Distributism and Externalities

All economic activity is conducted in the presence of externalities. These externalities might be positive or negative; they might be avoidable or unavoidable. At root, though, they are all the same thing: they are effects of that economic activity on things which are not a part of that activity. In other words, it is the effects of a transaction on someone who did not agree to the costs or benefits of the transaction. The quintessential example of an externality is pollution. A coal plant produces electricity and sells it to people; the people involved are the coal plant, its employees and owners, and its customers. But everybody, whether those involved in the electricity sale and those not, is effected by the emissions of the coal plant, even those who aren’t buying the electricity or working at the plant. Those emissions are an externality.

Unavoidable externalities exist, of course; the emissions of carbon dioxide produced by breathing, working humans, for example. Others are avoidable, like the wood chips from a lumber mill, which can become an externality by being dumped into a nearby river, or which can be absorbed by the lumber mill by simply cleaning them up and using them in some other way. And some externalities are positive, as when a game-management company increases the population of deer on private hunting grounds and that spills over onto public ones. But some, of course, are negative, like our coal plant emissions or the overheating of river water by factories. All of these are externalities; some of them are desirable and some are not. But all of them are economic failures.

According to the principle of commutative justice, a transaction is supposed to ensure that both parties are enriched to the same objective degree. Clearly, externalities fly in the face of that, because it involves forcing some enrichment or (more likely) detriment on others who are not parties to the transaction. Capitalists, of course, deny the principle of commutative justice (in fact if not in principle), but they espouse a notion of pricing that is supposed to exclude externalities. The price in a transaction is supposed to describe the entire cost-benefit calculation of the parties. But the price does not describe externalities; indeed, capitalists often define externalities precisely as those costs or benefits not reflected in the price.[1] In both cases, though, the existence of externalities means that the system has failed in some way. For a distributist who believes in commutative justice, justice is being denied those who are forced to endure costs without any compensating enrichment; for a capitalist, the price is failing to reflect the true costs of the transaction, which leads to a market failure. Externalities are a problem for both systems.

This is where the government is supposed to step in. Government economic activity is designed to require the internalization of externalities; that is, to require parties to transactions with externalities to absorb the external costs of those transactions. (We’re concerned here primarily with negative externalities, but in principle positive externalities are also a problem.) Government agencies see an industry with some substantial externalities; say, the coal industry. They insist that the coal industry internalize its externalities; that is, pay to clean up or prevent its own pollution. The coal company will then reflect the costs of this cleanup in the price of its electricity, which means that the transaction, the sale of electricity, now truly contains the full costs, including the cost of ensuring that those not parties to the transaction will not be effected by it. So, at least, goes the theory.

There are two problems with this theory, however. The first is that government sometimes simply fails; but that is unavoidable not the subject of this essay. The second problem is industry capture, sometimes also called regulatory capture. Companies which produce externalities substantial enough to be noticed by the government are typically large and powerful; they are also typically the ones with the most knowledge of a given field. So the government recruits members of these companies to assist in the regulation of the industries. But these recruits are often still more loyal to their former companies than to the government, and ensure that the government doesn’t regulate the industry any more than necessary to conform to statute and placate public opinion, even when this regulation doesn’t fully compensate for negative externalities. Government regulators and industry executives also have a tendency to move back and forth between these fields; they work in the regulatory agency until they can obtain a better-paying job in the industry, and ensure that eventuality by using their regulatory positions to assist the industry where they can. The industries thus, in a real sense, control at least partly their own regulators. This phenomenon has gotten blatant enough that large corporations, far from internalizing their externalities, are openly externalizing their internalities, as well, an occurrence seen most spectacularly in the corporate bailouts. Profits are internalized, of course, but even normally internal costs are externalized by persuading the government, through capture of industry regulators and the more or less open purchase of votes via fundraising and lobbying, to absorb them and spread them across society.

Obviously, this is a problem, and a problem that we’ve seen extensively in numerous fields of endeavor, especially financial regulation and intellectual property. The government here is simply not doing its job; it’s allowing private interests to overcome its pursuit of the common good, the latter of which is, after all, the entire purpose of its existence.

Distributists often feel as though their opinions are never heard and that they have no chance for affecting positive change in society. However, this area is one in which the public is already very sympathetic to our cause. The depravities of Goldman Sachs and the revolving-door of regulatory agencies to high-paying industry jobs are still very much fresh on the public’s mind, and the scourge of government by lobbyists is already widely hated by everyone the lobbyists aren’t already paying. Here, therefore, is one area in which distributism must make its voice be heard, standing up for a right economic order in our times.

Distributists should push for legislation which will help prevent this sort of blatant abuse of regulatory power against its proper end. Laws prohibiting regulators from taking jobs within or payments from their regulated industries for a period of time after their employment, say five years or so, would be an excellent start. Insulating government regulators from industry vote-buying, perhaps by raising the standard by which elected officials can hire and fire them, might be another. The ingenuity of the distributist mind should not be limited here; we must pursue all just means of ending this pernicious practice.

The distributist platform includes, of course, a sensible conception of the state and its role in society, a topic too broad to embark upon here but which has been treated extensively in the Review before. But the internalization of externalities is the rhythm to which we all must beat our drums. Corporations must not be permitted to force the public to absorb their costs; they must not be permitted to own their own regulatory agencies; and they must not be permitted to purchase legislation favorable to their own interests at the cost of the common good.

1. This is an inadequate definition because transactions can still have an effect on others even when the price reflects the possibility of those effects and the necessity of dealing with them. Such pricing reflects external effects of the transaction, but it does not eliminate them and it does not necessarily accurately reflect the cost of dealing with them. In such cases, the nature of an externality still exists even when the price is supposed to cover it.