External effects

There is no universally accepted definition of external effects. “The different definitions and interpretations of external costs relate to the principles of welfare economics, which state that economic activities by any party or individual making use of scarce resources cannot be beneficial if they adversely affect the well-being of a third party or individual (see, for example, Jones 2005).

Definition

External effects are changes in welfare due to an urban development project with which the owners, exploiters and users are not taking account of during the decision process. Put differently, external effects are “benefits and costs which arise when the social or economic activities of one group of people have an impact on another, and when the first group fails to fully account for their impacts (European Commission, 1994).

Types of external effects

Externalities can be classified according to their benefits or costs in two main categories:

• Environmental and human health externalities: These can additionally be classified as local, regional or global, referring to climate change caused by emissions of CO₂ or destruction of the ozone layer by emissions of CFCs or SF6; and
• Non-environmental externalities: Hidden costs, such as those borne by tax-payers in the form of subsidies, research and development costs, or benefits like employment opportunities, although for the latter it is debatable whether it constitutes an external benefit in the welfare economics sense.

External effects can be both primary and secondary impacts

Importance of externalities

By definition, markets do not include external effects or their costs. It is therefore important to identify the external effects and then to monetise the related external costs, for example with the help of a Social cost-benefit analysis. This so-called "internalisation" of external effects has to be achieved by adequate policy measures, such as taxes.