The Myth of Externalities and Carbon Credits

Photo of a calm river landscape with an industrial plant in the distance releasing pollutants into the air, capturing the juxtaposition between nature

In today’s economy, if an industrial plant upriver creates water pollution, and a community downriver is forced to cover the cost of the cleanup, it is considered an externality for the company causing the pollution. These types of externalities are a very common source of pollution: the local community, the nation, and the world bears the cost of industrial pollution while the corporation pockets the extra profit or increased market share by lowering the cost of its products.

The myth of a perfect market without externalities makes up a large part of the neo-liberal economy and is a leading cause behind the climate crisis. The actual cost of oil, if we include the military operations to protect the oil fields, the environmental impact of pollution, and the effect of greenhouse gases produced when burning the oil, would be many times higher than it is at present.

The same holds for nuclear energy. Recent studies have shown that the cost of dismantling old nuclear stations is far higher than anyone had previously thought. For example, it is estimated that it will cost more than $900 million to dismantle the Three Mile Island Unit 2 nuclear power plant, which was the site of the worst nuclear disaster in US history.

The nuclear disaster in Fukushima and the subsequent leaks into the ocean have not been factored into the cost of electricity for Japanese consumers. The cost of processing and storing the final waste has also become much higher than initially anticipated. Including these costs in the price of electricity generated by nuclear power plants would make nuclear energy much more expensive.

Neo-liberal economists today recognize that externalities exist but believe that they can and should be dealt with by the market rather than by government regulations. Theoretically, they assume that externalities are internalized into costs and, therefore, are technically not externalities. On the practical level, economic policies find a way to internalize the externality, for example, by inventing carbon credits. 

A business generally buys a carbon credit to justify or compensate for putting emissions into the atmosphere. It is essentially an accounting trick, which makes it possible for Business A to reduce or avoid creating a ton of CO2 so that Business B can buy the credit represented by the reduction and use it to ‘offset’ its emissions.

According to the Australia Institute, “Carbon credits may result in emissions reductions at a project level. But even if you assume all carbon credits are perfect, when they’re used as offsets, they, at best, only maintain the status quo. Carbon credits thus mean emissions are being moved from one sector to another, from the fossil fuel industry, for example, to the land sector (which is where most carbon credits come from).” In other words, when carbon credits are used to offset emissions, the overall result is an increase in emissions and a worsening of the climate crisis.

Another externality that neo-liberal economists do not account for is the free work provided by nature. Nature provides free services to us on a scale dwarfing the entire global economic output. Since nature’s total contribution is more significant than all business activities on earth, it is a far stretch to consider its contribution unimportant.

We are dependent on nature for our daily survival, even if we do not consider natural resources as adding economic value. Neither does the current system take note when our economic activities destroy the “free” resources that nature provides us.

Whatever economists today may assume, there are an overwhelming number of externalities in the real world that are not internalized or dealt with by the market. A self-regulating market creates externalities, and far from eliminating the need for government intervention, it makes such intervention necessary to avoid the destruction of the planet.

Hence, we cannot just theorize about externalities any longer or use carbon credits to whisk them away magically. If we continue, the trees will soon be gone, and the oceans will have more plastic containers than fish. The topsoil will be destroyed, and there will be no clean water to drink. We can no longer afford to internalize externalities on a massive scale. Because soon, the wheels of production will grind to a halt. Not for lack of technological ingenuity or financial smarts—no, due to a lack of our most precious economic resource: nature’s ecosystem services.


  • Roar Bjonnes is the co-founder of Systems Change Alliance, a long-time environmental activist and a writer on ecology and alternative economics, which he terms eco-economics.

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