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Externality-downplaying economics

from Duncan Austin

A major first response to our sustainability challenges has been to try and turn profit to more sustainable ends. Alas, even ‘purposeful profit’ seems unable to overcome the deeper momentum of what might be termed ‘externality-denying capitalism’ – ‘externality-denying’ in that billions of daily investment and consumption decisions ignore certain of their social and environmental consequences.

As just one example, the World Bank reports that less than 4 percent of global carbon emissions are currently priced at levels consistent with the Paris Agreement’s temperature goals, endorsed by 194 nations.[1] Hence, hardly any of today’s market transactions are fully costed, in terms of reflecting their contribution to climate change. The same neglect repeats to varying degrees for certain other environmental and social problems.

We don’t call our predominant socio-economic system ‘externality-denying capitalism’, but possibly we should, to constantly remind ourselves of what we are doing.

Figure 1

Matt Tweed

Caught in this embracing dynamic, first-response market-led sustainability strategies – such as socially responsible investing (SRI), corporate social responsibility (CSR), and an environmental, social and governance (ESG) movement – are showing signs of exhaustion. While these strategies have helpfully accelerated awareness of sustainability challenges and have catalysed fresh innovation paths and business models, they are being overpowered by the externality-denying capitalism that remains the larger force shaping our social and natural worlds. Hence, there is a pressing need to step out of the day-to-day frame to appraise this bigger system (Figure 1).

In part, we have arrived at externality-denying capitalism – read, consequence-denying capitalism – because it has been rationalized by an externality-downplaying economics discipline (Figure 2). Economics has had a theory of externalities for over a century, but a concept that should have been central to the subject was fatefully marginalized – and not for particularly good reasons.

Figure 2

Matt Tweed

There has been a general attitude that external costs might be small, or that positive and negative externalities might roughly cancel out to leave market signals as a still reliable guide for economic decisions. (Unfortunately, there is an important asymmetry: positive externalities are ‘free good things’, of which you can never have too much,  while negative externalities may accumulate to have system-breaking consequences).

Above all, 20th Century economists’ craving for elegant mathematical models, for which externalities were a complication too far, encouraged a view of externalities as the negligible residuals of an all-encompassing efficient market system. However, externalities can no longer be dismissed as negligible market failures when they are becoming the main event! Economics’ – and now society’s – markets-first, world-second perspective is no longer credible – no longer sustainable.

Externality-downplaying economics promotes various ideas – ‘trickle-down’, ‘rising tide lifts all boats’, ‘win-win’, ‘green growth’ etc. – that are all variants of the same basic attitude: whatever the problem, more growth is surely the answer (Figure 3).

But if the measurement of growth is externality-denying, then the growth that is meant to solve problems may simply create more of those problems along the way. Externality-denying growth may rebound or backfire to become not the solution but the driver of various social and environmental harms.

Figure 3

Matt Tweed

read more: https://p.feedblitz.com/t3/973841/4534930/0_/www.paecon.net/PAEReview/issue102/Austin102.pdf

  1. Greg Daneke
    February 5, 2023 at 5:47 pm

    Brilliant essay! Cheers! Comics are spot on!

  2. Steven Klees
    February 5, 2023 at 10:10 pm

    I couldn’t agree more. Downplaying the extent of externalities (and quasi-public goods) is one way the neoclassical house of cards manages to stay afloat. The gross inefficiencies of the invisible hand relying on market mechanisms are ignored. Similarly, cost-benefit analyses of government investments never come close to accounting for the far-reaching externalities that are part of the investments they are examining. Dani Rodrik has made the interesting argument that creating good jobs creates massive externalities. Within neoclassical economics, this has devastating implications for a capitalist system which fundamentally relies on markets to create jobs. If Rodrik is correct, neoclassical economics would imply that governments have a major responsibility to see to good job creation – anathema even to most liberal neoclassical economists.

    • Gerald Holtham
      February 6, 2023 at 5:55 am

      Is basic education run in a market? In most countries, US partly excepted, healthcare is not run in a market. The market does not determine agricultural prices which are controlled or subsidised in most countries. In nearly all European countries the state accounts for over 40 per cent of GDP because it takes responsibility for areas where externalities are important. R&D is state-subsidised everywhere, especially for “defence” purposes – on externality grounds. In fact externalities are pervasive and recognised as such. The public policy literature in economics discusses little else.
      The great externality of climate change is being addressed far too slowly but that is a failure of politics, not analysis. Everyone knows what we are supposed to do. Improved metrics for economic activity and welfare are certainly needed, though. Austin is right there.

  3. February 5, 2023 at 10:35 pm

    Spot On, brilliantly expressed, many thanks Duncan.

  4. Laurent Leduc
    February 6, 2023 at 5:25 pm

    Connected to this fine piece is the work of Herman Daly who unfortunately died three months ago. He would point to the fact that the economic system is embedded in an earth system which has a finite input. Prior to Daly, Nicholas Georgescu-Roegen wrote Entropy and the Economic Process. Sustainability definitions need to be aware of throughput of solar input and its degradation through the earth system.

  5. Laurent Leduc
    February 6, 2023 at 6:13 pm
  6. Eric
    February 9, 2023 at 6:25 pm

    Reblogged this on Calculus of Decay .

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