George, my neighbor, enjoys serenading his girlfriend with loud, out of tune, electric guitar solos. While George and his girlfriend seem to enjoy the sound, I dislike the loss of sleep and the decrease in productivity at work the next morning. However, George does not bear the cost of my lost sleep and lower productivity at my job. My lost sleep and lower productivity is an example of a negative externality of George's guitar playing.
An example on a larger scale. Consider a community in Malaysia that is home to a factory that produces goods to be sold in The United States and Europe. The final market price of these goods does not reflect the costs incurred by the community in the form of poorer air quality and poorer health.
While the world is dazzled by China's impressive 10% per year growth in GDP, some have estimated that the cost of pollution in China is equal to 10% of GDP. In other words, when we account for the impact of pollution, China may not be growing after all. China, along with other developing nations, faces a difficult trade off between industrial economic growth and the well being of the environment. The reason for this is that limiting pollution typically increases the cost of production. This increased cost in production slows the economic growth that government officials in the developing world are so proud of.
Because a lower level of pollution is a public good, we see developing nations under-invest in pollution control. Many developing nations are in competition for American and European factories; because pollution control increases the cost of doing business, we see an incentive for governments to be lenient in pollution reduction measures.
Cost of Pollution in China
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