One of the important concepts in environmental economics or economic valuation is the concept of externalities. This concept may sound so sophisticated and complex to understand to the novice in environmental economics. However, while teaching this concept to students I realized that this is a very important concept that everyone must know to be able to come up with informed decisions. Understanding what externalities are and how they can be used in making the most of your decisions can make a difference between “the devil and the deep blue sea” as the popular adage on difficult decision situations say. I narrate the story of the mango grower and the beekeeper to further make clear the concept of externalities.
Definition of Externalities
Externalities are just those unexpected outcomes or third party effects that may arise when someone makes a decision while making transactions with another entity. That entity may be a person, an organization or a company.
The concept of externalities can be made clearer by the classic story of the apple grower and the beekeeper. However, this is a temperate country example so to put it in context in tropical countries, I will relate the story of the mango grower and the beekeeper as an adapted version.
The Mango Grower and the Beekeeper
In a small island in the tropics, two farmers engaged in two different livelihood activities. The first man grows mango trees and produces mangoes for local consumption and exports these mangoes abroad. The other man, a beekeeper, rears bees in culture boxes also for the same purpose, i.e., for local consumption and export.
These activities went on for several years and both businesses thrived until the beekeeper noticed that the bees are no longer bringing in a significant amount of nectar in the culture boxes. This phenomenon happened when the mango grower started to cut down some trees in his farmland to make way for a road to facilitate transport of mangoes from his growing export business.
Due to poor honey production, the beekeeper decided to stop engaging in beekeeping because his income could no longer sustain his once thriving business. Since the decline in honey production, he had to trim down on the number of employees until he could no longer support even two of them.
Back to the mango grower, the farmer noticed a decline in mango production since his neighbor beekeeper stopped his business operation. What could be the reason behind this decline?
The mango grower, concerned that he might likewise stop his mango growing business like the beekeeper, sought the help of a local university knowing that there are faculty members engaged in agricultural research. The university dispatched a veteran researcher to look into the plight of the mango grower (that person could be someone from the environmental science department). The main objective of the researcher is to find out the reason why there was a decline in mango production.
The environmental scientist, knowing the classic story of the apple grower and the beekeeper, related the story to the farmer. He said, the decision of the beekeeper to stop his beekeeping operation affected the mango grower’s agricultural production because the bees pollinate the flowers of the mangoes. Since the mango grower decided to cut down some of his mango trees to make way for the road, the availability of nectar from these mango trees also declined. Hence, less honey for the beekeeper.
Realizing his mistake, the mango grower decided to see the beekeeper and explain the scenario. They were both illuminated of their situation. The mango grower convinced the beekeeper to resume his business and while doing so, he will compensate for the pollination services of the bees. He also assured the beekeeper that he will plant more mango trees to replace the number of trees that was lost. From then on, their business once again thrived and they lived happily ever after.
The Externalities in the Story
What then are the externalities in the story of the mango grower and the beekeeper? These are the unexpected benefits that arose from their business operations. What are these benefits?
Two unexpected benefits are evident in the business operation of the two farmers. These are 1) the pollinating services of the bees, and 2) the mango trees’ flowers as source of nectar.
Once these externalities are recognized and incorporated in decision making, these are internalized externalities and they no longer are considered externalities. So when someone talks about internalizing the externalities, this refers to the incorporation of the third party effects in any transaction. This means that in the story, the mango grower internalized the externality of the pollinating services of the bees.
But is the other externality, that is, the flowers of mango trees that serve as nectar internalized? In this story, it is not. How can this be internalized? The mango grower must also be compensated by the beekeeper because the honey are obtained by the bees from the mango trees. So if honey production is good, the beekeeper must likewise compensate or provide a share to the mango grower to internalize this externality.
From this story and discussion, externalities therefore are the benefits, disadvantages, or third party impacts that may ensue as a result of any situation or transaction that affects the environment. Thus, to come up with sound decisions and to achieve environmental sustainability, these externalities must be internalized.
Externalities may be positive or negative. I illustrate both types of externalities in the gulf oil spill incident in Mexico several years ago that caused not only negative externalities but also positive externalities. You may click here to read the article to further strengthen your understanding of externalities.
© 2013 November 3 P. A. Regoniel