The outsourcing of costs of a company occurs when a company decides to transport some activities that it carries out to external locations. This way you can have flexible labor legislation, cheaper production materials or better economic conditions.
On the other hand, the internalization of costs incorporates the knowledge of some social or environmental problems that are generated in certain activities so that companies can take them into account.
Both internalization and externalization of costs have their advantages and disadvantages. Contrary to what is believed, they are not opposite cases; rather one is the consequence of the other.
Outsourcing has many economic benefits and long-term improvements. It is quite an attractive activity for large companies since production costs are cheaper.
However, these activities have resulted in the deterioration of the environment. The common economic activities of developing countries and large companies have a great impact on the environment.
Internalization seeks to create and measure the impact of these activities. It could be said that internalization is a direct consequence of the externalization of costs of certain companies.
Cost outsourcing
Outsourcing costs are production costs that someone else must pay. For example, one reason California Central Valley vegetables are cheaper than local produce in the state of Pennsylvania is that they do not reflect their full cost.
There are many types of cost outsourcing: social costs, healthcare costs, environmental costs, military costs, security costs, subsidies, and infrastructure development, among others.
For example, producers are not responsible for paying the current and future costs of aquifer depletion, pesticide poisoning, soil salinization, and other effects from their farming methods. These costs do not contribute to the price of a head of lettuce, for example
Additionally, the transfer of products around the continent is also highly subsidized. The price of a tank of gasoline does not include the cost of pollution it generates, nor the cost of the wars fought to insure it, nor the cost of oil spills.
Transportation costs generally do not reflect the construction and maintenance of roads and highways. If all of these costs were added to the head of the lettuce, California lettuce would be incredibly expensive in Pennsylvania.
Another example of cost outsourcing is automobile manufacturing in the United States in the 1970s.
In this period, they began to outsource the workforce in Mexico, since labor laws were more flexible in that region and salaries were lower.
That said, cost outsourcing has the advantage of lowering production costs and creating many jobs. One downside would be low wages and few regulations regarding worker safety.
Most industries today can only operate because their costs are outsourced. For example, legal limits on liability for oil spills and nuclear disasters make subsea drilling and nuclear power profitable for their operators; even if the net effect on society is negative.
The elimination of cost outsourcing slows future business plans. Most companies have the mindset of keeping the profits while someone else pays the costs in the future.
It can be concluded that cost outsourcing means that companies receive higher profits, but society is paying for them. Most financial models reward companies for their cost outsourcing.
Cost internalization
Since private market activities create so-called outsourcing - such as air pollution - it is believed that society should take responsibility for holding the parties responsible for the cost of clean-up through the government.
Any damage they generate must be internalized in the price of the transaction. Polluters can be forced to internalize the costs of the environment through pollution taxes and tariffs, a method generally preferred by economists.
When these taxes are applied, the defective market (the price of pollution that is not counted in the transaction) is corrected.
Companies may have an incentive to reduce harmful activities and develop less harmful technology for the environment.
The downside of this system is that society does not have direct control over pollution levels, although it will receive monetary compensation for any losses that occur.
However, if the government imposed a tax on polluting individuals, it would have to place a monetary value on the damage.
In practice this is a difficult thing to do; you cannot put a price on the lives lost as a result of pollution.
Governments have attempted to control associated outsourcing activities through regulation; instead of implementing the pricing system. There are generally standards for specific industries and other social entities.
These standards are designed to limit environmental degradation to acceptable levels and are enforced through the EPA. They prohibit certain harmful activities, limit others, and prescribe alternative behaviors.
When market players do not adhere to these standards, they are subject to penalties.
In theory potential polluters have many incentives to reduce and treat their waste, to make less harmful products, to develop alternative technologies, etc.
There is currently a debate on the incorporation of a treaty in pollution permits. Governments would not put a tax on pollution, but would impose a number of permits that would add up to an acceptable level of pollution.
Buyers of these permits could use them to cover their own polluting activities or resell them to the highest bidder.
Polluters would be forced to internalize the environmental costs of their activities so that they have an incentive to reduce pollution.
In this way, the price of pollution would be determined by a market. The downside to this system is that the government would have no control over where the pollution takes place.
References
- Internalizing costs (2013) Recovered from encyclopedia.com.
- Externalization of costs. Recovered from wiki.p2pfoundation.net.
- Cost internalization. Recovered from stats.oecd.org.
- Externalization and internalization of costs (2013) Recovered from slideshare.com.
- Rise of externalized costs (2015) Recovered from thecenterforglobalawareness.wordpress.com.
- What are externalized costs? Recovered from natureandmore.com.