External effect

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In economics, an external effect (also called externality ) is the uncompensated effects of economic decisions on bystanders, i.e. effects for which no one pays or receives compensation. They are not included in the culprit's decision making. From an economic point of view, they create a form of market failure and can make government intervention necessary. One example is the consequences of climate change to be borne by the general public , which are not included in the ticket price of a flight or in the price of beef, although the consumption of these products contributes to a considerable extent to climate change through CO 2 and methane emissions. These consequences are therefore an external effect of the consumption of these products and CO 2 pricing is a way of internalizing these external costs.

Negative external effects are also referred to as external or social costs , positive ones as external benefit or social return . External means that the effects (side effects) of behavior are not (sufficiently) taken into account in the market . The term “external costs” was introduced into economics around 100 years ago by Arthur Cecil Pigou (1877–1959); in the 1950s, Karl William Kapp presented an extensive collection of empirical material.

Pollution is a negative (technological) external effect

Alternative definition

From the perspective of the new institutional economics, an economic decision with uncompensated effects on third parties should initially be seen as an interdependence . There is an external effect when the interdependence is not included in the decision within the framework of the existing regulatory framework. Since the creation of a regulatory framework is seen as a state task, the externality should rather be interpreted as a state failure. With this definition, not only the mutual influence is relevant, but also the decisive factor as to why this interdependence occurs.

to form

Intrapersonal

In the economy , the term intrapersonal external effect describes learning effects which result in a person assessing the consumption of a good differently before consumption because of a lack of information than afterwards, because the consumption causes a change in preferences.

Here, “external” refers to “outside the billing period ”. An example of an intrapersonal external effect is drug addiction when the risk of addiction was not previously known.

Psychologically

In the economy, the term psychological external effect denotes interdependencies of the utility functions without a physical connection. This can be of an altruistic or envious nature , for example .

An example is buying a new car: This creates an externality in the form of positive sympathy ( favor ) or envy from the neighbor.

Positional

The interdependence in the utility function can consist in relative consumption, in the ratio of one person's consumption to that of another. In this case, the position between the participants plays a role; one also speaks of positional externalities that arise. If one person increases their relative consumption of so-called positional goods , the other person suffers losses of utility by falling behind, i.e. H. a negative external effect. For example, according to surveys in the laboratory, building a particularly expensive house in the neighborhood appears to detract from the benefits of a relatively smaller house. The effect of the position does not have to be envy or favor; it can also change non-psychological aspects such as social recognition, income or power structures. For example, the particularly expensive, tailor-made clothing in a job interview can increase the applicant's chances towards others. Positional consumption can lead to a real arms race - so-called position competitions .

Pecuniary

The pecuniary external effect is the impact of a person's decisions on the distribution of income between people over which the third parties concerned have no influence, but which are conveyed through the market. Here, “external” refers to the “lack of participation opportunities”.

An example of a pecuniary external effect is a loss of profit for one person due to a change in the demand structure for another person. For example, offering a low-cost supplier will lower the profit of other companies. Another example is China's increased demand for steel in the first decade of the 21st century (due to the rapid economic growth), which made iron scarce and thus more expensive.

In contrast to technological externalities, pecuniary externalities act directly in the supply and demand functions of the market and are therefore internalized independently. The market failure due to the external effects (positive or negative) can thus cause the market to adjust even without external intervention.

Technologically

The theory of technological external effects plays a prominent role in the theoretical economic analysis of environmental pollution ( environmental economics ) in the form of the negative external effects occurring there (see environmental policy ). This is where market failure occurs. No less important are the positive external effects, especially of basic research , with which state research subsidies can be legitimized - although the interpretation of basic research as a public good is perhaps even better in this case.

Technological externalities (positive or negative) affect the production and utility functions of companies and households and cause market failure. In order to achieve efficient resource allocation and production volumes, external intervention must be made in the market in order to internalize the technological externalities .

External costs are costs that are not paid by the originator, but by others. As a rule, at least some of the taxpayers pay for it. External costs represent the negative part of the external effects. An external benefit is present if the originator (of the external benefit) does not enjoy the full benefit.

Negative external effect

External costs are mainly incurred in the energy and transport sectors. The situation in transport is as follows: Every transport service has a certain benefit (usually the achievement of a destination) and costs. However, these costs or benefits are not entirely incurred by those who use the transport service (transport users). Some of these costs are charged to others or to society as a whole. One can therefore distinguish between the "internal" or private costs borne by the person involved in the transport service (e.g. time expenditure, vehicle and fuel costs) and the "external costs" (the costs borne by others, e.g. road construction and maintenance, follow-up costs of exhaust emissions, road noise remediation ). The sum of both types of costs is referred to as “social costs” (not to be confused with social costs). Negative external effects arise when the well-being of an individual is impaired by the activities of another individual who does not take these "side effects" into account in its decisions. On the basis of this, negative external effects can arise on the one hand from the production side (e.g. air pollution in a factory) or from the consumption side (e.g. loud listening to music in the late evening).

Positive external effect

Third parties who benefit from an external benefit are also referred to as free riders , since they use a good without paying for it. The use of a perfume (often) has a pleasant and therefore beneficial effect on others, but we do not expect any monetary compensation for it. For example, the person called during a phone call can also enjoy free communication, a state that was also explicitly designed in this way.

However, a positive external effect does not lead to an optimal distribution in terms of “welfare technology” either. Because normally activities that cause a positive external effect are not carried out to a sufficient extent. Here, too, the external effects can be subdivided according to the production or consumption side.

A company that carries out research and development and also publishes the results can be cited as an example of positive external production. Although it has a profit itself, other companies also benefit from the increased knowledge. It can therefore be assumed that too little research and development will take place without appropriate funding. In this case, the costs for a positive external effect can be e.g. B. be offset by subsidies, in the case of research also by the definition and protection of intellectual property rights (e.g. in the form of patents ).

Another example that can be classified as positive consumer externality is the construction of dykes. Assuming the owner of a property that is close to a flood-prone body of water builds a dike, the properties behind it enjoy the protection of the dike, but only the owner of the dike has to bear the costs. The dike is therefore seen as an example of a public good that has to be financed by the state through taxpayers' money. Nevertheless, in the past centuries, dike associations have managed to distribute the costs of dykes to the beneficiaries without government intervention.

Measurement and evaluation

In order to describe external effects and to integrate them into decision-making processes, it is necessary, according to conventional economic theory, to measure them and evaluate them in terms of money. There is no universally valid procedure, so the estimates of external costs can vary greatly depending on the model or survey method used .

Strategies and tools

The economic problem of external effects is that those who caused the external effects do not consider them in their economic calculations. Without state intervention, negative external effects will result in costs for society as a whole, since they are not taken into account by the decision-maker, or in the case of positive external effects, they do not generate benefits for society as a whole because the decision-maker would not benefit from them. Both are undesirable from a welfare economic point of view and therefore often lead to state intervention. External effects prevent the Pareto optimality of a market. There are several options available to prevent external effects, the best solutions being achieved through internalization , i.e. including external effects in the market.

External effects can by jawboning ( moral persuasion be mitigated), but a weak measure.

General rules can also be drawn up which lead to internalization through the negotiability of property rights . This solution is based on the Coase theorem . One example of this is emissions trading . Another solution provides for the injuring party to be held liable according to the polluter pays principle .

There are also opportunities for government intervention : External effects could be mitigated by government provision, or the government could impose commands , bans and conditions . Taxes , subsidies and remuneration for public services ( eco bonus ) are further market-based instruments for internalising external costs. In this context, incentive taxes such as the Pigou tax (social cost tax ) with their internalizing effect should also be mentioned, as well as the standard price approach . These have the advantage that, in contrast to bans, they leave economic agents the freedom of choice to reduce costs where this is possible at the lowest possible cost. By charging each good with its real, external costs, producers, consumers, road users or other citizens participating in the market receive the right price signals. In the ideal case ( win-win ), this not only improves the environment, but also overall economic welfare . This is formulated in the double dividend hypothesis and applied in practice: In Switzerland, for example, the CO 2 tax (price standard approach) and the performance-based heavy vehicle tax (Pigou tax), in which the amount of the tax is based on based on the estimate of external costs, calculated as incentive taxes. Through a reimbursement to citizens and companies, the total burden remains largely tax-neutral (income-neutral).

The truck toll , the water cent ( water penny ) and the eco-taxes in Germany can also be viewed from the perspective of the internalisation of external costs. Certificates can also mitigate the effects of external effects.

As a counterexample, costs can also be externalized. The costs incurred and still to be incurred are passed on to other regions or to subsequent generations. This alternative is used regularly, especially in the classic case of a market failure .

Examples

Examples of external effects

Production reception area		 Reception area
consumption
Broadcast area
production,
ext. disadvantage 		Industrial river pollution reduces fishing results Industrial river pollution destroys bathing facilities
Broadcast area
production,
ext. advantages 		Electricity dam protects farmland from flooding The dam becomes a destination for excursions
Transmission range
use,
ext. disadvantage 		Skiers destroy pastureland Cigarette consumption harms non-smokers
Transmission range
use,
ext. advantages 		Hunting increases agricultural yield The flowerbed is a feast for the eyes

The table opposite is intended to give examples of a number of possible external effects.

Example: A craftsman carries out repair work in an apartment. The following people are affected:

  • the apartment owner (he benefits from the transaction in the form of a positive internal effect),
  • the wife of the apartment owner (positive external effect),
  • the resulting noise disturbs the neighbors (negative external effect).

In this case, state intervention could take place by compensating the neighbor so that he is compensated for the negative external effect suffered. At the same time, the wife could be obliged to make a contribution to obtaining the external benefit.

External costs in energy generation

The external costs in the energy sector result primarily from the emission of pollutants during energy conversion, which in turn cause damage to human and animal health and ecosystems, as well as from the emission of carbon dioxide as an important greenhouse gas . Other factors also play a role. The estimates for the cost of carbon dioxide emissions vary widely; in the literature values ​​between 10 and 1000 dollars / ton can be found. A study published in 2018 put the so-called "social costs of carbon" at more than 400 dollars / ton, which is more than twice as high as the previously determined values ​​of around 150 to 200 dollars / ton. Converted to the emissions in 2017, this corresponds to damage of more than 16 trillion US dollars per year. In 2015, the external costs of fossil energy generation for 2013 were estimated at 4.9 trillion US dollars or more than 150 dollars per ton of carbon dioxide. For 2015, including the economic costs of environmental, climate and health damage, etc., the subsidies were estimated at 5.3 trillion US dollars. The global warming caused by the burning of fossil fuels is considered the greatest market failure in history.

If the market is to find the most economically efficient mode of production, as is the aim of liberalization, all factors that distort competition must be avoided and true costs must be established by internalizing all external factors. If this does not happen, the efficiency advantages of a liberalized market can be negated by negative effects on the environment. Options for producing this true cost are incentive taxes such as B. a CO2 tax or a functioning emissions trading system . These necessary mechanisms set limits to a completely free energy market. So far (April 2014) these external effects have only been internalized to a small extent; full internalization is not foreseeable. So z. For example, the annual report on energy consumption in Germany in 2013 by the AG Energiebilanzen came to the conclusion that “the incentives intended with emissions trading for emission-reducing behavior at such certificate prices [of approx. 5 euros / ton] are not to be expected”. The external costs of lignite mining and power generation alone were estimated at 15 billion euros for Germany in 2015.

literature

Individual evidence

  1. ↑ N. Gregory Mankiw , Grundzüge der Volkswirtschaftslehre. 3. Edition. Stuttgart 2004, pp. 221-227
  2. ^ Lorenz Jarass , Gustav M. Obermair, Wilfried Voigt: Wind energy. Reliable integration into the energy supply. Berlin / Heidelberg 2009, p. 94.
  3. ↑ Kapp, KW: Economic costs of the private sector. Mohr (Siebeck), Tübingen 1958 (German translation from: The Social Costs of Private Enterprise. Harvard University. Press, Cambridge / Massachusetts 1950).
  4. ^ Friedrich Breyer, Martin Kolmar : Fundamentals of economic policy. Mohr Siebeck, Tübingen 2010, pp. 255–260.
  5. ^ Robert H. Frank : Positional Externalities . In: Richard Zeckhauser (Ed.): Strategy and Choice . MIT Press, 1991, ISBN 978-0-262-24033-8 .
  6. ↑ Massimiliano Vatiero: Positional Goods: A Diagramatic Exposition . In: Quaderni del Dipartimento di Economia Politica . No. 575 , October 2009 ( online ).
  7. ^ Robert H. Frank: Positional Externalities Cause Large and Preventable Welfare Losses . In: The American Economic Review . tape 95 , no. 2 , 2005.
  8. ^ Robert H. Frank: Should public policy respond to positional externalities? In: Journal of Public Economics . tape 92 , no. 8–9 , August 2008, doi : 10.1016 / j.jpubeco.2008.03.001 .
  9. ↑ Federal Department for the Environment, Transport, Energy and Communication : Road noise abatement: positive development, but still great need for action . In: admin.ch , February 4, 2020, accessed on February 5, 2020.
  10. ↑ a b Microeconomics - Externalities. Retrieved November 20, 2014 .
  11. ↑ Martin Baur: Basis for an ecological tax reform. (Chapter 2 ff.) Federal Finance Administration (FFA), July 2012, accessed December 31, 2012. ( PDF; 241 kB ( Memento of the original of September 23, 2015 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked Please check the original and archive link according to the instructions and then remove this note. ) @1@ 2Template: Webachiv / IABot / www.efv.admin.ch
  12. ↑ Kathrine Ricke et al .: Country-level social cost of carbon . In: Nature Climate Change . tape 8 , 2018, p. 895-900 , doi : 10.1038 / s41558-018-0282-y .
  13. ↑ Nature Editorial: The costs of climate inaction . In: Nature . tape 561 , 2018, p. 433 , doi : 10.1038 / d41586-018-06827-x .
  14. ^ Ottmar Edenhofer , King Coal and the queen of subsidies . In: Science 349, Issue 6254, (2015), 1286f, doi : 10.1126 / science.aad0674 .
  15. ^ David Coady et al .: How Large Are Global Fossil Fuel Subsidies? In: World Development . tape 91 , 2017, p. 11-27 , doi : 10.1016 / j.worlddev.2016.10.004 .
  16. ↑ Nicholas Stern et al., Stern Review: The Economics of Climate Change 2006, Link .
  17. ↑ Valentin Crastan : Electrical energy supply 2. Berlin / Heidelberg 2012, p. 87.
  18. ↑ Valentin Crastan: Electrical energy supply 2. Berlin / Heidelberg 2012, p. 88.
  19. ↑ AG Energiebilanzen , energy consumption in Germany in 2013. p. 41.
  20. ↑ Greenpeace: Social costs of lignite. 11/2015