Scoffing at the idea of externalities is a lot easier when wearing a gas mask.Industrial boilers and incinerators currently receive an enormous public subsidy. They emit toxic air pollutants like mercury, cadmium, and acid gases, which even in extremely small amounts cause a range of health maladies from asthma to heart attacks to premature death, yet the operators of those boilers and incinerators do not pay those health costs. The public picks up the tab for that. You’re welcome, boiler operators!
The public health costs imposed by boilers are classic “externalities” — costs of production that aren’t paid by producers, but rather “externalized” onto the general public. Obama’s EPA is attempting to internalize some of those costs by requiring boilers to install or upgrade pollution-control equipment. The agency unveiled its long-awaited rules on toxic emissions yesterday. Though they are substantially less strict than the ones EPA originally proposed last spring, they nonetheless face fierce opposition from a wide swath of congresscritters on both sides of the aisle.
What can this unfolding fight over toxics teach us about pricing externalities? Let’s examine the case from two different perspectives, economic and political.
The economics of externalities
The economist’s ideal market is characterized by perfect information, prices that reflect full costs, and low barriers to entry and exit. Anything that causes a market to fall short of that ideal is known as a “market failure.”
Externalities are paradigmatic market failures: costs that are hidden, not reflected in prices. When some costs are obscured, consumers are not able to make rational decisions about how to balance costs against benefits. The market thus produces suboptimal results.
When externalities are priced, those hidden costs are pulled into the light. Consumers get full information and can make informed decisions. Markets work better.
This last point is worth emphasizing, because I’m not sure it’s widely understood. The weak claim for advocates of pricing externalities is that no new costs are being imposed on the economy; costs are simply being shifted from the public to the private actors that created them. The weak claim, in other words, is that there is no net macroeconomic loss from pricing externalities.
The stronger claim is that when prices more accurately reflect costs, the market is “more perfect.” Pricing externalities, according to the strong claim, should generate a net increase in macroeconomic productivity — higher GDP, more jobs.
In other words, there’s good reason to think that forcing boiler and incinerator operators to pay the health costs they create will be an economic boon to the country.
The political economics of externalities
Pricing externalities shifts costs from being dispersed and hidden to being concentrated and transparent. This is smart economics, but turns out to be incredibly difficult politics.
Consider: Restricting toxic pollutants the way EPA envisions will, according to air pollution administrator Gina McCarthy, “avoid between 2,600 and 6,600 premature deaths, 4,100 heart attacks and 42,000 asthma attacks, each year beginning in 2004 and every year that follows.” That will save American families between $23 billion and $56 billion in health costs. However, EPA will never be able to point to an individual family and say, “Hey, look, you didn’t get asthma because of our rule!” Those who benefit from the boiler rules almost certainly won’t be aware that they are benefiting.
By contrast, the private companies who face higher costs will be intensely aware of it and will consequently scream bloody murder. They will funnel money to politicians; they will pay for protests and petitions; they will fund bogus studies showing that the economy will collapse if they have to pay their own costs.
It’s a classic political economy dilemma: Losers cry louder than winners cheer. The brute political fact is that any business or industry that has succeeded in externalizing costs is massively incentivized to keep them externalized. There is no comparable intensity on the side of those who would benefit from the shift. In politics, intensity wins. In terms of political economy, the battle is intrinsically weighted against the public interest.
The toxics example
Last spring, EPA proposed some toxics rules that would have been quite strict, reflecting the enormous health damage done by mercury and its ilk. All boilers and incinerators would have been forced to use the “maximum available technology” to limit their emissions. Industry freaked out, so the politicians who listen to industry freaked out. EPA has now backed down, issuing a far milder rules that will cost industry far less. Unsurprisingly, industry is still freaking out. EPA has said it will have an extended comment period, so who knows, maybe the agency will back down even more. That’s how these things go.
Consider the result, though: According to EPA, for every dollar industry invests in complying with the boiler rules, there will be $12 to $24 in public health benefits.
One way of reacting to that is, “Wow, these regulations make sense!” That’s the line EPA is pushing.
From another perspective, though, the rules don’t make sense. They leave too many externalities unpriced! If a dollar of investment produces $12 in health benefits, that means the regulations could have been 12 times stronger without imposing net costs on the economy. An optimal program would have equal costs and benefits. Anything short of that means we’re leaving improved economic productivity and thousands of human lives on the table in order to give industry a break.
The incredibly high benefit-cost ratio for these toxics rules ought to be an outrage. It ought to lead to widespread demands for stricter rules. Instead, it hasn’t even slowed the stampede of political opposition to the rules. That is the political economy of pricing externalities, in a nutshell: the status quo wins.
