Environmental Policy Objectives

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Lecture 1

• Environmental Policy Objectives
• Efficiency (static and dynamic)
• Sustainability
• Equity (fairness)
• Non-conflict with other objectives.

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Some Environmental Problems

• Global climate change
• Greenhouse gases
• Ozone depletion
• International air pollution
• Acid rain
• Local air pollution
• Traffic pollution
• Factory emissions
• Smogs
• Water pollution and water scarcity
• Nitrate spillovers
• Intensive agriculture
• Population conglomeration
• Others

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Economy-Environment Interactions

• Economic activity has a material basis.
• It draws resources from the environment, and
  provides flows back into the environment.
• These flows must satisfy the laws of
  thermodynamics
• First law Conservation of mass/energy (materials
  balance principle)
• Second law Entropy is non-increasing

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• Environmental resource services and functions
• Waste assimilation and re-processing by
  ecological systems
• Environmental systems support processes (air,
  climate, water, soil)
• Provision of productive inputs
• Provision of environmental amenities
• that contribute to labour productivity
• that contribute directly to well-being

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Sustainability and Sustainable Development
1987 report of the World Commission on
Environment and Development (WCED).
Sustainable development is development that
meets the needs of the present without
compromising the ability of future generations to
meet their own needs.
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The material basis of sustainability
We have seen that economic activity has a
material basis. It draws resources from the
environment, and provides flows back into the
environment. There are interactions between the
economic and environmental sub-systems. Key
question How can the stocks and flows in these
systems be reproduced over time, at
non-diminishing levels and rates?
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• Environmental and economic sustainability
• Two systems to be sustained
• Economic system (stocks and flows) Utility
• Ecological system (stocks and flows)
• And possibly others?
• Steve Hackett (1998) People in a sustainable
  society enjoy non-diminishing flows of
  ecological, economic, sociopolitical and cultural
  benefits.

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Economic sustainability Some economic concepts
of sustainability Sustainability is defined
as... non-declining utility of a representative
member of society for millennia into the
future. A sustainable state is one in which
utility (or consumption) is non-declining through
time. The alternative approach to sustainable
development is to focus on natural capital
assets and suggest that they should not decline
through time.
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Some interdisciplinary concepts of
sustainability Preserving opportunities for
future generations as a common sense minimal
notion of intergenerational justice Sustainable
activity is...that level of economic activity
which leaves the environmental quality level
intact, with the policy objective corresponding
to this notion being the maximisation of net
benefits of economic development, subject to
maintaining the services and quality of natural
resources over time.
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• CRITICAL ISSUES
• Critical to sustainability, however defined, seem
  to be
• the degree of resource substitutability
• the rate of technical progress
• the degree of eco-system stability and
  resilience
• irreversibility of investment decisions

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FEASIBILITY OF SUSTAINABILITY Is sustainability
feasible? That is, is it possible for the
economy to attain a state in which production and
consumption track along non-declining paths (or
grow at positive rates) over indefinite periods
of time, in the presence of finite stocks of
exhaustible resources and constraints imposed by
natural environmental processes?
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Irreversibility Suppose that an asset is
developed (or used in some way). Now suppose we
change our mind about the desirability of that
development. Is it possible to reverse the
process so that we are back in the original
position? Often this is NOT possible in those
cases, the decision is irreversible (for example,
depletion of an exhaustible resource, or
extinction of a species). This gives us much
less room for making mistakes.
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• POLICY IMPLICATIONS
• It seems sensible to adopt some form of
  precautionary principle. But how much premium
  are we willing to pay to avoid risks of
  catastrophic failures ?
• If sustainability is feasible, can it be achieved
  through the use of market-based incentives and
  instruments alone?
• Some sensible interim goals
• Encourage recycling
• Pay attention to safe disposal of wastes
• Information flows should be improved
• Ensure property rights are clearly established.
• Create incentive compatible instruments.

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Economic Efficiency
Efficiency Is about using resources
wisely. Which resources are we talking about?
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Efficiency Criteria

• Criteria
• Maximisation of net benefits (benefits - costs)
• Two dimensions
• static
• dynamic (intertemporal)

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Net benefit maximisation approach to
efficiency. Net benefit total benefit - total
cost NB B - C Suppose that B and C both depend
on X (which may be output, or pollution, or
something else) Maximisation of net benefit
requires marginal benefit of X marginal cost
of X
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Dynamic (intertemporal) efficiency Are resources
being used efficiently over time? And Are the
best incentives for innovation and productivity
improvements being generated?
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Efficiency and Market Mechanisms
Limited resources ? Use depletes resource
stock ? Resource becomes more scarce ? Resource
cost (price) rises ? Opportunity cost of using
resource rises ? Resource substitution takes
place also Higher price increases search and
extraction effort
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• Markets and Efficiency
• Under a set of ideal conditions, market forces
  alone may lead to efficient (but not necessarily
  optimal) outcomes.
• These include
• Markets exist for ALL goods and services
• All markets are competitive
• All transactors have perfect information
• Property rights are fully assigned
• There are no externalities.
• All goods and services are private (not public).

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Under these ideal conditions Supply curves
properly reflect true opportunity costs. Demand
curves properly reflect true preferences and
social benefits. And in each market P MC
MB (Market prices correctly reflect marginal
costs and benefits they are equal to the correct
shadow prices). And all the efficiency conditions
referred to above will be satisfied.
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Potential causes of Market Failure

• Absence of markets
• Externalities
• Public goods
• Poorly defined or difficult-to-enforce property
  rights (including open access
  conditions)
• Incomplete information and uncertainty
• Inability to ascertain preferences of future
  generations

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Why do these cause Market Failure

• Either
• Because of absence of markets (so there is no
  market to work!)
• or
• Prices (or costs), as expressed through markets,
  are incorrect, and so transmit wrong signals in
  the market-based resource allocation mechanisms
• (The market price does not equal the
  socially-efficient shadow price.)

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Potential causes of Market Failure

• Externalities
• An externality occurs where production and/or
  consumption activities impact directly upon human
  well-being, or indirectly via impacts on
  environmental resources, in uncompensated ways.
• Examples
• Electricity production
• Car transport
• Felling of tropical forests

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• Externalities lead to inefficient outcomes
• Outcomes do not maximise social net benefits
  because
• SMC ? SMB
• Solutions to externalities
• The externality has to be INTERNALISED, so that
• SMC SMB

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• Public goods
• Two characteristics
• Non-depletability
• Non-excludability
• Examples
• Clean air
• Wilderness areas
• Biodiversity

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• Public goods
• Non-depletability and non-excludability imply
  that public goods will not be provided in
  efficient quantities, or will not be provided
  at all, through standard market mechanisms.
• (Nor will quality be maintained appropriately).
• Examples again
• Clean air
• Wilderness areas
• Biodiversity

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• Poorly defined property rights
• Limit the scope of bargaining (or judicial)
  solutions to externalities
• (See work of Richard Coase).
• This problem interacts with the public goods
  problem.
• Examples again
• Car transport
• Felling of tropical forests

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• Poorly defined property rights
• Note that property rights do not have to be
  private ones. There are several forms
• Private property rights
• Common property rights
• State owned property rights
• What matters is whether access and use can be
  controlled by the owner. Where this is not
  possible we have
• Open access resource rights

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Efficiency and equity and sustainability Note
that an efficient outcome is not necessarily a
sustainable one, nor is it necessarily an
equitable one. There may be an incompatibility
between these three goals.
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Recommended reading Perman, Ma, McGilvray and
Common (2nd edition) Chapter 1 An
introduction Chapter 2 The origins of the
sustainability problem Chapter 3 Concepts of
Sustainability Chapter 4 Ethics and the
Environment Chapter 5 Welfare economics
efficiency and optimality Chapter 6 Market
failure and public policy