Externalities

One of the most common objections to capitalism is that it leads to unchecked negative externalities. An externality is an effect of economic activity that is not accounted for in the costs of the goods or services involved in the transaction.

Many externalities are positive: For instance, when a park is created near some houses, it adds to the value of the surrounding property, even if the neighboring homeowners did not have to pay for its existence. Others are negative, such as when an airport being constructed near houses reduces the value of those properties.

Usually, people citing negative externalities as an objection to capitalism have in mind the air or water pollution that capitalism seems to produce, since limiting such waste is often not profitable. The solution to these problems, says the opponent of capitalism, is the intervention of the state via subsidies, public services or regulations. Such intervention will fix the “inefficiency” of the free market.

In a completely free capitalist society — in which the state is committed to nothing but protecting the lives, liberty and property of its people — how can this problem be solved?

The answer might surprise you. It is a proper definition of individual rights, especially property rights.

It may be the case that we cannot always say precisely where one’s property ends. With some kinds of physical property, such as land, the issue is straightforward. With other kinds, such as the air above one’s property or the water that flows through one’s property, the issue is much more complex. Intellectual property is arguably even more complicated.

However, this just demonstrates the need for objective criteria that determine when harm has been done on a level that justifies compensation. Obviously, there are clear cases when I am “harmed” that do not justify compensation — I cannot justly require compensation for the fact that seeing a certain skyscraper next to my house annoys me.

On the other hand, it could never be the case that someone could get away with directly covering my property with toxic fumes. All of the cases in between can be solved by proper definitions of property in air or ocean, for example, and a system of courts that allows citizens to express their grievances and engage in litigation. The ever evolving principles of common law are an excellent tool here.

Economic regulations or taxes unfairly punish every capitalist engaging in certain kinds of economic activity by restricting their freedom whether or not they have created objectively defined sources of harm to others. Taxes on carbon emissions that can be found in several European countries are one such example.

It might be thought, though, that the restriction of freedom on some businessmen is worthwhile in the context of furthering the welfare of society as a whole.

But we should not think in these terms — individuals do not exist merely to meet the needs of the public at large (indeed, there is no “public good” independent of the values of each individual).

The activities of people in trade and production will presumably often create many positive effects and negative effects that are unaccounted for: The issue only becomes a legitimate state concern when people are objectively being coerced or a person or her property is directly physically harmed. If a given economic transaction or productive activity does not harm others in this way, then individuals are perfectly justified in engaging in that action to seek their own profit or happiness.

Not only are externalities not a problem for capitalism, but capitalism is the best system for dealing with such externalities, since it is the system where all property is privately owned and therefore has the most objective method of addressing the side-effects of economic activity on individuals.

TRISTAN DE LIEGE won’t require compensation for the positive externality of this free column. He can be reached at tflenaerts@ucdavis.edu.