Safe Harbor for Negative Externalities

Joe Gregorio

Negative externalities are the bane of a market economy. Those wider costs to products and services that aren’t included in the actual cost of a item can wreak major havoc on society and almost always result in years of litigation, lawmaking, and acrimony between businesses and government. So what exactly is an negative externality? Let’s start with the definition of externality from Wikipedia:

In economics, an externality (or transaction spillover) is a cost or benefit, not transmitted through prices[1], incurred by a party who did not agree to the action causing the cost or benefit. A benefit in this case is called a positive externality or external benefit, while a cost is called a negative externality or external cost.

The examples of negative externalities are legion: smoking causing cancer, asbestos causing cancer, CO2 causing global warming, lead in gas or paint leading to lead poisoning, ozone depleting CFCs, acid rain inducing sulfur emissions, etc. In each of the cases the discovery of the negative externality was followed by years of costly litigation, acrimony, industry FUD, astroturfing, lobbying, lawmaking, and more litigation. In each of the cases there was an industry supplying a product that produced the products with the negative externalities that fought the imposition of legislation governing the externality with all their might, including litigation, lobbying, and astroturfing. In all cases the goal was not to protect their customers, or that they really believed that the negative externalities didn’t exist, but to protect their business from taxation, or litigation by those affected by the negative externality. Cigarette companies knew that smoking caused cancer and did their level best to hide that finding, or to discredit those that brought the information forward. Their attack on the science around smoking and cancer was about protecting their business, not about protecting their customers from cancer. There’s an obvious cost, both economic and societal, when the incentives are for a company to hide, deny, attack, or otherwise ignore negative externalities of their products. Wouldn’t it be nice to reverse the direction of that incentive?

To reverse the incentive what we need is way to change the playing field so that it is in companies best interest to publicly acknowledge negative externalities, and the best way I can think to do that is a Safe Harbor law.

A safe harbor is a provision of a statute or a regulation that reduces or eliminates a party's liability under the law, on the condition that the party performed its actions in good faith. Legislators include safe-harbor provisions to protect legitimate or excusable violations. An example of safe harbor is performance of a Phase I Environmental Site Assessment by a property purchaser: thus effecting due diligence and a "safe harbor" outcome if future contamination is found caused by a prior owner.

For example, the DMCA contains a safe harbor provision for Internet Service Providers; as long as they respond to take-down notices in a timely manner according to the law then they can not be held liable for their user’s actions. A similar law should be put in place for negative externalities for products. As long as a company publicly acknowledges the negative externality then they can not be held liable for the negative effect. In the case of smoking, once a tobacco company acknowledged that smoking caused cancer then they could not be held liable by their customers for the cancer causing effects of smoking.

Such a law would completely change the dynamics of companies in an industry that had discovered a negative externality. Think of it from a game theory perspective, where each of the companies involved faces a prisoner’s dilemma for disclosing the negative externality. Without a safe harbor provision the cost of defection (acknowledgement) is very high, while the cost of cooperation (keeping the negative externality a secret) is low. With the safe harbor law in place, the benefit of defection would swamp the cost of cooperation. It would be in a companies best interest financially to find and expose negative effects as soon as possible, to make sure they would qualify for the safe harbor provision.

Now this is easier said than done, as the law would have to carefully crafted. For example, what class of products does this apply to? What does it mean to “acknowledge” a negative externality? How long can a company wait after their competitors have acknowledged a negative externality to also acknowledge it and still gain the benefits of the liability shield. Even with such a law in place the corporations involved would still lobby for their industry, as the tobacco lobby now does against the FDA regulating nicotine, and the coal and oil industries lobby against the EPA regulating CO2 emissions. Still, it is usually years if not decades between the discovery of a negative externality and the time legislation begins in earnest, and a safe harbor law could slash that time to a fraction of that, and in the process save the economy a lot of wasted money.

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