Market Internalization of Externalities: What Is Failing?

Abstract

The usual internalization of externality 'by the market' can be thought of through two different exchange modes: competitive markets, with Kenneth J. Arrow ( 1969 ); or bargaining, with Ronald H. Coase ( 1960 ). Although, in both cases, 'externality' refers to a non-exchanged effect that produces suboptimalities, these authors are working with two different, implicit conceptions of externality, rooted in different analytical worlds and calling for different institutions-parametric prices for the former but not for the latter. Moreover, while both start out with different theoretical frameworks, the authors share a concern for realism and unite when they introduce transaction costs, both advocating a policy design that calls for taking into account the costs of the different solutions. Nevertheless, this introduction of transaction costs does not itself escape consistency problems, since they do both maintain a reference to their respective ideal worlds.

On the definition of externality as a missing market

“…In order to explain why markets are missing, Arrow introduces such transaction costs at the end of his (1969) paper. Then he changes his previous conception of failure which becomes relative (see Papandreou 1994 or Berta andBertrand 2014). Nevertheless, he did not mention the transaction costs issue in his presentation of externalities a few years later (Arrow and Hahn 1971).…”

“…Since this study is limited to the Arrow-Debreu framework, it is restricted to an ideal world without transaction costs (for a discussion of the introduction of transaction costs in Arrow's and Coase's internalisation of externalities, see e.g., Berta and Bertrand 2014). It does not concern itself with the use of externalities in some important theoretical fields, especially in macroeconomics, the institutional approach and the theory of property rights.…”

“…See alsoBerta and Bertrand (2014).17 See alsoBerta and Bertrand (2014) for a comparison of Arrow and Coase on methodology and 'market' internalisation.…”

Paradise Lost: Accounting Narratives Without Numbers

“…For investors, company performance is a function of time, with past performance being the basis for estimating future profitability and returns to shareholders. It was not clear that there was a compelling need or urgency to 'internalise' externalities (e. g. Berta andBertrand, 2014, Nicolaus Tideman andPlassmann, 2010) and for those effects to be reflected in the financials (both ex ante and ex post). The company's response would be conditioned by the actions (or inactions) of competitors.…”

Internalizing Environmental Externalities in Cement Industry: Case Study for the Republic of Serbia and Selected Neighboring Countries

“…Although internalization of externalities was introduced with very positive intensions, group of authors opposed this by proclaiming internalization as " insufficient for solving externality problem" (van den Bergh & Grazi, 2010;Bithas, 2011;Berta & Bertrand, 2014;Weitzman, 2015). Authors found that in the real world where externalities exist, their internalization cannot lead to the sustainability due to specific form of externalities.…”