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What Is An 'Externality'?

• Externalities are side effects of a primary process that affects parties beyond the primary beneficiaries or decision makers.
• Many negative Externalities can be avoided or mitigated by anticipating potential Second-Order Effects and working to prevent unintended consequences.

Josh Kaufman Explains 'Externalities'

Between 1868 and 1969, the Cuyahoga River—a large tributary of Lake Erie that runs through the city of Cleveland, Ohio, in the United States—caught fire on at least thirteen separate occasions. The largest of the fires, which occurred in 1952, caused over $1 million of property damage—more than $10 million in today’s dollars.

The root cause wasn’t a mystery: pollution from petrochemicals, sewage, and manufacturing by-products was so severe that a forty-mile stretch of the river—from Cleveland to Akron—was unable to support fish or other aquatic life. The river was an inexpensive and convenient place to dump garbage, so many factories took the path of least resistance, building pipelines that carried industrial waste into the river in an effort to save money. The river died (and caught on fire) as a result.

The technical term for these events is Externality: a side effect of a primary process that affects parties beyond the primary beneficiaries or decision makers. Manufacturing in and around Cleveland was the primary process, and factory owners and employees were the primary beneficiaries: the pollution of the Cuyahoga and the effects of that pollution on other people and creatures were Externalities. The companies responsible for the pollution shifted the cost of waste disposal from their businesses to society at large.

Today, the Cuyahoga River is in much better shape. Improving the situation required significant intervention: laws, policies, and regulations that prevented and punished dumping, lawsuits and fines targeted at violators, and funds for cleaning and restoration efforts. Once the Externality was identified and understood, it was possible to coordinate societal efforts to fix the issue and prevent it from happening again.

Pollution isn’t the only type of negative Externality. Here’s a common example: many businesses collect Personally Identifiable Information (often abbreviated “PII”) as part of their Marketing, Sales, and customer-support efforts. This data is useful for Qualification, Segmentation, and outreach, so firms go to great lengths to collect as much information as possible. There is, however, an important Externality to consider: if unauthorized users (like hackers) gain access to this personal information, it can be used for all sorts of nefarious purposes, many of which can create financial and legal issues for the businesses’ prospects and customers.

Securing this data is important, but it doesn’t contribute to the businesses’ bottom line, so there’s little direct incentive to worry about it. In the event of a data breach, the businesses’ prospects and customers pay the price. That makes PII both an asset and a liability: companies that collect this sort of data have a responsibility to keep it secure and ensure their systems are protected from unauthorized access.

Many negative Externalities can be avoided or mitigated by anticipating potential Second-Order Effects and working to prevent unintended consequences. As a general rule: if you anticipate or identify negative side effects that occur (or may occur) as a result of your actions, it’s your responsibility to prevent or mitigate those effects as much as possible.

Some Externalities are positive. Consider communications technology like the internet or telephone network: each additional user of the system makes the network as a whole more valuable, creating a “network effect” that benefits every user of the system. Societal policies like widespread literacy and public-health practices (like handwashing and vaccination) have similar benefits: everyone benefits when there are lower barriers to communication and reduced exposure to infectious disease.

Externalities are sometimes difficult to predict in advance, but that doesn’t mean you shouldn’t try. The benefits and detriments of your actions are real, and it’s in everyone’s best interest to take full advantage of unexpected opportunities and prevent unnecessary issues.

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"Our planet is a lonely speck in the great enveloping cosmic dark. In our obscurity, in all this vastness, there is no hint that help will come from elsewhere to save us from ourselves . . . To me, it underscores our responsibility to deal more kindly with one another, and to preserve and cherish the pale blue dot, the only home we’ve ever known."

Carl Sagan, physicist and author of Pale Blue Dot: A Vision of the Human Future in Space

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https://personalmba.com/externality/

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