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| EU policy-making - counting the hidden costs

‘Externalities’ are the costs of an activity that are not included in its price - such as the impacts of greenhouse gases emitted during a car journey. These are nevertheless real costs that must be paid eventually, usually by society as a whole. Governments are increasingly taking these costs into account when making policy - but there is a lack of information about them. The RED project consolidated worldwide research data in a central database containing the external costs of activities across many sectors, including transport and energy. The online RED database is now available to policy-makers everywhere.

RED logo
To an economist, ‘externalities’ or ‘external costs’ are defined as ‘changes in welfare induced by a given economic activity that are not reflected in the market’ - but the rest of us probably need a simpler explanation.

Free ride

Andrea Ricci is the Managing Director of ISIS, an Italian institute for systems integration, with much experience in sustainability issues and external costs. "An example of external costs is found in a car journey," he explains. "The driver pays the fuel costs and some part of depreciation, insurance and tax - these are the internal costs. However, the exhaust gases the car emits can damage crops, coat ancient monuments and affect people’s health. These ‘external’ costs are not paid by the driver - they are met by society as a whole in compensating farmers, cleaning monuments and meeting health insurance claims. The driver does not have to consider these costs because they are not reflected in the market price he or she pays - so the market is distorted because the information available to the driver is incomplete. Simply put, there is a bit of a free ride in every car trip."

Many activities have external costs - and these include social, economic and health consequences as well as environmental impacts. A train journey does less environmental damage than a car, but trains passing through cities have a higher social cost because of the noise they make. To make rational choices we must understand all of these external costs. The energy sector also has many external costs that depend on the energy source used, and manufacturing industry is awash in externalities, from the environmental costs of toxic waste disposal to the social welfare and health costs of implementing shift work.

Hot topic

Externalities are now at the core of policy-making at European and national levels. Andrea Ricci explains, "Accounting for externalities began in the energy sector 20 years ago and then widened to include transport, driven by the growth of the European TEN networks. Today, the EU strategy for sustainable development demands that all new policies take account of social, economic and environmental costs - so understanding externalities is a hot topic."

Unfortunately, hard data on external costs are scarce. EU-funded projects like ExterneE have studied externalities, and many specific studies are dispersed in the academic literature worldwide. However, informed policy-making requires quantitative external cost data across a wide range of activities and sectors to allow comparison between diverse options. "External costs were an abstract topic in the past, but this has definitely changed," Ricci explains. "Now we must make them operational and that requires quantitative information and practical tools."

In the RED

The Review of Externalities Data (RED) project consolidated worldwide academic externalities studies into a central database.

ISIS, a specialist in the transport sector, led the project consortium, which included Finnish energy specialist Electrowatt-Ekono, Armines from France which has industrial and energy expertise, and EMRC, a UK environmental consultancy. "Around 80% of RED’s work was collecting and interpreting data in very specialised fields," says Ricci "Each partner brought specific sectoral knowledge."

The RED Database is an information retrieval tool that relates external costs to:

  • sectors, such as waste or energy
  • technologies, such as vehicle type or industrial process
  • burdens, such as emissions or noise
  • receptors, such as people or environment

Users can navigate the database according to their specific interest. For example a user can determine the monetary value of the damage generated by a unit of a given pollutant emission across different types of location, or the cost of the health damage produced by the incineration of waste compared across technologies. Customised outputs aggregate results across sectors and technologies - giving the helicopter views of external cost behaviours needed by planners and policy-makers.

Each external cost is linked to the original source article, and Ricci believes this link is vital. "The database cannot replace careful analysis, so we keep the links to the original research. Externalities research is young, and data is scarce. The database contains much information on transport and energy but agriculture and industry are under-represented, reflecting the lack of research done in these areas."

A range of users

European and national policy-makers will be RED’s main users. "They want to correct market distortions," says Ricci. "New policies like road-pricing may internalise the external costs. In other cases they may use RED data to inform people about true costs - when people often change their behaviour when they understand the real cost of their activities." Another user group is composed of operators, including companies. "Increasingly, utilities and companies take external costs into account in their long-term investment decisions, because they know that future regulations may internalise these costs," Ricci explains.

The RED Database is a unique tool for advancing sustainable development, and further research will continue to add to it. "The next step is to focus on the external costs of industry," Ricci believes. "This requires care because industry is already heavily regulated. We are also improving the methodology, In a new European project, Methodex, we are investigating how to transfer external cost data between situational contexts - for example, how to map external costs from an urban setting onto a rural setting and avoid the expense of collecting data twice. In Methodex we will work even more closely with policy-makers to improve RED’s contribution to key issues in sustainable development policies."

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Andrea Ricci, ISIS
+39 063612920