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An externality is a cost or benefit not borne by or given to the one who should rightly have to deal with it.[1]

Mainstream economists often urge governments to adopt policies that internalize negative externalities, e.g. regulation of pollution and adopting penalties for causing harm to innocent bystanders.[2] Methods used by governments to control negative externalities include:

  • Taxation
  • Regulations, including penalties
  • Allowing redress for parties affected by externalities via tort cases including class action lawsuits

The problem[edit]

The negative examples are the most common, usually dealing with pollution on neighboring populations. The clearest example of this is air pollution. A power plant that emits filthy, sooty smoke is imposing a cost unfairly on its neighbors, instead of bearing it itself. This causes overproduction and overuse of resources that could be more efficiently used elsewhere (such as clean air), since the one making the product does not suffer the costs of dirtying the air.

No business wants to bear the costs of its externalities, even if they could calculate an objective cost, as they increase the cost of production and the price of their product. This is one reason many companies move their factories outside of the US to countries with less stringent environmental laws and regulations. That way, they can dump anything they wish into the environment and not give a hoot. Corporations — and entire industries — have worked diligently to avoid internalization of externalities because of the large profits that can be made. Methods of avoidance include:

This is one instance where all mainstream economists, even the strongest pro-capitalism ones, will agree that government should step in and redistribute the costs in order to keep the economy running at maximum efficiency. This concept is very easy to understand if you're not a libertarian and think everyone should just stop whining.[3]

Based on Ronald Coase's 1960 paper "The Problem of Social Cost",[4] libertarian-style anarcho-capitalists such as the Ludwig von Mises Institute have argued that "as long as property rights are clearly defined and transaction costs are low, the individuals involved in these situations can always negotiate a solution that internalizes any externality."[5] This, however, assumes that information about externalities are shared equally among negotiators, which is often unlikely because a corporation will have both a larger financial ability and preexisting expertise to obtain more information by research, as well as a vested interest to keep that information secret.

Some anti-environmentalists, such as Christopher Horner of the Competitive Enterprise Institute, turn this whole concept on its head, basically arguing that if environmentalists want clean air, etc., they should pay for it.

Environmental policies come with a cost, often to the society as a whole, decreasing wealth, and so harming health. The average environmentalist, however, ignores this danger by assuming the policies' costs will fall on someone else's shoulders (multinational corporations, wealthier people, or if the environmentalist is a European: Americans)… American green activists confront a public that nonetheless remains more skeptical of government and state interventionism than the subjects of the European Union, who readily turn to the state once they are convinced a problem exists. This European faith in interventionism also yields a lower threshold of skepticism to alarmism. That is not to say that Americans are broadly disposed against calling on government to fix something believed to be a problem… Consider the response, or rather lack thereof, of some communities as Hurricane Katrina approached, and the apparent expectation that Washington would take care of it (and then the post-Katrina response of seeking a government-funded rebuild in the same storm-prone, sub-sea level location). If you expect the government to keep you safe from hurricanes while you live on the coast below sea level, you are probably willing to give the government whatever powers it claims to need to control the weather.
—Christopher Horner[6]

Negative examples[edit]

Your liberty to swing your fist ends just where my nose begins.
—Various people[7]

Here we have a list of people and entities that have by-and-large gotten away with hitting other people in the nose.

  • Air pollution emitted by a factory that the local residents must suffer as increases in respiratory illnesses.
  • Water pollution from cruise ships damaging stocks of fish in the waters they frequent.
  • Clearcutting a forest, resulting in a landslide without roots or vegetation to support the soil.
  • Second-hand smoke
  • Global warming — countries and people will be affected disproportionately to the amount that they contributed to global warming
  • Government-subsidized healthcare for industry-caused problems, such as from cancer caused by tobacco smoking, asbestos, lead paint, and coal mining. These are usually associated with corporate coverups that attempt to hide the true extent of the hazard from the public. Even without government-subsidized healthcare, these would still be negative externalities because the affected parties are often unaware of the full extent of the risks that they are taking or being subjected to.
  • Antibiotic resistance — overuse of antibiotics by some segments of the population has worse impacts on other segments (hospitalized people and those undergoing kidney dialysis).
  • Anti-vaccination movement — some people are unable to be vaccinated for medical reasons. People who oppose vaccinations for personal convictions compromise herd immunity and put the health of those who cannot be vaccinated at risk.
  • The Holocene extinction,Wikipedia an extinction level event that will primarily affect people that did not cause it
  • Various banking crises, caused primarily by subgroups of investors but widely affecting non-investors
  • Residents of American suburban sprawl located outside city limits often use the city's public services without paying the city taxes that fund those services.
  • The theft of land and subsequent displacement of indigenous peoples to make way for economic development.

Positive examples[edit]

  • Vaccinations that reduce the number of infected carriers of certain diseases, so even fewer people are exposed (herd immunity).
  • Businesses around a popular shop/restaurant that see an increase in business as well.
  • Buying a fuel efficient or electric vehicle, which reduces the demand for (and therefore the price of) gasoline for everyone else.
  • Beekeepers who raise bees for honey will also pollinate nearby crops
  • Educating employees to improve their on-the-job performance will also improve their performance when they move to new employers, and may have other social benefits. Some corporations have viewed this positive externality as unfavorable to their profits and have attempted to control its effects via non-disclosureWikipedia and non-compete agreementsWikipedia with employees as a condition of employment.

See also[edit]

  • Coase theorem — a method of dealing with externalities when certain conditions are met

External links[edit]


  1. Externality by James Buchanan & Wm. Craig Stubblebine (1962) Economica 29(116):371–84. doi:10.2307/2551386.
  2. Environmental Economics for Tree Huggers and Other Skeptics by William K. Jaeger (2005) Island Press. p. 80. ISBN 1559636688.
  3. Externalities by Alexander Volokh (Aug 15th, 2008) The Cato Institute.
  4. The Problem of Social Cost by R. H. Coase (1960) The Journal of Law & Economics 3:1-44.
  5. What is an Externality? by Gene Callahan (08/01/2001) Mises Institute.
  6. The Politically Incorrect GuideTM to Global Warming (and Environmentalism) by Christopher Horner (2007) Regnery Publishing. p. 12. ISBN 1596985011.
  7. Your Liberty To Swing Your Fist Ends Just Where My Nose Begins by Garson O'Toole (October 15, 2011) Quote Investigator.


  1. Yes, this is somehow perceived as being less expensive than just bearing the externality costs. (Risk management and long-term planning? What are those?) …In fact, almost the entirety of this list can be boiled down to "throwing money at problems to make them go away and avoid spending money to fix them", which… doesn't really make any sense if you think about it too hard. If you're going to be spending money either way, you might as well spend it on an actual solution rather than leaving a metaphorical hole in your pocket. One would be tempted to conclude that people are generally not very skilled at rational thought.