They pollute, you pay: why profit doesn’t equal progress

The profit motive is supposed to make businesses do useful things – but what if it actually encourages them to cause harm?

One of the main mechanisms by which the profit motive can do damage is a concept known as negative externalities.  Let’s find out more.

What’s an externality?

Negative externalities are the harmful side-effects of activities or economic transactions.

For example, second-hand smoke from cigarettes can make people ill even if they weren’t actually smoking.  The audience might enjoy a concert, but what about neighbours who can’t sleep because of the noise?  Plastic packaging is cheap for the manufacturer and convenient for the consumer, but ends up littering streets and beaches.

Positive externalities also exist, where people benefit from an activity that they didn’t take part in.

Somebody who redesigns their front garden may improve the view for their neighbours.  Vaccines can protect even those who do not receive them, by reducing the chance of disease spreading1.  Education can reduce crime2.

Litter on a beach in Singapore.  Image credit: Vaidehi Shah.

So what?

Profit and progress are not the same

Free markets are supposed to improve overall wellbeing in society, but negative externalities get in the way.

Although both buyer and seller should be better off after a voluntary transaction, other people may be worse off.

What is profitable and what is good for people, the planet and social progress therefore do not necessarily align.  This is a market failure3: a situation where financial decisions that make sense for individuals don’t make sense from the perspective of society as a whole.

How bad is it?  It’s often difficult to trace and measure negative externalities, but a few examples indicate the scale of the problem.

A shifting climate

“The greatest market failure the world has ever seen,” is how economist Nicholas Stern has described climate change4.

Burning fossil fuels, cutting down forests and raising livestock (among other things) cause the build-up of heat-trapping greenhouse gases in the atmosphere, raising global temperatures and affecting weather systems.  Climate change is likely to damage harvests, intensify extreme weather, worsen existing health problems and more5.

It’s hard to measure exactly how much damage is done6, but one report by Citi says the total cost of climate change could be tens of trillions of dollars7.  For comparison, the global economy trades around $76 trillion worth of goods and services each year8.

It doesn’t always make sense to measure damage in terms of money.  Some potential impacts can’t be fixed no matter how much money we throw at them, such as people dying, species going extinct, ecosystems collapsing or temperatures leaping suddenly and irreversibly9.

Normally colourful coral is bleached by warming seas.  Image credit: The Ocean Agency / XL Catlin Seaview Survey / Richard Vevers.

Dirty air

Air pollution comes from many different sources, including soot from indoor cooking stoves10, mercury from coal-fired power stations11 and nitrogen oxides from road traffic12, causing many health problems including heart disease, stroke, lung cancer, pneumonia and brain damage.

The World Bank estimates13 that, in 2013 alone, 5.5 million people died early because of air pollution, mostly in so-called developing countries – that’s one in every ten deaths.  This caused the global economy to lose $225 billion worth of labour.

In terms of “welfare losses” (a calculation method that measures costs to wellbeing according to how much people are willing to pay to reduce their risk of dying), the damage appears much higher, at $5.1 trillion.  This only covers early deaths and not, for example, illness that doesn’t kill, less food from farms or difficulties in attracting workers to polluted cities.  The true damage done to society by air pollution is therefore likely to be much higher.

Haze covers northern India in November 2017, caused by crop fires, industrial pollution and dust.  Image credit: NASA.

Ruined land

Land gives us more than just food: in good condition, it provides many ecosystem services14 such as filtering water, producing clean air, protecting against erosion and flooding, regulating extreme weather and giving us a place to relax and enjoy nature.

However, much land is mismanaged: high demand for food and other resources can cause overgrazing, deforestation, build-up of salt in the soil, soil erosion and more15.

Land degradation has been estimated to cost the world up to $10.6 trillion every year in lost ecosystem services16 – almost as much as China’s GDP.

Rain carries soil away from unterraced farmland in Yunnan, China, leaving deep gullies behind.  Image credit: Desmanthus4food.

Prices don’t reflect damage

When products are sold, the market price rarely accounts for the cost of fixing the problems they create.  Unfortunately, it makes financial sense for businesses to externalise costs as far as legally possible, making other people pay them.  Any company voluntarily paying compensation for damage caused would lose profits, drive away customers with higher prices and be undercut by other companies that didn’t pay any compensation.

So who pays?  You might pay through your taxes for litter to be cleaned up or damaged roads and bridges to be fixed.  Poorer nations will be affected the most by climate change17.  Climate change could make insurance premiums more expensive18.  Healthcare costs are covered by governments, insurance companies or individual patients.  Farmers may lose income if climate change affects harvests.  Future generations may lose out as well.  The list goes on.

What if externalities could somehow be incorporated into the price of products – in other words, what if the externalities were internalised?

Prices would be different for many products, altering consumption patterns and changing which sectors are profitable.  Things with negative externalities would be made less often (because they would be more expensive and therefore less profitable to produce); things with positive externalities would be made more often (because there would be more incentive to do so).

For example, economist Raj Patel estimates that you would have to pay $200 instead of $4 for a burger from cattle raised on deforested land if the price included its true cost to society19.  Although this is an extreme example, I doubt that meat consumption would stay as high as it is today (around 80 kg of meat per person per year in the developed world20).

A threat to some businesses…

Some industries could even be driven out of business entirely.  A report by Trucost21 found that none of the world’s 20 most damaging regional industries would be profitable if their prices reflected the impacts they cause and the natural resources they use (such as land and water).  These industries include coal power generation, cattle farming, cement manufacturing, water supply and wheat and rice farming in different locations around the world.

Cattle farming might not make money if producers had to pay for the true costs to society.  Image credit: RitaE.

This gives many existing industries a reason to block any reform of the economic system that would reduce their future profitability.  We see this in fossil fuel companies fighting against action on climate change22.  A parallel can be drawn with the tobacco industry’s attempts to halt regulation of smoking23, despite causing an estimated $1.4 trillion of damage per year in healthcare costs and reduced productivity24 (larger than the global $500 billion market for tobacco and the tobacco industry’s more than $35 billion in annual profits25).

…an opportunity for others

On the other hand, if we could solve the externalities problem, there would be many new business opportunities because it would become a lot more profitable to do good for the world.  I guess that renewable energy, meat replacements and sustainable transport would get a boost in profitability.  Many companies are already calling for the certainty of stronger environmental laws26.

What do you think?

We’ve seen that externalities help to explain why today’s markets don’t always create the best outcome for society and why existing business interests make it difficult to solve the problem.

How much do you think you might have paid for the last thing you bought if the price included all costs to society?  Post your comments below!

I’ll look at proposed ways of tackling the issue of externalities in future posts, so don’t forget to sign up for email updates.

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  1. University of Oxford (2016), Herd immunity
  2. Phys.org
  3. One definition can be found at Investopedia and examples of other types of market failure are given by Economics Online.
  4. Stern Review, Summary of Conclusions (pdf file)
  5. Source: the Summary for Policymakers of the Fifth Assessment Report by the Intergovernmental Panel on Climate Change.
  6. Carbon Brief
  7. Dana Nuccitelli (2015), Citi report: slowing global warming would save tens of trillions of dollars
  8. See this diagram from Howmuch.net for a breakdown by country.
  9. See this article by the Tällberg Foundation for an overview of abrupt climate change.
  10. World Health Organisation (2016), Household air pollution and health
  11. Union of Concerned Scientists, coal power: air pollution
  12. National Atmospheric Emissions Inventory, About Nitrogen Oxides
  13. Read a press release about the report here, or access the full report here: The Cost of Air Pollution (pdf file).
  14. The Economics of Ecosystems & Biodiversity, Ecosystem Services
  15. FAO, Causes of land degradation
  16. Read about the report in this Guardian article, or access the full report here: ELD Initiative (2015), The Value of Land (pdf file).
  17. Source: the Summary for Policymakers of the Fifth Assessment Report by the Intergovernmental Panel on Climate Change.
  18. The Telegraph (2017), How is the issue of climate change affecting insurance?
  19. Patel (2009), The Value of Nothing
  20. Worldwatch Institute, Global Meat Production and Consumption Continue to Rise
  21. Trucost (2013), Natural Capital at Risk: the top 100 externalities of business (pdf file)
  22. Fossil Free UK, The case against the fossil fuel industry
  23. Jessica Glenza (2017), Tobacco companies interfere with health regulations, WHO reports
  24. Goodchild et al. (2017), Global economic cost of smoking-attributable diseases
  25. Simon Bowers (2012), Global profits for tobacco trade total $35bn as smoking deaths top 6 million
  26. Matthew Gittsham (2015), More big businesses push for stricter environmental regulations

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