Multifunctionality and a new focus on externalities

The Journal of Socio-Economics 37 (2008) 293–307

Multifunctionality and a new focus on externalities

Stefan Mann a, Henry Wustemann b,∗a Swiss Federal Research Station for Agricultural Economics and Engineering, CH-8356 Ettenhausen, Switzerland

b Division of Economics and Politics of Rural Areas, Humboldt-University of Berlin, D-10117 Berlin, Germany

Accepted 1 December 2006

Abstract

The concept of multifunctionality has been developed to describe the constitutional importance of jointnessand externalities for agriculture and forestry. We argue that this notion is not restricted to the primary sector,but that the whole economy is characterised by multifunctionality. In addition, we show that welfare-relevantexternalities are not only technological or pecuniary. We also identify psychological, social and human capitalexternalities. Further, the concept of multifunctionality provides an opportunity to take the individual andsocial dimensions of externalities into account. Since not all externalities ought to be internalised and sincetheir perception is sometimes rather subconscious, it seems often reasonable to abandon willingness-to-paystudies for more deliberative processes.© 2007 Elsevier Inc. All rights reserved.

JEL classification: H23; P43; Q51; Z13

Keywords: Multifunctionality; Non-technical externalities; Deliberation; Internalisation

1. Introduction

Classical economic theory has for a long time been aware that cases of joint production exist(Smith, 1776; Mill, 1848). Without explicit reference to that, but certainly not unrelated, Pigou(1920) introduced the concept of externalities. However, both jointness and externalities werelong seen as accidental coincidences occurring through certain economic activities. It was in abook by a German forestry policy researcher (Dietrich, 1953) that the existence of jointness andexternalities was for the first time perceived as being a constitutional element of an economicsector. Upon terming this notion the multifunctionality of forests, a new concept had enteredeconomics.

∗ Corresponding author. Tel.: +49 30 2093 6199; fax: +49 30 2093 6474.E-mail address: [email protected] (H. Wustemann).

1053-5357/$ – see front matter © 2007 Elsevier Inc. All rights reserved.doi:10.1016/j.socec.2006.12.031

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The multifunctionality debate has so far largely been restricted to agriculture and forestry.A theoretical foundation for this limitation is lacking, however. And in spite of some casualand unsystematic references to externalities like farm abandonment (Hollander, 2004) and ruralpopulation development (Bennett et al., 2004), the multifunctionality framework has been verymuch focused on environmental externalities (Dobbs and Pretty, 2004).

This paper sets itself the ambitious target of broadening the debate in two dimensions: firstly,we would like to argue that not only agriculture and forestry, but many other economic sectorsare characterised by jointness through a lot of immanent externalities, making many economicactivities outside agriculture multifunctional, too. Secondly, we also argue that externalities areby no means restricted to ecologically relevant, and not even to technological externalities andwe claim that the operation base for defining externalities should be considerably enlarged.

After reflecting on the state of the discussion about multifunctionality in Section 2, we dwellon the definition and categorisation of externalities in Section 3. In Section 4, the relevance ofthese externalities is explored by using the utilitarian base on which economic theory is built.Section 5 is concerned with their measurement and Section 6 concludes.

2. The debate about multifunctionality

It was in the early 1990s that the term multifunctionality as such entered the political discussion(Harvey and Whitby, 1988; French, 1991; for a literature review see Bohmann et al., 1999).During this first phase of the multifunctionality debate, the particular view of each participatingcountry led to quite different perspectives on the concept. Special historical and geographicalbackgrounds, the economic situation and social preferences as well as the influence of politicalpressure groups are reasons for a country to focus on certain non-commodity outputs, neglectingothers (Kobayashi, 2004).1

When the European Commission started to make increased use of the multifunctionality con-cept around 1996, it took it as a description of what was already provided by farmers and wasin danger of being reduced in case of a process of full market liberalisation (Huylenbroeck andvan Durand, 2003). The ‘European model of agriculture’ (MEA) entered the dictionary of theCommon Agricultural Policy (CAP) with the Agenda 2000 reform (Cardwell, 2004; CEC, 1998).However, “it is an essential and normative concept” (EEAC, 2000), being based on the sug-gestion that European farming provides non-commodities which are generally associated withpositive attributes and may include food security, food safety, animal welfare, cultural landscape,biodiversity and rural development (Glebe, 2003).2

A theoretically more sound and positivistic rather than normative analysis of the concept wasestablished in 2001 by the Agricultural Division of the OECD (2001a). This analysis stands as amainly environmental economic approach that basically describes the multifunctionality conceptas a tool for the internalisation of external effects. Changing scarcities lead to both new functionsof agriculture and the creation of new markets, for commodities and non-commodity outputsalike, with the problem that the markets for some of those outputs fail.

In the following OECD work a wide variety of different, jointly produced and mostly insep-arable non-commodity outputs such as soil preservation, land degradation, landscape scenery,

1 The term non-commodity output introduced by the OECD (2001a) reflects outputs or benefits supported by agriculturewhich can have the properties of positive and negative externalities or public goods. From our point of view, there is nouse in creating a new term. Therefore, we usually stick to the term ‘externality’.

2 Including reduction of negative effects.

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tradition or employment were identified by each participating country with the aim of identify-ing, classifying and defining agricultural non-commodity outputs (OECD, 2001b). However, theOECD Secretariat formulated its standpoint as follows: “The key elements of multifunctionalityare: (i) the existence of multiple commodity and non-commodity outputs that are jointly producedby agriculture; and (ii) the fact that some of the non-commodity outputs exhibit the character-istic of externalities or public goods, with the result that markets for these goods do not existor function poorly.” (OECD, 2001a; p. 8 ff). It becomes obvious that the OECD definition ofmultifunctionality is strongly output-related. For example employment, identified by the OECDas a non-commodity output, is also a necessary input within the production process. Finally, theOECD’s multifunctionality concept obviously delivers a theoretical background but is not a directbasis for policies.

The first key element that makes a production process multifunctional is therefore multiplecommodity and non-commodity outputs (OECD, 2001a). For example, in sheep production alarge variety of commodities like meat, wool or milk arise within the process of sheep raising,which makes this activity multifunctional without any consideration of resulting non-commodityoutputs or rather externalities. Therefore, the process of sheep production is characterised bymultiple outputs (commodities and externalities) which are jointly connected. Generalising thisnotion, all production processes allowing for all weight and energy fluxes are characterised bysome sort of joint production (Baumgartner and Schiller, 2001). The radical view, with which thispaper sympathises, is that joint production is in fact a necessary characteristic of all productionprocesses (Baumgartner, 2000).3 It also seems crucial to extend the definition of production tonon-technical processes.

Another relevant aspect is the character of jointness between commodities and externalitiesoccurring.4 Especially if the idea of traditional agriculture has changed and thus the relevanceof resulting by-products is growing,5 the relation between commodities and externalities withinthe production process is becoming more and more important. For example, many Europeanfarmers are paid by the government for keeping grassland open with the aim of producing theexternality ‘biodiversity’. The process of keeping grassland open is mostly achieved by husbandryand therefore by producing commodities. Were the farmer to increase the number of animalsand thus increase commodity production, the production of the externality ‘biodiversity’ wouldarguably increase as well up to a certain degree, so a complementary jointness between theexternality ‘biodiversity’ and the commodity (wool, milk, meat) does exist (see Fig. 1; X1–X2).This is complementary jointness as described in-depth by Frisch (1965). However, beyond acertain point the increase in animals on a limited area would negatively influence the biodiversitydue to the higher level of organic pollutants from the animals, etc. (competing jointness) X2–X3).Besides that, a backward bending effect of the production curve is also conceivable (X3–X4).6

The large number of animals would influence the own population negatively, as well due to thelack of space and fodder.

3 The consideration of the entropy law shows that inherent interdependence is a thermodynamic reality (Georgescu-Roegen, 1971).

4 Frisch (1965) characterize coupled (joint) production between production products in general coherently. For a morecontemporary elaboration of the Frisch theory to recognize jointness in utility and production see also Lynne (1999, 2002)and Hayes and Lynne (2004).

5 The growing importance of new products like biodiversity, recreation or education which agriculture can make availableis associated with the creation of new markets and a so called process of “commoditization” of externalities (Marsden etal., 1993).

6 See also Wiggering et al. (2006); Lynne (2002) shows a comparable jointness in connection with utility.

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Fig. 1. The character of jointness within the provision process of externalities.

It is clear that the discussion about the multifunctionality of agriculture has not only arisen froman increased perceived importance of externalities; in turn it has also sharpened the perception ofjointness and externalities in economic science. It seems appropriate, however, to explore in moredepth where the scope, the genesis and the relevance of externalities start and where they end.

3. The scope of externalities

A major economics textbook defines externalities thus: “The uncompensated impact of oneperson’s actions on the well-being of a bystander.” (Mankiw, 2004, p. 830). The focus on humanwell-being, used mostly as synonymous with human utility, is due to the traditional utilitarianbase of economic science. An action likely to increase the total utility of a group of personsaccording to the weak Pareto principle is considered to be efficient, so that, as another textbookputs it, “When a negative externality exists, too much output is produced and sold in a competitivemarket relative to the efficient amount” (Hyman, 2002, p. 98).

The question about the scope of externalities is, thus, the question about ways to affect aperson’s well-being without including him in a market transaction. The best-known kinds of suchexternalities are technological externalities, particularly with relevance to the ecological situation(Hayes and Lynne, 2004). Such externalities are inherent in the features of our planet describedin the first and second entropy law (Sollner, 1997). Technological externalities are then followedin popularity by pecuniary externalities, where, for example, the entry of firm A into a market cancause welfare losses for firm B.

There is no need to go into an extensive description of these categories of externalities, becauseexamples of them can be found in any economics textbook. For technological externalities, hun-dreds of environmental economics publications add to these descriptions: factories and cars emitcarbon dioxide without paying for the consequences of global warming; noise from airports andmotorways decreases the well-being of nearby residents. And the fertilization of fields leads tonitrous emissions into the groundwater that are a health hazard for water consumers. On thepositive side, the effect of extensive agriculture on biodiversity and landscape is often mentioned.

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While it is obvious that such technological externalities may considerably affect our well-being, it is also clear that our well-being is influenced not only by technical changes (a smellin our nose or a butterfly in our sight), but also by non-technical effects like the knowledgeabout peace in the country or a loving spouse. There is also no ex ante reason to assumethat only the technological factors which influence our well-being are relevant, either to mar-ket transactions or to external effects. Indeed, marketing scientists know since a long time thatboth tangible and non-tangible product attributes can justify a price premium (Goodwin andEtgar, 1980; Chaudhuri and Holbrook, 2001). While it may be impossible to define every-thing where our well-being is affected by a transaction between others, we would like togive three examples of fields where non-technological externalities may considerably affectwell-being.

3.1. Psychological externalities

Starting with an extreme example: in December 2002, a crime in Germany upset the interna-tional tabloids: one man chopped up and literally grilled another and then ate his flesh. The twohad found each other via the Internet and their action was carried out in absolute consensus.

Consider this macabre incident as the generation of a new market, the market for humanmeat.7 Such a market is clearly a market for private goods, because a man, grilled or not, is not apublic good and does not even generate technological externalities while being chopped up andeaten. However, given the reaction of the public and the courts, the outcry in the tabloids and theprison sentence for the consumer of human flesh, the action seems to have generated a lot of badfeelings, which one could best term psychological externalities. While the utility of the providerof human meat (who wished to be killed) and his consumer (who desired human meat) may havebeen increased by the transaction, it is very likely that the well-being of society would have beengreater without it.

Another example may generate weaker externalities, but due to the broader character of theproblem may be of still greater relevance: the case of animal welfare. Assume, for a moment,that neither do animals have rights (for an extensive debate on this see Cohen and Regan, 2001),nor do their utilities enter the utilitarian calculus, which is barely human. In spite of these strongassumptions, it might be efficient (because of increasing utilities) to provide for animal welfare.Farming chickens free range instead of keeping them in cages leads to higher production costs.But possibly they are outweighed by an increased utility: (1) for consumers of eggs (colour, tasteand status) and (2) particularly for compassionate people who really worry about the suffering ofanimals.8 That means there would be classical externalities, serious impacts of chicken keepingon the well-being of people who neither produce nor consume eggs.

It should be emphasised that there is no very clear borderline between technological and psy-chological externalities. Landscapes, for example, provide a kind of externality that is somewherebetween technological and psychological. Of course, landscapes exist in a technical way and weview them technically. But our ability to enjoy landscapes is a purely psychological phenomenon(Nohl, 1977; Kaplan and Kaplan, 1989). Hence, if a farmer decides to cut down his hedges in order

7 The case would be very different in the case of non-consensual cannibalism: basic rights like the right to live are hurt,so that an economic analysis would not make sense.

8 Both Brennan and Lomasky (1983) as well as Etzioni (1986) develop a system of parted preferences. In these systems,“reflective preferences” or “moral utilities” allow for the possibility of what we term psychological externalities. Lynne(1999, 2002) has moulded this concept into a helpful economic model.

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to increase production, he thereby reduces my well-being through technical and psychologicalmechanisms.

This leads us to the notion of the different origins of technological and psychological externali-ties. We smell or hear technological externalities like the smoke from a factory or the noise from amachine, which may even be a health hazard or at least may catch our attention in an inappropriateand irritating way. Our negative attitude can be directly explained by physical factors. This doesnot apply if we suffer due to chickens being kept in cages or other people eating each other. Inthese cases, our suffering is purely cognitive, supported perhaps by the media, but caused by ourculture and education. The fact that animal welfare is much less of an issue in Arab countries ismainly due to the greater emphasis on human rather than animal well-being taught in the Muslimreligion. And also, cannibalism has been acceptable in some cultures for some time.

The peculiarity about psychological externalities is therefore that these externalities are deeplyrooted in our history and culture. They are very much shaped by societal norms, being a mirrorof the moral values of a society.

More innovative readers might want to challenge the clear line we draw between body andmind by defining explicitly psychological externalities. In modern strands of discussion in psy-chological science, body and mind present a functional unit (Reich, 1987; Capra, 1991). From thispsychosomatic view it seems impossible to distinguish between psychological and technologicalexternalities. Surprisingly, this view, while broadly accepted in psychological science, has hardlyentered or influenced the economic discussion. The old occidental, dualistic view of a strict dis-tinction between body and mind (Descartes 1596–1650) dominates (see Desmond, 2003). Hence,by introducing psychological externalities we pay intellectual tribute to the current focus of themainstream externality definition on purely technical incidents.

3.2. Social externalities

When Germany’s largest bank announced in early 2005 that it had made a record profit butwould lay off hundreds of employees in order to further increase its profits in years to come, dis-satisfaction among Germany’s politicians was great. While anyone would understand a companylaying off staff at critical times, employment by profitable companies was apparently seen as akind of societal obligation. Alternatively, one could argue that the politicians were only speak-ing on behalf of the newly unemployed staff. But this option is of limited plausibility. Negativeside effects of rising unemployment include, for example, a deteriorating payer/recipient ratio inunemployment insurance. In addition, increasing unemployment has also negative side effects forthe perceived happiness of the entire population (Di Tella et al., 2001; Grozinger and Matiaske,2004). Hence, the contract between employer and employee seems to have a significant effecton the well-being of (external) bystanders, which, for want of a better term, may be called socialexternalities.

Social externalities of a different kind may arise in the case of over-population or depop-ulation. Since Tiebout (1956) came forward with an economic model which claims to showthat communities should compete against one another like enterprises, allowing migration totake place freely, several authors (Buchanan and Goetz, 1972; Boadway and Flatters, 1982;Stahl and Varayia, 1983; Stiglitz, 1983) have criticised this standpoint. In spite of their dif-ferent lines of argument depending on their model assumptions, their common conclusion wasthat depopulation may well entail welfare losses. Empirical studies on migration processes (Cenaand Fernandez-Cavada, 1986; Bondarenko, 1999; Kontorovich, 2000; Savchenko, 2001) seemto confirm that two phenomena in particular have economic, social and cultural impacts caus-

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ing negative externalities: outward migration from villages by the young and skilled, leavingthe old and unskilled persons behind, and rapid urbanisation, which is bound to cause socialproblems. These phenomena were summarised by Buchanan and Goetz as early as 1972 asan “undue concentration of persons in the large and growing conurbations”. Again, the well-being of bystanders (non-migrants) is affected by the actions of migrants. For similar reasons,Godwin (1992) considers contraceptives in third world countries as generating positive (social)externalities.

Krieg (2002) draws our attention to another social externality: she argues that expenditures tobenefit the mentally ill will cause a lot of positive externalities, such as a lower crime rate,9 lowerunemployment and less homelessness. Her case can probably be generalised for a lot of socialpolicy expenditures which will undoubtedly have some positive effects for non-recipients. On theother hand, Rauscher (1993) displays the negative externalities of social status seeking. Everystatus symbol which I obtain causes a drop in status for everyone else and therefore less enjoyment.If we accept happiness as a good proxy for utility, this is close to a pecuniary externality in thesocial world.

One of the most popular and comprehensive books about social externalities has been writtenby Putnam (2000). He first describes a decline of social capital that affects everybody in Americansociety. The decreasing involvement of Americans in all sorts of communities leaves people lonelyand isolated. Then he identifies the causes of this development, like pressures of time and money,increased mobility or extensive television consumption. Hence, if I decide to spend my time athome with my telly instead of organising a school fair, this has implications for bystanders whichare not internalised by any market.

3.3. Human capital externalities

It is obvious that an investment in education generates returns for the investor through higherrates of pay during their working life. But this is not the end of the story. In an impressiveliterature review, Krueger and Lindahl (2001) show that the returns of education for society areusually higher than for individuals. They also speak of externalities of education, because thewell-being of bystanders, again, is influenced by the level of education of their fellow citizens.Consider yourself in an environment of sapients and the argument will become all too clear. If, asLucas (1988) suggests, we systematically under-invest in education in respect to public welfare,this may well be because important externalities are not internalised.

But education is not restricted to school, nor are ‘human capital externalities’ restricted to thefirst years of learning. Cohn and Addison (1998) estimate considerable returns from post-schooltraining investments. Hollander et al. (2003) show that religious studies can be an important sourceof human capital. And we all know from our own experience that human capital acquisition canhave many more sources than that: we may learn more about history from watching or readingclassical dramas than from history lessons at school. As to the skills which our job requires, it islikely that we did not acquire them all at university, but at least partly by training on the job, beit formal training, hints by colleagues or mere experience.

If investment in human capital generates externalities, there are therefore good arguments forassuming these externalities to come not only with formal education, but with a lot of differentactivities that generate relevant knowledge.

9 The costs of crime have partly been reasonably well explored by economists (Walker, 1997; Gibbons, 2004).

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4. The perceptive evolution of externalities

It has become clear that the common characteristic of externalities is that the subjects areinvolved in a process which they did not deliberately enter. However, it is worthwhile to examinethe process of “becoming involved” in more detail, in order to get a clearer picture of commonand distinct characteristics from market goods.

The basic component of a technological and psychological externality is perception. Whatmakes an effect an externality is the fact that it affects our well-being, but we can either con-sciously notice the effect or it can happen in the subconscious. Either way, perception is thebeginning of all psychological activities and even the basis for action, intention, thinking andfeeling (Prinz, 1990). At first, the information coming from the transmitter is only an effect, butfrom the moment the acceptor receives the information, the effect is transformed into an external-ity. Another relevant factor is the direction of the information flow, because it has to be a one-wayprocess. If the acceptor gave information back to the transmitter there would be, in economicterms, a process of compensation. Therefore, two prerequisites occur as being essential for theexistence of technological and psychological externalities: firstly, there is a transmitter which issending out information towards a particular acceptor. Secondly, there is no response from theacceptor towards the transmitter.

Besides perception, other factors like thinking, understanding, planning, judgement and decid-ing (Zimbardo, 1992) within the cognitive sphere are relevant for the existence of externalities.The individual nature of these processes is influenced by individual emotions, personal valuesand attitudes, needs, motivations, intentions and volition (Steurer, 1998). Behind that, there isa dynamic component. Whether an externality is perceivable can change in the course of time(Maturana, 1970).

Limited capacity for perception and converting are the reasons for a problem like boundedrationality (Simon, 1972). That makes things more complicated precisely when it comes to socialand human capital externalities. Occasionally, it may still happen that one notices a sudden dropin community activities, so that these externalities enter perception. More typically, however,the cause–effect relations in social and human capital issues will occur long-term and will beperceived, if at all, in a subconscious manner. In case of a decrease in social life, for example,people may forget how active the community was 20 years ago. Although they suffer from a lowlevel of well-being, they cannot consciously link it to the real cause, the decline of social life. Itseems to be impossible to overcome the temporal and spatial gap to fully understand the causalchain of externalities and the natural aversion of humans to dealing with difficult temporal andspatial problems (Meadows et al., 1972) because of the limited capacities of humans. “Severalresearchers have demonstrated that despite the presence of strong cues-to-causality, people willstill fail to make causal attributions if they cannot perceive a causal link (. . .)” (Einhorn andHogarth, 1986; p. 5). Therefore, an externality can also be something that is not perceived directly.It still qualifies as an externality, however, if it affects aggregated individual well-being.

Thus, the externalities which we have mentioned describe many sorts of non-market prefer-ences. Individuals can have preferences not only for non-market goods, but also for non-marketconditions. Referring back to human capital externalities, most people would rather live in ahuman environment which is skilled and intelligent than among uncultivated savages. It maytherefore be appropriate to summarise the perceptive evolution of externalities by the genesis ofnon-market preferences.

Would, for example, a loss in biodiversity which is not perceived at all by humans alsocount as an externality? From a strictly utilitarian viewpoint, the answer is probably No.

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Why should the loss in biodiversity count in the utilitarian calculus if it does not affect ourwell-being?

5. Relevance of externalities

Textbook economics suggest that externalities have to be internalised in order to achieve aPareto optimum. This may be true in general, but there are a number of exceptions to this rule onwhich we are going to reflect in this section.

Sorting our arguments again according to popularity we will first of all refer to the irrelevanceof pecuniary externalities. In a well-known essay, Shubik (1971) shows why it does not increasepublic welfare if we make reimbursements to parties who suffer pecuniary externalities. Hismain argument is that the price mechanism still works as an indicator for scarcity once pecuniaryexternalities occur. The same is not true for technological externalities. In addition, Holcombe andSobel (2001) show how accounting for pecuniary externalities slows down the speed of innovation.

While it is an important notion that externalities that play through the price mechanism need notbe taken into account by the government, the price mechanism only comes into play where marketsare competitive. Several scholars (Scotchmer, 1986; Makowski and Ostroy, 1995; Huntington,2003) present examples of markets which are not fully competitive, so that pecuniary externalitiesalso lead to welfare losses.

Another important case where externalities do not cause the need for internalisation is raisedby Buchanan and Stubblebine (1962) and Haddock (2004). They show that there are a number ofcases in which the supply of a positive externality will take place without compensating for theexternality’s utility. Even a positive willingness to pay is, in such instances, irrelevant because thetransfer of money would not cause increased provision of the good causing externalities. If I seea beautiful person, this may well entail a positive externality, but I will hardly pay for it. Underthese circumstances, the internalisation of the externality would lead to a money transfer and toincreased transaction costs, but not to a Pareto improvement.

The transaction cost argument leads us to a third case in which the internalisation of external-ities seems undesirable. Since Coase (1960), we know that the transaction costs of internalisingexternalities matter. In his case of grazing cows on wheat fields, only if the cow-keeper and thewheat farmer can agree on a common solution within a reasonable period of time will it be effi-cient to negotiate instead of letting the force of property rights reign. And it is not done only tochoose a mode of internalisation with minimum transaction costs. The case should be consideredthat weak externalities can only be internalised with high transaction costs, so that the welfaregain through the internalisation is more than outweighed by the necessary transaction costs. Inthis case, it is efficient to turn down the increase in welfare through internalisation and thereforeto save the massive transaction costs.

Holcombe and Sobel (2000) take an intuitively plausible example to make a case for anotherkind of externality that should be ignored by policymakers. If I suffer because a foreigner hasmoved into the house next door and I dislike foreigners, it would be unreasonable, even unethical tointernalise this psychological externality, for example by having him pay me extra rent. However,this externality contradicts the foundations of our society, namely the equal distribution of humanrights. Therefore, we consider some sort of property right distribution as unfair, such as the rightto settle only by agreement with my neighbours. Perhaps, we would even find it acceptable if Ipaid a foreigner not to move in next door to me, thus turning property rights around. Either way,more attention should be devoted to the question of psychological and other externalities thatcontradict some societal foundations.

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6. Measurement versus deliberation

The picture of ubiquitous externalities of all kinds that partly ought to be internalised andpartly ought not, appears confusing. This confusion has led economists to choose several differentstrategies. One of them is to assume most externalities away. The normative conclusions obtainedby most mathematical models could only be made on the basis that no externalities were present.Another is to limit the field on which economists may make normative statements (Lewin andTrumbull, 1990).

An alternative option chosen by economists who admitted that at least environmental externali-ties would indeed influence utility was to estimate consumer willingness to pay for external effects.Remarkable progress has been achieved in contingent valuation (CV) studies, often targeted atspecific environmental amenities.

On the other hand, many decision analysts (Raiffa, 1968; von Winterfeldt and Edwards, 1986;Watson and Buede, 1988) argue that people lack well differentiated values for all but the mostfamiliar of evaluation questions. Therefore, within the framework of what Fischhoff (1991) callsthe philosophy of basic values, evaluation problems have to be broken down into basic dimensionsof concern in order to get meaningful answers. While this will be difficult for some environmentalamenities, it will be impossible for most social, human capital and psychological externalities.Anderson et al. (2000) demonstrate on the basis of an experimental examination that there isa moral dimension to what respondents say in a CV survey. The fact that, for example, thewillingness to pay for continuous settlement in remote areas has been collected (Bennett et al.,2004) does not prove the sensibility of the resulting figures. Or have you already thought aboutyour willingness to accept cannibalism?

Willingness-to-pay studies suffer from another serious shortcoming. They do not indicatewhether an externality should be internalised or whether one of the arguments against mentionedin the previous section applies. A willingness-to-pay can be collected by elaborate surveys in casesof pecuniary externalities, in cases of externalities that would also be provided without payments,in cases of prohibitively high transaction costs and in cases of contradicting societal foundations.And their results would be nothing but irrelevant.

While we have seen in the last section that internalising externalities can cause prohibitivelyhigh transaction costs, the same may be said of the measurement of externalities. We owe oneillustrative example of this to Lippert (1999). It was extremely difficult to measure the microbialcount of milk a hundred years ago. Therefore, the farmer got the same price for clean milk asfor contaminated milk. Over the years, our ability to measure microbial counts or fat content hasimproved, with the result that the externalities resulting from the milk are internalised nowadays.However, it was entirely rational in former times not to measure certain externalities, and forother externalities it is still today rational not to make attempts to measure them. This is simplydue to the complexity of many existing systems and to our limited knowledge. In particular, if weconsider an appropriate remuneration for certain ecosystem services, incalculable and stochasticresults as well as long run results (recurrence of species) are mentioned by Hampicke (2001),Hagedorn (2001) and Steurer (1998). For example, the total number of species in the ecosystemis somewhere between 5 and 30 million (Swanson, 1997). This wide margin reflects the paucityof our knowledge of nature. So, how can we consider externalities in a system we do not know?

Let us briefly leave the measurement issue, turning towards the practical welfare relevanceof externalities. Consider the example of the welfare effects of trade. While it is commonplacesince Ricardo (1817) that trade increases welfare, it is also known that environmental externalitiesthat are not internalised can lead to welfare losses connected with trade (Dean, 2002). However,

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if all the other externalities have the same potential to influence individual welfare, they alsohave the potential to reverse the welfare gains from trade. What, for example, if many peoplelike a traditional, diversified economic structure, while trade leads to specialisation processes,thus resulting in negative psychological externalities? What if this specialisation process resultsin the long run in a loss of knowledge in many dying economic sectors, leading to a vulnerablesociety of similar specialists and perhaps to negative human capital externalities? And what ifthe increased capital productivity caused by trade leads, in an imperfect labour market, to higherunemployment and therefore to negative social externalities?

To put it in general terms: could it be that the repeated criticism faced by economic science(Georgescu-Roegen, 1971; Henderson, 2005), most recently in the discussion about the questionwhether a Nobel Prize for economics should continue to be awarded, is caused by economistsneglecting a lot of externalities that it would be important to internalise? That welfare effects areincorrectly predicted due to inappropriate simplification?

The concept of multifunctionality is a tool for accounting qualitatively for the many externalitiesthat are connected with economic activities. The concept itself, however, does yet not offer asolution to account quantitatively for this complexity in cases where externalities matter, butwhere they do not reveal themselves through willingness-to-pay estimates.

If externalities exist and if they are sufficiently strong, there may be political mechanisms forself-correction. Instead of an efficiency calculated by economists there might be what Krecke(2003) calls social efficiency. Going back to externalities of international trade, the sudden riseand success of anti-globalisation movements like ATTAC might be an indicator that people start toorganize themselves once they feel affected by negative externalities. It should be remembered thatthe need for both environmental protection and animal welfare was originally highlighted by non-governmental organizations rather than by economists. Perhaps discovering relevant externalitieshas not been the greatest strength of the economic profession.

This hypothesis, if not falsified, could well be used for a complementary argument as to whydemocratic procedures increase happiness (Frey and Stutzer, 2000). If a democratic discourseenables society to take account of relevant externalities, it is plausible that such a discourse willindeed lead to an increase in welfare.

That implies that the deliberative discourse as suggested by Habermas (1981) and developedand elaborated by many scholars since (Dryzek, 1990; Fishkin, 1995; Goodin, 2003) may be amore appropriate answer to a multifunctional economy than a further refinement of environmentalvaluation methods. The attempt to consider all aspects of politico-economic arrangements throughintense and reflective discussion may lead to better results than confronting randomly selectedrespondents with a willingness to pay for anything. And empirical research in environmentaleconomics (Wilson and Howarth, 2002) has shown that it may lead to a fair balance betweenindividual and societal interests.

If economists show that a positive willingness to pay exists for societal issues like child-labor-free production or animal welfare, this is an honourable attempt to integrate these issuesinto economic thinking. The question remains whether causal relations in the real world aretoo complex to deviate policy recommendations from such studies. And whether money is theappropriate scale to measure utility.

7. Conclusions

The concept of multifunctionality has been created out of the feeling that economic activities,particularly if connected with natural resources, entail a lot of side effects. Multifunctionality

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accounts for the notion that cultural situations with their “own potential, own constraints, ownhistory and internal struggles” (Losch, 2004) matter. This is by no means restricted to the agricul-tural and forestry sector, but is relevant for the whole of the economy. Accounting for technologicaland also for psychological, social and human capital externalities will increase the aggregatedutility of a society. But it is probably more by political tools like deliberative processes and not somuch by economic analyses of willingness to pay that these externalities can be understood andthat a multifunctional model of the economy can be developed from theory to practice. It shouldalso have become clear that the degree of individualism in a society will influence the degree ofdifficulty with which such a consensus can be achieved. The more diverse individual perceptionsand perspectives are, the more difficult it will become to find a social consensus for internalisingexternalities.

The implications for economic science of taking the concept of multifunctionality seriouslycan hardly be overestimated. In spite of the potential (and real) abuse of the concept of multi-functionality by interest groups to legitimise subsidies, it pays attention to the social, historicaland cultural peculiarities of a country and ultimately of individuals. For this reason, the conceptof multifunctionality provides an opportunity to take non-market preferences of all kinds intoaccount.

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