Monday, April 18, 2016

Turn Trash into Treasure by Internalizing Externalities

Many amazing University of Minnesota researchers are developing innovations that benefit the environment.  Some are literally micro:  bacteria that remediate pollution. Others are macro:  such as the Institute on the Environment’s collaboration with three other universities, The Natural Capital Project, which quantifies the value of nature so that informed decisions can be made at the intersection of economic and environmental sustainability.

Environmental technology innovators often complain that no one wants to pay to keep air and water clean, or to reduce energy waste.  The problem is that polluters and energy wasters don’t necessarily bear the consequences of their actions.  The economics term for this phenomenon is “externality” – a side effect of a commercial activity that is experienced by unrelated third parties.

Externalities are not necessarily bad.  For instance, people who pay for advanced educations not only increase their personal incomes, but also pay higher taxes that fund better schools and parks, and also spend their disposable incomes on charities and sports and cultural activities.  However, more attention is paid to negative externalities:  farmers whose fields’ fertilizer runoff pollutes waterways or coal plants that spew particulates that cause lung disease and premature deaths.

The trick is to “internalize” the negative externality, to create either a consequence or a benefit that at least equalizes the mitigation cost to an entity that would otherwise generate a negative environmental impact.  This has been successfully achieved on multiple fronts:

  • Cost Savings: Conversion to LED lights – LEDs produce a massive energy savings (4-5 times vs incandescents) that pays for itself not only with lower energy costs but also less maintenance
  • Market Incentives: Cap and trade systems – Over 25 government entities around the world have create pollution “markets,” where businesses who are polluting less than a specified level can sell their pollution credits to higher polluters.  The result is to incentivize pollution reduction.  An example is the U.S. Acid Rain program, which has resulted in a drastic reduction in sulfur dioxide emissions.
  • Recapture and reuse: Recycled aluminum consumes only about 5% of the energy of new aluminum, so manufacturers are incented to support recycling programs.  The result is that about 1/3 of the aluminum products are recycled from scrap.   University of Minnesota researchers are working on a technology to recapture phosphorus from farm fields so that it can be reused – this not only would reduce water pollution but also could save farmers money as world phosphorus reserves get depleted. 
  • Government Incentives:  Tax credits and other financial incentives have been used to jumpstart solar, wind and numerous other renewable energy sources.  The University of Minnesota zip code alone is eligible for 57 different energy incentive programs.
  • Government Fines:  The U.S. Corporate Average Fuel Economy (CAFÉ) standards for vehicles has resulted almost doubling gas mileage over the past 40 years.
  • Reputation/Brand:  Nonprofits have been very effective at publicizing negative company practices, thus driving consumer behavior.  An example of a current initiative is the Greenpeace Tuna Shopping Guide.  In a different sphere, companies find it easier to recruit employees if their work spaces are environmentally friendly, so LEED (Leadership in Energy and Environmental Design) certified office buildings are able to command a premium from renters.

So, while it can be challenging to identify a market for environmental technologies, it is not impossible.  The trick is to find the value proposition that internalizes the externality.