“We only have to internalize the externalities”.1 That’s what “environmental economists” say. For example by imposing a tax on the production/consumption that damages the environment, or by requiring producers/consumers to buy tradable emission rights.

But there are some fundamental issues in their way of thinking:

The absence of externalities does not imply that a deal is fair#

If you are (have been made/kept) poor and you really need a job (e.g. because you want to send your kids to school and there is no state support), and the same goes for your neighbours, you’re easily “pressed” into selling your labour (or your land) at a bottom price (e.g. to some foreign company).

This deal might be “voluntary”, it might leave both parties better off and it might not hurt others in the process.

Yet it would still be a disgrace, for the simple fact that “those who have a lot” abuse the desperation of “those who have little”. The outcome is that the former (who need it the least) benefit much more from the exchange than the latter (who need it the most).

No negative externalities. Still a disgrace.

(How) is damage compensated? And how ‘voluntary’ is this?#

By “internalizing the externalities” authorities make the participants in a deal “feel” the damage they are imposing on others (who are not part of the exchange). They do so by forcing these participants to pay the monetary equivalent of this damage.2 This should incentivize them to have fewer of such deals.3

Yet there are three fundamental problems:

  1. Certain types of damage do not have a monetary equivalent, and - as such - cannot be “internalized”. As one student in a recent class put it: how do you make the participants of a polluting exchange “feel” the pain of losing a family member to cancer? Or the extinction of a species?
  2. How do you make sure that the people who are actually experiencing the damage are compensated? (Making polluters pay taxes to reduce their pollution is one thing. Making sure that this money ends up with those who suffer from the pollution is another).
  3. Even if you could somehow manage to get the money paid by polluters to the people who experience the damage: who says that these people agree with this compensation? What amount of money would be required to compensate for the death of a family member?

The bottom line: many types of externalities cannot be internalized. Those deals should simply not happen, or be limited to a absolute minimum (rather than to some “social optimum”).

Sad times, sad truth#

Unfortunately, the idea of “internalizing the externalities” - to make polluters pay for the damage they do - is already considered to be radical by mainstream thinkers and politicians.

The sad truth is that this “radical idea” still does not even come close to what would be necessary and fair.

Whenever you hear people talk about a carbon tax, or tradable emission permits, think of what Naomi Klein writes about the “Golden Age of Environmental Law” (the 1960s and 1970s, which saw a lot of victories for the environmental movement):

Confronted with unassailable evidence of a grave collective problem, politicians across the political spectrum still asked themselves: “What can we do to stop it?” (Not: “How can we develop complex financial mechanisms to help the market fix it for us?”)

…

Simple principles governed this golden age of environmental legislation: ban or severely limit the offending activity or substance and where possible, get the polluter to pay for the cleanup.

—Naomi Klein, This Changes Everything (2014, 37%)

  1. Negative externalities are the damages that are imposed on a third party, when two parties engage in exchange. Whereas the latter two parties choose to engage in exchange, because it ultimately leaves both better off, the third party is not getting anything out of it except damage, and did not choose to be part of this. ↩︎

  2. They are expected to limit their production/consumption to the point where their marginal private benefit is equal to the marginal private + social damage. At this point, the damage they are imposing others is believed to be “socially” or “collectively” optimal. ↩︎

  3. The distribution of such a tax between buyer and seller will depend on their relative bargaining position. See also what neoclassical economists have to say about “tax incidence”, and how it depends on the price elasticity of the supply and demand curve. ↩︎