“Externalities” is a Big Word

Do we pay for these costs at the grocery store cash register? Not even close. That’s what I mean by the market’s failure to internalize external costs.

I’ve forgotten most of what I learned in college. For example, I took Multivariable Calculus my first semester. All that I remember from the class is that there is something called a “Lagrange multiplier.” Do I have any clue what it is? Nope – but my mother is from LaGrange, Georgia, so the name always stuck with me. The remainder of that class (math pun, for those playing along at home) has been lost to the cobwebs of my mind, and the same goes for many other classes.

Not that there’s anything wrong with that. I grew as a person during my four years of undergraduate study. Further, I think the value of a university education is better measured by the quality of that which is remembered, not by the quantity of that which is forgotten.

In my case, I am fortunate that a handful of the classes I remember quite well are relevant to my work today. More so than any other class, I rely upon what I learned in Environmental Economics.

We studied a range of topics in that class, including the value of services provided by our environment (i.e. water purification), the tragedy of the commons theorem, and environmental regulation at the federal and state level. We also studied the failure of the “free market” to internalize the external costs of economic activities, which is what I want to write about for the next couple weeks or so.

Please allow me to de-wonk (that’s a technical term, right?) that last sentence, and I’ll do so with an example. Let’s consider the list of costs that go into an ear of corn you might buy at the grocery store.

First, chances are pretty good that the farmer of that corn would have bought the corn seed from a big company. That corn plant would need water too, which probably means an irrigation system of some sort. Unless the corn was organic, the farmer would have purchased fertilizer, herbicides and pesticides for his crops. He or she would also have purchased equipment for planting and harvesting the corn, and those machines would have both initial costs as well as operating costs like fuel. The list continues with labor, transportation and distribution costs, along with the need for the farmer to earn enough profit to provide for his or her family.

Every single one of those costs can be calculated, and they are ultimately “baked in” to the price you pay. The free market works, right?

Here’s the problem – my list of costs is incomplete.

We need to include the costs associated with declining agricultural productivity as the farmer’s conventional methods strip the land of topsoil. Then there’s the runoff from excess fertilizer, contributing to eutrophication in aquatic ecosystems. The herbicides and pesticides, which might better be called “poisons,” are also accumulating in our natural environment, including in our own bodies. And the fossil-fuel dependency of that farmer’s operations is incrementally contributing to our pesky climate change issue.

Do we pay for these costs at the grocery store cash register? Not even close. That’s what I mean by the market’s failure to internalize external costs.

So, apparently, our free market system has a flaw in it. But is it the only flaw? More on that next week.