Is Climate Change an Externality?
This post is part of a symposium on Alyssa Battistoni’s Free Gifts: Capitalism and the Politics of Nature. Read the rest of the posts here.
** ** **
In Free Gifts, Alyssa Battistoni traces the concept of the “externality” across the past century. This history begins in 1920, when the economist Alfred Pigou observed how private market transactions could impose uncompensated harms on third parties, such that the prices of goods failed to reflect their true (social) cost. Fortunately, he argued, these external costs could be rectified by government intervention: adding a tax equal to the social cost, which would cause market trading to “internalize” the harm and produce the optimum amount of the activity in question. Free-market advocates viewed such externalities as a rare exception to the general rule of the wisdom of the market.
As Battistoni describes, however, this would change in the coming decades. As the U.S. postwar economy boomed, so did its pollution, and Pigou’s rare “market failures” began to seem ubiquitous rather than exceptional. In 1960, Ronald Coase challenged Pigou’s invitation for widespread government regulation in a landmark article, The Problem of Social Cost. Coase struck at the heart of welfare economics: how was Pigou, or the government, to determine the “optimal” level of pollution? How could they know how much people value the cost of pollution, or their own health? Battistoni dwells on Coase’s understanding of externalities as mutual costs. For Coase, the smokestack can only cause harm to health if people choose to live near it: “both parties cause the damage.”
Rather than dismiss Coase, Battistoni argues that Coase lands legitimate critiques on Pigou’s framework: Pigou makes a moral judgment (the assumption that pollution is bad) in pollution-generating markets, while declining to apply normative standards to any other types of markets or economic goods. But, in Battistoni’s words, “the distinction between pollution and other kinds of goods just doesn’t hold.”
Once Coase’s disciples recognized that pollution was just another kind of market, they launched an attack typical to that of the Chicago School, accusing regulators of paternalism. They argued that the government shouldn’t impose normative judgments on resource allocation; instead, it should set the conditions for people to negotiate the most efficient outcome amongst themselves. Markets all the way down. But Battistoni takes this observation in a different direction: “the burden of social costs is better characterized in terms of struggle between classes with disparate power than as a market exchange between equal individuals.” For Battistoni, “externalities” are the exception that explodes the rule: market allocations can never be assumed to achieve the “optimal” outcome, as they are always the product of unequal power relations.
Considering the host of this symposium, I cannot help but point out the similarities between Battistoni’s observations and some of the core principles of the LPE intellectual movement. Core to LPE is the revival of legal realist thought, and core to that thought are the anti-laissez faire writings of those like Robert Hale. Hale, writing around the same time as Pigou, and anticipating Coase, also recognized the reciprocity of social costs. Hale argued that the market itself was a system of “mutual coercion:” there was no such thing as the “free” market when it relied on an underlying state police power to enforce property rights. While Hale is not well known today, LPE scholars and their fellow travelers have resurrected his lessons for combatting the legacy of the Chicago School.
Hale and his compatriots were writing at a time of Lochnerism, when the conservative Supreme Court held an expansive view of due process protection of private property rights. While most economists and legal thinkers agreed that governmental price regulation was required in certain industries, such as state-granted monopolies, Hale believed that that utility-regulation, similar to Battistoni’s thoughts on externalities, was the exception that exploded the rule. Once you conceded that railroads, gas utilities, and hotels were “affected with the public interest” such that government regulation was justified, it was hard to identify any market that was not inextricably bound up with the “public interest.”
Another famous (proto) legal realist, Justice Oliver Wendell Holmes, in writing to justify governmental price regulation, once likened the harms of monopoly price power to that of pollution:
A hundred years ago, one could hardly use his land so as to injure another except by creating a nuisance. But things have grown more complex. The relations between property owners are not only those of mere contiguity: they are organic… If the railroads and elevators have a constitutional right to charge what they please, it is just as truly a right to destroy the property of others as a right to make noxious vapors would be.
This argument stands as a fascinating mirror of what Coase would do 80 years later. In order to get his audience comfortable with regulating price-related harms, Holmes likened them to smokestacks. To Holmes, the law of nuisance was a place where government intervention was clearly accepted, and pollution an obvious harm. Coase would argue from the other direction, saying that noxious vapors were a market like any other, where government intervention would lead to inefficiencies. Holmes, writing back in 1878, would likely have agreed with Battistoni’s argument that “The neoclassical assumption that a transaction can be contained to the parties to a contract appears delusional in a world where everything affects everything else.”
Yet Holmes discussion, appearing decades before Pigou formalized the concept of the externality, also makes clear that Pigou was far from the first person to recognize that pollution could harm third parties. The common law of tort had long recognized harms created by pollution, and Coase’s target in The Problem of Social Cost was just as much the common law approach as Pigou’s theory. And it wasn’t Pigou who assigned moral judgment to the harms of pollution, the very claims themselves were called “nuisance.” The common law’s recognition of pollution as a harm was bound up with moral judgments and social norms about who owed what to whom. It had nothing to do with efficiency and externalities, concepts whose later imposition on the law did more to distort than to clarify the underlying principles.
One of the lessons I have taken from teaching environmental law is that the LPE movement is in part about learning how to stop thinking like an economist at all. By the time the major modern environmental statutes were passed, the Supreme Court had long conceded the broad government right to regulate industries of all kinds. The Clean Air Act and Clean Water Act of 1970 and 1972 were passed before this country’s neoliberal turn toward Coasean thinking. The statutes do not talk of achieving the “optimal” levels of pollution, but rather “eliminating” pollution. The EPA is directed to limit pollution to the amount “requisite to protect the public health,” not to their most efficient levels. Today, however, environmental harms of all kinds are frequently cast as externalities, even by those seeking to emphasize the urgency of these harms. Indeed, as Battistoni observes, Nicholas Stern—who advocated for much more aggressive climate change action than many of his fellow economists—famously claimed that greenhouse gas emissions, as externalities, represented “the biggest market failure the world has seen.”
If we rejected the idea that climate change is best thought of as an externality, how would it change our thinking? One obvious alternative is to think of climate change is that of a moral harm. Battistoni, given her broadly Marxist approach, lays the blame for climate change on the capitalist system rather than individual bad actors. Yet for those who see climate change as a moral harm, one possibility could be to use the tools of criminal law, including charging fossil fuel companies with homicide, to work toward climate justice. Similarly, we might follow the lead of parties around the world pursuing nuisance claims against fossil fuel and other high-emitting corporations. To be clear, I do not think that conceiving of climate change as a moral harm requires resigning ourselves, as Jed Purdy’s post seems to suggest, to our inevitable demise at the hands of our own fundamental “human nature.”
Even when it comes to market governance, there is no need to conceptualize climate change as an externality, whose harm to be internalized, rather than eliminated entirely. Indeed, the Inflation Reduction Act of 2022 is arguably the result of successful campaigns to dethrone the externality-tackling carbon tax as the ideal climate policy. Worldwide, a new green industrial policy focuses on capital turnover and the replacement of fossil infrastructure with renewables. This Bidenomics approach, to draw from Ilmi Granoff, considers climate change to be “a substitution problem, not an externalities problem.” Even mainstream economists now write that climate change harms should be thought of as both externalities and “innovation failures.”
In many ways, unlearning externalities-thinking is just rediscovering what we knew in 1970. The Congress that passed the Clean Air Act expressly rejected the use of economic analysis in designing air pollution regulation. The Act’s Senate Report explained that “the health of people is more important than the question of whether [the achievement of air standards] is technically feasible… therefore… existing sources of pollutants either should meet the standard of law or be closed down.” The Supreme Court concluded that the Clean Air Act was a “drastic remedy,” “expressly designed to force regulated sources to develop pollution control devices that might at the time appear to be economically or technologically infeasible.” What this statutory design recognizes is that corporations don’t just act in markets, they control them. They can bring entire technologies, entire new compounds, into being. Asking a regulator or judge to assess the costs and benefits of limiting pollution—or expecting an affected individual to bargain in this situation—makes no sense. Before the automobile industry invented the catalytic converter, the costs of reducing air pollution seemed astronomical, enough to bankrupt the entire industry. After they invented the catalytical converter, the costs were manageable. And they only invented it because they were faced with the threat of being shut down.
Which brings me back to Robert Hale. While we no longer need Hale to argue on behalf of regulation in general, his insights have lessons for the fights of today, in which we are dominated by the decisions of the fossil and tech oligarchies. Hale’s insight into the coercive nature of markets led him to see that there was nothing free about the free market, and that corporations coerce and dominate us in much the same way a top-down government regulator might, but without any democratic accountability. He’s been dubbed “an originator of the concept of ‘private government.’” This insight leads me to conclude that it’s again time for a “drastic remedy” that reasserts the power of the people over the corporation in determining what our economy looks like.
So while Battistoni and I may disagree, in some abstract, academic way, that climate change should be called an externality, I think we ultimately agree on the remedy: Asserting democratic control over corporate investment decisions is key to an anti-capitalist climate agenda. Reporting has revealed that corporate AI-related capital expenditures were in the hundreds of billions of dollars in 2025 alone. We appear to be in the midst of yet another society-wrecking “innovation failure.” Imagine if we had collectively decided to build wind turbines and flood gates instead of data centers. Imagine that we could.
