POLLUTION: A CASE OF MARKET FAILURE OR GOVERNMENT FAILURE? Monday, March 05, 2007

Pollution has been declared indisputably bad. After all, who wants to drink dirty water or breath dirty air? So why not ban it completely and go for a pollution-free world? Why Shouldn't we insist on our politicians taking strident measures to combat the 'pollution menace' and save the planet? The answer is both simple and surprising. Not only is a pollution-free world impossible, it would also be severely damaging to human welfare!
What we should concern ourselves with is not pollution itself but excess pollution. What we must strive for is the socially desirable level of pollution: what the economists call the optimum pollution point. Pollution is generally defined as the release into the environment of man-made impurities. Not so. To have any practical meaning pollution must be defined as substances that are found in a locality and in such quantities as to damage directly or indirectly human welfare.
So what is the optimum? It is that point where cutting pollution by a given amount equals the benefits of doing so. It is that point where we maximise our welfare. Hence we stop cutting pollution when the costs of doing so exceed the benefits. In general, the more pollution is cut the more it will cost to cut it further and thus the gains to society will diminish with each successive redution. It is simply irrational to try and cut pollution beyond the point where the costs to society exceed the benefits. It would be like changing $100 note for a $20 note. It would leave us worse off and we wouldn't willingly do it.
It should be obvious that cutting pollution is not a costless task, regardless of what green propaganda implies. It involves the transfer of labour and capital from other activities. We do not live in a world of superabundance. It is not simply a case of more of everything but more of some things and less of others. In short, we are faced with a choice problem: a 'better environment' or fewer schools, hospitals, clinics, etc. This is something that ideologically motivated journalists and venal politicians do not tell the public.
The real cost of anything, be it a house or a new car, is what you must sacrifice to get it. If, for example, you have only enough money for a car or a holiday, and you choose the car, then the real cost of the car was the forgone holiday. This is what the economists call opportunity cost. And it is the real cost of anything. It therefore follows that society foots the bill for a 'cleaner environment,' not business. Economic laws will always ensure that so-called 'environmental costs' imposed on business will be factored back onto society, no matter what Bob Brown and other greens suggest. There is absolutely no way to escape that fact.
The concepts of optimum pollution and opportunity cost are vital to any understanding of the pollution debate. Without them we are rudderless. They allow us to formulate policies that will help maximise society's welfare while also helping to expose the economic fallacies expounded by the self-appointed guardians of the public interest. (The biggest fallacy/lie of these Green Guards is that 'conservation' is either costless or its benefits always exceed the costs).
This is not to deny that we do have pollution problems. In many instances the optimum is clearly being violated and 'social costs' are exceeding 'social benefits'. This is not caused by market failure, profiteering, capitalist greed or “economic growth at any cost”. (The true cost of growth, incidentally, is always forgone consumption), as claimed by 'conservationists'. It is caused by governments refusing to fully recognise and defend all property rights. Where governments should intervene, they have not. Thus we are faced with government failure and not market failure.
So basically we find that pollution is a private property problem. For example, if a factory spews out a chemical that damages surrounding property, economists call this an externality. What they mean is that the firm is being unwittingly subsidised by the neighbourhood. Firms do this because they are bad, they do it because the local environment is not priced.
The absence of local property rights has sent them a false signal. They have been told that the local environment is a free good that does not have to be factored into their production costs. Because the environment has not been priced investment is misallocated in way that encourages the use of air-polluting technology. (The situation might be different if residents were allowed to make arrangements with the firm that would result in a trade off that is satisfactory to both parties). (R. H. Coase, The Firm, the Market and the Law, University of Chicago Press, 1990).
If the environment is properly priced firms will be forced by economic incentive to treat it as they would any other factor of production. This means that they will have a constant incentive to find more economic ways of using it. Remember that in a free market firms not only strive to make money, they also strive to minimise costs.
As the environmental price will tend to be uniform the more efficient companies will use less of the environment than their less efficient competitors who will be forced to free their resources for other uses. Now some economists have claimed that by pricing the environment we would be directing resources from investment to consumption thus reducing future living standards. It would be better, they assert, to have more pollution so we can have more 'investment'. They believe that the value of the additional 'investment' would exceed social costs of the additional pollution.
They have made a grave error. Pricing the environment actually makes the investment\consumption ratio correspond more closely to consumers' preferences. These economists have overlooked that any investment directed by the market toward cutting pollution is actually contributing to human welfare by conforming more closely to consumer preferences. (Furthermore, these economists have unconsciously tried to substitute their values for those of the consumers. This is what greens consciously do).
However, even though there is no such thing as a free lunch the free market will still let us eat our cake and have it too. How so? Economic growth is the answer. Economic growth is not, as Green fundamentalists claim, a fiendish process based on "stupidity and greed" and which is "wantonly poisoning" and "raping Mother Earth". Economic growth is actually a resource generating process. It is economic growth that has flooded the Western world, and even parts of Asia, with unparalleled abundance.
Because economic growth means material progress which in turn generates more resources (and the greater the growth the greater the progress) we can allocate more of these resources to protecting the environment at less and less cost to ourselves. That is why only rich countries have the resources and the incentives to clean up the environment. The reverse, of course, is equally true.
Remember: richer really is safer and healthier.




Gerard Jackson Founder, the New Australian Brookes News Economic Editor
View all articles by Gerard Jackson