ECON 262

Notes on Environmental Economics, Externalities, etc. (short version)

 

 

Economists tend to approach environmental issues the same way they approach all social issues.  The same assumption (self interest) about human behavior is made and the analysis follows from that assumption.

 

Economists also tend to emphasize cooperative solutions over one's that entail conflict (being social scientists). 

 

  

 

Externalities - When costs or benefits are secondary - problems!!

 

Remember way back - our definition of efficiency -- not only must you be producing something of value, but also must take into consideration ALL costs - including external ones.  So let's take a closer look at these external costs (and also some external benefits).

 

Externality:  the uncompensated impact of one person's actions on the well-being of a bystander.  You do something to benefit yourself but in the process cause a cost or benefit for someone else.  So the cost or benefit is "external" to you.

 

    Positive:

 

    Negative:

 

Examples:

 

Careful - perfection is Unattainable (whatever that may be).  We can't judge any policy, law, institution, economic system, etc. against perfection - we must judge it against a viable alternative!! 

 

Economists usually talk about:  Internalizing the Externality -  when the party causing the externality must take the cost into account (pay) if it is a negative externality or when the party causing the externality is compensated for creating it (gets paid) if it is a positive externality. 

 

This will (theoretically) lead to a decrease in negative externalities and an increase in positive ones.

 

The idea is that the "private" costs or benefits do not equal the "social" (or total) costs or benefits.  Of course if reality there are no "social" costs and benefits -- none of this can be measured!!!!

 

Examples of different kinds of externalities -

 

Negative Externalities in Production:

 

 

 

Positive Externalities in Production:

 

 

 

 

Negative Externalities in Consumption:

 

 

 

 

Positive Externalities in Consumption:

 

 

 

 

Of course - sometimes we can't determine who is causing the externality - or we don't discover the externality until after those who created it are gone.  

 

So what are ways to internalize?

 

Private Solutions Toward Externalities:

 

1.  Assign property rights and allow voluntary agreements or contracts: if property rights exist and if private parties can bargain without cost (or with low enough costs), they can solve the problem of externalities on their own.  Does not matter how the property rights are initially distributed.  Depends upon the transaction costs (the opportunity costs of conducting a transaction) of bargaining.  (Ronald Coase)

 

The fly-fishing/farmers example.  The farmer's use of the water created a negative externality for the fishers - so they bargained.  The fishers paid the farmers not to farm.

 

But externalities work both ways:  Take for example smoking.  Smokers might create negative externalities for non-smokers - but if smokers do not smoke to please the non-smokers, then they have a negative externality put on them.

 

   Precedents (norms) are important in determining respective property rights.

 

 

        Addition:  Then, of course, once property rights are assigned - invading another's property or person can be taken care of under the criminal legal system.  For example, fraud or assault.

 

 

2.  Moral codes/social sanctions:

 

 

3.  Persuasion:

 

 

4.  Integration:

 

 

5.  Charities (positive externalities):

 

 

 

Public (Government) Policies Toward Externalities:

 

1.  Regulation:

 

    a.  ban production processes (problem: don't know if the costs outweigh the benefits)

 

    b.  specify minimum air or water quality levels (problem:  what level is best? - and why try to go below it with better technology)

 

    c.  the government specifies what kind of technology is used (problem:  stifles innovation)

 

 

 

2.  Taxes and Subsidies:

 

    a.  tax those who pollute (hard to know who to tax sometimes - and certainly how much????)

 

 

    b.  subsidize those who don't (hard to know who to subsidize - and certainly how much???)

 

3.  Tradable Pollution Permits (Cap and Trade):

 

 

 

Economists in general, however, will emphasize property rights as a way of internalizing externalities.  Let's look deeper...

 

Property Rights, Free Riding, and the Tragedy of the Commons

 

Property Right:  The owner has the right to dispense with the property in a manner he or she sees fit, whether to use or not use, exclude others from using, or to transfer ownership.  Property rights and incentives are very much related.  With ownership rights -- if I can increase the value of my property - I can reap the rewards from doing so. 

 

Common Resource:  goods that are not owned by any one person - no one is excluded from its use.

 

Free Rider Problem:  an individual reaps the benefits from free-riding, but the costs are spread among the whole group.  So individuals have an incentive to free ride.

 

A person receives the benefit of a good but avoids paying for it - with common property, people have an incentive to "free ride" off of others - throwing trash on the beach in the hopes that someone else will pick it up.  But if everyone is free riding...... what happens to the beach?

 

Tragedy of the Commons:  common resources get used more than is desirable - even to the point of destruction.

 

Example:  Codfish off the New England and Canadian coasts.  Problem - the fish had to be hauled from the sea before rights to it could be established.  The result was overfishing - each fisherman could benefit by catching fish but the cost (fewer fish in the future) was spread among all fishermen.  The catch dropped dramatically over a 30 year period - more than 75% (and the fish got smaller).  As a result -- the cod fishing in that area is virtually gone.

Main Economic Solution to the Tragedy of the Commons:  Property Rights

"It is important to remember this: Property rights generally are not something that government “grants” to people. They usually develop on their own."  See examples from Native American tribes and others.  R. Stroup  This is the theory that Elinor Ostrom won her Noble Prize in Economics for (2009). http://www.env-econ.net/2009/10/ostroms-take-on-the-tragedy-of-the-commons-.html

    Quasi Property Rights -- Britain has established quotas - and has made those quotas transferable - the right to catch specific numbers of fish can be purchased and sold.  The quotas assign property rights to fish before they are caught, and their transferability ensures that the lowest-cost, most sensible means of taking those fish will be used.  This eliminates the incentive to "catch it or lose it" - fish stocks have begun to turn around. 

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Economic Growth and the Environment - Are They Compatible?

 

Let's now return to principle #9 above:  As people's incomes increase, their willingness to pay for protecting the environment increases.

 

Some economists have found that pollution often appears first to worsen and later to improve as countries’ incomes grow.

 

Because of its resemblance to the pattern of inequality and income described by Simon Kuznets, this pattern of pollution and income has been labeled an ‘environmental Kuznets curve’.

 

The theory:  at relatively low levels of income the use of natural resources and/or the emission of wastes increase with income. Beyond some turning point, the use of the natural resources and/or the emission of wastes decline with income.

 

GRAPH:

 

 

 

 

 

 

 

Why?   Reasons for this inverted U-shaped relationship are hypothesized to include income-driven changes in:

 

(1) the composition of production and/or consumption - people can afford to change both how they produce goods/services and they can afford to choose goods/services that are more compatible with a better environment.

 

(2) the preference for environmental quality - environmental quality is seen as a "normal good."  People demand more of it as their income increases.

 

(3) institutions that are needed to internalize externalities - these become "affordable" at higher incomes.  Could be government institutions or private institutions - with high transactions costs in trade (the fly fishing example), people can afford to pay them with higher incomes.

 

(4) increasing returns to scale associated with pollution abatement - with higher incomes, more people demand environmentally friendly goods - so firms are able to produce them cheaper due to increasing returns to scale (economies of scale). 

 

 

The Evidence?

 

Mixed (as usual):

 

Some economists found that while many pollutants exhibit this pattern, peak pollution levels occur at different income levels for different pollutants, countries and time periods.

 

Most famous studies are from those that really introduced the idea - Grossman and Krueger (1995) used a simple empirical approach. They looked to see if there is a correlation in the data between air and water quality in cities worldwide and income per capita and other city and country characteristics. They found that many of the plots of data appear inverse-U-shaped, first rising and then falling. The peaks of these predicted pollution-income paths vary across pollutants, but in most cases they come before a country reaches a per capita income of $8,000 in 1985 dollars (Grossman and Kruger, 1995, p. 353). Note:  $8,000 in 1985 would be about $15,400 now.

Many other studies have followed.  Some generalizations across these studies have emerged.

a.  Roughly speaking, pollution involving local externalities begins improving at the lowest income levels. Fecal coliform in water and indoor household air pollution are examples. For some of these local externalities, pollution appears to decrease steadily with economic growth, and we observe no turning point at all. This is not a rejection of the EKC; pollution must have increased at some point in order to decline with income eventually, and there simply are no data from the earlier period.

b.  By contrast, pollutants involving very dispersed externalities tend to have their turning points at the highest incomes, or even no turning points at all, as pollution appears to increase steadily with income. Carbon emissions provide one such example. This, too, is not necessarily a rejection of the EKC; the turning points for these pollutants may come at levels of income per capita higher than in today’s wealthiest economies.

These could both be predicted theoretically.  The closer one is to the cost of his own actions, the more likely he will do something about that cost.  Living with open sewer at your front door - well, brings action sooner.  Driving a car and not recognizing the externality at the moment - action is put off.

Criticisms:

 

1.  Methods used in the studies have been criticized.  Measuring the pollution, for example.  And other statistical problems.

 

2.  More developed countries could be shipping their pollution to the less developed countries - this skews the results.  Like manufacturing of clothing and furniture, to poorer nations that are still in the process of industrial development.  Thus, this progression of environmental clean-up occurring in conjunction with economic growth cannot be replicated indefinitely, because there will be nowhere to export waste and pollution intensive processes

 

3.  Industrial societies will continually produce new pollutants as the old ones are controlled - so it is a never-ending battle.