Externalities of Organizational Activities and the Need for True Cost Accounting

Guest post by Steve Bolton, Project Manager at Trucost. Written in personal capacity. 

Call a thing immoral or ugly, soul-destroying or a degradation of man, a peril to the peace of the world or to the wellbeing of future generations; as long as you have not shown it to be ‘uneconomic’ you have not really questioned its right to exist, grow and prosper.” – E. F. Schumacher

Negative Externalities

Years ago, economics courses introduced me to the label of “negative externalities” for the adverse side effects of a transaction or decision that fall on society or the environment, beyond the immediate parties. Since social costs are not priced into an individual’s or organization’s decision-making, more than the optimal amount of the product or service is consumed, creating negative social impacts.

I must admit the conservationist in me appreciated being able to couch more principles-based reasoning within statements that could appeal to economists, policymakers and businesspeople. It was empowering to focus attention on previously hidden impacts, place prices on social injustice or environmental damage, and factor them into public and private decision-making. People and ecosystems could be considered alongside profits and development. Change the effective (or actual) price facing a decision-maker and change the action he/she takes. Whoop! Whoop! One for our team! Could this lead to a leveler playing ground?

However, pricing people and resources also can have unsettling implications. How do we use a spreadsheet to make sustainability decisions? What is the value of a tree? An ecosystem? Drinking water? Social justice? A person? A life? Although insurance companies, government agencies and business leaders have calculated similar values for years (either indirectly or overtly), that fact doesn’t simplify the task or make it less awkward. How do we price our values and ethics? Are some things simply priceless?

Costs vs. Benefits

Of course, many decisions about public and private courses of action come down to costs versus benefits. It’s easy to understand the difficulty of comparing the dispersed, often ill-defined (or even unknown) negative externalities of a potential project against the more tangible, explicit benefits to be achieved by going ahead with the project. For example, comparing the perceived benefits of bulldozing a tropical rainforest to permit cheap grazing of beef cattle against the harder to quantify, broader impacts on climate change, biodiversity, ecosystem services, habitat fragmentation, soil loss, and water quality never has been a clear cut victory for the conservation side (pun fully intended). What is our recourse? What should we do?

Improving Our Pricing of Impacts

Although applying prices to people and the environment challenges our ethics, our understanding of damages to people and ecosystems, and our ability to price those damages, it does not mean we should not try to price negative externalities. After all, sustainability considerations would be completely ignored if we tried to set prices as infinite. We should improve our pricing of impacts in the following ways:

  1. Cast a wider net of externalities to consider. Negative externalities are critical because they are markers of harm and they can be hidden. We shouldn’t leave rocks unturned in identifying impacts of potential actions or decisions.
  2. Evaluate externalities at broader scales. We should try to quantify impacts across multiple scales, from local, to regional, watershed, foodshed, societal, and global. Climate change demonstrates the scale of impacts that our actions can produce.
  3. Improve the measurement of harm to human health and ecosystems. It can be difficult to determine the human health effects of incremental actions or dispersed hazards, but the challenge of measuring these impacts should not prevent us from attempting to quantify them. On the non-human side, advancements are being made in measuring ecosystem services (e.g., bees pollinating our food, wetlands treating our wastewater, trees absorbing carbon dioxide) and pricing those services, beyond their market value as raw materials. Simply because such services have been received for free in the past does not mean they are valueless. We should try to use the best analysis tools available.
  4. Evaluate cumulative and synergistic impacts. The externalities of a new project will be added to the externalities of other projects that have come before. For example, a new building in a community will enhance or degrade that community’s existing quality of life in an additive way. Externalities also can feed off and even exacerbate one another. For example, a project’s climate change impacts could reduce local water availability, in addition to any direct harm to water quality.
  5. Do not overlook non-use value. We should improve our assessment of people’s non-use value for other people and the environment. The value of a resource is not instrumental only (e.g., harm to people should not be measured only by lost wages or productivity), but value also is derived from knowing individuals are healthy and our environment is conserved.
  6. Appraise some things as priceless. We should realize that some things are priceless and not be afraid to value them as such. For example, we do not want to be unwillingly exposed to toxic chemicals in products, toys or food. We cannot live without drinking water.

Actions That Organizations Should Take

The obvious question is: What does all this mean for organizations, their decision-making and operations?

First, since an organization’s decisions create both positive and negative externalities, every organization should identify and measure its impacts. To operate more sustainably and responsibly, an organization must price its hidden impacts and then effectively (or actually) pay for the true costs of its activities. For example, when considering booking an airline flight, which will produce carbon emissions, an individual should decide either to replace the flight with a video-/teleconference or pay for carbon offsets on top of the price of the airline ticket. Either option internalizes the otherwise external costs of flying, producing more optimal results for society and the environment.

Second, an organization has the opportunity to lead by example among its stakeholders. Factoring the external costs of organizational operations into internal decision-making, managers can encourage their colleagues, peer organizations, customers/members, vendors and other groups to do the same.

True Cost Accounting to Internalize Externalities

True cost accounting (or full cost accounting) is a tool to help organizations price the externalities of their actions. By quantifying off-the-spreadsheet social and environmental costs and incorporating them into internal decision-making, an organization can internalize its impacts. The organization then can undertake actions that prevent, reduce or compensate for its negative externalities.

For example, employee volunteering benefits charitable causes and helps pay back the local community for what it gives to the organization. An organization also can improve its recycling of electronics so their disposal does not harm human health or the environment and the organization is taking full, lifecycle responsibility for its products. Purchasing carbon offsets and using renewable energy help decrease global carbon emissions. Accounting for the negative impacts of its actions and making decisions that alleviate harm help an organization operate more sustainably, as well as educate its stakeholders about externality pricing within their own operations.

Every organization should work to measure its far-reaching, often hidden effects on our shared society, environment and economy, and take strides toward creating more beneficial impacts. Only by focusing on the true costs of its activities can organizations begin to achieve more sustainable, optimal outcomes.

Organizations can, and should, lead by example. They should internalize the full costs of their activities and integrate those externalities into their decision-making.

This article was originally published by Sustainability Defined

Steve Bolton joined Trucost in 2014 in a project management capacity. Steve was the Sustainability Program Manager for CFA Institute, where he developed its sustainability strategy and operational footprint. Prior to that, Steve led client engagements aimed at developing more sustainable businesses and products while at the Cradle to Cradle® consulting firm McDonough Braungart Design Chemistry (MBDC) for 10 years. Steve’s education includes an MBA from James Madison University, a Master of Environmental Management degree from Duke University, and a BS in Environmental Science from The College of William and Mary. He blogs at Sustainability Defined and tweets at @SustainablyDef.