It's an Externality, Stupid

With Copenhagen on our minds, some remarkably incisive commentary coming from — of all places — the IMF. Here’s Carlo Cottarelli, the Director of the Fund’s Fiscal Affairs Department:

The science of the issue can get pretty incomprehensible pretty quickly. And the politics are clearly very ugly. Let’s not forget, however, that much of the economics is simple.

It’s an externality, stupid — so price it.

An informed citizen trying to follow the debate may easily become overwhelmed. But Cottarelli is right: the economics principles here are pretty straightforward.

(Hat tip: Peter Martin)

Richard, UK

Indeed. But how to price the uncertain when no-one can agree on probabilities?


The decision of pricing it may be relatively easy. Accurately pricing its external costs is not.


God, it's so simple. Why don't we scrap these silly negotiations and simply implement this patently obvious simple solution?

Maybe because the reality is that the economics are NOT simple. There are short-term and long-term costs and benefits, coupled with massive uncertainty, inter-generational wealth transfers, and staggering distributional issues.

Of course, there's also no way to separate the economics from the politics or the science, so it's not entirely clear how this snarky observation contributes in any meaningful way to the debate.

Anand Bala

Is the suggestion that polluters get to pay for polluting?
Who do they pay? How do the pay? Let me guess - they buy some paper and resell it on some exchange?

The environment is not about the economy or economics.
To most people who are affected by polluters, it's about survival.

The suggestion to "price it" is not just naive, but insensitive and vulgar.

Leave the economics and other freaks out of this. Give the environment a chance, please.

Marc Resnick

This is the most (and perhaps the only) clear and honest statement emerging on the climate change debate. It is obvious that it is an externality. But coming up with the best price may be bit harder.

Carbon taxes are much cleaner and have low transaction costs, but the benefit of having some kind of auction mechanism allows the market to price it. Cap and trade will be a failure because there has been too much politics introduced. Special interests win again.

Patrick Sullivan

The problem is who sets the price and what is the process used to set it. It's clear that the positive aspects of a warmer planet are not being included in the equation and it seems that mankind's well being is secondary to Gaia's.

Dr. Bob

Noting that "externalities" and "internalities" are not natural with economic transactions....they are bounded by fluid boundaries, these boundaries subject to politics and power, knowledge and science, myth and associated religion; in short, all of human strengths and weaknesses.


I think if politicians wanted to do something for the externalities in this country, they could have pushed a gas tax using the idea of a national security issue. I am probably over-estimating the American people, but I think defense is something anti-tax Americans respond to. Republicans all talked about importing less oil, even though their solution was "Drill, baby, drill!"

Now, with the politicization of the climate issue, I think that no real majority of American's will ever be convinced to accept taxes on carbon.


I guess pricing externalities isn't simple to me.

What do you do with the moneys raised?
How do you set targets for desired behavior that isn't influenced by the revenue?
Are we sure it won't cause secondary affects that aren't desirable, like moving economic activity to black markets?

Nothing simple about it, if you ask me.


Pricing pollution is the right idea, but how? Auctioning off permits and then allowing them to be traded gives an unfair benefit to firms that can afford to buy permits. What about the new start-up or the smaller company?

What are some other approaches that might work?

J.P. Steele

Not so easy to price complex systems with imperfect information...


The problem is that the probabilities are not only unknown but also, in a certain sense, unknowable.

Scott W

Isn't this the same debate at one remove? Externality = anthropomorphic global warming, right? Simply calling it an externality shortcuts the debate about if and how much our carbon activities are contributing. Doesn't seem like a meaningful designation.

Ken Nelson

This is a case where the collection mechanism is known (taxes), and we have eager recipients - scientists, politicians, companies that have bought politicians, and NGOs eager to take a slice out of the pie they distribute.

But what is NOT known if the externality cost is real, or if so what its cost is, nor what the cost of injecting the externality into the pricing is..

Externalities - simple as throw away lines from bureaucrats at corrupt international finance institutions. Not simple at all in practice.


But it still doesn't fix the pollution problem. Paying a carbon tax fixes nothing so it holds no value.
Clean water however is now becoming more of a high value commodity that it'll become political soon. This is already the case in parts of Africa and Australia.
IMF should be investigating the far reaching monetary impact of water instead.

Ben Ho

As an economist who used to work for the White House and is right now sitting at the negotiations in Copenhagen, one thing I have learned is how much of the world, the simple models of economics does not capture. I agree completely that the economics of externalities are straightforward, but without even dipping into the many scientific uncertainties and political hurdles, even the economics is not so simple when you add in innovation and learning by doing which is a crucial component of addressing climate change, not to mention equity concerns when the main polluters for the next 50 years have only a fraction of the income compared to the developed world, and equity cannot be fixed by direct transfers for a wide variety of reasons.


It's not even proven whether global warming has more negative externalities or more positive ones.

fucius pratum

"It's an externality, stupid - so price it."

I want that on a t-shirt.

Joshua Northey

The first step is deciding how warm we actually want the planet to be, or at least guessing since we don't know. We need a target. Keeping it the same isn't a useful target because we are already going to blow way past that.

At the same time a lot of the scientists and most of the activists are way too doom-and-gloom about the consequences of warming, there are a lot of positives to warming along with the obvious negatives. A consequence isn't a negative externality if it is actually desirable.

This isn't about survival, earth its ecosystem and the human race are under no threat. There are plenty of other activities that are much more destructive to the environment. The main threat from warming sea-level-rise will take hundreds of years to manifest itself in any truly important way.

As we cannot even agree on this first small thing I have a hard time imagining we are going to come to some sort of agreement which has us accepting costs now to help future generations.

For the past 30 years the US populace is crippling its standing/wealth in future generations so it can spend more now and pay for it later, why would they change their mind about the value of their grandchildren now?



The idea is to make CO2 emissions more costly relative to other things, not to destroy value. If we have a carbon tax, and reduce other taxes to compensate, we've got a revenue-neutral way to discourage burning carbon. The US can do that for the US only, of course, but that would be significant since the US is one of the biggest CO2 producers.

This doesn't penalize small businesses, unless they planned to grow big by dumping lots of CO2 into the air. It doesn't cut down on economic activity overall; it just moves it around. Since this is a deliberate market distortion, it does cut the short-term efficiency, but probably not by all that much.

Of course, nobody has a good, clear idea of how much global warming is going to cost us. Some of the effects will be negative, some positive, and most will be disruptive, which does cost money in the short run.