The Market for Sustainable Goods: Pigouvian Taxation, Plastics and Waste

The Market for Sustainable Goods: Pigouvian Taxation, Plastics and Waste

A consumer who opts for a reusable water bottle instead of a single-use plastic cup is participating in something economists find genuinely interesting. They would describe it as a spontaneous, decentralised correction of a market failure. The market failure, as it relates in this case, is the negative externality that disposable goods create - the difference between what a consumer pays for an item and the cost incurred by society because of that item. Historically, this gap was ignored. Understanding why it is narrowing today, and what that means for markets, is the central question of this article.

The Problem with Externalities

Private costs are the costs that a producer incurs when creating or distributing a disposable product. Private costs include the cost of materials, labour and logistics. Private costs do not include any of the social costs associated with disposing of that product once it has been used. Social costs associated with the disposal of disposable products include landfilling, waterway pollution, and ocean gyre pollution. When the social costs of a product are greater than the private costs, this creates a negative externality. A negative externality results in the excessive use of disposable products, used in excess of the socially optimal amount.

Arthur Cecil Pigou's work in the 1920s laid the foundation for conventional economic theory. Conventional economic theory holds that the most efficient way to correct the market failure resulting from negative externalities is a tax that is equal to the external social cost of the product. By imposing this tax, both producers and consumers will have to internalise the social costs that they had previously externalised onto society.

Quantifying the Costs

The scale of the market failure is significant. According to the OECD, less than 9% of plastic waste generated globally has ever been recycled. From the perspective of the marine ecosystem, the Ellen MacArthur Foundation estimates that the cost associated with plastic pollution is around $13 billion per year — and this cost does not appear anywhere on the price tag associated with a disposable coffee cup.

Consumer Preferences Shifting Ahead of Regulation

The current state of consumer behaviour indicates that there is a shift away from buying disposable items and towards purchasing reusable products, such as insulated mugs, heavy-duty cotton tote bags and durable notebooks. Through their decisions to purchase items that create less waste over their lifetime and offer better functionality than disposable items, consumers are taking on some of the costs associated with disposable items that have been passed onto them.

What we are experiencing at this time is not a market-wide trend, but rather the rise of the premium reusable item sector among higher-income, educated individuals. These segments will likely remain the core demographic for this type of product until a larger percentage of consumers transition away from disposable products into reusable products.

As a result, the increase in sales of premium reusable products may indicate a trend toward a more environmentally conscious consumer, along with increased interest in eco-friendly alternatives to disposable products.

Where Pigouvian Policy Has Worked

England's plastic bag levy, created in 2015, serves as an excellent example of market-based Pigouvian policy in real-world situations. The plastic bag levy requires people to pay 5 pence for a single-use plastic shopping bag when shopping at any large store. The UK government's Department for Environment, Food and Rural Affairs (DEFRA) states that, in just two years, the usage of plastic bags in large grocery stores fell by 95%. The charge was not a ban on bags, but rather a way to make the societal costs associated with using them clear. People changed how they used plastic bags dramatically because of this societal cost.

In addition, Ireland experienced the same results prior to England when they introduced their plastic bag tax in 2002 at €0.15 per bag. In less than six months, the number of plastic bags used in Ireland was reduced by more than 90% compared to the previous year. The revenue generated from the tax was set aside for funding of environmental initiatives — the design and outcome of the plastic bag tax in Ireland matched the textbook example of a Pigouvian tax.

The Limits of Voluntary Correction

These two examples demonstrate the key point that the amount of correction for the externality problem cannot be achieved just by consumers preferring an item. The reusable merchandise trend is valid; however, it is also solely occurring at the high end of the marketplace and has not changed the economic structure regarding the production of disposable items enough. If a pricing structure does not truly reflect how much it costs society to produce it, then society will continue producing, generating, and discarding more disposable items than would otherwise be socially optimal.

Pigou understood more than a century ago that behaviour follows price. Get the price right, and the market does the rest.