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posted on 05 August 2016

The Centrality Of Externalities To Economic Understanding

by Doomstead Diner

--this post authored by Brian Davey, The Foundation for the Economics of Sustainability

This has also appeared at Credo Economics 31 July 31 2016 and Doomstead Diner 05 August 2016.

What economists call "externalities" are not unusual or a special case, they are ubiquitous. They are rooted in private property and the relationships of market society. The way in which non market societies protect bio-diversity through totem arrangements is described.


Private property means that a single owner has the right to do with a resource as s/he sees fit. However, what they decide about these "resources" affect communities of people and communities of species (eco- systems). Very often, the effects are not positive. John Ruskin, a 19th century art critic who also wrote on economics, coined the term "illth" to describe the destructive effects imposed on society and the environment by the economy of his day.

Economists have had to adjust their theories and have come up with the concept of "externalities", that is, the benefits or costs of an allocation decision that arise for non-owners. In a later chapter I critically examine the idea that these externalities can be managed by those people affected by them coming to a deal with those causing them. This would involve finding "the right price" for the externality and then doing a trade. The purpose of this chapter is to look at the institutional and property relationship contexts in which these "externalities" arise, and thus, to show how and why, in some kinds of society, there are no "externalities".

The word "externality", conveys the impression that this is a footnote to economic theory, a sort of additional point. Actually, externalities are ubiquitous. There cannot be any kind of resource allocation decision involving matter or energy without externalities. "The economy" is embodied and embedded in physical and energetic processes in the physical world.

It involves "stuff" processed by energy conversions. This stuff, the matter, can neither be created nor destroyed, though it can change its form. Likewise, energy changes its form when used. It follows from this that what are used as "economic resources" must have come from somewhere originally where these resources had an original function and/or were part of some other system or structure. These resources must also go somewhere after they are embodied in products and/or where they are wholly or partly turned into wastes. Extracting resources from places has consequences and dumping wastes and pollution has consequences. Over several centuries, this extraction and dumping has usually been out of, and back, into the commons.

Tip of the Iceberg --- Image by © Ralph A. Clevenger/CORBIS

Tip of the Iceberg - Image by © Ralph A. Clevenger/CORBIS

The fish on your plate was originally a part of the marine eco-system and, after it is processed by your body, will become sewerage that may go back into the marine eco-system. The heat from the cooker is from gas that was in the ground and getting it out of the ground changed the geological structure of a place. This process might affect underground water flow bringing contaminants to the surface, as it does in the case of fracking. Burning the gas will change the characteristics of the atmosphere.

Because production processes are embedded and embodied in the physical world, nothing of substance happens without "externalities". Climate change illustrates this clearly. No productive activity takes place without the use of energy. Almost all energy in developed economies, as well as a large amount of energy in "developing" economies, involves generating greenhouse gases. The greenhouse gases arise when producers use oxygen in the atmosphere to burn fuels with and thus, generate CO2. This is an all pervasive process and what is all-pervasive should be integral to production theory, which it isn't in neoclassical theory. In mainstream economics, climate change economics is a topic for a tiny number of specialists. It is almost as if climate change is some kind of special case.

"Externalities are ad hoc corrections introduced as needed to save appearances, like the epicycles of Ptolemaic astronomy. Externalities do represent a recognition of neglected aspects of concrete experience, but in such a way as to minimize restructuring of basic theory. As long as externalities involve minor details, this is perhaps a reasonable procedure. But when vital issues (e.g. the capacity of the earth to support life) have to be classed as externalities, it is time to restructure basic concepts and start with a different set of abstractions that can embrace what was previously external." (Daly & Cobb Jr, For the Common Good, 1994)

Protecting bio-diversity through totem arrangements

A crucial question is then whether or not the other people affected by so-called externalities get to have any say in the resource allocation decision - and if so, how much say or influence do they have. Some indigenous peoples "represent" particular species, get to know all about them, and therefore protect them in their totem arrangements. In this way, the "community" becomes more than its human members. "Non-human persons" are represented indirectly too.

The following is an example of how this works. In modern economics we would speak of there being an "externality" if trees are cut down and if this, in turn, results in maggots from those trees getting everywhere. In Australian aboriginal arrangements this is prevented by a specific man's totem responsibilities, rooted in the aboriginal religious code:

"I am boss for Mpwere [Maggot] Dreaming. My worship is maggots and witchetties and flies... and itchy grubs - those hairy caterpillars that line up- and those angente [sawfly] grubs that attach themselves in a mass to the river red gum trees. Those trees can't be cut down or there will be lots of maggots- maggots everywhere." Wenten Rubuntja quoted in (Gammage, 2011, pp. 129-129)

Here are community members who know how their eco-system works and by "representing" other species in their community's decision-making they prevent particular kinds of "externality" arising.

It would be wrong to over-idealise indigenous societies but it is also important to recognise skills, knowledge and practices which "modern societies" have lost and forgotten. Customary and commons based societies often do not have a problem of "externalities" if the community is functioning properly because everything is internal to the community. If the community is long standing and has a deep knowledge of the local eco-system then environmental impacts on all "people actors" and "other species actors" are taken into account in its decisions.

Buen Vivir or sumak Kawsay - the "Good Life" without externalities

Similar arrangements can be found among other indigenous peoples. In a society where harmony between the people, and between the people and the ecological system, is the desired norm there is an ethic and a belief that emphasises balance rather than "improvement". This means that all community interests (and all species) are taken into account and accommodated in whatever decisions are made. For example, the first nations living in the Andes region had and have a philosophy of Sumak Kawsay, translated into Spanish as "Buen Vivir" or "Good Life." (Fatheuer, 2011)

We must beware of understanding this in a non-indigenous, consumerist idea of a "Good Life". It is only conceivable in the social context in which people live. It involves striving for harmony and balance rather than dominance. This is important because the concept has plurality and a co-existence based on respect - both of human communities and of Nature - integral to it. It is also the opposite of "development" as conventionally understood. Eduardo Gudynas explains that

"Buen Vivir rejects the idea of a predetermined historical linearity in which 'development stages' must be followed by all nations (imitating industrialised nations) but rather defends the multiplicity of historical processes".

Western ideas are not rejected but seen as one among many options in an approach that has been called 'interculturality'. (Gudynas 2014).

Its features are:

• Harmony and balance of all and with all

• Complementarity, solidarity and equality

• Collective well-being and the satisfaction of the basic needs of all in harmony with Mother Earth

• Respect for the rights of Mother Earth and for human rights

• Recognition of people for what they are and not for what they own

• Removal of all forms of colonialism, imperialism and interventionism

• Peace between people and with Mother Earth

When people live as members of human communities, in communities of species, decisions about "resources" accommodate multiple users and therefore multiple uses. Externalities don't arise in so far as this accommodation occurs effectively.

In a commons and other social arrangements, to allocate community resources one would expect that efforts would be made to accommodate all interests so that extreme either/or allocation decisions are not made. However, private property is precisely defined by the power of the property owner to ignore and overrule consideration for other people and species. This has allowed the accumulation of wealth by stealing from the commons in one of two ways described by American author Peter Barnes:

"Enclosure, in which property rights are literally taken or given away, is half the reason for the commons" decline; the other half is a form of trespass called externalizing - that is, shifting costs to the commons. Externalizing is as relentless as enclosure, yet much less noticed, since it requires no active aid from politicians. It occurs quietly continuously as corporations add illth to the commons without permission or payment. The one-two punch of enclosure and externalizing is especially potent. With one hand, corporations take valuable stuff from the commons and privatize it. With the other hand, they dump bad stuff into the commons and pay nothing. The result is profits for corporations but a steady loss of value for the commons." (Barnes, 2006, pp. 19-20)

Extractivism and the "invisible elbow"

"Externalities" are therefore particularly the result of a breakdown of community management arrangements when private property displaces common property. As we saw earlier, private property arrangements tend to be associated with large scale specialist uses of land and resources which displace the diversity of community and species uses. The resulting resource use practice is sometimes described as "extractivist". The "Ricardian" specialism imposed on localities by their private owners focuses upon single uses which displace others. This enables large scale production for distant markets while at the same time necessitating further marketisation. In the world as recommended by Ricardo, if your area is now entirely given over to producing wine everyone living and working in that area has to buy in all their other food and other needs because there are no longer any local sources for other foods, fibre crops and clothing and so on.

The resulting "de-localisation" in this kind of world then also gives rise to pervasive "externalities" because they make it increasingly difficult to see dishonest, cruel and destructive practices which occur during the production of what you buy. When you purchase clothing and other goods produced outside your own area, you cannot possibly know in any detail or with any certainty the conditions under which the purchased in products are created. You can see the product and you can know what its price is, however, the fact that it was produced by child labour, or in a factory that was in danger of collapsing, is likely to be unknown to you.

Smithian economists make much of the "invisible hand"; of the self-organising market in which prices give people the information they need in order to make their buying and selling decisions. What is suggested here is that prices can tell you all that you need to know. But there is a flaw in this argument that economist Michael Jacobs called "the invisible elbow":

"If consumers had to suffer all the pollution caused by the products they bought, they wouldn't buy them in such damaging quantities. It is precisely because costs are passed on to third parties that we let them occur. Environmental degradation is a genuine case of passing the muck...environmental problems occur through the combination of millions of individual economic decisions. These decisions are taken privately, without reference to what everyone else is doing, because nobody can know what everyone else is doing. Added together, market forces generate an overall result which no-one can predict. This is the "invisible hand" which the economist Adam Smith argued brought general prosperity. But it can equally be an "invisible elbow" which brings the earth's precarious ecological balance crashing down like a pile of cans in a supermarket." (Jacobs, The Price of the Future, 1990)

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