The anatomy of externalities

Abstract

Debates over externalities often focus on failures: theories favouring state action rest on the notion of market failures, whereas those opposing state involvement emphasize governmental failures. The two polar approaches ignore a wide array of alternatives to manage externalities that are neither exclusively market-based nor state-oriented. Yet the literature has failed to unify these different approaches and alternatives into a single cohesive framework—this is the primary goal of this essay. This article proposes a new taxonomic framework for externalities based on the interplay between the physical attribute of an externality (scale) and its property-rights dimension, acknowledging the scope of both market-based and state-based approaches to internalizing externalities but moving beyond the narrow dichotomy to incorporate a wide range of alternative and hybrid solutions. This framework adds the much-needed nuance to academic and policy discussions about the scope and limitations of markets and states in addressing complex and nested externalities. It offers a pragmatic and less abstract way to map externalities to potential policy solutions or to the organizations best suited to address them.