This essay was submitted by my wife, Elke, for her Open University course.
Describe the neoclassical view of the free-market system. How do externalities occur in a free market? Why might some types of transport cause externalities?
Increased travel activity, various literature, and reports in the media, raise awareness about how global inequality currently creates two categories of nations. One consists of rich, sophisticated, civilised, industrialised countries with advanced political and healthcare systems, corporate culture, consumerism and financial institutions attempting to dominate people’s lives on a global scale. Poor “Third World” nations form the second category, deeply indebted to the world’s leading financial institutions and with populations exploited and prone to dangers of environmental problems and disasters along with starvation and diseases eradicated in industrialised nations.
The field of economics provides the basis for an investigation into causes for this inequality, looking first at basic workings of markets before obtaining the description of the neoclassical theory of the free-market system. This shall lead to answering the question of how externalities occur and a change of focus to reasons why some types of travel cause externalities.
Markets are places of exchange, where economic agents (buyers and sellers) meet to exchange goods or services for money at prices expressed as a monetary value. Barter – the exchange of goods for goods – is possible, but less practiced nowadays. Trading, generally regulated by rules and conventions, involves interaction of economic agents. Marketplaces vary from the local fruit stall with face-to-face interaction of buyer and seller to Internet trade, where there is no personal contact, or global markets for oil or copper.
The neoclassical view of markets emerged with Adam Smith and his book “The Wealth of Nations”, in which he explained the workings of an “invisible hand” that coordinates actions of economic agents driven by self-interest to the good of everyone – without people’s knowledge and intervention. This mainstream school of economics clarifies conditions which determine well-working markets and their benefits. One benefit is the allocation of – ideally privately owned – resources with the help of price mechanisms to satisfy human wants most effectively through a market with ideal conditions. All wants can be satisfied through consumption of goods and services. Customers buy according to their taste and firms produce the currently most profitable commodities. These choices made by economic agents, each following their own interests without considering consequences of actions, result in a balanced production of goods and services.
Price mechanisms ensure market efficiency and coordinate all agents’ actions and help shape their decisions and price-setting. One price, e.g. the world price for coffee, holds all necessary information on customers placing values on goods and producers’ resources and technology involved in production. Consumers calculate how much they are willing or able to pay. Producers decide what and how much should be produced. Only the most efficient producers – the ones able to offer goods and services at lowest prices to consumers due to low production costs – survive in markets with fierce competition. Inefficient companies drop out or change to producing more profitable items. An example to show the workings of price mechanisms is banana production. If there is a bad banana harvest in Honduras (or destroyed crops like in the aftermath of Hurricane Mitch), producers see a good reason (and critics an excuse) to raise banana prices. Higher prices result in less banana sales due to consumers opting for other fruit, people checking whether there are any cheaper bananas from other regions and buying those, or people without concerns on spending money simply paying more. Producers raise the prices until they reach a good balance between customers and producers.
Workings of markets and price mechanisms seem straightforward and positive, but don’t come without unintended or unconsidered consequences, which can also be well-known and willingly included in producing goods and profits. Michael Jacobs (1991) talks about an “invisible elbow” of market forces, able to cause general ruin, as a counterpart to Adam Smith’s “invisible hand”, bringing wealth and prosperity. Another term for “invisible elbow” is externalities. How do they occur?
Externalities refer to differences between private costs and benefits (incurred by economic agents involved in a market transaction) and social costs and benefits (incurred by other social agents not involved in a market transaction, along with private costs and benefits), which means economic agents can’t enjoy the full benefits, but also won’t pay the full costs of their actions. Externalities can be positive (flowers growing in one’s garden giving pleasure to neighbours and passers-by) or negative (environmental damage or destruction as a by-product of resource extraction, deforestation or chemicals production) and are usually not experienced by people who create them. Both producers and consumers are involved in creating externalities. Customers are interested in saving money by buying desired items at lowest prices without wondering whether their choice contributes to a low-wage exploitation culture or air or water pollution in another country. Producers are concerned about the creation of huge profits while investing as little money and resources as possible, moving their production wherever they find no or basic environmental and work regulations. Markets don’t consider wants of future generations or public goods, like air or water, and exclude people with no or little money available.
Looking at how transport causes externalities, it can be said that all types of travel using fossil fuels cause externalities in the form of air pollution – and annually increasing personal travel suggests implications on the earth’s climate for future generations. This applies both to private modes like cars, vans/lorries, motorcycles/mopeds as well as public transport like buses and especially planes. Manufacturing transport vehicles in low-cost production countries affect their people’s lives and environment. Trams or railways involve no fossil fuels (if engines are not diesel-powered) and are seen as environmentally friendly, but this depends on the electricity source to power the vehicles. Electricity generated by oil or coal power plants worsens air pollution like vehicles running on fossil fuels, and nuclear power plants are not proven to be without effects on the health of people living near them. Walking and cycling seem healthy ways to travel, giving people exercise to keep heart and body fit. However, it is not necessarily healthy to breathe in all the air pollution from private and public transport vehicles, and there are higher risks of involvement in accidents, especially for cyclists, if drivers of bigger vehicles don’t pay enough attention or if cyclists are careless.
The insight provided into the workings of free markets and externalities they cause for people and environment on a global scale contributes to knowledge about what creates inequalities, and food for thought to encourage changes to the free-market system with chances and benefits spreading from wealthy people and those in power to those people currently facing exclusion and disadvantages.
Copyright Elke Wallace, 2003
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