External economies, or externalities, are costs or benefits of an economic transaction that accrue to people other than those conducting the transaction. Elisa Giuliani and others have defined them as `positive or negative unpaid, out of the market rules, side-effects of the activities of one economic agent on other agents.'[1] The concept was introduced by Alfred Marshall in Principles of Economics (1920). Pollution is a common negative externality of the transaction between a capitalist industry and its customers. Usually neither of them pays for the degradation of air, water, etc. caused by the industry's activity; that cost is borne by society as a whole.

Industrial pollution imposes costs on people and the environment. These costs are not usually paid by the polluting industry and are thus externalities of its operation.

The existence of externalities is an important disadvantage of market economies, because externalities cause economic agents to make choices which are sub-optimal for society as a whole. As David Schweickart writes: `The neoclassical argument for the optimality of competitive capitalism rests on the presumption that a competitive market compels those who make decisions to bear the costs of these decisions.'[2]

Externalities have a connection to the tyranny of small decisions, wherin a sub-optimal macro decision results from the aggregation of optimal decisions at the micro (individual) level. For example, if I decide to buy disposable bottles, that puts an externality on the environment. Everyone may decide to do this despite preferring that there be a ban on disposable bottles.[3]

Other works

  • Some technical points about externalities by a bourgeois economist: Kenneth J Arrow, `The Organization of Economic Activity: Issues Pertinent to the Choice of Market versus Non-market Allocation', Joint Economic Committee of Congress (United States), 1969; page 9. Free from ucsb.edu


  1. Elisa Giuliani, Carlo Pietrobelli, and Roberta Rabellotti, `Upgrading in Global Value Chains: Lessons from Latin American Clusters', p. 3.
  2. David Schweickart, Capitalism or Worker Control?, p 102.
  3. David Schweickart, p 110.
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