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An Outlook to the Externalities of the Energy Sector - Alperen Ahmet Koçsoy


The energy we use for heating our homes, manufacturing, and all other benefits also have some downsides that we might not be aware of. Climate change, environmental damage, human rights violations, and conflicts worldwide are some results that come together with energy production. They are called negative externalities in economic terms. The concept of externalities, developed by Arthur Cecil Pigou in the early 20th century, means that there are social costs of the production process that the supplier does not feel as a cost of production. Every part of society must bear these costs at the end of the day. We need to ask ourselves how to reduce these costs to a minimum.

The most known externalities are environmental damage and, subsequently, climate change. The excessive wealth created with the help of fossil fuels costs us global warming. Along with the environmental damage, it has enormous costs to humankind. The cost should not be thought of only from the perspective of "We should save our planet!" The cost we are talking about is also in economic terms. According to a University College London study, the world GDP in 2100 could be 37% lower than a world that does not suffer from climate change. The effects are not only long-term, as the yearly cost of a typical individual's CO2 emissions is estimated to be over $1300.

Energy production is also associated with social evils, as it sometimes fuels human rights violations and regional conflicts. The resource curse is a typical example of why resource-rich countries are prone to create authoritarian governments that can use their natural resources to be resilient to the costs of being authoritarian. Resource-rich countries can also use their economic leverage to create conflicts. The most recent example of that is the Russian invasion of Ukraine. There is certainly a reasonable argument that Europe's dependence on Russian gas contributed to the decision to the invasion.

These problems are not peculiar to fossil fuel production. Renewables can also be the reason for human rights abuses and regional conflicts. The dispute between Ethiopia, Egypt, and Sudan arises from the construction of The Great Ethiopian Rennaissance Dam (GERD) and the water security on the Nile River. Solar panels, an alternative to fossil fuels, need cobalt to become solar panels. Non-industrial cobalt mines in the Democratic Republic of Congo (DRC) are known for exploiting child labor, which should have been the case in the past centuries.

Social evils are not purely about morality. They also harm the economy, so they are negative externalities. What are we going to do to prevent these negative externalities? The answer is not to stop generating energy. The solution is more market regulation by national governments to correct market failures. The textbook neoliberal economics started to fail to deliver solutions to emerging problems. This matter of fact was also contributed by Liz Truss's resignation, as her neoliberal ambitions had got backlashed, even by her party, the Conservatives. As the neoliberal global economy faces supply chain problems and geopolitical risks, there are enough imperatives to transform the current global economy to a more regulatory direction. Economists like Dani Rodrik argue that there are signs of a system change. Rodrik foresees a future global economic system following what he calls the New Productivism Paradigm, which is rooted in 'production, work, and localism instead of finance, consumerism, and globalism.' Although there are variations between the foresight of different economists, the world is heading towards prioritizing resiliency over efficiency.

This paradigm shift has implications for the energy sector too. Firstly, governments must design their economies to prevent negative externalities with gigantic long-term costs, such as the aforementioned CO2 cost. To be successful in that goal, long-term planning and state intervention are needed since the free market often fails to operate with negative externalities in mind. Energy efficiency is one of the state interventions that could work. For example, the European Commission targets utilizing energy efficiency of up to 13% by 2030. Another solution to tackle externalities from energy generation is to spend more from the national budgets on green energy investments. Secondly, building a more resilient energy economy is another goal that policymakers will have strong imperatives to achieve. As the Ukrainian War demonstrated, there is more need for reliable and diverse energy sources. Cheap gas from Russia was a lucrative incentive for European homes and industries, but relying too heavily on one energy source can create shocks.

However, there is a caveat to this story: the problem of social externalities such as human rights violations in raw material exporting countries. While energy supply security is at stake, it is hard to predict that the countries in desperate need of secure energy sources will focus more and more on the negative externalities of human rights violations.


To sum up, the global economy is moving away from neoliberalism and directing towards a more resilient and regulatory way. The trend is getting its power from solid imperatives to deal with externalities such as climate change and energy supply problems. Proper long-term planning and state intervention are necessary to tackle today's problems. Moreover, since it seems that today's problems will persist over the coming years –maybe decades– it is crucial to have consistent strategies to be more resilient and sustainable.