The health and well-being of people can be negatively affected, and this has direct costs to the healthcare system, as well as indirect costs to businesses – those people are their employees or customers in the end. The environment may be damaged and depleted, providing fewer or lower quality inputs to the enterprise. Tax increases are often needed to finance the effort, and that includes corporate taxes.
The public sector cannot solve all externalities, least of all for free. Thinking in a realistic way, taking higher-order effects into account, the sole purpose of maximizing profit in the short term does not hold. Someone else (often the public sector) is expected to take care of the externalities, and the enterprise can focus on its short term, isolated objectives. Thinking in a simplistic way, only of first-order effects, it makes perfect sense to focus solely on maximizing enterprise profit and its value to shareholders in the short term. In traditional economic models, externalities were ignored with the objective of avoiding costs – the costs of remunerating those negatively impacted (the polluted town) or those unknowingly or inevitably benefitting the enterprise (the honey makers).
Externalities can be negative, such as the air in a town being polluted by a nearby industry, or positive, such as someone’s fields being better pollinated by bees from near honey makers. “Externality” is bureaucratese for “sweep under someone else’s carpet”Īn externality is a cost or benefit that impacts a party who did not choose to incur that cost or enjoy that benefit. However, many relevant effects or phenomena were disregarded as “externalities”. Traditional economic models contemplated some qualitative external factors, such as governmental influence, and even quantified some of them, such as the impact of certain regulation or taxes. They failed to account for significant effects that become clearly noticeable when you consider the enterprise in a broader context.Īn enterprise is created and lives within a society, in a cultural and political context, within an environment – and for the last two decades, in a very complex hyperconnected world. One of their fundamental flaws is that they viewed enterprises as islands. Those economic models have been questioned because of their limitations. It is true that some of them extended their scope to the supply chain, but they still retained a clear enterprise centricity. In the twentieth century, the prevailing economic models focused on the enterprise in isolation.
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