Fraser Forum

William Watson: How to fix an externality—handle with care

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As I’ve mentioned in previous posts, May (and a little bit of June) is the Fraser Institute’s season for teaching economics to journalists, which I do with several American colleagues who are terrific teachers and enjoy economics as much as I do.

After we’ve described the virtues of markets we also talk about market failure, including the problem of externalities, both positive and negative. We introduce externalities by playing this video—“When is a Potato Chip not just a Potato Chip?”—by Duke University professor of political science, Michael Munger. (For a political scientist he knows a lot of economics!) As you can see, someone eating a potato chip can make unwanted noise that bothers people who weren’t party to the original potato chip transaction between grocer and buyer.

It’s great pedagogy but I always suspect it leaves the journalists hankering for something a little more real-worldly and substantial. On cue, enter the National Bureau of Economic Research, which this week published a working paper by the economists Akshaya Jha of Carnegie-Mellon University in Pittsburgh (once famous for its steel-town pollution externalities) and Nicholas Z. Muller of Middlebury College in Middlebury, Vermont, (recently made famous, or infamous, by the intentional negative externalities generated by protestors who disrupted a talk by libertarian political scientist Charles Murray).  

Jay and Muller's paper is called “Handle with Care: The local air pollution costs of coal storage.” The externality the authors are interested arises from the fact that handling coal creates coal dust, a fine particulate that can be bad for people's health.

There are three steps in their analysis:

1. Does handling of coal create an externality?  
2. Does the externality cause harm?
3. What's the cost of the harm?

Item 1 they establish by looking at the pattern of particulate dispersion across the United Sttaes, on which there's lots of information thanks to active, detailed monitoring under various clean air acts. Of course, finding particulates in the air isn't enough to determine coal-handling is responsible. But they also have data on where coal-handling takes place and how much coal is handled. And after some careful econometrics they are able to establish a correlation between particulate density and coal handling.

Item 2 they examine by looking at the pattern of various illnesses and causes of death across the U.S. Again, they find a correlation between particulate density in different U.S. counties and various health problems.

The final step, 3, is to figure out how much different diseases and premature deaths cost. That's easy: If it's my premature death we're talking about, the cost is infinite! But economists typically take a less extreme approach to costing than that. In fact, these increases in particulates don't kill anyone with certainty. They merely increase the risk of death of people who live within 25 miles of coal stockpiling. We all take reasonable risks of death everyday. The amounts we're willing to pay in order to avoid them are a good measure of how much we dislike these increased risks. So it's not unreasonable to use those amounts as an estimate of the "social cost" of handling coal. The amount the authors actually use, which they borrow from Environmental Protection Agency work on this question, is $9.85 million per death--which may not seem like much... but remember it's in U.S., not Canadian dollars.

It all seems pretty logical, or at least it does if you've been doing economics as long as I have: handle more coal, produce more particulates, cause more harm. Then compare the harm with the undeniable benefits of handling coal and see if you can find ways to reduce the harm without eliminating the benefits.

So, the $64,000 question, as they used to say in the famous 1950s quiz show of that name: How big is the cost? ($64K in 1959 is equivalent to $549,000 today, according to the Bank of Canada Inflation Calculator.)

The authors themselves would be the first to admit that the relationships they're studying are complex and the calculations difficult. But after 40 or so pages of pretty careful statistical work what they get is:

1. Increasing coal handling by 10 cent, as measured by deliveries, increases particulate concentrations within a radius of 25 miles by 0.12 per cent, with no significant effects beyond 25 miles.  
2. Increasing particulate concentrations by 10 per cent increases the chance of adult deaths by 1.1 per cent and of infant deaths by 6.6 per cent.  
3. Using standard estimates for the "value of a statistical life," the local environmental cost of particulate increases from coal stockpiles is $182.67 per ton of coal stockpiled, which is big since the average coal plant "pays $48 per ton for coal, stockpiles 212,781.6 tons of coal and has 106,235 tons of coal delivered to it each month." (The decimal points are a sign, as the old saying goes, that the economists have a sense of humour.)

Could they be wrong? Of course they could. The connections are complex and the data are not nearly as precise as the decimal places suggest. Does it follow that coal-mining should be shut down, as the losing candidate in last year's U.S. presidential election seemed at times to want to do. Not necessarily. But government policy toward coal may need to be re-thought. And not just in the way you might assume. For instance, government regulation of coal prices may cause coal firms to stockpile more coal than they would otherwise—13 per cent more on average according to another study by one of the authors (Jau)—and that extra stockpiling and attendant coal-handling creates appreciable costs that could be avoided with less or no price regulation.

To my mind, the neatest thing about economics is its tendency to reveal unanticipated consequences exactly like this one. If we're really smart, we understand we're not that smart.


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