This article from the New
York Times describes a classic case of an externality in production.
The frantic pace of economic growth in China, particularly in the manufacturing
sector, has wreaked havoc on the environment. Smog contaminates the air in
the most populated cities, and air pollution has even led citizens to wear masks outside. Of immediate
concern is the country’s high consumption of coal. Perhaps most disturbing is a
2010 report attributing the poor environment to 1.2 million early deaths that year. In
response to increasing concern, the Chinese government has announced a plan to
reduce air pollution by restricting the utilization of coal and the use of cars that
are not environmentally friendly. However, environmental groups find the new standards are not far
reaching enough.
China’s situation also demonstrates
an element of the prisoner's dilemma, because each factory can be seen as
having a dominant strategy of using cheap, environmentally hazardous methods of
production in order to compete. However, with government intervention now changing incentives,
production methods will hopefully move towards a Pareto optimal
outcome.
Although not mentioned in the
article, the Chinese government could also consider auctioning off “licenses to
pollute” as a strategy to clean up the environment. This is an idea we
discussed in class that has been researched extensively in the UVa Economics
Department. An auction would benefit the government both by fostering
innovation in production and raising revenue at the same time.
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