Ethical Limitations of Social Cost Pricing: An Application to Power Generation Externalities

By Soderholm, Patrik; Sundqvist, Thomas | Journal of Economic Issues, June 2000 | Go to article overview

Ethical Limitations of Social Cost Pricing: An Application to Power Generation Externalities


Soderholm, Patrik, Sundqvist, Thomas, Journal of Economic Issues


Patrik S[ddot{o}]derholm

According to neoclassical economic theory, the valuation of different externalities is necessary for assisting market processes and for socially efficient choices. For example, environmental effects that are unpriced in any market need to be assigned hypothetical monetary values. Taxes and subsidies that reflect these external costs will then ensure that profit-maximizing firms select the mix of goods and production technologies that best satisfy environmental and economic goals.

In recent years, policymakers and economists have particularly targeted the environmental damages arising from power generation. A series of valuation studies that attempt to estimate the environmental costs of various power-generating technologies have been commissioned by governmental authorities such as the European Commission, the U.S. Department of Energy, and the U.K. Department of Trade and Industry [Hohmeyer 1988; European Commission 1995a; Ottinger et al. 1990; Pearce et al. 1992]. These all underline the need to "get prices right" and to incorporate environmental externalities into market mechanisms. In his review and methodological critique of these studies Andrew Stirling [1998, 268] concludes that

. . . there is little doubt that neoclassical environmental valuation techniques are the approach to environmental appraisal currently preferred by the official bodies responsible for the formulation, implementation, and international coordination of environmental regulation in the electricity supply sector.

There are a number of valuation methods in use (e.g., abatement cost, contingent valuation, hedonic pricing, etc.), but ultimately they all aim at discovering people's willingness to pay (WTP) for environmental goods and services. While Stirling's work [1997, 1998] has dealt primarily with the methodological and measurement problems associated with these methods, this paper focuses solely on the philosophical and ethical aspects of environmental valuation when applied to power generation.

The purposes of the paper are (1) to explore some of the ethical limits of neoclassical environmental valuation, and (2) to discuss what the implications are of these limits for the social choice between power-generation technologies. The central message put forth is that the scope of electricity externalities where environmental valuation can be applied from an ethical point of view is likely to be narrower than commonly assumed. Consequently, since various power sources give rise to different types of externalities--some less amenable to social cost pricing than others--the choice between different technologies becomes much more complex than is implied by economic theory (and hence by the above environmental valuation studies).

In the next section, we review briefly the ethical foundations and the limits of environmental economics and discuss alternative philosophical approaches to social choice. The subsequent section analyzes these ethical limitations in the empirical context of power generation externalities, while the final section provides some concluding comments.

Ethical Limitations of Neoclassical Environmental Economics

Since the basic thesis of this paper is that monetary valuation of environmental externalities relies on specific ethical foundations, it is useful to review these before discussing alternative ethical bases for social choice. In neoclassical economics, human beings are treated as autonomous individuals who seek to satisfy their private preferences, which are exogenously determined. This implies that individuals have given preferences ("indifference maps") for public goods and are willing to consider tradeoffs in relation to the quantity or quality of these goods. The role of the economist is to discover these preferences and to aggregate them into the overall preference of society. The policy that maximizes total preference satisfaction should be chosen. …

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