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An Economic View of 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
Assolombarda Auditorium, Milano
November 20, 2014

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An Economic View of Environmental Protection

  1. 1. 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 AssolombardaAuditorium, Milano November 20, 2014
  2. 2. “What business are you in?” “I’m an environmental economist.” 1
  3. 3. “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 Understandingenvironmental problems And therefore can be exceptionally helpfulfor the design of solutionsthat will be effective, economically sensible, and politically pragmatic. 2
  4. 4. 3 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? Increase prices? 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?
  5. 5. 4 The Economic Consequences of Pollution 1.Producer Producer (steel production & laundry services –$) 2.Producer Consumer (paper production & recreational fishing) 3.Consumer Consumer (secondary exposure to cigarette smoke) 4.Consumer Producer (littering in a movie theatre –$) 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 …
  6. 6. 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… 5
  7. 7. 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 … 6
  8. 8. 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) 7
  9. 9. 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 8
  10. 10. 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) 9
  11. 11. 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 … 10
  12. 12. 11 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
  13. 13. 12 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) Private industry NGOs Governments 50 research initiatives in Argentina, Australia, China, Europe, India, Japan, and the United States Searching for the Path Forward
  14. 14. 13 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
  15. 15. 14 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 Key Questions 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!
  16. 16. 15 “Environmental Economics” is notan oxymoron. An economic perspective is essentialfor a full understandingof environmental problems. Economic analysis is key for design of solutionsthat are: environmentally effective economically sensible politically pragmatic
  17. 17. 16 For More Information Harvard Project on Climate Agreements Harvard Environmental Economics Program Website Blog Twitter @robertstavins