The manufacture of many products, and the provision of some services, results in adverse effects being experienced by people who are not directly involved as producers or consumers. Holiday-makers flying off to sunny foreign beaches impose noise costs on the residents of areas close to the airport. When a firm, as a by-product of its production activity, emits smoke or gas into the atmosphere, people outside the firm may experience unwelcome consequences. Damage may take the form of ill-health, physical deterioration of property or the natural environment, or simple displeasure at having to endure an unpleasant smell. Producers may also impose costs on one another. In the case of an open-access resource such as a fishing area at sea, the introduction of additional fishing boats will eventually deplete the stock of fish and make it more costly for existing boats to achieve a given size of catch. If new boats enter the industry and disregard the adverse effects experienced by other members of the fishing fleet, the fleet will grow to a size greater than that which is in the interests of the industry as a whole. It is possible that any resource which is available for unrestricted communal use may be so over-exploited that it is effectively destroyed. This has been called ‘the tragedy of the commons’.
Figure 4.1 External costs
Figure 4.1 illustrates the general problem of external costs. We suppose that an industry is competitive and that it is therefore possible to draw a supply curve which represents marginal costs of production (MIC). These costs are internal costs, i.e. they consist of explicit payments for factors of production used by the firm and compensation for the use of any resources supplied internally within the firm (for example the value of the owner's time and a return on equity capital). Assume that the demand for the output of the industry is given by the curve DD1. A price will then be established at p* and the output will be q*. The existence of external costs is indicated by the curve (MEC) in the diagram. These are marginal costs which are borne by people who are not compensated. As the industry grows these people become worse off.
If a group of people are made systematically worse off by the growth of an industry we might expect them to attempt to remedy the situation. This will require some form of collective action by the group in an attempt to influence the industry's behaviour.
If legal remedies are available they may attempt to gain compensation for damage through the courts. In England, action may be taken by an individual claiming negligence or perhaps private nuisance against a neighbouring polluter. This would not require any collective organization although representative actions are a possibility. Public nuisance applies to cases where a whole class of people are affected and is a crime. The law developed in an era when it was more natural to think of the typical public nuisance as a rowdy dance hall rather than the large-scale spillage of some polluting substance, but statutes have created new examples of public nuisances.
The case of Alphacell Ltd v Woodward (1972 2 All ER 475) illustrates the use of the courts to prosecute a company for causing a public nuisance. The Mersey and Weaver River Authority successfully brought an action against Alphacell Ltd for causing polluting matter to enter the River Irwell contrary to section 2(1) of the R ivers (Prevention of Pollution) Act 1951. The polluting matter had an adverse effect on fish life and resulted from the blocking of filters and the overflow of effluent into the river. The case established that it was not necessary to show that Alphacell Ltd was negligent.
If the groups harmed by the growth of industry are in other related industries, or if they are members of the same industry (as in the fishing example) so that the harm is external to the firm but internal to the industry as a whole, they may attempt to integrate their operations or form an association to regulate activities through professional codes of conduct.
In Scotland, the right to fish for salmon at any place on a river or on the sea coast is held exclusively by an individual owner. These rights can be bought and sold, leased to others and bequeathed to heirs like any other private property. This enables a single owner to accumulate rights over a sufficiently large area to manage the resource more efficiently. Williamson (1988) gives the following example: ‘The various salmon net fisheries in the lower reaches of the river Tay were brought under a single management at the turn of the century. This resulted in a decrease in the netting effort but, according to contemporary accounts, an increase in the value of both the net fisheries and the upstream rod fishings’ (p. 97). Rod fishing interests can also buy out netting stations. ‘An Atlantic Salmon Conservation Trust has been set up in Scotland specifically to purchase coastal netting stations for the benefit of salmon management …’(p. 98).
Source: Williamson (1988)
The groups may lobby the government for action to be taken against polluting firms.
Pressure groups may form at the local, national or even international levels. Although they face great problems of organizing collective action (see below) the ability to provide private benefits as part of their activities or to appeal to pure idealism has permitted many organizations to grow to a significant size. The National Trust, for example, had a membership of 2.7m in 2001. Greenpeace claimed 2.9 supporters in 158 countries in the same year.
None of these activities is costless to individuals and the benefits are widely dispersed. The organization of collective action therefore confronts great problems. People are tempted to free ride on the efforts of others and may hope to achieve the benefits of a cleaner environment at no expense to themselves. The greater the external costs incurred, however, the greater the incentive to attempt to overcome these difficulties. In local areas peer group pressure and disapproval of free riding will be a significant force producing cohesion; if consumers begin to take environmental considerations seriously in their shopping decisions, bad publicity may have a significant adverse impact on a firm's reputation and hence sales; if enough people are badly affected by an industry, or if they are concentrated in politically sensitive areas, politicians will have an incentive to take up their cause in the interests of election or re-election.
The potential gains available from agreement between polluting firms and those being polluted are illustrated in Figure 4.1. An agreement to reduce output from q* to q’, for example, will reduce the costs experienced by pollutees by the shaded area abq*q’. At the lower output level, price will rise from p* to p’. This will have two effects. It will raise industry profits from area hdp* to area hecp’. Profits are total revenue minus total cost – the area between the horizontal line representing price and the MIC curve. The increase in profits is therefore p’cfp* minus the small area def. Consumers are worse off than before by the area p’cdp*. However, it is evident from the diagram that the gains to firms and pollutees exceed the losses to consumers. Another way to look at this is to note that the combined loss to consumers and firms is area cde, while the gain to pollutees is abq*q’. Providing the latter area is bigger than the former, it is possible to think of an agreement that would make everyone better off than in the initial situation. The most convenient situation would be if each person consumed an equal proportion of the industry's output, owned the same proportion of the shares of the polluting firms, and placed the same value on reduction in pollution as everyone else. In this kind of situation, people would gain as residents and owners more on the roundabouts than they lost as consumers on the swings.
Of course, in practice we would not expect everyone to make a net gain in this way. Instead we would probably expect some groups of people to benefit and others to lose. If the industry is localized and the pollution is experienced in the immediate vicinity while consumers are distributed far and wide, it is not unrealistic to expect local industry and residents to benefit at the expense of consumers. On the other hand, if local firms face intense competition from firms elsewhere or from other non-polluting products, they will be unable to raise prices, and output reductions are likely to entail lower profits. Similarly, if the buyers of the product are organized (perhaps the product is an intermediate input into another industrial process) we would not expect the polluting industry to be able to use the environmental issue to raise prices and divert resources in its favour. Again, if those experiencing the pollution are widely spread and far away we would expect their interests to be registered only weakly by the political process unless the damage is greatly feared (e.g. nuclear energy). An important example of the relative political impotence of pollutees occurs in the case of transnational pollution (e.g. coal-fired power stations in the UK causing acid rain in Scandinavia). Further, agreements may be difficult to enforce and police. Suppose that through their industry representatives, firms agree to restrict output. Unless the Director General of Fair Trading and the Restrictive Practices Court agree that the social benefits are large enough or could not be achieved by other means (see Section 3.8) this may be unenforceable. The industry would also have to prevent new firms entering the market attracted by the higher profits that the output reduction has made possible. ‘ Voluntary’ agreements are therefore only likely to work in special circumstances, and governments will influence them using a range of policy instruments. Each of the instruments will have different effects, involve different distributions of gainers and losers, require differing administrative structures, and different access to information and so forth. In the next section we investigate some of the more important instruments of environmental policy.
