Suppose I own a chemical company and I have two options for disposing waste, a cheap option and an expensive option. The cheap option is to just pour the waste directly into the river. The expensive option is to buy a $100M waste treatment machine which keeps the chemicals out of the river. If I pour the waste into the river, the town downstream will need to buy a $100M water treatment upgrade to prevent the chemicals from enter their drinking water.
No matter which option I choose, the cost of disposing my chemical company's waste is $100M. The only difference is whether I pay the cost, or I unload the cost onto the residents of the town. Choosing to make others pay is called "externalizing" the cost, or creating a negative externality. In a way, my externalizing the cost is a way of transferring $100M out of the pockets of the community members and into mine. By forcing them to pay for my costs I rightfully owe them the money I pocketed. But, as long as the government doesn't force me to pay, I can get away with this theft. In the example, the cost I'm saving by dumping is the same as the cost the community is losing. Overall, the cost to society is the same, it's just a question of who's paying for it. But, in reality, externalizing a cost can make the overall cost to society much higher than if the people responsible had just paid it themselves. And it is also not always so clear what constitutes an externalized cost, and what's just an unfortunate cost of an industry existing. There are two ways to assess whether a business or industry is illegitimately dumping it's costs on society: our intuitive way, and a more objective way. Intuitively, we expect that if everyone does something one way, and they always have, then it's fine. So, if a certain kind of cost has always been externalized, we may not judge it to be an externalized cost (especially if it's not obvious how the business could have avoided externalizing that cost). But, rather than just going on our intuitions, we can approach the question systematically in order to develop a clear picture of who is really responsible for paying for what. For any possible act that could be performed by an industry, business or individual, we can make a comparison between the total state-of-affairs of how the world would be if they don't perform the act, and how it would be if they do perform the act. For any act that anyone would be interested in performing, there will be some expected positive consequences, even if those positive consequences are only of benefit to the those performing the act. For almost all acts there will also be negative consequences. When we add up all the consequences - that is, all the ways that the act-performed world would be different from the act-not-performed world - we can determine if the act had an overall positive or negative effect. While this is an overly simplified account of how to evaluate an act, we can see how this kind of approach can help us decide whether an act should be performed or not. This thought experiment alone doesn't tell us whether any costs have been externalized or not. Figuring that out requires an extra step. But before getting to that, some people may be wondering if it is really possible to objectively evaluate various consequences to be positive or negative. If someone has a speaker playing music on the bus, some people might evaluate it as positive and others as negative. Using the method described above, two different people might come up with different ways of evaluating the consequences of an act, making the whole exercise worth nothing more than someone's biased opinion. To be more objective, we can imagine finding out how much money it would be worth to society as a whole to choose one state-of-affairs over the other as an average of everyone's (idealized perfectly-informed) opinion. This way, we're not just adding up all the positive and negative consequences of an act, we're also averaging every person's individual evaluation and weighting those evaluations appropriately. Thinking back to the example of the chemical company dumping waste into the river, we can see how this rough evaluation method works. For acts in which costs are externalized, the externalizer's evaluation of state-of-affairs in which the cost is externalized will be have a positive monetary value (otherwise they wouldn't be interested in externalizing the cost in the first place), whereas the average evaluation of that state-of-affairs by all other people will have a negative monetary value (otherwise no costs would be externalized). But such an evaluation doesn't necessarily imply that the act shouldn't occur. For example, imagine again that the only consequence of my chemical company dumping waste in the river was that the town had to upgrade water treatment, but now suppose the upgrade would only cost $50M rather than $100M. That means that the total value of dumping the waste into the river is positive $100M to me and negative $50M to everyone else. If we add up the positive and negative consequences of dumping, we end up with positive $50M. In this limited example in which we don't have any other concerns (environmental or otherwise) to worry about, it makes the most sense to dump the waste into the river. But that still doesn't solve the problem of me stealing $50M (the cost of the water treatment upgrade) from the community members. While dumping in the river is the right choice in this case, the financial outcome isn't. Because a cost is being externalized, I now owe the community members the $50M it is costing them.
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