Global warming, externalities and government failure

Externalities are everywhere, and government policy to deal with them, at best, is mixed.

Just to remind readers, an ‘externality’ occurs when a market transaction affects people who are not involved in that transaction. For example, when I buy power from my electricity company, a generator somewhere in Victoria’s Latrobe valley works a little bit harder and makes some extra greenhouse gases. I pay for the electricity and that money compensates the electricity retailer, distributor, transmission company and the generator. But people who are adversely affected by the pollution receive no compensation. They suffer a ‘negative externality’.

With a negative externality, like pollution, the market tends to over produce the relevant commodity. Too much electricity is produced using coal because the buyers of that electricity do not face the full costs of their actions. If they did, they would buy less.

Externalities also can be positive. For example, basic research creates knowledge that can be used by many people even if they do not pay for using the knowledge. This ‘spillover’ from the research is a positive externality and the market will tend to produce too little research.

While externalities are everywhere, many are too trivial to worry about. If I forget to use deodorant then my colleagues may suffer an adverse impact, but that is not a reason for government intervention. Further, social rules and norms often develop to deal with these small externalities. If I forget deodorant every day then I may find that work colleagues and friends shun me.

But sometimes externalities have significant consequences. In these situations government intervention may improve the market. However, the government has a mixed record on dealing with externalities.

For example, antibiotics save millions of lives each year. They are also used in animal husbandry. But using antibiotics creates a negative externality. Each use raises the risk that resistant bacteria will develop. While using the antibiotic makes us well, we impose a small negative risk on the health system.

Governments are reluctant to restrict the human use of antibiotics. However, there is growing pressure on governments to restrict their use on farms and in fisheries. For example, earlier this month the Daily Mail reported calls by the British Science Minister to limit the use of antibiotics:

“Britain yesterday urged rich nations to clamp down on antibiotics amid fears their overuse will lead to the catastrophic spread of drug-resistant superbugs”.

The Science Minister stated that:

“Across the G8, we should regard the spread of antibiotic resistance as a global challenge that is up there with climate change, water stress and environmental damage, and there are genuine policy consequences that follow from that”.

Unfortunately, despite such calls and the recent history of superbugs, governments are reluctant to act. Indeed, concrete proposals to limit human use of antibiotics are not even discussed.

Similarly, vaccinations are a simple example of a health measure with a positive externality. Vaccinating your child against diseases such as measles or whooping cough reduces the risk of disease spreading. Government policy to deal with this type of positive externality is easier – subsidise it. Australian governments have subsidised childhood vaccinations for years.   However, governments have been reluctant to interfere when parents ignore the scientific evidence and put their children and society at risk by spurning vaccination. An exception is in New South Wales where parliament has just passed laws requiring childcare centres to ensure children in their centres are vaccinated.

“Childcare centres will face fines if they do not complete checks to ensure a child is vaccinated, or that they have exemption”.

The biggest government failure with an externality, however, is on greenhouse gases. Greenhouse gas pollution has the potential to cause major global climate change. Further, the pollution is not localised. The climate effects of carbon-based emissions are wide-spread and relatively slow.

To see why this matters, consider the problem of sulphur dioxide. This pollutant causes localised air pollution. Citizens living in polluted areas have a strong incentive to force the government to ‘do something’. Thus, in 1990, the United States government introduced a ‘cap and trade’ scheme to limit sulphur dioxide emissions. And the scheme worked. By putting a price on these pollutants, the scheme created significant incentives to reduce pollution.

Similarly, broad support and government action on greenhouse gases is most likely if there is a significant local problem. China is looking to limit its import of low quality coal. But this policy is driven by the problems of local air pollution. It may lower global greenhouse emissions but that is a side benefit of dealing with a local problem.

Global warming is a global negative externality and, in my opinion, it is highly unlikely that governments in different countries will agree to an effective scheme to deal with this negative externality. Even if developed nations could reach an agreement, developing nations would be reluctant to join in. After all, how do we tell the ‘bottom’ billion in Asia and Africa to limit their economic growth in order to avoid a problem which, from their perspective, seems ephemeral.

There are no easy answers to dealing with global warming. And, given the poor history of governments dealing with localised externalities, I am pessimistic that they will put policies in place to deal with a global issue. Sadly, effective policies to deal with global warming are only likely to gain political support when the problem becomes too big for it to be ignored at the local level.

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