How economists see the environment

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How economists see the environment

  1. 1. commentaryHow economists see the environmentEconomists and ecologists misunderstand each other about the environment. Improving interdisciplinarycommunication should enable natural scientists to take economic analysis and prescriptions more seriously.Don Fullerton and Robert StavinsOn a topic such as the environment, com- Supply pollutant emissions or limiting access to open-access resources, which can improve welfare and lead to greater efficiency. 8munication among those from different dis-ciplines in the natural and social sciences is Myth of market solutionsboth important and difficult. Economists A second common myth is that economiststhemselves may have contributed to some always recommend a market solution to amisunderstandings about how they think market problem. Economists tend to searchabout the environment, perhaps through for instruments of public policy that can fixenthusiasm for market solutions, perhaps by one market essentially by introducingneglecting to make explicit all the necessary another, allowing each to operate efficiently Demandqualifications, and perhaps simply by the use on its own. If pollution imposes large exter-of jargon. nal costs, for example, the government can There are several prevalent myths about establish a market for rights to emit a limitedhow economists think about the environ- amount of that pollutant. Such a market forment. By examining them here, we hope to tradable emission permits will work if thereexplain how economists really do think are many buyers and sellers, all are wellabout the natural environment. informed, and the other conditions of the ‘first theorem’ are met. In this case, the gov-Myth of the universal market ernment’s role is to enforce the rights andThe first myth is that economists believe that An economist’s view of the environment. responsibilities of permit ownership, so thatthe market solves all problems. The “first each unit of emissions is matched by thetheorem of welfare economics”, as taught to fied simultaneously in the real world. ownership of one emission permit. Then thegenerations of economics students, is that When a market thus fails, this same theo- market for the output will also work, as theprivate markets are perfectly efficient on rem offers guidance. For any particular mar- producer has to pay a price for each permittheir own, with no interference from govern- ket, it asks whether the number of sellers is that reflects the social cost of the associatedment, provided certain conditions are met. sufficiently small to warrant antitrust action, pollution. Equivalently, producers can be This theorem, easily proved, is excep- whether the returns to scale are great enough required to pay a tax on their emissions thattionally powerful, because it means that no to justify tolerating a single producer in a reg- reflects the external social cost. Either way,one needs to tell producers of goods and ser- ulated market, or whether the benefits from the result in theory will be the efficientvices what to sell to which consumers. the good are public in a way that might justify amount of pollution abatement, undertakenInstead, self-interested producers and con- outright government provision of it. A pub- at minimum aggregate abatement cost.sumers meet in the market-place, engage in lic good, like the light from a lighthouse, ben- This tradable-permit approach has muchtrade, and thereby achieve the greatest good efits additional users at no cost to society. to recommend it, and can be just the rightfor the greatest number, as if “guided by an Environmental economists are interested solution in some cases, but it is still a ‘market’.invisible hand”1. This maximum general in pollution and other externalities, where Therefore the outcome will be efficient onlywelfare is what economists mean by the ‘effi- some consequences of producing or con- if certain conditions are met. But these con-ciency’ of competitive markets. Economists suming a good or service are external to the ditions are not always met2. Could the sale ofin business schools are particularly fond of market (not considered by producers or con- permits be monopolized by a small numberidentifying markets where the necessary sumers). With a negative externality, such as of buyers or sellers? Do problems arise fromconditions are met, such as the stock market, environmental pollution, the total social cost inadequate information or significant trans-where many buyers and sellers operate with of production may exceed the value to con- action costs? Will the government find it toogood information and low transaction costs sumers. If the market is left to itself, too many costly to measure emissions? If the answer toto trade well-defined commodities with pollution-generating products are made. any such question is yes, the permit marketenforced rights of ownership. Similarly, natural-resource economists may work less than optimally. The environ- Other economists, especially those in are interested in common property, or open- mental goal may still be met, but at morepublic policy schools, have a different access resources, where anyone can extract than minimum cost.approach to this theorem. By clarifying the or harvest the resource freely and no one rec- As an example, to reduce acid rain in theconditions under which markets are effi- ognizes the full cost of using the resource. United States, amendments to the Clean Aircient, the theorem also identifies the condi- Extractors consider only their own direct Act of 1990 require electricity generators totions under which they are not. Private mar- and immediate costs, not the costs to others hold a permit for each tonne of SO2 they emit.kets are perfectly efficient only if there are no of increased scarcity (‘user cost’ or ‘scarcity A robust market for the permits has emerged,public goods, no externalities, no monopoly rent’). The result is that the resource is in which well-defined prices are broadlybuyers or sellers, no increasing returns to depleted too quickly. known to many potential buyers and sellers.scale, no information problems, no transac- So, the market by itself demonstrably Through continuous emissions monitoring,tion costs, no taxes, no common property does not solve all problems. Indeed, in the the government can track SO2 emissionsand no other ‘distortions’ between the costs environmental domain, perfectly function- from each plant. Equally important, penal-paid by buyers and the benefits received by ing markets are the exception rather than the ties are significantly greater than incrementalsellers. Those conditions are obviously very rule. Governments can try to correct these abatement costs and hence are sufficient torestrictive, and they are usually not all satis- market failures, for example by restricting ensure compliance. Overall, this marketNATURE | VOL 395 | 1 OCTOBER 1998 | www.nature.com Nature © Macmillan Publishers Ltd 1998 433
  2. 2. commentaryworks; acid rain deposition is being reduced reveal their preferences, as when individuals combine efficiency and distributional issuesby 50 per cent in a cost-effective manner. pay more for a house in a neighbourhood in a unified analysis. A permit market achieves this efficiency with cleaner air, all else being equal5. Available data often permit reliable esti-through trades because any company that has This is not to suggest that economists are mates of the impacts of environmental poli-high abatement costs can buy permits from concerned only with the financial value of cies on important subgroups of the popula-another that has low costs, so reducing the things. Far from it. The financial flows that tion7. On the other hand, environmental reg-total cost of abating pollution. These trades make up the gross national product represent ulations are neither effective nor efficientalso switch the source of the pollution fromone company to another, which is unimpor-tant when any emissions equally affect the only a fraction of all economic flows. The scope of economics encompasses the alloca- tion and use of all scarce resources. For exam- tools for achieving redistributional goals. The best economic analyses recognize the contributions and limitations of efficiency 8whole trading area. This ‘perfect mixing’ ple, the economic value of the human-health and distributional measures.assumption is certainly valid for global prob- damages of environmental pollution islems such as greenhouse gases or the effect of greater than the sum of health-care costs and Where does this leave us?chlorofluorocarbons on the stratospheric lost wages (or lost productivity), as it includes To summarize, economists do not necessarilyozone layer. It may also work reasonably well what lawyers would call ‘pain and suffering’. believe that the market solves all problems.for a regional problem such as acid rain, Economists might use a market price indi- Indeed, many economists, ourselves includ-because acid deposition in downwind states rectly to measure revealed rather than stated ed, make a living out of analysing market fail-of New England is about equally affected by preferences, but the goal is to measure the ures such as environmental pollution inSO2 emissions that were traded among total value of the loss that individuals incur. which laissez-faire policy leads not to socialupwind sources in Ohio, Indiana or Illinois. To take another example, the economic efficiency, but to inefficiency. When econo-But it does not work perfectly, as acid rain in value of part of the Amazon rainforest is not mists identify market problems, their ten-New England may increase if a plant there limited to its financial value as a repository of dency is first to consider the feasibility ofsells permits to a plant in the mid-west. future pharmaceutical products or as a loca- market solutions because of their poten- At the other extreme, many environmen- tion for ecotourism. That ‘use’ value may tial cost-effectiveness, but market-basedtal problems might not be addressed appro- only be a small part of the properly defined approaches to environmental protection arepriately by tradable-permit systems or other economic valuation. For decades, econo- no panacea. When market or non-marketmarket-based policy instruments4. One mists have recognized the importance of solutions to environmental problems areexample is a hazardous air pollutant such as ‘non-use’ value of environmental amenities being assessed, economists do not limit theirbenzene that does not mix in the airshed and such as wilderness areas or endangered analysis to financial considerations but useso can cause localized ‘hotspots’. Because a species. The public nature of these goods money as a unit of measurement in thecompany can buy permits and increase local make it particularly difficult to quantify absence of a more convenient unit. Andemissions, permit trading does not ensure these values empirically, as we cannot use although the efficiency criterion is by defini-that each location will meet a specific stan- market prices! The important fact is that tion aggregate in nature, economic analysisdard. Moreover, the damages caused by local benefit–cost analysis of environmental poli- can reveal much about the distribution ofconcentrations may increase nonlinearly. If cies, virtually by definition, cannot rely the benefits and costs of environmentalso, then even a permit system that reduces exclusively on market prices6. policy.total emissions might allow trades that move Economists insist on trying to convert all Having identified and sought to dispelthose emissions to a high-impact location these disparate values into monetary terms four prevalent myths about how economistsand thus increase total damages. because a common unit of measure is needed think about the natural environment, we The bottom line is that no specific policy to be able to add them up. How else can we acknowledge that our profession bears someinstrument, or even set of policy instruments, combine the benefits of ten extra miles of vis- responsibility for the existence of such mis-is a panacea. Market instruments do not ibility plus some amount of reduced mor- understandings. Like their colleagues inalways provide the best solutions, and some- bidity, and then compare these total benefits other social and natural sciences, academictimes not even satisfactory solutions. with the total cost of installing scrubbers to economists focus their greatest energies on clean stack gases at coal-fired power plants? communicating to their peers within theirMyth of market prices Money, after all, is simply a medium of own discipline. Greater effort can certainlyThe next myth is that, when non-market exchange, a convenient way to add together be made to improve communication acrosssolutions are considered, economists still use or compare disparate goods and services. disciplinary boundaries.only market prices to evaluate them. No mat- Don Fullerton is in the Department of Economics,ter what policy instrument is chosen, the Myth of efficiency University of Texas at Austin, Texas 78712, USAenvironmental goal of that policy must be The last myth we address here is that these and at the National Bureau of Economic Research.identified. For example, should vehicle emis- economic analyses are concerned only with Robert Stavins is at the John F. Kennedy School ofsions be reduced by 10, 20 or 50 per cent? efficiency rather than distribution. Many Government, Harvard University, Cambridge,Economists frequently try to identify the economists do give more attention to mea- Massachusetts 02138, USA and Resources for themost efficient degree of control that provides sures of aggregate social welfare than to mea- Future.the greatest net benefit. This means, of sures of the distribution of the benefits and The authors are grateful for suggestions from Robert Frosch, Robertcourse, that both benefits and costs need to costs of policies among members of society. Hahn, Gilbert Metcalf, Richard Revesz and Thomas Schelling.be evaluated. True enough, economists typi- The reason is that an improvement in eco- 1. Smith, A. An Inquiry into the Nature and Causes of the Wealth ofcally favour using market prices, whenever nomic efficiency can be determined by a sim- Nations (Whitestone, Dublin, 1776). 2. Hahn, R. W. & Hester, G. L. Ecol. Law Q. 16, 361–406 (1989).possible, to carry out such evaluations, ple and unambiguous criterion — an 3. Schmalensee, R. et al. J. Econ. Perspect.12, No. 3 (Summerbecause these prices reveal how members of increase in total net benefits. What consti- 1998).society actually value the scarce amenities tutes an improvement in distributional equi- 4. Hahn, R. W. & Stavins, R. N. Am. Econ. Rev. 82, 464–468and resources under consideration. ty, on the other hand, is inevitably the subject (1992). 5. Smith, V. K. & Huang, J.-C. J. Polit. Econ. 103, 209–227 (1995). Economists are wary of asking people of considerable dispute. Nevertheless, many 6. Arrow, K. et al. Science 272, 221–222 (1996).how much they value something, as respon- economists do analyse distributional issues 7. Christiansen, G. B. & Tietenberg, T. H. in Handbook of Naturaldents may not provide honest assessments of thoroughly. The more difficult problem, not Resource and Energy Economics Vol. 1 (eds Kneese, A. V. &their own valuations. Instead, actions may yet solved in a satisfactory manner, is how to Sweeney, J. L.) 345–393 (North-Holland, Amsterdam, 1985).434 Nature © Macmillan Publishers Ltd 1998 NATURE | VOL 395 | 1 OCTOBER 1998 | www.nature.com

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