Climate Change: The Externality That Came in From the Cold

By Julie Fox Gorte

An externality is something that costs nothing on the part of the person or enterprise that creates it, but imposes a cost or conveys a benefit to others. The world is full of them. My children create them by Skyping with their friends at elevated decibel levels all night. Externalities come in all sizes too. Fortunately for my neighbors, the Skype externality stays within the walls of my house. Companies that emit tons of greenhouse gases (GHG) create externalities that are bounded only by the size of the planet. They get so big, in fact, they aren’t externalities anymore.

A company that emits carbon dioxide is affecting the entire planet for at least a century. And countries—like the United States—that do not have national regimes regulating and curtailing GHG emissions are affecting all other countries. If Holland disappears beneath rising seas, it won’t be primarily because of Dutch emissions; the Netherlands emits less than 1 percent of the world’s GHG emissions. Countries like Kiribasi, the Maldives, and the Seychelles, all of which are likely to disappear beneath the ocean due to climate-induced sea level rise, have GHG emissions that round to zero. Climate change, something they didn’t create, is probably going to destroy them; that’s about as bad as negative as an externality gets.

But the big emitters don’t get to really externalize these costs forever either. Nearly every enterprise is likely to be affected somehow by the increasingly torrential rains, prolonged droughts, severe storms, and sea level rise that come with a warming globe. That particular chicken can come home to roost in many ways. A recent report from Nature Magazine illustrated this vividly by tracing the effects of Typhoon Heiyan, which pummeled the Philippines in 2013. The loss of production in the Philippines has (to date) had a very minor direct impact on U.S. production, 6 percent of which relies on supplies from the Philippines. But the indirect effect is more attention-getting: 21 percent of U.S. production could suffer from supply-chain problems related to this typhoon. Thailand’s 2011 flooding caused a global shortage of hard disk drives by shuttering production facilities of Japanese tech companies located in Thailand.

Another bit of evidence cited by the Nature paper was the fact that extraordinarily large rainfall and Cyclone Yasi in 2010-2011 paralyzed Queensland, Australia, which is also a major coal production region. Coking coal prices increased by 25 percent the following year. Perhaps that is poetic justice; coal combustion is, after all, a major contributor to GHG emissions and climate change. Through the increasingly complex and global supply chains of many companies, GHG emissions are no longer external freebies -- a way to get rid of waste products without costing anything.

Investors have known this for a while. Many of the large pension funds are considered universal owners, with assets so large that they own thousands of stocks and other securities across dozens of portfolios. For universal owners, the pollution externality of one company is an impediment to others in the same portfolio, making the very concept of externality increasingly meaningless. It is essential that companies begin to take responsibility for the costs they impose on others. A recent report from CDP (formerly the Carbon Disclosure Project) illustrated one way to do that, describing how several companies in the S&P 500 index are using an internal carbon price as a core element of their strategies, often in managing capital expenditures. Having a positive price for carbon will help those companies to reduce their own GHG emissions, and that’s a good thing.

Taking responsibility and being accountable for impacts on the environment and society is one of the fundamental concepts of the American Sustainable Business Council (ASBC), and that’s another good thing. Moreover, ASBC members also help to illustrate that small businesses, which are often portrayed as resistant to things like environmental regulation, don’t always fit the stereotype. It is the ambition of many small businesses to become big ones, and taking responsibility for externalities is far easier to do when the company is small and the impacts limited. That is also good preparation for the day when the companies are large. Inventing a system to tally and manage environmental impacts is never easy, but it’s far harder for a huge company than it is for a little one. Mohandas Gandhi had it right: “Your habits become your values, your values become your destiny.”

Image credit: Flickr/quinnanya

Julie Fox Gorte is Senior Vice President, Sustainable Investing, at Pax World Investments.