Externalities Are Costing You Money

Philip Kotler

Most companies do not cover the full costs of their operations. They cover their direct costs but not their external costs.

Consider a company that burns coal to generate electricity for its operations. This results in a lot of smoke emitted from its chimneys. This is an external cost for the company in that the company is not covering this cost. Smoke pollutes the air and makes breathing difficult.

The government orders the company to reduce the amount of smoke. The company now has to buy equipment to reduce the amount of smoke. This internalizes part of the smoke cost to the company. Meanwhile the government has to expend money to regulate pollution. That expense will be paid for by consumer taxes.

In the end, the public is (1) inhaling smoke and (2) paying for pollution regulation.

Here are other cases where companies don’t bare the full costs of their operations:

· A chemical company disposes of some chemicals in a nearby lake. This damages water quality and the local government has to order the company to clean it up or do the cleaning itself at the public’s expense.

· A copper mining company abandons its mining operation. The soil surrounding the mine is degraded and cannot grow any crops.

· A company producing nuclear energy fails to bear the cost of burying nuclear waste so that it doesn’t harm nearby water supply.

· A data center emits a steady buzzing noise that keeps people in nearby homes unable to fall asleep.

Possible solutions

Governments can consider a number of possible solutions.

1. Charge an emission fee. The government can identify the amount of pollution produced and charge a carbon tax on each unit of pollution produced by that company.

2. Install a cap- and-trade system. The government sets a total quantity of allowed emissions and issues tradable permits to polluting firms. Companies committing high pollution have to buy more permits from firms that need fewer permits.

3. The government identifies the most effective brands of equipment that companies can buy to control their own pollution. Instead of companies buying the cheapest equipment for reducing pollution, the government recommends the most cost-effective brands for regulating pollution.

Conclusion

The good news is that more companies are adopting policies of sustainability. Sustainability is the effort to reduce waste and to choose materials for the production process that are least harmful to human life or nature’s life. More companies seek to tell their customers and other stakeholders that their company pursues environmental values in conducting their business.

Needed are members of the public and elected legislators who can spot companies that are over-externalizing their costs and call public attention to prevent or tax these companies.