It’s easy to picture how someone’s personal interests can go against the social good. Just consider a noisy conversation in a library that makes it difficult for everyone to concentrate. Think about how secondhand smoke negatively impacts others—it doesn’t just affect the smoker. Even driving in congested areas isn’t particularly helpful to society since it only worsens the problem of traffic for everyone else.
Depending on how you might view them, these instances can range from “immoral” or “lacking common decency” all the way to them being just another fact of life. Indeed, it’s natural for humans to act selfishly—for our own interests—in certain ways. But this isn’t very helpful for society as a whole. We care about silence in libraries and our health and traffic in our cities and so on.
The Externality
To economists, all of these are examples of negative externalities. Essentially, these are just costs that society bears due to the actions of individuals.
The classic example of a negative externality is pollution: an individual—or firm—might do something that pollutes. Say, for instance, someone drives to work each day and their car releases greenhouse-gas emissions. The private cost, which the individual pays, is merely the price of gas for their journey. However, society has to pay an additional social cost—namely, the negative impacts of the pollution on the environment.
The noisy library conversationalist—if they’re self-interested, as economists often like to assume—wouldn’t care about other people’s reading or studying. Their private cost is nothing, while there is a social cost that everyone else bears.
Driving during rush hour is costly to the driver (the journey takes longer), but there’s also a social cost that comes along with it. That is the social cost of adding one extra car to the traffic, making it worse for every other driver on the road.
Thus, a more precise definition of a negative externality involves a cost that an individual does not “internalize”. That means the private cost, on which individuals and companies base their decisions, doesn’t include the social cost. And this is problematic because there’s no incentive for people to change their behaviour for the good of society as a whole.
Why a Tax?
So negative externalities come from social costs that an individual or company doesn’t have to pay themselves. The solution, then, is often just making people pay the social cost through a tax. This is what economists call a Pigouvian tax.
Common examples are carbon taxes and congestion taxes, which each respectively deal with carbon emissions and excess demand of public goods (like roads). Pigouvian taxes can also be sin taxes, where governments tax tobacco, alcohol, and certain foods, for example.
These all work by making people pay for the additional social cost that their actions incur, resulting in two benefits. First, the higher price after the tax discourages the activity. Second, the government gets extra revenue that can compensate for the problems caused by these activities.
And it’s clear that many of these measures are working. British Columbia has seen an estimated 5–15% decrease in fuel consumption and emissions in recent years. Likewise, the congestion charge in Central London meant that three years after its introduction, congestion had fallen by 30%.
What Else?
Beyond just the normal “externality”, economists have proposed the idea of an “internality“, which focuses not on social costs but indirect, long-term private costs. In this view, polluting is also an internality because the long-term costs of pollution do, in fact, affect the individuals or firms choosing to pollute. A Pigouvian tax could also serve to make this cost more apparent.
This sort of solution, however, has received its fair share of criticism as well. Some see taxes as a “half-solution” to bad behaviour, instead pushing for direct regulations on externalities. This could involve directly capping emissions or traffic levels in cities, for example.
On the other hand, positive externalities also exist. Vaccines are a great example: the private benefit from getting a vaccine doesn’t include the benefit that you provide to society by protecting others.
In the end, it is clear that thinking about problems that society faces from an economic perspective can shed light on and give us the tools necessary to approach them. And that is something worthwhile.