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Sunday, November 16, 2008

Environmental economics

Topics and concepts

Central to environmental economics is the concept of market failure. Market failure means that markets fail to allocate resources efficiently. As stated by Hanley, Shogren, and White (2007) in their textbook Environmental Economics[2]: "A market failure occurs when the market does not allocate scarce resources to generate the greatest social welfare. A wedge exists between what a private person does given market prices and what society might want him or her to do to protect the environment. Such a wedge implies wastefulness or economic inefficiency; resources can be reallocated to make at least one person better off without making anyone else worse off." Common forms of market failure include externalities, non excludability and non rivalry.

Externality: the basic idea is that an externality exists when a person makes a choice that affects other people that are not accounted for in the market price. For instance, a firm emitting pollution will typically not take into account the costs that its pollution imposes on others. As a result, pollution in excess of the 'socially efficient' level may occur. A classic definition is provided by Kenneth Arrow (1969), who defines an externality as “a situation in which a private economy lacks sufficient incentives to create a potential market in some good, and the nonexistence of this market results in the loss of efficiency.” In economic terminology, externalities are examples of market failures, in which the unfettered market does not lead to an efficient outcome.

Common property and non-exclusion: When it is too costly to exclude people from accessing a rivalrous environmental resource, market allocation is likely to be inefficient. The challenges related with common property and non-exclusion has long been recognized. Hardin's (1968) concept of the tragedy of the commons popularized the challenges involved in non-exclusion and common property. "commons" refers to the environmental asset itself, "common property resource" or "common pool resource" refers to a property right regime that allows for some collective body to devise schemes to exclude others, thereby allowing the capture of future benefit streams; and "open-access" implies no ownership in the sense that property everyone owns nobody owns. The basic problem is that if people ignore the scarcity value of the commons, they can end up expending too much effort, over harvesting a resource (e.g., a fishery). Hardin theorizes that in the absence of restrictions, users of an open-access resource will use it more than if they had to pay for it and had exclusive rights, leading to environmental degradation. See, however, Ostrom's (1990) work on how people using real common property resources have worked to establish self-governing rules to reduce the risk of the tragedy of the commons.

Public goods and non-rivalry: Public goods are another type of market failure, in which the market price does not capture the social benefits of its provision. For example, protection from the risks of climate change is a public good since its provision is both non-rival and non-excludable. Non-rival means climate protection provided to one country does not reduce the level of protection to another country; non-excludable means it is too costly to exclude any one from receiving climate protection. A country's incentive to invest in carbon abatement is reduced because it can "free ride" off the efforts of other countries. Over a century ago, Swedish economist Knut Wicksell (1896) first discussed how public goods can be under-provided by the market because people might conceal their preferences for the good, but still enjoy the benefits without paying for them.


Assessing the economic value of the environment is a major topic within the field. Use and indirect use are tangible benefits accruing from natural resources or ecosystem services (see the nature section of ecological economics). Non-use values include existence, option, and bequest values. For example, some people may value the existence of a diverse set of species, regardless of the effect of the loss of a species on ecosystem services. The existence of these species may have an option value, as there may be possibility of using it for some human purpose (certain plants may be researched for drugs). Individuals may value the ability to leave a pristine environment to their children.

Use and indirect use values can often be inferred from revealed behavior, such as the cost of taking recreational trips or using hedonic methods in which values are estimated based on observed prices. Non-use values are usually estimated using stated preference methods such as contingent valuation or choice modelling.


Solutions advocated to correct such externalities include:

* Environmental regulations. Under this plan the economic impact has to be estimated by the regulator. Usually this is done using cost-benefit analysis. There is a growing realization that regulations (also known as "command and control" instruments) are not so distinct from economic instruments as is commonly asserted by proponents of environmental economics. E.g.1 regulations are enforced by fines, which operate as a form of tax if pollution rises above the threshold prescribed. E.g.2 pollution must be monitored and laws enforced, whether under a pollution tax regime or a regulatory regime. The main difference an environmental economist would argue exists between the two methods, however, is the total cost of the regulation. "Command and control" regulation often applies uniform emissions limits on polluters, even though each firm has different costs for emissions reductions. Some firms, in this system, can abate inexpensively, while others can only abate at high cost. Because of this, the total abatement has some expensive and some inexpensive efforts to abate. Environmental economic regulations find the cheapest emission abatement efforts first, then the more expensive methods second. E.g. as said earlier, trading, in the quota system, means a firm only abates if doing so would cost less than paying someone else to make the same reduction. This leads to a lower cost for the total abatement effort as a whole.

* Quotas on pollution. Often it is advocated that pollution reductions should be achieved by way of tradeable emissions permits, which if freely traded may ensure that reductions in pollution are achieved at least cost. In theory, if such tradeable quotas are allowed, then a firm would reduce its own pollution load only if doing so would cost less than paying someone else to make the same reduction. In practice, tradeable permits approaches have had some success, such as the U.S.'s sulphur dioxide trading program, though interest in its application is spreading to other environmental problems.

* Taxes and tariffs on pollution/Removal of "dirty subsidies". Increasing the costs of polluting will discourage polluting, and will provide a "dynamic incentive", that is, the disincentive continues to operate even as pollution levels fall. A pollution tax that reduces pollution to the socially "optimal" level would be set at such a level that pollution occurs only if the benefits to society (for example, in form of greater production) exceeds the costs. Some advocate a major shift from taxation from income and sales taxes to tax on pollution - the so-called "green tax shift".

* Better defined property rights. The Coase Theorem states that assigning property rights will lead to an optimal solution, regardless of who receives them, if transaction costs are trivial and the number of parties negotiating is limited. For example, if people living near a factory had a right to clean air and water, or the factory had the right to pollute, then either the factory could pay those affected by the pollution or the people could pay the factory not to pollute. Or, citizens could take action themselves as they would if other property rights were violated. The US River Keepers Law of the 1880s was an early example, giving citizens downstream the right to end pollution upstream themselves if government itself did not act (an early example of bioregional democracy). Many markets for "pollution rights" have been created in the late twentieth century -- see emissions trading. The assertion that defining property rights is a solution is controversial within the field of environmental economics and environmental law and policy more broadly; in Anglo-American and many other legal systems, one has the right to carry out any action unless the law expressly proscribes it. Thus property rights are already assigned (the factory that is polluting has a right to pollute). DX

Relationship to other fields

Environmental economics is related to ecological economics but there are differences. Most environmental economists have been trained as economists. They apply the tools of economics to address environmental problems, many of which are related to so-called market failures--circumstances wherein the "invisible hand" of economics is unreliable. Most ecological economists have been trained as ecologists, but have expanded the scope of their work to consider the impacts of humans and their economic activity on ecological systems and services, and vice-versa. This field takes as its premise that economics is a strict subfield of ecology. Ecological economics is sometimes described as taking a more pluralistic approach to environmental problems and focuses more explicitly on long-term environmental sustainability and issues of scale.

These two groups of specialists sometimes have conflicting views which can often be traced to the different philosophical underpinnings of the two fields. Many ecologists[weasel words] subscribe to deontological ethical systems; many economists[weasel words] subscribe to teleological ethical systems. Neither ethical system can be demonstrated to be right or wrong, but they may sometimes have different implications for environmental policy. Environmental economics is sometimes viewed[weasel words] as relatively more pragmatic; ecological economics as relatively more idealistic.

Another context in which externalities apply is when globalization permits one player in a market who is unconcerned with biodiversity to undercut prices of another who is - creating a "race to the bottom" in regulations and conservation. This in turn may cause loss of natural capital with consequent erosion, water purity problems, diseases, desertification, and other outcomes which are not efficient in an economic sense. This concern is related to the subfield of sustainable development and its political relation, the anti-globalization movement.
The three pillars of sustainability

Environmental economics was once distinct from resource economics. Natural resource economics as a subfield began when the main concern of researchers was the optimal commercial exploitation of natural resource stocks. But resource managers and policy-makers eventually began to pay attention to the broader importance of natural resources (e.g. values of fish and trees beyond just their commercial exploitation;, externalities associated with mining). It is now difficult to distinguish "environmental" and "natural resource" economics as separate fields as the two became associated with sustainability. Many of the more radical green economists split off to work on an alternate political economy.

Environmental economics was a major influence for the theories of natural capitalism and environmental finance, which could be said to be two sub-branches of environmental economics concerned with resource conservation in production, and the value of biodiversity to humans, respectively. The theory of natural capitalism (Hawken, Lovins, Lovins) goes further than traditional environmental economics by envisioning a world where natural services are considered on par with physical capital.

The more radical Green economists reject neoclassical economics in favour of a new political economy beyond capitalism or communism that gives a greater emphasis to the interaction of the human economy and the natural environment, acknowledging that "economy is three-fifths of ecology" - Mike Nickerson.

These more radical approaches would imply changes to money supply and likely also a bioregional democracy so that political, economic, and ecological "environmental limits" were all aligned, and not subject to the arbitrage normally possible under capitalism.

Accordingly, there is still a need for a more conservative environmental economics, and its subfields environmental finance, natural capitalism, measuring well-being and sustainable development.

1 comment:

Frank Keegan said...

Species ending? It's our call
By Frank Keegan
Relax general. Cheer up. Things shall get worse, but they could get better. The choice is ours.

Hearing a vice chairman of the U.S. Joint Chiefs of Staff utter the words “species ending” about our near future should be enough to wake us all.

Gen. James E. Cartwright uttered the phrase recently during the inaugural Johns Hopkins University Leaders + Legends lecture. He spoke on “Leading Organizational Change to Meet New Challenges.”

What challenges? Financial crises, climate change, weapons of mass destruction widely and readily available to rogue states and lunatic groups. Is that all? No.

“Competition (for scarce world resources) inevitably will lead to conflict,” Cartwright said. “Are we at a tipping point? Yes. Will we have control? No.”

Generals are interested because when leaders of state, commerce and church mess up, armed forces have to clean up.

Cartwright’s love and admiration for the men and women who fight for us if things go wrong is palpable. Figuring out when and where the next conflict breaks out, and how best to combat it, is what generals are supposed to do.

Now they also try to figure out why, and ways to prevent it. For example, a 2004 Department of Defense study determined global warming is the No. 1 threat to the security of the United States. How can that be if there is no such thing?

Just because history proves we turn upon ourselves when stressed with a ferocity unequaled by any other species, is there any reason to think this time will be different?

Nope, according to Cartwright. The stress level is rising, fast. Along with heating things up, we inflict upon ourselves an increasing host of things — from radioactive isotopes to organic chemicals to new and emerging diseases — never before endured by humans.

Family by family, friend by friend we now begin to see the price we pay for our toxic past. We have not seen the worst of it. Our despoiling of our narrow ecological niche leaves us little room for survival.

We are learning the real price of living it up instead of eating bread from the sweat of our brow. We arrogantly believe “the laws of Nature and Nature’s God” beseeched in our Declaration of Independence somehow do not apply to us.

Environmentalists weep about saving Earth when actually our planet is not at risk. We are. Other species come and go. Why not us?

Don’t worry about biodiversity. While exterminating thousands of species, we create opportunities for others. Cockroaches and rats are doing very well. Doing even better are myriad bacteria and viruses. For example, we’ve created perfect environments for growth and spread of staphylococcus and influenza, and the willfully ignorant and criminal negligence of our political and spiritual leaders helped HIV propagate around the globe in less than a decade. Thanks.

Sure, if we ceased all carbon dioxide emissions now it would take only 100,000 years to return to pre-industrial levels.

And those new substances -- we cannot even count them all -- we poison the born and unborn with will continue to kill us for millennia, especially if we use them as weapons.

But we and we alone hold the power to begin undoing what we have done. The hard fact is environmental responsibility is good business, creating jobs, adding real value and paying long-term dividends.

Environmental atrocities are bad business, merely deferring costs that accrue and compound -- costs we cannot refuse to pay. Our ecological deficit is orders of magnitude larger than our fiscal debts, though both grow from our same inherent flaws.

We can pay down both at the same time if we have the wisdom and will to take control.

If we do we can thrive and prosper. If we don’t, Gen. Cartwright is correct. We’re doomed.

Frank Keegan is editor of The Baltimore Examiner. Reach him at