Hi, I'm John Byrd and this is week two of the first class in the MOOC specialization, become a sustainable business change agent. We just finished talking about a lot of the reasons that a company should become sustainable. We talked about saving money, reducing risk, helping recruit and retain talented employees, and protecting the company's brand reputation. We also talked about how developing greener products can lead to lots of other types of innovation and open up access to new sets of customers, which helps your company stay competitive. Then there's also it's just the right thing to do. Clearly, there are lots of benefits for being sustainable. But there are aspects of our economy that keep companies from becoming more sustainable. That's what I want to explore in this lecture. I think you've all heard politicians or high level business people argue for reducing or eliminating regulation and just letting the market do its thing. The notion is that an untethered economy will result in this wonderful world of prosperity and equality. As a card caring member or the economic's profession which means I got a PhD in economics. I'm here to tell you that's just not true. It's not true because of things called market failures. Market failures as the name suggest keep the economy from ever achieving that paradise, that free market advocates dream of. There's a number of different types of market failures, but I'm only going to talk about three here. In part, I'm going to do this because as you move forward in your career and if you continue working in the sustainability area, you're going to hear these concepts. So it's important that you understand what they are. The three market failures I'll talk about in this lecture and the next are externalities, common access resources and information failures. The first market failure, and probably the largest, is externalities. If you think about a typical economic transaction, there are two parties, a buyer and a seller. But often, the production, the use, and the disposal of a product affects more than just these two people. Externalities are third-party effects. They're the effects on people outside of the actual economic transaction. Externalities affect people external to the transaction. That's where the name came from. This all sounds a little esoteric but let me give you a couple of examples and you'll get it right away. I'm going to start with the goofy one. Somebody goes and buys a pack of chewing gum at the grocery store. That's a transaction, they chew some of the gum, they spit it out on the street, you step on it. You as a third party bare a cost, because of the production and sale of that gum. The company that made the gum doesn't include the cost of you having to clean it off your shoes in the price that they sell it for. This is an external cost. Now that was a trivial example, but the next one is more serious. Think about pollution, an electric utility uses coal to generate electricity. The emissions from the smokestacks contain all sorts of chemicals. Prior to about 1995, sulfur dioxide and nitrous oxides were a big part of these emissions. When they get into the atmosphere they combine with water to oxygen to form mild solutions of sulfuric and nitric acids. This becomes acid rain. It harms forests and pollutes rivers and lakes. The people buying the electricity don't pay extra to help clean up this pollution but communities suffer from it. There are other types of externalities such as traffic and noise, and the order from the sewage plant near your house, or a feed lot. The thing that all of these have in common from the gum to pollution is that unconstrained economic activity creates a burden on people or communities that aren't associated in anyway with the economic transaction. There are two questions that are worth asking about externalities. Why the externalities occur and what can we do about them? I'll talk about why they occur in the next lecture. But we have three standard ways of dealing with externalities. Command control regulation is one, taxes is another and trading. Command control regulation sets a limit on the emission of pollutants or noise or odors or whatever the offensive thing is. The limits are set based on the level of activity that does harm to human health or that a community finds acceptable. Almost never is the goal of a regulation to set the allowable level at zero. We never clean up 100% of the pollution, that's because we like the products that are associated with the pollution. We like electricity, and we like transportation, we like entertainment so we try to find a balance between having the benefits of the product or the service or whatever and bearing the cost of the externalities that it puts off. In the United States we have regulations to protect air and water quality, the Clean Air Act and the Clean Water Act. These regulations were created and implemented to protect human health and environmental quality while still allowing economic activity. Taxes work by raising the price of products. If we increase the price of something, people usually buy less of it. So there's less of the externality the product makes. This third solution trading works by selling or sometimes giving away a limited numbers permits to pollute. The sum of this permits is the total amount of pollution that the government agency or healthy authorities thinks is acceptable based on medical research. Then companies can trade these permits. If a company cleans up its operations really well it will have surplus permits that it can then sell. Companies where cleanup is more expensive will buy permits until the cleanup technology improves or becomes less expensive. Overtime the regulatory authority can reduce the number of permits so the environment gets cleaner and cleaner. The US created the first cap and trade system in the 1990s to deal with acid rain from the emission of sulfur dioxide and nitrous oxides. Here are some maps that show atmospheric sulfur over the East United States. The black dots are coal fired power plants. Remember, the power plants that burn coal emit sulfur dioxide and nitrous oxides that form acid rain. The cap-and-trade system was designed in about 1990 and it went into effect in 1995. Now, watch what happens to the dark red areas, those are the sulfur emissions. In 1995, you could see that except for one bad actor in Ohio, that the cap-and-trade system was a huge success in terms of reducing sulfur emissions and therefore acid rain. The utility companies had five years to get ready and they install pollution control equipment, they shifted to cleaner coal, they have created their generation equipment, whatever else. Not only that, it saved these electric utility companies several billion dollars compared to command control regulation. So we have ways to deal with externalities. Not all externalities are straightforward to address as sulfur dioxide from power plants but we do have tools. The other question that I asked was, why do externalities exist in the first place? We're going to talk about that in the next lecture. Thanks.
