Sunday, August 31, 2008

Internalizing Costs

This is the first of what I expect to be many references to internalizing costs. Without going into too much detail on the process of representing environmental cost into prices, I would like to summarize why such internalization is necessary. Contemporary economics, as influenced be Adam Smith, David Riccardo, and so on, grew up in an earlier time, a better time. Man-made capital was the limiting resource, and the idea that natural capital would ever be scarce was absurd. Today most environmentalists (and several key economists) have realized that natural capital is finally the more scarce of the two rudimentary types of capital. However, the price system that governs a market economy barely incorporates "natural capital" unless that capital is harvested, mined, or otherwise arranged in a commodity form--and even then most of the cost is in the labor needed for the extraction. The costs of lost ecosystem services, pollution, or less tangible environmental damage is usually paid indirectly--and as in the case of most external costs, inadequately and irresponsibly--through government spending of tax dollars.

The libertarian in me asks, "Why not internalize the costs and allow market forces to inspire sufficient environmental responsibility?" Scientists have devoted their careers to estimate the value, in dollars, that a particular ecosystem is worth to society. The commonly cited "economic trivia", if you will, is that the biosphere provides twice the global economy in services such as water filtration, pollution management, and crop pollination (among thousands if not millions of others). So the value is there, but how do we internalize it?

So the question becomes a "How do we represent these costs in our prices?" And where I'm stuck is exactly how marginalization breaks down regarding an ecosystem service. Ecology would suggest that a certain amount of exploitation can be sustained before a threshold is reached, though ecologists argue that knowledge of that threshold is unattainable. The overall value of the ecosystem can be gaged, though I'm skeptical that approximating average total cost as the marginal cost would work with many key issues. For example, carbon emissions might contribute only a minor environmental cost early on but eventually reach infinite environmental cost (and for those non-math majors, the average cost is going to end up being "infinity over total units", or... infinity). How can this be resolved?