Environmental economics

Introduction

Environmental economics is a subfield of economics concerned with the relationship between the economy and the environment. As such, it is concerned with both the use of resources drawn from the environment as well as the waste put back into the environment.

Environmental economics is useful not only in terms of its ability to facilitate an understanding of why and how economic incentives can contribute to environmental degradation, but also in terms of its ability to design policy solutions to environmental problems based upon the use of economic incentives.

Economic Incentives as Sources of Environmental Degradation

In many parts of the economy the incentives associated with private decisions can be shown to be compatible with social objectives. However, when decisions affect the environment, private decisions can rather frequently promote degradation. Market failure refers to all the situations where private decisions result in outcomes that fail to maximize the value that society could get from its resources.

The first example of a market failure involves externalities. An externality is a consequence of a decision that falls on someone other than the decision-maker. As a result, the decision-maker will either tend to undervalue that consequence or ignore it completely, which can result in private decisions being biased away from socially desirable outcomes.

Take the case of automobile pollution. We all know that exhaust from our automobiles causes pollution, but since the costs of that pollution mainly fall on other people, it is inadequately considered in the types of vehicles purchased, how often that vehicle is used (rather than using public transit or a carpool), and in the number of miles we drive it per year. As a result of this externality, we have a stock of vehicles that is too large, the average vehicle in that stock gets too few miles per gallon, and the fleet is driven an excessive number of miles per year. All these decisions result in more pollution than would result in the absence of externalities.

The second situation involves either the absence of property rights or a counterproductive structure of property rights. Suppose the access to some stock of resources is unrestricted, meaning they are allocated on a first-come, first-served basis. As the aggregate level of use of these open access resources grows, the tendency for overuse will arise. Garrett Hardin's Tragedy of the Commons is perhaps the most familiar example of this phenomenon. This type of outcome can be seen in some fisheries and even in the use of the atmosphere as a repository for pollution.

Using Economic Incentives for Environmental Protection

Increasingly, environmental policy is coming to include economic incentive polices in the policy mix. Some examples of economic incentive polices include:

Environmental taxation. In principle it is better to tax an activity (such a pollution) that you don't want rather than an activity that you do (such as income). Current examples of environmental taxation that are designed to discourage environmentally degrading behavior included emission charges, fuel taxes, and congestion charges. As is the case with water pollution charges in Europe environmental taxes may also be used to raise revenue to finance environmental improvements.

Tradable permits. Under a typical tradable permits system, an aggregate cap is set on resource use and allocated among users such that the sum of the user allocations is equal to the cap. Since users are free to trade their allocated amounts among themselves as long as the cap is not violated, this approach tends either to allow the environmental goal, as expressed via the cap, to be reached at a lower cost than more traditional [[command and control] regulatory policies or to allow a higher goal to be reached with same expenditure. Current examples of this approach to control pollution include the sulfur allowance program in the U.S. and the European Union Emissions Trading Scheme. Current examples of the use of this aproach to control resource use include individual transferable quotas in fisheries and tradable energy certificates for energy production.

Deposit-refund scheme. Under a deposit-refund scheme the purchaser of a product pays a deposit on the container or the product. This deposit is refunded when the product or container is returned to a designated collection center. The key feature to this approach is that it provides an incentive for the consumer to return the item (as opposed to simply throwing it away) and it has no negative budgetary impact on the public sector. The incentive is provided by the consumer's money, not the public treasury. Deposit-refund systems are used for such diverse items as soft drink bottles or cans, waste oil, and even old automobiles.

Liability law. Liability law requires someone who causes an injurious outcome (such as an oil spill) to pay for the clean-up and to compensate those who were injured by the action. By forcing the party that caused the damage to bear all of the costs of that damage, liability law removes the externality and the biased decision-making that results from it. In principle, parties engaged in an activity that poses an environmental risk are encouraged to take all cost-justified levels of precaution. Recent examples of the application of liability law include the 1989 Exxon-Valdez oil spill in Prince William Sound, Alaska, and the 1984 industrial disaster in Bhopal, India.

Disclosure strategies. Increasingly, right-to-know laws are forcing parties posing an environmental risk to make information about the nature and danger of the risk available to the public. Making that information public provides an economic incentive for those posing the risk to limit the adverse publicity resulting from that risk by lowering the magnitude of the risk posed. Examples of the use of thee police include: California's Proposition 65 and the Toxic Release Inventory in the United States.

Certification strategies. Surveys reveal that many consumers are willing to pay higher prices for commodities that pose a lower environmental risk either when they are produced or when they are consumed. However, most consumers would find it difficult to distinguish low- and high-risk products. To correct this information deficiency, certification systems have been set up where third-party certifiers monitor production processes and allow those who meet rigorous standards to label their product as 'green'. Examples include: organic foods, sustainably harvested wood products, and bird-friendly coffee.

These systems offer considerable promise in principle; in practice the experience is mixed. One common source of a failure to live up to expectations is that monitoring and enforcement may be lax.

Further Reading

Glossary

Citation

Tietenberg, T. (2008). Environmental economics. Retrieved from http://www.eoearth.org/view/article/152615

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