Imagine that an upstream logging company exports its timber to a foreign country and does so without compensating inhabitants downstream. The timber is under-priced at the country’s border because it does not include the cost borne by downstream inhabitants in the form of a heightened risk from floods. The timber is further under-priced because transportation of the product to the foreign country creates harmful externalities (carbon emissions), and that cost is also not paid for by the timber company. There are thus two elements of cost that are not included in the company’s invoice: the cost borne by the inhabitants downstream and the cost inflicted on the world’s population via the carbon emissions. The former element is a wealth transfer from downstream inhabitants to the importer; the latter element is a wealth transfer from the world’s population to the timber company.
Aside from the economic waste associated with externalities, this example has a feature that is rarely noted by proponents of free trade. As poor countries depend greatly on the export of primary products (coffee, tea, sugar, timber, fibres, palm oil, minerals), there is a hidden transfer of wealth from them to importing countries, many of which are rich (Chapter 13).
If the importing country is rich, the wealth transfer is a redistributive insult, especially so because the hidden subsidy is paid by downstream inhabitants in the exporting country,
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who are often among the poorest communities there (e.g. small farmers and fishermen).
The transfer of wealth remains hidden from the national accounts of both countries because national accounts do not record externalities (they are unaccounted-for consequences).222 The example also has a general message. Modern consumption patterns, relying as they do on imported primary goods from distant parts of the world, are prone to being under-priced. And they are under-priced at source for reasons similar to the present example.
When final products are under-priced, this provides people with an incentive to consume not only too much, but also to consume ecologically damaging goods. Moreover, research and development expenditure is directed towards producing new products and new
technologies that are profligate in the use of primary products. This puts further pressure on the biosphere.
7.2 Externalities and Rights
Although the failure to protect property rights has traditionally been at the heart of the theory of externalities, the language of rights sits awkwardly there. We are speaking of fundamental rights, not rights that are assigned to people or organisations because they are instrumental in advancing the well-being of the people involved. But even fundamental rights need to be justified. As elsewhere in the economics of biodiversity, trade-offs have to be weighed if actions are to be judged. Rights short-circuit those complexities.223
Rights are peremptory, which is why they are problematic. One way to overcome the problem is to place them in a hierarchy. That was the conclusion Rawls (1972) famously reached when framing his principles of justice. But if note is taken of adverse externalities accompanying a person’s actions, it is by no means clear whose rights are to trump. This is why the language of rights sits awkwardly in the economics of biodiversity.224
Perhaps the most striking – as well as the most sensitive – sphere where rights would seem to clash is reproduction. The 1994 International Conference on Population and Development reaffirmed the language of rights in the sphere of family planning and reproductive health. The Conference’s conclusions read:
“Reproductive rights … rest on the recognition of the basic right of all couples and individuals to decide freely and responsibly the number, spacing, and timing of their children, and to have information and means to do so, and the right to attain the highest standards of sexual and reproductive health.” (UNFPA, 1995).225
The qualifier ‘responsibly’ could be read as requiring couples to take into account the adverse environmental externalities their reproductive decisions may give rise to, but that probably would be a stretched reading. Certainly, writings affirming the UN declaration have interpreted the passage and its intent more narrowly. For example, the fundamental right of individuals
“to decide freely and for themselves whether, when, and how many children to have” is
222 Dasgupta (1990) and Chichilnisky (1994) drew attention to this distributive feature of contemporary international trade.
Economists had previously pointed to economic exploitation as a driver of trade imbalance between economic centres and their peripheries (e.g. Furtado, 1964). The cause of the imbalance we are identifying here lies in the exploitation of the biosphere.
223 Moral philosophers question the liberal use of the term ‘rights’ even in the United Nations’ landmark 1948 Declaration of Human Rights. They ask where rights come from. See Blackburn (2003).
224 In recognisably exceptional circumstances, governments resolve the dilemma by creating a hierarchy of rights. In the context of the COVID-19 pandemic, many governments have insisted that the right not to be infected by others trumps the individual right to do as we please when it comes to wearing face masks and a keeping safe distance from our friends.
225 Moral philosophers would argue that the evaluation of family planning programmes should include the quality of lives that will not be lived on account of the programmes. We avoid those difficult problems by assuming that thoughtful parents reach their fertility desires by taking into account the potential well-being of their offspring and, by recursion, the well-being of their dynasty.
On this and related matters in population ethics, see Dasgupta (2019).
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central to the vision and goals of Family Planning 2020 (FP2020, 2019). It is also pivotal in the reproductive health indicators of the UN’s Sustainable Development Goals (SDGs). In this vision, information and other services pertaining to family planning and reproductive health are rights, as is choosing one’s family size. But it is not clear that the two sets of rights have the same force, nor is it clear how they are to be weighed against one another should a choice have to be made at the margin between them.
In a world where the Impact Inequality holds, and holds strongly, it may seem reasonable to insist on the rights of future generations when an appeal is made to curb our impact on the biosphere. Sen (1982), for example, likened persistent pollutants to instruments of oppression:
“Lasting pollution is a kind of calculable oppression of the future generation.” But if additional births can be expected to contribute further to the discharge of persistent pollutants, why does a couple’s reproductive rights trump the rights of future people not to be oppressed? That is the kind of ethical dilemma the language of reproductive rights misses.
That reproductive decisions may involve a clash of rights has not been self-evident to scholars. In a powerful essay that dismissed concerns on over-population, Bauer (1981: 61–64) wrote:
“The comparatively high fertility and large families in many LDCs (less developed countries) should not be regarded as irrational, abnormal, incomprehensible or unexpected. They accord with the tradition of most cultures and with the precepts of religious and political leaders
… Allegations or apprehensions of adverse or even disastrous results of population growth are unfounded. They rest on seriously defective analysis of the determinants of economic performance; they misconceive the conduct of the peoples of LDCs; and they employ criteria of welfare so inappropriate that they register as deterioration changes which are in fact improvements in the conditions of people.”
One problem with Bauer’s critique is that it gives the impression that societies in past eras were also characterised by large families. While fertility rates were high then, so were mortality rates.
In fact, high fertility rates were a rational response to high mortality rates. The contemporary demographic problem in the world’s poorest regions is that fertility rates remain high even though mortality rates have fallen considerably (UNPD, 2019b). The main problem with Bauer’s critique, however, is that it does not acknowledge reproductive externalities.
Two categories of externalities are involved. One consists of the adverse externalities that are conveyed through the material world because the Impact Inequality today is large (Chapter 4). It is increasingly hard to argue that the vast quantities of produced capital and scientific and technological knowledge we will be bequeathing future people compensate for the vastly diminished biosphere we are leaving behind for them.
The other category consists of the externalities implicit in socially embedded preferences (Chapter 9). Bauer’s critique does not acknowledge that individual households may themselves affirm that their reproductive behaviour falls short of what they would ideally favour because they are unable to coordinate their decisions with other households. As in every other field of personal choice, it should be asked whether a collection of reasoned decisions at the individual level harbour collective failure. This is the central question raised by externalities, and it is particularly apposite in the case of adverse externalities and socially embedded preferences.
That family planning services bring many benefits (such as improved health, education, income, and female empowerment) to those who make use of them has been documented repeatedly in recent years (UNFPA, 2019). The focus in this Review on externalities points to the fact that they bring benefits to others as well. Those additional benefits need to be included in the design of social policies. In what follows, we study the tools that can be used for eliminating the externalities that arise from our production and consumption of goods and services.
Reproductive externalities raise deeper and more difficult issues, which may be why they have not been studied much in the literature on externalities. We present a few of the difficulties in Chapter 9. The subject remains unsettled.
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7.3 Taxing and Subsidising Externalities
A striking feature of well-functioning markets is that they make people responsible to others for what they produce and consume. The qualifier ‘well-functioning’ is intentional and significant.
Well-functioning markets ensure that people pay the social cost of the resources they use, which means that market prices correspond to accounting prices (Chapters 1 and 10). Well-functioning markets harbour no externalities because they ‘internalise’ potential externalities.
Thus, if qi is the market price of asset i and ei is the value of the externalities generated by the deployment of a marginal unit of i, then the asset’s accounting price is:
pi = qi + ei (7.1)
If the market price is nil, as is often the case with global commons (Chapter 8), the asset’s accounting price pi is composed entirely of externalities (Equation (7.1)). When some economists say that their estimate of the social cost of carbon in the atmosphere is US$40 per tonne, they mean that in their view the accounting price of carbon is minus US$40 per tonne.
Why not create markets for externalities so as to eliminate them? Although you might expect economists to have explored that avenue first, this is not how they first studied externalities. In his great work on the economics of welfare, Pigou (1920) took the elimination of externalities to be the responsibility of government. He argued that if a factory spews industrial smoke into the atmosphere, the owner should be taxed at a rate equal to the damage suffered by the rest of society from a marginal unit of emission. That way the factory owner would face a price for his output that would include the damage it causes (i.e. market price minus the tax per unit of emission). In this example, the product’s market price minus the tax per unit of output is its accounting price. The underlying idea is that because the smoke is a by-product of the factory’s output, the tax would make output less profitable. The owner would reduce output, or install smoke scrubbers, or find some other means to reduce pollution. The Pigouvian tax alters his incentives in the right direction and by the right amount. Congestion charges in cities, noise charges at airports, and most famously today, a tax on carbon emissions are further examples of Pigouvian taxes. Box 7.2 provides the formal analysis.
Pigouvian taxes raise the question of what the government should do with the revenue.
Suppose, to give an example, the government imposes a carbon tax but spends the revenue on general public services. As the benefits would be spread over the entire population, the tax would be regressive. That is because poor households spend a greater portion of their income than rich households on domestic heating and cooling, and on transportation. But if the revenue was returned on a lump sum basis, say equally to all households as a dividend, the tax-dividend policy would be progressive.
Pigouvian subsidies for beneficial externalities follow the same logic. Consider, for example, a landowner intent on converting a portion of his property into wilderness. Wilderness attracts pollinators, and that benefits neighbouring farmers. If the benefit is unaccounted for, it is a beneficial externality. The Pigouvian route, if we may use that expression, would be for the government to subsidise wilding, at a rate that equals the marginal benefit to farmers.
There is a natural inclination to think that Pigouvian taxes and subsidies are minor fixes for the gigantic set of problems we face on account of the enormous Impact Inequality we have created. A tax here and a subsidy there would certainly prove next-to-useless in closing the gap in the Inequality. But we should be imagining a socio-ecological world where all externalities are accounted for by the deployment of Pigouvian taxes and subsidies. Imagine for example that all countries taxed net carbon emissions at US$40 per tonne, or higher. That would be nothing short of a transformative change for our societies. Currently, environmental taxes are very low in OECD countries: only above 3% of GDP for six of the 37 countries (OECD, 2019d), despite the fact that a large proportion of economic activity causes environmental damage, involving
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externalities. Economies where the accounting prices of ecosystem services were reflected in their market prices would be markedly different.
We will have reasons for abandoning the idea of instituting Pigouvian taxes and subsidies for all externalities (Box 7.3), but they will be deep technical reasons, having to do with the inability of authorities to observe or verify who does what at each instant of time (Chapter 6). Creating protected zones for preserving biodiversity is a natural extension of Pigouvian reasoning, but that involves outright prohibitions, not taxes (Chapters 5, 18-19).