Tuesday, July 4, 2017

External Costs of Fossil Fuels

The production of goods and services, that use energy from burning fossil fuels, does not include the costs of the increased risk of premature deaths and ongoing healthcare for pollution related illnesses.  Economists refer to these costs as external costs.(1)

The cost to consumers for goods and services with external costs are effectively being subsidized by society-at-large.  For example, fossil fuel companies receive subsidies through tax breaks. External costs also include polluted water, land and air both locally and on a global scale. The external costs in burning fossil fuels (negative externality) mean the social cost will be greater than the private cost. The existence of external costs defines a market failure. This is because the American economic market ignores the existence of external costs.(2)

The benefits to consumers from decreased pollution are not included in the cost of renewable energy from wind and solar that decreases the risk of premature deaths and decreases healthcare costs for everyone.  These external benefits are being received by society-at-large.  The cost of renewable energy to consumers would be lower if the benefits to the overall economy were included.

The benefits to consumers from decreased pollution are not included in the cost of electric vehicle ownership.  The external benefits are being received by the global society.  The cost to consumers of electric transportation would be lower if the benefits to society-at-large were included.

The gap between the subsidized cost of fossil fuels and the high cost (due to externalized benefits) of renewables and electric transportation does not account for the economic impact of external costs and benefits.  Government policy to narrow the gap has Republicans focused on their ideology that requires individual rights to override any collective rights or social benefits.

Politics balances individual rights and collective rights.  Prior to 2017, individual rights to profit, wealth, choice and private property contributed to the low cost of fossil fuels by externalizing the costs to society.  America’s Constitution enshrines individual rights as the primary ideal.  Being an American requires believing in individual financial independence and individual rights defined in laws.  Republicans have embraced this ideology and their supporters identify with these ideals.

In the future, the collective rights to clean water, land and air will contribute to lowering the costs of renewable energy and electric transportation.  The cost of fossil fuels will increase to account for the pollution of water, land and air.  As of 2017, the market has failed for decades to account for either because of the focus on individual rights instead of valuing collective rights.

America needs a policy that internalizes the current external costs of fossil fuels and monetizes the benefits of renewables and electric transportation for consumers.

How do we solve the problem? In economics, there is a principle that applies generally to situations of market failure called the principle of the second best.  The best solution is to eliminate the externality.  However, that is not possible in this case.

The principle of the second best says that when you have a market failure, the best policy is the one that most precisely corrects for the original problem. Whatever policy the principle of the second best recommends will be the policy that most precisely offsets the original distortion. In this case, what’s the original problem?

The original problem is an externality that allows producers to pass costs on to someone else, who doesn’t have a say in the matter. To correct that problem, decision makers must internalize the externality through laws and changing the tax code.

Politicians will enact changes in laws, increase taxes and eliminate subsidizes. With changes will come a change in behavior.  Why would Republicans agree to this change?  They won’t.  Democrats, representing a majority of Americans, will need to pass legislation to enshrine into law (and maybe one or more Amendments to the Constitution) the ideology of collective rights as a balance to individual rights.


The recommended action is simple. The actual implementation is not because Republicans will fight against increasing collective rights. To balance individual rights and collective rights, governments must use the tax code to stop subsidizing fossil fuels and increase subsidizes for renewable energy and EV transportation.

2.  Block, Fred L., and Margaret R. Somers. The Power of Market Fundamentalism: Karl Polanyi's Critique. Harvard University Press, April 2014.