I’ve been looking back at material I read a long time ago by Robin Hahnel, economics professor emeritus at American University, and it got me thinking about the problem of externalities in market systems. As basic economics tells us, an externality is an effect of a purchase on a third party in addition to the buyer and seller. Thus, when someone buys gas for their car the gas company tries to get a maximum price and a buyer a minimum price, but air pollution does not factor into the price determination. It is basically supply and demand. There can be positive externalities too. An increase in electric cars reduces the amount of pollution. As Hahnel pointed out in his excellent book, The ABC’s of Political Economy (the link will take you to the full book in pdf format), a fundamental problem with markets is that they underprice goods with negative externalities and overprice goods with positive externalities.
The examples just given demonstrate this. When you buy gas, you may pay $3.50-4.00 per gallon, but there are additional costs. For example, an analysis of several studies on the externalized costs of gasoline by the Victoria Transport Policy Institute makes the observation that inpatient admissions among Medicare recipients to hospitals is 19% higher in high pollution areas. That’s partially tax money covering the costs of gasoline. Meanwhile, the benefits of an electric or hybrid car are not included in its price. This means that society bears the costs of gasoline usage and forgoes the benefits of electric cars.
If we are to have less pollution, the government needs to tax gas at a higher rate and subsidize electric cars so they can be sold at a lower price. I am using this as an example to illustrate the point, but the reality is that externalities are an inherent part of any economy and in a market economy the only way to address them is government intervention. Think of all the added costs of negative externalities in the form of environmental damage from a whole host of products. Or the poor nutritional value of fast food, which is very cheap to buy. We also have less incentive for renewable energy.
The fact that externality problems are inherent in markets makes in daunting to think of the government intervening to fix every imbalance. But markets cannot address externalities from within. Robin Hahnel and Michael Albert have developed a method of accounting for externalities in their vision of Participatory Economics, but that is in the context of a future society with far different economic institutions. I personally think their long-term vision is on the right track, but what is the best approach to externalities in the short run? I would love to hear suggestions.