A technological externality exists when the production function of one agent enters another agent's production or utility function, without the latter being compensated (Kolstad, 2000). Environmental externalities (when they affect productive processes such as polluted irrigation water) are, of course, specific examples of the more general case of technological externalities. However, they are by no means the only type of technological externality. In this section, the focus of the discussion is on "non-environmental" technological externalities which tend to reduce recycling rates.
In the area of waste, technological externalities would arise when one firm manufactures a product in such a way which increases the cost of recycling for the downstream processor, but for institutional reasons there is no means by which the potential waste recovery facility can provide the manufacturer with the incentives to change their product design (Porter, 2002 and Calcott and Walls, 2000). An illustrative list of areas in which technological externalities might exist would include the following:
All such product characteristics clearly provide benefits in the "primary" market, or they would not be undertaken. For instance, the use of complex plastic mixes in food packaging which reduce recyclability is used to ensure minimum hygiene standards and reduction of food wastes. Thus, whether or not the examples of technological externalities cited above have adverse impacts on social welfare is dependent upon whether or not the benefits conferred by such designs are greater or less than the costs. Stated differently, would the firms have designed their products in such a way if they could capture the benefits of increased recyclability themselves? As such, in order to identify the existence of a technological externality it is not sufficient to identify attributes of products which restrict recyclability. Many characteristics of products restrict recycling, and even if there were no missing markets firms would continue to design them in such a way.
The externalities will be internalised if subject to a market transaction between those who are deriving benefits and those who are bearing the costs (Kolstad, 2000). For instance, in cases where the manufacturer is linked with the recycler by commercial transactions - as for many types of industrial waste - the potential externality is internalised within the market. Similarly, the problem is likely to be obviated in cases where the waste stream exists within vertically-integrated industrial sectors. In this case internalisation is within the firm itself. In both cases the manufacturer will have incentives to change product design.
This is an area in which the distinction between the environmental externality and the non-environmental externality is particularly subtle. The sub-optimal level of recycling due to technological externalities has nothing to do with any loss of environmental benefits associated with recycling, but rather with the economic costs of not recycling. As such, the externality should be addressed, irrespective of environmental concerns. Of course, the level of recycling would be greater still if efforts to internalise associated environmental externalities favoured recycling over other strategies, but the two failures are quite distinct. Indeed, environmental internalisation may result in lower levels of recycling (if for instance incineration is a more efficient response from the environmental perspective), with technological internalisation pushing in the opposite direction.
There are good reasons to believe that technological externalities arising from the recyclability of product design are endemic in some waste streams due to the prevalence of "missing markets". For instance, for municipal solid waste streams it is only rarely that manufacturers bear the cost of producing goods which cannot be easily recycled. In practice, overcoming the joint presence of environmental externalities and "missing markets" for product attributes is often achieved through the application of single instruments which seek to deal with both problems simultaneously.
Products which are subject to deposit-refund schemes or other forms of extended producer responsibility would be one such example. Indeed, the presence of technological externalities was often the (usually unstated) logic behind product take-back schemes. An alternative is to provide support for "design-for-environment" such as through subsidies for research and development in product designs which are more recyclable. However, this does not address the fundamental problem of missing markets. Incentives have been changed, but in a rather crude manner, which requires large amounts of information for the public authority concerning alternative design options. Nonetheless, for markets which are relatively immature, "design for environment" policies can play an important role in helping to overcome barriers to the market penetration of recycled materials.
Worse still would be support for recycling technologies which reduce the downstream impacts of technological externalities at the recycling stage, without simultaneously affecting the upstream incentives to internalise such externalities. Implicitly, this indirectly provides incentives for the design of products which possess technological externalities. The public authority may find itself "chasing its own tail", providing increased levels of public support for recycling technologies to address technological externalities, generated by firms who face no incentive to design their products for recyclability. Thus, for example, if significant resources are devoted toward the development of sorting technologies to allow for the recycling of complex mixed wastes, product designers and manufactures will be discouraged from redesigning their products even if the net social costs would be less.
A final policy implication in this area relates to the formulation of product standard in light of potentially conflicting public policy objectives. For instance, in areas in which product standards are provided for other reasons related to the public good (i.e. hygiene standards for food packaging), it is important to balance the two objectives (environmental and health) appropriately. The examples cited above concerning the performance standards of certain products derived from construction and demolition waste are relevant in this regard (Papineshi, 2003).
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