Wishful Thinking and Hidden Costs

Our economy depends to an amazing extent on keeping the actual costs of doing business hidden. In order to maintain low prices, nonsustainable and inefficient processes get subsidized by taxpayers.

The most obvious example would be a company that pollutes the water table while manufacturing its product. Ideally, regulation would place the burden of solving this problem squarely on the manufacturer; the manufacturer would treat meeting these regulations as a cost of doing business, and set the price of goods accordingly.

Alternatively, the government could fully or partially subsidize changes in process before there's a serious environmental impact.

A far more expensive and inefficient system is to let manufacturers police themselves under the "honor system." They do whatever they please, and taxpayers pay for any clean-up (which may or may not get done). This is considered perfectly reasonable under neoclassical economics, which doesn't really concern itself with hidden costs or evironmental intensivity or public-health disasters.

Our current system is full of hidden costs. Consider conventional agriculture. Technological innovations and resultant economies of scale mean that we produce a lot of produce at a low cost. Sounds great, except that the costs of environmental remediation and healthcare don't get factored in. A classic example is the E. coli outbreak in Walkerton, Canada, clean-up of which cost each household in that town an average of $4,000 Canadian. The outbreak killed seven people and made many others ill, so medical costs were enormous. In addition to which,

[R]eal estate values in Walkerton fell a total of $1.1-million as a result of the contamination of the water supply. Costs for the town's businesses, for items such as bottled water or disinfecting and replacing equipment, are estimated at $651,422.

Lost revenues from May 1, 2000, to April 30, 2001, were estimated at $2.7 million. The study estimates that it cost more than $9 million to fix the town's water system, while the Ontario government spent about $3.5 million on legal fees and another $1.5 million to supply clean water to institutions.

The inquiry into this case showed that the person in charge of public health had failed to monitor chlorine levels. Furthermore,

It also pointed to deregulation of water testing and cuts to the Environment Ministry by the Ontario government as contributing factors.

Looking at costs like these, I think it's safe to say that everyone involved would've been better off if this disaster had never happened, and that any costs saved at the front end were more than made up for at the back.

And this is precisely the problem with anti-regulatory arguments. From society's standpoint, it's far better to have a certain amount of fixed cost at the front end, to avoid huge variable costs at the back. In some cases, these variable costs (or benefits, depending on where you stand) include the political destruction of deregulation fanciers; the Walkerton disaster was instrumental in bringing down Ontario's Tory party, who'd trumpeted the moral and economic necessity of deregulation.

Much of current economic theory depends on wishful thinking - particularly, the highly counterfactual belief that whatever can go wrong, won't go wrong - and on the curious belief that if a cause-and-effect relationship is complex enough, it can simply be ignored. It's always been a strange paradox that the people most prone to this fuzzy-headed utopian thinking invariably see themselves as hard-headed realists.

While economics will never be rocket science, some businesses are beginning to look beyond narrow neoclassical cost/benefit ratios in order to get a more accurate picture of the total costs of business activity. One example is the London-based company TruCost; click here for details.