money and the environment
April 13, 1994

"Environmental damage is an example of a detrimental externality, thus free markets will cause too much environmental damage."

This statement is both accurate and inaccurate, and requires clarification if it is to be meaningful. Its ambiguity stems from the value judgement "too much"; to decide what "too much" means, analysis of each component of the statement would be beneficial.

An externality can be said to be the result(s) of any action that affect a third party not connected with that action; externalities can be either beneficial or detrimental (Baumol, Blinder, Gunther and Hicks, 1992). For example, a stereo owner using their equipment loudly might generate a beneficial externality if the only listener who was not the owner happened to appreciate the style of music being played, while the owner might generate a detrimental externality if the only listener did not appreciate it. A result of an action can only be an externality if those experiencing it (such as the listener) make no payment, and those generating it (such as the owner) receive no payment (Baumol et al, 1992).

Environmental damage is the degradation of the natural surrounds as a result of the occurrence of an event. These events may not be man-made, but for the purposes of this essay it can be assumed that environmental damage means damage inflicted by artificially created events, such as industry. In this sense, environmental damage is an adverse result of activity not conducted by the environment, and as such it can be termed a detrimental externality.

The free market refers to the relatively unhindered method of trading that most communities use to exchange goods and services, specifically, the market system utilises the individuals' self-interest to further the individual, the system, and society as a whole (Baumol et al, 1992). The free market indirectly encourages externalities because it allows the individual freedom to do as they please (within the law). However, it is inaccurate to state that free markets cause externalities, as is attested by the environmental ruin in the former Soviet Union (Raven, Berg and Johnson, 1993); human nature is the more likely culprit. Nonetheless, the free market makes it easy for entities to serve their own ends, while allowing others to suffer the consequences (Baumol et al, 1992).

It's unfair to say that the free market is responsible for environmental damage. The damage has occurred through human action, both with and without the free market, and has been done not just by Big Business but also by governments and the average citizen (Baumol et al, 1992). Environmental damage is a global problem, literally; it has roots everywhere. The entrenched attitudes of the earth being Man's playground - and as such, available for exploitation - is a central causal issue. The realisation that humanity must live with the planet, rather than on it, is still fresh in the collective industrialised consciousness (Australian Aboriginals grasped this concept at least 30,000 years ago, but such wisdom was lost in their perceived savagery).

Additionally, environmental damage is unavoidable, as the mere existence of any object forever changes the environment in which it exists. Humanity is not to blame for the fact that it lives, and as such there will always be a degree of damage stemming from that fact (Baumol et al, 1992). However, humanity does have the ability to dictate to what degree it affects its environment, excluding the effects of sheer existence, and it is this ability that has been ignored, or at least under-utilised, in relatively recent industrial history (Baumol et al, 1992). With the modern era, humanity has become aware of the damage that has been done and is now taking steps to rectify it (French, 1993). Recognition that environmental damage can never be eliminated, due to the cause-and-effect nature of life itself, means that such rectification is limited to minimising our effects, rather than attempting to eliminate them (Baumol et al, 1992).

Legislation can be used to limit environmental damage, and has been used in Australia, for example, to facilitate removal of asbestos from buildings, prevent purchase of cars that use leaded petrol, and force publication of environmental impact statements (Nordhaus, Richardson, Scott and Wallace, 1992). However, legislation can be ignored, and is likely to be if the chances of getting caught, or the penalties if caught, are relatively small (Nordhaus et al, 1992). Further, checking that entities don't ignore the legislation, and prosecuting those that do, is time-consuming and expensive (Nordhaus et al, 1992). Claims have been made that legislating for ecofriendly production imposes costs on producers, making them uncompetitive, costing jobs and perhaps forcing relocation to less-legislated areas (so-called "pollution havens"), however, analysis after the fact found that losses were less than expected, relocation was not worth the expense, and pollution havens are not politically viable (French, 1993).

Attention can then be turned to economic methods of limiting environmental damage. There are two major suggestions, taxes and permits (Nordhaus et al, 1992). Both methods attempt to reduce pollution by adding the cost of pollution into the production costs of the polluter, setting market forces against the incentive to pollute (Raven et al, 1993). Figure 1 (Raven et al, 1993) illustrates this concept; by raising the marginal cost of pollution, less pollution will occur.

An emission charge can be imposed upon polluters, increasing the cost of the product (Nordhaus et al, 1992). From a consumer's perspective, this encourages reduced use, or use of less expensive alternatives (Raven et al, 1993). Australia does this now with petrol, super already costing several cents more per litre than unleaded. Sweden taxes the active ingredients in pesticides, while Finland and Norway impose charges on nonreturnable containers (Raven et al, 1993). This method has not been very successful, as the taxes are usually set too low to create concern (Raven et al, 1993). From a producer's perspective, the profit motive creates inspiration to reduce levels of pollution (Nordhaus et al, 1992).

The issue of a fixed number of emission reduction credits (ERCs), which permit a holder to emit a given amount of pollutant per credit, would also force pollution costs to be taken into account (Raven et al, 1993). The credits can then be bought and sold as a commodity. This method increases costs to those who wish to pollute more, while those reducing their pollution can sell their credits and lower costs; additionally, because the number of credits is fixed, the total amount of pollutant permitted remains fixed also (Raven et al, 1993). Permits could even be purchased by environmental groups and never used, thus reducing the total amount of emissions permanently (Nordhaus et al, 1992). The American Environmental Protection Agency has successfully used the permit method to lower the concentrations of lead in petrol and pollutants in the atmosphere (Raven et al, 1993).

Both taxes and permits are known as market-oriented strategies, as they use the market principles of supply and demand to implement environmental protection (Raven et al, 1993). Environmentalists contend that market-oriented strategies are not worthwhile, as they do not take into account the actual cost of pollution but rather simply seek to make it unprofitable (Raven et al, 1993).

A significant addition to the arsenal of the green economist is the recent push toward open, contestable international markets, represented in name by GATT, APEC, the EC and NAFTA. These agreements, accompanied by varying degrees of political and social change, implement economic strategies designed to create a "level playing field" upon which any entity from any nation can play (French, 1993). While the true nature of the trading blocs probably remains obscured in international political intrigue, it can be said that they represent a significant step down the path to a sustainable civilisation. The level playing field aims to minimise subsidies, which undermine the market mechanism by propping up uncompetitive producers, and minimise tariffs, which undermine the market mechanism by decreasing the viability of substitutes (French, 1993). A wider market provides more incentive for improvement in the quality of a product and forces producers to pay increased attention to efficient use of resources (French, 1993). Increased trade means more growth, thus more consumption, thus more pollution, but it is argued that the technological innovation, increased efficiency and increased investment that increased trade will bring will balance these factors out (French, 1993). The increased trade that GATT and associated agreements provide will increase the contestability of every international market and as such improve the efficiency and performance of those markets (French, 1993).

Finally, domestic policy can be used to limit environmental degradation. The establishment of 'green' product labels is one such policy (French, 1993). These labels indicate to the consumer that the product within is 'environmentally friendly'. While much attention has been given to packaging which misleadingly uses the green theme to sell the product, there are labels that justifiably use the theme, such as the Green Seal brand, or Energy Star electronics equipment.

Presumably increased public awareness of environmental issues, through advertising and education, would be beneficial to the environmental cause.

Back to the initial statement, it appears that it is potentially accurate if business does not become environmentally conscious, the people ignore governmental ineptitude, and GATT and the other trading agreements fail to deliver. However, given that momentum for all three clauses has already been established, it seems unlikely that either clause will come to pass. Environmental damage will continue to exist as a result of human endeavour, but with the growing awareness on all sides, this damage is likely to be minimised. The initial statement may have been accurate for its time, but that time has passed; the environmentally sustainable future beckons.


Raven, P.H., Berg, L.R., Johnson, G.B. (1993) Environment Saunders College Publishing

French, H.F. (1993) Reconciling Trade and the Environment State of the World 1993 Earthscan Publications

Nordhaus, W.D., Richardson, S., Samuelson, D.A., Scott, G., Wallace, R. (1992) Economics - 3rd Australian Edition McGraw Hill

Baumol W.J., Blinder A.S., Gunther A.W., Hicks J.R.L. (1992) Economics, Principles and Policy, Second Australian Edition Harcourt Brace Jovanovich