Topics Today 112008

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Topics Today (11/20/08)

• Economic Growth.
• Environmental Kuznets Curve.
• Sustainable Development.
• HW 7 on web, due in class on Tuesday, December
  2.
• Read 7.1 7.3 for next class.

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Economic Growth

• Theoretically, growth is supposed to reflect
  increases in peoples living standards over time.
• Gross National Product (GNP) is common measure.
• GNP is a monetary measure of the total market
  value of output of a country in any time-period.
• GNP measures all factors of production (land,
  labor, capital) and total spending (consumption
  plus investment).
• GNP typically measured per-capita.

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Economic Growth

• Critiques of GNP
• Only market values are included.
• Environmental externalities are not accounted
  for.
• GNP does not measure fairness or distribution of
  income factors.

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Economic Growth

• Why does GNP grow over time?
• Increasing resources.
• Changes in a countrys capital, labor, land,
  energy, and material resources.
• Capital accumulation (roads, buildings, etc.).
• Productivity growth.
• People learn over time.
• Investments in education and training lead to
  technological advances and to productivity
  growth.

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Economic Growth

• Growth vs. Development
• Development is a broader term than growth.
• Development measures indicators such as
• GNP.
• Income equality.
• Literacy.
• Health factors, including life span, infant
  mortality, etc.
• The U.N.s Human Development Indicator is an
  example.

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Historical Critiques of Economic Growth

• Thomas Malthus (1766-1834)
• Rising living standards lead to
• More people
• Food demand which would outstrip food supply.
• War, disease and famine.
• Malthus is why people refer to economics as the
  dismal science.
• Malthusian (absolute) scarcity the natural
  resource stock is fixed, but demands on resources
  are increasing.

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Historical Critiques of Economic Growth

• David Ricardo (1772-1823)
• Increase in peoples living standards leads to
• More people,
• Food demand which would lead to marginal
  agricultural land being use for production.
• Higher food prices.
• Rich landlords and poor workers.
• Ricardian (relative) scarcity as demand for food
  rises, the average productivity of land falls and
  the cost of food rises.

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Historical Critiques of Economic Growth

• Limits to Growth Report (1972), by an MIT systems
  dynamics group.
• A computer simulation model of the earths
  economic system predicted
• A shortage of natural resources.
• Population growth leading to starvation.
• Ever-increasing pollution.
• The environment has a carrying capacity.
• A trade-off exists between economic growth and
  human survival.

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The Environmental Kuznets Curve (EKC)

• The only way to attain a decent environment in
  most countries is to become rich. Wilfred
  Beckerman, 1992.
• Environmental Kuznets Curve as per capita
  incomes grow, environmental impacts rise, hit a
  maximum, and then decline.

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The Environmental Kuznets Curve (EKC)
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The Environmental Kuznets Curve (EKC)

• Up to Y, pollution rises with income. Why?
• Economic growth results in an increased use of
  resources.
• Growth results in more waste.
• After Y, pollution declines with income. Why?
• As people get rich, they demand higher levels of
  environmental quality.
• Technological improvements make production
  cleaner.
• The logic of EKC hypothesis is the following
• People first want food and shelter.
• Next they demand amenities.

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The Environmental Kuznets Curve (EKC)

• Evidence on EKC
• Evidence for EKC
• SO2 Y4000-6000/year GNP/capita (Grossman and
  Krueger 1995).
• Evidence against EKC
• CO2 Y8 million/capita (Hotz-Eakin and Selden
  1995).
• Evidence neither for nor against EKC
• SO2, Smoke, TSP the available empirical
  evidence cannot be used to support either the
  proposition that economic growth helps the
  environment or the proposition that it harms the
  environment. (Harbaugh et al. 2002).
• EKC more likely for local and regional pollutants
  than for global pollutants.

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Sustainable Development (SD)

• Bruntland Commission (1987) development that
  meets the needs of present generations without
  compromising the ability of future generations to
  meet their own needs.
• Sustainable Development (SD) often reflects
• Fairness across generations.
• Fairness within generations.
• The bigger the economic pie, the more there is to
  go around.

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Economic Definition of SD

• Three forms of capital
• Man-made capital (Km) machinery, roads, bridges,
  satellites, etc.
• Human capital (Kh) labor, knowledge, etc.
• Natural capital (Kn) renewable and non-renewable
  resources.
• Total capital stock K Km Kh Kn.

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Economic Definition of SD

• How can Kn be measured?
• How to add barrels of oil with acres of forest?
• Convert all forms of Kn to money?
• Some resources have monetary values (e.g. oil),
  but many dont (e.g. wolves).
• Impossible to quantify all non-market values.
• An alternative is to measure groups of natural
  resources
• Ex/ all forests in a country.
• Ex/ global fish stocks.

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Sustainability Rules

• Weak sustainability no declines in K Km Kh
  Kn
• Implies that Km and/or Kh can substitute for Kn.
• Strong sustainability no declines in Kn.
• Implies that neither Km or Kh can substitute for
  Kn.
• Alternative strong sustainability no declines in
  critical Kn.
• Critical Kn is a subset of Kn which is either
• Essential for human survival and/or
• Not substitutable by other elements of Kn, Km, or
  Kh.
• Ex/ Climate regulatory functions.

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Markets and Sustainability

• We want to allocate a fixed non-renewable
  resource over two periods.
• Assumptions
• Demand is known for both periods
• p 20 - q
• Marginal cost is known for both periods
• MCt5/unit
• Discount rate is 10.
• There are 4 units of the resource.

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Markets and Sustainability

• A one-period market solution with no scarcity

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Markets and Sustainability

• What will the market do?
• Applying Hotellings Rule
• Backstop price PT 20.
• PT-1 (PT MC)/(1r) MC 18.60
• QT-1 20 - PT-1 1.4 units.
• PT-2 (PT-1 - MC)/(1r) MC 17.40
• QT-2 20 PT-2 2.6 units.
• Resource is depleted in two periods.

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Markets and Sustainability
CS Consumer surplus PS Producer surplus
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Markets and Sustainability

• Total Value
• Period 1
• CS (1/2)(20 - 17.40)(2.6) 3.38
• PS (17.40 - 5)(2.6) 32.24
• Period 1 value 35.62
• Period 2
• CS (1/2)(20 - 18.60)(1.4) 0.98
• PS (18.60 5)(1.4) 19.04
• Discounted period 2 value 20.02/1.1 18.20.
• Total value 35.62 18.20 53.82.
• Efficient markets are not necessarily fair.

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Markets and Sustainability

• A fair allocation consume 2 units in each
  period.
• If Q1Q22 gt P1P218.
• Total Value
• Period 1 CS PS 2 26 28.
• Period 2 CS PS 2 26 28.
• Discounted period 2 28/1.1 25.45.
• Total value 28 25.45 53.45.

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Markets and Sustainability

• Are efficient markets always unfair to future
  generations?
• Not necessarily.
• Possibility of investment.
• Suppose period 1 generation keeps 28 and invests
  the remaining 7.62 at 10 interest.
• Period 2 generation gets 20.02 from consuming
  the remaining resource and 8.38 from the
  investment gt 28.40 total value.
• Period 2 generation could be better off with
  efficient markets and investment.

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Potential Government Response to SD

• Value all environmental services at their correct
  prices.
• Internalize externalities (e.g. green taxes).
• Implies setting property rights and correcting
  market failure.
• Problems
• Impossible to value all non-market goods.
• Addresses efficiency, but not necessarily
  fairness.

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Potential Government Response to SD

• The Hartwick rule
• Reinvest all profits (p-mc) from exploiting
  non-renewable resources in Km.
• The Hartwick rule intuitively
• Suppose your grandparents left you 10,000.
• You put it in a bank at 10 interest.
• If you spend 1000 per year, the 10,000 would
  remain in the bank and last indefinitely.
• If you spend more than 1000 per year, youll
  eventually deplete your savings.
• Spending more than 1000 per year is
  unsustainable by the Hartwick rule.

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Potential Government Response to SD

• The Hartwick rule
• Achieves weak sustainability.
• Problems
• Assumes the environment only matters as a source
  of inputs to production.
• Assumes Km and Kn are perfect substitutes.

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Potential Government Response to SD

• Herman Dalys Operational Principles
• Renewable resources harvest less than or equal
  to growth rates.
• Non-renewable resources invest sufficient income
  from extraction in renewable substitutes.
• Pollutants ensure that emissions dont exceed
  the assimilative capacity of the environment in
  any given time period.
• Control the scale of the world economy.

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Potential Government Response to SD

• Relevant issues with Dalys principles
• How much income is sufficient to invest in
  renewables?
• How to calculate assimilative capacity?
• What welfare losses result from controlling the
  scale of the economy?
• Cost of reducing energy use?
• Cost of controlling population?

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Potential Government Response to SD

• Shadow projects for natural capital (Kn)
• Reductions in Kn should be offset by
  replacements.
• Ex/ U.S. policy of no net loss in wetlands.
• Problems
• Do replacements adequately substitute for losses
  (e.g. young forests for old growth)?
• Non-renewables have a fixed stock.