Monday, January 28, 2013


Neoclassical and Austrian approaches to pollution externalities

Externalities refer to actions of the consumers and or the consumers which have either a positive or negative effects on the costs or benefits to the firm. A positive externality may arise due to actions by either a firm or an individual causing benefit to the other firms or individuals for instance a spillover of technology form one firm contributes to the societal technological pool while at the same time benefiting the other firms which operate in the industry. On the other hand, there are negative externalities which come about when the actions of individual or companies lead to the creation of harmful effects to other firms (Kneese, Ayres. and Arge, 1973). A common example of negative externality is pollution whose private cots outweigh the social costs. When a river is polluted by a firm, the society who is the major consumers of the river water will bear costs in terms of the purification of the waters of the river as well as any medical costs which might arise due to the health effects of the pollution. The essay is a discussion of the different types of pollution externalities; the Coase theorem is used to explain the type of externalities. The second part of the essay is an evaluation of the neoclassical and Australian approaches to o pollution externalities. The final issue will be the various ways through which pollution externalities can be controlled.
            According to Lipsey and Chrystal (2007) there are two types of pollution when the scope of the effects of the pollution is considered. To these writers the tow types of pollution externalities are local and global. Local pollution has a limited scope of effects for instance the pollution of a lake that serves one locality. The effects of the pollution will be felt only by the members of that locality and thus it will remain their problem. When the lake is polluted, there may be significant costs to the people who initially depended on the water for instance through the need to continuously purify the water so that it can be available for their use. Another example is when a manufacturer begins to use the pure waters from a stream that are also used by the locals for its plants while also dumping its wastes into the stream. The stream being a universal property resource, the manufacturing plant cannot be stopped from using the waters of the river. When the people downstream grow tired of the pollution that goes on in the stream, they may want to stop the firm from polluting the river by offering a deal o dissuade the plan from the practice.
Local pollution can also occur due to land degradation which may be a result of unsustainable use of the land resource. A farmer may keep to many herds of cattle in his piece of land, thereby exceeding the capacity of the particular peace of land to support the venture. This will lead to increased trampling and loosening of the land thus making fit prone to soil erosion through its various agents. Also, due to non-communal consideration a coffee farmer may decide to plant their crops on very step slopes thus exposing the farm to erosion from agents of erosion such as water. The entire two examples depict cases where the land owners consider their own individual benefits without looking at the costs that they will cause to the society at large.  Air pollution which arises from air pollutants may also be considered as local pollution especially resulting from use of sprays in farms by farmers, improper incineration of wastes which release toxic chemical into the atmosphere thus affecting the air quality in the immediate surrounding (Lewin, 1982).
Global pollution on the other hand is that whose effect is felt beyond local boundaries. To begin with, emissions from airplanes as well as ships affect the environment in a variety of ways. To begin with, the gases that are released due to the combustion of the engines for instance carbon monoxide, benzene and nitric oxide all contribute towards the destruction of the ozone layer. When the ozone layer is destroyed, the result is a rise in global temperatures which has other severe effects on both plant and animal life in the universe. The second case of global pollution can result from the pollution of large rivers that feed the oceans with their waters. This pollution interferes with the natural balance in the ecosystem thus leading to the death of both flora and fauna.  Accidents especially from sea shipping lines lead to destruction of important diversity thus leading to series of losses to the global populace who may be dependant on this diversity. Global pollution has led to an increased incidence of anthropogenic global warming (AGW) whose effects will continue to threaten the very existence of the human race (Lewin, 1982).
The pollution externalities that affect either in global or local scale can be understood through the theorem that was developed by Ronald Coase to provide a platform though which the negative externalities and other environmental problems could be dealt with (Coase, 1960). Coase was in agreement with the neoclassical economists about their central assumption that the effects of the market competition on the externalities. However, Coase came to the conclusion that the environmental damages are not a direct result of failures by the markets, but are created from the failures be the governments to allocate and define the property rights for the citizens as well as for the industrialists. Coase further went ahead to explain that when the government sufficiently carries out the task of defining and allocating the different property rights, disputes and tradable will and can, in principle, be settled though bargaining and property right exchanges without necessarily involving the government or its other machineries in the regulation or intervention into the various processes of the market. Coase argues that when dealing with negative externalities such as pollution, the main problem that must be dealt with is whether the gains that will result from the prevention of the harm are greater than the losses that other firms or individuals would suffer due to the stoppage of the of the action (s) which were identified to be causing the particular harm. Although the theorem rules out government interventions for instance through levying of taxes and specifying the different standards, property rights must be well defined and enforced while also working to mitigate on the transactional costs (Kneese, Ayres and Arge, 1973).
There are different conditions that were developed by Coase to aid the theorem in it work. They include the fact that there exists a particular person who holds the right to the property that is affected by the externality. The second condition is that the parties that are involved can be able to bargain effectively without any barriers and also that no bargains can start unless the parties have reached an agreement to engage in the bargain. Finally, there should be no transactional costs that are to be incurred by the parties to the property right dispute (Coase, 1960).
Coase theorem can be used to explain a pollution externality that may be affecting people access o their property rights. A property right issue may arise in the use of the waters of a river between the people who live along the river and the industries that want to rely on the waters of the river. All the parties have the right to the use of the river since it’s a common property resource. Problems may arise between the downstream users of the river and the industries that want to dump their wastes into the river. Various positions can be assumed in the case while applying the Coase theorem. To situations will be discussed; where the property right lies with the users who are downstream and a situation where the property right lies with the manufacturer who is upstream. When the property rights lies with the downstream users of the water, they will be able to stand up to prevent pollution when the industry tries to pollute the water. The firm may thus offer payments for the privilege to pollute the water for instance by offering to pay 60 dollars for every ton of waste that they dump into the water. The downstream users will determine the costs that they incur in purifying the water will be 80 dollars per ton of waste, they will refuse the deal and thus the industry will be forced to look for an alternative waste disposal method that will cost the firm 60 dollars per ton of waste (Lipsey and Chrystal, 2007).
On the other hand, when the property rights lies with the chemical manufacturer may decide to use the river as a disposal ground for their industrial wastes. A situation will arise where the downstream users of the water complain about the quality of the water that they get, they will be willing to pay for the use of fresh water. The cost that is incurred by the users of the water downstream especially in the purification process is 80 dollars. The downstream users are willing to offer up to 80 dollars to the chemical industry so that they can stop dumping their wastes into the river. In this case, the firm will look for an alternative method of disposing their wastes at 60 dollars. They can then give an offer to the downstream consumers to pay the firm say 65 dollars for every ton of waste that they do not dump into the river. Since the amount requested by the firm is cheaper, than that which they were using to purify the water. However, when there are improvement in technology, and the cost of purifying water drops by say 50 per cent, the downstream users will offer no more than 40 dollars to the industry to prevent their pollution of the river. The efficient use of the resources is produced when the tow sides to the dispute bargain (Lipsey and Chrystal, 2007).
There are different approaches that have been used to understand the pollution externalities. The neoclassical approach to environmental economics was developed by the 19th century liberal political thoughts which were shaped by the physics and traditions of the day (Dawson, 2011). Under the neoclassical approach, pollution externalities occur due to the failures of the market to maximize the welfares of the citizens especially through failures to determine the levels of outputs of goods which would contribute to the creation of equilibrium between marginal social costs and the marginal benefits.
The neoclassical approach seeks to find an acceptable balance between the interests and aims of the consumers and the producers whose major activities lead to the destruction of the environment. This provides a common ground for the need to protect the environment between the producers and the consumers without resorting to the use of force to effect environmental protection (Sankar, 2000). In dealing with pollution, neoclassical approach recognizes that it’s not feasible to attain zero levels of environmental pollution due to that it is the side effect of production of the goods which are of utmost importance to the well being of the citizens.
The neoclassical economics makes certain assumptions for instance that the individuals seeks to maximize their own welfare which is mainly constrained by the limited amounts of information that are available to them and their incomes. The neoclassical approach also assumes that services and goods loose their value with time and thus goods and services that are consumed today will be more valuable than those that will be consumed tomorrow. Form this assumption, the neoclassical approach concludes that there is an optimal resource depletion rate as the resources will not be needed tomorrow (Block, 1990). From these provisions of the approach, it can be noted that neoclassical economics has completely departed from establishing the harm that an individual polluter will cause to the others by denying them the pure use of the resources which they are entitled to. The notion of optimum pollution and resource depletion level leads to the coercion of individuals towards accepting the pollution externality. This mainly occurs in cases where it can be determined that the monetary benefit of the economic activity outweighs the monetary costs (Brown and Shaw, 1983).
 According to Brown and Shaw (1983), neoclassical economists advocate for environmental taxes to be levied on firms and industries which are engaged in pollution. The major obstacle to the environmental taxes is the difficulty and the huge costs that are incurred in determining the external costs of the pollution externality. The taxation is levied on carbon emission and not on the goods whose production leads to carbon emissions.  The carbon taxation does not require firm to reduce their levels of production but rather their total emission levels for instance switching to a less carbon intensive production process.
On the other hand, Austrian approach just as the Coesean theorem holds that the pollution externality arises not from the failures of the market but from the failure by the various governments to allocate and determine the property rights for the different individuals. According to this approach, most of the environmental problems arise due to the limited ability to solve conflicts due to lack of clearly defined and allocated rights to property as well as the lack of policies through which these rights can be defended (Anderson and Leal, 2001).
The Austrian approach has to core principles which underline its operations. The first is that the various costs are subjective and the second is that the competition between the firms is a dynamic process. Here the consumer’s preferences and resources determine the equilibrium position, while the dynamic competition leads to the creation and or development of new products. This approach is in complete disagreement with the neoclassical approach especially concerning market equilibriums. To the theorists under this approach no market equilibrium can be reached between social benefits and marginal costs due to the costs being subjective; the costs exists only in the minds of the individual who is measuring and cannot be measured by anyone else (Nordhaus, 2007)
The control of pollution externalities must consider the various contributors while also working with the fact that pollution externalities cannot be eradicated due to the need for production to satisfy the different human needs. The first method of pollution externality control is direct regulation. The direct regulations can take the form of standards which must be met by all the goods for instance all cars produced in the EU must meet certain level of emission status to be accepted by the market. Direct controls can also be achieved through the provision of tax incentives especially to switch from products which carry very large carbon footprints (Lipsey and Chrystal, 2007). However, direct controls are faced by a variety of problems for instance the economic inefficiency of the controls for instance costs of pollution abatement are not same to the polluter as they are to those affected. Moreover, control can also be carried out through the use of emission taxes. Pollution taxes can be attributed to Pigou (1877-1959). He sought to provide an alternative to direct control through the introduction of the taxes which worked to increase the costs to the firm by amounts equivalent to that which their production activities caused in terms of pollutants. Secondly, the pollution taxes do not put any requirement to the firms about the need to cut their emission levels. Firms are left to their own devices to find the most efficient method of controlling pollution. However, the main problem with emission taxes is the problem arising from the measurement of the levels of emission (Copp, 2008). Problems also arise in the setting of the tax rates especially since the marginal social damage cannot b actualized but are just estimated. Finally, pollution externalities can be controlled through permits of tradable emissions. It begins with the determination of the maximum level of pollution to permit. After the maximum threshold is set, the low polluter firms may sell part of their pollution quarter to the high polluters thus reducing the overall cost of meeting the target for the pollution reduction.
In conclusion, it is imperative to acknowledge that pollution and other negative externalities can sufficiently be dealt with through various market mechanisms. However, the various parties to the conflicts or those who are affected by the externality must first ensure that there are appropriate provisions for the property rights. Property rights work to ensure that the environment always remain healthy for the people that depend on it. Otherwise, the people whose right is taken away must be compensated. However, in the absence of clear property rights, the pollution externalities can be internalized so that the firms still bears some costs regarding their pollution activities.

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