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Economics is the study of the allocation of scarce resources. o Note that the theories of economics can be applied to any scarce resource, not just traditional commodities. o Economics is not simply about profits or money. It applies anywhere constraints are faced, so that choices must be made. o Economists study how incentives affect people’s behavior. Environmental and natural resource economics is the application of the principles of economics to the study of how environmental and natural resources are developed and managed. o Natural resources – resources provided by nature that can be divided into increasingly smaller units and allocated at the margin. o Environmental resources – resources provided by nature that are indivisible. o Natural resources serve as inputs to the economic system. Environmental resources are affected by the system (e.g. pollution).
Why Study Environmental Economics?
In general, prices reflect the relative scarcity of goods. o However, in environmental economics, markets, and thus prices, often do not exist. What aspects of environmental and natural resource economics make it unique? 1. Market failures When market failures exist, government intervention may be appropriate. 2. Dynamics The decision to consume a good today typically does not affect the ability to consume it tomorrow. However, the decision to use natural resources today does affect what will be available tomorrow. Note that prices will influence this. Higher prices both provide incentives to conserve resources, encourage exploration for new sources, and the development of technologies to better obtain resources. 3. Irreversibility Damage to natural resources has long-term effects. For example, if the Grand Canyon were flooded, future generations would be unable to enjoy its beauty. This is not as large a problem for normal consumer goods. 4. Linkages between the economic and ecological system An interdisciplinary understanding of the environment, political science, etc. necessary to be a good environmental economist.
The Invisible Hand
The goal of today's lecture is to discuss why the free market may fail, and to discuss the consequences when that happens. To begin, we must consider how the market should function.
Adam Smith, who coined the phrase "The Invisible Hand," was the first to notice that a free market of individuals acting in their own self interest leads to a socially-desirable result. Why does this occur: o Demand = Marginal Benefit (MB) o Supply = Marginal Cost (MC) o In equilibrium, P = MB = MC No further beneficial transactions are possible. Normally, a free market brings us to this point. However, there are times when private marginal benefits or costs are not equal to social marginal benefits or costs. When this occurs, the market is unable to allocate resources efficiency. We call this market failure. o The welfare lost because beneficial transactions do not occur is known as deadweight loss.
II. Market Failures in Environmental Economics
Most of today's lecture dealt with the problems that various types of market failures cause. Of course, most of the course will focus on externalities. However, it is useful to be aware of other types of market failures and how they are relevant for environmental economics. We discussed three in class today. A. Imperfect Information
The market depends on perfect information, so that everyone knows all of the options available to them. If this is not possible, people may not make optimal choices. o Note that imperfect information is when different parties have different levels of information. If no one realizes an activity is bad (e.g. Mercury pollution in Onondaga Lake in 1950s), imperfect information is not the problem. It may be that the result is uncertain. Uncertainty is an important consideration for environmental policy, which we will discuss later in the course. However, if all sides have the same knowledge, even if uncertainty exists, imperfect information is not a problem. How is this relevant to environmental economics? o People may have imperfect information about things such as health risks or the dangers of pollution. What can be done? o Information can be provided by the government or by private individuals (e.g. "dolphinfirendly tuna"). o The government may provide services that are not provided by the market because of imperfect information (e.g. insurance). B. Public Goods
Public goods have two key features: 1. non-rival -- one person enjoying the good does not keep others from enjoying it 2. non-excludable -- people cannot be kept from enjoying the good
Leads to free-rider problem. Because the goods are non-rival, efficiency requires that the sum of each individual's marginal benefit equal marginal cost. Underprovision results when public goods are provided by a free market. How is this relevant to environmental economics? o climate o clean air o parks What can be done? o The government can provide public goods and finance them with taxes. This helps to alleviate the free-rider problem. However, it still may be difficult to get people to reveal their true preferences for the good.
An externality is an activity of one entity that affects the welfare of another and is not reflected in market prices. o A key feature of this definition is that the welfare of others is not reflected in market prices. To find the efficient level of activity, we need to know the marginal social cost. o Marginal social cost is the sum of marginal private costs and the marginal external costs, which represent the damage done by the externally. o Note that, without policy, the free market will not lead to an efficient solution. Prices will reflect private costs, but not the additional external costs. o Individuals equate MPC and MB. Since MSC > MPC, over provision results.
III. Open Access Resources
Open Access Resources (also called an common property resources) are resources or facilities that are open to uncontrolled access by individuals who wish to use the resource. The problem is a lack of property rights. Consider someone using a public grazing area. o Individuals equate MB = MC o The benefits are the value of using the grass. o There are two costs: 1. The cost of obtaining the resource 2. The opportunity cost of not being able to use the resource later o The user bears all of the first cost, but only part of the second cost, as it is shared by all users. As a result, MPC < MSC Thus, MB = MPC < MSC This leads to over-utilization of the resource. Fisheries provide a good example of open access resources. Everyone shares the costs when fish are caught, as it makes it depletes the stock, making future fishing difficult.
o How does Hardin relate the Tragedy of the Commons to the environment? With pollution. New Zealand. Other methods achieve the same goal. Individual Transferable Quotas (ITQ) Used in Australia. and at higher prices. Management options Annual quotas These restrict the number of fish that can be caught in a season Leads to a "race to fish" Everyone wants to catch fish early. as we noted last week. it lasts 8 months Not only is it safer. fisheries managed by ITQs were half as likely to collapse as other fisheries The Alaskan halibut and king crab fisheries provide examples Before ITQ. Iceland. Nonetheless. "The Tragedy of the Commons". the fishing season lasted 3 days Now. o Note that auctioning spots uses the market. makes natural resources unique. each individuals share of the cost is small. and Alaska Divides an annual quota among fishermen as a long-term right This provides incentives to manage the fishery properly Shares can be traded In a recent study. but doesn't directly address the commons problem. we may be more comfortable using wealth as a way to ration cars than as a way to ration national parks. This leads to overfishing. Hardin: Tragedy of the Commons Hardin's article. rather than taking something out. Technology restrictions Only certain technologies can be used to catch fish This makes fishing more difficult. Hardin notes that private property encourages pollution. Note how they depend on different criteria. o One important criterion for choosing the method depends on our ethics toward the resource. For example. Note that it is the lack of property rights that causes the problem. Challenges Hard to use in international waters Allocating shares is difficult Shares provide economic rent to those who receive them IV. Canada. Says people think it is their right to dirty air/water by their property. using the market is just one way in which scarce resources can be rationed. people are putting something in to the commons.Note the dynamic nature of the problem which. but fish are sold fresh. However. Hardin notes different ways to ration scarce goods. since there isn't a one-time glut on the market. . relates the open access resource problem to the environment. For example. before others have caught them. there are no property rights for air. At the same time.
the MDF does not change over time (if other things remain equal). o The slope normally gets steeper as emissions increase. Stock pollutant – A pollutant that the environment cannot absorb. o We can look at damage in one of two ways: 1.the marginal damage done by additional flows of emissions.g. some other method is necessary to ration the good.g. For a flow pollutant. The type of pollutant affects the shape: An example where it gets steep very suddenly is a threshold effect. only the amount that occurs at a specific point in time matters (e. I. more attention is usually paid to monitoring and conflict than on sanctions and punishment. o We need to consider the marginal costs and marginal benefits of pollution. 2. would be difficult. Things that affect the position of the MDF include: Population . The level of the pollutant in the environment grows over time as the pollutant is accumulated. As a result. it may level off if there is a point where no more damage can be done (e. Flow pollutant – A pollutant that the environment can absorb. and strategies for successful commons management. The area under the marginal damage function shows the total damages. waste flowing into the river). These include the following: o Successful commons usually have elaborate conventions over who can use resources and when they can be used o What one takes out must be proportional to what is put in o Usage must be compatible with the common's health o Everyone must have a say in the rules o In successful commons. Ambient damage functions -. In this case. Example: CO2 emissions (take 200 years to decay). However.the marginal damage done by additional concentrations of pollution in the ambient environment. is to develop policies that lead to an optimal level of pollution. applying these lessons to "new commons" such as the global climate. and shifts up over time. The Marginal Damage Function Our goal. because the stock keeps getting larger. all the pond life is dead). o Recall that the optimal level of pollution is not zero. Emissions damage functions -. o It is upward-sloping. These include the means for rationing scarce resources. As we discussed. Modeling Pollution We began by finishing our discussion of the commons. of course. The marginal damage function shows the damage done by an additional unit of pollution. MDF is flat. which are on the last lecture notes.
How does the desired level of pollution change between summer and winter if the pollution leads to greater problems in the summer (e.).g. The efficient level of pollution falls. we want less pollution (e. o o o In these examples. As a result. o Note that this follows from what Field calls the equimarginal principle – to minimize total abatement costs. etc. Since abatement is cheaper. The marginal abatement cost curve is downward sloping. the marginal benefits are the marginal damages avoided by increased abatement. we use a horizontal summation. Things affecting the position of the MAC: o Technology To add together the MAC of individual firms. o Firms choose the easiest ways to reduce pollution first. we maximize net benefit by equating marginal benefits and marginal costs. The Marginal Abatement Cost Curve Marginal abatement costs can be: 1. more abatement) in the summer. If that were the case. 2. costs of scrubbers. Here. even if it means one firm does more than the other. ground level ozone)? Here. the additional benefits from pollution control are just equal to the additional costs. The opportunity costs of lowering consumption or production. III. 2. and equals zero at the level of unconstrained emissions. net benefits would be zero. The costs of reducing pollution (e. . o It may flatten if economies of scale are present. Note that this is not where total benefits equal total costs. The Efficient Level of Pollution The optimal level of pollution is where the MDF and the MAC curves intersect. Intuition: we do the simplest (the cheapest) abatement first.g.g. the marginal damage function is higher in the summer than in the winter. we should do more of it. How would the desired level of pollution control change if a new technology is discovered that improves the efficiency of scrubbers for power plants? A new technology lowers the marginal abatement costs curve. See Figure 5-5 in Field. Rather. choose the lowest marginal abatement costs first. Some examples: 1. labor needed to maintain them.Time of year II.
the government can increase compliance by either raising the penalty for cheating or increasing the probability of getting caught. However. an important policy consideration is the level of enforcement. Political considerations The Coase Theorem III . Ethics/moral considerations 8. this is just one of several. Efficiency Here. How well does the policy internalize the externality? 7. o These can be modeled as increasing the marginal abatement cost. criteria other than efficiency (such as minimizing health impacts) may be used to set the goal.The Coase Theorem I. some EPA air regulations require installation of a device to constantly measure emissions (continuous emissions monitoring systems. Long-run considerations How well a policy encourages innovation is important here. Evaluating Environmental Policy Analysis of marginal damages and marginal abatement costs assumes that efficiency is the criterion for evaluating environmental policy. but it must be practical. Enforcement can be continuous or random. Enforceability 3. The problem is to balance out the cost of monitoring and the punishment o For a regulated firm: MB of compliance = avoided penalty = penalty for cheating * probability of getting caught MC of compliance = marginal abatement costs o Thus. However. Enforcement Costs For any environmental policy. o For example. 5. Our list included (sorry if I've forgotten some): 1. A cost-effective policy meets a given goal for the least possible cost. we also need to consider the costs society pays to enforce and administer the policy. Thus. o Alternatively. II. which decreases the desired level of abatement. we discussed using cost-effectiveness as an alternative. Regulatory capacity 6. random spot checks can take place. Raising the penalty is less costly for the government. or CEMS). 2. Equity 4.
compensation would lead to too many people living in harm’s way. endangered species). There is no guarantee that bargainers will reach an agreement. different groups may have different bargaining power. The Coase Theorem doesn't simply mean that assigning property rights to a polluter will cause the pollution to continue. 5. The Coase Theorem is the notion that an efficient solution will be achieved independently of who is assigned property rights. o Because of income effects. or when the victims aren't well defined (e. as long as someone is assigned the rights. Need to be able to clearly establish who causes the harm. Victims should not be compensated Because of the reciprocal nature of externalities. Not only does the pollution cause an externality. Command and Control Policies for the Environment I. Thus. 4. Liability Law . The economic problem is to maximize the value of production. no government intervention is necessary. Definition of property rights might affect the number of participants. 3. 2. Coase argues that the highest value option should be preserved. o More people will come to the problem if they are likely to be compensated. A deal could be struck among both parties to bring about a more desirable solution. o Similarly. o Note that the distribution of income in the final outcome will vary based on who is assigned the rights. o Coase implies that once property rights are established. you may not be willing to pay as much to avoid damage as you would require in compensation to accept it. but also the presence of the victims harms the polluter. 3. These included: 1. you need to determine which activity has the higher value. affecting the distribution of the final outcome. Externalities are reciprocal in nature. 2. Costs of bargaining and transactions costs o Negotiation won't work when large numbers of people are involved. Coase's main points: 1. Since externalities are reciprocal. If no one were harmed. the decision on property rights will affect the distribution of income in the final outcome. there would be no problem. The Coase Theorem (continued) Our discussion of the policy examples on the reading list suggested several limitations to the Coase Theorem. Willingness to pay and willingness to accept are different. II.g. o However.
the firm lowers its liability. An example of how the Coase Theorem applies to environmental policy is liability law. the government can set the standard to yield the efficient level of pollution control. Need to know both who causes the harm and what the damages are. Types of Standards Ambient Standards o Regulates the amount of pollutant present in the surrounding (ambient) environment. it has incentive to avoid pollution when the marginal abatement cost is less than the marginal damage. Complications o The burden of proof may be difficult in court. Emission standards o Regulates the level of emissions allowed o Examples Emissions rates (pounds of SO2 per hour) Concentration (ppm of biochemical oxygen demand (BOD) in wastewater) . o If a firm will be held liable for the damages from its pollution. Note that the government does not need to know the marginal costs of the firm in order to achieve the desired level of pollution. If a region is in violation. In principle.g. o Examples: Parts per million (ppm) of dissolved oxygen in a river Sulfur dioxide (SO2) in an airshed Ground level ozone levels (ppm) o Measures are often an average (e. the sources of the pollution must be found and regulated to be sure that the ambient standard is met.g. o A standard simply makes excessive amounts of pollution illegal. III. due to changes in weather) o Note that the level itself cannot be directly enforced. Clean Air Act.S. they must come up with a plan to attain compliance. Rather. o Will courts be willing to hold polluters liable for damages that they cannot pay? o Litigation is costly. or per year) This is important. By avoiding damage. as concentrations vary by time of day and by season (e. A good example is the U. IV. The federal government sets ambient standards for six criteria pollutants in a region. Command and Control (CAC) Regulation Command and control regulation uses the setting of standards. o A standard is a mandated level of performance that is enforced in law. over a 24 hour period.
or techniques. but give the polluter freedom to choose the technology used. For enforcement. electric utilities were required to install scrubbers with 90% efficiency ratings. o Allow “reasonably small” damages Raises the question of how to decide what is reasonable. Should standards be applied uniformly? .S. it is difficult for the regulator to know MAC and MD o Alternative guides to setting regulation: Zero-risk Requires protecting everyone. o Whereas emissions standards require polluters to meet a goal for the level of pollution. requires catalytic converters in autos The 1972 Water Pollution Control Act Amendments set a goal of zero discharges by 1985. Economic Analysis of Standards Setting the standard o The first question. from damage. Used technology based effluent standards (TBES) EPA determines the “best practicable technology” and sets standards assuming that firms are using that standard. U. Total quantity of a pollutant Residuals per unit of output (SO2 per kWh of electricity) Residual content per unit of output (sulfur content of coal) Percentage removal of pollutant (90% of SO2 scrubbed) o Note that emissions standards do not guarantee a specific ambient level of pollution Weather conditions affect the concentrations Human behavior affects pollution levels Technology standards o Require polluters to use certain technologies. technology standards require a specific technology. Should abatement costs be considered? The recent Supreme Court case (American Trucking Company v. polluters must have a discharge permit issued by an EPA-backed state permitting program. the government mandates that the Best Available Control Technology (BACT) be used. Appropriate for cases in which there is a threshold. of course. no matter how sensitive. V. is deciding at what level to set the standard. as in the Clean Air Act. o Often. BACT is often not clearly defined. o Examples Until 1990. practices. However. Browner) raises this question. o Efficiency calls for setting the standard where MAC = MD In practice.
S. Older units are often exempt (“grandfathering”) o Examples Clean Air Act New Source Review Emissions standards for automobiles Clean Water Act effluent limits for water treatment plants o Why use VDR? Efficiency Costs are lower for newer units Relates to equimarginal principle Holding all plants to the same standard is not cost effective In principle. However. having different standards increases costs to the government. Newer units face more restrictive regulations. using vintage (which is easily observed) to differentiate regulations makes CAC more efficient. Vintage differentiated regulation can help address differences in MAC from command and control. However. investment falls. o Should standards be the same across firms? Efficiency is achieved when MAC is equal across firms. Note in this case the issue is variation in the marginal damage function. By efficiency. which won’t happen with uniform standards unless the MAC curves are the same. Federal standards apply throughout the U. and capital is kept longer o . Equity Rules aren't changed in midstream Politics Easier to pass regulations if don't harm existing firms Potential for economic rent for existing firms if VDR makes entry into the market harder. it raises additional issues. a uniform standard cannot be efficient in both jurisdictions. CAC could mimic an efficient standard if each plant’s regulations varied depending on MAC. o With vintage differentiated regulation (VDR). If MAC correlates with vintage. standards depend on the entry date of each unit. However. we mean that any given abatement level is achieved at the lowest cost possible. Is it appropriate to have uniform standards across regions? Are the needs of rural and urban areas similar? If marginal damages differ across regions. o Effect on investment Firms invest if NPV of benefits (net of O&M costs) > cost of investment VDR makes investment more costly Both initial costs and O&M costs higher As a result. particularly with dynamic investment decisions. this is hard to observe.
Gruenspecht found that VDR led to a 2-4% decrease in sales in the first 5 years after new standards Effect on emissions CO emissions up 1%/year for first 4 years HC emissions up 2%/year for first 5 years NOX emissions fell immediately Note that. Evidence from 1981 emissions standards increase Using price elasticities and estimates of cost increases from new emission standards. Plants facing rate of return regulation find it easier to pass costs on to customers. For example. newer plants may be idled first. Gas taxes instead of fuel economy standards Evidence: New Source Review New Source Review (NSR) is part of the Clean Air Act Regulations apply only to new sources However. However. existing sources that make major modifications must also comply. studying the effect of NOX trading markets. Evidence: Automobiles VDR for automobiles: Emission standards Safety standards Fuel economy regulations Note that retrofitting older vehicles would be very expensive and hard to enforce. and HC emissions down 16% Alternatives: Pay people to scrap old vehicles. thus extending the life of power plants. by 1990.o o In extreme cases. Stanton (1993) found that plants with weaker regulations were used more intensely. Thus VDR makes sense for automobiles. Several studies find that NSR lowers investment. CO emissions down 5. NSR can discourage investment at older plants. . As a result. less efficient equipment is kept longer than before. Fowlie (2007) finds that plants in deregulated markets are less likely to invest in capital intensive equipment. Greunspecht suggests a $250 bounty for scrapping cars more than 15 years old.3%. VDR could lead to more emissions in the short run. NSR can also raise the cost of operating newer plants. Wolfram and Bushnell (2008) find that this effect is small. as older. Note that market structure matters The effects will be largest in competitive markets.
The details are covered in the text. the firm doesn’t have the correct incentives to use the appropriate technology (e.g.) because there is no price placed on pollution. self-monitoring is often used. Incentive to do innovation o Command and control provides little incentive to innovate o There are incentives to avoid the costs of regulation. and are subject to surprise audits. as we’ve taxed the output. requiring or prohibiting certain methods) is easier to enforce than direct monitoring of emissions. Pigouvian Taxation Pigouvian tax – A tax levied on each unit of a polluter’s output in an amount equal to the marginal damage that it inflicts at the efficient level of production. For example. o However. even after costs are lower. technology standards (e. firms have no need to control more pollution. o It is a second-best solution because.) o o In the U. Enforcement (We won't discuss this in class. so we instead tax gasoline consumption. there may be times when this is the best we can do. Even when regulations are set at the federal level. or emissions. Firms keep their own records on emissions. . Enforceability helps determine which types of standards are appropriate. For example.S. Additional regulation would be needed. However. The Pigouvian tax works by internalizing the cost of the externality. more efficient machines. Modern economic solutions to pollution. We can do the same thing with a subsidy. enforcement is often left to local governments.g. since pollution is a by-product of gasoline consumption. etc. They find that NSR reduces capital expenditures at existing plants. For non-point sources.. Emissions Fees I. the opportunity cost of polluting is losing the subsidy. o The goal is to set the tax so that the polluter incorporates the social cost. take this into account. there are no incentives to exceed the level of regulation. fuel efficiency. water discharge permits are given out by state agencies with EPA backing. pollution control. we cannot measure the actual emissions from cars. o In this case. It would be better to tax the pollution directly. which we will discuss later. but they find no change in operating costs. but I've put this here for completeness. For example. although the level of output is correct for the technology being used. Note that Pigouvian taxation is a second-best solution.
since abating is cheaper than paying the fee. The main advantage of emissions fees is that. economists say that emissions fees are an efficient environmental policy. Problems with subsidies Very different distributional effects The polluter receives money from the government. they achieve a given level of pollution control at the lowest possible cost. o The government can rectify the problem by setting a price for pollution.o o Types of subsidies: An abatement equipment subsidy would pay a firm for adopting a specific abatement technology. See. rather than paying Firms may enter market. A per unit subsidy pays a firm for each unit of pollution reduced below some predetermined level. However. o Thus. o An efficient solution is found when the marginal abatement costs are equal across all firms. figure 12-7 in Field. o The goal is to set the fee so that the polluter incorporates the social cost. and pay less in fees. so no further abatement occurs. If MAC is known. II. paying the tax is cheaper than abatement. o The firm will find it beneficial to abate up to this point. since the firms pay both abatement costs and the fees. simply set the fee equal to MAC at the optimal level of pollution. o After this point. the fee should be based on the expected value (the “best guess” of MAC). and can be difficult to remove when no longer needed. o However. if you lower your MAC. the firm is taking into account the value of the damage it is doing. You may download a spreadsheet with the numbers I used in class by clicking here. At this point. Emission Fees Recall that the problem with externalities is that they are not reflected in prices. o Once you’ve met a CAC regulation. there is no way to shift abatement responsibilities among the firms and achieve a lower total cost. Thus. emissions fees are politically unpopular. you have little incentive to do better. for example. the cost to each individual firm is greater. o Note that since MAC = MD at the optimal level. so that total pollution increases Need to raise taxes to pay for subsidies Ethics? Should we have to pay to avoid pollution? Subsidies are often politically motivated. you can abate more. . o If MAC is unknown. when there is more than one polluter. Another potential advantage of fees over CAC is that fees encourage innovation.
there are more costs to be passed on here. but they don't guarantee which firms will reduce and which firms won't. we would like to tax users directly. taxes that affect the environment were not implemented primarily for environmental reasons. Varying the fee based on potential damages can help address this. damages may remain high. Ideally. Questions for designing an environmental excise tax: 1. o Distributional issues Concerns about equity might make some environmental taxes politically unpopular.Emissions Fees the disadvantages of emission fees. fees are more flexible In addition. However. Who is to be taxed? Here we’re focusing on administration. emissions). emission fees provide more certainty on costs. such as raising revenue.S. Issues raised included: o Uncertainty Compared to command and control. all pollution must be monitored and measured. o Geographically-varying damage Market-based policies guarantee an overall goal. or indirect (e. While all policies raise the possibility of costs being passed on to consumers. . o Note that most U.g. tend to be more important. Recall that economic incidence is independent of legal incidence. o Monitoring costs To charge a fee per unit of pollution. but less certainty on the final level of emissions. what is the tax base. Other concerns. fees allow responses to adjust to new conditions. What is to be taxed? That is. o Flexibility Compared to regulations that mandate a specific abatement technique. Implementation Issues We began class by discussing practical issues for implementing an environmental tax. May be direct (e. CFCs. not ultimate incidence.g. if economic conditions change. If firms near an urban center choose to pay the fee rather than reduce emissions. making a gas tax a regressive. I. it can be difficult to know the users. lower income families spend more of their income on gasoline. gasoline) 2. as firms pay both for abatement and the fee for the remaining units of pollution. For example.
The main reason is that the tax base for environmental taxes is much smaller than the tax base for more general taxes. Uncertainty could be bad if mistakes costly. Are their ancillary policy goals? Taxes are not enacted in a policy vacuum. However. since we can’t tax each farmer for his or her individual contribution. However. the economy benefits. Thus.g. For CFCs. abatement Taxes are a source of revenue. such as income taxes. Multiple goals often conflict. taxes may help us learn about the MAC of firms. Therefore. there may be many users. 4. threshold effects). we might adjust the rate.g energy conservation tax credits. Common conflict: revenue vs. to prevent non-point pollution. Examples Although many taxes may affect the environment. If an environmental tax is successful. gas guzzler tax) Environmental excise taxes generally fall in one of three categories: .For example. it lowers emissions. Also. environmental taxes correct a distortion. Therefore it is hard to set the tax correctly. Since the revenues from environmental taxes can be used to lower other taxes. most economists find these effects to be small. in these cases (e. 3. They will choose to pay the tax when tax < MAC. thus lowering the tax base. The theoretical argument is as follows: Most taxes cause distortions in the economy. it was easier to tax production than tax each user. but that they can also improve economic efficiency. As we'll see in a couple of weeks. What tax rate to impose? This is where most of the economic analysis comes in. Problems: Knowing MD is difficult. frequent use of tax policies directly focused on environmental issues began in the 1970s (e. Although we also might not know about MAC. even a large environmental tax only raises enough revenue to allow a small cut in a more general tax. if revenues are important. regulation may be better. II. we may tax fertilizer. What should be done with the revenue? Economists have noted that these taxes not only help the environment.
3.5 MPG Ranges from $1. depending on fuel efficiency Examples of environmental taxes (source: EPA Report: The United States Experience with Economic Incentives for Protecting the Environment. such as stickers for trash Reduce weight of trash in landfills. Pigouvian taxes Few environmental taxes explicitly aim to internalize external damages. several New Jersey counties assess open space taxes 1 to 5 cents per $100 assessed value of property Money must go to trust funds to be used for purchasing open space. developing parks. 2. . Note that reducing pollution is not a goal of the federal gas tax. etc. o Several states have taxes for hard to dispose of items (tires. The federal gas tax is essentially a user fee.37 per pound The amount has increased over time Gas guzzler tax on vehicles below a certain MPG Applies only to cars (not trucks) Applies to cars below 22. Production of CFCs is taxed per pound 1990 level was $1. User fees These are taxes designed to raise revenue for a specific purpose. but can also lead to more illegal dumping. chapter 4) o Emission fees in the South Coast Air Quality Management District (SCAQMD) in Southern California Facilities exceeding their allowable emissions limits must pay fees o Solid waste disposal fees. Revenue pays for cleanup of future hazardous waste sites. Examples: Excise taxes on sport fishing equipment and motorboat fuels fund programs such as fish hatcheries designed to ensure the survival of fish species. Some that do include: Tax on ozone-depleting chemicals Passed in 1989 to help eliminate chlorofluorocarbons (CFCs) A result of US support of the Montreal Protocol. the purpose is a public good.700. 1. Lesson: beware of unintended consequences.000 to $7. Insurance premia in mandated risk pooling Taxes collected by an industry to pay for liability against possible damages. Examples: Oil Spill Liability Trust Fund tax of 5 cents per barrel of oil Superfund tax on chemical companies. oil. refrigerators) o In response to suburban sprawl. Usually. since revenues go into the Highway Trust Fund.
despite lost tax revenue..6 cents per kWh in 1995 for biomass and wind) Estimated cost to government $970 million o Income tax credits for easements in Colorado Income tax credits are available for 50% of the fair-market value of the easement.S. up to $375.000 2005: almost 1 million Cost to government in lost revenue: 2001: $2. o Tax credits for alternative fuels Available for alternative fueled cars Available for renewable energy (1. there are two options: If there is a budget surplus. chapter 7) o Income tax credits in Colorado for conservation easements o Brownfield development grants (also include changes in liability law) For example. There is little regulation of the valuation of easements Some transactions have been found to be fraudulent Colorado doesn't audit the credits. o Loans for pollution control expenses The state of California issues tax-exempt bonds to provide low interest loans to small businesses for pollution control devices & solid waste recovery projects. This is left to the Internal Revenue Service. o Note that all these subsidies have a cost: there is lost tax revenue. such as ranchers.S. Impact Total acres protected: 2000: 350.S.3 million 2005: $85. the preserved open space raises the value of neighboring land. o Farming and land preservation The Conservation Reserve Program.The Conservation Reserve Program. part of the U. in New Jersey. developers get a 10 year property tax exemption for remediating a site in accordance with state standards and return it to industrial or commercial use. Food Security Act of 1985 (1985 Farm Bill) pays farmers for taking environmentally sensitive land out of cultivation. If there is no surplus.1 million Proponents argue that. the credits can be sold to buyers who have more taxable income. part of the U.Examples of subsidies in U. the credit is refundable. The credits sell for 80-85 cents per dollar of credit.000. Developing country examples . (source: EPA Report: The United States Experience with Economic Incentives for Protecting the Environment. Food Security Act of 1985 (1985 Farm Bill) pays farmers for taking environmentally sensitive land out of cultivation. For those with less taxable income.
Uses self reporting by firms. rates were low. but rather based on complex engineering formulas. 3(1). “Environmental Taxes in Developing and Transitional Economies. Firms have used a variety of techniques to reduce wastewater emissions.” Public Finance and Management 2003. Malaysia Uses a licensing fee for water pollution from palm oil production. non-payment was an issue.(from Randall Bluffstone. prior to 1999. Rates typically not market based (e. plus a pollution levy for industrial air or water pollution that exceeds annual limits. Rates change every 6 months! Revenues go to local environmental agencies. For example. waste water emissions are estimated to have fallen by about 20-25% in response to the fees. Lithuania charged several million dollars per ton of SO2. and typically only covered administrative costs. Uses a two-tiered system Charge a basic fee per unit. with spot checks by local environmental officials. Uses a two-tiered system Emissions above concentration standards are charged 10 times more. as well as the former Soviet Union. Not surprisingly. Highest in richer urban areas. o China Has used emissions fees for air and water since the early 1980s. The new rates vary by region. Central and Eastern Europe Many Central and Eastern European countries. Columbia Began water effluent charges in 1974 Rates increased in 1993 Prior to this.g. 80% of air pollution revenues to go pollution reduction programs. o o o III. considering marginal abatement costs). 143-175). Firms are only charged for emissions of their “worst” pollutant. suggesting that there may be differences in abatement costs across firms. implemented environmental taxes in the late 1970s and early 1980s. Nationally. Goal: to give incentives for state owned enterprises to reduce emissions. and are linked to damages. but implemented by local environmental protection boards. Rates vary by locality. Fees are assessed at national levels. Could lead to odd results. Comparison of Policies: NOX Charges in France and Sweden .
using real-time monitoring Main costs to firms were for monitoring and abatement Average abatement costs between 12-25 SEK/kg Monitoring costs about 2-3 SEK/kg (about $250/ton) Note this is greater than the charge itself in France. France needed 54% reduction from 1990 levels Sweden needed 56% reduction from 1990 levels o Potential technologies: Changes in combustion process Fuel switching Selective catalytic reduction for industry. o Both build off existing command and control systems.5% of revenues o Effect of the tax Emissions target not met until 1998 . suggesting that real-time monitoring would not make sense there. For another ½. because Swedish bedrock has little calcium. and thus does not provide buffering capacity. which sets specific NOX limits to be met by 2010. if cleaner than average. Sweden o Acid rain important issue.000/ton) NOX Rate based on engineering estimates of abatement costs. Covers approximately 250 plants with 365 boilers o What happens to revenues? After administrative costs.2 SEK/kg Low administrative costs for government: just 0. the EU set national emission ceilings in 2000. which ranged from 3 to 84 SEK/ton. catalytic converters for cars o Measurement of emissions important to properly calculate fees. a net gain after refund. Goal: reduce NOX emissions by 30% by 1995. in France and Sweden. Based on these goals. compared to 1980 levels. in that firms avoid needing to pay twice (for what they abate and for what they emit). there was a net loss after refund. The cost is that the government can not use the revenue for other purposes. For about ½ of firms. o Uses a refunded emissions payment (REP) for industrial boilers producing 25 GWh/yr Tax of 40 SEK/kg ($4. The article by Millock and Sterner looks at two fee systems for NOX emissions. o Both driven by the United Nations Economic Commission for European Convention on Long-Range Transboundary Air Pollution. can get back more than pay in Note that this can avoid one political drawback of fees. remainder of charge is returned to plants Returned in proportion to output of useful energy Thus. However. o Monitoring and compliance Units self-report annual emissions. the tax would be unlikely to pass without it. Administrative costs at plant about 1.
Swedish plants have half the emission rates of plants elsewhere In fact.o o The problem was mobile sources. Differences across industries Figure 5-2 shows that some industries gained. but easily checked against fuel consumption data Administrative costs 6% of total tax revenue Effect of the tax Government reports emission reduced by 27. .g. or $1. Clearly. but can also provide incentives that exacerbate problems. deductions). French policy is similar to a command and control policy Firms need to comply with national standards. fell by more than 50% Comparison of plants across countries US EPA compared similar plants (coal-fired plants with selective catalytic reduction. while energy gained the most Introduction of tax closely linked to European Community policy on acid rain. but there is little incentive for continual improvement Note that average abatement costs in Sweden about 1/3 to 1/2 of charge. covered by the tax. emission rates are below the Swedish standard Note that the emissions charge gives plants incentives to do better than the standard. the French charge does not induce additional abatement at such costs.333 . Applies to all units with 20 MW power capacity Higher threshold than the Swedish program Tax has consistently been lower than Sweden: 1990: 150 FF/ton NOX ($23/ton) 1995: 180 FF/ton NOX 1998: 250 FF/ton NOX ($38/ton) What happens to revenues? Pays for subsidies for abatement measures Compliance No fine for failure to pay Government said not needed. Often these come from “tax expenditures” (e. or SCR) in different countries. while other lost Pulp & paper hurt the most. because there was 97% compliance Emissions data self-reported. Hanson and Sandalow provide examples. Greening the Tax Code Note that taxes can not only correct externalities. where emissions only fell by 13% Stationary sources.000 tons Subsidies for new abatement technologies less effective Many just accelerated what would have happened anyway Because of low tax rate. France o o o o o o o IV.000/ton.$2.
The class was divided into six firms. and polluted less. so that they could pollute more. Firms did not know the costs of other firms. as much as 20% of fertilizer applied ends up in waterways. o Similarly. As expected. o Firms with high marginal abatement costs bought permits. Tax would encourage more efficient use. How would these work? o Water pollution tax Tax BOD in discharges from industry and wastewater treatment plants. Originally intended for large equipment (e. the abatement was done by the firms who could achieve abatement at the lowest cost. coal). discourages recycling. firms could offer to buy or sell permits. o Sport utility vehicle deduction Businesses can deduct $25. Note that the permit market enabled us to learn the marginal cost of abatement. so administrative costs would be low. o Transferable Discharge Permits I. construction) Repealing would save $700 million over five years. oil and gas companies can treat exploration and development as an expense. o Nitrogen fertilizer tax Tax fertilizer that leas to nutrient overload and “dead zones” in water. Transferable Discharge Permits Today's class was an exercise in permit trading. and firms with low marginal abatement costs sold permits. Currently.g. Already monitor BOD. Repealing would save $17 billion over five years.000 of purchase of large vehicles (> 6. Encourages use of cleaner fuels (e. Percent depletion allowance Oil and gas producers can deduct a fixed percentage of gross income each year. the final allocation lowered the variance of marginal abatement costs across firms. . natural gas vs. This was established in 19090 to stimulate domestic production.000 lbs) in the first year. o Carbon tax Tax fuels based on their carbon content. Is it still needed? Repealing would save $900 million over five years. but we still reached an equilibrium in which costs were lower. No expensing allowed for light vehicles. Encourages greater extraction of virgin materials. Hanson and Sandalow also propose new green taxes.g. rather than depreciating over a number of years. o Thus. and each firm was given an initial allocation of permits. Based on the marginal abatement costs of each group.
This is only $1 greater than the most efficient allocation of permits. The initial distribution can be done in several ways. as firms are still learning about the market. 3. if goal is 1000 tons of emissions. Thus. . Thus. along with some discussion. How Trades Work How permits work: 1. Only the desired number of permits is issued. I have placed the results of the market exercise on a spreadsheet. Firms can buy and sell permits. Similarly. 2.g. You can download the spreadsheet by clicking below. it is better off. as can be seen on the sheet labeled "Abatement Schedules". Firms are issued permits to emit pollutants. we rarely get the lowest costs possible in round 1. the government has control over the final amount of pollution. may give 100 firms permits for 10 tons each). Thus. Nonetheless. where the total abatement costs were as low as possible. firms need to have permits to trade. It can take the money it gets from selling the permit. use it to reduce pollution. if the price is greater than the MAC of the low-cost firm. Permits: Implementation Issues Initial allocation of permits o To begin a permit trading system. trading generally leads the class to a more efficient outcome. Transferable Discharge Permits I. and total abatement costs fell from $114 to $105. Round 2 had an efficient outcome. I've found that although costs usually fall in both rounds. In general. Government begins by setting the desired level of emissions (considering MAC and MD). As a result. Firms with higher MAC will be willing to buy permits from firms with lower MAC. The government can auction permits to highest bidder. the final marginal abatement costs were lower. even with imperfect information. Economists consider this least-cost solution to be efficient. If the price paid is less than the MAC of the high-cost firm. permit trading allows a given level of pollution control to be achieved for the least possible cost. as it did here. and still have some left over. the quantity is assured. like command and control policies. Results of permit trading exercise II. it is better off. In the first round. (e. sometimes the first couple of trades take place at too high or too low a price. Such trades are possible until MAC is equal across firms.
because supply of permits was not known until countries made allocations between the trading and non-trading sectors. At least initially. . Equal distribution among firms. coke ovens. monitoring and enforcement will be necessary. versus needing to buy them). May seem fairer. will be different. cement kilns. Historical emissions rates (more permits to bigger polluters). transactions costs must be low. o Who should be able to participate? Should environmental groups or private individuals be able to buy permits and then not use them? The EU Emissions Trading Scheme (EU-ETS) is a good example of this. Permits in the trading sector must be allocated among individual firms. The EU faces an overall cap on carbon emissions from Kyoto. From this.g. free distribution is more politically palatable. Establishing trading rules o For a market to work. the market should yield an efficient solution no matter what the initial allocation. this penalizes early actors. and the pulp and paper industry) Each country gets allowances based on its national cap in Kyoto. if want to reduce pollution by 10%. because market prices will be determined by the allocation decisions of all countries. but what if firms are of different sizes. as it gives them an additional asset. o Also. combined systems are possible (e. Should firms that have already reduced get fewer permits? Also. Thus. However. For example. Raises revenue for the government. at the same time. o However.g. Issues: Difficult to make projects about price. hold back some permits for auction). Total allowances are spread between the trading & nontrading sector 2. It faces two allocation decisions: 1. additional trading shouldn’t be needed. ceramics manufacturing. iron & steel. Need to track both emissions and the number of permits each firm has. Also makes it hard for an individual country to control emissions from its trading sector. note that if the market is competitive. the EU has specified the industries that will participate in trading (electric utilities. Auctioning permits makes the plan more like a tax. who benefits by selling permits. However. give each firm permits equal to 90% of their current emissions. o Note that firms will prefer getting the permits for free. as permits go to firms willing to pay the most. oil refineries. glass manufacturing. the effects on individual firms (e.
4 types of trades 0. Trades can be internal or external. 90% in California 90% of offset trades have been within a firm.g. the EPA has used permits to allow economic development in areas that failed to meet ambient air quality standards. New York state has tried to prohibit NY power plants from selling SO2 permits to plants in neighboring states.g. Clear Skies divides the country into two regions (East and West) for NOX trading However. CO2). likely to require more reductions from industries like electric utilities. Both internal and external trades (external if bubble over a region) Bubbles set up between 1979 and 1986 saved $315 million. so that they do not have a competitive disadvantage with firms from other countries. Offsets – included in 1977 CAA No new emission source can be located in areas where air quality standards are not met unless existing emissions are reduced at least as much. 1.Countries have incentives to give more allowances to industries that trade goods. Thus. Ways for permit system to deal with geographic concerns: Ambient-based permit system: permits needed for pollution as measured at each receptor. this limits competition. countries have given more allowances to the trading sector than expected. For others. . (e. location does matter. such rules may prohibit some beneficial trades. carbon monoxide in a city). A tax system would deal with this by charging higher fees in areas where pollution is a bigger concern.K. E. There have been over 10. In general. Bubbles – began in 1979 An imaginary bubble placed is over a plant Individual firms can sum all emissions from individual sources As long as the total doesn’t exceed their limit. where it is emitted doesn’t matter.g. they are O. For example. which might keep the market from working correctly. which has kept prices low. Also. Examples of how the EPA has dealt with the locality issue Since the 1970s. a firm downwind might need to buy two permits from a firm upwind to be able to emit one unit of pollution. Geographic considerations: For some types of pollution (e.000 offset trades. Limit trading to within regions Limits trades to areas where the emissions have the same effect.
a problem here is that the BPM must be certified by the state to receive credit. Pollution control options: Farmers can adopt best practice methods (BPM). innovation not only lowers marginal abatement costs. and also raises other implementation issues The problem: nitrogen from manure and phosphorus from fertilizer lead to algae growth. Not used often (only 24 emissions banks by 1994) 3.allowed in 1977 CAA Firms can save emissions reductions above and beyond permit requirements for future use in trading. . Because the runoff is a non-point pollutant.000 to $1 million per application. there has been only one trade between farmers and developers in the first three months. A firm does not have enough permits to cover its pollution. Internal trading only Most widely used of these programs Cost savings from being classified as a major source can range from $100. Consider two cases: 0. A 100 house development would require about 700 credits. such as Barriers to contain runoff Planting crops year-round. The Pennsylvania water trading article is a good example of offsets. Incentives for innovation The incentives for innovation are the same as with an emissions fee (see figure 13-4). The opportunity cost of polluting is that it cannot sell a permit. 1. A firm has enough permits to cover its pollution.6 pounds of pollution. with blocks sunlight and kills underwater grasses.$9. and reduces about 1. Netting – added to EPAs offset policy in 1980 Sources undergoing modification can avoid new source review if they can demonstrate plant-wide emissions don’t increase significantly. it is difficult to track runoff from specific farms. Thus. A typical credit is worth $2 . waste from sewage treatment plants can be filtered Pennsylvania has established a trading system where farmers receive credits for adopting BPM The value of the credit is based on a formula that considers the impact of improvement and the distance of the farm from Chesapeake Bay As discussed in class. so that storms don't wash soil away In urban areas. Developers need to purchase credits to offset new sewage treatment plants. but allows the firm to sell more permits. This provides uncertainty for farmers. Thus. Banking -. So far.2. firms can create new sources of emissions by reducing emissions elsewhere in plant.
the total level of emissions need not fall. o Customers or distributors must show that they use at least that percentage of renewable energy. Keep in mind that although individual firms have more incentives to develop technologies than under command and control. o During phase-out of lead from gasoline.1 grams/gal 1987: terminated o How trades worked: Refineries that produced gasoline below the allowable limits received credits that they could sell to refineries that could not meet the limits.1 grams/gal allowed 1985: banking allowed – average level of 0.5 grams/gal 1986: average level of 0. not allowing trading would have increased the price of gasoline Mitigation banking o Before allowing a project that will damage wetlands. Examples of Permit Trading Water pollution on Fox River in Wisconsin o Unsuccessful. They do this by purchasing permits. refineries were allowed to trade lead credits o Timetable: 1982: credits established – average level of 1. Thus. however. allow new sources to come on-line. o Producers get a certificate for each unit of renewable energy supplied to the grid. o Lead trading was very successful 50% of refineries participated in trading Reduced costs by at least 10% (several hundred million dollars) Because some refineries could not lower lead content quickly. Australia. they are compensated for the extra cost of producing renewable energy. . so that more output is produced for the same level of pollution. Since producers of renewable energy sell the permits. innovation not only lowers marginal abatement costs. Tradable green certificates o Used in Europe. only 1 trade in 6 years. Texas o The program begins with a target level for percentage of renewable energy use. located in clusters and were opposed to the plan. o Has led to a market for mitigation credits. It may. o Firms were similar. Lead trading o Background: lead caused health problems and doesn’t work with catalytic converters. II. but saves the firm from the need to buy additional permits.The opportunity cost of polluting is that the firm must buy a permit. the Army Corps of Engineers requires that developers restore or create wetlands elsewhere. since the permits that are sold may be used by someone else.
with a price of $2. Compared to EU. Most states auction nearly all permits. or about half of their obliged reductions. RGGI is more restrictive about the number of outside credits plants can use to offset emissionsOnly 3. early predictions are that the program will raise consumers’ monthly bills by no more than $1. This then falls 2. with a goal of capping emissions at current levels in 2009. NJ. and can decide how many to auction versus freely allocate. Estimated 2007 emissions were 172. for a total 10% reduction. which fell between 2005 & 2006. Originally proposed by Gov. on Chicago Board of Trade). and DE. George Pataki of NY o Allowed emissions are 188 million tons CO2 annually through 2014. Sources may choose to reduce their emissions early and bank their excess allowances for future use. As a result. starting at 60% in 2009. carbon futures prices have also fallen (e. The Regional Greenhouse Gas Initiative (RGGI) includes 10 northeastern states that have committed to reducing CO2 emissions from power plants. Nonetheless.07/ton CO2 12/17 price: $3. which can sold later. Because of these low prices.38/ton CO2 Most recent auction was 12/2/2009. o The states are the 6 New England states. Uncertainty in Environmental Economics Uncertainty is a problem for all policy decisions. and reducing emissions 10% by 2019.4 million tons CO2. all allowances have been sold above the floor price of $1. . plus NY. can be met using offsets. States set limits for carbon dioxide emissions. o Auction results Two "pre-compliance" auctions were held: 9/25/2008 & 12/17/2008 9/25 price: $3. This percentage increases 8% per year until 100% in 2014.g. Delaware auctions the fewest. Utilities bid for allowances.05/ton CO2 Prices are low because emissions cap overestimated current CO2 output. although cap for 2009 is 188 million tons CO2.5% per year through 2018. o How it works States are apportioned their share of allowances from the overall cap. Auctions are held quarterly. New York auctions 100%.3% of a plant’s emissions. o Often dealt with using expected values.86/ton. Proceeds from permit auction will be used for energy-saving and renewable energy programs in each state. Covers power plants of 25 MW or more burning at least 50% fossil fuels. MD.
Given this. Long time horizons Makes results very sensitive to the choice of discount rate. It may be that large reductions are very costly. Uncertainties may interact. 2.g. but be very high for total abatement (e. the tipping point itself is often uncertain. suggesting that traditional cost-benefit analysis biased for policy adoption. or tipping point. a negative opportunity cost) Suggests traditional cost-benefit analysis biased against policy adoption. cost of abatement may be low for low levels of abatement. climate change) While these may be well-known for some pollutants (e.g. this is important because we don’t want to go beyond the tipping point. there is an pportunity cost to adopting a policy now.g. what makes uncertainty different for environmental problems? 1. but become severe above some uncertain threshold. Our ability to substitute in the long-run depends on how well alternative energy sources substitute for fossil fuels. This is highly dependent on technological change. . rather than waiting for more information This works in the opposite direction. Uncertainty for environmental problems is highly non-linear Damages may be barely noticeable for low levels. For example. For policy. may just be lost expenditures Thus. this is more challenging. However. costs are uncertain For climate change. There are decent estimates for short-run. the level of tax needed to meet an emissions target depends on how responsive energy use is to prices. 3. Takes many years to remove carbon emissions Thus. Abatement efforts involve sunk costs Often in the form of capital expenditures However. However. adopting a policy now has a sunk benefit (e. SO2. for others. Irreversibilities Two types of irreversibilites: Environmental damage often irreversible. the benefits of climate change reductions depend on: Expected GHG levels without abatement (BAU) How rapidly CHG concentrations grow in response to emissions Effect of concentrations on temperatures Economic impact of higher temperatures Similarly. Can’t undo cutting down a virgin forest or extinction. NOX). for the long-run.
etc. the regulated level of emissions is too high if MAC are higher than expected (the regulation is too strong). if. we can roll back policy However. but the results will not depend on the policy chosen. You may download a copy of the handout by clicking here. policy matters: With regulation. The key points were: o When the MDF is uncertain. If we know with certainty how future generations will value the changes. o When MAC are uncertain. in the future.g. Policy implications (we'll discuss these more next Monday) o Policy timing Should we wait until we learn more. We will continue with this analysis The Role of Uncertainty: Theory (continued) .). on the shape of the curves (what Pindyck calls convexity) Choice of policy instrument IV. Policy intensity o Choice depends not just on expected values. we can incorporate that into our cost-benefit analysis.We will discuss this in the cost-benefit section of the course. base policy on expected values. try to avoid the worst outcome. since negative emissions in the future are impossible. we might emit less today. we would want negative carbon emissions to reverse climate change. and too high if MAC are lower than expected (the tax is too high). The Role of Uncertainty: Choice of Policy Instruments The diagrams drawn in class were intended to show how the regulated level of emissions varies from the optimal level of emissions when taxes or command and control regulations are used and the marginal abatement costs (MAC) are uncertain. both command and control and taxes result in the same errors. Only affects current decisions if it would constrain future choices under plausible conditions. in a “bad news” scenario.g. or should we act quickly? When do irreversibilities matter? Only if there is uncertainty. Thus. and too low if MAC are lower than expected (the regulation is too weak). the resulting level of emissions is too low if MAC are higher than expected (because the tax is too low). With fees. policy makers have to decide how to deal with uncertainty (e. but on variance o That is. we cannot correct the situation. One key here is long-lived effects In a “good news” scenario. E.
What is Voluntary Compliance? Policy makers and environmentalists have paid increasing attention to voluntary environmental programs. o Implementation: Along with emissions targets. Key questions include: o Why do firms participate? o Do programs increase environmental protection above and beyond what would have happened anyway? o What is the economic impact of voluntary programs? Types of voluntary programs: 1. A third option is to combine permits with a “safety valve. Unilateral commitments: business-led environmental programs. but restrict quantity even if costs are high. o Political analysis Conservatives view it as a tax. $25 per ton of carbon). because the tax represents MDF well. mistakes with quantity are more costly. Thus. . Perceived demand for green technologies as India and China develop. the government sets a “trigger price” (e.g.” o One problem with the above analysis is that fees are rarely used. industry is the source of action. o This proposal combines both features. o Permits are more practical politically. Examples: Chemical Manufacturers Association “Responsible Care Program” McDonalds’ replacing Styrofoam containers General Electric’s commitment to reduce CO2 emissions Note that GE’s CEO thinks this will be profitable. Here. in which firms improve environmental performance beyond what is required by regulation. Environmentalists fear stringent standards will not be met. Why? GE hopes to be a technology leader if regulations are put in place. If the price of permits rose above the trigger. the government would sell extra permits to maintain this price. o When MDF is flatter. Using the results we covered Monday. Voluntary Environmental Compliance I. regulation is a better option. a tax is better. we began class deriving rules for the desired policy based on the slope of the marginal damage function (MDF): o When MDF is steeper.
used more in Europe Examples: French agreement on end-of-life vehicles Swedish program for packaging Here. May be legally binding. Registered companies pay a fee in return for using the REPA’s recycling and recovery system. and tries to induce firms to comply. The agreement was established by industry representatives to control the system of collection. such as the product labels used in Europe)? 2. . Unlike the other two. compliance was required by the Swedish Ordinance on Producer Responsibility for Packaging. both firms and government are active participants. and new firms must agree to the principles to join the British Chemical Industries Association However. Used more in Europe than the United States Examples: EPA 33/50 program Green Lights program 3. Here. we discussed what it means to be "green" Is it just being cleaner than your competitor.Here. EPA Common Sense Initiative Example: Chemical Manufacturers Association “Responsible Care Program” o Example of unilateral commitment o Started by the Canadian Chemical Producers Association in 1985. re-use and recycling. Public voluntary schemes: Participating firms agree to standards developed by public bodies. Negotiated agreements: typically agreements of firms and government. US Chemical Manufacturers Association and British Chemical Industries Association began similar programs in 1989. o Motivation: To restore public trust in the industry To minimize government regulations in response to the accident o How it works Participants of British program agree to six guiding principles All 200 existing firms signed. little public data are available for public to monitor. such as the EPA. which set goals to be met by 1997. India. the public agency moves first. in response to the 1984 Union Carbide storage tank leak in Bhopal. or should certain standards be met? Does this lead to a need to regulate "green" claims (potentially pushing us from a firm-led program to a governmentled program. Again.
or recycling. The French effort was an attempt to pre-empt this. reuse. what are the risks? Example: Agreement on End-of-Life Vehicles o Example of negotiated agreement o Began in France in 1993 o Participants: French Ministry of Industry French Ministry of Environment 2 French car manufacturers 12 French automobile importers 8 trade associations for dismantlers. even when not compelled by regulation? Alternative theories o Improving corporate responsibility . In particular. After 2002. and 50% by 1995 Measured relative to a 1988 baseline o How it works EPA provides publicity and limited technical assistance No penalties for failure TRI data makes public monitoring possible o Results: From 1991 to 1994. emissions of these 17 chemicals fell 42%. o Goal: have total weight of vehicle destined for landfill be less than 15% of original weight by 2002. but there was a threat of legislation if program did not succeed. we first need to understand what the motives of participants are. That is. where TRI makes it possible to monitor firm activity Example: EPA 33/50 Program for Reducing Toxic Chemical Emissions o Example of public voluntary scheme o Began in 1991 o Goal: voluntary scheme to get firms to reduce emissions of 17 key toxic chemicals 33% by 1992. Why Do Firms Voluntarily Comply? To better understand voluntary agreements.Contrast with US. why do firms comply. new models must allow for 90% recovery. recyclers. II. Little useful data have been generated. compared to 22% for other TRI chemicals Raises question of substitution: if other chemicals are used more. o Monitoring Initially done by agreement participants Concern over lack of public scrutiny led to NGOs attending some meetings as observers. etc. o No specific enforcement mechanism. Germany was considering regulation on end of life vehicles (ELV) in 1992.
some argue that reducing pollution reduces costs. That is. o o Since pollution is waste. Relates to the Porter hypothesis. Thus. The products involve externalities. but is it better than having regulation put in place? May be if it avoids the costs of a legislative fight. the goal is to anticipate future regulation. or did firms previously ignore profitable options? Responding to green consumers and investors Some consumers are willing to pay a premium for “green” products. and provide “enough” improvement so that the government deems such regulation unnecessary. they could still fight for legislation to do more. Allows firms to differentiate products Examples: Dolphin-friendly tuna Organic foods McDonald’s replacing Styrofoam packaging Socially responsible mutual funds Avoid investing in irresponsible companies. Reduces supply of capital to such companies Note that voluntary behavior in response to consumer demand need not be socially optimal. Voluntary compliance may simply be a reaction to this demand. Commonly cited example is 3M’s Pollution Prevention Pays program. Thus. Key questions: Why didn’t firms do this before? Are there new opportunities. consumer preferences are unlikely to completely internalize these externalities. transactions costs are a key here. does this improve welfare? Presumably better than doing nothing. Concerns: Corporate lobbying may reduce effectiveness of consumer and/or environmental groups . It is important to differentiate marketing from performance. which we will discuss later in the course. would these projects be commercially viable anyway? Strategic behavior to avoid binding regulation Preempting tougher regulation Here. In such cases. If consumers didn’t feel better off after voluntary agreement.
g. it also slowed down a policy push for vehicles using methanol fuel. Legislators may delegate too much power to regulators with voluntary agreements. Is this welfare-enhancing? Depends on penalties for violations. the goal is to reduce the stringency with which the firm is treated by regulators. The XL program has had few participants. voluntary actions might help shape the regulations that are ultimately set. EPA’s Project XL is an example of this. abatement equipment) that commits them to better performance. If penalties are too high. Government can then shift its attention to competitors. While this garnered positive publicity for ARCO. Note that this also gives ARCO a first mover advantage. Commit to higher level of compliance with existing regulations in return for lower monitoring rate or laxer permitting scrutiny from regulators. or costs of information low). Regulators objectives may be different than welfare-maximization. Intel received a waiver to allow for routine changes without permits as long as total emissions did not exceed a plant-wide cap. Works best if the firm can make an irreversible investment (e. because citizens more active. Weakening forthcoming regulation Even if regulation cannot be avoided. Theory predicts voluntary action more likely when threat of regulation greater (e. . Example ARCO introduced reformulated gasoline between 1989 & 19991. Tests of this hypothesis are discussed later. Caps are more stringent than federal standards. as they are still vulnerable to third-party lawsuits.g. firms have incentive to overinvest in compliance. Firms that participate receive relief from EPA enforcement in acknowledgement of ongoing efforts to improve environmental performance. industry involvement in the EU carbon trading scheme led to freely allocated permits and favorable allocations for industry. Reducing regulatory monitoring Here. For example.
this can include: The value of recreation at a site The value of open land near a home The value from better health The value of ecological services provided (e. reducing competition. which we have taken as given. By showing they could achieve reductions voluntarily. For environmental goods. Even if you won’t go to the Grand Canyon this year. we have expressed concern in class about drilling for oil in the Alaskan National Wildlife Refuge. or we can infer damages indirectly from the behavior of individuals. What is Value? Up to now. Now. A voluntary effort by a large firm may convince regulators the costs are achievable. DuPont’s voluntary CFC reductions are an example. not all value is use value. this is what we care about. For example. Note that costs of compliance are often uncertain. because they are not typically part of market transactions. small firms may be forced out of the industry.o Encouraging anticompetitive regulations If fixed cost of compliance are high. we discuss how to place a value on environmental amenities. preserving it may have value to you so that you can visit in the future. particularly to regulators. by a wetland) o Non-use value For environmental goods. How many in the class are opposed to drilling? How many in the class will actually go there? Examples of non-use value: Option value – the amount a person would be willing to pay to preserve the option of being able to experience a particular environmental amenity in the future. o We can use data from firms to measure MAC. We can measure damages directly.the benefits people get from direct use of a good. they convinced regulators that a phaseout of CFCs was feasible. DuPont had developed substitutes for CFCs. Valuing Environmental Benefits: Revealed Preference Approaches I. we have found the optimal level of pollution by considering the marginal damage function. . To begin. by looking at damages and the value of what is lost. For most consumer goods.g. consider what makes up the value of environmental amenities: o Use value -. o Measuring benefits is more difficult.
o Examples: Filters for drinking water Air conditioners so that windows can remain closed Medication to mask symptoms of health effects Shrubbery to hide a polluted neighboring site By studying how much people spend on averting expenditures. Revealed Preference Approaches Economists typically use one of two approaches to measure the benefits of environmental quality: 1. but rather to maintain the health of the environment for all living organisms. economists focus on willingness to pay. and underestimates the value. people may undergo expenses to remedy the problem. For example. simply using a direct measure of expenditures ignores the consumer surplus. o We need to consider the same issues for costs and supply curves. Thus. Stewardship value – a value placed on preserving the environment not for human use. Bequest value – a willingness to pay to leave behind environmental quality for future generations. o Putting these together. To measure value. Existence value – a willingness to pay simply to help preserve the existence of some environmental amenity. 2. A. . in reaction to environmental harms. we want to ask how these change as we have an incremental change in pollution. Thus. but not non-use values. Willingness to pay includes actual expenditures and consumer surplus. II. the net value is the sum of consumer surplus and producer surplus. changes in policy may lead to changes in costs (see figure 7. Aversion Costs Note that. o We can see willingness to pay from a demand curve. Protection of endangered species is an example. we can estimate the benefits they would receive if the harm were removed. Recall that the difference between what consumers actually pay and the actual price is the consumer surplus. we look at changes in producer surplus. o It is the area under the demand curve.1 in the text). o Since policy analysis should focus on marginal analysis. Revealed preference approach – infer the value of environmental goods from other market transactions Note that revealed preference approaches get at use values. Stated preference techniques – ask individuals hypothetical questions about their willingness to pay.
Using regression analysis.g.g. they could plot the demand curve and found that the consumer surplus for 4.97 to avoid shortness of breath to $23. 4. Hedonic Pricing Techniques: Housing Hedonic pricing techniques look at the value that people place on the attributes of a good.5% decrease in time on the beach. they note that tourists spend 70 million tourist days/year on the beach => total value of Florida beaches = $2. . we can infer the value of the site. they need to know the slope of the demand curve.g.7 days = $179 (average of $38/day) To get a total value of beaches. number of rooms. but rather the features of a house (e. they could derive a demand curve Results Average tourist spent 4. We need to account for substitutes. Potential problems with the travel cost method 1. Quality is not always measured. location. Travel Cost Method The travel cost method looks at how far visitors travel to come to a site. By placing a value on the cost of travel.o Example: a study of Los Angeles in 1986 found that people would pay $0. do all beach users in Florida come for the beaches. airfare) and indirect costs (e. Using this.g. Using regression analysis. Sampling bias in surveys. they found that demand for beach days was inelastic: A 10% increase in “price” leads to a 1. it assumes that people don't value a house itself.7 days at the beach Average daily expense = $85 To calculate consumer surplus.87 to avoid chest tightness. Only measures value of those that use the amenity.37 billion. or are they there for other reasons (e. For example. o The travel cost includes both direct costs (e. we can find the correlation between housing prices and environmental quality in an area. B. o That is. in different types of weather). What is the opportunity cost of time? 2. C. Disney)? 3. the opportunity cost of travel time). o We can infer the value of a change in quality by looking at demand during different days (e. is there a fireplace) o One such feature is environmental quality.g. o Example: Economists surveyed 826 tourists in Florida: How many days did you use the beach? Where are you from? How much did it cost to get there? What is the total length of your stay? From this.
Valuing Environmental Benefits: Stated Preference Approaches I. People need to be compensated to be willing to take riskier jobs. 2. this is the most appropriate measure. Henning (Review of Economics and Statistics. We don't know who will die. o What is the value? Is it merely the opportunity cost (e. Examples: 1. by asking what is the willingness to pay for changes in risk.1. Note that specific deaths capture the attention of individuals. you can click on the title to be taken to it in J-Stor. but we expect someone will. Most studies find an elasticity of housing prices with respect to pollution that is around 0. o A sample study is "The Determinants of Residential Property Values with Special Reference to Air Pollution. o That is. We are valuing changes in the probability that a random individual will die.g. D. Ridker and John A. because policy does not prevent death. The value of environmental protection is lessening the risk of someone dying. May 1967). Can also be put into annual figures: value of a statistical life year (VSLY) Contrast this with the optimal insurance and compensation of accident victims. People will choose to live in cities with positive characteristics. Differences in wages can be seen as the value of these characteristics. but rather changes the probability that death will occur. Hedonic Pricing Techniques: Wages Another application of hedonics is with wages. . a 1% decrease in pollution leads to a 0. For policy. How Much is a Life Worth? The most controversial aspect of cost-benefit analysis is placing a value on human life. that is not what a statistical life focuses on.1% increase in housing prices." By Ronald G. If you are interested in reading the article. foregone wages)? Are there other values (perhaps non-market values) that need to be considered? o Concepts of the value of a life The most commonly used value is the value of a statistical life. Differences in wages represent the value of a human life. However.
000) Therefore. Risk-risk analysis Finally. and to be able to evaluate this information properly.000) Note that this assumes people’s preferences are linear. and risk Suppose a study revealed workers would accept an additional 1 in 1000 (0. How to measure the value of a life: 1. To do. 2. or for bottled drinking water? Challenge: separating value assigned to changing risk to other characteristics (e. is it possible? Viscusi suggests that in some cases. and cluster around $6-$7 million (all figures 2005 dollars). Differences in wages represent the value of a human life. things such as the opportunity cost of foregone wages and medical expenses make sense. Revealed preference approaches Expenditures to reduce risk For example.$20. Does $1. chemicals used to make flame retardant pajamas for children increased the risk of cancer. it simply isn’t possible to restore welfare to the level that it was before. since now we are focusing on a specific loss. we regress wages on job characteristics.000 .2 million.000 * 1.1%) annual risk of dying for $1000/year in wages. For example. worker characteristics. but for large changes in risks might not be appropriate.000 x 1.000 Issues: Requires people to have perfect information about risks. or better taste for bottled water) Hedonic wage approach People need to be compensated to be willing to take riskier jobs. The value needed to pay these people is $1 million ($1. does this mean that rich people are more valuable? The “make whole” principle is similar. Ask people: stated preference methods Estimates of the value of a life in the United States range from $900. What is the value of life? If 1000 people took the job.g. Here. the willingness to be compensated for one life is $1 million (= $1. other features of the car. Do people take risks knowingly and willingly? True locally (that is for marginal changes). However. . However. Viscusi notes that tradeoffs among risks should be considered.000 for 1/1000 => $100 for 1/10. after death or serious injury. one would be expected to die. how much more will people spend for a car with airbags.
it is these high risk groups who are most affected by a policy. uses $5 million DOT uses $3 million Issues for valuing life o How do we deal with different groups? Reducing risk extends one’s life expectancy. EPA adjusts VSL upward over time to account for higher incomes.A. o Extrapolating results across groups can be a problem. Given this. o Control matters Smoking vs. Given this.D. to aid China? If China is paying. OMB guidelines advise against adjusting VSL for age. Cannot ask them directly Parents often willing to pay more to reduce risk to children than to themselves. Note that this may mean values also vary across culture or country. Given this. the average income of air travelers is higher than for the population as a whole. should we pay more to reduce risk if high-income people are affected? For example. o o o . Moreover.g. the costs of increased air safety will be passed on to these passengers via higher ticket prices.A. the young and old tend to be most vulnerable to pollution.9 million (2008 dollars) F. Many VSL studies look at job risk in middle-aged men. Does ability to pay matter? Does it matter if we are considering a plan to be paid for by the Chinese government versus one sponsored by the U. their ability to pay constrains what they can do. However. should we place different weights on the lives of children? Should we place less value on protecting the elderly? In some cases (e. air pollution).P. airline safety o Values can change over time Not having lifeboats for lower class passengers on the Titanic would be unacceptable now. doesn’t say VSL higher for richer neighborhoods than for poorer ones). uses $6. o Should the value of human life vary by income? Studies such as those focusing on lost income will place more weight on high-income lives. should the standards for air safety be higher? The EPA does not adjust VSL for incomes within a cross-section (e. workplace safety Driving vs. However.g.S.The E. Estimating VSL for children particularly difficult. o What about people in other countries? These approaches suggest a lower value for lives in developing countries.
In addition to reducing the likelihood of future spills. we have studied revealed preference approaches to valuing environmental amenities.ask respondents whether they are WTP a certain amount. Policy background o The Comprehensive Environmental Response. Unfortunately. Stated Preference Approaches: Contingent Valuation So far. For example. close-ended -. there aren't always market transactions that can serve this purpose. The Department of Commerce was to draw up regulations on damage assessment. 2. through the National Oceanic and Atmospheric Administration (NOAA). The Dept. Compensation. It should not be controversial (e. assembled a blue ribbon panel to evaluate CV. ask them about a higher amount. CV estimate of damages: $3 billion o In response to the Exxon Valdez. A payment mechanism is specified. In these cases.g. Types of questions: open-ended -. This amount is varied across respondents.g. Congress passed the Oil Pollution Act of 1990. o After the Exxon Valdez crash in March of 1989.ask respondents whether they are WTP a certain amount. how do we value protection of endangered species. Sanctioned the use of CV In 1989.ask respondents for maximum WTP. and Liability Act of 1980 (CERCLA) gave government the right to sue for damages to natural resources for which they are trustees. Ask people their willingness to pay (WTP) to bring about a specific environmental improvement. the Department of Interior said nonuse (largely existence) values were recoverable if use values were not measurable. . The problem must be described carefully. until you find the highest amount they are WTP. property taxes).. Question to panel: Is the CV method capable of providing estimates of lost nonuse or existence values that are reliable enough to be used in natural resource damage assessments? How contingent valuation works: 1. the act provided for damage recovery. economists simply ask people for their valuation. Those approaches look at actual market transactions to infer value. a federal court of appeals directed the Department of the Interior to redraft its regulations with equal weight on use and nonuse values. bidding games -. increase sewer fees to improve water quality). The mechanism must be believable (e.II. DOI regulations meant that Exxon would have to pay for non-use damages. In 1986. If they say yes. It must be specific. The most common technique is contingent valuation (CV).
Information about the respondent is gathered. not simply stopping people on the street. Increased visibility at the Grand Canyon has been valued between $5 and $10. income. Why should CV be different? .g. expressing general preference for higher environmental quality). Alaskan coast) or preventing the action (e.60 III. The key is careful construction. The question should involve a firm sense of commitment. Evaluating Contingent Valuation Do surveys lead to true values? (content validity) o Hausman and Diamond point out flaws in surveys: Protest zeros (usually thrown out by researchers) Respondents may be expressing value for a class of goods (e. etc. age. When they do this. estimation of income elasticities. o Valuing clean air: WTP to avoid health problems: $10 per asthma day reduced WTP for better visibility: A 10 percent increase in visibility has been valued as between $7 and $101. Valuing cleaner water: WTP to improve water from "boatable" to "fishable": $12. verbal protocol analysis can determine why people answer as they do.. People may be reacting to news (e. Verbal protocol analysis asks respondents think out loud. “Warm glow” from supporting good causes. All surveys have potential problems. education.30 WTP to improve water from "boatable" to "swimmable": $29.g.g.. Survey samples should be based on probability sampling. Examples of Results: o First CV: Davis (1963) found the value of outdoor recreation opportunities in the Maine woods to be between $1 and $2 per day. E. they often say irrelevant things: “If we all do our part it won’t cost much. For example.g.g. Allows verification of results. oil spills) Do people care about the resource (e.Because the survey shouldn't serve as a referendum on the type of payment mechanism chosen.” Pretesting of surveys can avoid these problems. clean up oil spills)? o Hannemann and the NOAA panel (as mentioned in Portney) note that these problems can be dealt with by careful construction of surveys. 3. o Hannemann responds to the critique that the survey creates values: People often don’t make decisions until the time they are forced to do so.
It’s not just that people value X or Y. He points out that the key question is whether the results are stable. Environmentalists WTP more. Therefore.21. or 200.g. but that people feel good about supporting the environment. (1985) used CV and travel cost at 4 Texas lakes. CV $35. Brookshire et al. As we discussed in class. o Problems noted by Hausman and Diamond (to be covered Wednesday): Anchoring Whether ask for value of a seal and then a whale. For example.000. but within 95% interval). lots of issues come and go from the political landscape. which he says they are (that is. Said will protect 2.09 at one lake. Hausman and Diamond argue that would happen despite flaws in survey. (1982) compare hedonics and CV on air quality. or just the act of saving birds? Hausman says only the final number of birds should matter. Hannemann replies that economic theory says that other things can enter utility (e. they are consistent across studies). (1) + (2) often > 3 Example: Desgouves (1982) WTP to protect migratory birds from oil waste pools by covering them with nets. However. means did vary (TC $102. Are the results of CV consistent with theory? (construct validity) o Are the results similar to results from revealed preference approaches? Sellar et al. the 95% confidence intervals overlapped.000 birds from dying Values didn’t increase Do people care about the numbers saved. At 3 of the 4. the first value given is around $100. WTP depends on order of questions. . altruism) Hausman and Diamond argue that embedding is evidence of a warm glow. if measuring general taste for environmental quality. Embedding Suppose 1 group asked about X A second group is asked about Y A third group is asked about X + Y WTP of (1) + (2) should equal (3) However. or a whale and then a seal. o Are the results similar and consistent with theory? Values increase when income increases.000. 20.
you can view my lecture notes from the topic in my managerial economics class at: http://classes. such as pollution control standards.html. However. Defenses of embedding Hannemann argues that this results from diminishing return. it is important to distinguish between transfers of resources due to substitution and the creation of new resources. WTP is a small percentage of income. this is usually a physical project such as a dam or wastewater treatment plant. For environmental economics. or a regulatory program. If the project wasn't done. Others will need to be inferred from data. Determine quantitatively the inputs and outputs of the program.total costs). Income effects could be a factor. Can be difficult – for example. There could be large substitution effects between X and Y Benefit-Cost Analysis I. Benefit-cost analysis calculates the costs and benefits of a project and finds the total net benefits. 4. 2. Dealing with Uncertainty II. adding up results of individual studies leads to double counting of benefits. The last set of lectures cover benefitcost analysis. Compare these costs and benefits. jobs created by a project should normally not be included as a benefit.edu/pa723/723lect. Here. For students who would like a review of the nuts and bolts of benefit-cost analysis. Specify clearly the project or program. general equilibrium effects. . Estimate the social costs and benefits of these inputs and outputs. 3. Protecting one lake is valuable. Note that some costs and benefits can be observed directly from market data. Steps to benefit-cost analysis 1.maxwell. Also. one can also include other considerations. the workers could have been used elsewhere. the warm glow is added up twice. Protecting a second lake isn’t as important.syr. When you ask the values individually. making aggregation of results for policy difficult. Thus. such as equity. Introduction to Benefit-Cost Analysis Goal: Maximize total net benefits (= total benefits . Jobs created are a transfer of resources. For example.
o People may pay more to avoid unpleasant deaths. assessing risk involves two concerns: 1. systematic – depends on circumstances (e. A complication for policy makers is that. Risk has two components: 1. as they typically involve low probability events. o Control is important Consider that most people worry more about air travel than auto travel. . increased safety features reduce the risk of death from auto accidents. For example. The risk may be different for different people. although the likelihood of dying in a car accident is greater. Risk by analogy Often. This is a change in systemic risk. we focus on finding the probability of an event occurring. Physiology of animals and humans may be different. even after risk assessment is complete. the probability of an event occurring 2. a smoker is more likely to get cancer) In addition. New technologies Component analysis is often used to assess the risks of new technologies. o Risk assessments are hard to understand. people have a hard time perceiving risk accurately. it is important to be aware of changes that occur over time. cancer may be caused after exposure to a toxin. Problems: Animals are exposed to unrealistically high doses of toxins in the laboratory. However. Need to extrapolate risk of humans from low exposure from calculated risk based on high exposure. For example.g. studies on animals are often used to extrapolate human risks. stochastic – depends on chance 2. As a result. Example: what should the standard for ammonium perchlorate in groundwater be? o The example over the ammonium perchlorate standard shows how different criteria for risk assessment suggest different answers. Problem: components may be related. The first step in dealing with uncertainty is risk assessment. time lags make perceiving risk difficult. but only after many years. how serious the event will be Risk assessment o First. Historical data Risk can be determined by looking at past records.
chemical A has a higher expected value of risk.95 x . However. They base their figure on a study of exposure to human adults. They also make use of laboratory studies. . such as EPA. The value of a life o Avoid upper bound of risks Government agencies. o Cost-Effectiveness analysis Rather than compare costs and benefits.95) Consider two chemical hazards: Chemical A poses a known risk of 2 in 100.g. Which is correct? Once risk has been assessed. including the risk to fetuses. o Pentagon: Proposes a standard of 200 ppb. without needing to place a dollar value on the benefits. We can than ask if the costs justify the benefits received. policy makers face several alternatives for using the information: o Benefit cost analysis For BCA.o EPA: Proposes a standard of 1 part per billion (ppb) They look at sensitive populations. greatest potential risk. Note that this standard would release the Pentagon from most cleanup responsibility. The population exposed For example. this adds up If use 95% percentiles for several estimates. often use conservative risk estimates (e.000 Government policy says risk of B is greater.000 Chemical B is uncertain 9 out of 10 scientists believe no risk 1 out of 10 believe risk is 6 in 100. Both can be justified. since focuses on upper bound – that is. one study focuses on more sensitive populations. Takes the policy objective as worthwhile. whereas the other focuses on exposure to a typical person. 95% percentile). 95% percentiles) However. o Risk-risk analysis Compare risk after regulation to risk before. Superfund regulations consider possible future populations on a site. actual percentile is above 99% (. pieces of information needed to deal with risk include: The risk probability The government often uses conservative estimates (e. simply show that the agency has adopted the cheapest way possible to achieve its goal.g.95 x . o Thus.
The present value of a future amount of money is the maximum amount you would be willing to pay today for the right to receive that money in the future. To compare them fairly.24 o General rule PV = FV/(1 + r) o For a stream of payments: 2 t PV = x + X/(1+r) + X/(1+r) + … + X/(1+r) o For payments forever: PV = X/r o “Rule of 70” . it is important to discount costs and benefits that occur in the future. you will get 5% interest Next year.05)x100 = $105 2 After two years. net gain from banning the substance is not as great as it seems.05 = $95.05) PV = FV/r = 100/1. what is the additional risk of industrial accidents from workers who manufacture scrubbers for power plants? Opportunity costs of diverted resources What do we give up in other expenditures (e.05) (100) = $110. you wouldn’t give up $100 now for $100 next year. Issues: Substitution risks If substances that replace banned substances are also risky. o Present value accounts for the opportunity cost of not investing the money elsewhere. o The idea is to compare a flow of benefits and costs into a single value. it is worth (1. o Example: You have $100 now If you put it in the bank.05) = $100(1.g. The present value of $100 next year is the most you would give up today to get $100 next year FV => PV(1. because you could invest the money and get $105 next year.05)(100) = (1. Risk of other economic behavior For example. health care) by spending more on regulation? Benefit-Cost Analysis I. Discounting The costs and benefits we've discussed often occur at different times. and could even increase risk. that money is worth (1 + 0. PV = present value. r = interest rate t FV = PV(1 + r) o As a result.05)(1.25 o General rule: FV = future value. Notes that regulation will affect behaviors.
This is the discount rate. than additional money is less valuable when we are richer Might the social discount rate deviate from the market rate? . Which should we use? o Typically. investors need to be compensated with a higher rate of return. you will be willing to loan money. Thus. money doubles every 7 years [= 70/(0. A high discount rate says that current consumption is important to you. the return on T-bills is a measure of the nominal risk-free rate. we expect future generations to be richer If the marginal utility of income falls as we get richer. you will be willing to borrow money. If your discount rate is lower than the interest rate. o Higher discount rates place less importance on future returns. Note also how the discount rate relates to economic growth theory o discount rate = pure rate of time preference + growth rate of income x elasticity of marginal utility for income The first term captures the relative weight placed on the future versus today Involves ethical judgments The second term acknowledges that. for example. economists use a risk-free rate. o Note. To get the number of years needed to double an investment. If your discount rate is greater than the interest rate.1x100)] To proceed. Why the discount rate matters o Discounting affects the value placed on future benefits and costs. Treasury bills. o Lower values show a greater preference for future consumption. The discount rate reflects the relative value a person places on future consumption compared to current consumption. A low discount rate says that future consumption is important to you. divide 70 by 100 times the growth rate. There are several market interest rates. we can use the market interest rate as a measure of the discount rate.S. how this is a particular problem for long-term problems such as climate change. This additional return is known as a risk premium. Example: Invested @10%. Investors looking for a safe return invest in U. However. o Since the market interest rate reflects an equilibrium of lenders and borrowers. due to economic growth. a higher discount rate suggests very distant benefits have little weight in decision making. To purchase assets that are riskier. A very low discount rate suggests we would give up virtually all consumption today to protect the future. we need to know what value to use for r.
a lower rate is used for benefits and costs affecting future generations. uncertainty is not an excuse to do nothing. such as positive externalities from research and development. The social discount rate represents the willingness of society to trade off present and future consumption. People may be myopic. However. o Distributional issues Note that costs will often be focused on a few individuals (e. the market rate is a reasonable guide to individual preferences. Note that this is a controversial view in economics. since the market rate may ignore future generations. this may differ from discount rates observed from market behavior. The above estimates use market data to determine the discount rate. o II. Concepts of Cost I've included my complete set of notes on estimating costs below. Even without regulation. However. not before and after regulation. Are their reasons to believe that the market rate is flawed? o Some economists argue that the opportunity cost of foregone future consumption might differ from the opportunity cost revealed in the markets. What can be done? o Compromise view: Use the market rate for the first 30 years of a project. The intuition is that. Why might market rates not be appropriate? Long term projects involve benefits or costs for future generations. it might make sense to use a social discount rate which is lower than the rates observed in the marketplace. we expect some things to change over time. Important concerns: o Establishing the baseline We want to compare costs with regulation versus without regulation. and a lower social discount rate afterwards. analysis can be done without discounting. risk aversion may justify using a lower discount rate. future generations are not represented in the market. However. Most mainstream economists would disagree with a zero discount rate. affected firms or communities). and thus not save sufficiently. There may also be other externalities that cause the market rate of return on investments to deviate from the social discount rate. o Alternatively. for the first 30 years or so. Note that we did not cover all of these issues in class today. If there are market failures. In this case.g. Uncertainty may be a concern Therefore. .
regulating one pollutant may increase the use of another pollutant. Opportunity costs – the value of the best forgone opportunity. o Certainly the workers themselves are affected. Thus. Won’t change as the level of abatement changes. we may need to aggregate the costs per facility to get industry totals. Less than 0. It is what we give up by using a resource for this use. Will vary with the level of abatement. and R&D. Important to distinguish between costs and transfers. Types of costs 1. lost product variety. but the resources are still being employed. o In other cases. etc. Environmental costs – because most regulations focus on a single pollutant. and making process changes. What about the cost of lost jobs. equity concerns will be an issue. we cannot assume that resources now unused will be used elsewhere. o Types of costs: Fixed cost of building a facility (considered capital costs by accountants) Expenditures for plant. Estimating Costs Costs of a single facility o For some projects. lost income to merchants.g. o After regulations are in place.1% are attributed to environmental regulations! Abatement cost data . Implicit costs – nonmonetary costs of inconvenience. equipment. o For larger scale regulations (e. we need only consider the cost of a single facility. o Estimation depends primarily on engineering estimates. Example: an opportunity cost of going to school is foregone salary. etc. 2. o The Department of Labor surveys firms for the reasons for mass layoffs. Example: using scrubbers to clean SO2 emissions leaves behind a sludge that must be disposed of. these are not a cost to society. survey data is available. an entire industry). construction. such as building a wastewater treatment plant. Variable costs of operation (operating and maintenance costs) Costs incurred in the operation and maintenance of abatement processes. Enforcement costs 4. Benefits are more likely to affect a wider range of people. rather than the next best alternative use. Few studies include implicit costs III. time searching for substitutes. energy. such as labor. The present value of costs over the life of a facility are needed.? o If the workers will be absorbed into the economy. 3.
number of plants. EPA and OSHA tend to overestimate reductions. Evaluation of estimates o Harrington et al. o The most obvious is incorrectly estimating the costs of control. IV. How it is spent 96. . o However. o They compare pre-regulation estimates to actual costs after the regulation is in place. study 25 estimates of the cost of regulation. How Accurate are Cost Estimates? Sources of error o One difficulty is that errors can come in many ways. etc.8% on monitoring 1.6% on abatement 8.8 billion on PACE capital expenditures $11. even if the cost of control is estimated correctly. but not per unit costs. As a result. o Results: Unable to Determine 2 Accurate Overestimate Underestimate Quantity Reduction Unit Pollution Reduction Cost Total Cost 10 7 5 9 12 12 4 6 2 6 o Costs more likely to be overestimated Discussion of results: The two underestimates were for rather “minor” regulations: EPA aldicarb ban and OSHA’s powdered platform regulation. total costs are overestimated. predictions about emissions levels. can also be wrong. State and foreign agencies were more likely to overestimate per unit costs.8 billion on Pollution Abatement and Control Expenditures (PACE) in 1994 About 1.6% government 1. See examples on pages 11-12 of Harrington et al.9% business 25.9 billion on PACE operating and maintenance expenditures.o o o The US spent 121. o Label an estimate as “accurate” if it within 25% higher or lower than the actual costs.6% on R&D A 1999 pilot survey focused on PACE in manufacturing industries: $5.0% personal spending 62.7% of GDP.
rather than means. Growth and the Environment I. o Is economic growth good or bad for the environment? To begin. which usually means considering current technologies. The Macroeconomy Up to now. we need to know how economic growth affects the environment. o GDP is the sum of the money values of all final goods and services produced in the domestic economy during a year. population is important. Regulators have an obligation to identify a means of complying with the regulation. Estimates may focus on maximum values. Quantity errors: misestimating baseline emissions However. There is no similar group with strong incentives to bring overestimates to the attention of regulators. Also. we must distinguish between economic growth and economic development. However.o For market-based polices. o Growth refers to increases in aggregate level of output. Why do errors occur? Many estimates ignore the possibility of technological innovation. overestimating emissions reductions overestimates costs. the effect of higher energy prices on the economy during the 1970’s. Thus. Future technologies are much harder to predict. We begin with some macroeconomic basics. cost estimates aren’t for the final regulation. o Development refers to increases in per-capita output. Thus. Regulations may change during the public comment period. how do individual actors behave. all of these activities affect the economy as a whole. Especially if rely on industry for data. o Consider. Firms are likely to bring underestimates to the attention of regulators. for example. o The traditional measure of macroeconomic performance is Gross Domestic Product (GDP). but also overstates the benefits. keep in mind that this also means that benefits are wrong. the analysis in class has focuses on microeconomic issues. o That is. For example. and what incentives affect this behavior? o This analysis allows us to find the optimal level of various activities. Asymmetric correction of errors. seven of the eight estimates overestimated costs! Note that this is where we would expect technological innovation to be most important. .
including natural capital. or avoid damages caused by other economic activity. mitigate. Defensive expenditures are expenditures made to eliminate. defensive expenditures (e. Economists usually model output by using a production function. Only includes work done in the United States. Does not include sales of intermediate goods and services. But. minerals. has the car accident really increased welfare? A study of Germany found that 10% of the countries GDP consisted of defensive expenditures. as we discussed in class. For example. pay for lawyers. etc. repairs after an auto accident) are included. depleting the capital stock hurts. Only market activity is included. Defensive expenditures are included. since it results in new sales. Since there isn’t a market for most environmental goods. The growth rate is 7%. A represents changes in technology. the costs to repair the car.g. we proceed with a more detailed model of the economy.g. Growth that comes from the consumption of capital. we can derive a growth equation. we can address two questions: 1. they are not included!!! In contrast. II. The basic form of the equation is: o Rate of growth of output = A + a*rate of growth of capital + b*rate of growth of labor + c*rate of growth of energy + d*rate of growth of materials. With this model. or NDP). How does environmental policy affect economic growth? . Recalculating to include the degradation of resources such as timber lowers the growth rate to 4%. How Does the Environment Affect the Economy To see how the environment can affect the economy. as capital won’t be there for future generations (measured in net domestic product. For comparison. is not sustainable. Similar reasoning should follow for natural resources. provide medical treatment to the victims. all add to GDP. Example: Repetto recalculated Indonesia’s growth rate including natural capital. Problems that result: The value of environmental amenities is not included in GDP. oil. Depleting a stock of natural resources (e. From this. forests) increases GDP. In this model. after a car accident.
PACE were $121. so economic growth. . reducing the number of sick people reduces the costs of treating them. o History of environmental policy in Japan Early concerns arose in 1868. For example. National economic development was the central government’s top priority. as traditionally measured. and China. Even though most environmental benefits are not included in GDP.7% of GDP Environmental regulations may also prohibit certain resources. Not only are healthy workers more productive. If clean water is not available. such as reducing emissions. For example: Environmental resources are an input to production. Pollution was originally thought of as a local government problem.Environmental regulations divert inputs from the production of output to other goals. slows. in response to damage from copper mining. some benefits to have tangible dollar values. which affects A. which we discussed with the Porter hypothesis. South Korea. reduced air pollution makes agriculture more productive and provides healthier workers. 2. We’ll discuss that during the lecture on sustainable development. Environmental regulations that protect water thus benefit GDP. Whether this is good or bad for growth is a debated topic. it cannot be used. Note that this raises the question of how to incorporate the environment into GDP. How does the environment benefit economic growth? There are positive effects of the environment on the economy. Rapid growth in the 1950s led to increases in pollution. Since environmental benefits are not measured in GDP. Environmental policy can affect technological change. from being used at all. Income and the Environment Case study: the environment in East Asia o The article from Environment magazine focuses on the evolution of environmental policy in three East Asian countries: Japan. If average costs are rising. resources diverted to environmental protection cannot be considered in the equation. which was 1. In 1994 (the last year with available data). Environmental quality affects the quality of other inputs. GDP falls. This lowers M. Government did not pay serious attention to the environment until after WWII. such as timber. they are not part of measured output. III.8 billion. but health care is a large portion of GDP spending. Thus.
water pollution began to attract the government’s attention. Included the responsible that polluters should be held responsible for pollution treatment. Set water quality standards in 1978. Environmental protection was introduced into the Chinese Constitution in 1978. followed by a reaction to resulting environmental problems. Focus was on Five-Year Economic Development Plan of 1962 In 1963. and a national conference was held in 1973. so the government sent a representative to the 1972 Stockholm Conference on the Human Environment. Convergence of policy In each country. International pressure played a role. There is now more of a focus on “quality of life” issues. Before hosting the Tokyo Olympics in 1964. Environmental Protection Law passed in 1979. but it was ineffectual due to lack of resources. Made clean fuels such as liquefied natural gas mandatory for large cities in 1988. the government insisted pollution was a capitalist problem that did not exist in socialist countries. In 1972. International pressure played a role in each case. Environmental Preservation Act passed in 1977. These are the first laws at the national level. History of environmental policy in China Under Mao Zedong (beginning in 1949). Led to the creation of the Pollution Control Division of the Ministry of Health and Welfare (1964) & the Basic Law for Environmental Pollution Control (1967). policy focus shifted to global issues. Reducing air pollution became a priority before the Seoul Olympic games in 1988. and SO2 standards in 1979. the National Diet passed two water quality laws in 1958. there was international pressure to improve water quality in the Sumida River in Tokyo. including a polluter pays fee system. Government supplied lower sulfur oil beginning in 1981. Global warming became part of agenda in mid-80s. Rapid growth lead to greater water and air pollution in 1970s. positive results for the environment are limited by a lack of resources. Despite increased institutional attention. . History of environmental policy in South Korea Not an issue until after Korean War During 1960s. More recently. Strengthened vehicle emission standards in 1987.o o o In response to disease outbreaks from water pollution. economic growth came first. The Constitution stated that protecting the environment was the responsibility of the state. Pollution Prevention Act passed. Korea was under an authoritarian regime (President Park).
As income grows more. Germany. The Environmental Kuznets Curve Empirical studies of the relationship between per capita income and pollution typically find one of three patterns: 1. More time series studies needed.g. Current research focuses on criteria pollutants. SO2). attention first focused on water and air pollution on a sector by sector basis. Market forces played a bigger role in Japan Levels of democracy differ in each country. How is the Environmental Kuznets Curve (EKC) tested? o Typically. (See Figure 19-2 in Field for graphs) Initially. What about toxins? As noted in class. and SO2 (meaning emissions increase). the UK and the US find that economic growth has a positive effect on emissions of CO2. growth leads to industrialization that causes pollution. 2. CO2 emissions). Broader environmental regulation came later. and are now important for China Note that for all three countries. income growth always leads to less of a problem. local governments played a bigger role in policy. For some problems (e. because that is where the best data is available.g. 3. Time series studies of Netherlands. the level increases as per capita income begins to grow.o The Olympics were important for Japan and South Korea. access to drinking water). Results are sensitive to the specification. seems to only fit for a subset of pollutants. o Issues: Data availability is a problem. Differences Latecomers had the advantage of learning from other nations' environmental policies. IV. This makes it easier for citizens to influence the decision making process. For many pollutants (e. but then falls as income continues to grow. In Japan. although technological change may offset this. As noted by the earlier graphs. For still other problems (e. the problem gets worse as income grows. . Cross-section studies do not capture dynamics. results are sensitive to the inclusion of higher-order polynomial terms.g. the country becomes more willing to devote resources to pollution control. NOX. studies look at cross-country data using Global Environmental Monitoring Systems data (GEMS).
what factors lead to better environmental quality. Marginal utility of consumption falling or constant So that cost of giving up consumption falls as incomes are higher 1. critics raise concerns that suggest other possibilities: Revised EKC: proposes that the curve could shift downward over time Might the peak be lower for newly developing countries. Implications of the EKC: o While EKC relationships have been observed using the data above. o It is less important when the impacts are long term. Industrialization . and have tried to remember as many of the points raised in class as possible. Marginal disutility of pollution rises As problems get worse. We continued our discussion by noting the causes of environmental problems in developing countries. Our list included: 1. this article attempts to address causation -. Marginal abatement costs rising It is expensive to do a lot. I have highlighted some of the major points of the discussion below. o Unlike the environmental Kuznets curve literature we discussed last week. The Environment in Developing Countries Today's class was a discussion of the environment in developing countries. o Note: there is little empirical evidence for the last two theories. Population growth 2. o Good governance is important. since they can use technologies first developed elsewhere? Race to the Bottom: promoted by globalization. We began with a discussion of the Economist article on the Environmental Sustainability Index (ESI). One of the main points was to discuss what was different about environmental problems in developing countries. I apologize for any comments that have been left out. where does the pollution go? New Toxics Over time. countries shift away from traditional pollutants. it is more valuable to do something about them 2. Discussion: The Environment in Developing Countries I. but use more of pollutants that are more dangerous. Intuition: once everyone’s income rises. as compared to developed countries. or when they do not directly impact human health. o Income is particularly important when there are immediate health effects.Theoretical requirements for EKC: 0. Marginal damages rising 3.
current needs take precedence. As a result. people move to the cites. leading to more energy and resource use. o Causes of the problem The costs of the necessary infrastructure are high. 90% of sewage in developing countries is discharged without treatment. 5. Corruption and lack of democracy are also problems. but to price additional access at a higher rate. 3. Another alternative may be to price water correctly. Also.Developing countries are moving from agrarian societies to industrialized societies. Different priorities The environmental problems of concern to developing countries may differ from those promoted by NGOs and developed countries providing aid. Weak governance Not only are regulations often weaker. infrastructure is allowed to decay and utilities are reluctant to connect new customers. 4. but also provide subsidies to low-income people. 10. Question: Although pricing water at its true cost is efficient. which results in more pollution. developing countries place less weight on future considerations With lower incomes. Water o Access to clean water is a major concern in developing countries. Increasing urbanization As industrialization occurs. Technological constraints Technologies used may be less efficient than those used in developed countries. Poverty/pressures for economic growth As a result of lower incomes. as that is where jobs are. so that their actions affect others nearby. Poorly defined property rights 9. The price of water is subsidized. Lack of awareness/education Demand for environmental regulations depends on awareness of the problems 6. infrastructure to support increased populations is lacking in many cities. is it fair? One suggestion is to have a low base price for a basic unit of water. . Environmental problems become problems when people are close together. This may lead to weaker regulation as an attempt to promote industrial development 7. but when they do exist enforcement limits compliance. Infrastructure Lower incomes often mean that infrastructure is inadequate 8.
as the benefits are long-term. but less so to developing countries. Charging a lower rate for the first units of water used. 2. since the companies have monopoly power. and animal wastes in stoves. such as reducing soil erosion. crop residues. If few people have access to electricity. Lack of property rights People who do not own the land have little incentive to preserve it. o A possible solution to the subsidy problem is block pricing. and corrupt. inefficient. transportation policy is also important. Because electricity is subsidized. o Reasons why deforestation is a problem: Pressures from population growth and migration Lack of income Exporting timber products provide income. Timber and deforestation o Problems caused by deforestation: Soil erosion Water quality and supply both decrease Loss of biodiversity Loss of animal habitat Carbon emissions increase Because forests serve as carbon sinks o Note that the last three are likely to be important to people in developed countries. Lead emissions 3. Sustainable policies are not desirable if they don't provide enough income in the present.Water utilities may be bureaucratic. Air pollution o The most important air pollution problems in developing countries are: 1. they need to make it desirable for developed countries to do so. is important. but high rates to those that use more. they turn to burning fuel in stoves for energy. Developing countries are reluctant to devote resources to problems such as biodiversity or global warming. Developing countries are more concerned with current consumption than future consumption. Note that this requires infrastructure to monitor usage. o In addition. Small particles o Note that subsidies are a major problem. However. Indoor air pollution One-third of energy in developing countries comes from burning wood. Demonstrating local benefits. Lack of other energy supplies leads to using timber as a fuel. utilities are reluctant to hook up new customers. . these problems may continue with privatization. If people in developed countries want to protect these resources.
oil) leads to appreciation in domestic currency. logging firms can prove that timber has been harvested sustainably.g. This allows firms to differentiate themselves in market. legal logs are more expensive. Brazil offered tax breaks for development of forested land (such as for cattle ranching). Illegal logging cost governments $15 billion in 2002. Land reform in Brazil is another potential solution Property rights for small plots would be given to apparent owners. Certification can be time consuming in developing countries. limiting harvest to 20% of trees on the land). For example. enforcement is difficult due to poorly defined property rights. even after controlling for other variables. This makes non-oil sectors less competitive on world market. despite laws in Brazil to discourage deforestation (e. Resource-rich countries grow more slowly than other poor countries. Currently. Cannot ban all imports of uncertified timber due to WTO rules. the price premium is low: about 2-3% Also makes it possible for developed country consumers to differentiate. Countries do not have the resources necessary to enforce existing environmental regulations.g. developed countries can ban illegal timber for construction projects financed by government.” Increase in natural resources (e. yet their populations are poor. . The state would reclaim property rights for large plots Resource management (yet to be discussed) o Many developing countries have abundant natural resources. However. because royalties must be paid to governments. This paradox is known as “Dutch Disease. One estimate: 73% of forest products imported by the EU from Indonesia in 2008 were from illegally harvested timber Indonesia claims this is only 10% Decentralization makes enforcement difficult Local governments often resent the enforcement efforts of the national government Demand from developed countries o One solution that might help enforcement is labeling Using barcodes. Just 14% of privately owned land in the Amazon is backed by a secure title deed Most land is "acquired" by right of settlement Subsidies For example.Note that. Enforcement is also a problem because it is costly.
Has succeeded in producing more abundant. o Costs of increased productivity Soil degradation Soil is compacted from machines being used on it. but I thought I'd include my notes on it) o Since WWII. Thus. However. Pollution .As a result. Ten percent are to be held in a trust fund for future generations. Water and wind erosion Depletion of minerals from overplanting and overgrazing. Eighty percent will be devoted to education. o This system has spread to developing countries. ExxonMobil has invested in an oil project in Chad and Cameroon in which funds are deposited in an offshore escrow account. o Possible solutions Set aside revenues when prices are high Alaska’s fund that is redistributed to households is an example. less expensive food. health and social services.org/): “The EITI aims to ensure that the revenues from extractive industries contribute to sustainable development and poverty reduction. and environmental and water resource management. Ownership of resource concentrated. Oil revenues allow governments to keep taxes low. Agriculture (we skipped this in class today. making it easy to redirect funds. o Moreover. easy to dip into fund for other purposes. From their website (http://www. rural development.eitransparency. the oil sector dominates the economy. Tony Blair proposes the Extractive Industries Transparency Initiative (EITI) Voluntary effort between governments and oil companies to promote transparency. as they are unable to hedge risks. such as Zambia & Venezuela in 1970s. revenues pass through few people. and education. Thus. using more capital and fertilizer. An oversight committee evaluates proposed spending from the account. nutrition. Particularly a problem in developing countries. oil-rich countries do worse on issues such as child mortality. infrastructure. Oil employs few unskilled workers. population has less incentive to demand change.” Over 20 countries have joined. However. agriculture in developed nations has become increasingly intensive. there have been reports of Chad diverting funds from the account. Volatility of oil prices hurts poor the most.
Concerns: Access to seeds GM seeds can be designed so that they cannot be reused. Water scarcity 40% of the world’s food comes from 5% of the agricultural land that is irrigated. herbicide applications per acre have fallen by 9% to 14%. cause pollution problems. Farmers would thus need to purchase new seeds each year. Most of the use is in the U. Pesticide use has doubled over the past 30 years. Reductions in biodiversity Genetic resistance – will the surviving weeds be resistant to herbicides? Can the gene be transferred to other crops? Lack of consumer demand Some countries are reluctant to use GM seeds because they are afraid that consumers will not buy crops from their country. Part of the problem is that water is usually provided below cost. Biodiversity loss Intensive agriculture leads to species loss. Yields have not increased. . Focus is on high-yielding. 7. However. Pesticides such as DDT are still used in developing countries. Note that. 90% of the world’s food comes from 30 of them. Water is being pumped from the ground faster than it can be replenished. 13 million hectares of forest are lost to agriculture each year. we observed a couple of common problems Lack of property rights leads to overexploitation of resources.Runoff from fertilizers and pesticides is a major non-point source pollution. Crops are bred to resist herbicides or to be pest resistant. pest-resistant crops. such as manure.000 crop species are available for cultivation. where used. Inefficient use leads to waste of water. total applications up because acreages have also expanded. For example. General lessons o Throughout these examples. o Can biotechnology be a solution? Growth of biotech crops has been rapid (44% increase in 1999).S. Even organic materials.
Assumes natural capital and man-made capital are substitutes. may be difficult to remove. but.” These definitions imply no use of natural resources. What is Sustainable Development? The Brundtland Report (1987). ecological economics o Neoclassical economists view man-made capital and natural capital as substitutes. . Critical natural capital should be preserved under all circumstances. Assumes natural capital and man-made capital are compliments. The pressures of population growth often contribute.” o Solow's definition is an example of weak sustainability. Weak sustainability – any loss of natural capital should be balanced out by creation of new capital of at least equal value.” (Goodstein 1999) o These guidelines are examples of strong sustainability – natural systems should be maintained whenever possible.” o These can be summarized as: “Never reduce the stock of natural capital below a level that generates a sustained yield unless good substitutes are currently available for the services generated. because of equity concerns. Herman Daly (Beyond Growth 1996): o For renewable resources: “Keeping the annual offtake equal to the annual growth increment (sustainable yield) is equivalent to maintenance investment. How do we know what future generations will need? What are the needs of the current generation? Quotes from UNESCO report: o “…every generation should leave water. Poverty is part of the problem. can you have a moral obligation to do something impossible? Solow's definition: “an obligation to conduct ourselves so that we leave the future the option or the capacity to be as well off as we are.” o Note that this definition is quite vague. Many of these problems require large capital expenditures. proposed the following definition of sustainable development: o “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs. part of a World Commission on Environment and Development. Neoclassical vs. air.” o “each generation should leave undiminished all the species of animals it found existing on earth. Sustainable Development I. and soil resources as pure and unpolluted as when it came on earth. This is the approach taken by most neoclassical economists. This approach is taken by most ecological economists. Subsidies encourage inefficient use of resources. Is this possible? If not.” o For nonrenewables: “The general rule would be to deplete non-renewables at a rate equal to the development of renewable substitutes.
a measure of welfare needs to be maximized. Rather. Thus. where it accumulates from rainfall 52 million gallons of water is released into the ocean each time a ship uses the canal. according to Daly. causing it to overflow and run into the sea. o Water supply has been drying up Most freshwater stored upstream in Gatún Lake. rain runs into the lake too quickly. a key concern for ecological economists is the carrying capacity of the environment. Daly claims we are moving to a world in which natural capital is the limiting factor. he argues that it makes the uses more efficient. but helping poor people today requires more consumption. Will Sustainable Development Occur in Market Economies? Valuing environmental benefits o In some cases. which hurts sustainability. The magnitude of the ultimate sustainable level of welfare vis à vis current welfare levels. o Three dimensions of sustainability are important: The existence of a positive sustainable level of welfare. but says that knowledge does not simply substitute capital for nature. o II. The key question. an artificial lake created during the canal’s construction. o Both intergenerational and within-generation equity are also issues Solow notes a paradox: Sustainability says that you should be thinking about poor people today. markets are beginning to appreciate the values provided by ecosystems o Good values depend both on good science and good economics Early studies often gave implausibly high values. Note that Daly does acknowledge technological progress. because while the area gets 10 feet of rain per year (3x more than Seattle). most rain comes in the rainy season from May to December. and The sensitivity of the future welfare to actions by previous generations. Example: Panama Canal o The issue is that deforestation is harming the canal. . Deforested slopes around the lake do not absorb rainwater. clearly defining a sustainable path is difficult. Thus. Economics is driven by scarcity. is how big is the economic subsystem relative to the natural subsystem. As we noted in our discussion. o Ecological economists view man-made capital and natural capital as compliments. leading to the work being discredited. Neoclassical economists view sustainability as a need for dynamic efficiency. Thus. This is important.
Columbia Large agriculture producers pay fees for watershed management projects Note how the fees address the public goods problem o Costa Rica Hydro-electric producers. Other examples o Catskill Mountains. These companies would get discounts on insurance premiums they currently pay to insure against closure of the canal. If the land were forested. NY New York City gets its water from the Catskill Mountains watershed. o Much of the deforestation has occurred since the 1950s. o Cauca Valley. Instead. Leading Panamanian bankers stopped financing cattle ranchers who cut down forests for pasture. such as WalMart and the Asian auto companies. These companies would ask their big clients. government agencies had incentive to protect the watershed. private customers. to buy the bonds. the city made payments to preserve the Catskill watershed Spent $250 million to buy land to prevent development Spends $100 million/year to farmers to minimize pollution. Sediment and nutrients get into the canal Nutrients lead to growth of weeds Leads to expensive dredging o There have been some reductions in deforestation since the 1990s. o Cape Town. a private insurance firm. South Africa Found that it was cheaper to restore the local watershed than to divert water supplies from elsewhere or build reservoirs. the agencies do not have enough money for thorough monitoring and enforcement. When the canal was turned over to the Panamanian government in 1999. and the government contribute $57 million/year to protect a local watershed Services provided For hydro-electric producers: Stream-flow regulation Sediment retention Erosion control For private consumers . ForestRe has stepped in with a proposal The plan would have shipping companies that use the canal underwrite a 25 year bond to pay for reforestation. This had an up-front cost of $4-6 billion. plus $250 million/year operating costs. and reforestation needs to be done. the city faced building a water filtration plant to clean water from the watershed. o Still. In 1997. o As a result. the water would be absorbed and would flow into the lake more slowly. when a highway made the land accessible to loggers.
o Muthurajewela wetland sanctuary. that unlike the above examples. o In these cases. must buy credits from a mitigation bank. small number of beneficiaries (e.g. the beneficiaries are more widespread (e. the effectiveness of the audits depends on the reactions of the developed world o The proposal would subject resource-rich countries to financial audits of the revenues and resulting spending from sales of natural resources . These services include: Cleaning sewage and waste Flood attenuation Support of downstream fisheries But. NYC). o France Perrier-Vittel restored parts of a heavily farmed watershed and paid farmers to switch to organic farming to preserve the quality of some of its products. the article does not discuss how these benefits are supported financially. insect pollination) What can be done then? The article discusses cap and trade as a solution The Clean Development Mechanism for climate change fits here Provides a market for undertaking activities to reduce carbon emissions in developing countries Note that the principle of additionality is important: would the emissions reduction occur without the credit? Wetland mitigation trading is an example Developers who use wetlands in the U. Irrigation Government Water supply for towns Maintain scenic beauty for recreation and ecotourism o A study found that natural pollination of insects raised productivity of one coffee farm by $60.g.000 per square km.S. Note. Panama) o In other cases. well-defined. What to do with this information? o In some cases. note that in this case.g. Sri Lanka The World Conservation Union calculated the value of ecological services provided by the sanctuary at $8 million/year This amounts to $260. there is a clear. this does not protect a specific wetland. collective action and compensation is possible (e. Audits for resource-rich countries o These focus on providing information to allow market forces to work Like many other policies we've discussed. however. That is.000. who pays to preserve the wetland sanctuary.
Records of revenues raised would make it easier to save gains from boom years for later use. Subtract non-beneficial spending. since it ignores the value of natural resources. GDP growth is a “veto” target: failure to meet the target ensures that the cadre is considered underperforming. o Instead. Desired solution: adjust GDP to account for natural resources – “Green GDP. leading local officials to ignore environmental concerns Local leaders are evaluated based on an elaborate point system. China will use what is known as a “satellite system. The challenge is coming up with green GDP numbers One study said growth from 1980-2000 falls from 9. such as commuting to work.g. GDP does not give a complete picture of the effect of the environment on the economy. How to Incorporate the Environment in Economic Analysis As mentioned earlier. a certain level of GDP growth). Measured as a portion of the difference in wages between wages in urban and rural areas. Has led to abuse of environment and human rights to meet GDP growth goals. add capital services used.6%/yr to 6. China has begun to incorporate green GDP into its decision making o The motivation is that previous targets focused on economic growth. o Because of difficulties.” . the National Bureau of Statistics is skeptical about whether appropriate numbers can be devised.” o First attempt: Nordhaus/Tobin (1972) o Adjusted GDP to account for amount of welfare-reducing environmental damage done by pollution. o A pilot program in 10 regions began in February 2004 The hope is that a green GDP target will help local leaders focus on environmental concerns. o They also make other adjustments to GDP: Add value of leisure Subtract capital purchases.o o While corrupt countries may not wish to be audited. o End result: measure of economic welfare (MEW) MEW grew at 1/2 the rate of NNP from 1929-1965. the hope is that pressure from consumers would encourage multinational companies to insist on audits. Harder to steal funds if there is a public record. Points are rewarded for meeting specified targets (e.8%/yr if green GDP used. However. abandoned the effort in 2006. Sustainable Development/Trade and the Environment I.
Separate accounts that try to integrate environmental and economic measures. Green accounting data will be provided alongside GDP data. Guidelines for satellite systems published by UN in 1993. o Satellite systems relate economic activity, measured in cash terms, to environmental magnitudes measured in physical units. E.g.: tons of CO2 emitted by each sector of the economy. Measures the effect of economy on environment, but doesn’t adjust values. French President Nicholas Sarkozy recently appointed a commission to modify national accounts. The report noted three issues: 1. Problems with what GDP leaves out Depreciation of capital This could include both natural and physical capital Environmental benefits Government provided services are either imputed or left out, since there are no market values available. For example, private education has a market value, but the value of public education must be imputed The value of leisure time The report suggests that statistics should focus on household income, consumption, and wealth, rather than total production. It compared US and French GDP per capita using traditional measures and the suggested alternative. With traditional measures, French per capita GDP is 73% of US per capita GDP With alternative measures, French per capita GDP is 87% of US per capita GDP 2. Quality of life People in richer countries do not report being more "happy" The country of Bhutan includes happiness in its official statistics However, happiness is hard to quantify 3. Well-being of future generations In addition to natural and physical capital, human capital is also important. Finding a single measure to capture all of this will be difficult. How should Green GDP be measured? o The goal is to measure what is enjoyed or consumed. Traditional GDP uses quantities of goods and services, and prices of these. o Some resources, such as timber or minerals, have market values. However, most environmental benefits do not have market values. o The analog for the environment is ecosystem services. “Ecosystem services arise from – and depend on – the broader sets of ecological components, processes, and functions but are different: they are the aspects of the ecosystem that society uses, consumes, or enjoys to experience those benefits.” (p. 7 of Boyd’s article) o 5 principles to measuring:
1. Services are nature’s end products, not everything in nature. For example, we measure a car in GDP, not the steel, tires, leather, and workers used to produce the car. The value of the car embodies all of these other values. Thus, what we want for the ecosystem is what matters directly to people. It’s not that other things aren’t relevant, but that they should be embodied in this value. 2. Ecosystem-services are benefit-specific. Flood protection from wetlands should be counted. They substitute for flood control. Wetlands are not services for the water quality they provide. Instead, this quality should be valued directly. Including it again as a wetland service would be double counting. 3. Counts what we can count, not what should be counted. Boyd argues this is what we do for other goods. We consider the price of the car, not the satisfaction from owning it. That is, we use price, rather than consumer surplus, as the value. 4. Ecosystem services should be ecological. Recreation itself is not a service. Things in nature that make recreation possible are. 5. Ecosystem services should be counted with greatest possible spatial and temporal resolution. People benefit in specific places and times. For example, when and where clean water are available matters. The amount of pollution will have different effects depending on location. May make placing dollar values on these difficult. Note that key to these principles is marginal analysis. The question isn’t the cost of destroying all trees, but the cost of destroying one additional tree
II. The Benefits of Free Trade
Before discussing the links between trade and the environment, we first consider what benefits economists perceive from free trade. Goals of free trade: o To expand markets for goods for which a country has a comparative advantage in production, and to provide greater opportunities to procure goods for which the country has a comparative disadvantage. Free trade and comparative advantage o Comparative advantage – a person has a comparative advantage over another if that person can produce that good at a lower opportunity cost than someone else.
Comparative advantage makes international trade beneficial, even between seemingly different countries. Ex: 2 goods: computers and TVs 2 countries: Japan and US Output per year of labor:
U.S. Japan 50 10 50 40
In this example, the US has an absolute advantage in both goods. Its workers can make both more computers and more TVs than Japanese workers. Nonetheless, trade is beneficial: The U.S. has a comparative advantage in computers. To make 1 computer, the US makes 1 less TV In Japan, to make 1 computer, 4 less TVs are made. The opportunity cost is higher. Conversely, Japan has a comparative advantage in TVs. For each TV made in Japan, only ¼ of a computer is lost. Thus, the US can trade computers to Japan and both countries will be better off. Suppose there are 1 million workers in each country. If both countries specialize in what they have a comparative advantage in, Japan makes 40 million TVs, the US makes 50 million computers. This is more than can be produced if they each do some of each. Suppose workers assignments are split in half: US makes 25 million TVs, 25 million computers. Japan makes 5 million computers, 20 million TVs. Total is 45 million TVs, 30 million computers Example of trade. If US makes 1,000 more computers, 1,000 less TVs are made. However, Japan only needs to stop making 250 computers to make 1,000 more TVs. Thus, we have the same number of TVs and 750 more computers! Critique of comparative advantage:
III. autos) Thus. Factor mobility increases the opportunity set. Esty notes that. As well as the physical ability to assimilate pollution. so should make the country better off. o Example of a test of pollution haven hypothesis: The Heckscher-Ohlin model of international trade states that countries will have a comparative advantage in goods produced with endowed factors that are in relative abundance. Composition effects Higher incomes => preferences for cleaner goods. However. aluminum) Countries with cheap labor produce labor-intensive goods (e. o Developing countries may even be able to attract industry with low standards.g. clothing) Countries with large capital stock produce capital-intensive goods (e. Countries with hydroelectric resources trade goods that require a lot of electricity to produce (e. a country with monopoly power in world factor markets can make itself better off at the expense of the rest of the world by limiting factor mobility.g. o Three effects of economic growth on trade: 1.g. E. a country that becomes specialized has no choice to continue. Thus. absolute advantage matters. 3.g. Daly notes that the basic principle of comparative advantage depends on immobile factors. skilled vs. Scale effects Higher incomes => increased pollution due to greater consumption. while expanded trade and economic growth need not hurt the environment. income matters. . o If scale effects dominate. Response: The quality of a factor (e.g. unskilled labor) also matters. 2. critics of globalization ask if diversification has value. Pollution Haven Hypothesis Question: Does free trade make protecting the environment more difficult? Pollution haven hypothesis – the idea that firms will move from countries with strong environmental standards to those with weaker standards. Empirical evidence of the pollution haven hypothesis is weak. the theory predicts that countries with a large capacity to assimilate pollution will produce pollution-intensive goods. there is no guarantee that it won’t.o o o o Once trade begins. the environment will be worse off. Technique Higher incomes => cleaner production processes. If factors are mobile. all capital can go to the country with lowest costs.
Citizens of wealthier countries are more likely to demand cleaner environments. To determine if lax environmental regulations attract dirty industries, economists use the Heckscher-Ohlin model to explain trade in goods associated with pollution. Controlling for other resource endowments, one can test to see if environment variables are significant. Net Exportsij = ai + b1Ej1 + b2Ej2 + …+bKEjK + dRj + eij Ejk = endowment in country j of factor k (e.g. capital, labor, land, natural resources) Rj = strictness of environmental regulations in country j (e.g. pollution control expenditures) In general, economists fail to find a significant relationship between environmental regulation and trade. One criticism of such models is that stocks of capital change slowly, as they represent years of accumulation. Thus, measuring flows of capital may be a better alternative. This is done by using foreign direct investment (FDI) as the dependent variable. FDIij = ai + b1Fj1 + b2Fj2 + …+bKFjK + dRj + eij Fjk = level of variables affecting FDI in country j, such as tax policy Rj = strictness of environmental regulations in country j Using such a model, Xing and Kolstad (1997) find that foreign direct investment (FDI) for dirty industries, such as chemicals, does flow to countries with lax environmental regulations, but find no effect for low polluting industries, such as electronics. There has been more growth of toxic-intensive industries in developing countries. A recent paper by Ederington, Levinson and Minier offers explanations for small effects They argue that aggregate data misses effects in specific industries. Their work proposes three reasons why others find little effect Most trade is between similar countries (North/North) If look specifically at North/South trade, find an effect. They divide countries into low and high environmental costs When US environmental costs rise, net imports to low cost countries increase. Elasticity is 0.2 (10% increase in US costs => 2% increase in imports) Not all industries are mobile Industries are mobile if: Low benefits to agglomoration
Low transport costs Indstries that are mobile are more sensitive to environmental costs Not all industries are pollution intensive Surprisingly, they do not find a bigger effect of environmental costs on pollution intensive industries, unless they control for mobility. It appears that pollution intensive industries are also less mobile! However, this also means that the argument that there is no pollution haven effect because most PACE costs are insignificant is not sufficient. Other explanations for the weak evidence of pollution haven hypothesis In general, other factors are more important in choosing location: Skills of workers Proximity to markets Political stability Availability of materials As a result, even when evidence of the pollution haven hypothesis is found, the magnitudes are often weak. The Bureau of Labor Statistics collects data on total layoffs and the reasons. Few mass layoffs are due to environmental regulations.
2000 2001 2002 2003
Total Total people layoff affected events 5,620 1,170,427 8,350 1,751,464 7,295 1,546,976 7,346 1,502,825
Layoffs for Total people affected by environmental environmental reasons reasons 7 1,142 3 445 3 718 5 1,044
The most frequent reason for mass layoffs is completion of seasonal work (2,370 layoffs in 2003) and internal restructuring (1,437 layoffs in 2003). Other major reasons are contract completion and slack work. In 2003, 111 were due to import competition.
IV. International Agreements
The World Trade Organization (WTO), and its predecessor, the General Agreement on Tariffs and Trade (GATT), provides a framework of rules and procedures to be followed in international trade relationships. o GATT began in late 1940’s. The WTO was established in 1995 after the Uruguay round of GATT (1986-1994) GATT covers trade in goods, and still exists as a subset of WTO.
o o o
Aims to reduce barriers of trade. Does allow exceptions to protect “human, animal or plant life” and to conserve natural resources. Such import restrictions must be done in a non-discriminatory way. Examples: GATT upheld the US tax on luxury cars and gas guzzlers because they applied equally to all autos (Europe protested the taxes). Denmark placed a ban on nonrefillable drink containers. Imports of such containers were prohibited. Other European countries felt that this was done to give Danish beverage producers an advantage, rather than protect the environment. The European court ruled in favor of Denmark, since it was non-discriminatory. In the 1990’s, the U.S. banned imports of tuna caught in nets that kill dolphins. Mexico complained to GATT & won. GATT accepted America’s aim of protecting dolphins, but objected to the use of discriminatory trade sanctions. Suggested labeling of dolphin-friendly tuna instead. The WTO also ruled against a U.S. ban against shrimp harvested with technologies that harm sea turtle because it gave preference to Western Hemisphere countries. The ban gave Western Hemisphere countries more time to comply and provided financial aid for new technologies. India, Malaysia, Pakistan, and Thailand protested to WTO. However, the WTO noted it was the preferential treatment that violated GATT article 20. The ruling made clear, however, that countries did have the right to take trade action to protect the environment, as long as it is nondiscriminatory. The issue becomes cloudier when we consider pollution from production. Consider a firm in a country such as the U.S. that has strong environmental standards, but has a competitor in a nation with weak standards. The competitor has lower costs, so it has an advantage. However, it isn’t clear that the U.S. can do anything legally under GATT. GATT gives the U.S. the authority to protect the health of its citizens. However, imposing stronger environmental restrictions on the second country affects the health of those citizens, not Americans. As we discussed in class, an important question is whether we should do something. Whose standards should matter? A World Trade Organization (WTO) report in the fall of 1999 admitted that trade can harm the environment.
known reserves that can be profitably extracted at current prices. This leads to a bigger question: is it fair for developed countries to expecdt developing countries to strengthen environmental regulations? Exhaustible Resources I.MEC)/(1+i) o The owner of the oil is better off waiting to sell the oil next year. such as oil. and invest the profits at interest rate i. Thus. Thus. Wait and sell the oil next year. The owner of a resource. exhaustible resources should be treated as an asset. Decisions to use exhaustible resources are dynamic decisions. and fossil fuels should be eliminated.MEC < (P2 . P(t) = MUC(t) + MEC(t) . today: 1. potential reserves -. 2. A. current reserves -. Case A: Expected price next year rises less than the rate of interest: o Present value of marginal profits next year is less than current value this year: P1 . The Costs of Extraction There are two costs to using a resource. 3. fishing.o Report says that environmentally damaging subsidies for farming. resource endowment -.MEC = (P2 . o Leads to higher prices now (lower supply) and lower prices next year (higher supply). or o (1 + i)(P1 . the price of the resource will be greater than the MEC. o Leads to lower prices now (greater supply) and higher prices next year (lower supply).the entire geological supply of resources (including those not yet discovered). because future availability of the resource depends on what is used today. Sell all the oil now. Case B: Expected price next year rises faster than the rate of interest: o Present value of marginal profits next year is greater than current value this year: P1 . has two options to make money for next year: 1. 2. Extraction cost How much does it cost to obtain the resource? Obviously.MEC > (P2 . 2. only sell if P >= MEC (marginal extraction cost). o P1 . Prices adjust whenever one option (case A or B) looks better. equilibrium is reached when the expected price of the oil rises at the rate of interest.MEC) Marginal user cost (MUC) -.MEC) = (P2 . Report says more product labeling should be allowed.MEC)/(1+i) o The owner of the oil is better off selling the oil now and investing it. Optimal Extraction of an Exhaustible Resource Three classifications of exhaustible resources: 1. such as oil.reserves that could be recovered at higher prices.MEC)/(1+i). User cost -.the opportunity cost of not having the resource to sell in the future As a result.the present value of the opportunity cost of the last unit of oil used not being available in the next period.
since these prices do not account for negative externalities. such as pollution.xls. the marginal user cost will fall. Rather. and continue. E. you can download a spreadsheet with a numerical example by clicking here: energy_worksheet. the opportunity cost is not as high. Changes in the marginal extraction cost o Up to now. It is determined by a backstop technology. The mathematical example shows how the marginal user cost increases as scarcity is more of a problem. o A backstop technology is a technology that is available in vast quantities at the backstop price. we will begin by using the one with the cheapest extraction cost. o If marginal extraction costs rise over time. we have assumed the MEC is constant. For those who would like more practice working with these concepts. until the backstop technology is reached. Note that. Backstop Technologies This theory describes how the price should change over time. Intuition: MUC represents the opportunity cost of using the resource now. evidence of abuse of market power.: solar energy Note that the backstop price is constant. the marginal user cost rises at the rate of interest. Thus. using up each fuel. by themselves. if several fuels are available.g. o This implies that the present value of marginal user cost remains the same! o Note that the price of a resource is greater than the MEC. all of the dirty fuel supplies are used up! . o Note that. higher prices are not. o This is the backstop price. If it will be more costly to use the resource in the future. since the backstop technology is not exhaustible. they simply represent economic rent due to scarcity.If marginal extraction costs are constant. o B. But what price should we start at? o We want to run out of the resource at the highest price that people are willing to pay.
doe.30 unleaded 1985: $1. in 2000 dollars: (http://www. markets might not support this research.80 in today's dollars) While our model predicts that energy prices will rise gradually over time.o Technological innovation on the backstop technology could lower its price and speed the transition.72 unleaded 1990: $1.51 2005: $2. if the backstop won't be usable for many years. However.10 2000: $1. For example.48 1970: $1. and have risen more dramatically in recent years. In reality.25 1998: $1.33 ($2.62 1960 $1.43 1995: $1. II.53 1980: $2.eia. What other factors have influenced energy prices? o Factors leading to higher prices Higher demand. they instead fell for much of the 20th century.23 2007: $2.20 leaded.gov/emeu/aer/txt/ptb0524.04 2006: $2. they have fallen until recent years. consider the price of a gallon of gasoline in the US. Energy Prices Over Time These theories predict that energy prices should rise over time.html) 1950: $1. $2.30 1974: $1. particularly in the United States and China Risk premium o o o o o o o o o o o o o .
The Role of OPEC What role does OPEC play? o The Organization of Petroleum Exporting Countries (OPEC) is a cartel of oil producing countries. and are in less stable regions of the world. and receive more investment. Scarcity rents have come a factor as demand increases. Lack of refining capacity Even if more oil comes into the U. political uncertainty in Latin America.S. Lower extraction costs increase economic reserves => lower MUC as well. One question is whether we have reached a peak. OPEC has kept supplies tight. there isn't additional capacity to refine it into gasoline more quickly. . Energy Prices Over Time (continued) We concluded this topic with a brief discussion of peak oil. Concerns over security in the Middle East. Alternative Energy Technologies I. the user cost is near zero. II.. so the price is set at the marginal costs of extraction. to avoid a return to cheap oil o Factors leading to lower prices Resource scarcity If a resource is not scarce. The model assumes constant marginal extraction costs Technological change has lowered extraction costs. when prices are higher. o Optimists point to the role of improved technologies and substitutes. Hamilton (2008) finds evidence that scarcity rents were 0 before 1997. These become more viable. Price volatility has reduced investment in recent years. New discoveries have limited the importance of scarcity in oil prices. New sources are harder to find. o Pessimists note that consumption has outpaced production over the past 20 years. leading to slowly rising prices. Higher prices in recent years have made it feasible to extract energy from places with higher extraction costs. and corruption in Russia all raise the risks of future shortages. Early price spikes were due to supply fluctuations.
o OPEC can be analyzed using a dominant firm model. Formed in 1960. o Most of this is combustible renewables and renewable waste. OPEC's price will fall.44 were fossil fuels.06 million barrels/day Persian Gulf region: 22. Note that if the supply of oil in the rest of the world increases.17 million barrels/day US: 9. which makes up 9. They control the price of oil by agreeing on how much oil each member nation will produce. By 1986. In 2009. Just 7% of renewables were wind. most were hydropower and wood. Where Does Our Energy Currently Come From? Most energy used in the US is consumed by industry and transportation (handout).76 million barrels/day come from Saudi Arabia alone. 83.30 quads were renewable.89 million barrels/day 9. o Of the renewables.88 million barrels/day III.30 quads consumed in 2008. OPEC supplied only 30%. renewables made up 12. and 1% of renewables were solar. Of the 99. o Power generation is dominated by coal. OPEC provided 50% of the world's oil. Just 7. nuclear and natural gas. In 1979. This has happened since the oil embargo of 1970. In 2006: 49% coal 21% natural gas 20% nuclear Worldwide.04 million barrels/day US: 18. OPEC: 33. Higher prices increase the supply of the rest of the world. OPEC supplied 40% of the world's oil. Because marginal extraction costs are higher elsewhere. non-OPEC producers will not be profitable when prices are low. . Marginal extraction cost per barrel: Middle East $2 Venezuela $7 Gulf of Mexico $11 North Sea $11 Russia $14 Global supply and demand o 2009 demand for oil Global: 84.7% of total primary energy supply in 2006 (TPES).69 million barrels/day o 2009 oil production Global: 84.9% of total primary energy supply.
Biomass is particularly important in developing countries.8oC) has already had effects o This would lead to warming of about 2 C Emissions path: Emissions begin to decline around 2012 Peak at 9 billion tons in 2020 Decline to 3.8% o Hydro is another 2. and oceans.2%. o Concerns Dependence on oil leaves countries vulnerable to price shocks. o The remainder is geothermal.4% of its oil in 2005 o Nearly all transportation powered by oil.1% Non-OECD Europe 10. Military conflicts to ensure supply Here. increased prices affect every country. Note that it isn’t just dependence on foreign oil. Thus. The oil problem o Oil is 40% of US primary energy supply.1% China 14. solar. o Potential mitigation targets frequently discussed 550 ppm atmospheric CO2 Emissions path: Emissions begin to decline around 2020 Peak at 11 billion tons in 2040 Decline to 7 billion tons by 2100 BAU is about 20 billion tons Gradual decline to 3 billion tons by 2200 o Would lead to warming of about 3 C above pre-industrial values 450 ppm atmospheric CO2 Advocated by those concerned that even moderate warming currently experienced (about 0.2% Asia (except China) 28. and 34% of global supply o US imported 65.5% of carbon emissions globally).2% Former USSR 3. 2006: Africa 49.5%). projected emissions over 21st century are around 1400 billion tons o . wind. domestic production can help The climate change problem o Electricity generation is the main source of carbon emissions (24. they have higher shares of renewable energy.2% OECD 6. In a global market.0% Latin America 30.0% Middle East 0.5 billion tons by 2100 Decline to 2. Share of renewables in TPES.5 billion tons by 2200 Without reductions. followed by deforestation (18%) and transportation (13.
Amounts of sulfates in the atmosphere would need to increase by 15-30X to offset climate change. Alternative Sources . National Academy of Science panel suggests this could be done for pennies per ton reduced. What are the risks? Ocean acidification Aerosols could destroy the ozone Spatial climate patterns would change International considerations Geoengineering could be done unilaterally Raises potential for conflict Changes in climate may benefit some countries at the expense of others. IV. Increase removal of CO2 Currently. mitigation will play a large role. we need to remove 600-900 billion tons. and have a known cooling effect Consider. for example. weather changes after large volcanic eruptions. vegetation holds 500-700 billion tons carbon Increasing by 20% (which seems unlikely) would reduce only 100-150 billion tons more. How can this be done? Geogengineering Change environment to offset emissions Seen as costly and risky Seeding clouds over oceans would increase their reflectivity One cost estimate is $4 billion Another more common proposal is projecting sunlight-deflecting sulfate particles into the atmosphere Sulfates are already in the atmosphere. Thus. These reductions would allow emissions of 500-800 billion tons Thus.
Increasing supply via nuclear raises security concerns. such as power plants. in the oil sands in Canada. 2. Large embodied capital investment and long turnover times of world’s energy supply Replacement cost of today’s global supply system is $12 trillion Typical turnover times are 30-40 years The potential and problems of energy sources o Conventional oil and gas What is available? Emissions are a concern o Coal. Because this requires more energy. o Carbon capture and storage (a/k/a carbon sequestration) Can be done before combustion (removing carbon from fuel) or afterwards (removing from waste gases) Some capture is already done (e. and security aims Limiting costs increases usage (and emissions) and reduces funds for investment in infrastructure. deep saline aquifers. and un-minable coal beds are options. this does not mean that cheap energy will always be available. 3. Multiple economic. The technology is expensive. and hydrogen is used to generate electricity Avoids the technical challenge of separating CO2 from other flue gasses. Increasing domestic supply unpopular if it involves drilling in environmentally-sensitive places. to produce fertilizer) However. Carbon is stored by injecting it into the ground Oil & gas reservoirs. tar sands. once captured. Needs a carbon price of at least $30/ton to be viable. However. a gallon of gasoline from tar sands releases 3x more carbon than a traditionally produced gallon. only appropriate for large emitters. Rather. Note that we are not running out of energy. more carbon is released For example. oil shale Usage increases carbon emissions Coal has a high carbon content. the oil must be melted out of rocks. . environmental. Integrated gasification combined-cycle (IGCC) is a way to reduce CO2 emissions from coal Turns coal into a gas before burning CO2 is separated from hydrogen when gasified CO2 is stored. The process of extracting oil from tar sands is more energy intensive. For example.g. energy is a difficult issue for the following reasons 1. All sources face some limitations These are discussed in detail below. the CO2 is then released Because of economies of scale.
In contrast.S. Hydropower Used for 16% of world electricity production. Cost estimates suggest a carbon price of $40 . it could have negative emissions. Does not require technological breakthroughs. If the project receives credit for using material that would decompose anyway. the project could be carbon neutral. Thus. political acceptance is an issue. Space is an issue Storing 60% of the CO2 produced in the U. would fill all the space from oil consumed in the U. which is captured as steam or used to heat water that is piped below the earth. However. Carbon content of biofuels depends on how produced A project in Georgia uses waste from cut trees.$90/ton C needed. Is there enough farmland to grow the needed feedstocks as well as supplying necessary food supply? Recent concerns over corn prices is an example here Short term challenges Supply of feedstocks Medium term challenges Developing new feedstocks and conversion methods. this is currently costly ($50-110/ton C) Biofuels Currently. this is the largest source of renewable energy. Small hydro is cost competitive Geothermal Uses heat from the earth. Other fuels include things such as ethanol. forestation) Scale will be an issue Increased re-forestation will reduce land available for agriculture. Retrofits would be more expensive. . using corn as a feedstock uses fossil fuels in production. Note how a CO2 tax would affect the incentives for different types of feedstocks.g.o o o Must be stored in formations with impermeable cap rock to avoid leakage. However. safety has been a concern for some. Eventually will dissolve in water. much of this is low-technology uses in developing countries. Biomass can also be used for storage (e. However.S. Presumably usage of these fuels will fall as countries grow. If biomass as fuel were combined with carbon capture and sequestration.
Distance from center decreases intermittency. Finding appropriate sites is a limitation. Offshore sites take advantage of stronger. However. but increases transmission losses. Currently feasible at about $93/ton Denmark and Norway work in tandem to provide power. . o The technology is mature. Costs of wind fell by a factor of four between 1981-1999 Wind is now competitive in favorable locations. Essentially. and could be situated further away with a price of $76/ton CO2. For instance. but cost reductions are needed to make it competitive. Barrett cites a source saying that wind could provide 100x the necessary power for the world. excess power could be used to produce hydrogen stored under pressure in a reservoir. Because wind is intermittent. Wind Alternative Energy Technologies I. Norway exports hydropower to Denmark. the hydropower not used when wind energy is exported is “stored” energy. Now about 5-8 cents/kWh Competitive with traditional fuels with a $25/ton CO2 tax Barrett cites a study showing wind is competitive at $38/ton CO2 near Chicago. I would argue that there is not universal agreement on this. Alternative Energy Sources (continued) The potential and problems of energy sources (continued) o Solar Solar is the most expensive of currently used renewable sources. R&D needs include: Continued cost reductions Understanding extreme wind conditions Integrating wind turbines to the electric grid Storage Are there enough acceptable sites? Good sites have sufficient wind or solar resources. When not. are near where energy demanded (to avoid transmission losses) and are not ruled out politically. storage is an issue. However. more consistent winds. Denmark exports wind energy to Norway. When winds are favorable. these are more expensive and require better technologies.
Passive reactors automatically shut down during an accident. More difficult for developing countries. storage of solar energy is also an issue. solar is most abundant in places where wind energy is scarce. 400 plants in operation Reserves could power 1. even after 50 years of research. could be competitive at $35/ton C.000 new reactors over the next 50 years. Safety concerns Has improved since Chernobyl. Ocean energy Uses waves or tides to produce energy Costly and environmentally damaging Nuclear fission Hugely sensitive to capital costs In US. However. which turns a turbine.g. remote lighting. waste is stored on site. many of the best locations are in developing countries. Nuclear fusion Poses no accident risk Fuel is abundant Waste is less risky Still requires more energy to run than is produced. etc. competitive with carbon prices above $27/ton C. Who will pay this price? Solar photovoltaics Remain very expensive Useful for modular locations (e. are there enough acceptable sites? However. Particularly an issue if nuclear spreads to developing countries Uranium is an exhaustible resource Currently. to make it available in an easily handled form. Uranium prices will rise if nuclear expands Could lead to new discoveries. Hydrogen Needs to be extracted from hydrocarbons or water Both of these currently use more energy than is produced. Reprocessing waste. increases the risks of nuclear proliferation. signs. but not for mainstream use. because large capital costs mean that large scale plants (> 1000 MW) are most profitable. Waste is an issue Long-term storage has yet to be implemented Currently. . As with wind. In prime locations. because high pressure areas have fewer clouds and less wind. Concentrated solar uses mirrors to produce heat.).o o o o o In addition to improving technology to lower cost.
and most rapidly expandable option. and make these technologies more competitive. In the IEA’s “greenest” energy projection. and about 0. To use for vehicles requires new infrastructure & new vehicles Costs may exceed $272/ton C o Hybrid vehicles Plug-in hybrids could serve as a transition technology If recharged from electricity grid.03% of world GDP Only Japan has increased R&D efforts recently II. Until the past few years. Global efforts around $15-20 billion This is 0. infrastructure for both charging and additional power generation will be needed o Improved energy efficiency “Cheapest. energy efficiency accounts for 2/3 of averted emissions Many profitable measures currently exist Could earn average returns of 10-17% Some investments have been made Energy intensity falling 2%/yr in US. As usage increases. Technological Change and the Environment The process of technological change includes three steps: . all clean technologies face technological hurdles.5% of energy expenditures.” but lack of knowledge limits diffusion. o Current efforts $5-6 billion/year in US This is 1% of what US spends on electricity and fuels $3 billion comes from the federal government Revkin notes that government R&D funding for health and the military has grown much more rapidly. particularly from industry. energy R&D efforts have remained relatively flat since the 1970s. demand for services increases For example. Overcoming these will lower costs. focuses on traditional fossil fuels. Note that much of this R&D. cleanest. surest. CO2 emissions depend on the type of power used. 1/5%/yr globally Potential concern is the “rebound effect” Higher efficiency makes using energy cheaper Thus. drive more when cars use less gasoline Two British studies suggest the rebound effect cancels out 26-37% of the gains from energy efficiency The role of innovation o As the previous section makes clear.
others can make use of it. market failures affect the process of technological change more generally. Thus. Firms only care about the private returns. the marginal social rate of return will be higher than the marginal cost. there will still be insufficient R&D. o Of course. Firms may face revenue constraints. o We don’t know whether research will be successful. resources available to do R&D are inelastic. one concern is environmental externalities. At this point. firms will not have incentive to develop environmentally-friendly products if the costs of pollution are not internalized. even if environmental externalities are corrected. They invest in R&D until the marginal private rate of return equals the marginal cost. we can consider the results of innovation a positive externality. Technological change and the environment is complicated by the presence of multiple market failures. Alternatively. As a result. Invention – the birth of an idea 2. Opportunity costs are important This high social rate of return is true for all R&D. “Picking winners” can be costly E. . Even if R&D markets functioned perfectly (which they don’t). the social returns to R&D are greater than the private returns to R&D. Innovation – commercialization of an idea 3. At least in the short-run.g. Implications: 1. Studies typically find that the social returns to R&D are about 4X higher than the private returns to R&D. we must consider where those resources come from. if we design policy to enhance environmental R&D.1. the inventor is not able to capture all of the social benefits of the innovation. Diffusion – Adoption and utilization of the innovation Note that technological change is uncertain. not just environmental R&D. Market failures for knowledge o Knowledge is a public good. Once an idea is in the public domain. Underprovision of R&D. o While some patents are worth billions of dollars. or which projects will be successful. Thus. synfuels in the 1970s. o In addition. o This suggests that a diversified strategy is desirable. 2. most have little commercial value. As such.
Many of the government laboratories are for the Department of Energy (DOE). Because of the temporary monopoly.g.7 billion performed directly by govt. or can perform research itself in government laboratories. Policy issues Because of the public goods nature of knowledge. $9. broader policies (e. the US government provided $112. but slow diffusion.0 billion performed by universities $5. In Popp (2004). R&D requires highly-skilled scientists and engineers. In 2007.g.5 billion performed by industry $25. As such. as compared to generic drugs. who receive larger wages when subsidies are increased.6 billion performed by Federally Funded Research and Development Centers (FFRDCs) $46. Of that: $24. .8 billion performed by nonprofits Government funding gives the government more control over the type of R&D done. supporting a range of options). patents encourage innovation. patents. Government R&D funding The government can provide research funding to firms and universities. is preferable to picking winners. which enables them to capture more of the returns to their invention. copyrights) Give inventors a temporary monopoly. government policies are used to foster invention and innovation: Intellectual property rights (e. In return. However. More importantly. Concern over the high price of patented drugs.8 billion of federal R&D funding. I estimate that approximately one-half of the energy R&D spending that took place in the 1970s and 1980s came at the expense of other R&D. the patent document makes the invention public. is an example. not every inventor chooses to patent an invention. Goolsbee (1998) finds that one of the chief beneficiaries of R&D tax subsidies are scientists and engineers.
so tax credits are unlikely to stimulate basic research. However.S. Firms will still choose to do the most profitable projects first. Basic research can complement research done by firms. However. This is particularly a problem for energy efficiency People demand high returns (greater than 30%) to invest in energy efficiency Demand payback periods of 2-3 years One key issue is price Energy is a small portion of the average household’s budget Energy efficiency is higher in counties with higher energy prices In the U. DOE labs often include public/private partnerships to help commercialize new technologies. energy consumption in a state is about 7% lower for each cent/kWh by which electricity prices exceed the national average. o Incomplete information Uncertainties for R&D are particularly large. Tax credits Tax credits lower the cost of R&D for firms. . For example. Government funding is particularly useful when spillovers are large. basic research that cannot be patented and/or embodied in a proprietary product. o Adoption externalities Adoption may also include positive externalities.. This may be a particular problem for projects with long term payoffs. Also problematic for long-term environmental problems like climate change. they give the government less control over the projects done. Potential adoption market failures Information As more people use a technology. such as basic research. others learn about it (epidemic effects) There are transaction costs to learning about new technologies. For example. recent research suggests firm characteristics are more important than epidemic effects in explaining adoption. This makes raising capital to invest in projects difficult.
slow diffusion of capital goods may be rational. the potential savings) This suggests that subsidizing energy efficiency purchases would help Consider. Network externalities are when one person’s usage of a product affects others. for example.Learning by doing & learning by using As firms or consumers gain experience with a product. don’t get rid of your current car right away. the case of energy-service companies (ESCOs) described in The Economist These companies borrow money to make energy efficiency improvements in a building Earn profits by retaining the resulting cost savings Most customers are government. Moreover. In addition. Thus. even if gas prices up. Paul David suggests asking whether we can identify cases in which society would have been better off if another technology had been chosen. For example. he suggests delaying irreversible commitments.g. As a result.g. hydrogen-powered cars aren’t practical without filling stations. the technology must not only be beneficial. do landlords have incentives to improve building efficiency if tenants pay their own energy bills? Do tenants have incentives to conserve if landlords pay the bills? Lock-in Switching to new technologies can be expensive Thus. But filling stations aren’t profitable without many cars to serve. Lock-in is particularly problematic when there are network externalities. but the benefits must justify the costs of switching. there is a positive externality. switching from fossil-fuel based filling stations would be expensive. hospitals. If this learning benefits others as well. Principal-agent problems E. E. What matters most for energy efficiency? Studies suggest that households are more sensitive to up-front costs of investment than to energy prices (and thus. costs may fall. to adopt. schools. and universities Policy options .
regulator lets price rise If demand is higher. permits.g. product efficiency standards) Forces consumers to make choices that they are not currently making For instance. these are policy goals that are accompanied by other policies to help meet these targets.g. E. Calls to increase federal R&D spending address innovation market failures. these are binding constraints. o Types of policies used Many policies designed to encourage alternative energy are very specific. In other cases. Investment subsidies Deal with concern over up-front costs Product labeling Energy Star labeling is an example Deals with the information problem Product standards (e. Environmental market failures require environmental policies such as taxes. or command and control policies. . Australia has proposed banning incandescent light bulbs Tradable “white certificates” Projects that improve energy efficiency are certified Utilities required to have minimum investments in energy efficiency Can buy and sell certificates to meet requirements Utility regulation Because operate in regulated markets. regulator cuts prices III. rather than broad-based policies such as a carbon tax. Renewable energy targets Many EU countries and US states have targets for a percentage of energy that should be generated by renewable resources by a certain date. In some countries. How to Get There: Policy Options Recall that there are two market failures at work (environmental and innovation). but not environmental market failures. such as Australia and Japan. utilities face little incentive to encourage efficiency One way to do so is to decouple sales and profits Regulators forecast demand and set a price that earns profits at that price If demand is lower than expected. all wholesalers must get 2% of their electricity from renewable sources.
In contrast. since the credits need to be renewed frequently Policy considerations Even if current technologies make large scale reductions costly. since they guarantee a return on solar investments.o Price guarantees Some EU countries guarantee a higher price for electricity generated from renewable sources. Customers or distributors must show that they use at least that percentage of renewable energy. don’t we want to provide incentives for some basic reductions now? It will be more costly to do more later. Since producers of renewable energy sell the permits.9¢/kWh production tax credit Encourages wind production. Texas The program begins with a target level for percentage of renewable energy use. However. as it gives time for the capital stock to turn over. Examples include feed-in tariffs in Germany Germany guarantees a price of 55¢/kWh for solar.S. consider what types of R&D encouraged by these incentives. Because the costs of wind are lower. Environmental policies provide incentives for increased R&D. that feed-in tariffs encourage R&D on solar. Producers get a certificate for each unit of renewable energy supplied to the grid. has a 1. R&D efforts focus on wind. as we will have missed low cost options that are currently feasible.4¢/kWh for wind Tradable green certificates (Energy Policy 2003) Used in Europe. Gradual phase-in is useful. they are compensated for the extra cost of producing renewable energy. U. Investment subsidies Examples are tax credits for installation of solar panels. This helps make these sources competitive with other fuels. Will projects with only long-term payoffs (e.g. . solar PV) be encouraged? Note. in countries using renewable portfolio standards. Australia. for example. and 8. etc. They do this by purchasing permits. energy efficient appliances. since that is closest to being competitive Uncertainty is an issue. it is the alternative energy source chosen if a specific technology is not mandated by policy. Policies are needed to provide rewards for green innovation.
the problem is that human activities have increased the rate of growth. so that cleaner sources become more competitive. Today they are at 390 ppm for CO2 only. o The effect is natural. The Problem of Climate Change Climate change comes from the accumulation of greenhouse gases in the atmosphere: o carbon dioxide (CO2) major contributor: 49% of the proportionate effect is from CO2 o methane (CH4) 18% of proportionate effect o nitrous oxide (N2O) 6% of the proportionate effect o water vapor As these gases accumulate in the atmosphere. Innovation market failures require government support for R&D. concentrations were at 365 ppm. Without the greenhouse effect. Concentrations of these gases have been growing. o Applied research This is developing technologies for the ma Climate Change I. Examples include using solar energy to produce hydrogen fuel. o Although some emissions are natural.4oF). Sources of emissions: o CO2: Burning of fossil fuels Deforestation (because forests are carbon sinks) o Methane: . rather than +15oC (59oF). they trap infrared radiation (heat) that would otherwise escape into the earth’s atmosphere. o Basic research Recall that this is particularly important for basic research. but they are not a substitute for environmental policy. o The question is the effect that human activity has on the greenhouse effect. Some of these. policies addressing emissions change the relative price of fossil fuels. o Were between 270-290 ppm for thousands of years before the Industrial Revolution By 1998. the earth’s temperature would be -18oC (-0. Also needed when payoffs are in distant future. Finally. even produce more carbon emissions. Basic research will be important for discovering new technologies. Hence. In contrast. Higher energy prices also encourage the search for more fossil fuels. and 430 ppm CO2 equivalent. note that higher energy prices help encourage investment in alternatives. such as tar sands. the name greenhouse effect.
methane has a greater radioactive forcing than carbon dioxide. What consequences will climate change bring? Predicted consequences to global warming include: o A rise in sea level 50 cm rise expected by 2100 Leads to erosion of shoreline and loss of habitat. but is often 30-50% of GDP in developing countries. different gases have different radioactive forcings (heat absorbing potential). o Increased strain on fragile ecosystems o Health effects For example. In addition. such as cows Leakage from natural gas pipelines. but does not persist for nearly as long in the atmosphere. tropical diseases may spread. o Changes in energy use Less need for heating. o Released from wetlands and other areas where anaerobic decay of organisms occurs. “Emissions from ruminants” – gases from cud-chewing animals. However. but more for air conditioning. Then we can address relevant policy issues. may be positive in some areas. we want to consider the economic costs of climate change. Developing nations expected to be hurt the most. Overall effect expected to be negative. o For example. N2O: Burning of fossil fuels Agricultural fertilizer Part of the problem is that some greenhouse gases (particularly CO2) remain in the atmosphere for a long time. o Changes in ocean currents Shifts in ocean currents could dramatically cool the European continent. For example. There are two options for dealing with global warming: o Mitigation – taking steps today to reduce emissions to avoid or limit future problems. o Increased intensity of storms o Changes in agriculture Can be both positive and negative. Pollution control devices. Crop locations will change. Examples of mitigation: Using less fossil fuels. . Estimating the Damages from Climate Change To begin. Agriculture makes up just 3% of GDP in developed economies. increased precipitation will help. II.
Consider Malawi. Thus. However. Reforestation – trees act as carbon sinks. is adaptation possible for developing countries? Not only do developing countries have fewer resources. Adaptation – efforts of future generations to adjust in ways that reduce the negative impacts of climate change. Enhancing the ability of oceans to absorb carbon. . The cost of a sea level rise to the island of Manhattan is not the cost of Manhattan being under water. we need to consider the cost of adaptation. and Tol use enumerative method. calculate effects of agriculture by modeling how crop prices change as crop outputs change Advantage Based on literature from natural science Disadvantage Concerns about extrapolation Studies from limited areas extrapolated to rest of word Results from recent past extrapolated to distant future Are assumptions about adaptation realistic? Additional adaptation would lower costs Mendelsohn and his co-authors use a statistical approach.g. but they are often smaller. The readings discuss how adaptation is easier for developed countries. Nordhaus. Begin by estimating physical effects from natural science research Give each physical effect a price and add up E. but the cost of preventing flooding on the island. Compare to Australia. and thus in only one climate zone. When valuing the damage done by climate change. Raises the question of whether raising incomes in developing countries is a better solution. substitution of activities among different regions of the country would be impossible. which lacks irrigation and depends on a single crop (maize). which uses desalination to cope with drought. Methodologies for estimating damages o Studies must make assumptions about o Future emissions Extent and pattern of climate impacts Economic value of these damages o Types of studies Nordhaus (1994) interviewed experts Frakhauser.
added up. Might there be other unobserved variables that matter. Table 1 in Tol presents results for warming between 1-3oC. Note that the 2010 World Development Report from the World Bank says that 2oC climate change will cost Afric 4% of GDP. Advantages Based on real-world observations. More CO2 reduces water stress in plants. some important aspects. rather than extrapolated differences Disadvantages Differences in values across places attributed to climate.8% of GDP for 3 C warming Equivalent to about one year’s GDP o Figure 1 fits a regression line to the estimates Note low levels of warming may have small benefits o Turning point occurs around 1. where warming reduces cold weather problems More people live in tropical areas. Direct estimates of welfare impacts using observed variations in prices and expenditures Done for selected countries.1 C Much of this warming will occur anyway. allowing them to grow faster. but there is less economic activity there Raises interesting equity issues Damages get more substantial as temperature increases More recent studies tend to be less pessimistic. . and one estimate for sub-Saharan Africa at 23. cross-section variation gives you variation in climates However. Thus. o o Estimates range from no effect to a loss of 4.5%. do not have much spatial variation. Most economic activity in temperate zones. not year to year variation. Much of the research looks at cross-section variation Appropriate because climate is about long-term trends. Africa is typically the worst off region. as they incorporate more adaptation opportunities Uncertainty is skewed to the right More likely to experience disaster than for climate change to have large benefits o Regional differences The table also lists the areas from each study with the smallest and largest effects. These are total cost estimates. such as sea level rise. as early emissions are sunk costs. and India 5%. and extrapolated. with losses around 5-10%.
need to assume when the warming will occur. o E.g. etc. thus already hotter Less able to adapt to climate change because of lack of resources and less capable institutions. as a carbon tax should equal the marginal social cost. Why are developing country losses larger? In tropical regions. effects of carbon cycle. changes in ocean currents) Biodiversity loss is hard to quantify Benefits Higher wind speed lowers future cost of wind energy Reduced polar ice opens shipping lanes . poor households lost 15-20% of their assets. all use one of 9 total cost studies as a starting point.g. etc. Estimates of marginal damage o Estimates of marginal damage give us a social cost of carbon. developing countries) will be impacted more. This can be used to guide policy. runoff. Nations that depend more on unmanaged ecosystems (that is. o Table 2 summarizes results Mean is $105/ton C Median only $29/ton C Mode only $13/ton C o Higher with lower discount rates th At a 3% discount rate. for a study with 3 C warming. future emissions. the 99 percentile is just $45/ton C o What are these studies missing? Both positive and negative effects may be ignored. and/or temperatures. Examples include Costs Saltwater intrusion into groundwater due to sea level rise Increased damages from storms Extreme events are unknown (e. Inadequate housing and health care systems leave poor people more vulnerable to natural disasters Example: After Hurricane Mitch in Honduras in 1998. These nations are more dependent on naturally occurring rainfall. 10 of the 15 largest cities are in low-lying areas prone to flooding Impact on natural systems must be considered. o Methodology Estimates begin with a total cost estimate Of the marginal cost estimates reviewed by Tol. whether the damages are linear or quadratic. Different assumptions about discount rates. lead to different marginal cost estimates from these 9 studies. while rich households only lost 3%.
5% of GDP. such as: The feedback between emissions and temperature change The effect of temperature change Because of the uncertainty surrounding global warming. or will we need to scrap existing plants? o Assumed effects of climate change.g. o Effect by region (% of GDP): US: 0. They are tables 4-10 and 4-11. which estimates the global impact to be about 1. Warmer weather in cold regions reduces costs of heating and disruptions from snow storms.83% Japan 0.1% of GDP (a net benefit) to 1. III.5% of GDP. As an example. Warming the World: Economics Models of Global Warming (with Joseph Boyer). Kyoto leads to a 0.5% India: 4. Both tables used in class come from chapter 4.22% o We also looked at other studies from the US. Puting targets in perspective: . The Costs of Dealing With Climate Change What are the costs? They depend on: o How much we can improve energy efficiency o How fast the price of renewable technologies falls o The availability of technological solutions such as carbon sequestration o Willingness of consumers to change behavior o Policy instruments used Costs are higher if inefficient policies (e. we looked at tables from Nordhaus (1999). many assumptions are needed in these models. o Examples: The rate of technological change The feedback between emissions and temperature change The effect of temperature change Examples from IPCC: cost of Kyoto varies by country. Most studies stop at 2100 Longer term effects not as well known.93% China: 0. which found damages ranging from -0.45% European Union: 2.5 to 7% loss of GDP. but not elsewhere. those not encouraging the lowest cost reductions first) are used o How fast will reductions occur Can we replace existing capital with more efficient equipment as it wears out. with most countries clustering around 1%. o Both of the tables used in class are available from William Nordhaus' web site for his book. Allowing for trading within the EU.
7% What is the cost of various policy options? o The following table presents the carbon tax necessary to achieve each of the following policy options. lowest cost emissions reductions done first.g.edu/~nordhaus/homepage/dicemodels. fuels with high carbon contents.26 ('06) 15% $0. As population increases.5% of world GDP in 2050. Examples of the effect of carbon taxes on prices: o Oil Absolute price increase Current price (2007/08) Percent increase Natural Gas Coal Electricity Gasoline $1.18/barrel $0.03 0.01 1. o The "optimal policy" is one which equates marginal benefits and marginal costs. on a global scale) Finally. o A carbon tax would be based on the carbon content of fuels.15/mcf $5. Thus. such as coal. The Stern Review has generated much discussion o It estimates damages from emissions ranging from 5-20% of GDP Note that this is higher than the estimates in Tol’s review o It estimates the cost of abatement (for stringent abatement) would be about 1% of GDP per year Would limit concentrations to 500-550 ppm o Weynat (2008) notes that IPCC estimates costs for stabilizing greenhouse gas concentrations ranging from -1% (slight benefit) to 5.9% $3. o The results are taken from William Nordhaus' DICE model of global warming.5-3 C.1% $13. Policy Option 2010 2025 2100 .econ.0017/kWh $0. The idea was to convert the costs of various policy options into an easy to understand numerical framework. the marginal costs of reducing emissions increase. are taxed more heavily.19/ton $0.yale. o Present concentrations are 430 ppm CO2 equivalent (390 CO2 only) o o A 550 ppm CO2 equivalent target yields warming around 2.htm.91 1. Reducing warming to 2 0C requires concentrations no larger than 450 ppm CO2 equivalent. The complete study including these results is available from his web site: http://www. Note that the tax levels increase over time. in class I presented data on carbon taxes necessary to achieve various goals.0914 1.024/gal $108.2% $34. o Critiques Uses a low discount rate Optimistic about future technologies High damage estimates ignore opportunities for adaptation Assumes perfect policy implementation (e.
5oC o 16.9% 2x pre-industrial concentrations (560 ppm) Limit temperature increase to 2. Environmental economics contributes to policy by clarifying the choices available. What role does economics (and economists) play in environmental policy? An interesting point raised is that environmental policy is dominated by lawyers and economists.50 $60.5% 26.4% 1. o The development of cost-effective policy is also important.5% 40.20 $39.97 $445. . This has led to a more normative use of environmental economics. By placing values on potential benefits.48 in the limit to 2x case. The Political Economy of Environmental Policy Today's class was a discussion of the role that economics plays in environmental policy.40 Effect on emissions (reduction from a no-policy baseline projection): Policy Option Optimal policy 2015 2025 2095 15. It is 1.20 $102.5x case.8% 58. and 2.Optimal policy 1.40 $189. because carbon emissions persist in the atmosphere for a long time.5% 97.5x pre-industrial concentrations (420 ppm) 42.5oC o $33.80 $53.5x pre-industrial concentrations (420 ppm) 2x pre-industrial concentrations (560 ppm) Limit temperature increase to 2.8% Note that. it can help clarify what we are getting for these costs.25 $863.5% 61.9% 18. Why might economists play an important role.. as well as summarizing some of the important points from the reading.60 $58. o In the U. In these models. I.70 $421. Natural scientists play more of a role bringing issues to policy makers attention and deciding on the targets to be met. temperature increase by 2100 in optimal policy is 2. there is little difference in the effect of each policy on temperature over the next 100 years. but not necessarily when goals are set. o One thing we discussed was that this is true at the stage of policy implementation.3% 87. the most visible role for economics is for cost-benefit analysis.90 $202.61o C in the limit to 1.3% 21. The notes below highlight some of the key points raised in today's discussion.6% 19.S.61o C.92 $761.
For example. Economists play two roles here: Estimating compliance costs Designing cost effective policies.g. while the costs of policy may fall on a few affected firms.g. However. auctioned permits Taxes hurt firms because they must pay both for the reductions they make and pay a fee for the reductions they do not make. This affects both the type of policy and the timing of policy. firms have incentive to lobby against regulations. Even socially efficient regulations may impose costs on individual firms. Still. In the 1980s. DuPont favored CFC reductions because it had developed a substitute. New policy instruments (e. They note that individual consumers or firms receive little reward for lobbying Note also that. Considering the players involved in environmental policy may help explain why. environmental policy. Thus. the benefits will be shared by a larger group of citizens. Note that transfers of wealth are important.S. there are limitations to this: Information: do individuals understand the environmental effects of their purchases? Free-riding: people may feel that individual actions will have little effect. Interest groups . Regulations can generate rents Firms will support regulations that offer new opportunities for them. tradable permits) have gained increased acceptance among policy makers. Industry Prefer policy instruments with low costs to the firm (not necessarily to society as a whole) E. firms that produce pollution control equipment benefit from technologybased standards that require their product. Consumers Individual consumers can influence firms by their purchasing decisions. market-based policies are not often used in U. grandfathered permits vs. Concentrated costs and diffuse benefits make it more difficult to generate support for regulation.
what key insights does economics offer to the study of environmental problems? One of the key lessons of economics is that individual behavior matters. is that the individual motives of each group are important. in a democratic system. Environmental economics can both tell us when the incentives of the marketplace are insufficient to achieve an efficient solution. what are the implications of environmental regulation for existing property rights? III. whether they are firms. However. that is highlighted in the readings. consumers. government policy can also lead to constraints. being identified with successful legislation could increase fundraising Most groups oppose market-based policies Market based policies provide less control over final outcomes than command and control policies. A key point here is that incentives matter. the preferences of environmental groups likely differs from those of the general population. or environmentalists. Environmental organizations care about: Likelihood that the instrument considered will be chosen Increasing their influence For example. it is important . o These constraints typically come from scarcity. What role should economics (and economists) play in environmental policy? A concern was raised that cap-and-trade provided a new concept of property. and also tell us how individuals will respond to the incentives given to them by various policy mechanisms. Economics is not about how people should behave. o Understanding how people will react to policy is important to achieving policy goals. but how they do behave. Note also that. After taking a semester of environmental economics. Individual actors. which leads to opportunity costs. o Should the government be able to create property rights? o If not. One take-away from this. o Economists study how people react when their behavior faces constraints. have more power when organized as interest groups. II. Economics is about how people respond to incentives. Since the preferences of environmentalists may differ from others. This can often be helpful for environmentalists to remember.
o Do they. We discussed. o Regulations provide incentive to innovate. this becomes more important. to realize that not everyone will choose to protect the environment without incentives to do so. and that the benefits of remaining environmental problems often occur in the future. As remaining environmental problems become harder to solve. get less attention from the policy community? Another related to discounting o How does economics deal with issues where costs occur today. IV. making the costs of future regulation lower. Are there weaknesses to the economic approach to environmental policy? One point that came up early in class (regarding ecosystems) is that some benefits are more difficult to quantify. Another important insight was the effect of regulation on costs over time. many of the easy problems have been solved. for example. in turn. that in developed countries. This can make it easier for developing countries to regulate. but the benefits are delayed? .
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