How does socialism deal with negative external effects?

external effects

External effects are influences of one economic entity on one (or more) others that are not subject to the control of a price mechanism. A distinction is made between external costs and external benefits that can occur in production, consumption and government economic activity and between these areas.
External effects play an important role, especially when it comes to protecting the environment. They can be eliminated (internalized) in two different ways:
(1) Those affected - the polluter and the injured party - come to an agreement through negotiations (Ronald H. Coase); this assumes that the property rights and rights of use are designed accordingly (Coase theorem).
(2) The activity that is responsible for the creation of external effects is taxed or subsidized (Arthur C. Pigou).

The effect of an action (production or consumption) that does not occur with the decision-maker and / or is not explicitly taken into account in the decision-making process of the causer. A distinction is made between positive external effects (fertilization of an orchard by the bees of a neighboring beekeeper) and negative external effects (environmental pollution of a factory). As a rule, neither a fee (for the use of a positive external effect) nor compensation (for a negative external effect) can be demanded or obtained for the external effect.

In a market economy, an external effect is important because it influences the efficient allocation. In the case of external costs, consumers and / or producers are negatively influenced by the economic activities of other economic agents. (Example: Air pollution from an industrial company that does not have filter systems).

On the other hand, there are no problems with external benefits where those affected benefit from the consumption and / or production of others. A well-known example is the interaction between bees and orchards during flowering. Without pollination by the bees, the harvest would be much smaller, and the beekeeper would have no honey without the plantation. The problem, especially with external costs (additional social costs), is to assign them to the causers and to force them to include the external costs in their own accounting (internalization of external costs). Because the private costs are below the societal (social) costs, since the negative effects are not included in the price calculation. The state can stipulate internalization by law, e.g. by installing soot filters or catalytic converters in motor vehicles. However, it is also conceivable to achieve a reduction in external costs through voluntary agreements between the injured party and the injured party (Coase theorem).

Externalities, external influences on the utility function of an individual.

Detailed representation:

If the benefit function of an individual cannot only be influenced by himself, but also depends on the decisions of others, there are external effects. They are represented in the formula:

U (a) = U (a) * (X (an), Y)

U (a) = utility function of A
X (an) = decision parameter of A
Y = decision parameters of others that cannot be influenced but nevertheless influence the utility function of A.

Three types of external effects are distinguished in the literature:
Pecuniary, psychological, and technological externalities.

Pecuniary externalities describe a shift in the relative price relations of a market; they are a fundamental instrument of the market economy and therefore conform to the market.

If the utility function of an individual depends on the activities of another without a physical connection (e.g. due to feelings such as envy, malicious pleasure, sympathy, etc.), there are psychological externalities.

For economics are above all Technological external effects are interesting as they are a cause of market failure.

If property rights cannot be enforced in a market due to transaction costs, this will result in a quantity and / or price distortion.
This lies in the difference between social and private marginal costs, the external effects.

The classic examples of positive external effects are the bees in the garden of A and an apple tree in the garden of B. The bees fertilize the blossoms of the tree: A receives honey and B receives apples.

The classic example of negative external effects is the fisherman and the steel mill. Because the steelworks pollute the river, the fisherman experiences a drop in sales or is threatened to exist. Therefore, the fisherman can pay the steel company something to reduce the pollution of the river. In this way, the optimal degree of pollution can be found through payment (marginal social costs).

At negative external effects However, the resulting marginal social costs can often not be attributed to the cause. If it is not possible to adequately sanction behavior that damages cooperation or to exclude a cooperation member from the joint cooperation income, there are even incentives to free-rider behavior (cheating).

An example:
If, for example, a franchisee in a franchise system provides services of inferior quality without this being sanctioned by the system head, he can damage the reputation of the overall system and thus all other franchisees (negative external effect).

Who is the cause of an external effect from an economic point of view depends on the design and distribution of the property rights. This is not necessarily identical to the physical cause of the external effect (see Coase theorem).

External effects are both external advantages (= external benefits) and external disadvantages (= external costs).

In socialist economics: Effects of an economic activity. that occur outside of market relationships and where the causer and the person affected do not agree.

In the environmental economy:
A distinction is made between different types of external effects, of which one form, namely technological externalities, is particularly relevant for economic policy. Many types of environmental problems are the result of technological externalities.

Technological external effects exist when the actions of one actor directly influence the benefit or profit of another actor without this relationship being captured by the market mechanism; So there is no compensation - for example in the form of a compensation payment. Technological external effects can be both positive and negative in nature. For environmental problems, it is above all the negative technological effects that are relevant.

A paint factory discharges sewage into a river, which is why the catch of the river fishermen deteriorates in terms of quality and quantity. The amount of pollutants enters into the fishermen's production function without this influence being regulated by appropriate market relationships (e.g. compensation for fishermen) (negative external effect).

Since findings from basic research cannot be patented under current law, there are no rights to this knowledge. Any company that comes into possession of the results of basic research (in some way) may use this knowledge for its own purposes without having to contribute to the corresponding costs of basic research (positive external effect).

If there are technological external effects, this means that the private costs and benefits (i.e. those that are perceptible to the respective producer or consumer as expenditure or income) differ from the social costs or benefits arising for society as a whole (see figure). The difference between the two cost or benefit categories indicates the extent of the technological external effect and, in the case of a negative external effect, is referred to as "external costs" or "additional social costs". In the case of positive technological externalities, one speaks of “external benefit” or “additional social benefit”. The presence of technological externalities has the consequence that market prices reflect the actual scarcity relations (social costs and benefits) only in a “distorted” way.

Technological external effects lead to a distortion of the factor allocation and result in a loss of welfare. In the case of negative extremalities, the misallocation consists in the fact that the person causing the external costs operates the activity in question to a large extent, e.g. B. (if it is a manufacturer of goods) produces too large a quantity; if the good in question is traded on markets, the price in question is too low (since the producer does not bear all the costs). Since the injured party is burdened with additional costs, their level of activity is too low for society as a whole, and a commodity that they provide commercially would be too expensive (since they do not have to bear the costs they have caused). In the case of positive external effects, the polluter is only compensated for part of the benefits he has brought about; consequently the price of the good produced is too low and the level of activity of the beneficiary is too low. Since the respective beneficiary only bears part of the costs for the service purchased, his level of activity is too high and he sells his service too cheaply.

Without appropriate countermeasures, technological external effects lead to misallocations and thus to a loss of welfare; however, it is generally by no means economically viable to completely eliminate an externality and thus avoid all negative effects on the environment. The reason for this is that avoiding a negative externality (e.g. a unit of pollutant emissions) is associated with corresponding avoidance costs. In order to be able to assess whether the avoidance of a unit of damage makes sense, one has to compare the expenses incurred (marginal avoidance costs) with the damage avoided by the restriction of the externality (marginal damage). Only if the benefits associated with the restriction of emissions (= avoided damage) exceed the corresponding avoidance costs, the reduction of the externality is economically advantageous. Since the complete avoidance of an emission is usually associated with enormous costs, but a very low level of emissions often proves to be less harmful, such benefit-cost calculations usually speak against the complete avoidance of an emission. The optimal extent of an emission is characterized by the fact that the marginal damage measured in monetary units is the same as the marginal avoidance costs.

The existence of technological external effects is closely linked to the corresponding legal framework. They are only possible by not applying the so-called "exclusion principle" to all components of the costs or benefits of a good. In the case of external use, this means that someone who does not provide anything in return is not excluded from the usufruct. In the case of external costs, the non-application of the exclusion principle means that third parties have to accept costs without corresponding compensation. The occurrence of technological external effects is therefore closely linked to the form of the applicable property rights. The existence of positive externalities is therefore due to the fact that there are no property rights (which can be enforced at a reasonable cost) that would enable the producer to prevent the free usufruct by others. In the case of negative technological external effects, the injuring party does not have to pay for all the consequences of his actions due to the existing property rights: the injured party cannot adequately protect himself from the damage due to a lack of appropriate (enforceable) rights. If, for example, a river fisherman whose catch results have deteriorated due to the sewage of a paint factory had property rights on the river (in particular a right to ward off pollution), he would be entitled to prevent the development of negative extremality.

A number of different instruments are available for combating the negative consequences of technological externalities. In addition to moral appeals, the merger of those involved, and orders and bans, particular mention should be made of duties / taxes, the negotiation of compensation payments and tradable environmental certificates; In addition, the design of liability law can provide not inconsiderable incentives to avoid negative technological external effects. When assessing these various instrumental alternatives, it is not just a question of the extent to which the harmful consequences are reduced to an optimum with the agent in question (criterion of static efficiency). It is also of essential importance to what extent an intervention instrument provides incentives to develop technologies that are associated with a lower level of damage from the outset or with which harmful emissions can be avoided more cheaply (criterion of dynamic efficiency).

It would also be important how exactly a certain environmental standard (e.g. CO2 emissions per year) can be achieved with a certain instrument (criterion: accuracy). The various instruments used to combat technological externalities vary considerably in terms of these criteria.

Further reading:

Fritsch, M. / Wein, T. / Ewers, H.- J .: Market failure and economic policy, 3rd edition, Munich 1999; Feess, E .: Environmental Economics and Environmental Policy, Munich 1995.

Sohmen, L., Allokationstheorie und Wirtschaftsppolitik, Tübingen 1976. Schlieper, U., External Effects, in: HdWW, Vol. 2, Tübingen et al. 1980, pp. 524ff

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