Editing Externality (section)

==Possible solutions==
===Solutions in non-market economies===

* In [[planned economies]], production is typically limited only to necessity, which would eliminate externalities created by overproduction. 
* The central planner can decide to create and allocate jobs in industries that work to mitigate externalities, rather than waiting for the market to create a demand for these jobs.

===Solutions in market economies===

[[File:Outdated "No Dumping" in Derryhallagh townland, County Monaghan.jpg|thumb|right|200px|Regulations against actions with negative externalities, like "No Dumping" laws, can reduce these actions.]]
There are several general types of solutions to the problem of externalities, including both public- and private-sector resolutions:
* [[Corporations]] or [[partnerships]] will allow confidential sharing of information among members, reducing the positive externalities that would occur if the information were shared in an economy consisting only of individuals. 
* [[Pigovian tax]]es or [[subsidies]] intended to redress economic injustices or imbalances.
* [[Regulation]] to limit activity that might cause negative externalities
* [[Government provision]] of services with positive externalities
* [[Lawsuit]]s to compensate affected parties for negative externalities
* Voting to cause participants to internalize externalities subject to the conditions of the [[Efficient Voter Rule|efficient voter rule]].<ref>{{Cite journal|last=Anderson|first=David A.|date=2020|title=Environmental Exigencies and the Efficient Voter Rule|journal=Economies|volume=8|issue=4|pages=7|doi=10.3390/economies8040100|doi-access=free|hdl=10419/257149|hdl-access=free}}</ref>
* [[Mediation]] or negotiation between those affected by externalities and those causing them

A [[Pigovian tax]] (also called Pigouvian tax, after economist Arthur C. Pigou) is a tax imposed that is equal in value to the negative externality. In order to fully correct the negative externality, the per unit tax should equal the marginal external cost.<ref>{{cite book |last1=Gruber |first1=Jonathan |title=Public Finance and Public Policy |publisher=Worth Publishers |isbn=978-1-319-20584-3 |pages=364–365}}</ref> The result is that the market outcome would be reduced to the efficient amount. A side effect is that revenue is raised for the government, reducing the amount of [[Distortion (economics)|distortionary]] taxes that the government must impose elsewhere.  Governments justify the use of Pigovian taxes saying that these taxes help the market reach an efficient outcome because this tax bridges the gap between marginal social costs and marginal private costs.<ref>Barthold, Thomas A. (1994). "Issues in the Design of Excise Tax". ''Journal of Economic Perspectives''. 133–51.</ref>

Some arguments against Pigovian taxes say that the tax does not account for all the transfers and regulations involved with an externality. In other words, the tax only considers the amount of externality produced.<ref>Nye, John (2008). "The Pigou Problem". ''The Cato Institute''. 32–36.</ref> Another argument against the tax is that it does not take private property into consideration.  Under the Pigovian system, one firm, for example, can be taxed more than another firm, even though the other firm is actually producing greater amounts of the negative externality.<ref>{{cite journal |last1=Barnett |first1=A. H. |last2=Yandle |first2=Bruce |title=The end of the externality revolution |journal=Social Philosophy and Policy |date=24 June 2009 |volume=26 |issue=2 |pages=130–50 |doi=10.1017/S0265052509090190 |s2cid=154357550 }}</ref>

Further arguments against Pigou disagree with his assumption every externality has someone at fault or responsible for the damages.<ref>Coase, R.H. (1960). "The Problem of Social Cost". ''The Journal of Law and Economics''. 1-44.</ref> Coase argues that externalities are reciprocal in nature. Both parties must be present for an externality to exist. He uses the example of two neighbors. One neighbor possesses a fireplace, and often lights fires in his house without issue. Then one day, the other neighbor builds a wall that prevents the smoke from escaping and sends it back into the fire-building neighbor’s home. This illustrates the reciprocal nature of externalities. Without the wall, the smoke would not be a problem, but without the fire, the smoke would not exist to cause problems in the first place. Coase also takes issue with Pigou’s assumption of a “benevolent despot” government. Pigou assumes the government’s role is to see the external costs or benefits of a transaction and assign an appropriate tax or subsidy. Coase argues that the government faces costs and benefits just like any other economic agent, so other factors play into its decision-making.

However, the most common type of solution is a tacit agreement through the political process.  Governments are elected to represent citizens and to strike political compromises between various interests.  Normally governments pass laws and regulations to address pollution and other types of environmental harm.  These laws and regulations can take the form of "command and control" regulation (such as enforcing standards and limiting [[process variable]]s), or [[environmental pricing reform]] (such as [[ecotax]]es or other Pigovian taxes, [[pollution market|tradable pollution permits]] or the creation of markets for ecological services). The second type of resolution is a purely private agreement between the parties involved.

Government intervention might not always be needed. Traditional ways of life may have evolved as ways to deal with external costs and benefits. Alternatively, democratically run communities can agree to deal with these costs and benefits in an amicable way. Externalities can sometimes be resolved by agreement between the parties involved. This resolution may even come about because of the threat of government action.

The use of taxes and subsidies in solving the problem of externalities
Correction tax, respectively subsidy, means essentially any mechanism that increases, respectively decreases, the costs (and thus price) associated with the activities of an individual or company.<ref>{{cite book |title=Journal of Mathematical Economics |publisher=Feb-2008 |pages=367–382 |edition=volume 44}}</ref>

The private-sector may sometimes be able to drive society to the socially optimal resolution. [[Ronald Coase]] argued that an efficient outcome can sometimes be reached without government intervention. Some take this argument further, and make the political argument that government should restrict its role to facilitating bargaining among the affected groups or individuals and to enforcing any contracts that result.

This result, often known as the [[Coase theorem]], requires that
* Property rights be well-defined
* People act rationally
* [[Transaction costs]] be minimal (costless bargaining)
* [[Complete information]]
If all of these conditions apply, the private parties can bargain to solve the problem of externalities. The second part of the [[Coase theorem]] asserts that, when these conditions hold, whoever holds the property rights, a [[Pareto efficient]] outcome will be reached through bargaining.

This theorem would not apply to the steel industry case discussed above. For example, with a steel factory that trespasses on the lungs of a large number of individuals with pollution, it is difficult if not impossible for any one person to negotiate with the producer, and there are large transaction costs. Hence the most common approach may be to regulate the firm (by imposing limits on the amount of pollution considered "acceptable") while paying for the regulation and enforcement with [[taxes]]. The case of the vaccinations would also not satisfy the requirements of the Coase theorem. Since the potential external beneficiaries of vaccination are the people themselves, the people would have to self-organize to pay each other to be vaccinated. But such an organization that involves the entire populace would be indistinguishable from government action.

In some cases, the Coase theorem is relevant. For example, if a [[logging|logger]] is planning to clear-cut a [[forest]] in a way that has a negative impact on a nearby [[resort]], the resort-owner and the logger could, in theory, get together to agree to a deal. For example, the resort-owner could pay the logger not to clear-cut – or could buy the forest. The most problematic situation, from Coase's perspective, occurs when the forest literally does not belong to anyone, or in any example in which there are not well-defined and enforceable property rights; the question of "who" owns the forest is not important, as any specific owner will have an interest in coming to an agreement with the resort owner (if such an agreement is mutually beneficial).

However, the Coase theorem is difficult to implement because Coase does not offer a negotiation method.<ref>Varian, Hal (1994). "A Solution to the Problem of Externalities When Agents Are Well Informed". ''The [[American Economic Review]]''. Vol. 84 No. 5.</ref> Moreover, Coasian solutions are unlikely to be reached due to the possibility of running into the [[assignment problem]], the [[holdout problem]], the [[free-rider problem]], or [[transaction cost]]s. Additionally, firms could potentially bribe each other since there is little to no government interaction under the Coase theorem.<ref>Marney, G.A. (1971). "The ‘Coase Theorem:' A Reexamination". ''Quarterly Journal of Economics''.Vol. 85 No. 4. 718–23.</ref> For example, if one oil firm has a high pollution rate and its neighboring firm is bothered by the pollution, then the latter firm may move depending on incentives. Thus, if the oil firm were to bribe the second firm, the first oil firm would suffer no negative consequences because the government would not know about the bribing.

In a dynamic setup, Rosenkranz and Schmitz (2007) have shown that the impossibility to rule out Coasean bargaining tomorrow may actually justify Pigouvian intervention today.<ref>{{Cite journal|last1=Rosenkranz|first1=Stephanie|last2=Schmitz|first2=Patrick W.|date=2007|title=Can Coasean Bargaining Justify Pigouvian Taxation?|journal=Economica|language=en|volume=74|issue=296|pages=573–585|doi=10.1111/j.1468-0335.2006.00556.x|issn=0013-0427|hdl=10419/22952|s2cid=154310004|hdl-access=free}}</ref> To see this, note that unrestrained bargaining in the future may lead to an underinvestment problem (the so-called [[hold-up problem]]). Specifically, when investments are relationship-specific and non-contractible, then insufficient investments will be made when it is anticipated that parts of the investments’ returns will go to the trading partner in future negotiations (see Hart and Moore, 1988).<ref>{{Cite journal|last1=Hart|first1=Oliver|last2=Moore|first2=John|date=1988|title=Incomplete Contracts and Renegotiation|jstor=1912698|journal=Econometrica|volume=56|issue=4|pages=755–785|doi=10.2307/1912698|url=https://dspace.mit.edu/bitstream/1721.1/63746/1/incompletecontra00hart.pdf|hdl=1721.1/63746}}</ref> Hence, Pigouvian taxation can be welfare-improving precisely because Coasean bargaining will take place in the future. Antràs and Staiger (2012) make a related point in the context of international trade.<ref>{{cite journal |last1=Antràs |first1=Pol |last2=Staiger |first2=Robert W |title=Offshoring and the Role of Trade Agreements |journal=American Economic Review |date=December 2012 |volume=102 |issue=7 |pages=3140–3183 |doi=10.1257/aer.102.7.3140 |url=http://dash.harvard.edu/bitstream/handle/1/3374525/antras_offshoringrole.pdf }}</ref>

Kenneth Arrow suggests another private solution to the externality problem.<ref>{{Citation|last=Arrow|first=Kenneth|title=Political and Economic Evaluation of Social Effects and Externalities|work=The Analysis of Public Output|pages=1–30}}</ref> He believes setting up a market for the externality is the answer. For example, suppose a firm produces pollution that harms another firm. A competitive market for the right to pollute may allow for an efficient outcome. Firms could bid the price they are willing to pay for the amount they want to pollute, and then have the right to pollute that amount without penalty. This would allow firms to pollute at the amount where the marginal cost of polluting equals the marginal benefit of another unit of pollution, thus leading to efficiency.

Frank Knight also argued against government intervention as the solution to externalities.<ref>{{Citation|last=Knight|first=Frank H.|title=Some Fallacies in the Interpretation of Social Cost|work=Quarterly Journal of Economics|pages=582–606}}</ref> He proposed that externalities could be internalized with privatization of the relevant markets. He uses the example of road congestion to make his point. Congestion could be solved through the taxation of public roads. Knight shows that government intervention is unnecessary if roads were privately owned instead. If roads were privately owned, their owners could set tolls that would reduce traffic and thus congestion to an efficient level. This argument forms the basis of the traffic equilibrium. This argument supposes that two points are connected by two different highways. One highway is in poor condition, but is wide enough to fit all traffic that desires to use it. The other is a much better road, but has limited capacity. Knight argues that, if a large number of vehicles operate between the two destinations and have freedom to choose between the routes, they will distribute themselves in proportions such that the cost per unit of transportation will be the same for every truck on both highways. This is true because as more trucks use the narrow road, congestion develops and as congestion increases it becomes equally profitable to use the poorer highway. This solves the externality issue without requiring any government tax or regulations.

===Solutions to greenhouse gas emission externalities===
The negative effect of carbon emissions and other [[greenhouse gas]]es produced in production exacerbate the numerous environmental and human impacts of anthropogenic climate change. These negative effects are not reflected in the cost of producing, nor in the market price of the final goods. There are many public and private solutions proposed to combat this externality

====Emissions fee====
An emissions fee, or [[carbon tax]], is a tax levied on each unit of pollution produced in the production of a good or service. The tax incentivised producers to either lower their production levels or to undertake abatement activities that reduce emissions by switching to cleaner technology or inputs.<ref>{{Cite web | url=https://www.c2es.org/content/carbon-tax-basics/ |title = Carbon Tax Basics|date = 20 October 2017}}</ref>

====Cap-and-trade systems====
The cap-and-trade system enables the efficient level of pollution (determined by the government) to be achieved by setting a total quantity of emissions and issuing tradable permits to polluting firms, allowing them to pollute a certain share of the permissible level. Permits will be traded from firms that have low abatement costs to firms with higher abatement costs and therefore the system is both cost-effective and cost-efficient. The cap and trade system has some practical advantages over an emissions fee such as the fact that:
1. it reduces uncertainty about the ultimate pollution level. 
2. If firms are profit maximizing, they will utilize cost-minimizing technology to attain the standard which is efficient for individual firms and provides incentives to the research and development market to innovate. 
3. The market price of pollution rights would keep pace with the price level while the economy experiences inflation.

The emissions fee and cap and trade systems are both incentive-based approaches to solving a negative externality problem.

====Command-and-control regulations====
Command-and-control regulations act as an alternative to the incentive-based approach. They require a set quantity of pollution reduction and can take the form of either a technology standard or a performance standard. A technology standard requires pollution producing firms to use specified technology. While it may reduce the pollution, it is not cost-effective and stifles innovation by incentivising research and development for technology that would work better than the mandated one. Performance standards set emissions goals for each polluting firm. The free choice of the firm to determine how to reach the desired emissions level makes this option slightly more efficient than the technology standard, however, it is not as cost-effective as the cap-and-trade system since the burden of emissions reduction cannot be shifted to firms with lower abatement.<ref>{{Cite web | url=https://www.khanacademy.org/economics-finance-domain/microeconomics/market-failure-and-the-role-of-government/environmental-regulation/a/command-and-control-regulation-cnx | title=Command-and-control regulation (Article)}}</ref>

==== Scientific calculation of external costs ====
[[File:Visualization of percentage price increases for broad food categories.webp|thumb|"Relative percentage price [∆] increases for broad categories [...] when externalities of greenhouse gas emissions are included in the producer's price."<ref name="10.1038/s41467-020-19474-6"/>]]
A 2020 scientific analysis of external climate costs of foods indicates that external greenhouse gas costs are typically [[environmental impact of meat|highest for animal-based products]] – conventional and organic to about the same extent within that [[ecosystem]]-subdomain – followed by conventional dairy products and lowest for [[organic food|organic]] [[Plant-based diet#Sustainability|plant-based foods]] and concludes that contemporary monetary evaluations are "inadequate" and that [[policy]]-making that lead to [[Sustainable food system|reductions of these costs]] to be possible, appropriate and urgent.<ref>{{cite news |last1=Carrington |first1=Damian |title=Organic meat production just as bad for climate, study finds |url=https://www.theguardian.com/environment/2020/dec/23/organic-meat-production-just-as-bad-for-climate-study-finds |access-date=16 January 2021 |work=The Guardian |date=23 December 2020}}</ref><ref>{{cite news |title=Organic meats found to have approximately the same greenhouse impact as regular meats |url=https://phys.org/news/2020-12-meats-approximately-greenhouse-impact-regular.html |access-date=16 January 2021 |work=phys.org |language=en}}</ref><ref name="10.1038/s41467-020-19474-6">{{cite journal |last1=Pieper |first1=Maximilian |last2=Michalke |first2=Amelie |last3=Gaugler |first3=Tobias |title=Calculation of external climate costs for food highlights inadequate pricing of animal products |journal=Nature Communications |date=15 December 2020 |volume=11 |issue=1 |pages=6117 |doi=10.1038/s41467-020-19474-6 |pmid=33323933 |pmc=7738510 |bibcode=2020NatCo..11.6117P |url=|language=en |issn=2041-1723}} [[File:CC-BY icon.svg|50px]] Available under [https://creativecommons.org/licenses/by/4.0/ CC BY 4.0].</ref>