Externalities...

I want to play a little 'Economics 101' and before you tune out and go check the latest cuteness on insta_kitten, I need you along for the ride. Because sometimes they make these things obtuse and hey I'm still learning too...

Today in the news I heard about a massive soft drinks company that is taking legal action against the Northern Territory government over a law designed to promote recycling of containers. The deal is that under the scheme companies are compelled to pay a 10c refund on returned bottles. Now the companies don't like this because if they are charging you say $2 for a bottle of their fizzy stuff that 10c represents a 5% loss for them (greater if you measure it just against their profit). Now the soft drink company could just put up the price of the drinks, but that might lose them customers.

Soft drink companies don't particularly want their bottles back; they send them out into the world, full of goodness hoping they find a good home. Soft drink companies are selling you a product; the beverage, and you in turn are buying a product. The container is just a necessary evil in delivering sticky, sugary goodness to your belly. Except that the container must go somewhere and someone has to deal with it.

This is known as an 'externality'. The can or bottle is completely external to your decision to buy the drink and when the drink is gone, more often than not so is your interest in the container. The container does not disappear however, though it might go to trash, or to recycling or worst of all just become rubbish out in the big wide world. In all of these scenarios someone, somewhere down the line has to pay for it.

To deal with the cost of an externality we sometimes use a device called an 'externality charge'. Basically an externality charge is the cost of dealing with the externality. So in the case of the soft drink company and the bottles, the 10c refund is the externality charge. It's like the NT government is saying 'Hey, if we have to clean up your mess, well then we're going to make you pay for it!'

We all deal with externalities every day...

Who does the cooking at your place? I love to mix it up in the kitchen, but I'm often a little over it when it comes to cleaning up. My goal is to make an awesome meal and by the time that's achieved the dishes are just a nuisance. See the dishes are our externality.

We've all got our 'externality charge' techniques to deal with this. I'm most familiar with 'the cook doesn't clean', brilliant right! Except that the next night, when I'm not cooking, it's my turn to clean. This scheme ensures that the cooking gets done by a happy chef, the cleaning gets done by a grateful diner and everyone tries to be tidy knowing that their turn is coming up.

Car registration is another externality charge. "What?!" you say, not our precious cars! But did you really think you were getting free use of the roads and all the bright shiny lights that come with it? Cars produce wear and tear on roads, as well as pollution, traffic congestion and our registration fees contribute towards paying these costs.

Is it starting to sound like externalities and externality charges have a lot to do with cleaning stuff up? That's probably because many of the externalities we encounter in our day to day world are of the messy, polluting kind. Many tend to be the by-products of our modern world that we didn't understand completely when they were first invented. Things like the exhaust from cars, non-biodegradable plastic containers and the emissions created when electricity is generated. Because they weren't fully understood when they were introduced they weren't adequately accounted for.

The problem with externalities is that they always have to be accounted for. Now you might not ever see that cigarette butt you threw away again, but someone will end up fishing it out of a waterway when it goes down the drain. Similarly your exhaust fumes today might not ever kill a fish you'll meet, but it contributes to an overall air toxicity that will rain down into the water table and on to rivers, lakes...

Externality charges are not designed to punish; they are put in place to make sure the right person pays for the externality. Let's go back to the soft drink bottles. Chances are the company will raise the price of the drink a little bit, maybe even the full 10c. This might make you as a consumer decide not to purchase the more expensive drink - awesome no rubbish! Equally you might decide to buy the drink but then keep your bottle and claim your refund - awesome, still not rubbish! For any in-between scenario the refund has created an incentive for any random stranger to make a few dollars collecting cans and bottles. Rubbish problem solved and no one loses in real terms.

There are plenty of other situations where we see externalities and their charges every day. One big one is the Federal Government's so-called 'Carbon Tax'. Just like the bottle refund it's intended to make us think about our consumption, maybe change our behaviour a little bit and ultimately provide a way to pay for any mess. At the moment it sounds far from perfect but there's room for improvement unless we dump it. But more on that later...