The Entrepreneurial View #474
Emissions as Externalities
by Raymond J. Keating
When taking a basic economics course, students learn about "externalities."
For those who have long forgotten their high school or college Economics 101 class, an externality is a cost or benefit resulting from an activity or transaction that spills over to third parties who are not directly involved in the undertaking.
A classic example of an external costs is pollution from a factory that has a negative impact on the surrounding community. Those costs are not factored into production for the plant. When all costs are not taken into account, inefficiencies result in markets.
In many cases of external costs, the problem can best be solved by clearer definitions of property rights. But sometimes that is not feasible. That's when many argue for government regulation and/or taxation.
From an economics perspective, externalities is the issue when it comes to government action on global warming or climate change.
Power plants, automobiles, buildings and people all emit carbon dioxide. Indeed, there is a strong correlation between greater economic growth and increased energy usage, and therefore more CO2 emissions. Those who fear that rising CO2 emissions will bring about major environmental ills argue that the government must do something about such external costs. That is, they view CO2 as a pollutant - an externality - that government must address.
As a result, we have international efforts to cap and reduce CO2 emissions, such as through the Kyoto Protocol, as well as federal, state and even local government measures or proposals.
But it is critical to keep in mind that the mere existence of an externality does not mean that government action is going to improve matters. Don Boudreaux, chairman of the economics department at George Mason University, brought up this point during a panel discussion at the 2008 International Conference on Climate Change in New York City on March 2-4.
Boudreaux noted that economics does not dictate that government must act regarding externalities. He wisely warned that government action has its own externalities.
Indeed, it is often the case that government's so-called cure turns out far worse than the disease. That's not surprising given, for example, the perverse incentives, the knowledge problems, and the special interest influences at work in government.
If government officials are serious about reining in CO2 emissions, then the only way to go about that is by reducing energy consumption. How is that accomplished? Well, the costs of energy must be pushed much higher - whether through some kind of carbon tax or regulatory cap-and-trade scheme - which in turn will reduce economic growth, development and opportunity.
For developed nations like the United States, that, of course, would mean reduced entrepreneurship and investment, slower income growth, and lost jobs. As study after study has shown, the economic costs would be considerable. And tax and regulatory costs always hit individuals, families, and small businesses hardest.
People in developing nations would face similar costs, but on a far different scale. Remember that with economic growth and development come, for example, improved health care, enhanced sanitation, an expanded diet, and clean water. Among the most under-developed nations, the lack of such fundamentals results in disease and death on a staggering scale. A denial of economic development due to a denial of expanded energy use would have the grimmest consequences in such countries.
Externalities certainly are a challenge to be wrestled with in a market economy. But the most daunting externalities come from government intervention in or interference with the free market. The external costs of government policies directed at the issue of climate change must be given the most sober attention and evaluation.
_______
Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.
