Externalities isn’t external

An externality is deemed as a cost or benefit caused by a producer that is not incurred (financially) by the producer. The view is that because the producer is not paying for the portion of costs, or receiving the portion of gains from that economic activity, it is under or over-produced.

Of course, there are further variations of consumption externalities where it is happening on the consumer side of things.

The manner economists perceive these effects are based on analysis in a single snapshot of time, considering only a very narrow dimension of financially accountable cost and benefits. The typical solution prescribed on paper is to provide a tax or subsidy to close the gap: or to internalise the externality.

What if an externality actually isn’t external to begin with? That through time and the interconnectedness of people, organisations, nature and environment, would bring the costs or benefits back to the producer? After all, won’t reputation or enployer branding matter? Would it matter if an all-knowing government discloses the truth about how much pollution a company is causing? If the government in the economic analysis can close the gap, then there isn’t actually a genuine externality because somehow, within the system, the level and details of the externality is known.

And how are compensatory funds to be used by the government? For example, should carbon tax revenues be used to innovate in further development of low-carbon technologies to make it easier for companies to emit less carbon? Or should they be directed towards mitigating the impact of climate change? Eg. Building levees to buffer sea level rises? Should the role and impact of the externality have any say in that?