Externalized Costs 101

Long ago in an economics class, I learned about externalized costs, or externalities.  It appears that most of the American public doesn’t know about this concept, however, based on their consistent lack of ability to connect the dots we see each night on the news.  As a public service, then, here’s a little primer.

Many of us are used to simple economic ideas like supply and demand, but externalized costs are sort of sneaky.  They skew normally simple economic equations a little like insurance can do because they trick us into thinking we’re making rational policy decisions — but if we ignore externalized costs, we’re not (collectively) making good decisions at all.

Although most of the economic externalities we’re interested in are negative, the actual definition of an externality is either a negative or positive economic consequence of an activity that affects a party who didn’t choose to incur that consequence.  One more time in English: if you do something that causes an economic impact to me, and I didn’t have a say in you doing that thing, that’s an externality.

Externalities can take place between two individual parties, but a far more typical scenario involves a governmental entity –maybe because the one function governments perform best is confusing economic transactions.  Recently, AEP CEO Nick Akins made a speech at a conference in California, and he dropped a great one on the crowd gathered there.  You see, Akins believes that our government should start funding carbon capture projects so that AEP can continue to operate coal-fired power generation plants.

In this case, the (proposed) externality would occur by transferring the costs of burning higher-polluting coal (vs. natural gas, for example) from the publicly-traded AEP to the federal government, despite our government’s well-publicized budget challenges.  Those costs, then, would effectively be passed on to all US taxpayers — the ultimate cost-shifting move.

Once you start tuning into this sort of cost-shifting, you’ll begin to recognize more and more cases of externalization — some operating on a truly massive scale.   I’ll touch on a couple of these in upcoming posts.