This is what externalities look like? South Africa and the Alien Tort Claims Act

So, one of my favorite critiques of modern economics is that it sees externalities as small and relatively inconsequential to the larger stories of the modern economy. Sure, there are problems with pollution, and maybe something related to carbon emissions (take Mankiw’s Pigou Club for example), but the market still works pretty well – meaning, market prices are pretty close to true prices, and thus externalities are small.

But maybe we should think of externalities as something a bit more fundamental. Wikipedia (the most convenient if least authoritative source on hand) defines an externality as “an impact (positive or negative) on any party not involved in a given economic transaction.” One impact we could think about is the so-called “race to the bottom”, where countries compete on labor and environmental standards and tax policies (or states within a country, for that matter) to attract businesses. One way to be attractive to business is to have a repressed workforce with few labor rights. Every time a company chooses to locate a factory (etc.) in a country with crappy standards, other countries feel more pressure to lower their standards or else lose out on more opportunities. The citizens of those countries suffer as labor and environmental standards are lowered to keep the same businesses that were already there. Thus, there is an externality to the transaction of a company choosing to do business in a country with low standards.

Enter South Africa and the American Courts:

Supreme Court Won’t Hear Apartheid Lawsuit – New York Times:

The Second Circuit reinstated the human rights suit against a list of American, Canadian and European corporations “on behalf of all persons who lived in South Africa between 1948 and the present and who suffered damages as a result of apartheid.” The Second Circuit overruled a 2004 federal district court ruling dismissing the suit for lack of jurisdiction.

The suit is based on the Alien Tort Claims Act, a law enacted in 1789 that was meant to protect American ships from pirates and American diplomats from attack overseas. In throwing out the suit in 2004, Judge John E. Sprizzo wrote that courts must be “extremely cautious in permitting suits here based upon a corporation’s doing business in countries with less than stellar human rights records,” and that such suits could have “significant, if not disastrous, effects” on trade.

Yes, these suits could indeed have significant effects on trade. But maybe those effects would just be correcting for the (massive) externalities suffered by all? Imagine if companies had to worry about lawsuits when they choose to do business with repressive governments. Then it make not make economics sense to do so, and they would in fact locate their factories, etc. in countries with above average standards, creating some sort of race to the top. That would be disastrous, wouldn’t it?

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