So the prices paid for goods and services sold by these companies are subsidized externally and do not reflect the full cost of those employees.  Again, the employer has structured the situation to obtain a “free lunch”, a negative externality.

What if the system were changed in some way so that it was economically advantageous for employers to take those 50 part time jobs and restructure them into 25 full time jobs, with benefits?  The number of hours worked would be the same, and, in reality, the benefits paid would also be similar, but now all the costs would be clearly attributable to the company and reflected in the price of goods.  The price of goods would go up, but that price would fairly reflect the full costs.  The external systems required to provide the negative externalities could be eliminated, eliminating those costs.

Final thoughts for now

It is not my intention to solve these problems in this blog.  I don’t believe government regulation is the best way to solve these problems except in a few specific cases.  Rather, if we start becoming aware of these negative externalities, these “free lunch” decisions, we can begin to consider better, long term approaches which are more economically rational and holistic.

So, I encourage you to “see” where the free lunches occur in your life.  They occur in your job, your purchases, your taxes, your interactions with your spouse and family.  Once we begin to see these externalities, we can make other choices.  Feel free to comment in this blog.  I suspect there will be some lively commentary.

My best wishes to you!

Foster

“The frog does drink up the pond in which he lives.”

(1) FundamentalFinance.com:  Negative Externality

(2)  Wikipedia:  Externality

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