In economics, an externality is defined as an indirect consequence of production or consumption that affects not the producer or consumer but a third party — society as a whole or some sub-population. Because the costs and benefits of externalities are not included in the price of the product, externalities have the potential to distort markets, where prices are theorized to reflect the “real” value. Positive externalities bring benefits to the third party; negative externalities impose costs. Below are some examples of positive and negative externalities.
Positive Corporate Externalities
- A workplace vaccination program reduces absenteeism for the company but also benefits society as a whole by slowing spread of infectious diseases.
- Insurance discounts for those who complete driver education programs can reduce payouts for company, costs and accidents for drivers, and motor vehicle injury rate for society.
- Voluntary installation of pollution control systems can win a manufacturer a tax break, benefit nearby residents by lowering pollution and benefit society as a whole by lowering pollution-related costs.
Negative Corporate Externalities
- Air pollution from industrial manufacturing contributes to respiratory and cardiovascular diseases and cancer, agricultural damage and climate change.
- Tobacco use leads to increased hospitalizations and lost productivity, the costs of which are borne by tax payers and government.
- Industrial production of meat led to farms that were easier to run, with fewer and often less-skilled employees, and a greater output of uniform animal products. Social costs include contributing to the increase in the pool of antibiotic-resistant bacteria because of the overuse of antibiotics; air quality problems; the contamination of rivers, streams, and coastal waters with concentrated animal waste; animal welfare problems, mainly as a result of the extremely close quarters in which the animals are housed.
One important reason that corporations contribute to premature death and preventable illnesses and injuries is that they are able to externalize, i.e., shift to consumers, taxpayers, or society as a whole, the real costs of production or consumption of the products they manufacture. In this commentary, I explain how corporate externalities contribute to public health problems. In a later post, I will explore a few proposals to improve population health by requiring corporations to “internalize” these external costs back into the price, thus reducing socially subsidized use. My larger purpose is to encourage public health professionals and researchers to focus more closely on public health externalities and the development of strategies to promote positive and reduce negative externalities.
Because manufacturers of goods (or services) that impose negative externalities are not required to pay these costs, the public subsidy increases profits for the maker. Companies therefore tend to produce more of that product, which in turn magnifies the adverse impact on population health. In effect, negative externalities initiate a vicious circle of more sales, more profits, more subsidies and more disease. Examples include the dramatic expansion of the production and marketing of cigarettes, alcoholic beverages and unhealthy food such as fast food, sugary beverages and processed snacks in the second half of the twentieth century.
Since the overall cost and benefit to society is defined as the sum of the economic benefits and costs for all parties involved, the cost accounting that looks only at producers and consumers misses the externalities. Unlike those who “decide” to produce or consume goods, those who suffer from external costs do so involuntarily, creating an additional moral and political problem. In free market economic theory, an efficient market finds the ideal price for a good or service, defined as the price that best promotes the general welfare of society given the supply and demand. In reality, however, most transactions include some unforeseen externalities that confer costs or benefits on society at large and disrupt this theoretical efficiency. This tendency is amplified because in general neither corporations nor consumers account for such externalities when they make their transactions. What fast food outlet or customer considers who is going to pay for the diabetes treatment services that are attributable to aggressive marketing of unhealthy food? In some cases, this oversight results from the difficulties of determining the scope and costs of such externalities in the context of an individual transaction.
In other cases, however, corporations hide information that would allow consumers to make more informed choices. The tobacco industry’s comprehensive knowledge of the social costs of tobacco use revealed by the tobacco documents released as part of various court settlements illustrates this non-disclosure dramatically. Other industries have also hidden such information. In this way, market practice again departs from classical economic theory, in which both consumers and producers have equal access to relevant information. The problem of asymmetrical access to information further compounds the problem of negative externalities. The public that ends up paying the cost of these externalities e.g., tobacco, alcohol or unhealthy food-related diseases, does not even know they are being stuck with the tab.
To correct these problems, governments can seek to force companies to internalize externality costs. This means that if a company’s pollution creates economic costs (for example, the medical bill of a patient who gets sick from pollution), and then the government will force the company to pay that cost. In this way, the company can more accurately compare revenues and expenses and decide whether production is indeed profitable. In a future post, I’ll describe some of the proposals to achieve this goal.
For more on externalities and public health:
Biglan A. Corporate externalities: a challenge to the further success of prevention science. Prev Sci. 2011;12(1):1-11.
Carande-Kulis VG, Getzen TE, Thacker SB. Public goods and externalities: a research agenda for public health economics. J Public Health Manag Pract. 2007;13(2):227-32.
Global Diet and Sustainability Assessing the negative externalities of animal agriculture: A conference in New York City, October 12, 2012
Lustig RH, Schmidt LA, Brindis CD. Public health: The toxic truth about sugar. Nature. 2012; 482(7383):27-9.