Environmental Economics

I.    What is Environmental Economics?

Economics is the study of the allocation of scarce resources.

Environmental Economics undertakes theoretical or empirical studies of the economic effects of national or local environmental policies around the world. Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming.

Environmental economics is distinguished from ecological economics in that it emphasizes the economy as a subsystem of the ecosystem with its focus upon preserving natural capital. One survey of German economists found that ecological and environmental economics are different schools of economic thought, with ecological economists emphasizing "strong" sustainability and rejecting the proposition that natural capital can be substituted by human-made capital.

Note that the theories of economics can be applied to any scarce resource, not just traditional commodities. Economics is not simply about profits or money.  It applies anywhere constraints are faced, so that choices must be made. 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.

Natural resources – resources provided by nature that can be divided into increasingly smaller units and allocated at the margin.

Environmental resources – resources provided by nature that are indivisible.

Natural resources serve as inputs to the economic system.  Environmental resources are affected by the system (e.g. pollution).

II.    Why Study Environmental Economics?

In general, prices reflect the relative scarcity of goods.        However, in environmental economics, markets, and thus prices, often do not exist.

What aspects of environmental and natural resource economics make it unique?

Market failures - When market failures exist, government intervention may be appropriate.

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.

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.

Linkages between the economic and ecological system -  An interdisciplinary understanding of the environment, political science, etc. necessary to be a good environmental economist.

III.    Key questions for environmental economics

What is the market failure? Typically, externalities are a problem.  However, we will also deal with other market failures. For example, imperfect competition leads to regulated utilities.

What type of intervention works best?  The problem in environmental economics is often that there is no market for environmental resources. Thus, one option is to create a market. However, economists realize that this is not always the best solution.

           

How to evaluate environmental programs?

Ideally, we need to know what level of environmental protection is desired. Economists focus on decisions at the margin: equating marginal costs and marginal benefits. The choice is not between clean air and dirty air, but rather between levels of pollution.

Note that this requires placing a value on environmental protection.

However, this valuation is complicated by the lack of market prices for environmental goods.

               

Efficiency versus equity

Finally, we need to remember that even when an efficient solution occurs, it might not be desirable. Recall that the fundamental theorem of welfare economics says nothing about the distribution of resources in an efficient solution.

Equity issues are also important. Policymakers need to consider how various groups will be impacted.

Solutions

Environmental regulations.

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

Quotas on pollution.

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

Taxes and tariffs on pollution/Removal of "dirty subsidies."

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

Better defined property rights.

If people living near a factory had a right to clean air and water, or the factory had the right to pollute, then either the factory could pay those affected by the pollution or the people could pay the factory not to pollute. Or, citizens could take action themselves as they would if other property rights were violated. The US River Keepers Law of the 1880s was an early example, giving citizens downstream the right to end pollution upstream themselves if government itself did not act (an early example of bioregional democracy). Many markets for "pollution rights" have been created in the late twentieth century.