Based on the article “Take into account environmental externalities” written by Dr. Pola Singh in The Star, (http://biz.thestar.com.my/news/story.asp?file=/2012/4/2/business/11012372&sec=business), it is discussed by the author that in the process of generating electric energy in Malaysia, there are many side effects that arises from it, mainly environmental pollution.
Externality refers to a cost or a benefit that affects parties outside of a transaction, besides the seller and the buyer, and is not reflected on the price. Externalities are made up of two parts, a consumption externality and a production externality, with both can be either a positive externality or a negative externality. The environmental problems created as a result of electricity generation is a negative production externality, and negative production externality occurs when the marginal social cost exceeds the marginal private cost.
In Peninsular Malaysia, 52% of electricity is generated by natural gas, 40% by coal, 5% by hydro and the other 3% by diesel, fuel oil and renewable resources. The burning of fossil fuels will release gasses such as nitrogen, carbon dioxide and sulphur dioxide, all which are detrimental to the health of residents living nearby. As we can see from graph, the residents are facing higher costs compared to the firms; the marginal social cost is above the marginal private cost. Thus, it is proven that the generation of electricity causes a negative production externality.
Also, there would be a welfare loss as a result of the electricity generation in terms of over production. The optimum point is at B, where the Marginal Social Benefit equals to Marginal Social Cost, while cost and quantity are P1 and Q1 respectively. The market equilibrium, on the other hand, is set at point A, where cost is at P and quantity is at Q. Any point between Q1 and Q creates a welfare lost, as there is a divergence between the MSC and the MSB. As the quantity increases, the gap between MSC and MSB grows. The quantity which the market achieves equilibrium is greater than the optimum quantity, thus there is an over production. The sector is producing too much energy than the required and the people’s health are affected by it.
It is also mentioned in the article that Malaysia’s power sector is heavily subsidized by the government. The fuels used by the Independent Power Producers in Malaysia are subsidized by Petronas, and it is estimated that the amount adds up to RM86.6 billion from 1997 to 2010. By providing subsidies, the government hopes that it would help them increase their production and help the consumers stabilise the electricity rates charged. But instead, this will encourage inefficiency in the sector as IPPs would not have the incentive to be productive efficient.
So, does it mean that because the social cost of generating electricity is higher is greater than the social benefit, the government should just shut down the whole power plant? In my opinion, that is almost impossible to do. It is important to consider factors other than the costs and benefits before deciding whether it brings more harm than good to society. We should instead focus on the long run. Electricity generation in Malaysia relies heavily on fossil fuels, and in the long term, residents may face health problems and the air quality will be worse due to the burning of the fossil fuels.
According to statistics, it is estimated that Malaysia produces about 105.08 billion kWh of electricity in 2009. And out of that, 93.8 billion kWh are consumed in the country and another 91.7 million kWh are exported to neighboring countries. If the government decides to shut down the plants, not only would Malaysia lose out on export revenues, the whole country may face a power shortage and lives would be made much worse.
However, externalities can be tackled, only if the right measures are taken. One of the popular methods to tackle externality of pollution is by imposing carbon taxes. The carbon tax requires firms pay taxes for the amount of carbon contents that they release throughout the production process. This is a great way to tackle inefficiency in the independent power producers as externalities are now reflected on the market price. The IPPs are now forced to reduce the externalities they caused to as low as possible and achieve efficiency.
Also, another effective way of reducing externalities by adopting the pollution permit system, or the Cap-and-Trade system as they call it. The government sells these permits to firms, giving the firms a quota on the limit which they are able to pollute. Firms are able to trade, sell or buy these permits among themselves. Firstly, these permits encourage the firms to reduce its inefficiency. Due to their inefficient production, the firms are polluting at a higher rate. Firms would then have to purchase more permits and this will incur higher costs for them. As a result, there would be an incentive for them to reduce the cost of buying permits by polluting less. Moreover, the issuing of permits gives the government the ability to control the overall rate of pollution in the country. The government is able to restrict the number of permits that they issue, indirectly controlling the level of pollution.
All in all, the carbon tax and pollution permit system are actually very effective ways to tackle environment externalities of electric generation and should be encouraged in all countries. One of the down side to these methods is that the higher cost will be carried by consumers; the taxes will be passed on to consumers in terms of higher price.
In conclusion, electricity still holds a great part in our lives and it is inevitable that some degree of environmental impact would occur as a result of its production. But there also long term solutions where this could avoided, maybe through current green technologies such as solar energy and bio fuels. Who knows, in the near future we could be enjoying a pollution free environment without worrying about power shortages and environmental issues.
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