Externalities

Externalities are the costs that have to be borne by the environment or taxpayer if businesses or individuals are not made to bear them themselves. A factory's pollution of the natural environment is the classic example of an externality.

The idea of externalities is most associated with the regulation of industry. Externalities are those costs that businesses do not automatically 'internalise'. 'Internalised' costs include wages for employees, the expense of buying production machinery and money spent on sales and marketing. Internal costs are all costs that businesses cannot avoid paying in any normal free market economy.

Environmental externalities

'Externalities' are those costs that businesses might not pay in an inadequately regulated economy. The most noted externality is pollution. As a byproduct of a production process a business may be pumping poisons into a river - damaging biodiversity and perhaps destroying the livelihood of people who depend upon water quality - eg fishermen and the tourist industry. Governments attempt to ban the worst kinds of pollution but milder forms of pollution - such as congestion - are 'green taxed' and the revenues sometimes used to compensate those affected.

Social externalities

A less discussed problem is that of 'social externalities'. Sixties socialists and social libertarians often believe in a laissez-faire approach to 'private behaviours' like sexual experimentation and the use of drugs. The trouble with this indulgent approach to 'private behaviours' is that they often have social consequences.

Smoking has obvious social externalities or what might be called social side-effects. The treatment of smoking-related illnesses costs the NHS billions of pounds every year. This cost to the NHS is rightly reflected in the high levels of tax imposed on buying tobacco. Recently the Government has decided to make certain pubs pay for the cost of policing the drunken yobs they serve.

Other 'private behaviours' are not subject to regulation, taxation or even stigma, however - despite the costs they represent. Extreme sportsters often cost the taxpayer a lot of money in healthcare and rescue. Should their insurance policies have to pay for any costs incurred by them getting lost on a mountain top?

Family breakdown is perhaps the biggest and most neglected social externality - costing British society upwards of £15bn every year. Shouldn't a prudent government do more to encourage sustainable family units?