Externalities are economic effects that are not felt exclusively by the initiator and are not traditionally taken into account when looking where the demand and supply of a good find each other. Thus a different equilibrium price and quantity would be found if externalities were taken into account. External effects can take place when producing and/or when consuming a certain good or service. Furthermore, they can be of a positive or negative nature. They can even be positive and negative at the same time, depending on the planned effects or unintended consequences they have for different involved parties. If externalities are taken into consideration when trying to find the optimal level of production/consumption for society, we will often find a different price/quantity. That will not only maximize the profit level for the producer and the user value for the consumer, but it will also look at the costs and benefits to others – non-consumers/producers – who are confronted with the external effects of these goods.
The existence of externalities plays a role in many kinds of markets. In the natural world and built environment these effects are clearly felt but not often effectively dealt with. Government traditionally has the monopoly to decide on the distribution of externality costs and profits. In many Western, late modern and late capitalist societies governments play a declining role in the functioning of markets and society, and therefore have a reduced role in the distribution of externalities. Furthermore, a case can be made that the traditional fixed distribution of externalities through law and regulation can lead to reduced total system wealth when compared to a more market-based system that makes use of negotiation, barter, incentives and collective action to allocate externalities.
Economic theory focuses more on calculating, pricing and managing negative externalities than on positive ones. This goes hand in hand with the tendency in society to focus on those issues that are un-wanted. The NIMBY (Not In My Back Yard) phenomenon, where citizens justly or unjustly organize strong local opposition to the arrival of a certain unwanted ‘good’ in their neighborhood, is an issue known to city councils around the world. We believe that this is because positive externalities are often harder to anticipate than negative ones and their effects more diffused.
Positive Externalities in the Built Environment
This project focuses on a number of economic, financial, and fiscal instruments that stimulate the production and consumption of positive externalities. With negative externalities production is deemed excessive because of the negative external effects they cause, and so must be addressed by forcing producers to internalize the costs. In contrast, goods with positive externalities tend to be under-produced because the simple market, without externalities taken into consideration, undervalues these goods. In other words: the market does not correctly price them, failing to factor in the full societal benefits that come from producing or consuming them, because it traditionally has no way of pricing and valuing those externalities. Thus, attaching value to the positive externalities incentivizes the creation of the goods.
One area in which the concept of externalities valuation has received mainstream acceptance is carbon trading. The right to pollute – to produce carbon as a by-product of another activity – is being traded between large companies, states and NGOs. The market functions far from perfectly because participation is voluntary, excessive credits are handed out by governments and enforcement is lax. Nonetheless, these exchanges have created the first market prices of carbon dioxide emissions. In principle market participants have an incentive to allocate the rights to pollute and the necessary compensation in the most effective way. This should lead to an overall decline of carbon pollution. Another domain where externalities are being valued is biodiversity finance, where in contrast to carbon trading positive externalities are being valued. Biodiversity is supported and those responsible get financial, legal, fiscal or others reward for their action.