The Definition of External Costs
The scope of the ExternE Project is to value the external costs, i. e. the major impacts of
economic activities, both referred to production and consumption. Up to now, valuations of external costs have mainly been applied to energy-related activities such as fuel cycles, and activities related to transport
of persons and freight, but the focus is being broadened and the methodology extended to activities such as different industrial processes.
An external cost, also known as an externality, arises when the social or economic activities of one group of persons have an impact on another
group and when that impact is not fully accounted, or compensated for, by the first group. Thus, a power station that generates emissions of SO2,
causing damage to building materials or human health, imposes an external cost. This is because the impact on the owners of the buildings or on those
who suffer damage to their health is not taken into account by the generator of the electricity when deciding on the activities causing the damage.
In this example, the environmental costs are "external" because, although they are real costs to these members of society, the owner of the power
station is not taking them into account when making decisions. Note that external costs are unintended and result from there being no property rights
or markets for these environmental effects. The potential value of the ExternE project therefore lies in valuing external costs in order for those
values to be included in the design of policy to correct for the present lack of such property rights and markets.
There are several ways of taking account of the cost to the environment and health, i.e. for 'internalising' external costs. One possibility would be
via eco-taxes, i.e. by taxing damaging fuels and technologies according to the external costs caused. For example, if the external cost of producing
electricity from coal were to be factored into electricity bills, between 2 and 7 cents per kWh would have to be added to the current price of electricity
in the majority of EU Member States. Another solution would be to encourage or subsidise cleaner technologies thus avoiding socio-environmental costs.
The Community guidelines on state aid for environmental protection explicitly foresee that EU member states may grant operating aid, calculated on the
basis of the external costs avoided, to new plants producing renewable energy. Besides that, in many other widely accepted evaluation methods such as green
accounting, life-cycle analysis and technology comparison, the quantitative results of external costs are an important contribution to the overall results.
Another application is the use of external cost estimates in cost-benefit-analysis. In such an analysis the costs to establish measures to reduce a certain
environmental burden are compared with the benefits, i.e. the avoided damage due to this reduction. The avoided costs can then be calculated with the
methods described here.
