Ecological breakdown: What are externalities external to?

The 2018 Bank of Sweden Prize (falsely known as the Economics Nobel Prize) winner William Nordhaus opens the revised version of his Prize lecture as follows: “I begin with the fundamental problem posed by climate change – that is a public good or externality. Such activities are ones whose costs or benefits will spill outside the market and are not captured in market prices.”

The concept of externalities is a catch-all term, or, an empty box to capture the so-called spillover effects. Under the presumption that the market mechanism brings about the efficient allocation of resources, mainstream economic theory as well as many of its heterodox critiques argue for internalizing these spillovers by determining their costs (or benefits) and including it in the price of the commodity. In other words, the spillover effect itself must be turned into a commodity so that the market can efficiently handle it through the price mechanism.

Insofar as human-induced global warming has not been priced, so the story goes, it is an externality. In fact, it is today “the most significant of all environmental externalities” even in Nordhaus’ wisdom. Make no mistake – Nordhaus fiercely advocated inaction for over three decades, and portrayed projected levels of global warming, which are defined as devastating, or even catastrophic by scientists, as optimal.

What separates the external from the internal?

Anyone not trained in mainstream economics would note that the notion of spillover implies a border between the sphere that is its source and another one that is affected by it. By fixing the analysis to ostensibly voluntary exchange between atomistic micro entities (consumers and firms), mainstream economic theory deems anything as an externality that is not captured in the price at which exchange takes place.

While attention is predominantly focused on exchange and prices, the sphere of production is treated as a black box, or a function transforming inputs into outputs, while social reproduction disappears totally. Not only are the social relations that shape these processes deliberately assumed away, but also the complex ways in and through which nature and society condition each other are expelled from the analysis. Insofar as the economy is grasped as a closed, isolated system, and studied in terms of circular flows of money, goods, and services between micro entities, it comes as no surprise that any social or environmental phenomenon appears as an externality.

This perception has a dual character. On the one hand, it is a theoretical construction that does away with the historical and social foundations of any given economic formation, and the power differentials and conflicts that characterize the latter. It is hence important to reveal the absurdity of how neoclassical economics downplays ecological breakdown as a deviation from an otherwise perfectly functioning market mechanism. Yet, on the other hand, the framing of ecological breakdown as an externality does to some extent accurately reflect capitalist realities of non-valuation of whatever is not manifested as a money cost in the relentless quest for profit. In other words, it is not a matter of an illusion that operates only in the sphere of knowledge and theory. The illusion is itself a product of the underlying social reality.

External to what?

A closer look reveals that externalities, supposedly outside the reach of the market mechanism, are controlled and regulated by market forces in many respects. What is referred to as ‘carbon leakage’ in a depoliticizing, neutralizing way is a process of cost (or, burden) shifting. It could result indirectly from the outsourcing of production motivated by differences in labor costs. It is equally possible, however, that outsourcing is motivated by the very fact that environmental regulations are less stringent, and hence money costs are lower in other countries. In other words, capital has a strict preference for ‘externalizing’ costs.

It suffices to ask for the source of profits to see that what is included in the price, or what counts as a (money) cost is a political question, which boils down to power. Just like money and capital, costs and prices are reflections of social relations. It is in this sense that a critique of the concept of ‘externalities’ merely on methodological grounds is not sufficient as the active process of externalization, or, subjectivity of capital is overlooked.

This is not a process that operates only at the micro level, manifested in the perpetual profit-seeking of individual capitals. It also demarcates the possibilities and limits of politics at the macro level. It suffices to remember the internal memo circulated by the then President of the World Bank, Larry Summers, arguing that “the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable” because “[t]he measurements of the costs of health impairing pollution depends on the foregone earnings from increased morbidity and mortality. From this point of view a given amount of health impairing pollution should be done in the country with the lowest cost, which will be the country with the lowest wages.”  

Externalities (and the process of externalization) is internal to the profit quest by individual capitals. At the same time, their regulation is subject to international economic and political power asymmetries, and as such, they are internal to global capitalism and imperialism.   

What to do with externalities?

It is striking that many economists critical of the mainstream paradigm are mesmerized by concepts such as the ‘social cost of carbon’, ‘optimal carbon price’, ‘optimal mitigation path’, and the like. The notion that there exists a ‘right price’ to internalize the externality (the social cost of carbon) comes along with the whole baggage of microeconomic assumptions associated with optimizing individuals, availability of information, marginal costs and benefits of mitigation, and so on.

In addition, it contains crucial normative orientations. There is no ‘right price’ for species extinction, sea level rise, climate breakdown, or ocean acidification. Claiming that there is a right price implies the vulgar reduction of various dimensions of wellbeing (or welfare, if you like) into a single quantitative scale: money. In this framework, loss of human life in floods in Jakarta, a city sinking due to sea level rise, can be compensated for by super luxury golf resorts in San Francisco as the overall willingness to pay for the latter will be higher than the one for saving the lives in the former, or their estimated lifetime earnings.

It is one thing to understand that in some ways this reflects how the capitalist market economy allocates resources. Yet it is another thing to join the search for ‘efficient pollution levels’, ‘the right discounting rate’, or ‘the true social cost of carbon’, which shares the mentioned normative and political judgements.        

What made externalities ostensibly external to the market mechanism was nothing but the internal logic of the market. In this sense, externalities are both ideology (they are not external to market relations) and reality (they are externalized by agents subject to market relations). This double character reveals a crucial insight: ecological breakdown is not a case of market failure, but the failure of the market economy to apprehend, value, and preserve the complex conditions of sustained life for humans and other species on Earth.

It has not been false consciousness or lack of knowledge that brought us to the edge of the abyss, but the juggernaut of capital that is able to eliminate any barriers in its relentless quest for profit. As such, it is not a minor, one-off, or accidental deviation from the functioning of the market economy. Rather, it is an outcome of the systemic externalization of costs for the sake of maximizing profits. Hoping to overturn the functioning of the system, while at the same time leaving its defining elements, namely private property and production for profit untouched, is naïve at best.   

Güney Işıkara is a a Clinical Assistant Professor in Liberal Studies at New York University.

One thought on “Ecological breakdown: What are externalities external to?

  1. Great article Güney! So much in there… I think you could write a whole article on this:

    ‘loss of human life in floods in Jakarta, a city sinking due to sea level rise, can be compensated for by super luxury golf resorts in San Francisco as the overall willingness to pay for the latter will be higher than the one for saving the lives in the former, or their estimated lifetime earnings.’

    All the best



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