Internalising Externalities

In economics, externalities are activities conducted that affect those who did not wish to be involves in said activity. Common negative examples include pollution, noise and second-hand smoke. But they can be positive as well, such as pollination from a beekeeper's bees, general levels of education and vaccinations.

Policy makers usually try to 'internalize' externalities through taxation and subsidies, which intend to equate the private costs and benefits to that of society. As simple as it may sound, attaching an accurate figure to social costs and benefits is incredibly difficult. Particularly, how do we measure the long-term damage done to nature, and then try to value this damage?

This job has been given to ONS and Defra, but it seems a pretty thankless task given that economists view the subject area as separate to economics, hence External...ity.

The concept of externalities came into prominence through Pigou, in his 1921 book The Economics of Welfare, far after the earliest developments in economic thought. It seems crazy that Pigou had to specify the economics in his book to that of welfare: economics is the study of welfare! Instead of changing the subject area of economics, topics focusing on the environment were pushed to the side, and remain a footnote in 'modern' economics textbooks.

Ever since, the economic study of the environment has been a separate field to the mainstream. I have never studied an economic model that has included any environmental factors. It's as if economists have believed that economic actions are completely separate to the Earth in which they are performed. And the notion that the Earth may actually impose a limit on the 'size' an economy is derided by mainstream economics. More importantly, no one seems to have informed orthodox economics of the second law of thermodynamics: endless growth is not possible!

A glaring issue with the orthodox 'solutions' to pollution, climate change and land conversion is the assumption that we have to use the market, and that these markets are efficient. For decades, economists were of the persuasion that prices adjust freely, at least in the long run (whatever that is). This means that any environmental damage caused by fossil fuels, radioactive waste or landfill, will be reflected in the market price for these 'goods.' Hotelling published this 'rule' in 1931, and, apart from needing perfectly efficient markets, basically embedded the idea that intervention is unnecessary as markets will sort everything out. Don't worry about the planet as when we start to cause irreparable damage and substantially reduce the welfare of generations to come, polluting goods will get more expensive and then everyone will use them far less, problem solved, "tick!"

Of course, we have seen progress in recent times, with government policies and global accords and treaties built to stem the flow of damage we've caused to the Earth. And there are many great foundations, charities and companies that are actively fixing humankind's mess, by replanting forests, investing in and developing clean technologies, and designing new approaches to persuade people to behave in a more sustainable way, to name a few.

The key development in the world of economics is Kate Raworth's Doughnut of social and planetary boundaries. She obviously explains it far better than me, but the summary is that the task of humanity is to meet the needs of all within the means of the planet. What seems a little scary to me, is how obvious and commonsensical this sounds: how can this thought be described as 'renegade?'

It's time that we put the earth at the centre of economics. We owe a huge debt to the planet: it's resources fueling life, production and consumption. There is no 'resource' as scarce as the earth. It is unique, and, at this time, there is no celestial body even close to being a substitute. We've already witnessed the extinction of countless species and irreversible depletion of natural resources, all due to humanities actions.

If economists continue to believe that economics transcends the Earth on which it lies, the planet will be next victim. We need to realise that the problem is larger than an economic one, there are key roles for other social sciences: sociology, psychology, politics for example. Other disciplines can provide more insight into problems than economics, and need equal voice going forward.