Ramblemuse Touch Points

One of the economic shortcomings that’s more or less obvious in “just letting the market handle it” is that the market often doesn’t include total costs of use. The situation is akin to letting someone buy supplies for a large party, holding the party on common land, and then simply walking off, leaving the trash and costs of clean-up to others. The costs of producing the party supplies are included in their price, but not their costs of use. The market can only achieve an equitable balance, one that does not foster costs onto third parties, if a way is found to include all costs within the price. In short, the costs of use need to be born by those receiving the benefits of use.

The Economist column Do economists all favour a carbon tax? addresses just this situation applied to use of fossil fuels and carbon emissions.

Carbon emissions represent a negative externality. When an individual takes an economic action with some fossil-fuel energy content—whether running a petrol-powered lawnmower, turning on a light, or buying bunch of grapes—that person balances their personal benefits against the costs of the action. The cost to them of the climate change resulting from the carbon content of that decisions, however, is effectively zero and is rationally ignored. The decision to ignore carbon content, when aggregated over the whole of humanity, generates huge carbon dioxide emissions and rising global temperatures. The economic solution is to tax the externality so that the social cost of carbon is reflected in the individual consumer’s decision.

The concept is far more general than just fossil fuel use. It applies to any situation in which side-effect costs of production or costs of disposal are not included in the cost accounting, be it slag from mining or disposal of chemicals or sewage into streams. Regulation and/or taxation is required, not to interfere with the market, but to ensure that the market correctly accounts for total costs.