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A Philosophical Analysis of the Concept of an Externality in Economic Theory and Policy A PHILOSOPHICAL ANALYSIS OF THE CONCEPT OF AN EXTERNALITY IN ECONOMIC THEORY AND POLICY by REBECCA LIVERNOIS B.A., University of Guelph, 2011 M.A., University of British Columbia, 2013 A DISSERTATION SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY in THE FACULTY OF GRADUATE AND POSTDOCTORAL STUDIES (Philosophy) THE UNIVERSITY OF BRITISH COLUMBIA (Vancouver) August 2019 © Rebecca Livernois, 2019 The following individuals certify that they have read, and recommend to the Faculty of Graduate and Postdoctoral Studies for acceptance, the dissertation entitled: A Philosophical Analysis of the Concept of an Externality in Economic Theory and Policy submitted in partial fulfillment of the requirements by Rebecca Livernois for the degree of Doctor of Philosophy in Philosophy Examining Committee: Margaret Schabas, Philosophy Supervisor John Beatty, Philosophy Supervisory Committee Member Alison Wylie, Philosophy Supervisory Committee Member Matt Bedke, Philosophy University EXaminer Brian Copeland, Economics University EXaminer David Schmidtz, Philosophy External EXaminer ii ABSTRACT Economists generally understand externalities as unpriced spillover effects. The paradigmatic case is pollution because it is unpriced and affects agents external to the market choices that lead to its production. One solution to an externality is to set a tax on the unpriced activity at the value of the externality in equilibrium. The concept of an externality, however, is notoriously difficult to precisely define and there is a notable absence of consensus among economists. In this dissertation, I offer an analysis of the contemporary treatment of externalities in economic theory and arrive at the following definition: Externalities arise when unpriced activities generate untapped gains from exchange that are associated with untapped welfare gains. It is unclear, however, whether this concept could be instantiated in any concrete sense because gains from exchange often diverge from welfare gains. I suggest possible ways to interpret an externality given this problem, but argue that each interpretation falls short of an adequate account of externalities. The ambiguity of the concept of an externality carries over to attempts to estimate the value of a specific externality. I suggest that this accounts for some of the controversy among both economists and philosophers over one approach to estimating the value of an externality, called the contingent valuation method. Furthermore, this ambiguity renders problematic certain policies, such as the carbon tax, that are intended to internalize an externality. I then argue that the problem of climate change is not merely caused by the presence of externalities, as some economists have suggested. I argue that, even if all externalities were eliminated, a social planner might still bring about a regretful environmental state when they aim to maximize net benefit derived from polluting activities. This is a result of the peculiar cost structure of climate change in which the marginal costs are uninformative of the total costs of polluting. I suggest that, instead of aiming to balance the costs and benefits of polluting, we might need to forgo some of the potential net benefits in order to avoid reaching an irreversible and regretful state. iii LAY SUMMARY Economists generally understand externalities as unpriced spillover effects. The paradigmatic case is pollution because it is unpriced and affects agents external to the market choices that lead to its production. The concept of an externality, however, is notoriously difficult to precisely define. In this dissertation, I develop a novel definition of externalities that coheres with the contemporary treatment of externalities in economic theory. I then argue that there are several distinct interpretations of externalities in the world that are consistent with this definition. As a consequence of this ambiguity, I suggest that policies that aim to internalize an externality are not well supported. Finally, I argue that the problem of climate change is not merely the result of the presence of externalities. If all externalities were resolved, the peculiar cost structure associated with climate change could still create an incentive for a community to pollute beyond the socially optimal level. iv PREFACE This dissertation is the original and independent work of Rebecca Livernois. A slightly modified version of chapter five is originally published as Livernois, Rebecca. 2018. “Regretful Decisions and Climate Change.” Philosophy of the Social Sciences 48, no. 2: 168-191. Copyright © 2017 (Rebecca Livernois) https://doi.org/10.1177/0048393117741335. v TABLE OF CONTENTS Abstract ................................................................................................................................... iii Lay Summary ..........................................................................................................................iv Preface ....................................................................................................................................... v Table of Contents ....................................................................................................................vi List of Figures....................................................................................................................... viii Acknowledgements ................................................................................................................ ix Dedication ................................................................................................................................x CHAPTER 1 Introduction ..................................................................................................... 1 CHAPTER 2 A Conceptual Clarification of Externalities ................................................ 31 2.1 Introduction ......................................................................................................... 31 2.2 Literature on Externalities .................................................................................. 33 2.3 The Treatment of Externalities in Contemporary Economics........................ 36 2.3.1 Why externalities cause a market failure............................................ 36 2.3.2 Externalities in an optimization framework...................................... 40 2.4 Characterizing Externalities in the Model ......................................................... 46 2.4.1 Assumptions of the Modeler .............................................................. 47 2.4.2 Outcomes that establish features of externalities ............................. 49 2.4.2.1 Untapped gains from exchange ......................................... 49 2.4.2.2 Untapped welfare gains ...................................................... 50 2.5 Implications of the Gains View of Externalities .............................................. 54 2.6 The Relationship between Models and the World ........................................... 56 2.7 The Gains View of Externalities ........................................................................ 77 2.8 Conclusion ........................................................................................................... 78 CHAPTER 3 The Instantiation of Externalities ................................................................. 81 3.1 Introduction ......................................................................................................... 81 3.2 Problems with the Preference Satisfaction Theory of Welfare ....................... 83 3.3 Interpreting Externalities in the World ........................................................... 111 3.3.1 Externalities arise when actual preferences are sufficiently informed ............................................................................................ 115 3.3.2 Externalities arise from welfare gains and hypothetical preferences ........................................................................................ 121 3.4 Conclusion ......................................................................................................... 129 CHAPTER 4 The Misplaced Controversy over the Contingent Valuation Method ...... 131 4.1 Introduction ....................................................................................................... 131 4.2 The Contingent Valuation Method.................................................................. 134 4.3 Long-standing Concerns with Surveys in Economics ................................... 139 vi 4.3.1 Incentives to misreport willingness to pay ...................................... 139 4.3.2 Scientific realism and instrumentalism ............................................ 142 4.4 Criticisms of the Contingent Valuation Method within Economics ............ 146 4.4.1 Hypothetical response bias ............................................................... 149 4.4.2 Willingness to pay and willingness to accept .................................. 154 4.4.3 The scope problem ........................................................................... 156 4.5 Lessons ............................................................................................................... 159 4.6 Philosophical Criticisms of the Contingent Valuation Method .................... 165 4.6.1 Daniel Hausman on contingent valuation ...................................... 165 4.6.2 Mark Sagoff on citizen
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