An Economic Viewof Environmental Protection
Robert N. Stavins
Albert Pratt Professor of Business and Government
John F. Kennedy School of Government, Harvard University
Conference on Sustainability in Manufacturing
Assoreca and the Green Economy Network
November 20, 2014
“What business are you in?”
“I’m an environmental economist.” 1
“Environmental economics” is notoxymoronic.
1.The causes of environmental problems (in a market economy) are economic –unintended side-effects of market activity (“externalities”).
2.The consequences of environmental problems have important economic dimensions.
Therefore, an economic perspective is essentialfor
And therefore can be exceptionally helpfulfor the design of solutionsthat will be effective, economically sensible, and politically pragmatic.
The Causes of Environmental Pollution are Economic
Pollution is an externality.
May(U.S.) firms go beyond full compliance with the law (sacrifice profits in the social interest)?
For publicly-owned firms:
Fiduciary responsibility to shareholders
But the business- judgment rule (long- term, public relations)
Canfirms –public or private –go beyond full compliance on a sustainable basis?
Commodities vs niche markets
Some firms can pass on price increase – monopolists
Where does the pollution go?
Commercial laundry next door
Does cost (to laundry) show up in annual report of steel producer?
The Economic Consequences of Pollution
(steel production & laundry services –$)
(paper production & recreational fishing)
(secondary exposure to cigarette smoke)
(littering in a movie theatre –$)
Economic consequences ≥ financial consequences
Economics is notthe same as accounting
The most important economic impacts are notthe most obvious
Economic perspective is particularly important when thinking about global climate change …
Science Economics Geopolitics of Climate Change
Greenhouse gases mix in the atmosphere, so the location of emissions has no effecton impacts –In economic terms, climate change is a global commons problem
Any jurisdiction taking action –a country, province, or city –incurs the costs of its actions
But direct benefits (averted climate change) are distributed globally
Therefore, for virtually any jurisdiction, the direct climate benefits it reaps from its actions will be lessthan the direct costs it incurs ….
despite the fact that the global benefits may be greater–possibly muchgreater –than the global costs
This presents a classic free-rider problem, ….
which is why international, if not global, cooperation will be essential,
And why the highest levelsof effective governance need to be engaged, that is, national governments…
Most policy analysts favor national carbon-pricing. Why?
No other feasible approach can provide meaningful emissions reductions
Least costly approach in short term (heterogeneous abatement costs)
Least costly approach in the long term (incentive for carbon-friendly technological change)
Most policies have favored cap-and-trade over carbon taxes, partly because of experience …
Experience with Cap-and-Trade Policies
U.S. EPA Leaded Gasoline Phasedown (1982-1987)
U.S. SO2Allowance Trading, CAAA of 1990 (1995-2010)
European Union Emissions Trading System (2008-2020)
U.S. Regional Greenhouse Gas Initiative, RGGI (2009-2019)
California’s AB-32 GHG Cap-and-Trade System (2013-2020)
California’s Global Warming Solutions Act (2006, AB 32)
Broad, ambitious policy to cut GHG emissions to 1990 level by 2020
Energy efficiency standards for vehicles, buildings, & appliances
Renewable portfolio standard (increases from 20% to 33%)
Low carbon fuel standard
Cap-and-trade system …
Cap covers 85%of economy, declinesfrom 2012 through 2020
Increasing use of auctionsover time
Price collar creates essentially a hybrid of cap-and-trade and tax
Provides protection for trade-sensitive industries
Lessons from California’s AB 32 Cap-and-Trade System
Carbon pricing is necessary, but not sufficient, due to other market failures
Examples include basic R&D and principal-agent problem (buildings)
So, specific non-pricing policies can be complementary
But some “complementary policies” conflictrather than complement!
California example–Low Carbon Fuel Standard, Renewable Electricity Standards
Consequences of policy for sources under the cap of a cap-and-trade system
Achieves no incremental CO2emission reductions–relocates emissions
Drives up abatement costs(marginal costs not equated)
Suppresses allowance price(by reducing overall demand for allowances)
With carbon taxes, other policies can achieve additional reductions (but not c/e)
As long as cap-and-trade is employed, many so-called “complementary policies” are nothing of the kind! (Also a major problem with European Union policies)
More Lessons from California’s Cap-and-Trade System
Initial free allocation fostered political support
Economy-wide system feasible, and much more effectivethan sectoralsystem
Price collar effective (Europe resistant to this)
Free allocation per se does notaffect leakage/competitiveness (inframarginal)
So, attemptsat competitiveness protection under EU ETS are ineffective
But output-based updatingsystem makes allocations marginal
So, in California system, this reduces competitiveness and leakage risksfor trade-sensitive sectors
But leakage risks remain for electricity sector, due to contract reshuffling
Ultimately, only way to eliminateleakage/competitiveness risk is through broader (national & international) coalition of action …
International climate change policy is a marathon, not a sprint
Scientifically: stock, not flow environmental problem
Economically: cost-effective path is gradual global ramp-up in target severity (to avoid unnecessary capital-stock obsolescence)
Economically: technological change is key, hence long-term price signals
Administratively: creation of durable international institutions is essential
International climate negotiations will be an ongoing process –much like trade talks –not a single task with a clear end-point
So, sensible goal for climate negotiations is progress on sound foundation for meaningful long-term action, not necessarily an immediate “solution”
A View of the International Domain: Placing Climate Negotiations in Perspective
The Harvard Project on Climate Agreements
Mission: To help identify key design elements of a scientifically sound, economically rational, and politically pragmatic international policy architecture for global climate change
Drawing upon research & ideas from leading thinkers around the world from:
Academia (economics, political science, law, international relations)
50 research initiatives in Argentina, Australia, China,
Europe, India, Japan, and the United States
Searching for the Path Forward
Four lessons have emerged
1.Market-based approaches are essential
2.Getting (carbon) prices right is necessary, but notsufficient
•Because of public-good nature of R&D, private sector will under-invest
•Possible need for government-funding of private-sector R&D, such as for CCS
3.“Developing county” participation is essential
•Impossibleto address climate change withoutmeaningful participation by China & other key emerging economies (even ifOECD emissions were zero)
•Central taskin international negotiations is developing means of bringing key emerging economies on board
4.Defacto interim(or post-2020) policy architecture mayalready be emerging
Direct and indirect linkage of regional, national, and sub-national cap-and-trade and other policy instruments
A Hybrid International Climate Policy Architecture
Bottom-up: National targets and actions that arise from –or are at least consistent with –national policies and goals.
Top-down: Centralized oversight, guidance, and coordination.
The Path Ahead to COP-21 in Paris, December 2015
Can such an agreement that is anchoredin domestic political realities, …
… adequately address emissions with sufficient ambition?
Are there ways to enable and facilitate increased ambitionover time?
Linkage of regional, national, and sub-national policies can be part of the answer.
Full answer forthcoming in Paris one year from now!
“Environmental Economics” is notan oxymoron.
An economic perspective is essentialfor a
full understandingof environmental problems.
Economic analysis is key for design of solutionsthat are:
For More Information
Harvard Project on Climate Agreements
Harvard Environmental Economics Program