Environmental and Natural Resource Economics - 11th Edition

Environmental and Natural Resource Economics Environmental and Natural Resource Economics Environmental and Natural Resource Economics is the bestselling text for natural resource economics and environmental economics courses offering a policyoriented approach and introducing economic theory and empirical work from the field Students will leave the course with a global perspective of both environmental and natural resource economics and how they interact Complemented by a number of case studies showing how underlying economic principles provided the foundation for specific environmental and resource policies this key text highlights what can be learned from the actual experience This new 11th edition includes updated data a number of new studies and brings a more international focus to the subject Key features include Extensive coverage of the major issues including climate change air and water pollution sustainable development and environmental justice Dedicated chapters on a full range of resources including water land forests fisheries and recyclables Introductions to the theory and method of environmental economics including externalities benefitcost analysis valuation methods and ecosystem goods and services Boxed Examples and Debates throughout the text which highlight global examples and major talking points The text is fully supported with endofchapter summaries discussion questions and selftest exercises in the book and multiplechoice questions simulations references slides and an instructors manual on the Companion Website Tom Tietenberg is the Mitchell Family Professor of Economics Emeritus at Colby College Maine USA Lynne Lewis is Elmer W Campbell Professor of Economics at Bates College Maine USA The Economic Approach Taylor Francis Taylor Francis Group httptaylorandfranciscom Choice Experiment Attributes and Levels Environmental and Natural Resource Economics 11th Edition Tom Tietenberg and Lynne Lewis Routledge Taylor Francis Group NEW YORK AND LONDON ROUTLEDGE Eleventh edition published 2018 by Routledge 711 Third Avenue New York NY 10017 and by Routledge 2 Park Square Milton Park Abingdon Oxon OX14 4RN Routledge is an imprint of the Taylor Francis Group an informa business 2018 Taylor Francis The right of Tom Tietenberg and Lynne Lewis to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright Designs and Patents Act 1988 All rights reserved No part of this book may be reprinted or reproduced or utilised in any form or by any electronic mechanical or other means now known or hereafter invented including photocopying and recording or in any information storage or retrieval system without permission in writing from the publishers Trademark notice Product or corporate names may be trademarks or registered trademarks and are used only for identification and explanation without intent to infringe First edition published by Scott Foresman and Co 1984 Tenth edition published by Pearson 2014 Library of Congress CataloginginPublication Data A catalog record for this book has been requested ISBN 9781138632295 hbk ISBN 9781315208343 ebk Typeset in Sabon by Keystroke Neville Lodge Tettenhall Wolverhampton Visit the Companion Website wwwroutledgecomcwTietenberg v Contents in Brief Preface xxiii New to this Edition xxiii An Overview of the Book xxv 1 Visions of the Future 1 2 The Economic Approach Property Rights Externalities and Environmental Problems 17 3 Evaluating TradeOffs BenefitCost Analysis and Other DecisionMaking Metrics 45 4 Valuing the Environment Methods 73 5 Dynamic Efficiency and Sustainable Development 107 6 Depletable Resource Allocation The Role of Longer Time Horizons Substitutes and Extraction Cost 123 7 Energy The Transition from Depletable to Renewable Resources 145 8 Recyclable Resources Minerals Paper Bottles and EWaste 171 9 Water A Confluence of Renewable and Depletable Resources 197 10 A Locationally Fixed Multipurpose Resource Land 233 11 Storable Renewable Resources Forests 251 12 CommonPool Resources Commercially Valuable Fisheries 273 13 Ecosystem Goods and Services Natures Threatened Bounty 307 14 Economics of Pollution Control An Overview 333 15 StationarySource Local and Regional Air Pollution 357 16 MobileSource Air Pollution 373 17 Climate Change 399 Contents in Brief vi 18 Water Pollution 421 19 Toxic Substances and Environmental Justice 453 20 The Quest for Sustainable Development 475 21 Visions of the Future Revisited 499 Answers to SelfTest Exercises 509 Glossary 529 Index 545 vii Contents in Full Preface xxiii New to this Edition xxiii An Overview of the Book xxv 1 Visions of the Future 1 Introduction 1 The SelfExtinction Premise 1 Future Environmental Challenges 2 Climate Change 2 Example 11 A Tale of Two Cultures 3 Water Accessibility 4 Example 12 Climate Change and Water Accessibility How Are these Challenges Linked 5 Meeting the Challenges 5 How Will Societies Respond 6 The Role of Economics 7 Debate 11 Ecological Economics versus Environmental Economics 7 The Use of Models 8 The Road Ahead 9 The Underlying Questions 9 Example 13 Experimental Economics Studying Human Behavior in a Laboratory 10 Debate 12 What Does the Future Hold 11 An Overview of the Book 12 Summary 13 Discussion Questions 13 SelfTest Exercise 14 Further Reading 14 2 The Economic Approach Property Rights Externalities and Environmental Problems 17 Introduction 17 Contents in Full viii The HumanEnvironment Relationship 18 The Environment as an Asset 18 The Economic Approach 19 Example 21 Economic Impacts of Reducing Hazardous Pollutant Emissions from Iron and Steel Foundries 20 Environmental Problems and Economic Efficiency 21 Static Efficiency 21 Property Rights 23 Property Rights and Efficient Market Allocations 23 Efficient Property Rights Structures 23 Producers Surplus Scarcity Rent and LongRun Competitive Equilibrium 24 Externalities as a Source of Market Failure 25 The Concept Introduced 25 Types of Externalities 26 Example 22 Shrimp Farming Externalities in Thailand 27 Perverse Incentives Arising from Some Property Right Structures 27 Public Goods 30 Imperfect Market Structures 31 Example 23 Public Goods Privately Provided The Nature Conservancy 33 Asymmetric Information 34 Government Failure 34 The Pursuit of Efficiency 36 Private Resolution through NegotiationProperty Liability and the Coase Theorem 36 Legislative and Executive Regulation 39 An Efficient Role for Government 40 Example 24 Can EcoCertification Make a Difference Organic Costa Rican Coffee 40 Summary 42 Discussion Questions 42 SelfTest Exercises 43 Further Reading 44 3 Evaluating TradeOffs BenefitCost Analysis and Other DecisionMaking Metrics 45 Introduction 45 Normative Criteria for Decision Making 45 Evaluating Predefined Options BenefitCost Analysis 46 Finding the Optimal Outcome 47 Relating Optimality to Efficiency 48 Comparing Benefits and Costs across Time 49 Dynamic Efficiency 51 Contents in Full ix Applying the Concepts 51 Pollution Control 51 Example 31 Does Reducing Pollution Make Economic Sense Evidence from the Clean Air Act 52 Estimating Benefits of Carbon Dioxide Emission Reductions 54 Example 32 Using the Social Cost of Capital The DOE Microwave Oven Rule 55 Issues in Benefit Estimation 56 Debate 31 What Is the Proper Geographic Scope for the Social Cost of Carbon 57 Approaches to Cost Estimation 58 The Treatment of Risk 58 Distribution of Benefits and Costs 60 Choosing the Discount Rate 60 Example 33 The Importance of the Discount Rate 61 Debate 32 Discounting over Long Time Horizons Should Discount Rates Decline 62 Divergence of Social and Private Discount Rates 63 A Critical Appraisal 64 Example 34 Is the Two for One Rule a Good Way to Manage Regulatory Overreach 65 Other DecisionMaking Metrics 66 CostEffectiveness Analysis 66 Impact Analysis 68 Summary 68 Discussion Questions 69 SelfTest Exercises 70 Further Reading 71 4 Valuing the Environment Methods 73 Introduction 73 Why Value the Environment 74 Debate 41 Should Humans Place an Economic Value on the Environment 75 Valuation 75 Types of Values 77 Classifying Valuation Methods 78 Stated Preference Methods 78 Contingent Valuation Method 79 Debate 42 Willingness to Pay versus Willingness to Accept Why So Different 81 Choice Experiments 83 Example 41 Leave No Behavioral Trace Using the Contingent Valuation Method to Measure PassiveUse Values 84 Example 42 The Value of US National Parks 87 Contents in Full x Revealed Preference Methods 89 Example 43 Using the Travel Cost Method to Estimate Recreational Value Beaches in Minorca Spain 90 Benefit Transfer and MetaAnalysis 91 Using Geographic Information Systems to Enhance Valuation 92 Challenges 93 Example 44 Using GIS to Inform Hedonic Property Values Visualizing the Data 94 Example 45 Valuing the Reliability of Water Supplies Coping Expenditures in Kathmandu Valley Nepal 95 Debate 43 Distance Decay in Willingness to Pay When and How Much Does Location Matter 96 Valuing Human Life 97 Debate 44 What Is the Value of a Polar Bear 98 Debate 45 Is Valuing Human Life Immoral 100 Summary Nonmarket Valuation Today 102 Discussion Question 103 SelfTest Exercises 103 Further Reading 104 5 Dynamic Efficiency and Sustainable Development 107 Introduction 107 A TwoPeriod Model 108 Defining Intertemporal Fairness 112 Are Efficient Allocations Fair 113 Example 51 The Alaska Permanent Fund 114 Applying the Sustainability Criterion 114 Example 52 Nauru Weak Sustainability in the Extreme 116 Implications for Environmental Policy 117 Summary 117 Discussion Question 118 SelfTest Exercises 118 Further Reading 120 Appendix The Simple Mathematics of Dynamic Efficiency 120 6 Depletable Resource Allocation The Role of Longer Time Horizons Substitutes and Extraction Cost 123 Introduction 123 A Resource Taxonomy 124 Efficient Intertemporal Allocations 127 The TwoPeriod Model Revisited 127 The NPeriod ConstantCost Case 128 Transition to a Renewable Substitute 129 Increasing Marginal Extraction Cost 131 Exploration and Technological Progress 133 Contents in Full xi Example 61 Historical Example of Technological Progress in the Iron Ore Industry 134 Market Allocations of Depletable Resources 134 Appropriate Property Rights Structures 135 Environmental Costs 135 Example 62 The Green Paradox 137 Summary 138 Discussion Question 138 SelfTest Exercises 139 Further Reading 140 Appendix Extensions of the Constant Extraction Cost Depletable Resource Model Longer Time Horizons and the Role of an Abundant Substitute 141 7 Energy The Transition from Depletable to Renewable Resources 145 Introduction 145 Natural Gas From Price Controls to Fracking 146 Some Early History 146 Fracking 147 Oil The Cartel Problem 148 Price Elasticity of Demand 148 Debate 71 Does the Advent of Fracking Increase Net Benefits 149 Income Elasticity of Demand 150 Nonmember Suppliers 150 Compatibility of Member Interests 151 Fossil Fuels National Security Considerations 152 Debate 72 How Should Countries Deal with the Vulnerability of Imported Oil 154 Example 71 Strategic Petroleum Reserve 156 Example 72 Fuel from Shale The Bakken Experience 157 Electricity The Role of Depletable Resources 158 Electricity Transitioning to Renewables 159 Debate 73 Dueling Externalities Should the United States Promote Wind Power 160 Example 73 The Relative CostEffectiveness of Renewable Energy Policies in the United States 162 Electricity Energy Efficiency 163 Example 74 Energy Efficiency in Rental Housing Markets 164 Electricity Targeted Distributed Energy 165 Example 75 Energy Efficiency Rebound and Backfire Effects 165 Example 76 Thinking about Cost Reduction Outside of the Box The Boothbay Pilot Project 166 Example 77 The Economics of Solar Microgrids in Kenya 166 Summary 167 Discussion Questions 168 Contents in Full xii SelfTest Exercises 168 Further Reading 170 8 Recyclable Resources Minerals Paper Bottles and EWaste 171 Introduction 171 Minerals 171 An Efficient Allocation of Recyclable Resources 173 Extraction and Disposal Cost 173 Recycling A Closer Look 174 Recycling and Ore Depletion 176 Factors Mitigating Resource Scarcity 176 Exploration and Discovery 176 Example 81 Lead Recycling 177 Technological Progress 177 Substitution 178 Example 82 The Bet 179 Market Imperfections 180 Disposal Cost and Efficiency 180 The Disposal Decision 180 Disposal Costs and the Scrap Market 181 Subsidies on Raw Materials 182 Corrective Public Policies 183 Example 83 An Early Example Pricing Trash in Marietta Georgia 183 Example 84 Does Packaging Curbside Recycling with Incentives Promote Efficiency 184 Debate 81 Bottle Bills Economic Incentives at Work 186 Plastic Bag Bans and Fees 188 Example 85 Implementing the TakeBack Principle 189 Markets for Recycled Materials 190 EWaste 190 Pollution Damage 192 Summary 193 Discussion Questions 193 SelfTest Exercises 194 Further Reading 195 9 Water A Confluence of Renewable and Depletable Resources 197 Introduction 197 The Potential for Water Scarcity 198 The Efficient Allocation of Scarce Water 202 Surface Water 202 Groundwater 204 The Current Allocation System 205 Riparian and Prior Appropriation Doctrines 205 Contents in Full xiii Sources of Inefficiency 207 Debate 91 What Is the Value of Water 210 Remedies and Reforms 212 Agricultural Water Pricing 212 Municipal Water Pricing 213 Example 91 The Cost of Conservation Revenue Stability vs Equitable Pricing 217 Full Cost Recovery Pricing 219 Pricing and Price Elasticity of Demand 219 Water Markets Sales Leases and Banks 220 Example 92 Using Economic Principles to Conserve Water in California 220 Example 93 Water Transfers in Colorado What Makes a Market for Water Work 222 Example 94 Water Market Assessment Australia Chile South Africa and the United States 223 Environmental Water Transactions 224 Example 95 Reserving Instream Rights for Endangered Species 225 Desalination and Wastewater Recycling 226 Example 96 Moving Rivers or Desalting the Sea Costly Remedies for Water Shortages 227 Privatization 227 Debate 92 Should Water Systems Be Privatized 228 Summary 228 Discussion Questions 229 SelfTest Exercises 230 Further Reading 231 10 A Locationally Fixed Multipurpose Resource Land 233 Introduction 233 The Economics of Land Allocation 234 Land Use 234 LandUse Conversion 235 Sources of Inefficient Use and Conversion 236 Sprawl and Leapfrogging 236 Incompatible Land Uses 238 Undervaluing Environmental Amenities 238 The Influence of Taxes on LandUse Conversion 239 Debate 101 Should Landowners Be Compensated for Regulatory Takings 240 Market Power 240 Debate 102 What Is a Public Purpose 242 Special Problems in Developing Countries 242 Innovative MarketBased Policy Remedies 244 Establishing Property Rights 244 Contents in Full xiv Transferable Development Rights 244 Example 101 Controlling Land Development with TDRs 245 Grazing Rights 245 Conservation Easements 245 Land Trusts 246 Development Impact Fees 246 Property Tax Adjustments 247 Summary 247 Discussion Question 248 SelfTest Exercises 248 Further Reading 249 11 Storable Renewable Resources Forests 251 Introduction 251 Characterizing Forest Harvesting Decisions 252 Special Attributes of the Timber Resource 252 The Biological Dimension 252 The Economics of Forest Harvesting 253 Extending the Basic Model 256 Sources of Inefficiency 257 Perverse Incentives for the Landowner 258 Perverse Incentives for Nations 260 Poverty and Debt 261 Sustainable Forestry 261 Public Policy 262 Example 111 Producing Sustainable Forestry through Certification 263 DebtNature Swaps 264 Extractive Reserves 264 Conservation Easements and Land Trusts 265 The World Heritage Convention 265 Example 112 Conservation Easements in Action The Blackfoot Community Project 265 Royalty Payments 266 Example 113 Does Pharmaceutical Demand Offer Sufficient Protection to Biodiversity 267 Example 114 Trust Funds for Habitat Preservation 267 Summary 268 Discussion Questions 269 SelfTest Exercises 269 Further Reading 270 Appendix The Harvesting Decision Forests 271 12 CommonPool Resources Commercially Valuable Fisheries 273 Introduction 273 Efficient AllocationsBioeconomics Theory 274 Contents in Full xv The Biological Dimension 274 Static Efficient Sustainable Yield 276 Dynamic Efficient Sustainable Yield 278 Appropriability and Market Solutions 280 Public Policy Toward Fisheries 282 Example 121 Harbor Gangs of Maine and Other Informal Arrangements 283 Raising the Real Cost of Fishing 283 Taxes 285 Catch Share Programs 286 Example 122 The Relative Effectiveness of Transferable Quotas and Traditional Size and Effort Restrictions in the Atlantic Sea Scallop Fishery 290 Debate 121 ITQs or TURFs Species Space or Both 293 Aquaculture 294 Subsidies and Buybacks 294 Debate 122 Aquaculture Does Privatization Cause More Problems Than It Solves 295 Exclusive Economic ZonesThe 200Mile Limit 296 Marine Protected Areas and Marine Reserves 297 EnforcementIllegal Unreported and Unmanaged Fishstocks 298 Debate 123 Bluefin Tuna Difficulties in Enforcing HighValue Species 300 Summary 301 Discussion Questions 302 SelfTest Exercises 302 Further Reading 304 Appendix The Harvesting Decision Fisheries 304 13 Ecosystem Goods and Services Natures Threatened Bounty 307 Introduction 307 The State of Ecosystem Services 308 Economic Analysis of Ecosystem Services 309 Demonstrating the Value of Ecosystem Services 309 The Value of Reefs 309 Example 131 The Value of Coral Reefs in the US Virgin Islands 311 Damage Assessments Loss of Ecosystem Services 312 Valuing Supporting Services Pollination 312 Example 132 Valuing Pollination Services Two Illustrations 313 Valuing Supporting Services Forests and Coastal Ecosystems 314 Challenges and Innovation in Ecosystem Valuation 315 Institutional Arrangements and Mechanisms for Protecting Natures Services 316 Payments for Environmental Services 317 Contents in Full xvi Debate 131 Paying for Ecosystem Services or Extortion The Case of Yasuni National Park 318 Example 133 Trading Water for Beehives and Barbed Wire in Bolivia 319 Tradable Entitlement Systems 319 Wetlands Banking 320 Carbon Sequestration Credits 320 Example 134 Reducing Emissions from Deforestation and Forest Degradation REDD A Twofer 321 Conflict Resolution in OpenAccess Resources via Transferable Entitlements 322 Debate 132 Tradable Quotas for Whales 322 Ecotourism 323 Debate 133 Does Ecotourism Provide a Pathway to Sustainability 324 Example 135 Payments for Ecosystem ServicesWildlife Protection in Zimbabwe 325 The Special Problem of Protecting Endangered Species 326 Conservation Banking 326 The Agglomeration Bonus 327 Example 136 Conservation Banking The Gopher Tortoise Conservation Bank 327 Safe Harbor Agreements 328 Preventing Invasive Species 328 Example 137 The Changing Economics of Monitoring and Its Role in Invasive Species Management 329 Moving Forward 330 Summary 330 Discussion Questions 331 SelfTest Exercises 331 Further Reading 332 14 Economics of Pollution Control An Overview 333 Introduction 333 A Pollutant Taxonomy 334 Defining the Efficient Allocation of Pollution 335 Stock Pollutants 335 Fund Pollutants 336 Market Allocation of Pollution 338 Efficient Policy Responses 339 CostEffective Policies for Uniformly Mixed Fund Pollutants 340 Defining a CostEffective Allocation 340 CostEffective Pollution Control Policies 341 Debate 141 Should Developing Countries Rely on MarketBased Instruments to Control Pollution 346 Other Policy Dimensions 346 The Revenue Effect 347 Contents in Full xvii Example 141 The Swedish Nitrogen Oxide Charge 348 Example 142 RGGI Revenue The Maine Example 349 Responses to Changes in the Regulatory Environment 350 Instrument Choice under Uncertainty 350 Summary 351 Discussion Question 352 SelfTest Exercises 352 Further Reading 354 Appendix The Simple Mathematics of CostEffective Pollution Control 355 15 StationarySource Local and Regional Air Pollution 357 Introduction 357 Conventional Pollutants 357 The CommandandControl Policy Framework 358 The Efficiency of the CommandandControl Approach 359 Debate 151 Does Sound Policy Require Targeting New Sources via the New Source Review 359 Debate 152 The Particulate and Smog Ambient Standards Controversy 361 CostEffectiveness of the CommandandControl Approach 362 Example 151 Controlling SO2 Emissions by Commandand Control in Germany 363 Air Quality 364 MarketBased Approaches 364 Emissions Charges 364 Emissions Trading 365 Example 152 The Sulfur Allowance Program after 20 Years 367 Summary 368 Example 153 Technology Diffusion in the Chlorine Manufacturing Sector 369 Discussion Questions 370 SelfTest Exercises 371 Further Reading 371 16 MobileSource Air Pollution 373 Introduction 373 Subsidies and Externalities 375 Implicit Subsidies 375 Externalities 375 Consequences 377 Policy toward Mobile Sources 377 History of US Policy 377 The US and EU Policy Approaches 378 Example 161 Monitoring and Enforcement The Volkswagen Experience 378 Contents in Full xviii Lead Phaseout Program 379 Example 162 Getting the Lead Out The Lead Phaseout Program 380 Fuel Economy Standardsthe US Approach 380 Debate 161 CAFE Standards or Fuel Taxes 381 Example 163 Fuel Economy Standards When Fuel Prices Are Falling 382 Gas Guzzler Tax 383 Fuel Economy Standards in the European Union 383 Example 164 CarSharing Better Use of Automotive Capital 384 Fuel Economy Standards in Other Countries 385 External Benefits of Fuel Economy Standards 385 Alternative Fuels and Vehicles 385 Transportation Pricing 387 Example 165 Zonal MobileSource PollutionControl Strategies Singapore 389 Example 166 Modifying Car Insurance as an Environmental Strategy 392 Example 167 The CashforClunkers Program Did It Work 393 Example 168 Counterproductive Policy Design 394 Summary 394 Discussion Questions 396 SelfTest Exercises 396 Further Reading 397 17 Climate Change 399 Introduction 399 The Science of Climate Change 400 Example 171 Betting on Climate Science 401 Negotiations over Climate Change Policy 402 Characterizing the Broad Strategies 402 Game Theory as a Window on Global Climate Negotiations 402 Debate 171 Should Carbon Sequestration in the Terrestrial Biosphere Be Credited 403 The Precedent Reducing OzoneDepleting Gases 406 Economics and the Mitigation Policy Choice 408 Providing Context A Brief Look at Two Illustrative Carbon Pricing Programs 408 Carbon Markets and Taxes How Have These Approaches Worked in Practice 409 Three Carbon Pricing Program Design Issues Using the Revenue Offsets and Price Volatility 410 Controversy The Morality of Emissions Trading 413 Debate 172 Is Global Greenhouse Gas Trading Immoral 413 Mitigation Policy Timing 414 The Role of Adaptation Policy 415 Summary 417 Contents in Full xix Discussion Questions 418 SelfTest Exercises 418 Further Reading 419 18 Water Pollution 421 Introduction 421 Nature of Water Pollution Problems 422 Types of WasteReceiving Water 422 Sources of Contamination 422 Types of Pollutants 424 Debate 181 Toxics in Fish Tissue Do Fish Consumption Advisories Change Behavior 426 Traditional Water Pollution Control Policy 427 The US Experience 427 Early Legislation 427 Subsequent Legislation 428 The TMDL Program 430 The Safe Drinking Water Act 430 The Clean Water Rule 431 Ocean Pollution 431 Efficiency and CostEffectiveness 432 Ambient Standards and the ZeroDischarge Goal 433 National Effluent Standards 434 Municipal Wastewater Treatment Subsidies 434 Pretreatment Standards 435 Nonpoint Source Pollution 435 WatershedBased Trading 436 Example 181 Effluent Trading for Nitrogen in Long Island Sound 437 Atmospheric Deposition of Pollution 441 The European Experience 441 Developing Country Experience 442 Example 182 The Irish Bag Levy 443 Example 183 Economic Incentives for Water Pollution Control The Case of Colombia 444 Oil SpillsTankers and OffShore Drilling 445 An Overall Assessment 446 Example 184 Deepwater Horizon BP Oil SpillEstimating the Damages 447 Summary 449 Discussion Questions 449 SelfTest Exercises 450 Further Reading 451 Contents in Full xx 19 Toxic Substances and Environmental Justice 453 Introduction 453 Nature of Toxic Substance Pollution 454 Health Effects 455 Policy Issues 455 Example 191 The Arduous Path to Managing Toxic Risk Bisphenol A 456 Market Allocations and Toxic Substances 457 Occupational Hazards 457 Example 192 Susceptible Populations in the Hazardous Workplace An Historical Example 460 Product Safety 461 Third Parties 461 The Incidence of Hazardous Waste Siting Decisions 462 History 462 Environmental Justice Research and the Emerging Role of GIS 463 The Economics of Site Location 463 Example 193 Do New Polluting Facilities Affect Housing Values and Incomes Evidence from New England 464 Example 194 Which Came FirstThe Toxic Facility or the Minority Neighborhood 465 The Policy Response 466 The Toxic Release Inventory 468 Debate 191 Does Offering Compensation for Accepting an Environmental Risk Always Increase the Willingness to Accept the Risk 469 Proposition 65 470 International Agreements 470 Example 195 Regulating through Mandatory Disclosure The Case of Lead 471 Summary 472 Discussion Questions 473 SelfTest Exercises 473 Further Reading 474 20 The Quest for Sustainable Development 475 Introduction 475 Sustainability of Development 476 Market Allocations 477 Efficiency and Sustainability 478 Trade and the Environment 480 Debate 201 Would the Protection of Elephant Populations Be Enhanced or Diminished by Allowing Limited International Trade in Ivory 481 Example 201 Has NAFTA Improved the Environment in Mexico 485 Contents in Full xxi Trade Rules under GATT and the WTO 485 Debate 202 Should an Importing Country Be Able to Use Trade Restrictions to Influence Harmful Fishing Practices in an Exporting Nation 486 Natural Disasters 487 Example 202 Enhancing Resilience Against Natural Disasters with Flood Insurance 488 The Natural Resource Curse 489 Example 203 The Natural Resource Curse Hypothesis 489 The GrowthDevelopment Relationship 490 Conventional Measures 490 Alternative Measures 492 Summary 494 Example 204 Happiness Economics Does Money Buy Happiness 495 Discussion Questions 496 SelfTest Exercises 496 Further Reading 497 21 Visions of the Future Revisited 499 Introduction 499 Addressing the Issues 499 Conceptualizing the Problem 500 Institutional Responses 501 Example 211 Private Incentives for Sustainable Development Can Adopting Sustainable Practices Be Profitable 502 Sustainable Development 504 Example 212 PublicPrivate Partnerships The Kalundborg Experience 505 A Concluding Comment 507 Discussion Questions 507 Further Reading 507 Answers to SelfTest Exercises 509 Glossary 529 Index 545 Taylor Francis Taylor Francis Group httptaylorandfranciscom xxiii Preface A glance at any newspaper will confirm that environmental economics is now a major player in environmental policy Concepts such as capandtrade renewable portfolio standards block pricing renewable energy credits development impact fees conservation easements carbon trading the commons congestion pricing corporate average fuel economy standards payasyouthrow debtfornature swaps extended producer responsibility sprawl leapfrog ging pollution havens strategic petroleum reserves payments for ecosystem services and sustainable development have moved from the textbook to the legislative hearing room As the large number of current examples in Environmental and Natural Resource Economics demonstrates not only are ideas that were once restricted to academic discussions now part of the policy mix but they are making a significant difference as well New to this Edition In addition to updating the data in the text tables and charts this edition brings a more international focus It incorporates many new studies and as noted below new topics new figures new discussion questions and new examples Chapters receiving an especially large amount of new material include valuation energy water and climate change New or Expanded Topics Social cost of carbon Chapter 3 The 2017 contemporary guidelines on best practice for both contingent valuation and choice experiments Chapter 4 The Environmental Valuation Reference Inventory Chapter 4 Choice Experiments and Benefit Transfer Chapter 4 The EU Renewable Energy Directive Chapter 7 Microgrids Chapter 7 Varieties of payasyouthrow trash disposal pricing Chapter 8 Plastic disposal bag bans and fees Chapter 8 The EU Water Framework Directive Chapter 9 Full Cost Recovery Pricing Chapter 9 Narcodeforestation Chapter 11 Catch share programs in the United States Chapter 12 European Common Fisheries Policy Chapter 12 Preface xxiv Fisheries enforcement illegal unreported and unmanaged fish stocks Chapter 12 Ecosystem Services Valuation Chapter 13 A review of existing capandtrade programs Chapter 15 Fuel economy standards in the European Union and other countries Chapter 16 The economics of bike sharing programs Chapter 16 The dynamics of the Paris Accord and their impacts on climate change Chapter 17 The Montreal Protocol and its effect on climate change impacts Chapter 17 Using the revenue from carbonpricing programs Chapter 17 Price collars as a check on price volatility Chapter 17 The economics of investment in adaptation to a changing climate Chapter 17 The European Water Framework Directive Chapter 18 Societal costs of exposure to toxic substances Chapter 19 The Flint Michigan lead contamination case Chapter 19 The economics of natural disasters Chapter 20 The California Global Warming Solutions Act Chapter 21 New or Expanded Examples and Debates Climate Change and Water Accessibility How Are these Challenges Linked What Is the Proper Geographic Scope for the Social Cost of Carbon Is the Two for One Rule a Good Way to Manage Regulatory Overreach The Value of US National Parks Fuel from Shale The Bakken Experience Energy Efficiency Rebound and Backfire Effects Thinking about Energy Cost Reduction Outside of the Box The Boothbay Pilot Project The Economics of Solar Microgrids in Kenya The Cost of Water Conservation Revenue Stability vs Equitable Pricing The Changing Economics of Monitoring and Its Role in Invasive Species Management The Swedish Nitrogen Oxide Charge Monitoring and Enforcement The Volkswagen Experience Fuel Economy Standards When Fuel Prices Are Falling Betting on Climate Science Deepwater Horizon BP Oil SpillEstimating the Damages Would the Protection of Elephant Populations Be Enhanced or Diminished by Allowing Limited International Trade in Ivory Enhancing Resilience Against Natural Disasters with Flood Insurance New Features New discussion questions Chapter 1 Chapter 2 Chapter 13 Chapter 15 Chapter 17 Chapter 18 Chapter 20 New selftest exercises Chapter 6 Chapter 7 New further reading references Chapter 1 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 Chapter 11 Chapter 14 chapter 15 Chapter 17 Chapter 20 Chapter 21 New figures Chapter 2 Chapter 9 Chapter 12 Chapter 18 New terms added to the glossary Preface xxv An Overview of the Book Environmental and Natural Resource Economics attempts to bring those who are beginning the study of environmental and natural resource economics close to the frontiers of knowledge Although the book is designed to be accessible to students who have completed a twosemester introductory course in economics or a onesemester introductory microeconomics course it has been used successfully in several institutions in lowerlevel and upperlevel undergraduate courses as well as lowerlevel graduate courses The structure and topical coverage of this book facilitates its use in a variety of contexts For a survey course in environmental and natural resource economics all chapters are appropriate although many of us find that the book contains somewhat more material than can be adequately covered in a quarter or even a semester This surplus material provides flexibility for the instructor to choose those topics that best fit his or her course design A oneterm course in natural resource economics could be based on Chapters 113 and 2021 A brief introduction to environmental economics could be added by including Chapter 14 A singleterm course in environmental economics could be structured around Chapters 14 and 1421 In this eleventh edition we examine many of these newly popular market mechanisms within the context of both theory and practice Environmental and natural resource economics is a rapidly growing and changing field as many environmental issues become global in nature In this text we tackle some of the complex issues that face our globe and explore both the nature of the problems and how economics can provide potential solutions This edition retains a strong policy orientation Although a great deal of theory and empiri cal evidence is discussed their inclusion is motivated by the desire to increase understanding of intriguing market situations and policy problems This explicit integration of research and policy within each chapter avoids a problem frequently encountered in applied economics textbooksthat is in such texts the theory developed in earlier chapters is often only loosely connected to the rest of the book This is an economics book but it goes beyond economics Insights from the natural and physical sciences literature political science and other disciplines are scattered liberally throughout the text In some cases these references raise outstanding issues that economic analysis can help resolve while in other cases they affect the structure of the economic analysis or provide a contrasting point of view They play an important role in overcoming the tendency to accept the material uncritically at a superficial level by highlighting those characteristics that make the economics approach unique Intertemporal optimization is introduced using graphical twoperiod models and all mathematics other than simple algebra is relegated to chapter appendices Graphs and numerical examples provide an intuitive understanding of the principles suggested by the math and the reasons for their validity In the eleventh edition we have retained the strengths that are particularly valued by readers while expanding the number of applications of economic principles clarifying some of the more difficult arguments and updating the material to include the very latest global developments Reflecting this new role of environmental economics in policy a number of journals are now devoted either exclusively or mostly to the topics covered in this book One journal Ecological Economics is dedicated to bringing economists and ecologists closer together in a common search for appropriate solutions for environmental challenges Interested readers can also find advanced work in the field in Land Economics Journal of Environmental Economics and Management Review of Environmental Economics and Policy Environmental and Preface xxvi Resource Economics International Review of Environmental and National Resource Economics Environment and Development Economics Resource and Energy Economics and Natural Resources Journal among others A discussion list that involves material covered by this book is ResEcon It is an academi cally inclined list focusing on problems related to environmental and natural resource management A very useful blog that deals with issues in environmental economics and their relationship to policy is located at wwwenveconnet Services on the Internet change so rapidly that some of this information may become obsolete To keep updated on the various web options visit the Companion Website of this text at wwwroutledgecomcwtietenberg The site includes an online reference section with all the references cited in the book Supplements For each chapter in the text the Online Instructors Manual originally written by Lynne Lewis of Bates College and revised by Pallab Mozumder provides an overview teaching objectives a chapter outline with key terms common student difficulties and suggested classroom exercises PowerPoint presentations prepared by Hui Li of Eastern Illinois University are available for instructors and include all art and figures from the text as well as lecture notes for each chapter Professors can download the Online Instructors Manual and the PowerPoint presentations at the Instructor Resource Center wwwroutledgecomcwtietenberg The books Companion Website wwwroutledgecomcwtietenberg features chapterby chapter web links to additional reading and economic data The site also contains Excelbased models that can be used to solve common depletable resource problems numerically These models developed by Arthur Caplan and John Gilbert of Utah State University may be presented in lectures to accentuate the intuition provided in the text or they may underlie specific questions on a homework assignment The Companion Website also provides selfstudy quizzes for each chapter Written and updated by Elizabeth Wheaton of Southern Methodist University each of these chapter quizzes contains multiplechoice questions for students to test what they have learned Acknowledgments The most rewarding part of writing this book is that we have met so many thoughtful people We very much appreciate the faculty and students who pointed out areas of particular strength or areas where coverage could be expanded Their support has been gratifying and energizing One can begin to understand the magnitude of our debt to our colleagues by glancing at the several hundred names in the lists of references Because their research contributions make this an exciting field full of insights worthy of being shared our task was easier and a lot more fun than it might otherwise have been We also owe a large debt of gratitude to the following group who provided detailed helpful reviews of the text and supplied many useful ideas for this revision Massimiliano Mazzanti Universita Bocconi Italy Richard Stahl Louisiana State University USA Julia Swart Utrecht University School of Economics Netherlands Beth Wheaton Southern Methodist University USA Hermann Waibel University of Hannover Germany Preface xxvii Theocharis Grigoriadis Freie Universitat Berlin Germany Jim Vincent University of St Thomas USA Viktoria Kahui University of Otago New Zealand Joost Burmann National University of Singapore Malaysia Wei Zhang Connecticut College USA Dennis Guignet American University USA Working with Routledge has been a delightful experience Our commissioning editor Andy Humphries has been continually helpful since the initiation of this edition We would also like to acknowledge Alaina Christensen production editor as well as Kate Reeves copyeditor Hugh Jackson proofreader Judith Reading indexer Gareth Toye cover designer and Keystroke typesetting on the production side and those who managed the Companion Website content Thanks to you all Lynnes most helpful research assistants for this edition were Amy Schmidt and Madeleine Shapiro Working with all of the fine young scholars who have assisted with this text over the years has made it all the more obvious why teaching is the worlds most satisfying profession Finally Tom would like to express publicly his deep appreciation to his wife Gretchen his daughter Heidi and his son Eric for their love and support Lynne would like to express her gratitude to Jack for his unwavering support patience and generosity Thank you Tom Tietenberg Lynne Lewis Taylor Francis Taylor Francis Group httptaylorandfranciscom 1 Visions of the Future From the arch of the bridge to which his guide has carried him Dante now sees the Diviners coming slowly along the bottom of the fourth Chasm By help of their incantations and evil agents they had endeavored to pry into the future which belongs to the almighty alone and now their faces are painfully twisted the contrary way and being unable to look before them they are forced to walk backwards Dante Alighieri Divine Comedy The Inferno translated by Carlyle 1867 Introduction The SelfExtinction Premise About the time the American colonies won independence Edward Gibbon completed his monumental The History of the Decline and Fall of the Roman Empire In a particularly poignant passage that opens the last chapter of his opus he recreates a scene in which the learned Poggius a friend and two servants ascend the Capitoline Hill after the fall of Rome They are awed by the contrast between what Rome once was and what Rome has become In the time of the poet it was crowned with the golden roofs of a temple the temple is overthrown the gold has been pillaged the wheel of fortune has accomplished her revolu tion and the sacred ground is again disfigured with thorns and brambles The forum of the Roman people where they assembled to enact their laws and elect their magistrates is now enclosed for the cultivation of potherbs or thrown open for the reception of swine and buffaloes The public and private edifices that were founded for eternity lie prostrate naked and broken like the limbs of a mighty giant and the ruin is the more visible from the stupendous relics that have survived the injuries of time and fortune Vol 6 pp 650651 Chapter 1 Visions of the Future 2 What could cause the demise of such a grand and powerful society Gibbon weaves a complex thesis to answer this question suggesting ultimately that the seeds for Romes destruction were sown by the Empire itself Although Rome finally succumbed to such external forces as fires and invasions its vulnerability was based upon internal weakness The premise that societies can germinate the seeds of their own destruction has long fascinated scholars In 1798 Thomas Malthus published his classic An Essay on the Principle of Population in which he foresaw a time when the urge to reproduce would cause population growth to exceed the lands potential to supply sufficient food resulting in starvation and death In his view the most likely response to this crisis would involve rising death rates caused by environmental constraints rather than a recognition of impending scarcity followed either by innovation or selfrestraint Historically our society has been remarkably robust having survived wars and shortages while dramatically increasing living standards and life expectancy Yet actual historical examples suggest that Malthuss selfextinction vision may sometimes have merit Example 11 examines two specific cases the Mayan civilization and Easter Island Future Environmental Challenges Future societies will also face challenges arising from resource scarcity and accumulating pollutants Many specific examples of these broad categories of problems are discussed in detail in the following chapters This section provides a flavor of what is to come by illustrating the challenges posed by one pollution problem climate change and one resource scarcity problem water accessibility Climate Change Energy from the sun drives the earths weather and climate Incoming rays heat the earths surface radiating heat energy back into space Atmospheric greenhouse gases water vapor carbon dioxide and other gases trap some of the outgoing energy Without this natural greenhouse effect temperatures on the earth would be much lower than they are now and life as we know it would be impossible It is possible however to have too much of a good thing Problems arise when the concentration of greenhouse gases increases beyond normal levels thus retaining excessive heat somewhat like a car with its windows closed in the summer Since the Industrial Revolution greenhouse gas emissions have increased considerably enhancing the heattrapping capability of the earths atmosphere According to the US Global Change Research Program USGCRP 20141 Evidence from the top of the atmosphere to the depths of the oceans collected by scientists and engineers from around the world tells an unambiguous story the planet is warming and over the last half century this warming has been driven primarily by human activitypredominantly the burning of fossil fuels As the earth warms the consequences are expected to affect both humans and ecosystems Humans are susceptible to increased heat as shown by the thousands of deaths in Europe in the summer of 2003 due to the abnormal heat waves Human health can also be affected by diseases such as Lyme disease which spread more widely as the earth warms Rising sea levels as warmer water expands and previously frozen glaciers melt coupled with an increase in Visions of the Future 3 A Tale of Two Cultures The Mayan civilization a vibrant and highly cultured society that occupied parts of Central America did not survive One of the major settlements Copán has been studied in sufficient detail to learn reasons for its collapse After ad 400 the population growth began to bump into an environmental constraint specifically the agricultural carrying capacity of the land The growing population depended heavily on a single locally grown cropmaizefor food By early in the sixth century however the carrying capacity of the most productive local lands was exceeded and farmers began to depend upon more fragile parts of the ecosystem Newly acquired climate data show that a twocentury period with a favorable climate was followed by a general drying trend lasting four centuries that led to a series of major droughts Food production failed to keep pace with the increasing population By the eighth and ninth centuries the evidence reveals not only high levels of infant and adolescent mortality but also widespread malnutrition The royal dynasty an important source of leadership collapsed rather abruptly sometime about ad 820822 The second case study Easter Island shares some remarkable similarities with both the Mayan case and the Malthusian vision Easter Island lies some 2000 miles off the coast of Chile Current visitors note that it is distinguished by two features 1 its enormous statues carved from volcanic rock and 2 a surprisingly sparse veget ation given the islands favorable climate and conditions Both the existence of these imposing statues and the fact that they were erected at a considerable distance from the quarry suggests the presence of an advanced civilization but current observers see no sign of it What happened According to scholars the short answer is that a rising population coupled with a heavy reliance on wood for housing canoe building and statue transportation decimated the forest Brander and Taylor 1998 The loss of the forest contributed to soil erosion declining soil productivity and ultimately dimin ished food production How did the community react to the impending scarcity Apparently the social response was war among the remaining island factions and ultimately cannibalism We would like to believe not only that in the face of impending scarcity societies would react by changing behavior to adapt to the diminishing resource supplies but also that this benign response would follow automatically from a recognition of the problem We even have a cliché to capture this sentiment necessity is the mother of invention These stories do point out however that nothing is automatic about a problemsolving response As we shall see as this book unfolds sometimes societies not only fail to solve the problem but their reactions can actually intensify it Sources Webster D Freter A Golin N 2000 Copan The Rise and Fall of an Ancient Maya Kingdom Fort Worth TX Harcourt Brace Publishers Brander J A Taylor M S 1998 The simple economics of Easter Island A RicardoMalthus model of renewable resource use The American Economic Review 881 119138 Turner B L Sabloff J A 2012 Classic period collapse of the central Maya lowlands Insights about humanenvironment relationships for sustainability Proceedings of the National Academy of Sciences 10935 1390813914 Pringle Heather 2012 Climate change had political human impact on ancient Maya Science November 9 730731 EXAMPLE 11 Visions of the Future 4 storm intensity are expected to flood coastal communities with greater frequency Ecosystems will be subjected to unaccustomed temperatures some species will adapt by migrating to new areas but many others are not expected to be able to react in time While these processes have already begun they will intensify throughout the century Climate change also has an important moral dimension Due to their more limited adaptation capabilities many developing countries which have produced relatively small amounts of greenhouse gases are expected to be the hardest hit as the climate changes Dealing with climate change will require a coordinated international response That is a significant challenge to a world system where the nationstate reigns supreme and international organizations are relatively weak Water Accessibility Another class of threats is posed by the interaction of a rising demand for resources in the face of a finite supply Water provides a particularly interesting example because it is so vital to life According to the United Nations about 40 percent of the worlds population lives in areas with moderatetohigh water stress Moderate stress is defined in the UN Assessment of Freshwater Resources as human consumption of more than 20 percent of all accessible renewable freshwater resources whereas severe stress denotes consumption greater than 40 percent By 2025 it is estimated that about twothirds of the worlds populationabout 55 billion peoplewill live in areas facing either moderate or severe water stress This stress is not uniformly distributed around the globe For example in parts of the United States Mexico China and India groundwater is already being consumed faster than it is being replenished and aquifer levels are steadily falling Some rivers such as the Colorado in the western United States and the Yellow in China often run dry before they reach the sea Formerly enormous bodies of water such as the Aral Sea and Lake Chad are now a fraction of their oncehistoric sizes Glaciers that feed many Asian rivers are shrinking According to UN data the continents most burdened by a lack of access to sufficient clean water are Africa and Asia Up to 50 percent of Africas urban residents and 75 percent of Asians are estimated to lack adequate access to a safe water supply The availability of potable water is further limited by human activities that contaminate the remaining supplies According to the United Nations 90 percent of sewage and 70 percent of industrial waste in developing countries are discharged without treatment And climate change is expected to intensify both the frequency and duration of droughts simultaneously increasing the demand for water and reducing its supply Some arid areas have compensated for their lack of water by importing it via aqueducts from more richly endowed regions or by building large reservoirs This solution can however promote conflict when the water transfer or the relocation of people living in the area to be flooded by the reservoir produces a backlash Additionally aqueducts and dams may be geologically vulnerable For example in California many of the aqueducts cross or lie on known earthquakeprone fault lines Reisner 2003 The reservoir behind the Three Gorges Dam in China is so vast that the pressure and weight from the stored water have caused tremors and landslides Furthermore climate change and water accessibility are interdependent problems Example 12 explores both their relationship and why it matters Visions of the Future 5 EXAMPLE 12 Climate Change and Water Accessibility How Are these Challenges Linked From a policy analysis point of view whether these challenges are interdependent matters If they are linked their interactions must be considered in the design of any polices created to meet the challenges Otherwise the response may be neither efficient nor effective On May 3 2016 the World Bank released a report that documents and analyzes the nature and economic implications of the linkages It notes that climate change will exacerbate water scarcity even as demand for water increases potentially leading to negative economic impacts and security challenges According to the report Within the next 3 decades the global food system will require between 40 to 50 percent more water municipal and industrial water demand will increase by 50 to 70 percent the energy sector will see water demand increase by 85 percent and the environment already the residual claimant may receive even less The report further anticipates that in the Middle East and Africa conditions will worsen costing these regions up to six percent of their GDP by 2050 The report concludes While adopting policy reforms and investments will be demanding the costs of inaction are far higher The future will be thirsty and uncertain but with the right reforms governments can help ensure that people and ecosystems are not left vulnerable to the consequences of a world subject to more severe waterrelated shocks and adverse rainfall trends p ix Source World Bank 2016 High and Dry Climate Change Water and the Economy Washington DC World Bank License Creative Commons Attribution CC BY 30 IGO Meeting the Challenges As the scale of economic activity has proceeded steadily upward the scope of environmental problems triggered by that activity has transcended both geographic and generational boundaries When the environmental problems were smaller in scale the nationstate used to be a sufficient form of political organization for resolving them but is that still the case Whereas each generation used to have the luxury of being able to satisfy its own needs without worrying about the needs of generations to come intergenerational effects are now more prominent Solving problems such as poverty climate change ozone depletion and the loss of biodiversity requires international cooperation Because future generations cannot speak for themselves the current generation must speak for them Current policies must incorporate our obligation to future generations however difficult or imperfect that incorporation might prove to be Visions of the Future 6 International cooperation is by no means a foregone conclusion Global environmental problems can result in very different effects on countries that will sit around the negotiating table While lowlying countries could be completely submerged by the sea level rise predicted by some climate change models arid nations could see their marginal agricultural lands succumb to desertification Other nations may see agricultural productivity rise as warmer climates in traditionally intemperate regions support longer growing seasons Countries that unilaterally set out to improve the global environmental situation run the risk of making their businesses vulnerable to competition from less conscientious nations Industrialized countries that undertake stringent environmental policies may not suffer much at the national level due to offsetting increases in income and employment in industries that supply renewable cleaner energy and pollution control equipment Some specific industries facing stringent environmental regulations however may well face higher costs than their competitors and can be expected to lose market share accordingly Declining market share and employment resulting from especially stringent regulations and the threat of outsourced production are powerful influences The search for solutions must accommodate these concerns The market system is remarkably resilient in how it responds to challenges As we shall see prices provide incentives not only for the wise use of current resources but also for promoting innovations that can broaden the menu of future options Yet as we shall also see market incentives are not always consistent with promoting sustainable outcomes Currently many individuals and institutions have a large stake in maintaining the status quo even when it poses an existential threat Fishermen harvesting their catch from an overexploited fishery are loath to reduce harvests even when the reduction may be necessary to conserve the stock and to return the population to a healthy level Farmers who depend on fertilizer and pesticide subsidies will give them up reluctantly Coal companies resist any attempt to reduce carbon emissions from coalfired power plants How Will Societies Respond The fundamental question is how our society will respond to these challenges One way to think systematically about this question involves feedback loops Positive feedback loops are those in which secondary effects tend to reinforce the basic trend The process of capital accumulation illustrates one positive feedback loop New investment generates greater output which when sold generates profits These profits can be used to fund additional new investments Notice that with positive feedback loops the process is selfreinforcing Positive feedback loops are also involved in climate change Scientists believe for example that the relationship between emissions of methane and climate change may be described as a positive feedback loop Because methane is a greenhouse gas increases in methane emissions contribute to climate change The rise of the planetary temperature however is triggering the release of extremely large quantities of additional methane that was previously trapped in the permafrost layer of the earth the resulting larger methane emissions intensify the temperature increases resulting in the release of more methanea positive feedback Human behavior can also deepen environmental problems through positive feedback loops When shortages of a commodity are imminent for example consumers typically begin to hoard the commodity Hoarding intensifies the shortage Similarly people faced with shortages of food may be forced to eat the seed that is the key to more plentiful food in the future Situations giving rise to this kind of downward spiral are particularly troublesome Visions of the Future 7 In contrast a negative feedback loop is selflimiting rather than selfreinforcing Perhaps the bestknown planetaryscale example of a negative feedback loop is provided in a theory advanced by the English scientist James Lovelock Called the Gaia hypothesis after the Greek concept for Mother Earth this view of the world suggests that the earth is a living organism with a complex feedback system that seeks an optimal physical and chemical environment Deviations from this optimal environment trigger natural nonhuman response mechanisms that restore the balance In essence according to the Gaia hypothesis the planetary environment is characterized by negative feedback loops and therefore is within limits a selflimiting process As we proceed with our investigation the degree to which our economic and political institutions serve to intensify or to limit emerging environmental problems will be a key focus of our analysis The Role of Economics How societies respond to challenges will depend largely on the behavior of humans acting individually or collectively Economic analysis provides an incredibly useful set of tools for anyone interested in understanding andor modifying human behavior particularly in the face of scarcity In many cases this analysis points out the sources of the market systems resilience as embodied in negative feedback loops In others it provides a basis not only for identifying the circumstances where markets fail but also for clarifying how and why that specific set of circumstances supports degradation This understanding can then be used as the basis for designing new incentives that restore a sense of harmony in the relationship between the economy and the environment for those cases where the market fails Over the years two different but related economic approaches have been devised to address the challenges the future holds Debate 11 explores the similarities and the differ ences of ecological economics and environmental economics and what they both can bring to the table Ecological Economics versus Environmental Economics Over several decades or so the community of scholars dealing with the role of the economy and the environment has settled into two camps ecological economics wwwecoecoorg and environmental economics wwwaere org Although they share many similarities ecological economics is consciously more methodologically pluralist while environmental economics is based solidly on the standard paradigm of neoclassical economics While neoclassical economics emphasizes maximizing human welfare and using economic incentives to modify destructive human behavior ecological economics uses a variety of methodologies including neoclassical economics depending upon the purpose of the investigation While some observers see the two approaches as competitive presenting an eitheror choice others including the authors of this text see DEBATE 11 Visions of the Future 8 The Use of Models All of the topics covered in this book will be examined as part of the general focus on satisfying human wants and needs in light of limited environmental and natural resources Because this subject is complex it is better understood when broken into manageable portions Once we master the components in individual chapters we will be able to coalesce the individual insights into a more complete picture in the concluding chapter In economics as in most other disciplines we use models to investigate complex subjects such as relationships between the economy and the environment Models are simplified characterizations of reality Consider a familiar analog Maps by design leave out much detail They are nonetheless useful guides to reality By showing how various locations relate to each other maps give an overall perspective Although they cannot capture all of the unique details that characterize particular locations maps highlight those characteristics that are crucial for the purpose at hand The models in this text are similar Through simplification less detail is considered so that the main concepts and the relationships among them become more obvious Fortunately models allow us to study rigorously issues that are interrelated and global in scale Unfortunately due to their selectivity models may yield conclusions that are dead wrong Details that are omitted may turn out in retrospect to be crucial in understanding a particular dimension Therefore models are useful abstractions but the conclusions they yield depend on the structure of the model As you shall see as you proceed though this book change that structure and you are likely to change the conclusions As a result models should always be viewed with some caution Most peoples views of the world are based on models although frequently the assumptions and relationships involved may be implicit perhaps even subconscious In economics the models are explicit objectives relationships and assumptions are clearly specified so that the reader understands exactly how the conclusions are derived The models are transparent The validity and reliability of economic models are tested by examining the degree to which they can explain actual behavior in markets or other settings An empirical field known as them as complementary Complementarity of course does not mean full acceptance Significant differences exist not only between these two fields but also within them over such topics as the valuation of environmental resources the impact of trade on the environment and the appropriate means for evaluating policy strategies for longduration problems such as climate change These differences arise not only over methodologies but also over the values that are brought to bear on the analysis This book draws from both fields Although the basic foundation for the analysis is environmental economics the chapters draw heavily from ecologi cal economics to critique that view when it is controversial and to complement it with useful insights drawn from outside the neoclassical paradigm when appropriate Pragmatism is the reigning criterion If a particular approach or study helps us to understand environmental problems and their resolution it has been included in the text regardless of which field it came from Visions of the Future 9 econometrics uses statistical techniques primarily regression analysis to derive key economic functions These dataderived functions such as cost curves or demand functions can then be used for such diverse purposes as testing hypotheses about the effects of various water policies or forecasting future prices of solar panels Examining human behavior in a nonlaboratory setting however poses special challenges because it is nearly impossible to control completely for all the various factors that influence an outcome beyond those of primary interest The search for more control over the circumstances that provide the data we use to understand human behavior has given rise to the use of another complementary analytical approachexperimental economics see Example 13 Together econometrics and experimental economics can provide different lenses to help us understand human behavior and its impact on the world around us The Road Ahead Are current societies on a selfdestructive path In part the answer depends on whether human behavior is perceived as a positive or a negative feedback loop If increasing scarcity results in a behavioral response that involves a positive feedback loop intensifies the pressure on the environment pessimism is justified If on the other hand human responses serve to reduce those pressures or could be reformed so as to reduce those pressures optimism may be justified Not only does environmental and natural resource economics provide a firm basis for understanding the behavioral sources of environmental problems but it also provides a firm foundation for crafting specific solutions to them In subsequent chapters for example you will be exposed to how economic analysis can be and has been used to forge solutions to such diverse areas as climate change biodiversity loss and water scarcity Many of the solutions are quite novel Market forces are extremely powerful Attempts to solve environmental problems that ignore these forces run a high risk of failure Where normal market forces are compatible with efficient and sustainable outcomes those outcomes can be supported and reinforced Where normal market forces prove inefficient andor unsustainable they can be channeled into new directions that restore compatibility between outcomes and objectives Environmental and natural resource economics provide a specific set of directions for how this compatibility between goals and outcomes can be achieved The Underlying Questions As we look to the future optimists see a continued prosperity based upon a market system that effectively responds to challenges while pessimists see the challenges as sufficiently different in scope and scale as to raise doubts about our ability to deal with them in time Debate 12 Visions of the Future 10 EXAMPLE 13 Experimental Economics Studying Human Behavior in a Laboratory The appeal of experimental economics is based upon its ability to study human behavior in a more controlled setting During the midtwentieth century economists began to design controlled laboratory experiments with human subjects The experimental designs mimic decision situations in a variety of settings Paid participants are informed of the rules of the experiment and asked to make choices By varying the treatments faced by participants in these controlled settings experimenters can study how the treat ments affect both choices and collective outcomes Consider one policy example of how these methods have been used in resource policy Cummings et al 2004 In April 2000 the Georgia legislature passed The Flint River Drought Protection Act which required the state to hold an auction in drought years to pay some farmers to suspend irrigation The purpose was to use a market mechanism to identify those farmers who could forego irrigation at the lowest cost and to fairly compensate them for their reduction in water use With time running short to implement this act state policymakers relied upon laboratory experiments designed by a team of economists using local farmers as participants The results were used to inform the process of choosing the specific auction design that was used to fulfill the requirements of this act To the extent that the results of experiments have proved to be replicable they have created a deeper understanding about the effectiveness of markets policies and institutions The large and growing literature on experimental economics has already shed light on such widely divergent topics as the effectiveness of alternative policies for controlling pollution and allocating water how uncertainty affects choices and how the nature of cooperative agreements affects the sustainability of shared natural resources While experiments have the advantage of being able to control the decisionmaking environment the artificiality of the laboratory setting raises questions about the degree to which the results from laboratories can shed light on actual human behavior outside the lab While the degree of artificiality can be controlled by careful research design it cannot be completely eliminated Over the years however this approach has provided valuable information that can complement what we have learned from observed behavior using econometrics Sources Cummings R G Taylor L O 20012002 Experimental economics in natural resource and environmental management In H Folmer and T Tietenberg Eds The International Yearbook of Environmental and Natural Resource Economics Cheltenham UK Edward Elgar 123149 Smith V L 1998 Experimental methods in economics In J Eatwell M Murray P Newman Eds The New Palgrave Dictionary of Economics Volume 2 London The Macmillan Press 241249 Cummings Ronald G Holt Charles A Laury Susan K 2004 Using laboratory experiments for policymaking An example from the Georgia irrigation reduction auction Journal of Policy Analysis and Management 232 341363 Visions of the Future 11 To act as if one vision is correct when it is not could prove to be a costly error Thus it is important to examine these two views or some third view as a basis for forging your own view In order to assess the validity of these visions we must address some basic issues Is the problem correctly conceptualized as exponential growth with fixed immutable resource limits Does the earth have a finite carrying capacity If so how can the carrying capacity concept be operationalized Do current or forecasted levels of economic activity exceed the earths carrying capacity How does the economic system respond to scarcities Is the process mainly characterized by positive or negative feedback loops Do the responses intensify or ameliorate any initial scarcities Does the answer depend upon the decision context What Does the Future Hold Is the economy on a collision course with the environment Or has the process of reconciliation begun One group led most notably by Bjørn Lomborg President of the Copenhagen Consensus Center concludes that societies have resourcefully confronted environmental problems in the past and that environmentalist concerns to the contrary are excessively alarmist As he states in his book The Skeptical Environmentalist The fact is as we have seen that this civilization over the last 400 years has brought us fantastic and continued progress And we ought to face the factsthat on the whole we have no reason to expect that this progress will not continue On the other end of the spectrum are the researchers at the Worldwatch Institute who believe that current development paths and the attendant strain they place on the environment are unsustainable As reported in that institutes State of the World 2012 report In 1992 governments at the Rio Earth Summit made a historic commitment to sustainable developmentan economic system that promotes the health of both people and ecosystems Twenty years and several summits later human civilization has never been closer to ecological collapse one third of humanity lives in poverty and another 2 billion people are projected to join the human race over the next 40 years These views not only interpret the available historical evidence differently but also they imply very different strategies for the future Sources Lomborg B 2001 The Skeptical Environmentalist Measuring the Real State of the World Cambridge Cambridge University Press The Worldwatch Institute 2012 The State of the World 2012 Washington DC Island Press DEBATE 12 Visions of the Future 12 What is the role of the political system in controlling these problems In what circumstances is government intervention necessary What forms of intervention work best Is government intervention uniformly benign or can it make the situation worse What specific roles are appropriate for the executive legislative and judicial branches Many environmental problems are characterized by a considerable degree of uncertainty about the severity of the problem and the effectiveness of possible solutions Can our economic and political institutions respond to this uncertainty in reasonable ways or does uncertainty become a paralyzing force Can the economic and political systems work together to eradicate poverty and social injustice while respecting our obligations to future generations Or do our obligations to future generations inevitably conflict with the desire to raise the living standards of those currently in absolute poverty or the desire to treat all people especially the most vulnerable with fairness Can short and longterm goals be harmonized Is sustainable development feasible If so how can it be achieved What does the need for sustain able outcomes imply about the future of economic activity in the industrialized nations In the lessindustrialized nations The rest of this book uses economic analysis and evidence to suggest answers to these complex questions An Overview of the Book In the following chapters you will study the rich and rewarding field of environmental and natural resource economics The menu of topics is broad and varied Economics provides a powerful analytical framework for examining the relationships between the environment on one hand and the economic and political systems on the other The study of economics can assist in identifying circumstances that give rise to environmental problems in discovering causes of these problems and in searching for solutions Each chapter introduces a unique topic in environmental and natural resource economics while the overarching focus on development in an environment characterized by scarcity weaves these topics into a single theme We begin by comparing perspectives being brought to bear on these problems by economists and noneconomists The manner in which scholars in various disciplines view problems and potential solutions depends on how they organize the available facts how they interpret those facts and what kinds of values they apply in translating these interpretations into policy Before going into a detailed look at environmental problems we shall compare the ideology of conventional economics to other prevailing ideologies in the natural and social sciences This comparison not only explains why reasonable people may upon examining the same set of facts reach different conclusions but also it conveys some sense of the strengths and weaknesses of economic analysis as it is applied to environmental problems Chapters 2 through 6 delve more deeply into the economic approach highlighting many of the tools used by environmental economists including costbenefit analysis costeffectiveness analysis and methods available for monetizing nonmarket goods and services Specific evaluation criteria are defined and examples are developed to show how these criteria can be applied to current environmental problems In Chapters 7 through 13 we turn to some of the topics traditionally falling within the subfield known as natural resource economics The topics covered in these chapters include depletable and renewable energy resources recyclable resources water and land as well as forests fisheries and other ecosystems Visions of the Future 13 We then move on to an area of public policypollution controlthat has come to rely much more heavily on the use of economic incentives to produce the desired response The chapters in this section of the book reveal the unique aspects of local and regional air pollution global problems such as climate change and ozone depletion vehicle air pollution water pollution and toxic substances as well as the effectiveness of the various economic approaches used to control these pollutants Following this examination of the individual environmental and natural resource problems and the successes and failures of policies that have been used to ameliorate these problems we return to the big picture by assembling the bits and pieces of evidence accumulated in the preceding chapters and fusing them into an overall integrated response to the questions posed in the chapter We also cover some of the major unresolved issues in environmental policy that are likely to be among those commanding center stage over the next several years if not decades Summary Are our institutions so myopic that they have chosen a path that can only lead to the destruction of society as we now know it We have briefly examined two points of view that provide different answers to that question The Worldwatch Institute finds that the path is destructive while Lomborg strikes a much more optimistic tone The pessimistic view is based upon the inevitability of exceeding the carrying capacity of the planet as the population and the level of economic activity grow The optimistic view sees initial scarcity triggering sufficiently powerful reductions in population growth and increases in technological progress bringing further abundance not deepening scarcity Our examination of these different visions has revealed questions that can guide our assessment of what the future holds Seeking the answers requires that we accumulate a much better understanding about how choices are made in economic and political systems and how those choices affect and are affected by the natural environment We begin that process in Chapter 2 where the economic approach is developed in broad terms and is contrasted with other conventional approaches Discussion Questions 1 In his book The Ultimate Resource economist Julian Simon makes the point that calling the resource base finite is misleading To illustrate this point he uses a yardstick with its oneinch markings as an analogy The distance between two markings is finite one inchbut an infinite number of points is contained within that finite space Therefore in one sense what lies between the markings is finite while in another equally meanin gful sense it is infinite Is the concept of a finite resource base useful or not Why or why not 2 This chapter contains two views of the future Since the validity of these views cannot be completely tested until the time period covered by the forecast has passed so that predictions can be matched against actual events how can we ever hope to establish in advance which view is better What criteria might be proposed for evaluating predictions 3 Positive and negative feedback loops lie at the core of systematic thinking about the future As you examine the key forces shaping the future what examples of positive and negative feedback loops can you uncover Visions of the Future 14 4 Which point of view in Debate 12 do you find most compelling Why What logic or evidence do you find most supportive of that position 5 How specifically might the interdependence of the water accessibility and climate change challenges affect the design of polices enacted to meet these challenges Give some specific examples of how welldesigned policies might differ in the interdependence case compared to the independence case 6 In his book Thank you for Being Late An Optimists Guide to Thriving in the Age of Acclerations Thomas L Friedman documents how the digital revolution is fundamentally changing life as we have known it How do you think it will change the relationship between humans and the environment Is this likely to be a force for renewed harmony or intensified disruption Why Do you have any specific examples to share that illustrate one outcome or the other SelfTest Exercise 1 Does the normal reaction of the price system to a resource shortage provide an example of a positive or a negative feedback loop Why Note 1 See wwwglobalchangegovclimatechange Further Reading Batabyal A A Nijkamp P 2011 Introduction to research tools in natural resource and environmental economics In A A Batabyal P Nijkamp Eds Research Tools in Natural Resource and Environmental Economics Hackensack NJ World Scientific Publishing 326 An introduction to the most frequently used theoretical empirical experimental and interdisciplinary research tools in natural resource and environmental economics Delbeke J Klaassen G van Ierland T Zapfel P 2009 The role of environmental economics in recent policy making at the European Commission Review of Environmental Economics and Policy 4 2443 This article examines how environmental economics has been used at the European Commission in climate change energy and air pollution policy Managi Shunsuke Ed 2015 The Routledge Handbook of Environmental Economics in Asia New York Routledge An edited collection of essays that illustrates how the principles and methods of environmental economics can be applied to specific environmental and natural resource issues in Asia Motesharrei Safa Rivas Jorge Kalnay Eugenia 2014 Human and nature dynamics HANDY Modeling inequality and use of resources in the collapse or sustainability of societies Ecological Economics 101 May 90102 This paper discusses two mechanisms leading to two types of collapses and presents a dynamic model capable of reproducing the irreversible collapses found in history Noussair Charles N van Soest Daan P 2014 Economic experiments and environ mental policy Annual Review of Resource Economics 6 319337 This survey reviews the literature addressing whether government intervention is always necessary to protect Visions of the Future 15 the environment and whether it is always effective in doing so and discusses the use of experimental laboratories to test marketbased approaches to environmental policy Repetto R Ed 2006 Punctuated Equilibrium and the Dynamics of US Environmental Policy New Haven CT Yale University Press A sophisticated discussion of how positive and negative feedback mechanisms can interact to produce environmental policy stalemates or breakthroughs Spash Clive 2017 The Routledge Handbook of Ecological Economics New York Routledge Edited by a leading figure in the field this handbook provides a current guide to the literature on ecological economics in an informative and easily accessible form Stavins R Ed 2012 Economics of the Environment Selected Readings 6th ed New York W W Norton Company Inc An excellent set of complementary readings that captures both the power of the discipline and the controversy it provokes Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 17 The Economic Approach Property Rights Externalities and Environmental Problems The charming landscape which I saw this morning is indubitably made up of some twenty or thirty farms Miller owns this field Locke that and Manning the woodland beyond But none of them owns the landscape There is a property in the horizon which no man has but he whose eye can integrate all the parts that is the poet This is the best part of these mens farms yet to this their land deeds give them no title Ralph Waldo Emerson Nature 1836 Introduction Before examining specific environmental problems and the policy responses to them it is important that we develop and clarify the economic approach so that we have some sense of the forest before examining each of the trees By having a feel for the conceptual framework it becomes easier not only to deal with individual cases but also perhaps more importantly to see how they fit into a comprehensive approach In this chapter we develop the general conceptual framework used in economics to approach environmental problems We begin by examining the relationship between human actions as manifested through the economic system and the environmental consequences of those actions We can then establish criteria for judging the desirability of the out comes of this relationship These criteria provide a basis for identifying the nature and severity of environmental problems and a foundation for designing effective policies to deal with them Throughout this chapter the economic point of view is contrasted with alternative points of view These contrasts bring the economic approach into sharper focus and stimulate deeper and more critical thinking about all possible approaches Chapter 2 The Economic Approach 18 The HumanEnvironment Relationship The Environment as an Asset In economics the environment is viewed as a composite asset that provides a variety of services It is a very special asset to be sure because it provides the lifesupport systems that sustain our very existence but it is an asset nonetheless As with other assets we wish to enhance or at least prevent undue depreciation of the value of this asset so that it may continue to provide aesthetic and lifesustaining services The environment provides the economy with raw materials which are transformed into consumer products by the production process and energy which fuels this transformation Ultimately these raw materials and energy return to the environment as waste products see Figure 21 The environment also provides goods and services directly to consumers The air we breathe the nourishment we receive from food and drink and the protection we derive from shelter and clothing are all benefits we receive either directly or indirectly from the environ ment One significant subclass of these ecosystem goods and services incorporates the benefits obtained directly from ecosystems including biodiversity breathable air wetlands water quality carbon sequestration and recreation Anyone who has experienced the exhilaration of whitewater rafting the total serenity of a wilderness trek or the breathtaking beauty of a Figure 21 The Economic System and the Environment The Economic Approach 19 sunset will readily recognize that ecosystems provide us with a variety of amenities for which no substitute exists Chapter 13 provides a closer look at the role economics plays in maintaining and protecting these very special goods and services If the environment is defined broadly enough the relationship between the environment and the economic system can be considered a closed system For our purposes a closed system is one in which no inputs energy or matter are received from outside the system and no outputs are transferred outside the system An open system by contrast is one in which the system imports or exports matter or energy If we restrict our conception of the relationship in Figure 21 to our planet and the atmosphere around it then clearly we do not have a closed system We derive most of our energy from the sun either directly or indirectly We have also sent spaceships well beyond the boundaries of our atmosphere Nonetheless historically speaking for material inputs and outputs not including energy this system can be treated as a closed system because the amount of exports such as abandoned space vehicles and imports eg moon rocks are negligible Whether the system remains closed depends on the degree to which space exploration opens up the rest of our solar system as a source of raw materials The treatment of our planet and its immediate environs as a closed system has an important implication that is summed up in the first law of thermodynamicsenergy and matter can neither be created nor destroyed1 The law implies that the mass of materials flowing into the economic system from the environment has either to accumulate in the economic system or return to the environment as waste When accumulation stops the mass of materials flowing into the economic system is equal in magnitude to the mass of waste flowing into the environment Excessive wastes can of course depreciate the asset when they exceed the absorptive capacity of nature wastes reduce the services that the asset provides Examples are easy to find air pollution can cause respiratory problems polluted drinking water can cause cancer smog obliterates scenic vistas climate change can lead to flooding of coastal areas The relationship of people to the environment is also conditioned by another physical law the second law of thermodynamics Known popularly as the entropy law this law states that entropy increases Entropy is the amount of energy unavailable for work Applied to energy processes this law implies that no conversion from one form of energy to another is completely efficient and that the consumption of energy is an irreversible process Some energy is always lost during conversion and the rest once used is no longer available for further work The second law also implies that in the absence of new energy inputs any closed system must eventually use up its available energy Since energy is necessary for life life ceases when useful energy flows cease We should remember that our planet is not even approximately a closed system with respect to energy we gain energy from the sun The entropy law does remind us however that the flow of solar energy establishes an upper limit on the flow of available energy that can be sustained Once the stocks of stored energy such as fossil fuels and nuclear energy are gone the amount of energy available for useful work will be determined solely by flow resources such as solar wind and hydro and by the amount that can be stored through dams trees and so on Thus in the very long run the growth process will be limited by the availability of these flow resources and our ability to put them to work The Economic Approach Two different types of economic analysis can be applied to increase our understanding of the relationship between the economic system and the environment Positive economics attempts to describe what is what was or what will be Normative economics by contrast deals with The Economic Approach 20 what ought to be Disagreements within positive economics can usually be resolved by an appeal to the facts Normative disagreements however involve value judgments Both branches are useful Suppose for example we want to investigate the relationship between trade and the environment Positive economics could be used to describe the kinds of impacts trade would have on the economy and the environment It could not however provide any guidance on the question of whether trade was desirable That judgment would have to come from normative economics a topic we explore in the next section The fact that positive analysis does not by itself determine the desirability of some policy action does not mean that it is not useful in the policy process Example 21 provides one example of the kinds of economic impact analyses that are used in the policy process EXAMPLE 21 Economic Impacts of Reducing Hazardous Pollutant Emissions from Iron and Steel Foundries The US Environmental Protection Agency EPA was tasked with developing a maximum achievable control technology standard to reduce emissions of hazardous air pollutants from iron and steel foundries As part of the rulemaking process the EPA conducted an ex ante economic impact analysis to assess the potential economic impacts of the proposed rule If implemented the rule would require some iron and steel foundries to imple ment pollution control methods that would increase the production costs at affected facilities The interesting question addressed by the analysis is how large those impacts would be The impact analysis estimated annual costs for existing sources to be 2173 million These cost increases were projected to result in small increases in output prices Specifically prices were projected to increase by only 01 percent for iron castings and 005 percent for steel castings The impacts of these price increases were expected to be experienced largely by iron foundries using cupola furnaces as well as consumers of iron foundry products Unaffected domestic foundries and foreign producers of coke were actually projected to earn slightly higher profits as a result of the rule This analysis helped in two ways First by showing that the impacts fell under the 100 million threshold that mandates review by the Office of Management and Budget the analysis eliminated the need for a much more time and resourceconsuming analysis Second by showing how small the expected impacts would be it served to lower the opposition that might have arisen from unfounded fears of much more severe impacts Source Office of Air Quality Planning and Standards United States Environmental Protection Agency November 2002 Economic Impact Analysis of Proposed Iron and Steel Foundries NESHAP Final Report National Emissions Standards for Hazardous Air Pollutants for Iron and Steel Foundries April 17 2007 Proposed Rule Federal Register 7273 1915019164 The Economic Approach 21 A rather different context for normative economics can arise when the possibilities are more openended For example we might ask how much should we control emissions of greenhouse gases which contribute to climate change and how should we achieve that degree of control Or we might ask how much forest of various types should be preserved Answering these questions requires us to consider the entire range of possible outcomes and to select the best or optimal one Although that is a much more difficult question to answer than one that asks us only to compare two predefined alternatives the basic normative analysis framework is the same in both cases Environmental Problems and Economic Efficiency Static Efficiency The chief normative economic criterion for choosing among various outcomes occurring at the same point in time is called static efficiency or merely efficiency An allocation of resources is said to satisfy the static efficiency criterion if the economic surplus derived from those resources is maximized by that allocation Economic surplus in turn is the sum of consumers surplus and producers surplus Consumer surplus is the value that consumers receive from an allocation minus what it costs them to obtain it Consumer surplus is measured as the area under the demand curve minus the consumers cost This is the shaded triangle in Figure 22 The cost to the consumer is the area under the price line bounded from the left by the vertical axis and the right by the quantity of the good This rectangle which captures price times quantity represents consumer expenditure on this quantity of the good Figure 22 The Consumers Choice The Economic Approach 22 Why is this area above the price line thought of as a surplus For each quantity purchased the corresponding point on the market demand curve represents the amount of money some person would have been willing to pay for the last unit of the good The total willingness to pay for some quantity of this goodsay three unitsis the sum of the willingness to pay for each of the three units Thus the total willingness to pay for three units would be measured by the sum of the willingness to pay for the first second and third units respectively It is now a simple extension to note that the total willingness to pay is the area under the continuous market demand curve to the left of the allocation in question For example in Figure 22 the total willingness to pay for QD units of the commodity is the total area under the demand curve up to QD Thus it is the shaded triangle of consumer surplus plus the rectangle of cost Total willingness to pay is the concept we shall use to define the total value a consumer would receive from the amount of the good they take delivery of Thus total value the consumer would receive is equal to the area under the market demand curve from the origin to the allocation of interest Consumer surplus is thus the excess of total willingness to pay over the lower actual expenditure Meanwhile sellers face a similar choice see Figure 23 Given price P the seller maximizes his or her own producer surplus by choosing to sell Qs units The producer surplus is designated by the shaded area B the area under the price line that lies above the marginal cost curve supply Curve S bounded from the left by the vertical axis and the right by the quantity of the good To calculate producer or consumer surplus notice that as long as the functions are linear as they are in the Figures each area is represented as a right triangle Remember that the area of a right triangle is calculated as 12 the base of the triangle the height of the triangle Using this formula try calculating these areas in the first selftest exercise at the end of this chapter Figure 23 The Producers Choice The Economic Approach 23 Property Rights Property Rights and Efficient Market Allocations The manner in which producers and consumers use environmental resources depends on the property rights governing those resources In economics property rights refer to a bundle of entitlements defining the owners rights privileges and limitations for use of the resource By examining such entitlements and how they affect human behavior we will better understand how environmental problems arise from government and market allocations These property rights can be vested either with individuals groups or with the state How can we tell when the pursuit of profits is consistent with efficiency and when it is not Efficient Property Rights Structures Lets begin by describing the structure of property rights that could produce efficient allocations in a wellfunctioning market economy An efficient structure has three main characteristics 1 ExclusivityAll benefits and costs accrued as a result of owning and using the resources should accrue to the owner and only to the owner either directly or indirectly by sale to others 2 TransferabilityAll property rights should be transferable from one owner to another in a voluntary exchange 3 EnforceabilityProperty rights should be secure from involuntary seizure or encroachment by others An owner of a resource with a welldefined property right one exhibiting these three characteristics has a powerful incentive to use that resource efficiently because a decline in the value of that resource represents a personal loss Farmers who own the land have an incentive to fertilize and irrigate it because the resulting increased production raises income Similarly they have an incentive to rotate crops when that raises the productivity of their land When welldefined property rights are exchanged as in a market economy this exchange facilitates efficiency We can illustrate this point by examining the incentives consumers and producers face when a welldefined system of property rights is in place Because the seller has the right to prevent the consumer from consuming the product in the absence of payment the consumer must pay to receive the product Given a market price the consumer decides how much to purchase by choosing the amount that maximizes his or her individual consumer surplus Is this allocation efficient According to our definition of static efficiency it is clear the answer is yes The economic surplus is maximized by the market allocation and as seen in Figure 24 it is equal to the sum of consumer and producer surpluses areas A B Thus we have not only established a procedure for measuring efficiency but also a means of describing how the surplus is distributed between consumers and producers This distinction is crucially significant Efficiency is not achieved because consumers and producers are seeking efficiency They arent In a system with welldefined property rights and competitive markets in which to sell those rights producers try to maximize their surplus and consumers try to maximize their surplus The price system then induces those selfinterested parties to make choices that also turn out to be efficient from the point of view of society as a whole It channels the energy motivated by selfinterest into socially productive paths The Economic Approach 24 Familiarity may have dulled our appreciation but it is noteworthy that a system designed to produce a harmonious and congenial outcome could function effectively while allowing consumers and producers so much individual freedom in making choices This is truly a remarkable accomplishment Producers Surplus Scarcity Rent and LongRun Competitive Equilibrium Since the area under the price line is total revenue and the area under the marginal cost or supply curve is total variable cost producers surplus is related to profits In the short run when some costs are fixed producers surplus is equal to profits plus fixed cost In the long run when all costs are variable producers surplus is equal to profits plus rent the return to scarce inputs owned by the producer As long as new firms can enter into profitable industries without raising the prices of purchased inputs longrun profits and rent will equal zero Scarcity Rent Most natural resource industries however do give rise to rent and therefore producers surplus is not eliminated by competition even with free entry This producers surplus which persists in longrun competitive equilibrium is called scarcity rent David Ricardo was the first economist to recognize the existence of scarcity rent Ricardo suggested that the price of land was determined by the least fertile marginal unit of land Since the price had to be sufficiently high to allow the poorer land to be brought into production other more fertile land could be farmed at an economic profit Competition could not erode that profit because the amount of highquality land was limited and lower prices would serve only to reduce the supply of land below demand The only way to expand production would be to bring additional less fertile land more costly to farm into production consequently additional production does not lower price as it does in a constantcost industry As we shall see other circumstances also give rise to scarcity rent for natural resources Figure 24 Market Equilibrium The Economic Approach 25 Externalities as a Source of Market Failure The Concept Introduced Exclusivity is one of the chief characteristics of an efficient property rights structure This characteristic is frequently violated in practice One broad class of violations occurs when an agent making a decision does not bear all of the consequences of his or her action Suppose two firms are located by a river The first produces steel while the second somewhat downstream operates a resort hotel Both use the river although in different ways The steel firm uses it as a receptacle for its waste while the hotel uses it to attract customers seeking water recreation If these two facilities have different owners an efficient use of the water is not likely to result Because the steel plant does not bear the cost of reduced business at the resort resulting from waste being dumped into the river it is not likely to be very sensitive to that cost in its decision making As a result it could be expected to dump too much waste into the river and an efficient allocation of the river would not be attained This situation is called an externality An externality exists whenever the welfare of some agent either a firm or household depends not only on his or her activities but also on activities under the control of some other agent In the example the increased waste in the river imposed an external cost on the resort a cost the steel firm could not be counted upon to consider appropriately in deciding the amount of waste to dump The effect of this external cost on the steel industry is illustrated in Figure 25 which shows the market for steel Steel production inevitably involves producing pollution as well as steel The demand for steel is shown by the demand curve D and the private marginal cost of producing the steel exclusive of pollution control and damage is depicted as MCp Because society considers both the cost of pollution and the cost of producing the steel the social marginal cost function MCs includes both of these costs as well Figure 25 The Market for Steel The Economic Approach 26 If the steel industry faced no outside control on its emission levels it would seek to produce Qm That choice in a competitive setting would maximize its private producer surplus But that is clearly not efficient since the net benefit is maximized at Q not Qm Can you see the deadweight loss A deadweight loss arises whenever marginal social costs are not equal to marginal social benefits In this case at the market allocation marginal social costs are higher than marginal benefits With the help of Figure 25 we can draw a number of conclusions about market allocations of commodities causing pollution externalities 1 The output of the commodity is too large 2 Too much pollution is produced 3 The prices of products responsible for pollution are too low 4 As long as the costs remain external no incentives to search for ways to yield less pollution per unit of output are introduced by the market 5 Recycling and reuse of the polluting substances are discouraged because release into the environment is so inefficiently cheap The effects of a market imperfection for one commodity end up affecting the demands for raw materials labor and so on The ultimate effects are felt through the entire economy Types of Externalities External effects or externalities can be positive or negative Historically the terms external cost external diseconomy and external benefit external economy have been used to refer respectively to circumstances in which the affected party is damaged by or benefits from the externality Clearly the water pollution example represents an external cost External benefits are not hard to find however As noted in the opening quote to this chapter private individuals who preserve a particularly scenic area provide an external benefit to all who pass Generally when external benefits are present the market will undersupply the resources One other distinction is important One class of externalities known as pecuniary externalities does not present the same kinds of problems as pollution does Pecuniary externalities arise when the external effect is transmitted through altered prices Suppose that a new firm moves into an area and drives up the rental price of land That increase creates a negative effect on all those paying rent and therefore is an external diseconomy This pecuniary diseconomy however does not cause a market failure because the resulting higher rents are reflecting the true scarcity of land The land market provides a mechanism by which the parties can bid for land the resulting prices reflect the value of the land in its various uses Without pecuniary externalities the price signals would fail to sustain an efficient allocation The pollution example is not a pecuniary externality because the effect is not trans mitted through prices In this example prices do not adjust to reflect the increasing waste load The damage to the water resource is not reflected in the steel firms costs An essential feedback mechanism that is present for pecuniary externalities is not present for the pollution case The externalities concept is a broad one covering a multitude of sources of market failure Example 22 illustrates one The next step is to investigate some specific circumstances that can give rise to externalities The Economic Approach 27 EXAMPLE 22 Shrimp Farming Externalities in Thailand In the Tha Po village on the coast of Surat Thani Province in Thailand more than half of the 1100 hectares of mangrove swamps have been cleared for commercial shrimp farms Although harvesting shrimp is a lucrative undertaking mangroves also serve as nurseries for fish and as barriers for storms and soil erosion Following the destruction of the local mangroves Tha Po villagers experienced a decline in fish catch and suffered storm damage and water pollution Can market forces be trusted to strike the efficient balance between preservation and development for the remaining mangroves Calculations by economists Sathirathai and Barbier 2001 demonstrated that the value of the ecological services that would be lost from further destruction of the mangrove swamps exceeded the value of the shrimp farms that would take their place Preservation of the remaining mangrove swamps would be the efficient choice Would a potential shrimpfarming entrepreneur make the efficient choice Unfortunately the answer is no This study estimated the economic value of mangroves in terms of local use of forest resources offshore fishery linkages and coastal protection to be in the range of 2726435921 per hectare In contrast the economic returns to shrimp farming once they are corrected for input subsidies and for the costs of water pollution are only 194209 per hectare However as shrimp farmers are heavily subsidized and do not have to take into account the external costs of pollution their financial returns are typically 770695833647 per hectare In the absence of some sort of external control imposed by collective action converting mangroves to shrimp farming would be the normal if inefficient result The externalities associated with the ecological services provided by the mangroves support a biased decision that results in fewer social net benefits but greater private net benefits Sources Sathirathai S Barbier E B April 2001 Valuing mangrove conservation in southern Thailand Contemporary Economic Policy 192 109122 Barbier E B Cox M 2004 An economic analysis of shrimp farm expansion and mangrove conversion in Thailand Land Economics 803 389407 Perverse Incentives Arising from Some Property Right Structures Private property is of course not the only possible way of defining entitlements to resource use Other possibilities include stateproperty regimes the government owns and controls the property commonproperty regimes the property is jointly owned and managed by a specified group of coowners and res nullius or openaccess regimes in which no one owns or exercises control over the resources All of these create rather different incentives for resource use Stateproperty regimes exist not only in former communist countries but also to varying degrees in virtually all countries of the world Parks and forests for example are frequently owned and managed by the government in capitalist as well as in socialist nations Problems The Economic Approach 28 with both efficiency and sustainability can arise in stateproperty regimes when the incentives of bureaucrats who implement andor make the rules for resource use diverge from collective interests Commonproperty resources are those shared resources that are managed in common rather than privately Entitlements to use commonproperty resources may be formal pro tected by specific legal rules or they may be informal protected by tradition or custom Commonproperty regimes exhibit varying degrees of efficiency and sustainability depending on the rules that emerge from collective decision making While some very successful examples of commonproperty regimes exist unsuccessful examples are even more common One successful example of a commonproperty regime involves the system of allocat ing grazing rights in Switzerland Although agricultural land is normally treated as private property in Switzerland grazing rights on the Alpine meadows have been treated as common property for centuries Overgrazing is protected by specific rules enacted by an association of users which limit the amount of livestock permitted on the meadow The families included on the membership list of the association have been stable over time as rights and responsibilities have passed from generation to generation This stability has apparently facilitated reciprocity and trust thereby providing a foundation for continued compliance with the rules Unfortunately that kind of stability may be the exception rather than the rule particularly in the face of heavy population pressure The more common situation can be illustrated by the experience of Mawelle a small fishing village in Sri Lanka Initially a complicated but effective rotating system of fishing rights was devised by villagers to assure equitable access to the best spots and best times while protecting the fish stocks Over time population pressure and the infusion of outsiders raised demand and undermined the collective cohesion sufficiently that the traditional rules became unenforceable producing overexploitation of the resource and lower incomes for all the participants Res nullius property resources the main focus of this section can be exploited on a first come firstserved basis because no individual or group has the legal power to restrict access Openaccess resources as we shall henceforth call them have given rise to what has become known popularly as the tragedy of the commons The problems created by openaccess resources can be illustrated by recalling the fate of the American bison Bison are an example of commonpool resources Commonpool resources are shared resources characterized by nonexclusivity and divisibility Nonexclusivity implies that resources can be exploited by anyone while divisibility means that the capture of part of the resource by one group subtracts it from the amount available to the other groups Note the contrast between commonpool resources and public goods the subject of the next section In the early history of the United States bison were plentiful unrestricted hunting access was not a problem Frontier people who needed hides or meat could easily get whatever they needed the aggressiveness of any one hunter did not affect the time and effort expended by other hunters In the absence of scarcity efficiency was not threatened by open access As the years slipped by however the demand for bison increased and scarcity became a factor As the number of hunters increased eventually every additional unit of hunting activity increased the amount of time and effort required to produce an additional yield of bison Consider graphically how various property rights structures and the resulting level of harvest affect the scarcity rent in this case equivalent to the economic surplus received by consumers and producers where the amount of rent is measured as the difference between the revenues received from the harvest minus the costs associated with producing that harvest Figure 26 compares the revenue and costs for various levels of harvest In the top panel the The Economic Approach 29 revenue is calculated by multiplying for each level of hunting activity the assumed constant price of bison by the amount harvested The upward sloping total cost curve simply reflects that fact that increases in harvest effort result in higher total costs Marginal cost is assumed to be constant for this example In terms of the top panel of Figure 26 the total surplus associated with any level of effort is measured as the vertical difference between the total revenue benefits curve and the total cost curve for that level of harvest In the bottom panel the marginal revenue curve is downward sloping despite the constant price because as the amount of hunting effort increases the resulting bison population size decreases Smaller populations support smaller harvests per unit of effort expended The efficient level of hunting activity in this model E maximizes the surplus This can be seen graphically in two different ways First E maximizes the vertical difference between the total cost and total benefit top panel Second in the bottom panel E is the level where the marginal revenue which records the addition to the surplus from an additional unit of Figure 26 Bison Harvesting The Economic Approach 30 effort crosses the marginal cost curve which measures the reduction in the surplus due to the additional cost of expending that last unit of effort These two panels are simply two different mathematically equivalent ways to demonstrate the same outcome The curves in the bottom panel are derived from the curves in the top panel With all hunters having completely unrestricted access to the bison the resulting allocation would not be efficient No individual hunter would have an incentive to protect scarcity rent by restricting hunting effort Individual hunters under this open access scenario without exclusive rights would exploit the resource until their total benefit equaled total cost implying a level of effort equal to EOA Excessive exploitation of the herd occurs because individual hunters cannot appropriate the scarcity rent therefore they ignore it One of the losses from further exploitation that could be avoided by exclusive ownersthe loss of scarcity rent due to overexploitationis not part of the decisionmaking process of openaccess hunters Two characteristics of this formulation of the openaccess allocation are worth noting 1 in the presence of sufficient demand unrestricted access will cause resources to be overex ploited 2 the scarcity rent is dissipatedno one is able to appropriate the rent so it is lost Why does this happen Unlimited access destroys the incentive to conserve A hunter who can preclude others from hunting his stock has an incentive to keep the herd at an efficient level This restraint results in lower costs in the form of less time and effort expended to produce a given yield of bison On the other hand a hunter exploiting an openaccess resource would not have an incentive to conserve because the potential additional economic surplus derived from selfrestraint would to some extent be captured by other hunters who simply kept harvesting Thus unrestricted access to scarce resources promotes an inefficient allocation As a result of excessive harvest and the loss of habitat as land was converted to farm and pasture the Great Plains bison herds nearly became extinct Lueck 2002 Another example of openaccess fisheries is the principal topic of Chapter 12 Public Goods Public goods defined as those that exhibit both consumption indivisibilities and nonexclud ability present a particularly complex category of environmental resources Nonexcludability refers to a circumstance where once the resource is provided even those who fail to pay for it cannot be excluded from enjoying the benefits it confers Consumption is said to be indivis ible when one persons consumption of a good does not diminish the amount available for others Several common environmental resources are public goods including not only the charming landscape referred to by Emerson but also clean air clean water and biological diversity2 Biological diversity includes two related concepts 1 the amount of genetic variability among individuals within a single species and 2 the number of species within a community of organisms Genetic diversity critical to species survival in the natural world has also proved to be important in the development of new crops and livestock It enhances the opportunities for crossbreeding and thus the development of superior strains The availability of different strains was the key for example in developing new diseaseresistant barley Because of the interdependence of species within ecological communities any particular species may have a value to the community far beyond its intrinsic value Certain species contribute balance and stability to their ecological communities by providing food sources or holding the population of the species in check The richness of diversity within and among species has provided new sources of food energy industrial chemicals raw materials and medicines Yet considerable evidence suggests The Economic Approach 31 that biological diversity is decreasing Biodiversity is a valuable ecosystem service Ecosystem services will be covered in detail in Chapter 13 Can we rely solely on the private sector to produce the efficient amount of public goods such as biological diversity Unfortunately the answer is no Suppose that in response to diminishing ecological diversity we decide to take up a collection to provide some means of preserving endangered species Would the collection yield sufficient revenue to pay for an efficient level of ecological diversity The general answer is no Lets see why In Figure 27 individual demand curves for preserving biodiversity have been presented for two consumers A and B The market demand curve is represented by the vertical summation of the two individual demand curves A vertical summation is necessary because everyone can simultaneously consume the same amount of biological diversity We are therefore able to determine the market demand by finding the sum of the amounts of money they would be willing to pay for that level of diversity What is the efficient level of diversity It can be determined by a direct application of our definition of efficiency The efficient allocation maximizes economic surplus which is represented geometrically by the portion of the area under the market demand curve that lies above the constant marginal cost curve The allocation that maximizes economic surplus is Q the allocation where the demand curve crosses the marginal cost curve Why would a competitive market not be expected to supply the efficient level of this good Since the two consumers have very different marginal willingness to pay from the efficient allocation of this good OA versus OB the efficient pricing system would require charging a different price to each consumer Person A would pay OA and person B would pay OB Remember consumers tend to choose the level of the good that equates their marginal willingness to pay to the price they face Yet the producer would have no basis for figuring out how to differentiate the prices In the absence of excludability consumers are not likely to willingly reveal the strength of their preference for this commodity All consumers have an incentive to understate the strength of their preferences to try to shift more of the cost burden to the other consumers Therefore inefficiency results because each person is able to become a free rider on the others contribution A free rider is someone who derives the value from a commodity without paying an efficient amount for its supply Because of the consumption indivisibility and nonexcludability properties of the public good consumers receive the value of any diversity purchased by other people When this happens it tends to diminish incentives to contribute and the contributions are not sufficiently large to finance the efficient amount of the public good it would be undersupplied In Chapter 17 we shall use the lens provided by game theory to show how the free rider effect helps to shape climate policy The privately supplied amount may not be zero however Some diversity would be privately supplied Indeed as suggested by Example 23 the privately supplied amount may be considerable Imperfect Market Structures Environmental problems also occur when one of the participants in an exchange of property rights is able to exercise an inordinate amount of power over the outcome This can occur for example when a product is sold by a single seller or monopoly It is easy to show that monopolies violate our definition of efficiency in the goods market see Figure 28 According to our definition of static efficiency the efficient allocation would result when OB is supplied This would yield consumer surplus represented by triangle IGC and producer surplus denoted by triangle GCH The monopoly however would produce and Figure 27 Efficient Provision of Public Goods The Economic Approach 33 sell OA where marginal revenue equals marginal cost and would charge price OF At this point although the producers surplus HFED is maximized the sum of consumer and producer surplus is clearly not because this choice causes society to lose economic surplus equal to triangle EDC3 Monopolies supply an inefficiently small amount of the good Imperfect markets clearly play some role in environmental problems For example the major oilexporting countries have formed a cartel resulting in higherthannormal prices and lowerthannormal production A cartel is a collusive agreement among producers to restrict production and raise prices This collusive agreement allows the group to act as a monopolist The inefficiency in the goods market would normally be offset to some degree by an associated reduction in social costs The reduction in the combustion of oil would result in lower levels of pollution and hence the social cost associated with that pollution EXAMPLE 23 Public Goods Privately Provided The Nature Conservancy Can the demand for a public good such as biological diversity be observed in practice Would the market respond to that demand Apparently so according to the existence of an organization called the Nature Conservancy The Nature Conservancy was born of an older organization called the Ecologist Union on September 11 1950 for the purpose of establishing natural area reserves to aid in the preservation of areas objects and fauna and flora that have scientific educational or aesthetic significance This organization purchases or accepts as dona tions land that has some unique ecological or aesthetic significance to keep it from being used for other purposes In so doing it preserves many species by preserving the habitat From humble beginnings the Nature Conservancy has as of 2017 been responsible for the preservation of 119 million acres of forests marshes prairies mounds and islands around the world Additionally the Nature Conservancy has protected 5000 miles of rivers and operates over 100 marine conservation projects These areas serve as home to rare and endangered species of wildlife and plants The Conservancy owns and manages the largest privately owned nature preserve system in the world This approach has considerable merit A private organization can move more rapidly than the public sector Because it has a limited budget the Nature Conservancy sets priori ties and concentrates on acquiring the most ecologically unique areas Yet the theory of public goods reminds us that if this were to be the sole approach to the preservation of biological diversity it would preserve a smallerthanefficient amount Source The Nature Conservancy wwwnatureorgaboutusvisionmissionindexhtmintcnaturefnavabout The Economic Approach 35 Government failure shares with market failure the characteristic that improper incentives are the root of the problem Special interest groups use the political process to engage in what has become known as rent seeking Rent seeking is the use of resources in lobbying and other activities directed at securing legislation that results in more profitable outcomes for those funding this activity Successful rentseeking activity will typically increase the net benefits going to the special interest group but it will also frequently lower the surplus to society as a whole In these instances it is a classic case of the aggressive pursuit of a larger slice of the pie leading to a smaller pie Why dont the losers rise up to protect their interests One main reason is voter ignorance It is economically rational for voters to remain at least partially ignorant on many issues simply because of the high cost of keeping fully informed and the low probability that any single vote will be decisive In addition it is difficult for diffuse groups of individuals each of whom is affected only to a small degree to organize a coherent unified opposition Successful opposition is in a sense a public good with its attendant tendency for free riding Opposition to special interests would normally be underfunded especially when the opposition is dispersed and the special interests are concentrated Rent seeking can take many forms Producers can seek protection from competitive pressures brought by imports or can seek price floors to hold prices above their efficient levels Consumer groups can seek price ceilings on goods or special subsidies to transfer part of their costs to the general body of taxpayers Rent seeking is not the only source of inefficient government policy Sometimes governments act without full information and establish policies that are ultimately very inefficient For example some time ago one technological strategy chosen by the government to control motor vehicle pollution involved adding a chemical substance MTBE to gasoline Designed to promote cleaner combustion this additive turned out to create a substantial water pollution problem Governments may also pursue social policy objectives that have the side effect of causing an environmental inefficiency For example looking back at Figure 25 suppose that the government when pressured by lobbyists decides to subsidize the production of steel Figure 29 illustrates the outcome The private marginal cost curve shifts down and to the right causing a further increase in production lower prices and even more pollution produced Thus the subsidy moves us even further away from where surplus is maximized at Q The shaded triangle A shows the deadweight loss inefficiency without the subsidy With the subsidy the deadweight loss grows to areas A B C This social policy has the side effect of increasing an environmental inefficiency In another example in Chapter 7 we shall see how the desire to hold down natural gas prices for consumers led to subsequent shortages These examples provide a direct challenge to the presumption that more direct intervention by the government automatically leads to either greater efficiency or greater sustainability These cases illustrate the general economic premise that environmental problems arise because of a divergence between individual and collective objectives This is a powerful explanatory device because not only does it suggest why these problems arise but it also suggests how they might be resolvedby realigning individual incentives to make them compatible with collective objectives As selfevident as this approach may be it is controversial when people disagree about whether the problem is our improper values or the improper translation of our quite proper values into action Economists have always been reluctant to argue that values of consumers are warped because that would necessitate dictating the correct set of values Both capitalism and democracy are based on the presumption that the majority knows what it is doing whether it is casting ballots for representatives or dollar votes for goods and services The Economic Approach 36 The Pursuit of Efficiency We have seen that environmental problems can arise when property rights are ill defined and when these rights are exchanged under something other than competitive conditions We can now use our definition of efficiency to explore possible remedies such as private negotiation judicial remedies and regulation by the legislative and executive branches of government Private Resolution through NegotiationProperty Liability and the Coase Theorem The simplest means to restore efficiency occurs when the number of affected parties is small making negotiation feasible Suppose for example we return to the case used earlier in this chapter to illustrate an externalitythe conflict between the polluting steel company and the downstream resort Figure 210 allows us to examine how this negotiation might take place If the resort offers a payment of C D to the steel company they would be better off if the steel firm responded by decreasing its production from Qm to Q Lets assume that the payment is equal to this amount Would the steel company be willing to reduce production to the desired level If they refused the compensation their producer surplus would be A B D If they accepted their producer surplus would be A B plus the payment so their total return would be A B C D Clearly they are better off by C if they accept the payment Society as a whole is better off by the amount C as well since the economic surplus from Qm is A C and the economic surplus from Q is A Our discussion of individual negotiations raises two questions 1 Should the property right always belong to the party who held it first in this case the steel company 2 How can Figure 29 The Market for Steel Revisited The Economic Approach 37 environmental risks be handled when prior negotiation is clearly impractical These questions are routinely answered by the court system The court system can respond to environmental conflicts by imposing either property rules or liability rules Property rules specify the initial allocation of the entitlement or property right The entitlements at conflict in our example are on one hand the right to add waste products to the river and on the other the right to an attractive river In applying property rules the court merely decides which right is preeminent and places an injunction against violating that right The injunction is removed only upon obtaining the consent of the party whose right was violated Consent is usually obtained in return for an outofcourt monetary settlement achieved via negotiation Note that in the absence of a court decision the entitlement is naturally allocated to the party that can most easily seize it In our example the natural allocation would give the entitlement to the steel company The courts must decide whether to overturn this natural allocation How would they decide And what difference would their decision make The answers may surprise you In a classic article economist Ronald Coase 1960 held that as long as negotiation costs are negligible and affected consumers can negotiate freely with each other when the number of affected parties is small the court could allocate the entitlement to either party and an efficient allocation would result The only effect of the courts decision would be to change the distribution of surplus among the affected parties This remarkable conclusion has come to be known as the Coase theorem Why is this so In Figure 210 we showed that if the steel company has the property right it is in the resorts interest to offer a payment that results in the desired level of output Figure 210 Efficient Output with Pollution Damage The Economic Approach 38 Suppose now that the resort has the property right instead To pollute in this case the steel company must pay the resort Suppose it could pollute only if it compensated the resort for all damages In other words it would agree to pay the difference between the two marginal cost curves up to the level of output actually chosen As long as this compensation was required the steel company would choose to produce Q since that is the level at which its producers surplus given the compensation is maximized Note that due to the compensation the curve the steel company uses to calculate its producer surplus is now the higher marginal cost curve The difference between these different ways of allocating property rights lies in how the cost of obtaining the efficient level of output is shared between the parties When the property right is assigned to the steel company the cost is borne by the resort part of the cost is the damage and part is the payment to reduce the level of damage When the property right is assigned to the resort the cost is borne by the steel company it now must compensate for all damage In either case the efficient level of production results The Coase theorem shows that the very existence of an inefficiency triggers pressures for improvements Furthermore the existence of this pressure does not depend on the assignment of property rights This is an important point but the importance of this theorem should not be overstated As we shall see in succeeding chapters private efforts triggered by inefficiency can frequently prevent the worst excesses of environmental degradation However both theoretical and practical objections can be raised The chief theoretical qualification concerns the assumption that wealth effects do not matter The decision to confer the property right on a particular party results in a transfer of wealth to that party This transfer might shift the demand curve for either steel or resorts out as long as higher incomes result in greater demand Whenever wealth effects are significant the type of property rule issued by the court does affect the outcome Wealth effects normally are small so the zerowealtheffect assumption is probably not a fatal flaw Some serious practical flaws however do mar the usefulness of the Coase theorem The first involves the incentives for polluting that result when the property right is assigned to the polluter Since pollution would become a profitable activity with this assignment other polluters might be encouraged to increase production and pollution in order to earn the payments That certainly would not be efficient Negotiation is also difficult to apply when the number of people affected by the pollution is large You may have already noticed that in the presence of several affected parties pollution reduction is a public good The freerider problem would make it difficult for the group to act cohesively and effectively for the restoration of efficiency When individual negotiation is not practical for one reason or another the courts can turn to liability rules These are rules that award monetary damages after the fact to the injured party The amount of the award is designed to correspond to the amount of damage inflicted Thus returning to Figure 210 a liability rule would force the steel company to compensate the resort for all damages incurred In this case it could choose any production level it wanted but it would have to pay the resort an amount of money equal to the area between the two marginal cost curves from the origin to the chosen level of output In this case the steel plant would maximize its producers surplus by choosing Q Why wouldnt the steel plant choose to produce more than that Why wouldnt the steel plant choose to produce less than that The moral of this story is that appropriately designed liability rules can also correct inefficiencies by forcing those who cause damage to bear the cost of that damage Internalizing previously external costs causes profitmaximizing decisions to be compatible with efficiency As we shall see in subsequent chapters this internalizing externalities principle The Economic Approach 39 plays a large role in the design of efficient policy in many areas of environmental and natural resource policy Liability rules are interesting from an economics point of view because early decisions create precedents for later ones Imagine for example how the incentives to prevent oil spills facing an oil company are transformed once it has a legal obligation to clean up after an oil spill and to compensate fishermen for reduced catches It quickly becomes evident that in this situation accident prevention can become cheaper than retrospectively dealing with the damage once it has occurred This approach however also has its limitations It relies on a casebycase determination based on the unique circumstances for each case Administratively such a determination is very expensive Expenses such as court time lawyers fees and so on fall into a category called transaction costs by economists In the present context these are the administrative costs incurred in attempting to correct the inefficiency The Coase theorem relies on an assumption that transaction costs are low In reality though this is rarely the case Transaction costs in many cases can be quite high When the number of parties involved in a dispute is large and the circumstances are common we are tempted to correct the inefficiency by statutes or regulations rather than court decisions Legislative and Executive Regulation These remedies can take several forms The legislature could dictate that no one produce more steel or pollution than Q This dictum might then be backed up with sufficiently large jail sentences or fines to deter potential violators Alternatively the legislature could impose a tax on steel or on pollution A perunit tax equal to the vertical distance between the two marginal cost curves would work see Figure 210 Legislatures could also establish rules to permit greater flexibility and yet reduce damage For example zoning laws would establish separate areas for steel plants and resorts This approach assumes that the damage can be substantially reduced by keeping nonconforming uses apart They could also require the installation of particular pollution control equipment as when catalytic converters were required on automobiles or deny the use of a particular production ingredient as when lead was removed from gasoline In other words they can regulate outputs inputs production processes emissions and even the location of production in their attempt to produce an efficient outcome In subsequent chapters we shall examine the various options policymakers have not only to show how they can modify environmentally destructive behavior but also to establish the degree to which they can promote efficiency Payments are of course not the only means victims have at their disposal for lowering pollution When the victims also consume the products produced by the polluters consumer boycotts are possible When the victims are employed by the polluter strikes or other forms of labor resistance are also possible Legislation andor regulation can also help to resolve the asymmetric information problem Because the fundamental problem is that one or more of the parties do not have sufficient crucial trustworthy information the obvious solution involves providing that information How should that information be provided Labeling is one attempt to provide more information to consumers Examples of labeling for food products include notifying consumers about products containing genetically modified organisms and identifying organically grown crops and fair trade products A recent source of encouragement for organic farms has been the demonstrated willing ness of consumers to pay a premium for organically grown fruits and vegetables To allow The Economic Approach 40 consumers to discern which products are truly organic growers need a reliable certification process Additionally fear of lost access to important foreign markets such as the European Union led to an industrywide push in the United States for mandatory labeling standards that would provide the foundation for a national uniform seal Voluntary US certification programs had proved insufficient to assure access to European markets since they were highly variable by state In response to these pressures the Organic Foods Production Act OFPA was enacted in the 1990 Farm Bill4 Title 21 of that law states the following objectives 1 to establish national standards governing the marketing of certain agricultural products as organically produced 2 to assure consumers that organically produced products meet a consistent standard and 3 to facilitate interstate commerce in fresh and processed food that is organically produced5 The USDA National Organic Program established as part of this Act is responsible for a mandatory certification program for organic production The Act also established the National Organic Standards Board NOSB and charged it with defining the organic standards The new rules which took effect in October 2002 require certification by the USDA for labeling Foods labeled as 100 percent organic must contain only organic ingredients Foods labeled as organic must contain at least 95 percent organic agricultural ingredients excluding water and salt Products labeled as Made with Organic Ingredients must contain at least 70 percent organic agricultural ingredients Certification allows socially conscious consumers to make a difference As Example 24 demonstrates ecocertification for coffee seems to be one such case An Efficient Role for Government While the economic approach suggests that government action could well be used to restore efficiency it also suggests that inefficiency is not a sufficient condition to justify government intervention Any corrective mechanism involves transaction costs If these transaction costs are high enough and the surplus to be derived from correcting the inefficiency is small enough then it is best simply to live with the inefficiency Consider for example the pollution problem Woodburning stoves which were widely used for cooking and heat in the late 1800s in the United States were sources of pollution but because of the enormous capacity of the air to absorb the emissions no regulation resulted More recently however the resurgence of demand for woodburning stoves in cold climates with nearby forests precipitated in part by high oil prices has resulted in strict regulations for woodburning stove emissions because the population density is so much higher Over time the scale of economic activity and the resulting emissions have increased Cities are experiencing severe problems from air and water pollutants because of the clustering of activities Both the increase in the number of emitters and their clustering have increased the amount of emissions per unit volume of air or water As a result pollutant concentrations have caused perceptible problems with human health vegetation growth and aesthetics Historically as incomes have risen the demand for leisure activities has also risen Many of these leisure activities such as canoeing and backpacking take place in unique pristine environmental areas With the number of these areas declining as a result of conversion to other uses the value of remaining areas has increased Thus the values derived from protecting The Economic Approach 41 some areas have risen over time until they have exceeded the transaction costs of protecting them from pollution andor development The level and concentration of economic activity has increased pollution problems and driven up the demand for clean air and pristine areas These changes have created the preconditions for government action Can government respond efficiently or will rent seeking prevent efficient political solutions We devote much of this book to pinning down the answer to that question EXAMPLE 24 Can EcoCertification Make a Difference Organic Costa Rican Coffee Environmental problems associated with agricultural production for export in develop ing countries can be difficult to tackle using conventional regulation because producers are typically so numerous and dispersed while regulatory agencies are commonly inadequately funded and staffed In principle ecocertification of production could cir cumvent these problems by providing a means for the socially conscious consumer to identify environmentally superior products thereby providing a basis for paying a price premium for them These premiums in turn would create financial incentives for producers to meet the certification standards Do socially conscious buyers care enough to actually pay a price premium that is high enough to motivate changes in the way the products are produced Apparently for Costa Rican coffee at least they are One study examined this question for certified organic coffee grown in Turrialba Costa Rica an agricultural region in the countrys central valley about 40 miles east of San José the capital city This is an interesting case because Costa Rican farmers face significant pressure from the noncertified market to lower their costs a strategy that can have severe environmental consequences In contrast organic production typically not only involves higher labor costs but the conversion from chemically based production can also reduce yields In addition the costs of initial certification and subsequent annual monitoring and reporting are significant The authors found that organic certification did improve coffee growers environ mental performance Specifically they found that certification significantly reduced the use of pesticides chemical fertilizers and herbicides and increased the use of organic fertilizer In general their results suggest that organic certification has a stronger causal effect on preventing negative practices than on encouraging positive ones The study notes that this finding is consistent with anecdotal evidence that local inspectors tend to enforce the certification standards prohibiting negative practices more vigorously than the standards requiring positive ones Source Blackman A Naranjo M A 2012 Does ecocertification have environmental benefits Organic coffee in Costa Rica Ecological Economics 83November 5866 The Economic Approach 42 Summary How producers and consumers use the resources making up the environmental asset depends on the nature of the entitlements embodied in the property rights governing resource use When property rights systems are exclusive transferable and enforceable the owner of a resource has a powerful incentive to use that resource efficiently since the failure to do so results in a personal loss The economic system will not always sustain efficient allocations however Specific circumstances that could lead to inefficient allocations include externalities improperly defined property rights systems such as openaccess resources and public goods imperfect markets for trading the property rights to the resources monopoly and asymmetric information When these circumstances arise market allocations typically do not maximize the surplus Due to rentseeking behavior by special interest groups or the lessthanperfect implementation of efficient plans the political system can produce inefficiencies as well Voter ignorance on many issues coupled with the publicgood nature of any results of political activity tends to create a situation in which maximizing an individuals private surplus through lobbying for example can be at the expense of a lower economic surplus for all consumers and producers The efficiency criterion can be used to assist in the identification of circumstances in which our political and economic institutions lead us astray It can also assist in the search for remedies by facilitating the design of regulatory judicial or legislative solutions Discussion Questions 1 In a wellknown legal case Miller v Schoene 287 US 272 a classic conflict of property rights was featured Red cedar trees used only for ornamental purposes carried a disease that could destroy apple orchards within a radius of 2 miles There was no known way of curing the disease except by destroying the cedar trees or by ensuring that apple orchards were at least 2 miles away from the cedar trees Apply the Coase theorem to this situation Does it make any difference to the outcome whether the cedar tree owners are entitled to retain their trees or the apple growers are entitled to be free of them Why or why not 2 In primitive societies the entitlements to use land were frequently possessory rights rather than ownership rights Those on the land could use it as they wished but they could not transfer it to anyone else One could acquire a new plot by simply occupying and using it leaving the old plot available for someone else Would this type of entitlement system cause more or less incentive to conserve the land than an ownership entitlement Why Would a possessory entitlement system be more efficient in a modern society or a primitive society Why 3 In this chapter we have discussed how markets work Recently some new markets have emerged that focus on sharing of durable goods among a wider circle of users Examples include Airbnb and Uber The rise of these sharing markets may well have an impact on the relationship between the economy and the environment a What are the market niches these firms have found How is Airbnb different from Hilton How is Uber different from Hertz or Yellow Cab Is this a matter mainly of a different type of supply or is the demand side affected as well The Economic Approach 43 b Why now Markets for personal transportation and temporary housing have been around for a long time How can these new companies find profitable opportunities in markets that have existed for some time Is it evidence that the markets are not competitive Or have the new opportunities been created by some changes in market conditions c Are these new sharing markets likely on balance to be good for or harmful to the environment Why SelfTest Exercises 1 Suppose the state is trying to decide how many miles of a very scenic river it should preserve There are 100 people in the community each of whom has an identical inverse demand function given by P 10 10q where q is the number of miles preserved and P is the permile price he or she is willing to pay for q miles of preserved river a If the marginal cost of preservation is 500 per mile how many miles would be preserved in an efficient allocation b How large is the economic surplus 2 Suppose the market demand function expressed in dollars for a normal product is P 80 q and the marginal cost in dollars of producing it is MC 1q where P is the price of the product and q is the quantity demanded andor supplied a How much would be supplied by a competitive market b Compute the consumer surplus and producer surplus Show that their sum is maximized c Compute the consumer surplus and the producer surplus assuming this same product was supplied by a monopoly Hint The marginal revenue curve has twice the slope of the demand curve d Show that when this market is controlled by a monopoly producer surplus is larger consumer surplus is smaller and the sum of the two surpluses is smaller than when the market is controlled by competitive industry 3 Suppose you were asked to comment on a proposed policy to control oil spills Since the average cost of an oil spill has been computed as X the proposed policy would require any firm responsible for a spill immediately to pay the government X Is this likely to result in the efficient amount of precaution against oil spills Why or why not 4 In environmental liability cases courts have some discretion regarding the magnitude of compensation polluters should be forced to pay for the environmental incidents they cause In general however the larger the required payments the better Discuss 5 Label each of the following propositions as descriptive or normative and defend your choice a Energy efficiency programs have created jobs b Money spent on protecting endangered species is wasted c Fisheries must be privatized to survive d Raising transport costs lower suburban land values e Birth control programs are counterproductive 6 Identify whether each of the following resource categories is a public good a common pool resource or neither and defend your answer a A pod of whales in the ocean to whale hunters b A pod of whales in the ocean to whale watchers The Economic Approach 44 c The benefits from reductions of greenhouse gas emissions d Water from a town well that excludes nonresidents e Bottled water Notes 1 We know however from Einsteins famous equation E mc2 that matter can be transformed into energy This transformation is the source of energy in nuclear power 2 Notice that public bads such as dirty air and dirty water are also possible 3 Producers would lose area JDC compared to the efficient allocation but they would gain area FEJG which is much larger Meanwhile consumers would be worse off because they lose area FECJG Of these FEJG is merely a transfer to the monopoly whereas EJC is a pure loss to society The total pure loss EDC is called a deadweight loss 4 The European Union has followed a similar but not identical policy 5 Golan et al 2001 Further Reading Lueck D 2002 The extermination and conservation of the American bison Journal of Legal Studies 31S2 s609s652 A fascinating look at the role property rights played in the fate of the American bison Mason C F 2012 The economics of ecolabeling Theory and empirical implications International Review of Environmental and Resource Economics 6 341372 A survey of the growing literature on ecolabeling Ostrom E 1992 Crafting Institutions for SelfGoverning Irrigation Systems San Francisco CA ICS Press A classic book by a Nobel Prize laureate that demonstrates that in favorable circumstances commonpool problems can sometimes be solved by voluntary organizations rather than by a coercive state among the cases considered are communal tenure in meadows and forests irrigation communities and fisheries Ostrom E Dietz T Dolsak N Stern P Stonich S Weber E U Eds 2002 The Drama of the Commons Washington DC National Academy Press A compilation of articles and papers on commonpool resources Stavins R 2012 The Economics of the Environment Selected Readings 6th ed New York W W Norton and Company A carefully selected collection of readings that would complement this text Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 45 Evaluating TradeOffs BenefitCost Analysis and Other DecisionMaking Metrics No sensible decision can be made any longer without taking into account not only the world as it is but the world as it will be Isaac Asimov US science fiction novelist and scholar 19201992 Introduction In the last chapter we noted that economic analysis has both positive and normative dimensions The normative dimension helps to separate the policies that make sense from those that dont Since resources are limited it is not possible to undertake all ventures that might appear desirable so making choices is inevitable Normative analysis can be useful in public policy in several different situations It might be used for example to evaluate the desirability of a proposed new pollution control regulation or a proposal to preserve an area currently scheduled for development In these cases the analysis helps to provide guidance on the desirability of a program before that program is put into place In other contexts it might be used to evaluate how an already implemented program has worked out in practice Here the relevant question is Was this a wise use of resources In this chapter we present and demonstrate the use of several decision making metrics that can assist us in evaluating options Normative Criteria for Decision Making Normative choices can arise in two different contexts In the first context we need simply to choose among options that have been predefined while in the second we try to find the optimal choice among all the possible options Chapter 3 Evaluating TradeOffs 46 Evaluating Predefined Options BenefitCost Analysis If you were asked to evaluate the desirability of some proposed action you would probably begin by attempting to identify both the gains and the losses from that action If the gains exceed the losses then it seems natural to support the action That simple framework provides the starting point for the normative approach to evaluating policy choices in economics Economists suggest that actions have both benefits and costs If the benefits exceed the costs then the action is desirable On the other hand if the costs exceed the benefits then the action is not desirable Comparing benefits and costs across time will be covered later in this chapter We can formalize this in the following way Let B be the benefits from a proposed action and C be the costs Our decision rule would then be if support the action B C 2 Otherwise oppose the action1 As long as B and C are positive a mathematically equivalent formulation would be 1 if support the action B C 2 Otherwise oppose the action So far so good but how do we measure benefits and costs In economics the system of measurement is anthropocentric which simply means human centered All benefits and costs are valued in terms of their effects broadly defined on humanity As shall be pointed out later that does not imply as it might first appear that ecosystem effects are ignored unless they directly affect humans The fact that large numbers of humans contribute voluntarily to organizations that are dedicated to environmental protection provides ample evidence that humans place a value on environmental preservation that goes well beyond any direct use they might make of it Nonetheless the notion that humans are doing the valuing is a controversial point that will be revisited and discussed in Chapters 4 and 13 along with the specific techniques for valuing these effects In benefitcost analysis benefits are measured simply as the relevant area under the demand curve since the demand curve reflects consumers willingness to pay Total costs are measured by the relevant area under the marginal cost curve It is important to stress that environmental services have costs even though they are pro duced without any human input All costs should be measured as opportunity costs To firm up this notion of opportunity cost consider an example Suppose a particular stretch of river can be used either for whitewater rafting or to generate electric power Since the dam that generates the power would flood the rapids the two uses are incompatible The opportunity cost of producing power is the foregone net benefit that would have resulted from the white water rafting The marginal opportunity cost curve defines the additional cost of producing another unit of electricity resulting from the associated incremental loss of net benefits due to reduced opportunities for whitewater rafting Since net benefit is defined as the excess of benefits over costs it follows that net benefit is equal to that portion of the area under the demand curve that lies above the supply curve Consider Figure 31 which illustrates the net benefits from preserving a stretch of river Suppose that we are considering preserving a 4mile stretch of river and that the benefits and costs of that action are reflected in Figure 31 Should that stretch be preserved Why or why not Hold on to your answer because we will return to this example later Evaluating TradeOffs 47 Finding the Optimal Outcome In the preceding section we examined how benefitcost analysis can be used to evaluate the desirability of specific actions In this section we want to examine how this approach can be used to identify optimal or best approaches In subsequent chapters which address individual environmental problems the normative analysis will proceed in three steps First we will identify an optimal outcome Second we will attempt to discern the extent to which our institutions produce optimal outcomes and where divergences occur between actual and optimal outcomes to attempt to uncover the behavioral sources of the problems Finally we can use both our knowledge of the nature of the problems and their underlying behavioral causes as a basis for designing appropriate policy solutions Although applying these three steps to each of the environmental problems must reflect the uniqueness of each situation the overarching framework used to shape that analysis remains the same To provide some illustrations of how this approach is used in practice consider two examples one drawn from natural resource economics and another from environmental economics These are meant to be illustrative and to convey a flavor of the argument the details are left to upcoming chapters Consider the rising number of depleted ocean fisheries Depleted fisheries which involve fish populations that have fallen so low as to threaten their viability as commercial fisheries not only jeopardize oceanic biodiversity but also pose a threat to both the individuals who make their living from the sea and the communities that depend on fishing to support their local economies How would an economist attempt to understand and resolve this problem The first step would involve defining the optimal stock or the optimal rate of harvest of the fishery The second step would compare this level with the actual stock and harvest levels Once this economic framework is applied not only does it become clear that stocks are much lower than optimal for many fisheries but also the reason for excessive exploitation becomes clear Understanding the nature of the problem has led quite naturally to some solutions Once implemented these Figure 31 The Derivation of Net Benefits Evaluating TradeOffs 48 policies have allowed some fisheries to begin the process of renewal The details of this analysis and the policy implications that flow from it are covered in Chapter 12 Another problem involves solid waste As local communities run out of room for landfills in the face of an increasing generation of waste what can be done Economists start by thinking about how one would define the optimal amount of waste The definition necessarily incorporates waste reduction and recycling as aspects of the optimal outcome The analysis not only reveals that current waste levels are excessive but also suggests some specific behavioral sources of the problem Based upon this understanding specific economic solutions have been identified and implemented Communities that have adopted these measures have generally experienced lower levels of waste and higher levels of recycling The details are spelled out in Chapter 8 In the rest of the book similar analysis is applied to energy minerals water pollution climate change and a host of other topics In each case the economic analysis helps to point the way toward solutions To initiate that process we must begin by defining optimal Relating Optimality to Efficiency According to the normative choice criterion introduced earlier in this chapter desirable outcomes are those where the benefits exceed the costs It is therefore a logical next step to suggest that optimal polices are those that maximize net benefits benefits minus costs The concept of static efficiency or merely efficiency was introduced in Chapter 2 An allocation of resources is said to satisfy the static efficiency criterion if the economic surplus from the use of those resources is maximized by that allocation Notice that the net benefits area to be maximized in an optimal outcome for public policy is identical to the economic surplus that is maximized in an efficient allocation Hence efficient outcomes are also optimal outcomes Lets take a moment to show how this concept can be applied Previously we asked whether an action that preserved 4 miles of river was worth doing Figure 31 The answer is yes because the net benefits from that action are positive Can you see why Static efficiency however requires us to ask a rather different question namely what is the optimal or efficient number of miles to be preserved We know from the definition that the optimal amount of preservation would maximize net benefits Does preserving 4 miles maximize net benefits Is it the efficient outcome We can answer that question by establishing whether it is possible to increase the net benefit by preserving more or less of the river If the net benefit can be increased by preserving more miles clearly preserving 4 miles could not have maximized the net benefit and therefore could not have been efficient Consider what would happen if society were to choose to preserve 5 miles instead of 4 Refer back to Figure 31 What happens to the net benefit It increases by area MNR Since we can find another allocation with greater net benefit 4 miles of preservation could not have been efficient Could 5 Yes Lets see why We know that 5 miles of preservation convey more net benefits than 4 If this allocation is efficient then it must also be true that the net benefit is smaller for levels of preservation higher than 5 Notice that the additional cost of preserving the sixth unit the area under the marginal cost curve is larger than the additional benefit received from preserving it the corresponding area under the demand curve Therefore the triangle RTU represents the reduction in net benefit that occurs if 6 miles are preserved rather than 5 Since the net benefit is reduced both by preserving less than 5 miles and by preserving more than 5 we conclude that five units is the preservation level that maximizes net benefit the Evaluating TradeOffs 49 shaded area Therefore from our definition preserving 5 miles constitutes an efficient or optimal allocation2 One implication of this example which will be very useful in succeeding chapters is what we shall call the first equimarginal principle First Equimarginal Principle the Efficiency Equimarginal Principle Social net benefits are maximized when the social marginal benefits from an allocation equal the social marginal costs The social marginal benefit is the increase in social benefits received from supplying one more unit of the good or service while social marginal cost is the increase in cost incurred from supplying that additional unit of the good or service This criterion helps to minimize wasted resources but is it fair The ethical basis for this criterion is derived from a concept called Pareto optimality named after the Italianborn Swiss economist Vilfredo Pareto who first proposed it around the turn of the twentieth century Allocations are said to be Pareto optimal if no other feasible allocation could benefit at least one person without any deleterious effects on some other person Allocations that do not satisfy this definition are suboptimal Suboptimal allocations can always be rearranged so that some people can gain net benefits without the rearrangement causing anyone else to lose net benefits Therefore the gainers could use a portion of their gains to compensate the losers sufficiently to ensure they were at least as well off as they were prior to the reallocation Efficient allocations are Pareto optimal Since net benefits are maximized by an efficient allocation it is not possible to increase the net benefit by rearranging the allocation Without an increase in the net benefit it is impossible for the gainers to compensate the losers sufficiently the gains to the gainers would necessarily be smaller than the losses to the losers Inefficient allocations are judged inferior because they do not maximize the size of the pie to be distributed By failing to maximize net benefit they are forgoing an opportunity to make some people better off without harming others Comparing Benefits and Costs across Time The analysis we have covered so far is very useful for thinking about actions where time is not an important factor Yet many of the decisions made now have consequences that persist well into the future Time is a factor Exhaustible energy resources once used are gone Biological renewable resources such as fisheries or forests can be overharvested leaving smaller and possibly weaker populations for future generations Persistent pollutants can accumulate over time How can we make choices when the benefits and costs occur at different points in time Incorporating time into the analysis requires an extension of the concepts we have already developed This extension provides a way for thinking not only about the magnitude of benefits and costs but also about their timing In order to incorporate timing the decision rule must provide a way to compare net benefits received in different time periods The concept that allows this comparison is called present value Before introducing this expanded decision rule we must define present value Present value explicitly incorporates the time value of money A dollar today invested at 10 percent interest yields 110 a year from now the return of the 1 principal plus 010 Evaluating TradeOffs 50 interest The present value of 110 received one year from now is therefore 1 because given 1 now you can turn it into 110 a year from now by investing it at 10 percent interest We can find the present value of any amount of money X received one year from now by computing X1 r where r is the appropriate interest rate 10 percent in our above example What could your dollar earn in 2 years at r percent interest Because of compound interest the amount would be 11 rl r 11 r2 It follows then that the present value of X received 2 years from now is X1 r2 The present value of X received in three years is X1r3 By now the pattern should be clear The present value of a onetime net benefit received n years from now is 1 PV r B Bn n n 6 The present value of a stream of net benefits B0 Bn received over a period of n years is computed as where r is the appropriate interest rate and B0 is the amount of net benefits received immediately The process of calculating the present value is called discounting and the rate r is referred to as the discount rate The number resulting from a presentvalue calculation has a straightforward interpretation Suppose you were investigating an allocation that would yield the following pattern of net benefits on the last day of each of the next 5 years 3000 5000 6000 10000 and 12000 If you use an interest rate of 6 percent r 006 and the above formula you will discover that this stream has a present value of 2920592 see Table 31 Notice how each amount is discounted back the appropriate number of years to the present and then these discounted values are summed What does that number mean If you put 2920592 in a savings account earning 6 percent interest and wrote yourself checks respectively for 3000 5000 6000 10000 and 12000 on the last day of each of the next 5 years your last check would just restore the account to a 0 balance see Table 32 Thus you should be indifferent about receiving 2920592 now or in the specific 5year stream of benefits totaling 36000 given one you can get the other Hence the method is called present value because it translates everything back to its current worth It is now possible to show how this analysis can be used to evaluate actions Calculate the present value of net benefits from the action If the present value is greater than zero the action can be supported Otherwise it should not Table 31 Demonstrating Present Value Calculations Year 1 2 3 4 5 Sum Annual Amounts 3000 5000 6000 10000 12000 36000 Present Value r 006 283019 444998 503772 792094 896710 2920592 PVB0 Bn1 r B n n 1 r B n n Evaluating TradeOffs 51 Dynamic Efficiency The static efficiency criterion is very useful for comparing resource allocations when time is not an important factor How can we think about optimal choices when the benefits and costs occur at different points in time The traditional criterion used to find an optimal allocation when time is involved is called dynamic efficiency a generalization of the static efficiency concept already developed In this generalization the presentvalue criterion provides a way for comparing the net benefits received in one period with the net benefits received in another An allocation of resources across n time periods satisfies the dynamic efficiency criterion if it maximizes the present value of net benefits that could be received from all the possible ways of allocating those resources over the n periods3 Applying the Concepts Having now spent some time developing the concepts we need lets take a moment to examine some actual studies in which they have been used Pollution Control Benefitcost analysis has been used to assess the desirability of efforts to control pollution Pollution control certainly confers many benefits but it also has costs Do the benefits justify the costs That was a question the US Congress wanted answered so in Section 812 of the Clean Air Act Amendments of 1990 it required the US Environmental Protection Agency EPA to evaluate the benefits and costs of the US air pollution control policy initially over the 19701990 period and subsequently over the 19902020 time period see Example 31 In responding to this congressional mandate the EPA set out to quantify and monetize the benefits and costs of achieving the emissions reductions required by US policy Benefits quantified by this study included reduced death rates and lower incidences of chronic bronchitis lead poisoning strokes respiratory diseases and heart disease as well as the benefits of better visibility reduced structural damages and improved agricultural productivity We shall return to this study later in the book for a deeper look at how these estimates were derived but a couple of comments are relevant now First despite the fact that this study Table 32 Interpreting Present Value Calculations Year 1 2 3 4 5 6 Balance at Beginning of Year 2920592 2795828 2463577 2011392 1132075 000 YearEnd Fund Balance before Payment r 006 3095828 2963577 2611392 2132075 1200000 Payment 3000 5000 6000 10000 12000 Evaluating TradeOffs 52 did not attempt to value all pollution damage to ecosystems that was avoided by this policy the net benefits are still strongly positive While presumably the case for controlling pollution would have been even stronger had all such avoided damage been included the desirability of this form of control is evident even with only a partial consideration of benefits An inability to monetize all benefits and costs does not necessarily jeopardize the ability to reach sound policy conclusions Although these results justify the conclusion that pollution control made economic sense they do not justify the stronger conclusion that the policy was efficient To justify that conclusion the study would have had to show that the present value of net benefits was maximized not merely positive In fact this study did not attempt to calculate the maximum net benefits outcome and if it had it would have almost certainly discovered that the policy during this period was not optimal As we shall see in Chapters 15 and 17 the costs of the chosen policy approach were higher than necessary to achieve the desired emissions reductions With an optimal policy mix the net benefits would have been even higher EXAMPLE 31 Does Reducing Pollution Make Economic Sense Evidence from the Clean Air Act In its 1997 report to Congress the EPA presented the results of its attempt to discover whether the Clean Air Act had produced positive net benefits over the period 1970 1990 The results suggested that the present value of benefits using a discount rate of 5 percent was 222 trillion while the costs were 0523 trillion Performing the necessary subtraction reveals that the net benefits were therefore equal to 217 trillion According to this study US air pollution control policy during this period made very good economic sense Soon after the period covered by this analysis substantive changes were made in the Clean Air Act Amendments of 1990 the details of those changes are covered in later chapters Did those additions also make economic sense In August of 2010 the US EPA issued a report of the benefits and costs of the Clean Air Act from 1990 to 2020 This report suggests that the costs of meeting the 1990 Clean Air Act Amendment requirements are expected to rise to approximately 65 billion per year by 2020 2006 dollars Almost half of the compliance costs 28 billion arise from pollution controls placed on cars trucks and buses while another 10 billion arises from reducing air pollution from electric utilities These actions are estimated to cause benefits from reduced pollution damage to rise from roughly 800 billion in 2000 to almost 13 trillion in 2010 ultimately reaching approximately 2 trillion per year 2006 dollars by 2020 For persons living in the United States a cost of approximately 200 per person by 2020 produces approximately a 6000 gain in benefits per person from the improvement in air quality Many of the estimated benefits come from reduced risk of early mortality due to exposure to fine particulate matter Table 33 provides a summary of the costs and benefits and includes a calculation of the benefitcost ratio Evaluating TradeOffs 53 Table 33 Summary Comparison of Benefits and Costs from the Clean Air Act 19902020 Estimates in Million 2006 Annual Estimates Present Value Estimate 2000 2010 2020 19902020 Monetized Direct Costs Low1 Central 20000 53000 65000 380000 High1 Monetized Direct Benefits Low2 90000 160000 250000 1400000 Central 770000 1300000 2000000 12000000 High2 2300000 3800000 5700000 35000000 Net Benefits Low 70000 110000 190000 1000000 Central 750000 1200000 1900000 12000000 High 2300000 3700000 5600000 35000000 BenefitCost Ratio Low3 51 31 41 41 Central 391 251 311 321 High3 1151 721 881 921 Notes 1 The cost estimates for this analysis are based on assumptions about future changes in factors such as consumption patterns input costs and technological innovation We recognize that these assumptions introduce significant uncertainty into the cost results however the degree of uncertainty or bias associated with many of the key factors cannot be reliably quantified Thus we are unable to present specific low and high cost estimates 2 Low and high benefit estimates are based on primary results and correspond to 5th and 95th percentile results from statistical uncertainty analysis incorporating uncertainties in physical effects and valuation steps of benefits analysis Other significant sources of uncertainty not reflected include the value of unquantified or unmonetized benefits that are not captured in the primary estimates and uncertainties in emissions and air quality modeling 3 The low benefitcost ratio reflects the ratio of the low benefits estimate to the central costs estimate while the high ratio reflects the ratio of the high benefits estimate to the central costs estimate Because we were unable to reliably quantify the uncertainty in cost estimates we present the low estimate as less than X and the high estimate as more than Y where X and Y are the low and high benefitcost ratios respectively Sources US Environmental Protection Agency 1997 The Benefits and Costs of the Clean Air Act 1970 to 1990 Washington DC Environmental Protection Agency Table 18 p 56 US Environmental Protection Agency Office of Air and Radiation The Benefits and Costs of the Clean Air Act 1990 to 2020 Summary Report 8162010 Full Report available at wwwepagovcleanairactoverviewbenefits andcostscleanairact19902010firstprospectivestudy accessed January 14 2018 Evaluating TradeOffs 54 Estimating Benefits of Carbon Dioxide Emission Reductions Benefitcost analysis is frequently complicated by the estimation of benefits and costs that are difficult to quantify Chapter 4 takes up the topic of nonmarket valuation in detail One such value is the benefit of reductions in carbon emissions Executive Order 12866 requires government agencies to assess both the costs and the benefits of the intended regulation and recognizing that some costs and benefits are difficult to quantify propose or adopt a regulation only upon a reasoned determination that the benefits of the intended regulation justify its costs4 In order to include benefits from reducing carbon dioxide emission agencies use what is called the social cost of carbon to reflect what those damages would have been in the absence of the reductions The social cost of carbon is the marginal increase in the present value in dollars of the economic damages eg sea level rise floods changes in agricultural productivity and altered ecosystem services resulting from a small increase usually 1 metric ton in carbon dioxide emissions Since the social cost of carbon is a present value calculation both the timing of the emission reduction and the discount rate play an important role The Interagency Working Group on Social Cost of Carbon presented the first set of estimates for the social cost of carbon in 2010 In 2013 these estimates were revised upwards with the estimate for the social cost of carbon increasing from 22 to approximately 37 per ton of carbon using a discount rate of 3 percent In 2016 they were revised again Table 34 illustrates the 2016 revised social cost of carbon dioxide using 25 3 and 5 percent discount rates for selected years The fourth column presents the extreme case 95th percentile using a 3 percent discount rate Notice the importance of the discount rate in determining what value is used Can you explain why The social cost of carbon is useful in making sure that the calculated benefits of carbon reductions reflect the reduced damages that can be expected Example 32 demonstrates one way the social cost of carbon has been used in policy How much difference has it made in general One study examined all economically significant federal regulations since 2008 to see what difference using a social cost of carbon would make When they compared the ranking of the proposed policy to the status quo they Table 34 Revised Social Cost of CO2 20152050 in 2007 dollars per metric ton of CO2 Discount Rates Year 5 Avg 3 Avg 25 Avg 3 95th 2015 11 36 56 105 2020 12 42 62 123 2025 14 46 68 138 2030 16 50 73 152 2035 18 55 78 168 2040 21 60 84 183 2045 23 64 89 197 2050 26 69 95 212 Source https19january2017snapshotepagovclimatechangesocialcostcarbonhtml accessed May 15 2017 Evaluating TradeOffs 55 found little evidence that use of the social cost of carbon to include carbon reduction benefits into the calculation affected US policy choices to date The authors speculate that the absence of a discernible impact may be explained in part because US regulators have succeeded in selecting the lowhanging fruit where the net benefits of early policies that reduce carbon are the largest and therefore most likely to pass a benefitcost test even without using the social cost of carbon5 In 2017 with the election of President Donald Trump everything changed Soon after taking office President Trump signed an Executive Order that calls on agencies to disband the Interagency Working Group on Social Cost of Greenhouse Gases and to withdraw the docu ments that are the basis for the current calculation of the social cost of carbon That EPA website has now been removed although scientists have preserved the material it can be found at https19january2017snapshotepagovclimatechangesocialcostcarbonhtml While this order does not abandon the concept completely it does signal a desire to use a new approach to measuring and using the concept What will this mean for future policies Stay tuned EXAMPLE 32 Using the Social Cost of Capital The DOE Microwave Oven Rule In 2013 the Department of Energy DOE announced new rules for energy efficiency for microwave ovens in standby mode By improving the energy efficiency of these ovens this rule would reduce carbon emissions In the regulatory impact analysis associated with this rule it was necessary to value the reduced damages from this lower level of emissions The social cost of carbon was used to provide this information Using the 2010 social cost of carbon produced a present value of net benefits for the microwave oven rule over the next 30 years of 42 billion Since this value is positive it means that implementing this rule would increase efficiency We know that using the revised 2013 number would increase the present value of net benefits but by how much According to the DOE using the 2013 instead of the 2010 social cost of carbon increases the present value of net benefits to 46 billion In this case the net benefits were large enough both before and after the new SCC estimates to justify implementing the rule but it is certainly possible that in other cases these new estimates would justify rules that prior to the change would not have been justified Note that microwave purchasers will bear the cost of this set of rules as prices rise to reflect the higher production costs but they will not receive all of the benefits those reflecting a reduction in external costs However the DOE notes that due to the increased energy efficiency of the appliances subject to these rules and the resulting lower energy costs for purchasers the present value of savings to consumers is estimated to be 34 billion over the next 30 years DOE 2013 an amount that is larger than the costs In this case the rules represent a win for both microwave consumers and the planet Sources httpenergygovarticlesnewenergyefficiencystandardsmicrowaveovenssaveconsumersenergy bills Technical Update of the Social Cost of Carbon for Regulatory Impact AnalysisUnder Executive Order 12866 httpsobamawhitehousearchivesgovsitesdefaultfilesombinforegscctsdfinaljuly2015pdf Evaluating TradeOffs 56 Issues in Benefit Estimation The analyst charged with the responsibility for performing a benefitcost analysis encounters many decision points requiring judgment If we are to understand benefitcost analysis the nature of these judgments must be clear in our minds Primary versus Secondary Effects Environmental projects usually trigger both primary and secondary consequences For example the primary effect of cleaning a lake will be an increase in recreational uses of the lake This primary effect will cause a further ripple effect on services provided to the increased number of users of the lake Are these secondary benefits to be counted The answer depends upon the employment conditions in the surrounding area If this increase in demand results in employment of previously unused resources such as labor the value of the increased employment should be counted If on the other hand the increase in demand is met by a shift in previously employed resources from one use to another it is a different story In general secondary employment benefits should be counted in high unemployment areas or when the particular skills demanded are underemployed at the time the project is commenced They should not be counted when the project simply results in a rearrangement of productively employed resources Accounting Stance The accounting stance refers to the geographic scale or scope at which the benefits are measured Scale matters because in a benefitcost analysis only the benefits or costs affecting that specific geographic area are counted Suppose for example that the federal government picks up many of the costs but the benefits are received by only one region Even if the benefitcost analysis shows this to be a great project for the region that will not necessarily be the case for the nation as a whole Once the national costs are factored in the national project benefits may not exceed the national project costs Debate 31 examines this issue in relation to the social cost of carbon Aggregation Related to accounting stance are challenges of aggregation Estimates of benefits and costs must be aggregated in order to derive total benefits and total costs How many people benefit and how many people incur costs are very important in any aggregation but additionally how they benefit might impact that aggregation Suppose for example those living closer to the project received more benefits per household than those living farther away In this case these differences should be accounted for With and Without Principle The with and without principle states that only those benefits that would result from the project should be counted ignoring those that would have accrued anyway Mistakenly including benefits that would have accrued anyway would overstate the benefits of the program Tangible versus Intangible Benefits Tangible benefits are those that can reasonably be assigned a monetary value Intangible benefits are those that cannot be assigned a monetary value either because data are not available or reliable enough or because it is not clear how to measure the value even with data6 Quantification of intangible benefits is the primary topic of the next chapter How are intangible benefits to be handled One answer is perfectly clear they should not be ignored To ignore intangible benefits is to bias the results That benefits are intangible does not mean they are unimportant Evaluating TradeOffs 57 Intangible benefits should be quantified to the fullest extent possible One frequently used technique is to conduct a sensitivity analysis of the estimated benefit values derived from less than perfectly reliable data We can determine for example whether or not the outcome is sensitive within wide ranges to the value of this benefit If not then very little time has to be spent on the problem If the outcome is sensitive the person or persons making the decision bear the ultimate responsibility for weighing the importance of that benefit What Is the Proper Geographic Scope for the Social Cost of Carbon The Social Cost of Carbon is an estimate of the economic damages associated with a small increase in carbon dioxide CO2 emissions conventionally 1 metric ton in a given year Any reduction in these damages resulting from a proposed regulation is used to estimate the climate benefits of US rulemakings Because climate change is a global public good the efficient damage estimate must include all damages not just damages to the United States Some critics argue that because it is used in US regulatory procedures it should include only US damages otherwise it might justify regulations that impose costs on US citizens for the purpose of producing benefits enjoyed by citizens of other countries who do not bear the cost Proponents of the global metric point out that the measure is designed to be a means of internalizing a marginal external cost and it cannot do that accurately and efficiently if it leaves out some of the costs Calculating it only for US damages would create a biased measure that would underestimate the damages and raise the possibility of biased regulatory decisions based upon it Furthermore they argue that the characterization of this measure as allow ing benefits created by American citizens to be enjoyed by foreign citizens is a bit misleading These benefits do not reflect goods and services purchased by US citizens that are enjoyed abroad Rather they reflect a reduction in the damages that US citizens would otherwise be imposing on others American law typically does not allow someone to inflict damage on neighbors simply because they are on the other side of some boundary Reducing damages imposed on others has a different moral context than spillover benefits Some regulatory analysts have now suggested that the USonly measure should not replace the existing measure but complement it Both should be provided What do you think Source Dudley Susan E Fraas Art Gayer Ted Graham John Lutter Randall Shogren Jason F Viscusi W Kip 2016 How much will climate change rules benefit Americans Forbes February 9 DEBATE 31 Evaluating TradeOffs 58 Approaches to Cost Estimation Estimating costs is generally easier than estimating benefits but it is not easy One major problem for both derives from the fact that benefitcost analysis is forwardlooking and thus requires an estimate of what a particular strategy will cost which is much more difficult than tracking down what an existing strategy does cost Two approaches have been developed to estimate these costs The Survey Approach One way to discover the costs associated with a policy is to ask those who bear the costs and presumably know the most about them to reveal the magnitude of the costs to policymakers Polluters for example could be asked to provide controlcost estimates to regulatory bodies The problem with this approach is the strong incentive not to be truthful An overestimate of the costs can trigger less stringent regulation therefore it is financially advantageous to provide overinflated estimates The Engineering Approach The engineering approach bypasses the source being regulated by using general engineering information to catalog the possible technologies that could be used to meet the objective and to estimate the costs of purchasing and using those technologies The final step in the engineering approach is to assume that the sources would use technologies that minimize cost This produces a cost estimate for a typical wellinformed firm The engineering approach has its own problems These estimates may not approximate the actual cost of any particular firm Unique circumstances may cause the costs of that firm to be higher or lower than estimated the firm in short may not be typical The Combined Approach To circumvent these problems analysts frequently use a combi nation of survey and engineering approaches The survey approach collects information on possible technologies as well as special circumstances facing the firm Engineering approaches are used to derive the actual costs of those technologies given the special circumstances This combined approach attempts to balance information best supplied by the source with that best derived independently In the cases described so far the costs are relatively easy to quantify and the problem is simply finding a way to acquire the best information This is not always the case however Some costs are not easy to quantify although economists have developed some ingenious ways to secure monetary estimates even for those costs Take for example a policy designed to conserve energy by forcing more people to carpool If the effect of this is simply to increase the average time of travel how is this cost to be measured For some time transportation analysts have recognized that people value their time and a large amount of literature has now evolved to provide estimates of how valuable time savings or time increases would be The basis for this valuation is opportunity costhow the time might be used if it werent being consumed in travel Although the results of these studies depend on the amount of time involved individual decisions seem to imply that travelers value their travel time at a rate not more than half their wage rates The Treatment of Risk For many environmental problems it is not possible to state with certainty what consequences a particular policy will have because scientific estimates themselves often are imprecise Determining the efficient exposure to potentially toxic substances requires obtaining results Evaluating TradeOffs 59 at high doses and extrapolating to low doses as well as extrapolating from animal studies to humans It also requires relying upon epidemiological studies that infer a pollutioninduced adverse human health impact from correlations between indicators of health in human populations and recorded pollution levels For example consider the potential damages from climate change While scientists agree on most of the potential impacts of climate change such as sea level rise and species losses the timing and extent of those losses are not certain The treatment of risk in the policy process involves two major dimensions 1 identifying and quantifying the risks and 2 deciding how much risk is acceptable The former is primarily scientific and descriptive while the latter is more evaluative or normative Benefitcost analysis grapples with the evaluation of risk in several ways Suppose we have a range of policy options A B C D and a range of possible outcomes E F G for each of these policies depending on how the economy evolves over the future These outcomes for example might depend on whether the demand growth for the resource is low medium or high Thus if we choose policy A we might end up with outcomes AE AF or AG Each of the other policies has three possible outcomes as well yielding a total of 12 possible outcomes We could conduct a separate benefitcost analysis for each of the 12 possible out comes Unfortunately the policy that maximizes net benefits for E may be different from that which maximizes net benefits for F or G Thus if we only knew which outcome would prevail we could select the policy that maximized net benefits the problem is that we do not Furthermore choosing the policy that is best if outcome E prevails may be disastrous if G results instead When a dominant policy emerges this problem is avoided A dominant policy is one that confers higher net benefits for every outcome In this case the existence of risk concerning the future is not relevant for the policy choice This fortuitous circumstance is exceptional rather than common but it can occur Other options exist even when dominant solutions do not emerge Suppose for example that we were able to assess the likelihood that each of the three possible outcomes would occur Thus we might expect outcome E to occur with probability 05 F with probability 03 and G with probability 02 Armed with this information we can estimate the expected present value of net benefits The expected present value of net benefits for a particular policy is defined as the sum over outcomes of the present value of net benefits for that policy where each outcome is weighted by its probability of occurrence Symbolically this is expressed as 1 EPVNB P PVNB j J 0 j i ij i I where EPVNBj expected present value of net benefits for policy j Pi probability of the ith outcome occurring PVNBij present value of net benefits for policy j if outcome i prevails J number of policies being considered I number of outcomes being considered The final step is to select the policy with the highest expected present value of net benefits This approach has the substantial virtue that it weighs higher probability outcomes more heavily It also however makes a specific assumption about societys preference for risk This approach is appropriate if society is riskneutral Riskneutrality can be defined most easily by the use of an example Suppose you were to choose between being given a definite 50 or entering a lottery in which you had a 50 percent chance of winning 100 and a 50 percent Evaluating TradeOffs 60 chance of winning nothing Notice that the expected value of this lottery is 50 05100 050 You would be said to be riskneutral if you would be indifferent between these two choices If you view the lottery as more attractive you would be exhibiting riskloving behavior while a preference for the definite 50 would suggest riskaverse behavior Using the expected present value of net benefits approach implies that society is riskneutral Is that a valid assumption The evidence is mixed The existence of gambling suggests that at least some members of society are riskloving while the existence of insurance suggests that at least for some risks others are riskaverse Since the same people may gamble and own insurance policies it is likely that the type of risk may be important Even if individuals were demonstrably riskaverse this would not be a sufficient condition for the government to forsake riskneutrality in evaluating public investments One famous article Arrow Lind 1970 argues that riskneutrality is appropriate since when the risks of a public investment are publicly borne the total cost of riskbearing is insignificant and therefore the government should ignore uncertainty in evaluating public investments The logic behind this result suggests that as the number of risk bearers and the degree of diversifica tion of risks increases the amount of risk borne by any individual diminishes to zero When the decision is irreversible as demonstrated by Arrow and Fisher 1974 considerably more caution is appropriate Irreversible decisions may subsequently be regretted but the option to change course will be lost forever Extra caution also affords an opportunity to learn more about alternatives to this decision and its consequences before acting Isnt it comforting to know that occasionally procrastination can be optimal There is a movement in national policy in both the courts and the legislature to search for imaginative ways to define acceptable risk In general the policy approaches reflect a caseby case method We shall see that current policy reflects a high degree of risk aversion toward a number of environmental problems Distribution of Benefits and Costs Many agencies are now required to consider the distributional impacts of costs and benefits as part of any economic analysis For example the US EPA provides guidelines on distri butional issues in its Guidelines for Preparing Economic Analysis According to the EPA distributional analysis assesses changes in social welfare by examining the effects of a regula tion across different subpopulations and entities Distributional analysis can take two forms economic impact analysis and equity analysis Economic impact analysis focuses on a broad characterization of who gains and who loses from a given policy Equity analysis exam ines impacts on disadvantaged groups or subpopulations The latter delves into the normative issue of equity or fairness in the distribution of costs and benefits Loomis 2011 outlines several approaches for incorporating distribution and equity into benefitcost analysis Some issues of the distribution of benefits and costs related to energy efficiency rules for appliances were highlighted in Example 32 Choosing the Discount Rate Recall that discounting allows us to compare all costs and benefits in current dollars regardless of when the benefits accrue or costs are charged Suppose a project will impose an immediate cost of 4000000 todays dollars but the 5500000 benefits will not be earned until 5 years out Is this project a good idea On the surface it might seem like it is but recall that 5500000 in 5 years is not the same as 5500000 today At a discount rate of 5 percent the present value of benefits minus the present value of costs is positive However at a 10 percent Evaluating TradeOffs 61 EXAMPLE 33 The Importance of the Discount Rate Lets begin with an historical example For years the United States and Canada had been discussing the possibility of constructing a tidal power project in the Passamaquoddy Bay between Maine and New Brunswick This project would have heavy initial capital costs but low operating costs that presumably would hold for a long time into the future As part of their analysis of the situation a complete inventory of costs and benefits was completed in 1959 Using the same benefit and cost figures Canada concluded that the project should not be built while the United States concluded that it should Because these conclusions were based on the same benefitcost data the differences can be attributed solely to the use of different discount rates The United States used 25 percent while Canada used 4125 percent The higher discount rate makes the initial cost weigh much more heavily in the calculation leading to the Canadian conclusion that the project would yield a negative net benefit Since the lower discount rate weighs the lower future operating costs relatively more heavily Americans saw the net benefit as positive In a more recent illustration of why the magnitude of the discount rate matters on October 30 2006 economist Nicholas Stern from the London School of Economics issued a report using a discount rate of 01 percent that concluded that the benefits of strong early action on climate change would considerably outweigh the costs Other economists such as William Nordhaus of Yale University who preferred a discount rate around 6 percent found that optimal economic policies to slow climate change involve only modest rates of emissions reductions in the near term followed by sharp reductions in the medium and long term In this debate the desirability of strong current action is dependent at least in part on the size of the discount rate used in the analysis Higher discount rates reduce the present value of future benefits from current investments in abatement implying a smaller marginal benefit Since the costs associated with those investments are not affected nearly as much by the choice of discount rate remember that costs occurring in the near future are discounted less a lower present value of marginal benefit translates into a lower optimal investment in abatement Far from being an esoteric subject the choice of the discount rate is fundamentally important in defining the role of the public sector the types of projects undertaken and the allocation of resources across generations Sources Stokey E Zeckhauser R 1978 A Primer for Policy Analysis New York W W Norton 164165 Mikesell R 1977 The Rate of Discount for Evaluating Public Projects Washington DC The American Enterprise Institute for Public Policy Research 35 the Stern Report httpwebarchive nationalarchivesgovuk20100407011151httpwwwhmtreasurygovuksternreviewindexhtm Nordhaus W 2007 A review of the Stern Review on the economics of climate change Journal of Economic Literature XLV September 686702 discount rate this same calculation yields a negative value since the present value of costs exceeds the benefits Can you reproduce the calculations that yield these conclusions As Example 33 indicates this has been and continues to be an important issue When the public sector uses a discount rate lower than that in the private sector the public sector Evaluating TradeOffs 62 will find more projects with longer payoff periods worthy of authorization And as we have already seen the discount rate is a major determinant of the allocation of resources among generations as well The discount rate can be defined conceptually as the social opportunity cost of capital This cost of capital can be divided further into two components 1 the riskless cost of capital and 2 the risk premium Traditionally economists have used longterm interest rates on government bonds as one measure of the cost of capital adjusted by a risk premium that would depend on the riskiness of the project considered Unfortunately the choice of how large an adjustment to make has been left to the discretion of the analysts This ability to affect the desirability of a particular project or policy by the choice of discount rate led to a situation in which government agencies were using a variety of discount rates to justify programs or projects they supported One set of hearings conducted by Congress during the 1960s discovered that at one time agencies were using discount rates ranging from 0 to 20 percent During the early 1970s the Office of Management and Budget published a circular that required with some exceptions all government agencies to use a discount rate of 10 percent in their benefitcost analysis A revision issued in 1992 reduced the required discount rate to 7 percent This circular also includes guidelines for benefitcost analysis and specifies that certain rates will change annually7 This standardization reduces biases by eliminating the agencys ability to choose a discount rate that justifies a predetermined conclusion It also allows a project to be considered independently of fluctuations in the true social cost of capital due to cycles in the behavior of the economy On the other hand when the social opportunity cost of capital differs from this administratively determined level the benefitcost analysis will not in general define the efficient allocation Example 33 highlights a different aspect of the choice of the discount rate for decisions involving long time horizons It considers the question of whether or not discount rates should decline over time Debate 32 explores this question Discounting over Long Time Horizons Should Discount Rates Decline As you now recognize the choice of the discount rate can significantly alter the outcome of a benefitcost analysis This effect is exacerbated over long time horizons and can become especially influential in decisions about spending now to mitigate damages from climate change which may be uncertain in both magnitude and timing What rate is appropriate Recent literature and some evidence argue for declining rates of discount over long time horizons Should a declining rate schedule be utilized A blueribbon panel of experts recently gathered to debate this and related questions Arrow et al 2012 An unresolved debate in the economics literature revolves around the question of whether discount rates should be positive descriptive reflecting actual market rates or normative prescriptive reflecting ethical considerations Those who argue for the descriptive approach prefer to use market rates of return since expenditures to mitigate climate change DEBATE 32 Evaluating TradeOffs 63 Divergence of Social and Private Discount Rates Earlier we concluded that producers in their attempt to maximize producer surplus also maximize the present value of net benefits under the right conditions such as the absence of externalities the presence of properly defined property rights and the presence of competitive markets within which the property rights can be exchanged Now lets consider one more condition If resources are to be allocated efficiently firms must use the same rate to discount future net benefits as is appropriate for society at large If firms were to use a higher rate they would extract and sell resources faster than would be efficient Conversely if firms were to use a lowerthanappropriate discount rate they would be excessively conservative Why might private and social rates differ As noted above the social opportunity cost of capital can be separated into two components the riskfree cost of capital and the risk are investment expenditures Those who argue for the alternative prescriptive approach argue for including judgments about intergenerational equity These rates are usually lower than those found in actual markets Griffiths et al 2012 In the United States the Office of Management and Budget OMB currently recommends a constant rate of discount for project analysis The recommendation is to use 3 percent and 7 percent real discount rates in sensitivity analysis OMB 2003 with options for lower rates if future generations are impacted The United Kingdom and France utilize discount rate schedules that decline over time Is one of these methods better than the other for discounting over long time horizons If a declining rate is appropriate how fast should that rate decline The blueribbon panel agreed that theory provides strong arguments for a declining certaintyequivalent discount rate Arrow et al 2012 p 21 Although the empirical literature also supports a rate that is declining over time especially in the presence of uncertainty about future costs andor benefits the results from the empirical literature vary widely depending on the model assumptions and underlying data If a declining rate schedule were to be adopted in the United States this group of experts recommends that the EPAs Science Advisory Board be asked to develop criteria that could be used as the common foundation for determining what the schedule should look like Sources Arrow K Maureen J Cropper L Gollier C Groom B Heal G M et al December 2012 How should benefits and costs be discounted in an intergenerational context The views of an expert panel RFF DP 1253 Griffiths C Kopits E Marten A Moore C Newbold S Wolverton A 2012 The social cost of carbon Valuing carbon reductions in policy analysis In R A de Mooij M Keen I W H Parry Eds Fiscal Policy to Mitigate Climate Change A Guide for Policy Makers Washington DC IMF 6987 OMB Office of Management and Budget Circular A4 Regulatory Analysis Washington DC Executive Office of the President wwwwhitehousegov ombcircularsa004a4 Evaluating TradeOffs 64 premium The riskfree cost of capital is the rate of return earned when there is absolutely no risk of earning more or less than the expected return The risk premium is an additional cost of capital required to compensate the owners of this capital when the expected and actual returns may differ Therefore because of differences in the risk premium the cost of capital is higher in risky industries than in norisk industries Another difference between private and social discount rates may stem from a difference in social and private risk premiums If the risk of certain private decisions is different from the risks faced by society as a whole then the social and private risk premiums may differ One obvious example is the risk caused by the government If the firm is afraid its assets will be confiscated by the government it may choose a higher discount rate to make its profits before nationalization occurs From the point of view of societyas represented by governmentthis is not a risk and therefore a lower discount rate is appropriate When private rates exceed social rates current production is higher than is desirable to maximize the net benefits to society Both energy production and forestry have been subject to this source of inefficiency Another divergence in discount rates may stem from different underlying rates of time preference Such a divergence in time preferences can cause not only a divergence between private and social discount rates as when firms have a higher rate of time preference than the public sector but even between otherwise similar analyses conducted in two different countries Time preferences would be expected to be higher for example in a cashpoor developing country than in an industrialized country Since the two benefitcost analyses in these two countries would be based upon two different discount rates they might come to quite different conclusions What is right for the developing country may not be right for the industrialized country and vice versa Although private and social discount rates do not always diverge they may When those circumstances arise market decisions are not efficient A Critical Appraisal We have seen that it is sometimes but not always difficult to estimate benefits and costs When this estimation is difficult or unreliable it limits the value of a benefitcost analysis This problem would be particularly disturbing if biases tended to increase or decrease net benefits systematically Do such biases exist In the early 1970s Robert Haveman 1972 conducted a major study that continues to shed some light on this question Focusing on Army Corps of Engineers water projects such as flood control navigation and hydroelectric power generation Haveman compared the ex ante before the fact estimate of benefits and costs with their ex post after the fact counterparts Thus he was able to address the issues of accuracy and bias He concluded that In the empirical case studies presented ex post estimates often showed little relationship to their ex ante counterparts On the basis of the few cases and the a priori analysis pre sented here one could conclude that there is a serious bias incorporated into agency ex ante evaluation procedures resulting in persistent overstatement of expected benefits Similarly in the analysis of project construction costs enormous variance was found among projects in the relationship between estimated and realized costs Although no persistent bias in estimation was apparent nearly 50 percent of the projects displayed realized costs that deviated by more than plus or minus 20 percent from ex ante projected costs8 In the cases examined by Haveman at least the notion that benefitcost analysis is purely a scientific exercise was clearly not consistent with the evidence the biases of the analysts were merely translated into numbers Evaluating TradeOffs 65 Does their analysis mean that benefitcost analysis is fatally flawed Absolutely not Valuation methods have improved considerably since the Haveman study but problems remain This study does however highlight the enduring importance of calculating an accurate value and of including all of the potential benefits and costs eg nonmarket values As elementary as it might seem including both the benefits and the costs is necessary As Example 34 illustrates that is not always the case in practice EXAMPLE 34 Is the Two for One Rule a Good Way to Manage Regulatory Overreach Environmental regulations can be costly but they also produce economic benefits Efficiency suggests that regulations whose benefits exceed their costs should be pursued and that is the path followed by previous Executive Orders EOs from Presidents Reagan EO 12291 Clinton EO 12866 and Obama EO 13563 In 2017 the Trump administration abandoned business as usual and issued EO 13771 mandating that for every new regulation issued two must be thrown out9 What does economic analysis and in particular benefitcost analysis have to say about this onein twoout prescription Executive Order 13771 reads in part c any new incremental costs associated with new regulations shall to the extent permitted by law be offset by the elimination of existing costs associated with at least two prior regulations In his attempt to reduce regulatory overreach President Trumps approach seems to suggest that only the costs are important when evaluating current and new regulations Benefits dont matter Since most of the current regulations were put into place based on benefits and costs removing them based solely on costs would be a blunt instrument one that is poorly targeted on making efficient choices Economist Robert Shiller further argues that regulation is in the public interest in many areas and the world is far too complex to make it possible to count up regulations meaningfully and impose a twoforone rule Alan Krupnick economist at Resources for the Future points out that even if a cost only approach were justified it would not be easy to implement For example what is a cost Is it a projected cost in the rule or actual costs as implemented Is it present discounted costs or something else to account for cost streams over time Is it direct costs or do indirect costs say to consumers count Is it private costs or costs to society Regardless of the answer to those questions however benefits do matter As Krupnick notes How do we determine which regulations are ineffective and unnecessary without considering their benefits The answer is simplewe cannot Imagine if we only saved endangered species that cost the least to save or cleaned up only the least expensive oil spills Making decisions based solely on costs is misguided economics Sources wwwrfforgresearchpublicationstrumpsregulatoryreformprocessanalyticalhurdlesand missingbenefits wwwnytimescom20170217upshotwhytrumps2for1ruleonregulationsis noquickfixhtml wwwenveconnet201702twoforonetoobluntaninstrumentforgood governancehtml Evaluating TradeOffs 66 Havemans analysis also serves to remind us that benefitcost analysis is not a standalone technique It should be used in conjunction with other available information Economic analysis including benefitcost analysis can provide useful information but it should not be the only determinant for all decisions Benefitcost analysis also limited in that it does not really address the question of who reaps the benefits and who pays the cost It is quite possible for a particular course of action to yield high net benefits but to have the benefits borne by one societal group and the costs borne by another This scenario serves to illustrate a basic principleensuring that a particular policy is efficient provides an important but not always the sole basis for public policy Other aspects such as who reaps the benefit or bears the burden are also important considerations Distributional benefitcost analysis can help illuminate potential inequities In summary on the positive side benefitcost analysis is frequently a very useful part of the policy process Even when the underlying data are not strictly reliable the outcomes may not be sensitive to that unreliability In other circumstances the data may be reliable enough to give indications of the consequences of broad policy directions even when they are not reliable enough to finetune those policies Benefitcost analysis when done correctly can provide a useful complement to the other influences on the political process by clarifying what choices yield the highest net benefits to society On the negative side benefitcost analysis has been attacked as seeming to promise more than can actually be delivered particularly in the absence of solid benefit information This concern has triggered two responses First regulatory processes have been developed that can be implemented with very little information and yet have desirable economic properties The recent reforms in air pollution control which we cover in Chapters 14 and 15 provide some powerful examples The second involves techniques that supply useful information to the policy process without relying on controversial techniques to monetize environmental services that are difficult to value The rest of this chapter deals with the two most prominent of thesecosteffectiveness analysis and impact analysis Even when benefits are difficult or impossible to quantify economic analysis has much to offer Policymakers should know for example how much various policy actions will cost and what their impacts on society will be even if the efficient policy choice cannot be identified with any certainty Other DecisionMaking Metrics CostEffectiveness Analysis What can be done to guide policy when the requisite valuation for benefitcost analysis is either unavailable or not sufficiently reliable Without a good measure of benefits making an efficient choice is no longer possible In such cases however it is often possible to set a policy target on some basis other than a strict comparison of benefits and costs One example is pollution control What level of pollution should be established as the maximum acceptable level In many countries studies of the effects of a particular pollutant on human health have been used as the basis for establishing that pollutants maximum acceptable concentration Researchers attempt to find a threshold level below which no damage seems to occur That threshold is then further lowered to provide a margin of safety and that becomes the pollution target Evaluating TradeOffs 67 Approaches could also be based upon expert opinion Ecologists for example could be enlisted to define the critical numbers of certain species or the specific critical wetlands resources that should be preserved Once the policy target is specified however economic analysis can have a great deal to say about the cost consequences of choosing a means of achieving that objective The cost conse quences are important not only because eliminating wasteful expenditures is an appropriate goal in its own right but also to assure that they do not trigger a political backlash Typically several means of achieving the specified objective are available some will be relatively inexpensive while others turn out to be very expensive The problems are frequently complicated enough that identifying the cheapest means of achieving an objective cannot be accomplished without a rather detailed analysis of the choices Costeffectiveness analysis frequently involves an optimization procedure An optimization procedure in this context is merely a systematic method for finding the lowestcost means of accomplishing the objective This procedure does not in general produce an efficient allocation because the predetermined objective may not be efficient All efficient policies are costeffective but not all costeffective policies are efficient Earlier in this chapter we introduced the concept of the efficiency equimarginal principle According to that principle net benefits are maximized when the marginal benefit is equal to the marginal cost A similar and equally important equimarginal principle exists for costeffectiveness Second Equimarginal Principle the CostEffectiveness Equimarginal Principle The leastcost means of achieving an environmental target will have been achieved when the marginal costs of all possible means of achievement are equal Suppose we want to achieve a specific emissions reduction across a region and several possible techniques exist for reducing emissions How much of the control responsibility should each technique bear The costeffectiveness equimarginal principle suggests that the techniques should be used such that the desired reduction is achieved and the cost of achieving the last unit of emissions reduction in other words the marginal control cost should be the same for all sources To demonstrate why this principle is valid suppose that we have an allocation of control responsibility where marginal control costs are much higher for one set of techniques than for another This cannot be the leastcost allocation since we could lower cost while retaining the same amount of emissions reduction To be specific costs could be lowered by allocating more control to the lower marginal cost sources and less to the high marginal cost sources Since it is possible to find a way to lower cost while holding emissions constant then clearly the initial allocation could not have minimized cost Once marginal costs are equalized it becomes impossible to find any lowercost way of achieving the same degree of emissions reduction therefore that allocation must be the allocation that minimizes costs In our pollution control example costeffectiveness can be used to find the leastcost means of meeting a particular standard and its associated cost Using this cost as a benchmark case we can estimate how much costs could be expected to increase from this minimum level if policies that are not cost effective are implemented Costeffectiveness analysis can also be used to determine how much compliance costs can be expected to change if the EPA chooses a more stringent or less stringent standard In Chapters 14 and 15 we shall examine in detail the current movement toward costeffective polices a movement that was triggered in part by studies showing that the cost reductions from reform could be substantial Evaluating TradeOffs 68 Impact Analysis What can be done when the information needed to perform a benefitcost analysis or a cost effectiveness analysis is not available The analytical technique designed to deal with this problem is called impact analysis An impact analysis regardless of whether it focuses on economic impact or environmental impact or both attempts to quantify the consequences of various actions In contrast to benefitcost analysis a pure impact analysis makes no attempt to convert all these consequences into a onedimensional measure such as dollars to ensure comparability In contrast to costeffectiveness analysis impact analysis does not necessarily attempt to optimize Impact analysis places a large amount of relatively undigested information at the disposal of the policymaker It is up to the policymaker to assess the importance of the various predicted consequences and act accordingly On January 1 1970 President Nixon signed the National Environmental Policy Act of 1969 This act among other things directed all agencies of the federal government to include in every recommendation or report on proposals for legislation and other major Federal actions significantly affecting the quality of the human environment a detailed statement by the responsible official on i the environmental impact of the proposed action ii any adverse environmental effects which cannot be avoided should the proposal be implemented iii alternatives to the proposed action iv the relationships between local shortterm uses of mans environment and the maintenance and enhancement of longterm productivity and v any irreversible and irretrievable commitments of resources which would be involved in the proposed action should it be implemented10 This was the beginning of the environmental impact statement which is now a familiar if controversial part of environmental policy making Current environmental impact statements are more sophisticated than their early predeces sors and may contain a benefitcost analysis or a costeffectiveness analysis in addition to other more traditional impact measurements Historically however the tendency has been to issue huge environmental impact statements that are virtually impossible to comprehend in their entirety In response the Council on Environmental Quality which by law administers the environmental impact statement process has set content standards that are now resulting in shorter more concise statements To the extent that they merely quantify consequences statements can avoid the problem of hidden value judgments that sometimes plague benefit cost analysis but they do so only by bombarding the policymakers with masses of noncomparable information Summary Finding a balance in the relationship between humanity and the environment requires many choices Some basis for making rational choices is absolutely necessary If not made by design decisions will be made by default Evaluating TradeOffs 69 Normative economics uses benefitcost analysis for judging the desirability of the level and composition of provided services Costeffectiveness analysis and impact analysis offer alternatives to benefitcost analysis All of these techniques offer valuable information for decision making and all have shortcomings A static efficient allocation is one that maximizes the net benefit over all possible uses of those resources The dynamic efficiency criterion which is appropriate when time is an important consideration is satisfied when the outcome maximizes the present value of net benefits from all possible uses of the resources Later chapters examine the degree to which our social institutions yield allocations that conform to these criteria Because benefitcost analysis is both very powerful and very controversial in 1996 a group of economists of quite different political persuasions got together to attempt to reach some consensus on its proper role in environmental decision making Their conclusion is worth reproducing in its entirety Benefitcost analysis can play an important role in legislative and regulatory policy debates on protecting and improving health safety and the natural environment Although formal benefitcost analysis should not be viewed as either necessary or sufficient for designing sensible policy it can provide an exceptionally useful frame work for consistently organizing disparate information and in this way it can greatly improve the process and hence the outcome of policy analysis If properly done benefitcost analysis can be of great help to agencies participating in the development of environmental health and safety regulations and it can likewise be useful in evaluating agency decisionmaking and in shaping statutes11 Even when benefits are difficult to calculate however economic analysis in the form of costeffectiveness can be valuable This technique can establish the least expensive ways to accomplish predetermined policy goals and to assess the extra costs involved when policies other than the leastcost policy are chosen What it cannot do is answer the question of whether those predetermined policy goals are efficient At the other end of the spectrum is impact analysis which merely identifies and quantifies the impacts of particular policies without any pretense of optimality or even comparability of the information generated Impact analysis does not guarantee an efficient outcome All three of the techniques discussed in this chapter are useful but none of them can stake a claim as being universally the best approach The nature of the information that is available and its reliability make a difference Discussion Questions 1 Is riskneutrality an appropriate assumption for benefitcost analysis Why or why not Does it seem more appropriate for some environmental problems than others If so which ones If you were evaluating the desirability of locating a hazardous waste incinerator in a particular town would the ArrowLind rationale for riskneutrality be appropriate Why or why not 2 Was the executive order issued by President George W Bush mandating a heavier use of benefitcost analysis in regulatory rule making a step toward establishing a more rational regulatory structure or was it a subversion of the environmental policy process Why Evaluating TradeOffs 70 SelfTest Exercises 1 Suppose a proposed public policy could result in three possible outcomes 1 present value of net benefits of 4000000 2 present value of net benefits of 1000000 or 3 present value of net benefits of 10000000 ie a loss Suppose society is risk neutral and the probability of occurrence of each of these three outcomes are respectively 085 010 and 005 should this policy be pursued or trashed Why 2 a Suppose you want to remove ten fish of an exotic species that have illegally been introduced to a lake You have three possible removal methods Assume that q1 q2 and q3 are respectively the amount of fish removed by each method that you choose to use so that the goal will be accomplished by any combination of methods such that q1 q2 q3 10 If the marginal costs of each removal method are respectively 10q1 5q2 and 25q3 how much of each method should you use to achieve the removal costeffectively b Why isnt an exclusive use of method 3 costeffective c Suppose that the three marginal costs were constant not increasing as in the previous case such that MC1 10 MC2 5 and MC3 25 What is the costeffective outcome in that case 3 Consider the role of discount rates in problems involving long time horizons such as climate change Suppose that a particular emissions abatement strategy would result in a 500 billion reduction in damages 50 years into the future How would the maximum amount spent now to eliminate those damages change if the discount rate is 2 percent rather than 10 percent Notes 1 Actually if B C it wouldnt make any difference if the action occurs or not the benefits and costs are a wash 2 The monetary worth of the net benefit is the sum of two right triangles and it equals 125 5 122505 or 1875 Can you see why 3 The mathematics of dynamic efficiency are presented in the appendix to Chapter 5 4 Interagency Working Group on the Social Cost of Carbon August 2016 wwwepagovsites productionfiles201612documentsscco2tsdaugust2016pdf accessed November 18 2017 5 Hahn Robert W and Ritz Robert A 2015 Does the social cost of carbon matter Evidence from US policy The Journal of Legal Studies 441 January 229248 6 The division between tangible and intangible benefits changes as our techniques improve Recreation benefits were until the advent of the travelcost model treated as intangible The travelcost model will be discussed in the next chapter 7 Annual rates can be found at wwwwhitehousegovomb 2010 rates can be found at www whitehousegovombcircularsa094a94appxc 8 A more recent assessment of costs Harrington et al 1999 found evidence of both overestima tion and underestimation although overestimation was more common The authors attributed the overestimation mainly to a failure to anticipate technical innovation 9 Executive Order 13371 Reducing Regulation and Controlling Regulatory Cost 10 83 Stat 853 11 From Arrow Kenneth et al 1996 Is there a role for benefitcost analysis in environmental health and safety regulation Science 272 April 12 221222 Reprinted with permission from AAAS Evaluating TradeOffs 71 Further Reading Freeman A Myrick III 2003 The Measurement of Environmental and Resource Values 2nd ed Washington DC Resources for the Future A comprehensive and analytically rigorous survey of the concepts and methods for environmental valuation Hanley N Spash C L 1994 CostBenefit Analysis and the Environment Brookfield VT Edward Elgar An account of the theory and practice of this form of analysis applied to environmental problems Contains numerous specific case studies Norton B Minteer B A 2002 From environmental ethics to environmental public philosophy Ethicists and economists 1973future In T Tietenberg and H Folmer Eds The International Yearbook of Environmental and Resource Economics 20022003 Cheltenham UK Edward Elgar 373407 A review of the interaction between environmental ethics and economic valuation Scheraga J D Sussman F G 1998 Discounting and environmental management In T Tietenberg and H Folmer Eds The International Yearbook of Environmental and Resource Economics 19981999 Cheltenham UK Edward Elgar 132 A summary of the state of the art for the use of discounting in environmental management US Environmental Protection Agency 2010 Guidelines for Preparing Economic Analyses Report EPA 240R10001 Downloadable at wwwepagovenvironmentaleconomics guidelinespreparingeconomicanalysesdownload The procedures prescribed by the USEPA for its analytical work Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 73 Valuing the Environment Methods For it so falls out That what we have we prize not to the worth Whiles we enjoy it but being lackd and lost Why then we rack the value then we find The virtue that possession would not show us Whiles it was ours William Shakespeare Much Ado About Nothing Introduction Soon after the Exxon Valdez oil tanker ran aground on the Bligh Reef in Prince William Sound off the coast of Alaska on March 24 1989 spilling approximately 11 million gallons of crude oil the Exxon Corporation now Exxon Mobil accepted the liability for the damage caused by the leaking oil This liability consisted of two parts 1 the cost of cleaning up the spilled oil and restoring the site insofar as possible and 2 compensation for the damage caused to the local ecology Approximately 21 billion was spent in cleanup efforts and Exxon also spent approximately 303 million to compensate fishermen whose livelihoods were greatly damaged for the 5 years following the spill1 Litigation on environmental damages settled with Exxon agreeing to pay 900 million over 10 years The punitive damages phase of this case began in May 1994 In January 2004 after many rounds of appeals the US District Court for the State of Alaska awarded punitive damages to the plaintiffs in the amount of 45 billion2 This amount was later cut almost in half to 25 billion and in 2008 the Supreme Court ruled that even those punitive damages were excessive based on maritime law and further argued that the punitive damages should not exceed the 507 million in compensatory damages already paid3 In the spring of 2010 the Deepwater Horizon a BP well in the Gulf of Mexico exploded and began spewing an Exxon Valdezsized oil spill every 4 to 5 days By the time the leaking well was capped in August 2010 an estimated 134 million gallons had been spread through the Gulf of Mexico almost 20 times greater than the Exxon Valdez spill and the largest Chapter 4 Valuing the Environment 74 maritime spill in US history In 2016 a settlement was reached calling for total payments of 208 billion 88 billion of this was for natural resource damages4 This amount is over and above the approximately 30 billion already spent on cleanup and other claims after the spill5 How can the economic damages from oil spills like these that caused substantial economic and environmental harm be calculated Thousands of birds have been found dead in the Gulf since the BP spill for example What are they worth Interestingly the Exxon Valdez spill triggered pioneering work focused on providing monetary estimates of environmental damages setting the stage for what is today considered standard practice for nonmarket valuationthe monetization of those goods and services without market prices In Chapter 3 we examined the basic concepts economists use to calculate these damages Yet implementing these concepts is far from a trivial exercise While the costs of cleanup are fairly transparent estimating the damage is far more complex For example how were the 900 million in damages in the Exxon case and the 20 billion in the BP case determined In this chapter we explore how we can move from the general concepts to the actual estimates of compensation required by the courts A series of special techniques has been developed to value the benefits from environmental improvement or conversely to value the damage done by environmental degradation Special techniques are necessary because most of the normal valuation techniques that have been used over the years cannot be applied to environmental resources Benefitcost analysis requires the monetization of all relevant benefits and costs of a proposed policy or project not merely those where the values can be derived from market transactions As such it is also important to monetize those environmental goods and services that are not traded in any market Even more difficult to grapple with are those nonmarket benefits associated with values unrelated to use topics explored below Why Value the Environment While it may prove difficult if not impossible to place a completely accurate value on certain environmental amenities not making the attempt leaves us valuing them by default at 0 Will valuing them at 0 lead us to the best policy decisions Probably not but that does not prevent controversy from arising over attempts to replace 0 with a more appropriate value Debate 41 Many federal agencies depend on benefitcost analyses for decisionmaking Ideally the goal is to choose the most economically desirable projects given limited budgets Estimation of benefits and costs is used for such diverse actions as follows natural resources damage assessments such as for oil spills National Oceanic and Atmospheric Administration the designation of critical habitat under the Endangered Species Act US Fish and Wildlife Service dam relicensing applications The Federal Energy Regulatory Commission estimating the costs and benefits of the Clean Air Act and the Clean Water Act These analyses however frequently fail to incorporate important nonmarket values If the analysis does not include all the appropriate values the results will be flawed Is this exercise worth it Valuing the Environment 75 Should Humans Place an Economic Value on the Environment Arne Naess the late Norwegian philosopher used the term deep ecology to refer to the view that the nonhuman environment has intrinsic value a value that is independent of human interests Intrinsic value is contrasted with instrumental value in which the value of the environment is derived from its usefulness in satisfying human wants Two issues are raised by the Naess critique 1 what is the basis for the valuing of the environment and 2 how is the valuation accomplished The belief that the environment may have a value that goes beyond its direct usefulness to humans is in fact quite consistent with modern economic valuation techniques As we shall see in this chapter economic valuation techniques now include the ability to quantify a wide range of nonuse values as well as the more traditional use values Controversies over how the values are derived are less easily resolved As described in this chapter economic valuation is based firmly upon human preferences Proponents of deep ecology on the other hand would argue that allowing humans to determine the value of other species would have no more moral basis than allowing other species to determine the value of humans Rather deep ecologists argue humans should only use environmental resources when necessary for survival otherwise nature should be left alone And because economic valuation is not helpful in determining survival necessity deep ecologists argue that it contributes little to environmental management Those who oppose all economic valuation face a dilemma when humans fail to value the environment it may be assigned a default value of zero in calculations designed to guide policy A value of zero however derived will tend to justify a great deal of environmental degradation that could not be justified with proper economic valuation Support seems to be growing for the proposition that economic valuation can be a very useful means of demonstrating when environmental degradation is senseless even when judged from a limited anthropomorphic perspective Sources Costanza R et al 1998 The value of ecosystem services Putting the issues in perspective Ecological Economics 251 6772 Daily Gretchen Ellison Katherine 2003 The New Economy of Nature The Quest to Make Conservation Profitable Washington DC Island Press DEBATE 41 Valuation While the valuation techniques we shall cover can be applied to both the damage caused by pollution and the services provided by the environment each context offers its own unique Valuing the Environment 76 aspects We begin our investigation of valuation techniques by exposing some of the special challenges posed by the first of those contexts pollution control In the United States damage estimates are not only used in the design of policies but as indicated in the opening paragraphs of this chapter they have also become important to the courts who need some basis for deciding the magnitude of liability awards6 The damage caused by pollution can take many different forms The first and probably most obvious is the effect on human health Polluted air and water can cause disease when ingested Other forms of damage include loss of enjoyment from outdoor activities and damage to vegetation animals and materials Assessing the magnitude of this damage requires 1 identifying the affected categories 2 estimating the physical relationship between the pollutant emissions including natural sources and the damage caused to the affected categories 3 estimating responses by the affected parties toward mitigating some portion of the damage and 4 placing a monetary value on the unmitigated physical damages Each step is often difficult to accomplish Because the data used to track down causal relationships do not typically come from controlled experiments identifying the affected categories is a complicated matter Obviously we cannot run large numbers of people through controlled experiments If people were subjected to different levels of some pollutant such as carbon monoxide so that we could study the shortterm and longterm effects some might become ill and even die Ethical concern precludes human experimentation of this type This leaves us essentially two choices We can try to infer the impact on humans from controlled laboratory experiments on animals or we can do statistical analysis of differences in mortality or disease rates for various human populations living in polluted environments to see the extent to which they are correlated with pollution concentrations Neither approach is completely acceptable Animal experiments are expensive and the extrapolation from effects on animals to effects on humans is tenuous at best Many significant exposure effects do not appear for a long time To determine these effects in a reasonable period of time test animals are commonly subjected to large doses for relatively short periods The researcher then extrapolates from the results of these highdosage shortduration experiments to estimate the effects of lowdose long duration exposure to pollution on a human population Because these extrapolations move well beyond the range of experimental observations many scientists disagree on how the extrapolations should be accomplished Ethical concerns also arise with animal experiments Statistical studies on the other hand deal with human populations exposed to low doses for long periods but unfortunately they have another set of problemscorrelation does not imply causation To illustrate the fact that death rates are higher in cities with higher pollution levels does not prove that the higher pollution caused the higher death rates Perhaps those same cities averaged older populations or perhaps they had more smokers Existing studies have been sophisticated enough to account for many of these other possible influences but because of the relative paucity of data they have not been able to cover them all The problems discussed so far arise when identifying whether a particular observed effect results from pollution The next step is to estimate how strong the relationship is between the effect and the pollution concentrations In other words it is necessary not only to discover whether pollution causes an increased incidence of respiratory disease but also to estimate how much reduction in respiratory illness could be expected from a given reduction in pollution The nonexperimental nature of the data makes this a difficult task It is not uncommon for different researchers analyzing the same data to come to remarkably different conclusions Diagnostic problems are compounded when the effects are synergisticthat is when the effect Valuing the Environment 77 depends in a nonadditive way on contributing factors such as the victims smoking habits or the presence of other harmful substances in the air or water Once physical damages have been identified the next step is to place a monetary value on them It is not difficult to see how complex an undertaking this is Think about the difficulties in assigning a value to extending a human life by several years or to the pain suffering and grief borne by both a cancer victim and the victims family How can these difficulties be overcome What valuation techniques are available not only to value pollution damage but also to value the large number of services that the environment provides Types of Values Economists have decomposed the total economic value conferred by resources into three main components 1 use value 2 option value and 3 nonuse or passiveuse values Use value reflects the direct use of the environmental resource Examples include fish harvested from the sea timber harvested from the forest water extracted from a stream for irrigation even the scenic beauty conferred by a natural vista If you used one of your senses to experience the resourcesight sound touch taste or smellthen you have used the resource Pollution can cause a loss of use value such as when air pollution increases the vulnerability to illness an oil spill adversely affects a fishery or smog enshrouds a scenic vista Option value reflects the value people place on a future ability to use the environment It reflects the willingness to pay to preserve the option to use the environment in the future even if one is not currently using it Whereas use value reflects the value derived from current use option value reflects the desire to preserve the potential for possible future use Are you planning to go to Yellowstone National Park next summer Perhaps not but would you like to preserve the option to go someday Passiveuse or nonconsumptive use values arise when the resource is not actually consumed in the process of experiencing it These types of values reflect the common observation that people are more than willing to pay for improving or preserving resources that they will never use One type of nonuse value is a bequest value Bequest value is the willingness to pay to ensure a resource is available for your children and grandchildren A second type of nonuse value a pure nonuse value is called existence value Existence value is measured by the willingness to pay to ensure that a resource continues to exist in the absence of any interest in future use The term existence value was coined by economist John Krutilla in his now famous quote There are many persons who obtain satisfaction from mere knowledge that part of wilderness North America remains even though they would be appalled by the prospect of being exposed to it7 These values are independent of any present or future use these people might make of those resources8 When the Bureau of Reclamation began looking at sites for dams near the Grand Canyon groups such as the Sierra Club rose up in protest of the potential loss of this unique resource When Glen Canyon was flooded by Lake Powell even those who never intended to visit recognized this potential loss Because this value does not derive either from direct use or potential use it represents a very different category of value These categories of value can be combined to produce the total willingness to pay TWP TWP Use Value Option Value Nonuse Value Since nonuse or passiveuse values are derived from motivations other than personal use they are obviously less tangible than use values Total willingness to pay estimated without Valuing the Environment 78 nonuse values however will be less than the minimum amount that would be required to compensate individuals if they are deprived of this environmental asset Furthermore estimated nonuse values can be quite large Therefore it is not surprising that they are controversial Indeed when the US Department of Interior drew up its regulations on the appropriate procedures for performing natural resource damage assessment it prohibited the inclusion of nonuse values unless use values for the incident under consideration were zero A subsequent 1989 decision by the District of Columbia Court of Appeals 880 F 2nd 432 overruled this decision and allowed nonuse values to be included as long as they could be measured reliably Classifying Valuation Methods Typically the researchers goal is to estimate the total willingness to pay for the good or service in question This is the area under the demand curve up to the quantity consumed recall discussion from Chapter 2 For a market good this calculation is relatively straight forward However nonmarket goods and services the focus of this chapter require the estimation of willingness to pay either through examining behavior drawing inferences from the demand for related goods or through responses to surveys And as highlighted above capturing all components of value is challenging This section will provide a brief overview of some of the methods available to estimate these values and to convey some sense of the range of possibilities and how they are related Subsequent sections will provide more specific information about how they are actually used Valuation methods can be separated into two broad categories stated preference and revealed preference methods Revealed preference methods are based on actual observable choices that allow resource values to be directly inferred from those choices For example in calculating how much local fishermen lost from the oil spill the revealed preference method might calculate how much the catch declined and the resulting diminished value of the catch In this case prices are directly observable and their use allows the direct calculation of the loss in value Or more indirectly in calculating the value of an occupational environmental risk such as some exposure to a substance that could pose some health risk we might examine the differences in wages across industries in which workers take on different levels of risk Compare this with the direct stated preference method that can be used when the value is not directly observable such as the value of preserving a species Analysts derive this value by using a survey that attempts to elicit the respondents willingness to pay their stated preference for preserving that species Each of these broad categories of methods includes both indirect and direct techniques The possibilities are presented in Table 41 We start with an examination of stated preference survey methods Stated Preference Methods Stated preference methods use survey techniques to elicit willingness to pay for a marginal improvement or for avoiding a marginal loss These methods are typically of two types contingent valuation surveys and choice experiments Contingent valuation the most direct approach provides a means of deriving values that cannot be obtained in more traditional ways The simplest version of this approach merely asks respondents what they would be willing to pay for a change in environmental quality such as an improvement in wetlands or reduced exposure to pollution or on preserving the resource in its current state Typically this question is framed as What is the maximum you are willing to pay for the change Valuing the Environment 79 Alternative versions ask a yes or no question such as whether or not the respondent would pay X to prevent the change or preserve the species The answers reveal either an upper bound in the case of a no answer or a lower bound in the case of a yes answer Choice experiments on the other hand present respondents with a set of options Each set consists of various levels of attributes or characteristics of the good One of the characteristics will be the price of that bundle of attributes Each choice set typically includes the status quo bundle which includes a price of 0 since it represents no change Respondents choose their preferred option Contingent Valuation Method The contingent valuation survey approach creates a hypothetical market and asks respondents to consider a willingnesstopay question contingent on the existence of this market Contingent valuation questions come with their own set of challenges The major concern with the use of the contingent valuation method has been the potential for survey respondents to give biased answers Six types of potential bias have been the focus of a large amount of research 1 strategic bias 2 information bias 3 startingpoint bias 4 hypothetical bias 5 payment vehicle bias protest bids and 6 the observed discrepancy between willingness to pay WTP and willingness to accept WTA Strategic bias arises when the respondent intentionally provides a biased answer in order to influence a particular outcome If a decision to preserve a stretch of river for fishing for example depends on whether or not the survey produces a sufficiently large value for fishing the respondents who enjoy fishing may be tempted to provide an answer that ensures a high value rather than the lower value that reflects their true valuation Another variation on strategic bias is social desirability bias which occurs when respondents try to present themselves in a favorable light one common example is when voters claim to have voted when they did not Information bias may arise whenever respondents are forced to value attributes with which they have little or no experience For example the valuation by a recreationist of a loss in water quality in one body of water may be based on the ease of substituting recreation on another body of water If the respondent has no experience using the second body of water the valuation could be based on an entirely false perception Visual aids have been shown to reduce uncertainty and unfamiliarity with the good or service being valued but the nature of the visual aid may affect the response Labao et al 2008 found that colored photographs as opposed to blackandwhite photographs influenced respondent Table 41 Economic Methods for Measuring Environmental and Resource Values Methods Revealed Preference Stated Preference Direct Market Price Simulated Markets Contingent Valuation Indirect Travel Cost Hedonic Property Values Hedonic Wage Values Avoidance Expenditures Choice Experiments Conjoint Analysis AttributeBased Models Contingent Ranking Source Modified by the authors from Mitchell and Carson 1989 Valuing the Environment 80 willingness to pay for the Philippine Eagle The colored photographs resulted in a higher willing ness to pay than blackandwhite photos Why The authors suggest that the higher willingness to pay could be explained by photographs in color simply providing more information or by enhancing respondents ability to assimilate information In any case the nature of the visual aide seems important for revealing preferences Startingpoint bias may arise in those survey instruments in which a respondent is asked to check off their WTP from a predefined range of possibilities How that range is defined by the designer of the survey may affect the resulting answers A range of 0100 may produce a valuation by respondents different from for example a range of 10100 even if no responses are in the 010 range Ladenburg and Olsen 2008 in a study of willingness to pay to protect nature areas in Denmark from new highway development found that the startingpoint bias in their choice experiment was gender specific with female respondents exhibiting the greatest sensitivity to the starting point Hypothetical bias can enter the picture because the respondent is being confronted by a contrived rather than an actual set of choices Since he or she will not actually have to pay the estimated value the respondent may treat the survey casually providing illconsidered answers One early survey Hanemann 1994 found ten studies that directly compared willingnesstopay estimates derived from surveys with actual expenditures Although some of the studies found that the willingnesstopay estimates derived from surveys exceeded actual expenditures the majority of those found that the differences were not statistically significant Subsequently Ehmke Lusk and List 2008 tested whether hypothetical bias depends on location andor culture In a study based on student experiments in China France Indiana Kansas and Niger they found significant differences in bias across locations Given that policymakers frequently rely on existing benefits estimates from other locations when making decisions this finding should not be taken lightly The strengths and weaknesses of using estimates derived in one setting to infer benefits in another a technique known as benefit transfer are discussed below Increasingly environmental economists are using these types of experiments to try to determine the severity of some of these biases as well as to learn how to reduce bias Some of these experiments are conducted in a laboratory setting such as a computer lab or a classroom designed for this purpose In one such experiment on voluntary provision of public goods donations Landry et al 2006 found that for doortodoor interviews an increase in physical attractiveness of the interviewer led to sizable increases in giving Interestingly physical attractiveness also led to increases in response rates particularly by male households Sometimes called interviewer bias biases like these can be kept small through welldesigned and pretested surveys Another challenge payment vehicle bias can arise when respondents react negatively to the choice of the payment vehicle The payment vehicle represents how the stated WTP would be collected Common choices include donations taxes or increases to utility bills If a respondent is averse to taxes or has a negative perception of the agency collecting the hypothetical payment they may state 0 for their willingness to pay If their true willingness to pay is actually greater than zero but they are protesting the question or payment vehicle this zero must be excluded from the analysis Determining which zero bids are valid and which are protests is important The final source of bias addresses observed gaps between two supposedly closely related conceptswillingness to pay WTP and willingness to accept WTA compensation Respondents to contingent valuation surveys tend to report much higher values when asked for their willingness to accept compensation for a specified loss of some good or service than if asked for their willingness to pay for a specified increase of that same good or service Economic theory suggests the two should be equal Debate 42 explores some of the reasons offered for the difference Valuing the Environment 81 Measuring willingness to pay or willingness to accept in the presence of price changes makes two new concepts relevantcompensating variation and equivalent variation Compensating variation is the amount of money it would take to compensate for a price increase in order to make a consumer just as well off as she or he was before the price increase How much the consumer was hurt by the price increase can be measured by the compensating variation Equivalent variation on the other hand is the amount of money it would take to make a consumer indifferent same income between the money and the price increase In other words how much money would she or he pay to avoid the price increase If the compensating variation is greater than zero that amount represents willingness to pay If it is negative it represents willingness to accept In other words for increases in environmental quality compensating variation should be positive WTP For decreases in environmental quality it should be negative WTA Equivalent variation is just the opposite the amount of money the household would need to be given to be just as well off as before the environmental change Equivalent variation will be positive for increases in environmental quality WTA and negative for decreases WTP In theory in the absence of any income effects these measures along with consumer surplus should be equivalent Much experimental work has been done on contingent valuation to determine how serious a problem biases may present One early survey Carson et al 1994 uncovered 1672 contingent valuation studies A much more recent one gives annotations for more than 7500 studies in 130 countries Carson 2011 Are the results from these surveys reliable enough for the policy process Willingness to Pay versus Willingness to Accept Why So Different Many contingent valuation studies have found that respondents tend to report much higher values for questions that ask what compensation the respondent would be willing to accept WTA to give something up than for questions that ask for the willingness to pay WTP for an incremental improvement in the same good or service Economic theory suggests that differences between WTP and WTA should be small but experimental findings both in environmental economics and in other microeconomic studies have found large differences Why Some economists have attributed the discrepancy to a psychological endowment effect the psychological value of something you own is greater than something you do not In other words you would require more compensation to be as well off without it than you would be willing to pay to get that same good and as such you would be less willing to give it up WTA WTP Kahneman Knetsch Thaler 1990 This is a form of what behavioral economists call loss aversionthe psychological premise that losses are more highly valued than gains Others have suggested that the difference may be explainable in terms of the market context In the absence of good substitutes large differences between WTA and WTP would be the expected outcome In the presence of DEBATE 42 Valuing the Environment 82 close substitutes WTP and WTA should not be that different but the divergence between the two measures should increase as the degree of substitution decreases Hanemann 1991 Shogren et al 1994 The characteristics of the good may matter as well In their review of the evidence provided by experimental studies Horowitz and McConnell 2002 find that for ordinary goods the ratio of WTAWTP is smaller than the ratio of WTAWTP for public and nonmarket goods Their results support the notion that the nature of the property rights involved is not neutral The moral context of the valuation may matter as well Croson et al Draft 2005 show that the amount of WTA compensation estimated in a damage case increases with the culpability of the party causing the damage as long as that party is also paying the damages If however a third party is paying WTA is insensitive to culpability This difference suggests that the valuation implicitly includes an amount levied in punishment for the party who caused the damage the valuation becomes the lost value plus a sanction It may also be the case that in dynamic settings respondents are uncertain about the value of the good Zhao and Kling 2004 argue that in intertempo ral settings the equivalence of compensating variationequivalent variation and WTPWTA breaks down in part because WTP and WTA have a behavioral component and the timing of a decision will be impacted by the consumers rate of time preference and willingness to take risks A buyer or seller by com mitting to a purchase or sale must forgo opportunities for additional informa tion These commitment costs reduce WTP and increase WTA The larger the commitment costs the larger is the divergence between the two measures Ultimately the choice of which concept to use in environmental valuation comes down to how the associated property right is allocated If someone owns the right to the resource asking how much compensation they would require to give it up is the appropriate question If the respondent does not have the right using WTP to estimate the value of acquiring it is the right approach However as Horowitz and McConnell point out since the holders and nonholders of rights value them differently the initial allocation of property rights can have a strong influence on valuation decisions for environmental amenities And as Zhao and Kling note the timing of the decision can also be an important factor Sources Croson R Rachlinski J J Johnston J Draft 2005 Culpability as an explanation of the WTAWTP discrepancy in contingent valuation Hanemann W M 1991 Willingness to pay and willingness to accept How much can they differ American Economic Review 81 635647 Horowitz J K McConnell K E 2002 A review of WTAWTP studies Journal of Environmental Economics and Management 44 426447 Kahneman D Knetsch J Thaler R 1990 Experimental tests of the endowment effect and the Coase theorem Journal of Political Economy 98 13251348 Shogren J F Shin Senung Y Hayes D J Kliebenstein J B 1994 Resolving differences in willingness to pay and willingness to accept American Economic Review 841 255270 Zhao Jinhua Kling Catherine 2004 Willingness to pay compensating variation and the cost of commitment Economic Inquiry 423 503517 Valuing the Environment 83 Faced with the need to compute damages from oil spills the National Oceanic and Atmospheric Administration NOAA convened a panel of independent economic experts including two Nobel prize laureates to evaluate the use of contingent valuation methods for determining lost passiveuse or nonuse values Their report issued on January 15 1993 58 FR 4602 was cautiously supportive The committee made clear that it had several concerns with the technique Among those concerns the panel listed 1 the tendency for contingent valuation willingnesstopay estimates to seem unreasonably large 2 the difficulty in assuring the respondents have understood and absorbed the issues in the survey and 3 the difficulty in assuring that respondents are responding to the specific issues in the survey rather than reflecting general warm feelings about publicspiritedness known as the warm glow effect9 But the panel also made clear its conclusion that suitably designed surveys could eliminate or reduce these biases to acceptable levels and it provided in an appendix specific guidelines for determining whether a particular study was suitably designed The panel suggested that when practitioners follow these guidelines they can produce estimates reliable enough to be the starting point of a judicial process of damage assessment including lost passiveuse values A wellconstructed contingent valuation study contains information that judges and juries will wish to use in combination with other estimates including the testimony of expert witnesses Specifically they suggested the use of referendumtype yesno willingnesstopay questions personal interviews when possible clear scenario descriptions and followup questions These guidelines have been influential in shaping subsequent studies For example Example 41 shares the results of a large contingent valuation survey designed to estimate the value of preventing future spills While influential these guidelines have become dated and in 2017 new contemporary guidelines were published Johnston et al 2017 These guidelines provide best practice recommendations for both contingent valuation and choice experiments using what has been learned in the approximately 8000 stated preference studies published since the NOAA guidelines were first published The authors offer 23 recommendations including designing a survey that clearly describes the status quo or baseline scenario selecting a random sample of the affected population and choosing an appropriate survey mode They also recommend pretesting of the survey instrument They give extensive guidance on when to choose contingent valuation over a choice experiment and vice versa as well recommendations for reducing and addressing response bias Choice Experiments Indirect hypothetical stated preference methods include several attributebased methods Attributebased methods such as choice experiments are useful when project options have multiple levels of different attributes Like contingent valuation choice experiments are also survey based but instead of asking respondents to state a willingness to pay they are asked to choose among alternate bundles of goods Each bundle has a set of attributes and the levels of each attribute vary across bundles Since one of the attributes in each bundle is a price measure willingness to pay can be identified Consider an example Landry and Mires 2017 that surveyed North Carolina residents on their preferences and willingness to pay for marine cultural heritage sites eg shipwrecks The choice experiment included five attributes including the preservation zone the availability of public programs and whether or not there was a walking virtual or diving trail Table 42 Valuing the Environment 84 EXAMPLE 41 Leave No Behavioral Trace Using the Contingent Valuation Method to Measure PassiveUse Values Until the Exxon Valdez tanker spilled 11 million gallons of crude oil into Prince William Sound in Alaska the calculation of nonuse or passiveuse values was not a widely researched topic However following the 1989 court ruling in Ohio v US Department of the Interior that said lost passiveuse values could now be compensated within natural resources damages assessments and the passage of the Oil Pollution Act of 1990 the estimation of nonuse and passiveuse values became not only a topic of great debate but also a rapidly growing research area within the economics community One study Carson et al 2003 discusses the design implementation and results of a large survey designed to estimate the passiveuse values related to large oil spills In particular the survey asked respondents their willingness to pay to prevent a similar disaster in the future by funding an escort ship program that would help prevent andor contain a future spill The survey was conducted for the State of Alaska in preparation for litigation in the case against the Exxon Valdez The survey followed the recommendations made by the NOAA panel for conducting contingent valuation surveys and for ensuring reliable estimates It relied upon faceto face interviews and the sample was drawn from the national population The study used a binary discretechoice yesno question where the respondent was asked whether he or she would be willing to pay a specific amount with the amount varying across four versions of the survey A onetime increase in taxes was the chosen method of payment They also avoided potential embedding bias where respondents may have difficulty valuing multiple goods by using a survey that valued a single good The survey contained pictures maps and background information to make sure the respondent was familiar with the good heshe was being asked to value Using the survey data the researchers were able statistically to estimate a valuation function by relating the respondents willingness to pay to respondent characteristics After multiplying the estimate of the median willingness to pay by the population sampled they reported aggregate lost passiveuse values at 28 billion in 1990 dollars They point out that this number is a lower bound not only because willingness to accept compensation would be a more appropriate measure of actual lost passiveuse from the spill see Debate 42 but also because their median willingness to pay was less than the mean The Exxon Valdez spill sparked a debate about the measurement of nonuse and passiveuse values Laws put into place after the spill now ensure that passiveuse values will be included in natural resource damage assessments Should other parts of the world follow suit Source Carson Richard T Mitchell Robert C Hanemann Michael Kopp Raymond J Presser Stanley Ruud Paul A 2003 Contingent valuation and lost passive use Damages from the Exxon Valdez oil spill Environmental and Resource Economics 25 257286 Table 43 Sample Choice Experiment Question I Here is the first voting opportunity Please chose one of the four options below by putting an X in one of the empty boxes 26 Program 1 Program 2 Program 3 Status Quo Preservation Zone Yellow Zone Yellow Zone Red Zone Red Zone Public Programs Large Investment No Investment Large Investment No Investment Walking Trails Yes No No No Virtual Trails No Yes Yes No SCUBA Diving Trails Yes No No No Onetime Tax 12 55 145 0 put an X in one of the boxes to the right 27 How confident are you about this choice from these options Please select one Very Certain Somewhat Certain Somewhat Uncertain Very Uncertain Dont Know II Now consider another voting opportunity with different choices Please choose one of the four options below by putting an X in one of the empty boxes 28 Program 4 Program 5 Program 6 Status Quo Preservation Zone Orange Zone Orange Zone Yellow Zone Red Zone Public Programs Large Investment No Investment No Investment No Investment Walking Trails No Yes No No Virtual Trails No Yes No No SCUBA Diving Trails Yes No Yes No Onetime Tax 145 12 55 0 put on X in one of the boxes to the right 29 How confident are you about this choice from these options Please select one Very Certain Somewhat Certain Somewhat Uncertain Very Uncertain Dont Know III Finally consider this third opportunity with different choices Please chose one of the four options below by putting an X in one of the empty boxes 30 Program 7 Program 8 Program 9 Status Quo Preservation Zone Red Zone Red Zone Yellow Zone Red Zone Public Programs No Investment Moderate Investment Moderate Investment No Investment Walking Trails Yes No Yes No Virtual Trails Yes No Yes No SCUBA Diving Trails No Yes No No Onetime Tax 12 145 55 0 put on X in one of the boxes to the right 31 How confident are you about this choice from these options Please select one Very Certain Somewhat Certain Somewhat Uncertain Very Uncertain Dont Know Valuing the Environment 87 EXAMPLE 42 The Value of US National Parks In 2016 the National Park Service in the United States turned 100 years old As federal budget deficits loom there has been some talk of selling off some of these sites What is the value of the National Park lands waters and historic sites According to the first ever comprehensive estimate it is at a minimum valued at 92 billion Haefele et al 2016 present the results of a survey of American households focused on estimating the total economic value TEV of National Parks and Programs Previous studies have focused on the value of specific National Park or monument sites but none had attempted to estimate the value of all of these national treasures The goal was to calculate total economic value visitation values and passiveuse or nonuse values Using the population of all US households from which to draw a sample researchers used a mixed mode approach that utilized both mail and internet surveys with phone call reminders Two rounds of surveys were implemented between 2013 and 2015 In the survey participants were asked whether protecting National Parks was impor tant to them Nearly 95 percent of the sample said they were even if they did not visit them Moreover 935 percent thought it was important to protect trails parks and open spaces for current and future generations whether they use them or not The language in these questions suggests bequest and passiveuse values Only 62 percent thought the US should sell off some National Parks The survey also included questions on respondents political point of view The sample of respondents leaned to the conservative side of the aisle The stated preference survey design was a choice experiment in which respondents chose among bundles that included the size of cuts to programs as well as the percentages of lands sold Choice experiments typically allow respondents to choose a status quo bundle for which the price is 0 In order to minimize hypothetical bias respondents stating a higher willingness to pay than they would actually pay the choice question was followed by reminders to consider their budgets This cheap talk technique has been shown to significantly reduce hypothetical bias Respondents were asked their willingness to pay a specific amount of money to pay for the National Park Service Programs The payment vehicle utilized was an increase in federal income tax for each of the next 10 years As we have discussed in this chapter protest responses must be omitted from the data since those answers do not represent willingness to pay instead representing a scenario usually payment vehicle protest Since the payment vehicle chosen was federal income tax there was some initial concern that protest zeros would be problematic however only 75 percent of the responses were considered to be protests Using econometric analysis the marginal willingness to pay or implicit price for each type of National Park or National Park Service Program were estimated These values are reproduced in Table 44 Valuing the Environment 88 Table 44 Perhousehold total economic value TEV for the National Park system and NPS Programs National Parks Estimated value Naturefocused National Parks 79096632 acres 111324 Historyfocused National Parks 226 sites 87472 Waterfocused National Parks 4818275 acres 97793 Per household value for all National Park acressites 296700 NPS Programs Historic sites and buildings protected each year 2000 31631 Acres transferred to communities each year 2700 9841 National landmarks protected each year 114 34798 Schoolchildren served by NPS educational programs 41 million 68262 Per household value for all NPS programs 144500 Source Table 4 in Haefele et al 2016 These household values were then multiplied by the total number of households in the population to determine the total economic value In order to present a minimum bound or very conservative estimate they assumed that households that did not return a survey were willing to pay 0 The final tally of 92 billion includes both use values for visitors and passiveuse or existence values 62 billion of which or twothirds is for the National Park Service lands and waters and historic sites with 30 billion for programs Of the 62 billion the authors suggest that approximately half of that value is passiveuse value Of course these values do not even include the willingness to pay of the millions of international tourists that visit US National Parks each year or those who hold passiveuse values for these locations Thus the 92 billion TEV also represents the minimum amount that US households are willing to pay to avoid the loss of the NPS and its programs Haelfele et al 2016 p 25 According to one of the authors of the study Linda Bilmes at Harvard University the study shows that Americans value the National Park Service at least 30 times more than the government spends on them It is a happy 100th birthday indeed Sources Haefele Michelle Loomis John Bilmes Linda 2016 Total economic valuation of the National Park Service Lands and Programs Results of a survey of the American public Faculty Research Working Paper Series RWP16024 June Haefele Michelle Loomis John and Bilmes Linda 2016 Total economic valuation of US National Park Service estimated to be 92 billion Implications for policy The George Wright Forum 333 335345 National Park Foundation Press Release June 30 2016 National Park Foundation announces study determining value of Americas National Parks to be 92 billion Valuing the Environment 89 Revealed Preference Methods Revealed preference methods are observable because they involve actual behavior and expenditures and indirect because they infer a value rather than estimate it directly Suppose for example a particular sport fishery is being threatened by pollution and one of the damages caused by that pollution is a reduction in sportfishing How is this loss to be valued when access to the fishery is free TravelCost Method One way to derive this loss is through travelcost methods Travelcost methods may infer the value of a recreational resource such as a sport fishery a park or a wildlife preserve where visitors hunt with a camera by using information on how much visitors spend in getting to the site to construct a demand curve representing willingness to pay for a visitor day Freeman et al 2014 identify two variants of this approach In the first analysts examine the number of trips visitors make to a site In the second the analysts examine whether people decide to visit a site and if so which site This second variant includes using a special class of models known as random utility models to value quality changes The first variant allows the construction of a travel cost demand function The value of the flow of services from that site is the area under the estimated demand curve for those services or for access to the site aggregated over all who visit the site Using this variant individual consumer surplus can be estimated The area below the demand curve but above the travel cost price is the consumer surplus The second variant enables an analysis of how specific site characteristics influence choice and therefore indirectly how valuable those characteristics are Knowledge of how the value of each site varies with respect to its characteristics allows the analyst to value how degradation of those characteristics eg from pollution would lower the value of the site Travelcost models have been used to value National Parks mountain climbing recreational fishing and beaches Travelcost models have also been used to value losses from events such as beach closures during oil spills fish consumption advisories and the cost of develop ment that has eliminated a recreation area The methodology for both variants is detailed in Parsons 2003 In the random utility model a person choosing a particular site takes into consideration site characteristics and its price trip cost Characteristics affecting the site choice include ease of access and environmental quality Each site results in a unique level of utility and a person is assumed to choose the site giving the highest level of utility to that person Welfare losses from an event such as an oil spill can then be measured by the resulting change in utility should the person have to choose an alternate less desirable site Example 43 looks at the use of travel cost methods to estimate the economic impacts of beach closures due to oil spills in Minorca Spain One interesting paradox that arises with the travel cost model is that those who live closest to the site and may actually visit frequently will have low travel costs These users will appear to have a lower value for that site even if their unmeasured willingness to pay for the experience is very high Another challenge in this model is how to incorporate the opportunity cost of time Usually this is represented by wages but that approach is not universally accepted Hedonic Property Value and Hedonic Wage Methods Two other revealed preference methods are the hedonic property value and hedonic wage methods They share the characteristic that they use a statistical technique known as multiple regression analysis to Valuing the Environment 90 EXAMPLE 43 Using the Travel Cost Method to Estimate Recreational Value Beaches in Minorca Spain Minorca an island in the Mediterranean Sea is a very popular tourist destination Minorcas population doubles in the summer months from about 80000 yearround residents to between 150000 and 175000 in the summer The islands beaches are a major attraction Just how valuable are those beaches To provide an estimate researchers considered a hypothetical scenario in which an oil spill resulted in closure of certain beaches on the island The analysis involved using a random utility model based upon survey data to estimate the economic impacts of these closures In 2008 573 facetoface individual surveys were conducted at 51 different beaches on the island using a discrete choice travelcost survey Respondents were asked some typical travelcost survey questions such as where the trip originated how they got to the site how many people they were traveling with and their ages and some questions to collect socioeconomic demographics on the respondents After being asked about their attitudes toward different beach attributes they completed a questionnaire on the characteristics of the beach they were visiting The characteristics included a measure of how urban the area was the type of sand how clean the beach was how crowded it was whether or not there was a toilet presence of drink vendors water temperature calmness of the water environmental quality presence of a life guard the direction the beach faced and whether or not nudism was present on the beach Travel costs included the cost of fuel and tolls plus travel time Travel time varied by mode of transportation using average walking and average driving speeds The random utility model allowed researchers to estimate the impacts on utility of the various beach characteristics identified by the surveys Those characteristics positively affecting utility included north facing presence of a life guard presence of toilets and drink vendors thin sand presence of nudism warm water temperatures and good environmental quality Characteristics negatively affecting utility included non northern beaches urban beaches crowding algae and calm water Because some beach attributes were more highly valued than others the range of estimates was dramatically affected by the details in the scenario For example for a closure affecting beaches on the west coast the willingness to pay to avoid this loss was 24 euros 2008 per day per person with peak visitation of 25000 visitors Aggregating the pervisitor value across visitors produced a daily welfare loss from these closures of 6000 euros On the other extreme a spill forcing closure of the more valuable northern beaches would cause the welfare loss to rise to 173 euros per day per person for a total of 43250 euros during peak visitation It is easy to take highly enjoyable recreational sites for granted since they are freely provided by nature As a result they may not be given their due when resources are allocated for their protection and enhancement The travelcost method can help to Valuing the Environment 91 inform policy not only by demonstrating how truly valuable they are but also by allowing useful distinctions to be made among various recreation resources Source Pere Riera McConnell Kenneth E Giergiczny Marek Mahieu PierreAlexandre 2011 Applying the travelcost method to Minorca beaches Some policy results In Jeff Bennett Ed International Handbook on NonMarket Environmental Valuation Cheltenham UK Edward Elgar 6073 tease out the environmental component of value in a related market For example it is possible to discover that all other things being equal property values are lower in polluted neighborhoods than in clean neighborhoods Property values fall in polluted neighborhoods because they are less desirable places to live Hedonic property value models use market data house prices and then break down the house sales price into its attributes including the house characteristics eg number of bedrooms lot size and features the neighborhood characteristics eg crime rates school quality and so on and environmental characteristics eg air quality percentage of open space nearby distance to a local landfill etc Hedonic models allow for the measurement of the marginal willingness to pay for discrete changes in an attribute Numerous studies have utilized this approach to examine the effect on property value of things such as distance to a hazardous waste site Michaels Smith 1990 large farm operations Palmquist et al 1997 open space and land use patterns Bockstael 1996 Geoghegan et al 1997 Acharya Bennett 2001 dams and rivers Bohlen Lewis 2009 Lewis and Landry 2017 brownfields Mihaescu vom Hofe 2012 and shale oil production facilities Gopalakrishnan Klaiber 2013 This approach has become commonplace with the use of geographic information systems discussed below10 Hedonic wage approaches are similar except that they attempt to isolate the environmental risk component of wages which serves to isolate the amount of compensation workers require in order to work in risky occupations It is well known that workers in highrisk occupations demand higher wages in order to be induced to undertake the risks When the risk is environmental such as exposure to a toxic substance the results of the multiple regression analysis can be used to construct a willingness to pay to avoid this kind of environmental risk Additionally the compensating wage differential can be used to calculate the value of a statistical life Taylor 2003 Techniques for valuing reductions in lifethreatening risks will be discussed later in this chapter Benefit Transfer and MetaAnalysis The NOAA panel report has created an interesting dilemma Although it legitimized the use of contingent valuation for estimating passiveuse nonconsumptive use and nonuse values the panel has also set some rather rigid guidelines that reliable studies should follow The cost of completing an acceptable contingent valuation study could well be so high that they will only be useful for large incidents those for which the damages are high enough to justify their use Yet due to the paucity of other techniques the failure to use contingent valuation may by default result in passiveuse values of zero That is not a very appealing alternative11 One key to resolving the dilemma created by the possible expense of implementing the NOAA panels recommendations may be provided by a technique called benefit transfer Since original studies are time consuming and expensive benefit transfer allows the estimates for Valuing the Environment 92 the site of interest to be based upon estimates from other sites or from an earlier time period to provide the foundation for a current estimate Benefit transfer methods can take one of three forms value transfers benefit function transfers or metaanalysis Sometimes the actual benefit values derived from point estimates can simply be directly transferred from one context to another usually adjusted for differences between the study site and the policy site Function transfer involves using a previously estimated benefit function that relates site characteristics to site values In this case the differentiating characteristics of the site of interest are entered into the previously derived benefit function in order to derive newer more sitespecific values Johnston et al 2006 Most recently metaanalysis has been utilized Metaanalysis sometimes called the analysis of analyses takes empirical estimates from a sample of studies statistically relates them to the characteristics of the studies and calculates the degree to which the reported differences can be attributed to differences in location subject matter or methodology For example metaanalysis has been used with cross sections of contingent valuation studies as a basis for isolating and quantifying the determinants of nonuse value Once these deter minants have been isolated and related to specific policy contexts it may be possible to transfer estimates from one context to another by finding the value consistent with the new context without incurring the time and expense of conducting new surveys each time Benefit transfer methods have been widely used in situations for which financial time or data constraints preclude original analysis Policymakers frequently look to previously published studies for data that could inform a prospective decision Benefit transfer has the advantage of being quick and inexpensive but the accuracy of the estimates deteriorates as the new context tends to deviate either temporally or spatially the further it is from the context used to derive the estimates Benefit transfer has not escaped controversy Johnston and Rosenberger 2010 and Johnston et al 2015 provide a comprehensive discussion of benefit transfer and outline some of the potential problems with the use of benefit transfer including a lack of studies that are both of sufficiently high quality and policy relevant Additionally many of the published studies do not provide enough information on the attributes to allow an assessment of how they might have affected the derived value In response to some of these concerns a valuation inventory database has emerged The Environmental Valuation Reference Inventory EVRI is an online searchable database of over 4000 empirical studies on the economic value of environmental benefits and human health effects It was specifically developed as a tool for use in benefit transfer12 Benefit transfers are also subject to large errors A few studies have tested the validity of environmental value transfer across sites In those that have the transfer errors have been sizable and wide ranging sometimes over 100 percent for stated preference survey transfers Brouwer 2000 and Rosenberg and Stanley 2006 Using metadata from 31 empirical studies Kaul et al 2013 find a median transfer error of 39 percent Lewis and Landry 2017 compare original hedonic property value model results to a test of transferring those results via benefit function transfer and find errors ranging from 29 percent to 1000 percent These results suggest caution with the use of benefit transfer Using Geographic Information Systems to Enhance Valuation Geographic information systems GIS are computerized mapping models and analysis tools A GIS map is made up of layers such that many variables can be visualized simultaneously using overlays GIS offers a powerful collection of tools for depicting and examining spatial relationships Most simply GIS can be used to produce compelling measurements and graphics that communicate the spatial structure of data and analytic results with a force and clarity Valuing the Environment 93 otherwise impossible But the technologys real value lies in the potential it brings to ask novel questions and enrich our understanding of social and economic processes by explicitly considering their spatial structure Models that address environmental externalities have almost by definition a strong spatial component13 Fundamentally spatial in nature use of GIS in hedonic property models is a natural fit Housing prices vary systematically and predictably from neighborhood to neighborhood Spatial characteristics from air quality to the availability of open space can influence property values of entire neighborhoods if one house enjoys abundant open space or especially good air quality it is highly likely that its neighbors do as well In a 2008 paper Lewis Bohlen and Wilson used GIS and statistical analysis to evaluate the impacts of dams and dam removal on local property values In a unique experiment they collected data on property sales for 10 years before and after the Edwards Dam on the Kennebec River in Maine was removed The Edwards Dam was the first federally licensed hydropower dam in the United States to be removed primarily for the purpose of river restoration They also collected data on property sales approximately 20 miles upstream where two dams were still in place GIS technology enhanced this study by facilitating the calculation of the distance from each home to both the river and the nearby dams Lewis et al 2008 found that homeowners pay a price penalty for living close to a dam In other words willingness to pay for identical housing is higher the further away from the dam the house is located They also found that the penalty near the Edwards Dam site dropped to nearly zero after the dam was removed Interestingly the penalty upstream also dropped significantly While a penalty for homes close to the dams upstream remains it fell after the downstream dam was removed Can you think of reasons why14 Example 44 shows how the use of GIS can enable hedonic property value models to investigate how the view from a particular piece of property might affect its value Averting Expenditures A final example of an indirect observable method involves examining averting or avoidance expenditures Averting expenditures are those designed to reduce the damage caused by pollution by taking some kind of averting or defensive action Examples include installing indoor air purifiers in response to an influx of polluted air or relying on bottled water as a response to the pollution of local drinking water supplies Since people would not normally spend more to prevent a problem than would be caused by the problem itself averting expenditures can provide a lowerbound estimate of the damage caused by pollution They also cause a disproportionate hardship on poor households that cannot afford such coping expenditures Dickie 2016 argues that ignoring averting expenditures or behavior may under estimate damages He offers a simple example using contaminated drinking water Suppose contaminated drinking water increases waterborne illness by 4 percent If half the population avoids the contamination by some form of averting action such as using an alternate source of water frequency of illness will drop to 2 percent Only half the population is now exposed thus reducing damages However the avoidance expenses must be included in the damage estimate If they are not the damages will be underestimated Dickie 2016 Example 45 illustrates the impact of coping or averting expenditures on residents of Kathmandu Nepal Challenges Aggregation As you have probably figured out by now nonmarket valuation faces several challenges One challenge involves the aggregation of estimated values into a total value that can be used in benefitcost analysis How large is the relevant population Do benefits change with distance to the resource in question Debate 43 explores some of these challenging issues Valuing the Environment 94 Partial Values Another large challenge for nonmarket valuation is that most studies only capture a portion of the total value of an environmental good or service For example ecosystems are bundles of values but the methods outlined in this chapter are only capable of capturing a portion of the value Figure 41 illustrates the different methods environmental economists use to capture different types of value Each of these methods relies on different data and many times different experts Rarely is the available time or money sufficient to apply all methods to a particular question Debate 44 illustrates the challenges and importance of attempts to capture the total economic value by examining a specific case studypolar bears in Canada EXAMPLE 44 Using GIS to Inform Hedonic Property Values Visualizing the Data GIS offers economists and others powerful tools for analyzing spatial data and spatial relationships For nonmarket valuation GIS has proven to be especially helpful in enhancing hedonic property value models by incorporating both the proximity of environmental characteristics and their size or amount GIS studies have also allowed for the incorporation of variables that reflect nearby types and diversity of land use Geocoding housing transactions assign a latitude and longitude coordinate to each sale GIS allows other spatial data such as land use watercourses and census data to be layered on top of the map By drawing a circle of the desired circumference around each house GIS can help us to calculate the amount of each amenity that is in that circle as well as the density and types of people who live there Numerous census data are available on variables such as income age education crime rates and commuting time GIS also makes it relatively easy to calculate straightline distances to desired or undesired locations such as parks lakes schools or landfills In a 2002 paper entitled Out of Sight Out of Mind Using GIS to Incorporate Visibility in Hedonic Property Value Models Paterson and Boyle use GIS to measure the extent to which visibility measures affect house prices in Connecticut In their study visibility is measured as the percentage of land visible within one kilometer of the property both in total and broken out for various land use categories Finally they added variables that measured the percentage of area in agriculture or in forest or covered by water within one kilometer of each house They find that visibility is indeed an important environmental variable in explaining property values but the nature of the viewshed matters While simply having a view is not a significant determinant of property values viewing certain types of land uses is Proximity to development reduces property values only if the development is visible for example suggesting that out of sight really does mean out of mind They conclude that any analysis that omits variables that reflect nearby environmental conditions can lead to misleading or incorrect conclusions about the impacts of land use on property values GIS is a powerful tool for helping a researcher include these important variables Source Paterson Robert Boyle Kevin 2002 Out of sight out of mind Using GIS to incorporate visibility in hedonic property value models Land Economics 783 417425 Valuing the Environment 95 EXAMPLE 45 Valuing the Reliability of Water Supplies Coping Expenditures in Kathmandu Valley Nepal Nepal like many other poor developing countries experiences chronic shortages of safe drinking water The Kathmandu Valley is no exception The National Water Supply Corporation serves 70 percent of the population but the public water supply is neither reliable nor safe Shortages are frequent and the water quality is frequently contaminated with fecal coliform and nitrogenammonia Pattanayak et al 2005 How much should be invested in improving water quality depends on how valuable clean water is to this population Quantifying those benefits requires establishing how much residents would be willing to pay for cleaner water One pathway for quantifying willingness to pay in this context can be found in analyzing how much households spend to cope with the unreliable water supply It turns out they purchase water from water vendors collect water from public taps invest in wells or storage tanks purchase filtration systems andor boil water All of these coping mechanisms have both a financial cost and a cost associated with the time devoted to coping Using coping costs as a proxy for willingness to pay can serve as the basis for constructing a lowerbound estimate of the demand curve for water provision in settings where other more direct valuation strategies are simply not practical to implement In a survey of 1500 households in five municipalities researchers found that for households in the Kathmandu Valley coping or averting behaviors cost the average household about 1 percent of monthly income most of this attributed to the time spent collecting water The authors note that these coping costs are almost twice as much as the current monthly bills paid to the water utility Some demographic factors were found to have influenced household coping expenditures Wealthier households were found to have higher coping expenditures As the authors note this confirms the intuition that relatively rich households have more resources and therefore invest more in water treatment storage and purchases More educated respondents also had higher coping costs perhaps because these households better understood the risks of contaminated water If as suggested by these two findings the poor face higher financial and educational barriers in their quest for cleaner water water policy in this region faces an environmental justice issue as well as an efficiency issue Even though averting expenditures represent only a lower bound of willingness to pay for water supply they can provide valuable information for the estimation of benefits of water provision In addition these data imply that the common assertion that in poor countries the costs of supplying clean water are so high that they necessarily exceed the benefits received by water users may be a misconceptionthe value of water in this valley was found to be at least twice the current per unit charge even when the lower bound estimating technique was used Source Pattanayak Subhrendu K Yang JuiChen Whittington Dale Bal Kumar K C 2005 Coping with unreliable public water supplies Averting expenditures by households in Kathmandu Nepal Water Resources Research 412 doi1010292003WR002443 Valuing the Environment 96 Distance Decay in Willingness to Pay When and How Much Does Location Matter One challenge in performing benefitcost analysis is accurately choosing the extent of the market The extent of the market refers to who benefits from the resource in question Loomis 1996 argues that not accounting for the full extent of the market ie including everyone who gains some benefit can lead to underestimates of willingness to pay and aggregate value On the other hand a more inclusive design might include respondents with vastly lower willingness to pay simply because of their location For some resources distant respondents have a lower willingness to pay for its improvement It seems reasonable to expect for example that the benefits from a reduction in river pollution to an individual household would probably depend on its proximity to the river Those closest to the river place the highest value on the improvement In other words since it seems reasonable to expect that some types of values do experience a distance decay in aggregating benefits this deterioration should certainly be taken into account Bateman et al 2006 argue that not accounting for distance decay can lead to overestimates of willingness to pay Those who are further away still benefit and should be counted but at some kind of decreasing rate Recently the number of stated preference studies contingent valuation and choice DEBATE 43 FIGURE 41 Different Methods Different Experts Different Data Source Courtesy of James Boyd Resources for the Future Valuing the Environment 97 Valuing Human Life One fascinating public policy area where these various approaches have been applied is in the valuation of human life Many government programs from those controlling hazardous pollutants in the workplace or in drinking water to those improving nuclear power plant safety are designed to save human life as well as to reduce illness How resources should be allocated among these programs depends crucially on the value of human life In order to answer this question an estimate of the value of that life to society is necessary and federal regulations require such estimates for benefitcost analysis How is life to be valued experiments that focus on distance decay has increased so we have learned more about it What do these studies say about the circumstances that give rise to distance decay Interestingly the empirical evidence suggests that both the type of value being measured use or nonuse value as well as the type of willingness to pay question compensating versus equivalent variation matter Hanley et al 2003 and Bateman et al 2006 both find that distance decay does arise for use value but very little or not at all for nonuse values If however some of the current nonusers become users under the proposed scenario their valuation would experience some distance decay This result follows the intuition that if the willingness to pay question is framed as a marginal improvement in quality compensating variation then some of the nonusers might become users and that possibility would be reflected in their valuations If the question is framed as equivalent variation willingness to pay to avoid loss nonuser valuations experience no distance decay since they will remain nonusers These studies suggest that spatial patterns in nonmarket values have important implications not only for how benefitcost analysis should be conducted and interpreted but also for how that analysis affects the policy evaluations Different design choices as to the extent of the market and whether to aggregate across particular political or economic jurisdiction can lead to very different results As Schaafsma et al 2012 suggest these spatial patterns should be taken into account both when drawing samples for willingness to pay surveys and when aggregating the results Sources Bateman Ian Day Brett H Georgiou Stavros Lake Ian September 2006 The aggregation of environmental benefit values Welfare measures distance decay and total WTP Discussion paper Hanley Nick Schlapfer Felix Spurgeon James 2003 Aggregating the benefits of environmental improvements Distancedecay functions for use and nonuse values Journal of Environmental Management 68 297 304 Loomis John B 1996 How large is the extent of the market for public goods Evidence from a nationwide contingent valuation survey Applied Economics 28 779 782 Schaafsma Marije Brouwer Roy Rose John 2012 Directional heterogeneity in WTP models for environmental valuation Ecological Economics 791 2131 Valuing the Environment 98 What Is the Value of a Polar Bear Because polar bears are such a charismatic species they have obviously attracted lots of popular support but exactly how valuable are they In 2011 the Canadian government issued a report in which it attempted to estimate the different socioeconomic values of polar bears in Canada They commissioned the study in part to determine the economic impact of adding the polar bear to a list of atrisk species This study represents one of the few studies to try to estimate the value of polar bears and the only one that tries to do it in a comprehensive fashion The authors tried to capture active use values subsistence and sport hunting polar bear viewing and value in scientific research as well as passiveuse values existence and bequest values Multiple nonmarket valuation methods were used in this study including travel cost viewing market prices hunting metaanalysis and benefit transfer passiveuse values Time and budgetary constraints precluded the use of stated preference methods such as contingent valuation or choice experiments The summary of their findings is reproduced in Figure 42 Note that the direct use values actually comprise a relatively small portion of the total value An effort to document the value of a species like this produces a value that is no doubt much closer to the truth than the default value of zero but how close are these numbers to the true value There are several caveats to consider Consider the calculation for the value of polar bear meat For this the cost the next best substitute which in this case was beef for humans and dog food was used One could certainly argue for alternatives Sport values were estimated using the benefit transfer method Recall the challenges for using benefit transfer in particular for a unique species like the polar bear The study closest to this one was conducted in 1989 and focused on big game and grizzly bear hunting For the polar bear study the 1989 values were translated into 2009 dollars The authors suggest their number might be an underestimate since hunting for a polar bear is such a unique experience On the other hand they also acknowledge that the number could just as easily be an overestimate if the charismatic image of the polar bear reduces willingness to pay for hunting Finally passiveuse values were also calculated using benefit transfer Since no study has been done on the preservation value of the polar bear in Canada the researchers used a metaanalysis of species at risk Richardson Loomis 2009 While that study calculated a total economic value for the polar bear study the benefit transfer was specifically designed to capture only preservation value It was relatively straightforward to remove direct uses visitors from the transferred value but not the indirect use benefits such as scientific value DEBATE 44 Valuing the Environment 99 Using any of these values as inputs into others creates a potential to double count a common mistake that will be discussed further in Chapter 13 In fact scientific values were calculated separately for the polar bear study as well as being included in the preservation value estimated via benefit transfer As such these numbers could overestimate the value What would you be willing to pay to protect the polar bear As we have seen in this chapter these types of questions are challenging to answer Source ÉcoRessources Consultants 2011 Evidence of the socioeconomic importance of Polar bears for Canada Report for Environment Canada Full report is accessible at httppublicationsgccasitearchiveearchivedhtmlurlhttppublicationsgcca collectionscollection2012ecCW662912011engpdf Richardson Leslie Loomis John 2009 Total economic valuation of endangered species A summary and comparison of the United States and the rest of the world estimates In K N Ninan Ed Conserving and Valuing Ecosystem Services and Biodiversity Economic Institutional and Social Challenges London Earthscan 2546 FIGURE 42 Monetary Values Associated with Polar Bears in Canada by Value Category Aggregate Amounts for Canada Source ÉcoRessources Consultants for Environment Canada 2011 p 32 Valuing the Environment 100 Is Valuing Human Life Immoral In 2004 economist Frank Ackerman and lawyer Lisa Heinzerling teamed up to write a book that questions the morality of using benefitcost analysis to evaluate regulations designed to protect human life In Priceless On Knowing the Price of Everything and the Value of Nothing 2004 they argue that benefitcost analysis is immoral because it represents a retreat from the traditional standard that all citizens have an absolute right to be free from harm caused by pollution When it justifies a regulation that will allow some pollutioninduced deaths benefitcost analysis violates this absolute right Economist Maureen Cropper responds that it would be immoral not to con sider the benefits of lifesaving measures Resources are scarce and they must be allocated so as to produce the greatest good If all pollution were reduced to zero even if that were possible the cost would be extremely high and the resources to cover that cost would have to be diverted from other beneficial uses Professor Cropper also suggests that it would be immoral to impose costs on people about which they have no sayfor example the costs of additional pollution controlswithout at least trying to consider what choices people would make themselves Like it or not hard choices must be made Cropper also points out that people are always making decisions that recognize a tradeoff between the cost of more protection and the health consequences of not taking the protection Thinking in terms of tradeoffs should be a familiar concept She points out that people drive faster to save time thereby increasing their risk of dying They also decide how much money to spend on medicines to lower their risk of disease or they may take jobs that pose morbidity or even mortality risks In her response to Ackerman and Heinzerling Cropper acknowledges that benefitcost analysis has its flaws and that it should never be the only decision making guide Nonetheless she argues that it does add useful information to DEBATE 45 The simple answer of course is that life is priceless but that turns out to be not very helpful Because the resources used to prevent loss of life are scarce choices must be made The economic approach to valuing lifesaving reductions in environmental risk is to calculate the change in the probability of death resulting from the reduction in environmental risk and to place a value on the change Thus it is not life itself that is being valued but rather a reduction in the probability that some segment of the population could be expected to die earlier than others This value of statistical life VSL represents an individuals willingness to pay for small changes in mortality risks It does not represent a willingness to pay to prevent certain death It is measured as the marginal rate of substitution between mortality risk and money ie other goods and services Cameron 2010 and as such is also called mortality risk valuation Debate 45 examines the controversy associated with valuing changes in these mortality risks Valuing the Environment 101 It is possible to translate the value derived from this procedure into an implied value of statistical life This is accomplished by dividing the amount each individual is willing to pay for a specific reduction in the probability of death by the probability reduction Suppose for example that a particular environmental policy could be expected to reduce the average concentration of a toxic substance to which 1 million people are exposed Suppose further that this reduction in exposure could be expected to reduce the risk of death from 1 out of 100000 to 1 out of 150000 This implies that the number of expected deaths would fall from 10 to 667 in the exposed population as a result of this policy If each of the 1 million persons exposed is willing to pay 5 for this risk reduction for a total of 5 million then the implied value of a statistical life is approximately 15 million 5 million divided by 333 Alternatively the VSL can be calculated using the change in WTP divided by the change in risk For this example that would be 5 divided by the change in risk of death 1100000 1150000 or 15 million Thus the VSL is capturing the rate of tradeoff between money and a very small risk of death What actual values have been derived from these methods One early survey Viscusi 1996 of a large number of studies examining reductions in a number of lifethreatening risks found that most implied values for human life in 1986 dollars were between 3 million and 7 million This same survey went on to suggest that the most appropriate estimates were probably closer to the 5 million estimate In other words all government programs resulting in risk reductions costing less than 5 million per life saved would be justified in benefitcost terms Those costing more might or might not be justified depending on the appropriate value of a life saved in the particular risk context being examined In a metaanalysis Mrozek and Taylor 2002 found much lower values for VSL Using over 40 labor market studies their research suggests that a range of 15 million to 25 million for VSL is more appropriate What about age Does the VSL change with age Apparently so Viscusi 2008 finds an inverted Ushape relationship between VSL and age Specifically using the hedonic wage model they estimate a VSL of 37 million for persons ages 1824 97 million for persons ages 3544 and 34 million for persons ages 5562 According to their study VSL rises with age peaks and then declines What about the value of statistical life across populations or countries with different incomes Most agencies in the United States use VSLs between 5 million and 8 million15 These estimates are based largely on hedonic wage studies that have been conducted in the United States or in other highincome countries16 How might those results be translated into settings featuring populations with lower incomes Adjustments for income are typically derived using an estimate of the income elasticity of demand Recall that income elasticity is the percent change in consumption given a 1 percent change in income Hammitt and Robinson 2011 note that applying income elasticities derived for countries like the United States might result in nonsensical VSL the process and throwing that information away could prove to be detrimen tal to the very people that Ackerman and Heinzerling seek to protect Sources Ackerman Frank Heinzerling Lisa 2004 Priceless On Knowing the Price of Everything and the Value of Nothing New York The New Press Ackerman Frank 2004 Morality costbenefit and the price of life Environmental Forum 215 4647 Cropper Maureen 2004 Immoral not to weigh benefits against costs Environmental Forum 215 4748 Valuing the Environment 102 estimates if blindly applied to lowerincome countries While US agencies typically assume a 04 to 06 percent change in VSL for a 1 percent change in real income over time elasticities closer to 10 or higher are more realistic for transfers of these values between high and low income countries Using the higher income elasticity number is merited since willingness to pay for mortality risk reduction as a percentage of income drops at very low incomes what limited income is available in poorer households is reserved for basic needs Summary Nonmarket Valuation Today In this chapter we have examined the most prominent but certainly not the only techniques available to supply policymakers with the information needed to implement efficient policy Finding the total economic value of the service flows requires estimating three components of value 1 use value 2 option value and 3 nonuse or passiveuse values Our review of these various techniques included direct observation contingent valuation contingent choice experiments travel cost hedonic property and wage studies and averting or defensive expenditures When time or funding precludes original research benefit transfer or metaanalysis provide alternate methods for the estimation of values In January 2011 a panel of experts gathered at the annual meeting of the American Economics Association to reflect on nonmarket valuation 20 years after the Exxon Valdez spill and unknown to any of them when the panelists were asked to participate 8 months after the Deepwater Horizon spill The panelists had all worked on estimation of damages from the Exxon Valdez spill The consensus among panelists was that while many of the issues with bias have been addressed in the literature many unanswered questions remain and some areas still need work While they all agreed that it is hard to underestimate the powerful need for values ie some number is definitely better than no number and we now have in place methods that can be easily utilized by all researchers they also emphasized several problem areas First the value of time in travel cost models has not been resolved What is the opportunity cost of time if you are unemployed for example Second in discussing other revealed preference methods they asked the question How do the recent numerous foreclosures in the real estate market affect hedonic property value model assumptions17 Third choice experiments do not resolve all of the potential problems with contingent valuation While choice experiments do seem to better represent actual market choices some of the issues that arise in contingent valuation such as the choice of the payment vehicle also arise with choice experiments In addition some new challenges such as how the sequencing of choices in choice experiments might affect outcomes arise The panel highlighted how this area of research has been enhanced by the field of behavioral economics an emerging research area that combines economics and psychology to examine human behavior And finally they suggested that the NOAA panel recommendations be updated to reflect the new body of research In 2017 a new set of guidelines was published to do just that The 23 recommendations in those guidelines address these questions regarding stated preference surveys and attempt to synthesize the now large body of research that informs nonmarket valuation Johnston et al 2017 Some of these same experts along with several others implemented a nationwide survey following the BP spill to assess what US households would pay to avoid damages from another spill Using state of the art techniques for stated preference surveys they found that US households would be willing to pay 172 billion to avoid the damages from another spill Bishop et al 2017 One author claimed this is proof that our natural resources have an immense monetary value to citizens of the United States who visit the Gulf and to those who simply care that this valuable resource is not damaged Valuing the Environment 103 Discussion Question 1 Certain environmental laws prohibit the EPA from considering the costs of meeting various standards when the levels of the standards are set Is this a good example of appropriately prioritizing human health or simply an unjustifiable waste of resources Why SelfTest Exercises 1 In Mark A Cohen The Costs and Benefits of Oil Spill Prevention and Enforcement Journal of Environmental Economics and Management Vol 13 June 1986 an attempt was made to quantify the marginal benefits and marginal costs of US Coast Guard enforcement activity in the area of oil spill prevention His analysis suggests p 185 that the marginal pergallon benefit from the current level of enforcement activity is 750 while the marginal pergallon cost is 550 Assuming these numbers are correct would you recommend that the Coast Guard increase decrease or hold at the current level their enforcement activity Why 2 Professor Kip Viscusi estimated that the cost per life saved by current government riskreducing programs ranges from 100000 for unvented space heaters to 72 billion for a proposed standard to reduce occupational exposure to formaldehyde a Assuming these values to be correct how might efficiency be enhanced in these two programs b Should the government strive to equalize the marginal costs per life saved across all lifesaving programs 3 a Suppose that hedonic wage studies indicate a willingness to pay 50 per person for a reduction in the risk of a premature death from an environmental hazard of 1100000 If the exposed population is 4 million people what is the implied value of a statistical life b Suppose that an impending environmental regulation to control that hazard is expected to reduce the risk of premature death from 6100000 to 2100000 per year in that exposed population of 4 million people Your boss asks you to tell her what is the maximum this regulation could cost and still have the benefits be at least as large as the costs What is your answer Notes 1 US District Court for the State of Alaska Case Number A890095CV January 28 2004 2 Ibid 3 Exxon Shipping Company v Baker 4 Bishop et al 2017 5 In 2017 the United States Department of the Interior released the Deepwater Horizon Response and Restoration Administrative Record which included an estimate of the total value of damages see Example 184 6 The rules for determining these damages are defined in Department of Interior regulations See 40 Code of Federal Regulations 3007274 7 Krutilla John V 1967 Conservation reconsidered American Economic Review 574 777786 8 Ibid p 779 Valuing the Environment 104 9 A more detailed description of the methodological issues and concerns with contingent valuation with respect to the actual Exxon Valdez contingent valuation survey can be found in Mitchell 2002 10 There are many examples in this category These are just a few 11 Whittington 2002 examines the reasons why so many contingent valuation studies in developing countries are unhelpful Poorly designed or rapidly implemented surveys could result in costly policy mistakes on topics that are very important in the developing world The current push for cheaper quicker studies is risky and researchers need to be very cautious 12 wwwevrica 13 For examples see Bateman et al 2002 who describe the contributions of GIS in incorporat ing spatial dimensions into economic analysis including benefitcost analysis and Clapp et al 1997 who discuss the potential contributions GIS can make for urban and real estate economics 14 Interestingly after this study was complete one of the two upstream dams the Fort Halifax Dam was removed in July 2008 after years of litigation about its removal 15 See for example wwwepagovenvironmentaleconomicsmortalityriskvaluation 16 Many labor market estimates of VSL average near 7 million Viscusi 2008 17 This question was taken up by another panel of experts at the 2012 Association of Environmental and Resource Economics annual conference and later published by Boyle et al 2012 Further Reading Bateman Ian J Lovett Andrew A Brainard Julii S 2005 Applied Environmental Economics A GIS Approach to CostBenefit Analysis Cambridge Cambridge University Press Uses GIS to examine land use change and valuation Bennett Jeff Ed 2011 The International Handbook on NonMarket Environmental Valuation Cheltenham UK Edward Elgar An excellent compilation on nonmarket valuation Boardman Anthony E Greenberg David H Vining Aidan R Weimer David L 2005 CostBenefit Analysis Concepts and Practice 3rd ed Upper Saddle River NJ Prentice Hall An excellent basic text on the use of costbenefit analysis Champ Patricia A Boyle Kevin J Brown T C 2016 A Primer on Nonmarket Valuation 2nd ed New York Springer A thorough overview of nonmarket valuation methods Costanza R et al 1998 The value of the worlds ecosystem services and natural capital Reprinted from Nature 387 253 1997 Ecological Economics 251 315 An ambitious but ultimately flawed attempt to place an economic value on ecosystem services This issue of Ecological Economics also contains a number of articles that demonstrate some of the flaws Johnston R J Rolfe J Rosenberger R Brouwer R Eds 2015 Benefit Transfer of Environmental and Resource Values A Guide for Researchers and Practitioners Dordrecht the Netherlands Springer This article is a practical guide for the design and use of benefit transfer Johnston Robert J Boye Kevin J Adamowicz Wiktor Bennett Jeff Brouwer Roy Cameron Trudy Ann Hanemann W Michael Hanley Nick J Ryan Mandy Scarpa Riccardo Tourangeau Roger Vossler Christian A 2017 Contemporary guidance for stated preference studies JAERE 42 httpdxdoiorg101086691697 This issue includes an update to the NOAA guidelines for the use of contingent valuation It also has recommendations for the use of choice experiments Mitchell Robert Cameron Carson Richard T 1989 Using Surveys to Value Public Goods The Contingent Valuation Method Washington DC Resources for the Future Valuing the Environment 105 A comprehensive examination of contingent valuation research with brief summaries of representative studies and recommendations for survey design Whitehead John Haab Tim Huang JuChin Eds 2011 Preference Data for Environmental Valuation Combining Revealed and Stated Approaches London Routledge A compilation of articles that use more than one valuation method or novel applications of data combinations written by nonmarket valuation economists Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 107 Dynamic Efficiency and Sustainable Development We usually see only the things we are looking forso much so that we sometimes see them where they are not Eric Hoffer The Passionate State of Mind 1993 Introduction In previous chapters we have developed two specific criteria for identifying allocation problems The first static efficiency allows us to evaluate those circumstances where time is not a crucial aspect of the allocation problem Typical examples might include allocating resources such as an annually replenished water supply or solar energy where next years flow is independent of this years choices The second more complicated criterion dynamic efficiency is suitable for those circumstances where time is a crucial aspect and subsequent choices are dependent on earlier choices The combustion of depletable energy resources such as oil would be a typical example since supplies used now are unavailable for future generations After defining these criteria and showing how they could be operationally invoked we demonstrated how helpful they can be They are useful not only in identifying the misuse of environmental resources and ferreting out their behavioral sources but also in providing a basis for identifying different types of remedies These criteria even help design optimal policy instruments for restoring some sense of balance between the economy and the environment But the fact that these are powerful and useful tools in the quest for a sense of balance does not imply that they are the only criteria in which we should be interested In a general sense the efficiency criteria are designed to prevent wasteful use of environmental and natural resources That is a desirable attribute but it is not the only possible desirable attribute We might care for example not only about the value of the environment the size of the pie but also how this value is shared the size of each piece to recipients In other words fairness or justice concerns should accompany efficiency considerations Chapter 5 Dynamic Efficiency and Sustainability 108 In this chapter we investigate one particular fairness concernthe treatment of future generations We begin by considering a specific ethically challenging situationthe allocation of a depletable resource over time Specifically we trace out the temporal allocation of a depletable resource that satisfies the dynamic efficiency criterion and show how this allocation is affected by changes in the discount rate To lay the groundwork for our evaluation of fairness we define what we mean by a just allocation among generations Finally we consider not only how this theoretical definition can be made operationally measurable but also how it relates to dynamic efficiency To what degree is dynamic efficiency compatible with intergenerational fairness A TwoPeriod Model Dynamic efficiency balances present and future uses of a depletable resource by maximizing the present value of the net benefits derived from its use This implies a particular allocation of the resource across time We can illustrate the properties of this allocation with the aid of a simple numerical example We begin with the simplest of modelsderiving the dynamic efficient allocation across two time periods In subsequent chapters we show how these conclusions generalize to longer time periods and to more complicated situations Assume that we have a fixed supply of a depletable resource to allocate between two periods Assume further that the demand function is the same in each of the two periods the marginal willingness to pay is given by the formula P 8 04q and the marginal cost of supplying that resource is constant at 2 per unit see Figure 51 Note that if the total supply Q were 30 or greater and we were concerned only with these two periods an efficient allocation would allocate 15 units to each period regardless of the discount rate Thirty units would be sufficient to cover the demand in both periods Figure 51 The Allocation of an Abundant Depletable Resource a Period 1 and b Period 2 Dynamic Efficiency and Sustainability 109 the consumption in Period 1 would not reduce the consumption in Period 2 In this case the static efficiency criterion is sufficient because the allocations are not temporally interdependent abundance eliminates the scarcity Consider however what happens when the available supply is less than 30 Suppose it equals 20 How do we determine the efficient allocation According to the dynamic efficiency criterion the efficient allocation is the one that maximizes the present value of the net benefit The present value of the net benefit for both periods is simply the sum of the present values in each of the two periods To take a concrete example consider the present value of a particular allocation15 units in the first period and five in the second How would we compute the present value of that allocation The present value in the first period would be that portion of the geometric area under the demand curve that is over the supply curve45001 The present value in the second period is that portion of the area under the demand curve that is over the supply curve from the origin to the five units received multiplied by 11 r If we use r 010 then the present value of the net benefit received in the second period is 22732 and the present value of the net benefits for the 2 years is 6773 Having learned how to find the present value of net benefits for any allocation how does one find the allocation that maximizes present value One way with the aid of a computer is to try all possible combinations of q1 and q2 that sum to 20 The one yielding the maximum present value of net benefits can then be selected That is tedious and for those who have the requisite mathematics unnecessary It turns out that the dynamically efficient allocation of this resource has to satisfy the condition that the present value of the marginal net benefit from the last unit in Period 1 equals the present value of the marginal net benefit from the last unit in Period 2 see appendix at the end of this chapter for the derivation Even without the mathematics this principle is easy to understand as can be demonstrated with the use of a simple graphical representation of the twoperiod allocation problem Figure 52 depicts the present value of the marginal net benefit for each of the two periods The net benefit curve for Period 1 is to be read from left to right The net benefit curve intersects the vertical axis at 6 demand would be zero at 8 and the marginal cost is 2 so the difference marginal net benefit is 6 The marginal net benefit for the first period goes to zero at 15 units because at that quantity the marginal willingness to pay for that unit exactly equals its marginal cost Can you verify those numbers The only challenging aspect of drawing the graph involves constructing the curve for the present value of net benefits in Period 2 Two aspects of Figure 52 are worth noting First the zero axis for the Period 2 net benefits is on the right rather than the left side Therefore increases in Period 2 are recorded from right to left By drawing the two periods this way all points along the horizontal axis yield a total of 20 units allocated between the two periods Any point on that axis picks a unique allocation between the two periods3 Second the present value of the marginal net benefit curve for Period 2 intersects the vertical axis at a different point than does the comparable curve in Period 1 Can you see why This intersection is lower because the marginal benefits in the second period need to be discounted multiplied by 11 r to convert them into present value This follows from the fact that they are received one year later Thus with the 10 percent discount rate we are using the marginal net benefit on the right hand axis is 6 and its present value is 6110 545 Note that larger discount rates r 10 would rotate the Period 2 marginal benefit curve around the point of zero net benefit q1 5 q2 15 toward the righthand axis We shall use this fact in a moment Dynamic Efficiency and Sustainability 110 The efficient allocation is now readily identifiable as the point where the two curves representing present value of marginal net benefits cross since that is the allocation where the two marginal present values of net benefits for the two periods are equal The total present value of net benefits is then the area under the marginal net benefit curve for Period 1 up to the efficient allocation plus the area under the present value of the marginal net benefit curve for Period 2 from the righthand axis up to its efficient allocation Because we have an efficient allocation the sum of these two areas is maximized4 Since we have developed our efficiency criteria independent of an institutional context these criteria are equally appropriate for evaluating resource allocations generated by markets government rationing or even the whims of a dictator While any efficient allocation method must take scarcity into account the details of precisely how that is done depend on the context Intertemporal scarcity imposes an opportunity cost that we henceforth refer to as the marginal user cost When resources are scarce greater current use diminishes future oppor tunities The marginal user cost is the present value of these forgone future opportunities at the margin To be more specific uses of those resources which would have been appropriate in the absence of scarcity may no longer be appropriate once scarcity is present Consider a practical example Using large quantities of water to keep lawns lush and green may be wholly appropriate for an area with sufficiently large replenishable water supplies but quite inappropriate when it denies drinking water to future generations Failure to take the higher future scarcity value of water into account in the present would lead to inefficiency due to the additional cost resulting from the increased scarcity imposed on the future This additional marginal value created by scarcity is the marginal user cost We can illustrate this concept by returning to our numerical example With 30 or more units each period would be allocated 15 units the resource would not be scarce and the marginal user cost would therefore be zero With 20 units however scarcity emerges No longer can 15 units be allocated to each period each period will have to be allocated less than would be the case with abundance Figure 52 The Dynamically Efficient Allocation Dynamic Efficiency and Sustainability 111 Due to this scarcity the marginal user cost for this case is not zero As can be seen from Figure 52 the present value of the marginal user costthe additional value created by scarcityis graphically represented by the vertical distance between the quantity horizontal axis and the intersection of the two presentvalue curves Notice that the present value of the marginal net benefit for Period 1 is equal to the present value of the marginal net benefit for Period 2 This common value can either be read off the graph or determined more precisely as demonstrated in the chapter appendix to be 1905 We can make this concept of marginal user cost even more concrete by considering its use in a market context An efficient market would have to consider not only the marginal cost of extraction for this resource but also the marginal user cost Whereas in the absence of scarcity the price would equal only the marginal cost of extraction with scarcity the price would equal the sum of marginal extraction cost and marginal user cost To see this solve for the prices that would prevail in an efficient market facing scarcity over time Inserting the efficient quantities for the two periods 10238 and 9762 respectively into the willingnesstopay function P 8 04q yields P1 3905 and P2 4095 The corresponding supplyanddemand diagrams are given in Figure 53 Compare Figure 53 with Figure 51 to see the impact of scarcity on price Note that marginal user cost is zero in Figure 51 as expected from the absence of scarcity In an efficient allocation involving scarcity the marginal user cost for each period is the difference between the price and the marginal cost of extraction Notice that it takes the value 1905 in the first period and 2095 in the second In both periods the present value of the marginal user cost is 1905 In the second period the actual marginal user cost is 1905 l r Since r 010 in this example the actual as opposed to present value marginal user cost for the second period is 20955 Thus while the present value of marginal user cost is equal in both periods the actual marginal user cost rises over time Figure 53 The Efficient Market Allocation of a Depletable Resource The ConstantMarginalCost Case a Period 1 and b Period 2 Dynamic Efficiency and Sustainability 112 Both the size of the marginal user cost and the allocation of the resource between the two periods are affected not only by the degree of scarcity but also by the discount rate In Figure 52 because of discounting the efficient allocation allocates somewhat more to Period 1 than to Period 2 A discount rate larger than 010 would be incorporated in this diagram by rotating not shifting the Period 2 curve an appropriate amount toward the right hand axis holding fixed the point at which it intersects the horizontal axis Can you see why The larger the discount rate the greater the amount of rotation required The implication is clearthe amount allocated to the second period would be necessarily smaller with larger discount rates The general conclusion which holds for all models we consider is that higher discount rates tend to skew resource extraction toward the present because they give the future less weight in balancing the relative value of present and future resource use The choice of what discount rate to use then becomes a very important consideration for decision makers Defining Intertemporal Fairness While no generally accepted standards of fairness or justice exist some have more prominent support than others One such standard concerns the treatment of future generations What legacy should earlier generations leave to later ones This is a particularly difficult issue because in contrast to other groups for which we may want to ensure fair treatment future generations cannot articulate their wishes much less negotiate with current generations Well accept your radioactive wastes if you leave us plentiful supplies of titanium One starting point for intergenerational equity is provided by philosopher John Rawls in his monumental work A Theory of Justice Rawls suggests that one way to derive general principles of justice is to place hypothetically all people into an original position behind a veil of ignorance This veil of ignorance would prevent them from knowing their eventual position in society Once behind this veil people would be asked to decide on rules to govern the society that they would after the decision be forced to inhabit In our context this approach would suggest a hypothetical meeting of all members of present and future generations to decide on rules for allocating resources among generations Because these members are prevented by the veil of ignorance from knowing the generation to which they will belong after the rules are defined they will not be excessively conservationist lest they turn out to be a member of an earlier generation or excessively exploitative lest they become a member of a later generation What kind of rule would emerge from such a meeting One possibility is the sustainability criterion The sustainability criterion suggests that at a minimum future generations should be left no worse off than current generations Allocations that impoverish future generations in order to enrich current generations are according to this criterion patently unfair In essence the sustainability criterion suggests that earlier generations are at liberty to use resources that would thereby be denied to future generations as long as the wellbeing of future generations remains just as high as that of all previous generations On the other hand diverting resources from future use would violate the sustainability criterion if it reduced the wellbeing of future generations below the level enjoyed by preceding generations One of the implications of this definition of sustainability is that it is possible for the current generation to use resources even depletable resources as long as the interests of future generations could be protected Do our institutions provide adequate protection for future generations We begin with examining the conditions under which efficient allocations satisfy the sustainability criterion Are all efficient allocations sustainable Dynamic Efficiency and Sustainability 113 Are Efficient Allocations Fair In the numerical example we have constructed it certainly does not appear that the efficient allocation satisfies the sustainability criterion In the twoperiod example more resources are allocated to the first period than to the second Therefore net benefits in the second period are lower than in the first Sustainability does not allow earlier generations to profit at the expense of later generations and this example certainly appears to be a case where that is happening Yet appearances can be deceiving Choosing this particular extraction path does not prevent those in the first period from saving some of the net benefits for those in the second period If the allocation is dynamically efficient it will always be possible to set aside sufficient net benefits accrued in the first period for those in the second period so that those in both periods will be at least as well off as they would have been with any other extraction profile and one of the periods will be better off We can illustrate this point with a numerical example that compares a dynamic efficient allocation with sharing to an allocation where resources are committed equally to each generation Suppose for example you believe that setting aside half 10 units of the available resources for each period would be a better allocation than the dynamic efficient allocation The net benefits to each period from this alternative scheme would be 40 Can you see why Now lets compare this to an allocation of net benefits that could be achieved with the dynamic efficient allocation For the dynamic efficient allocation to satisfy the sustainability criterion we must be able to show that it can produce an outcome such that each generation would be at least as well off as it would be with the equal allocation and one will be better off Can that be demonstrated In the dynamic efficient allocation with no sharing the net benefits to the first period were 40466 while those for the second period were 395126 Clearly in the absence of sharing between the periods this example would violate the sustainability criterion the second generation is worse off than it would be with equal sharing While it would receive 4000 from equal resource allocation across the two periods it receives only 39512 from the dynamic efficient allocation in the absence of any benefit sharing But suppose the first generation was willing to share some of the net benefits from the extracted resources with the second generation If the first generation keeps net benefits of 40 thereby making it just as well off as if equal amounts were extracted in each period and saves the extra 0466 the 40466 net benefits earned during the first period in the dynamic efficient allocation minus the 40 reserved for itself at 10 percent interest for those in the next period this saving would grow to 0513 by the second period 0466110 Add this to the net benefits received directly from the dynamic efficient allocation 39512 and the second generation would receive 40025 Those in the second period would be better off by accepting the dynamic efficient allocation with sharing than they would if they demanded that resources be allocated equally between the two periods This example demonstrates that although dynamic efficient allocations do not automatically satisfy sustainability criteria they could be compatible with sustainability even in an economy relying heavily on depletable resources The possibility that the second period can be better off is not a guarantee the required degree of sharing must take place Example 51 points out that under some conditions this sharing does take place although as we shall see such sharing is more likely to be the exception rather than the norm In subsequent chapters we shall examine both the conditions under which we could expect the appropriate degree of sharing to take place and the conditions under which it would not Dynamic Efficiency and Sustainability 114 EXAMPLE 51 The Alaska Permanent Fund One interesting example of an intergenerational sharing mechanism currently exists in the state of Alaska Extraction from Alaskas oil fields generates significant income but it also depreciates one of the states main environmental assets To protect the interests of future generations as the Alaskan pipeline construction neared completion in 1976 Alaska voters approved a constitutional amendment that authorized the establishment of a dedicated fund the Alaska Permanent Fund This fund was designed to capture a portion of the rents received from the sale of the states oil to share with future generations The amendment requires At least 25 percent of all mineral lease rentals royalties royalty sales proceeds federal mineral revenuesharing payments and bonuses received by the state be placed in a permanent fund the principal of which may only be used for income producing investments The principal of this fund cannot be used to cover current expenses without a majority vote of Alaskans The fund is fully invested in capital markets and diversified among various asset classes It generates income from interest on bonds stock dividends real estate rents and capital gains from the sale of assets To date the legislature has used some of these annual earnings to provide dividends to every eligible Alaska resident while retaining the rest in the fund in order to increase the size of the endowment thereby assuring that it is not eroded by inflation As of 2015 the market value of the fund was 528 billion and the dividend to every resident in that year was 207200 Although this fund does preserve some of the revenue for future generations two characteristics are worth noting First the principal could be used for current expendi tures if a majority of current voters agreed To date that has not happened but it has been discussed Second only 25 percent of the oil net revenue is placed in the fund assuming that net revenue reflects scarcity rent full sustainability would require dedicat ing 100 percent of it to the fund Because the current generation not only gets its share of the income from the permanent fund but also receives 75 percent of the proceeds from current oil sales this sharing arrangement falls short of full sustainability Source The fund is managed by the Alaska Permanent Fund Corporation wwwapfcorghomeContent homeindexcfm accessed January 19 2017 The Alaska Permanent Fund Website wwwpfd stateakus accessed January 19 2017 Applying the Sustainability Criterion One of the difficulties in assessing the fairness of intertemporal allocations using this version of the sustainability criterion is that it is so difficult to apply Discovering whether the well being of future generations would be lower than that of current generations requires us not only to know something about the allocation of resources over time but also to know Dynamic Efficiency and Sustainability 115 something about the preferences of future generations in order to establish how valuable various resource streams are to them That is a tall impossible order Is it possible to develop a version of the sustainability criterion that is more operational Fortunately it is thanks to what has become known as the Hartwick Rule In an early article John Hartwick 1977 demonstrated that a constant level of consumption could be maintained perpetually from an environmental endowment if all the scarcity rent derived from resources extracted from that endowment were invested in capital That level of investment would be sufficient to assure that the value of the total capital stock would not decline Two important insights flow from this reinterpretation of the sustainability criterion First with this version it is possible to judge the sustainability of an allocation by examining whether or not the value of the total capital stock is declininga declining capital stock violates the rule That test can be performed each year without knowing anything about future allocations or preferences Second this analysis suggests the specific degree of sharing that would be necessary to produce a sustainable outcome namely all scarcity rent must be invested Lets pause to be sure we understand what is being said and why it is being said Although we shall return to this subject later in the book it is important now to have at least an intuitive understanding of the implications of this analysis Consider an analogy Suppose a grandparent left you an inheritance of 10000 and you put it in a bank where it earns 10 percent interest What are the choices for allocating that money over time and what are the implications of those choices If you withdrew exactly 1000 per year the amount in the bank would remain 10000 and the income would last forever you would be spending only the interest leaving the principal intact If you spend more than 1000 per year the principal would necessarily decline over time and eventually the balance in the account would go to zero In the context of this discussion spending 1000 per year or less would satisfy the sustainability criterion while spending more would violate it What does the Hartwick Rule mean in this context It suggests that one way to tell whether an allocation spending pattern is sustainable or not is to examine what is happening to the value of the principal over time If the principal is declining the allocation spending pattern is not sustainable If the principal is increasing or remaining constant the allocation spending pattern is sustainable How do we apply this logic to the environment In general the Hartwick Rule suggests that the current generation has been given an endowment Part of the endowment consists of environmental and natural resources known as natural capital and another part consists of physical capital such as buildings equipment schools and roads Sustainable use of this endowment implies that we should keep the principal the value of the natural and physical endowment intact and live off only the flow of services provided We should not in other words chop down all the trees and use up all the oil leaving future generations to fend for themselves Rather we need to assure that the value of the total capital stock is maintained not depleted The desirability of this version of the sustainability criterion depends crucially on how substitutable the two forms of capital are If physical capital can readily substitute for natural capital then maintaining the value of the sum of the two is sufficient If however physical capital cannot completely substitute for natural capital investments in physical capital alone may not be enough to assure sustainability How tenable is the assumption of complete substitutability between physical and natural capital Clearly it is untenable for certain essential categories of environmental resources Although we can contemplate the replacement of natural breathable air with universal air conditioning in domed cities both the expense and the artificiality of this approach make it an Dynamic Efficiency and Sustainability 116 absurd compensation device Obviously intergenerational compensation must be approached carefully see Example 52 Recognizing the weakness of the constant total capital definition in the face of limited substitution possibilities has led some economists to propose a new additional definition According to this new definition an allocation is sustainable if it maintains the value of the stock of natural capital This definition assumes that it is natural capital that drives future wellbeing and further assumes that little or no substitution between physical and natural capital is possible To differentiate these two definitions the maintenance of the value of total capital is known as the weak sustainability less restrictive definition while maintaining the value of natural capital is known as the strong sustainability more restrictive definition A final additional definition known as environmental sustainability requires that certain physical flows of certain key individual resources be maintained This definition suggests that it is not sufficient to maintain the value of an aggregate For a fishery for example this definition would require catch levels that did not exceed the growth of the biomass for the fishery For a wetland it would require the preservation of specific ecological functions EXAMPLE 52 Nauru Weak Sustainability in the Extreme The weak sustainability criterion is used to judge whether the depletion of natural capital is offset by sufficiently large increases in physical or financial capital so as to prevent total capital from declining It seems quite natural to suppose that a violation of that criterion does demonstrate unsustainable behavior But does fulfillment of the weak sustainability criterion provide an adequate test of sustainable behavior Consider the case of Nauru Nauru is a small Pacific island that lies some 3000 kilometers northeast of Australia It contains one of the highest grades of phosphate ever discovered Phosphate is a prime ingredient in fertilizers Over the course of a century first colonizers and then after independence the citizens of Nauru decided to extract massive amounts of this deposit This decision has simultaneously enriched the remaining inhabitants including the creation of a trust fund believed to contain over 1 billion and destroyed most of the local ecosystems Local needs are now mainly met by imports financed by the sales of the phosphate However wise or unwise the choices made by the people of Nauru were they could not be replicated globally An entire population cannot subsist solely on imports financed with trust funds every import must be exported by someone The story of Nauru demonstrates the value of complementing the weak sustainability criterion with other more demanding criteria Satisfying the weak sustainability criterion may be a necessary condition for sustainability but it is not always sufficient Source Gowdy J W McDaniel C N 1999 The physical destruction of Nauru An example of weak sustainability Land Economics 752 333338 Dynamic Efficiency and Sustainability 117 Implications for Environmental Policy In order to be useful guides to policy our sustainability and efficiency criteria must be neither synonymous nor incompatible Do these criteria meet that test They do As we shall see later in the book not all efficient allocations are sustainable and not all sustainable allocations are efficient Yet some sustainable allocations are efficient and some efficient allocations are sustainable Furthermore market allocations may be either efficient or inefficient and either sustainable or unsustainable Do these differences have any policy implications Indeed they do In particular they suggest a specific strategy for policy Among the possible uses for resources that fulfill the sustainability criterion we choose the one that maximizes either dynamic or static efficiency as appropriate In this formulation the sustainability criterion acts as an overriding constraint on social decisions Yet by itself the sustainability criterion is insufficient because it fails to provide any guidance on which of the infinite number of sustainable allocations should be chosen That is where efficiency comes in It provides a means for maximizing the wealth derived from all the possible sustainable allocations This combination of efficiency with sustainability turns out to be very helpful in guiding policy Many unsustainable allocations are the result of inefficient behavior Correcting the inefficiency can either restore sustainability or move the economy a long way in that direction Furthermore and this is important correcting inefficiencies can frequently produce winwin situations In winwin changes the various parties affected by the change can all be made better off after the change than before This contrasts sharply with changes in which the gains to the gainers are smaller than the losses to the losers Winwin situations are possible because moving from an inefficient to an efficient allocation increases net benefits The increase in net benefits provides a means for compensating those who might otherwise lose from the change Compensating losers reduces the opposition to change thereby making change more likely Do our economic and political institutions normally produce outcomes that are both efficient and sustainable In upcoming chapters we will provide explicit answers to this important question Summary Both efficiency and ethical considerations can guide the desirability of private and social choices involving the environment Whereas the former is concerned mainly with eliminating waste in the use of resources the latter is concerned with assuring the fair treatment of all parties Previous chapters have focused on the static and dynamic efficiency criteria Chapter 19 will focus on the environmental justice implications of environmental degradation and remediation for members of the current generation The present chapter examines one globally important characterization of the obligation previous generations owe to generations that follow and the policy implications that flow from acceptance of that obligation The specific obligation examined in this chaptersustainable developmentis based upon the notion that earlier generations should be free to pursue their own wellbeing as long as in so doing they do not diminish the welfare of future generations This notion gives rise to three alternative definitions of sustainable allocations Weak Sustainability Resource use by previous generations should not exceed a level that would prevent subsequent generations from achieving a level of wellbeing at least as great One operational implication of this definition is that the value of the capital stock natural Dynamic Efficiency and Sustainability 118 plus physical capital should not decline Individual components of the aggregate could decline in value as long as other components were increased in value normally through investment sufficiently to leave the aggregate value unchanged Strong Sustainability According to this interpretation the value of the remaining stock of natural capital should not decrease This definition places special emphasis on preserving natural as opposed to total capital under the assumption that natural and physical capital offer limited substitution possibilities This definition retains two characteristics of the previous definition it preserves value rather than a specific level of physical flow and it preserves an aggregate of natural capital rather than any specific component Environmental Sustainability Under this definition the physical flows of individual resources should be maintained not merely the value of the aggregate For a fishery for example this definition would emphasize maintaining a constant fish catch referred to as a sustainable yield rather than a constant value of the fishery For a wetland it would involve preserving specific ecological functions not merely their aggregate value It is possible to examine and compare the theoretical conditions that characterize various allocations including market allocations and efficient allocations to the necessary conditions for an allocation to be sustainable under these definitions According to the theorem that is now known as the Hartwick Rule if all of the scarcity rent from the use of scarce resources is invested in capital the resulting allocation will satisfy the first definition of sustainability In general not all efficient allocations are sustainable and not all sustainable allocations are efficient Furthermore market allocations can be 1 efficient but not sustainable 2 sustainable but not efficient 3 inefficient and unsustainable and 4 efficient and sustain able One class of situations known as winwin situations provides an opportunity to increase simultaneously the welfare of both current and future generations We shall explore these themes much more intensively as we proceed through the book In particular we shall inquire into when market allocations can be expected to produce allocations that satisfy the sustainability definitions and when they cannot We shall also see several specific examples of how the skillful use of economic incentives can allow policymakers to exploit winwin situations to promote a transition onto a sustainable path for the future Discussion Question 1 The environmental sustainability criterion differs in important ways from both strong and weak sustainability Environmental sustainability frequently means maintaining a constant physical flow of individual resources eg fish from the sea or wood from the forest while the other two definitions call for maintaining the aggregate value of those service flows When might the two criteria lead to different choices Why SelfTest Exercises 1 In the numerical example given in the text the inverse demand function for the depletable resource is P 8 04q and the marginal cost of supplying it is 2 a If 20 units are to be allocated between two periods in a dynamic efficient allocation how much would be allocated to the first period and how much to the second period when the discount rate Dynamic Efficiency and Sustainability 119 is zero b Given this discount rate what would be the efficient price in the two periods c What would be the marginal user cost in each period 2 Assume the same demand conditions as stated in Problem 1 but let the discount rate be 010 and the marginal cost of extraction be 4 How much would be produced in each period in an efficient allocation What would be the marginal user cost in each period Would the static and dynamic efficiency criteria yield the same answers for this problem Why 3 Compare two versions of the twoperiod depletable resource model that differ only in the treatment of marginal extraction cost Assume that in the second version the constant marginal extraction cost is lower in the second period than the first perhaps due to the anticipated arrival of a new superior extraction technology The constant marginal extraction cost is the same in both periods in the first version and is equal to the marginal extraction cost in the first period of the second version In a dynamic efficient allocation how would the extraction profile in the second version differ from the first Would relatively more or less be allocated to the second period in the second version than in the first version Would the marginal user cost be higher or lower in the second version Why 4 a Consider the general effect of the discount rate on the dynamic efficient allocation of a depletable resource across time Suppose we have two versions of the twoperiod model discussed in this chapter The two versions are identical except for the fact that the second version involves a higher discount rate than the first version What effect would the higher discount rate have on the allocation between the two periods and the magnitude of the present value of the marginal user cost b Explain the intuition behind your results 5 a Consider the effect of population growth on the allocation on the dynamic efficient allocation of a depletable resource across time Suppose we have two versions of the twoperiod model discussed in this chapter that are identical except for the fact that the second version involves a higher demand for the resource in the second period eg the demand curve shifts to the right due to population growth than the first version What effect would the higher demand in the second period have on the allocation between the two periods and the magnitude of the present value of the marginal user cost b Explain the intuition behind your results Notes 1 The height of the triangle is 6 8 2 and the base is 15 units The area is therefore 12 615 45 2 The undiscounted net benefit is 25 The calculation is 6 2 5 12 8 6 5 25 The discounted net benefit is therefore 25110 2273 3 Note that the sum of the two allocations in Figure 52 is always 20 The lefthand axis repre sents an allocation of all 20 units to Period 2 and the righthand axis represents an allocation entirely to Period 1 4 Demonstrate that this point is the maximum by first allocating slightly more to Period 2 and therefore less to Period 1 and showing that the total area decreases Conclude by allocating slightly less to Period 2 and showing that in this case as well total area declines 5 You can verify this by taking the present value of 2095 and showing that it equals 1905 6 The supporting calculations are 190510238 05409510238 for the first period and 20959762 0539059762 for the second period Dynamic Efficiency and Sustainability 120 Further Reading Heal G 2012 ReflectionsDefining and measuring sustainability Review of Environmental Economics and Policy 61 147163 An examination of the concept of sustainability and the possibility of quantifying it Kiron D Kruschwitz N Haanæs K Velken I V S 2012 Sustainability nears a tipping point MIT Sloan Management Review 532 6974 What is the role for the private sector in sustainable development Is concern over the bottom line consistent with the desire to promote sustainable development Lopez R Toman M A Eds 2006 Economic Development and Environmental Sustainability New York Oxford University Press Thirteen essays that explore how the principles of sustainability can be implemented in the context of reducing poverty through development Pezzey J V C Toman M A 2002 Progress and problems in the economics of sustainability In T Tietenberg H Folmer Eds The International Yearbook of Environmental and Resource Economics A Survey of Current Issues Cheltenham UK Edward Elgar 165232 An excellent technical survey of the economics literature on sustainable development USEPA Sustainability website wwwepagovsustainabilitylearnaboutsustainabilitywhat A description of how the concept of sustainability affects the work of the United States Environmental Protection Agency World Bank 2011 The Changing Wealth of Nations Measuring Sustainable Development in the New Millennium Washington DC World Bank This study presents for the first time a set of wealth accounts for over 150 countries for 1995 2000 and 2005 This set of accounts allows a longerterm assessment of global regional and country performance within the weak sustainability context Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Appendix The Simple Mathematics of Dynamic Efficiency Assume that the demand curve for a depletable resource is linear and stable over time Thus the inverse demand curve in year t can be written as P a bq t t The total benefits from extracting an amount qt in year t are then the integral of this function the area under the inverse demand curve 2 Total benefits t a bq dq aq b q2 0 qt t t Dynamic Efficiency and Sustainability 121 Further assume that the marginal cost of extracting that resource is a constant c and therefore the total cost of extracting any amount qt in year t can be given by Total cost cq t t If the total available amount of this resource is Q then the dynamic allocation of a resource over n years is the one that satisfies the maximization problem 1 2 Q Max r aq bq cq q 1 2 1 1 q i i i i i n i i n m F Assuming that Q is less than would normally be demanded the dynamic efficient allocation must satisfy 1 0 1 0 Q r a bq c i n q 1 1 i i i i n m An implication of the first of these two equations is that P MC increases over time at rate r This difference which is known as the marginal user cost will play a key role in our thinking about allocating depletable resources over time An exact solution to the twoperiod model can be illustrated using these solution equations and some assumed values for the parameters The following parameter values are assumed by the twoperiod example 8 2 04 20 010 and a c b Q r Inserting these parameters into the two equations one for each period we obtain 8 04 2 0 110 8 04 2 0 20 q q q q 1 2 1 2 m m It is now readily verified that the solution accurate to the third decimal place is 10238 9762 1905 q q 1 2 m We can now demonstrate the propositions discussed in this text 1 Verbally in a dynamic efficient allocation the present value of the marginal net benefit in Period 1 8 04q1 2 has to equal m In addition the present value of the marginal net benefit in Period 2 should also equal m Therefore they must equal each other This demonstrates the proposition shown graphically in Figure 52 Dynamic Efficiency and Sustainability 122 2 The present value of marginal user cost is represented by m Thus the price in the first period 8 04q1 should be equal to the sum of marginal extraction cost 2 and marginal user cost 1905 Multiplying m by 1 r it becomes clear that price in the second period 8 04q2 is equal to the marginal extraction cost 2 plus the higher marginal user cost m 1 r 1905110 2095 in Period 2 These results show why the graphs in Figure 53 have the properties they do They also illustrate the point that in this case marginal user cost rises over time 123 Depletable Resource Allocation The Role of Longer Time Horizons Substitutes and Extraction Cost The whole machinery of our intelligence our general ideas and laws fixed and external objects principles persons and gods are so many symbolic algebraic expressions They stand for experience experience which we are incapable of retaining and surveying in its multitudinous immediacy We should flounder hopelessly like the animals did we not keep ourselves afloat and direct our course by these intellectual devices Theory helps us to bear our ignorance of fact George Santayana The Sense of Beauty 1896 Introduction How do societies react when finite stocks of depletable resources become scarce Is it reason able to expect that selflimiting feedbacks would facilitate the transition to a sustainable steady state Or is it more reasonable to expect that selfreinforcing feedback mechanisms would cause the system to overshoot the resource base possibly even precipitating a societal collapse We begin to seek answers to these questions by studying the implications of both efficient and profitmaximizing decision making What kinds of feedback mechanisms are implied by decisions motivated by efficiency and by profit maximization Are they compatible with a smooth transition or are they more likely to produce overshoot and collapse We approach these questions in several steps beginning by defining and discussing a simple but useful resource taxonomy classification system as well as explaining the dangers of ignoring the distinctions made by this taxonomy We initiate the analysis by defining an efficient allocation of an exhaustible resource over time in the absence of any renewable substitute and explore the conditions any efficient allocation must satisfy Numerical examples illustrate the implications of these conditions Renewable resources are integrated into the analysis by relying on the simplest possible casethe resource is assumed to be supplied at a fixed abundant rate and can be accessed at Chapter 6 Depletable Resource Allocation 124 a constant marginal cost Solar energy and replenishable surface water are two examples that seem roughly to fit this characterization Integrating a renewable resource backstop into our basic depletable resource model allows us to characterize efficient extraction paths for both types of resources assuming that they are perfect substitutes We also explore how these efficient paths are affected by changes in the nature of the cost functions as well as by the presence or absence of externalities Succeeding chapters will use these principles to examine the allocation of such diverse resources as energy minerals land and water and to provide a basis for developing more elaborate models of renewable biological populations such as fisheries and forests A Resource Taxonomy Three separate concepts are used to classify the stock of depletable resources 1 current reserves 2 potential reserves and 3 resource endowment The US Geological Survey USGS has the official responsibility for keeping records of the US resource base and has developed the classification system described in Figure 61 Note the two dimensionsone economic and one geological A movement from top to bottom represents movement from cheaply extractable resources to those extracted at substantially higher costs By contrast a movement from left to right represents increasing geological uncertainty about the size of the resource base Current reserves shaded area in Figure 61 are defined as known resources that can profit ably be extracted at current prices The magnitude of these current reserves can be expressed as a number Potential reserves on the other hand are most accurately defined as a function rather than a number The amount of reserves potentially available depends upon the price people are willing to pay for those resourcesthe higher the price the larger the potential reserves Higher prices enable not only more expensive measures to recover more of the resource from conventional sources but also measures to extract resources from previously untapped unconventional sources The resource endowment represents the natural occurrence of resources in the earths crust Since prices have nothing to do with the size of the resource endowment it is a geological rather than an economic concept This concept is important because it represents a physical upper limit on the availability of terrestrial resources The distinctions among these three concepts are significant One common mistake in failing to respect these distinctions is using data on current reserves as if they represented the maximum potential reserves This fundamental error can cause a huge understatement of the time until exhaustion A second common mistake is to assume that the entire resource endowment can be made available as potential reserves at a price people would be willing to pay Clearly if an infinite price were possible the entire resource endowment could be exploited but dont hold your breath until the arrival of infinite prices Other distinctions among resource categories are also useful The first category includes all depletable recyclable resources such as copper A depletable resource is one for which the natural replenishment feedback loop can safely be ignored The rate of replenishment for these resources is so low that it does not offer a potential for augmenting the stock in any reasonable time frame A recyclable resource is one that although currently being used for some particular purpose exists in a form allowing its mass to be recovered once that original purpose is no Figure 61 A Categorization of Resources Terms Identified resources specific bodies of mineralbearing material whose location quality and quantity are known from geological evidence supported by engineering measurements Measured resources material for which quantity and quality estimates are within a margin of error of less than 20 percent from geologically wellknown sample sites Indicated resources material for which quantity and quality have been estimated partly from sample analyses and partly from reasonable geological projections Inferred resources material in unexplored extensions of demonstrated resources based on geological projections Undiscovered resources unspecified bodies of mineralbearing material surmised to exist on the basis of broad geological knowledge and theory Hypothetical resources undiscovered materials reasonably expected to exist in a known mining district under known geological conditions Speculative resources undiscovered materials that may occur in either known types of deposits in favorable geological settings where no discoveries have been made or in yet unknown types of deposits that remain to be recognized Source US Bureau of Mines and the US Geological Survey 1976 Principles of the Mineral Resource Classification System of the US Bureau of Mines and the US Geological Survey Geological Survey Bulletin 1450A Depletable Resource Allocation 126 longer necessary or desirable For example copper wiring from an automobile can be recovered after the car has been shipped to the junkyard The degree to which a recyclable resource is actually recycled is determined by economic conditions a subject covered in Chapter 8 The current reserves of a depletable recyclable resource can be augmented by economic replenishment as well as by recycling Economic replenishment takes many forms all sharing the characteristic that they turn previously unrecoverable resources into recoverable ones One obvious stimulant for this replenishment is price As price rises producers find it profitable to explore more widely dig more deeply and use lowerconcentration ores Higher prices also stimulate technological progress Technological progress simply refers to an advancement in the state of knowledge that allows us to expand the set of feasible possibilities Harnessing nuclear power and the advent of both horizontal drilling and hydraulic fracturing are two obvious examples Both are discussed in Chapter 7 The potential reserves of depletable recyclable resources however can be exhausted The depletion rate is affected by the demand for and the durability of the products built with the resource and the ability to reuse the products Except where demand is totally price inelastic ie insensitive to price higher prices tend to reduce the quantity demanded Durable products last longer reducing the need for newer ones Reusable products eg rechargeable batteries or products sold at flea markets provide a substitute for new products For some resources the size of the potential reserves depends explicitly on our ability to store the resource For example helium is generally found commingled with natural gas in common fields As the natural gas is extracted and stored unless the helium is simultaneously captured and stored it diffuses into the atmosphere This diffusion results in such low atmospheric concentrations that extraction of helium from the air is not economical at current or even likely future prices Thus the useful stock of helium depends crucially on how much we decide to store Not all depletable resources can be recycled or reused Depletable energy resources such as coal oil and gas are irreversibly transformed when they are combusted Once turned into heat energy the heat dissipates into the atmosphere and becomes nonrecoverable The endowment of depletable resources is of finite size Current use of depletable nonrecyclable resources precludes future use hence the issue of how they should be shared among generations is raised in the starkest least forgiving form Depletable recyclable resources raise this same issue though somewhat less starkly since recycling and reuse make the useful stock last longer all other things being equal It is tempting to suggest that depletable recyclable resources could last forever with 100 percent recycling but unfortunately the physical theoretical upper limit on recycling is less than 100 percentan implication of a version of the entropy law defined in Chapter 2 Some of the mass is always lost during recycling or use Because less than 100 percent of the mass is recycled the useful stock must eventually decline to zero Therefore even for recyclable depletable resources the cumulative useful stock is finite and current consumption patterns still have some effect on future generations Renewable resources are differentiated from depletable resources primarily by the fact that natural replenishment augments the flow of renewable resources at a nonnegligible rate Solar energy water and biological populations are all examples of renewable resources For this class of resources it is possible though not inevitable that a flow of these resources could be maintained perpetually1 For some renewable resources the continuation and volume of their flow depend crucially on humans Soil erosion and nutrient depletion reduce the flow of food Excessive fishing reduces the stock of fish which in turn reduces the rate of natural increase of the fish population What other examples can you come up with Depletable Resource Allocation 127 For other renewable resources such as solar energy the flow is independent of humans The amount consumed by one generation does not reduce the amount that can be consumed by subsequent generations Some renewable resources can be stored others cannot For those that can storage provides an additional way to manage the allocation of the resource over time We are not left simply at the mercy of natural ebbs and flows Food without proper care perishes rapidly but under the right conditions stored food can be used to feed the hungry in times of famine Unstored solar energy radiates off the earths surface and dissipates into the atmosphere While solar energy can be stored in many forms the most common natural form of storage occurs when it is converted to biomass by photosynthesis Storage of renewable resources usually provides a different service than storage of deplet able resources Storing depletable resources prolongs their economic life storing renewable resources on the other hand can serve as a means of smoothing out the cyclical imbalances of supply and demand Surpluses can be stored for use during periods when deficits occur Familiar examples include food stockpiles and the use of dams to store water to use for hydropower Managing renewable resources presents a different challenge from managing depletable resources although an equally significant one The challenge for depletable resources involves allocating dwindling stocks among generations while meeting the ultimate transition to renewable resources In contrast the challenge for managing renewable resources involves the maintenance of an efficient sustainable flow Chapters 7 through 13 deal with how the economic and political sectors have responded to these challenges for particularly significant types of resources Efficient Intertemporal Allocations If we are to judge the efficiency of market allocations we must define what is meant by efficiency in relation to the management of depletable and renewable resources Because allocation over time is the crucial issue dynamic efficiency becomes the core concept The dynamic efficiency criterion assumes that societys objective is to maximize the present value of net benefits coming from the resource For a depletable nonrecyclable resource this requires a balancing of the current and subsequent uses of the resource In order to refresh our memories about how the dynamic efficiency criterion defines this balance we shall begin with recalling and elaborating on the very simple twoperiod model developed in Chapter 5 We can then proceed to demonstrate how conclusions drawn from that model generalize to longer planning horizons and more complicated situations The TwoPeriod Model Revisited In Chapter 5 we defined a situation involving the allocation over two periods of a finite resource that could be extracted at constant marginal cost With a stable demand curve for the resource an efficient allocation involved allocating more than half of the resource to the first period and less than half to the second period How the resources were divided between the two periods was affected by the marginal cost of extraction the marginal user cost and the discount rate Due to the fixed and finite nature of depletable resources use of a unit today precludes use of that unit tomorrow Therefore production decisions today must take forgone future net benefits into account Marginal user cost is the opportunity cost measure that allows intertemporal balancing to take place Depletable Resource Allocation 128 In our twoperiod model the marginal cost of extraction is assumed to be constant but the value of the marginal user cost was shown to rise over time In fact as was demonstrated mathematically in the appendix to Chapter 5 when the demand curve is stable over time and the marginal cost of extraction is constant the rate of increase in the current value of the marginal user cost is equal to r the discount rate Thus in Period 2 the marginal user cost would be 1 r times as large as it was in Period 12 Marginal user cost rises at rate r in an efficient allocation in order to preserve the balance between present versus future production In summary our twoperiod example suggests that an efficient allocation over time of a finite resource with a constant marginal cost of extraction involves rising marginal user cost and falling quantities consumed How can we generalize to longer time periods and different extraction circumstances The NPeriod ConstantCost Case We begin this generalization by retaining the constantmarginalextractioncost assumption while extending the time horizon within which the resource is allocated In the numerical example shown in Figures 62a and 62b the demand curves and the marginal cost curve from the twoperiod case are retained The only changes in this numerical example from the two period case involve spreading the allocation over a larger number of years and increasing the total recoverable supply from 20 to 40 The specific mathematics behind this and subsequent examples is presented in the appendix at the end of this chapter but we shall guide you through the intuition that follows from that analysis in this section Figure 62a demonstrates how the efficient quantity extracted varies over time while Figure 62b shows the behavior of the marginal user cost and the marginal cost of extraction We shall use the term total marginal cost to refer to the sum of the two The marginal cost of extraction is represented by the lower line and the marginal user cost is depicted as the vertical distance between the marginal cost of extraction and the total marginal cost To avoid Figure 62 a Constant Marginal Extraction Cost with No Substitute Resource Quantity Profile b Constant Marginal Extraction Cost with No Substitute Resource Marginal Cost Profile Depletable Resource Allocation 129 confusion note that the horizontal axis is defined in terms of time not the more conventional designationquantity Several trends are worth noting First of all in this case as in the twoperiod case the efficient marginal user cost rises steadily in spite of the fact that the marginal cost of extraction remains constant This rise in the efficient marginal user cost reflects increasing scarcity and the resulting rise in the opportunity cost of current consumption reflecting forgone future opportunities as the remaining stock dwindles In response to these rising costs over time the extracted quantity falls over time until it finally becomes zero which occurs precisely at the moment when the total marginal cost becomes 8 At this point total marginal cost is equal to the highest price anyone is willing to pay so demand and supply simultaneously equal zero Thus even in this challenging case involving no increase in the cost of extraction an efficient allocation envisions a smooth transition to the exhaustion of a resource The resource does not suddenly run out because prices have signaled the increasing scarcity although in this case it does run out Transition to a Renewable Substitute So far we have discussed the allocation of a depletable resource when no substitute is available to take its place Suppose however we consider the nature of an efficient allocation when a substitute renewable resource is available at constant marginal cost This case for example could describe the efficient allocation of oil or natural gas with a solar or wind substitute or the efficient allocation of exhaustible groundwater with a surfacewater substitute How could we define an efficient allocation in this circumstance Since this problem is very similar to the one already discussed we can use what we have already learned as a foundation for mastering this new situation Just as in the previous case the depletable resource would also be exhausted in this case but now the exhaustion will pose less of a problem since well merely switch to the renewable substitute at the appropriate time For the purpose of our numerical example assume the existence of a perfect substitute for the depletable resource that is infinitely available at a cost of 6 per unit The transition from the depletable resource to this renewable resource would ultimately transpire because the renewable resource marginal cost 6 is less than the maximum willingness to pay 8 Can you figure out what the efficient allocation would be if the marginal cost of this substitute renewable resource was 9 instead of 6 The total marginal cost for the depletable resource in the presence of a 6 perfect substitute would never exceed 6 because society could always substitute the renewable resource whenever it was cheaper Thus while the maximum willingness to pay 8 the choke price sets the upper limit on total marginal cost when no substitute is available the marginal cost of extraction of the substitute 6 in our example sets the upper limit in this new case as long as the perfect substitute is available at a marginal cost lower than the choke price The efficient path for this situation is given in Figures 63a and 63b In this efficient allocation the transition is once again smooth Quantity extracted per unit of time is gradually reduced as the marginal user cost rises until the switch is made to the substitute No abrupt change is evident once again in either marginal cost or quantity profiles What about the timing of the extraction of the depletable resource When a renewable resource is available more of the depletable resource would be extracted in the earlier periods than was the case without a renewable resource Do you see why In this example the switch is made during the sixth period whereas in the previous example involving no renewable substitute the last units were exhausted at the end of the eighth Depletable Resource Allocation 130 period That seems consistent with common sense When a substitute is available the need to save some of the depletable resource for the future is certainly less pressing The opportunity cost is lower At the switch point consumption of the renewable resource begins Prior to the switch point only the depletable resource is consumed while after the switch point only the renew able resource is consumed This sequencing of consumption patterns results from the costs of the choices Prior to the switch point the depletable resource is cheaper At the switch point the total marginal cost of the depletable resource including marginal user cost rises to meet the marginal cost of the substitute and the transition occurs Due to the availability of the substitute resource after the switch point consumption never drops below five units in any time period Why five Five is the amount that maximizes the net benefit when the marginal cost equals 6 the price of the substitute Convince yourself of the validity of this statement by substituting 6 into the willingnesstopay function and solving for the quantity demanded We shall not show the numerical example here but it is not difficult to see how an efficient allocation would be defined when the transition is from one constant marginalcost deplet able resource to another depletable resource with a constant but higher marginal cost see Figure 64 The total marginal cost of the first resource would rise over time until it equaled that of the second resource at the time of transition T In the period of time prior to transition only the cheapest resource would be consumed all of it would have been consumed by T A close examination of the totalmarginalcost path reveals two interesting characteristics worthy of our attention First even in this case the transition is a smooth one total marginal cost never jumps to the higher level Second the slope of the total marginal cost curve over time is flatter after transition The first characteristic is easy to explain The total marginal costs of the two resources have to be equal at the time of transition If they werent equal the net benefit could be increased by switching to the lowercost resource from the more expensive resource Total marginal Figure 63 a Constant Marginal Extraction Cost with Substitute Resource Quantity Profile b Constant Marginal Extraction Cost with Substitute Resource Marginal Cost Profile Depletable Resource Allocation 131 costs are not equal in the other periods In the period before transition the first resource is cheaper and therefore used exclusively whereas after transition the first resource is exhausted leaving only the second resource The slope of the marginal cost curve over time is flatter after transition simply because the component of total marginal cost that is growing the marginal user cost represents a smaller portion of the total marginal cost of the second resource than of the first The total marginal cost of each resource is determined by the marginal extraction cost plus the marginal user cost In both cases the marginal user cost is increasing at rate r and the marginal cost of extraction is constant As you can see in Figure 64 the marginal cost of extraction which is constant constitutes a much larger proportion of total marginal cost for the second resource than for the first Hence total marginal cost rises more slowly for the second resource at least initially Increasing Marginal Extraction Cost We have now expanded our examination of the efficient allocation of depletable resources to include longer time horizons and the availability of other depletable or renewable resources that could serve as perfect substitutes As part of our trek toward increasing realism we will now consider a situation in which the marginal cost of extracting the depletable resource rises with the cumulative amount extracted This is commonly the case for example with minerals where the highergrade ores are extracted first followed by an increasing reliance on lower grade higher marginal cost ones Analytically this case is handled in the same manner as the previous case except that the function describing the marginal cost of extraction is slightly more complicated3it increases with the cumulative amount extracted The dynamic efficient allocation of this resource is once again found by maximizing the present value of the net benefits but in this case using Figure 64 The Transition from One ConstantCost Depletable Resource to Another Depletable Resource Allocation 132 this modified cost of extraction function The results of that maximization are portrayed in Figures 65a and 65b The most significant difference between this case and those that preceded it lies in the behavior of marginal user cost In the constant marginal cost cases we noted that marginal user cost rose over time at rate r When the marginal cost of extraction increases with the cumulative amount extracted as in this case marginal user cost declines over time until at the time of transition to the renewable resource it goes to zero Can you figure out why Remember that marginal user cost is an opportunity cost reflecting forgone future marginal net benefits In contrast to the constant marginalcost case in the increasing marginal cost case every unit extracted now raises the cost of future extraction Therefore as the current marginal cost rises over time the sacrifice made by future generations diminishes as an additional unit is consumed earlier the net benefit that would be received by a future generation if a unit of the resource were saved for them gets smaller and smaller as the marginal extraction cost of that resource gets larger and larger By the last period the marginal extraction cost is so high that earlier consumption of one more unit imposes no sacrifice at all At the switch point the opportunity cost of current extraction as reflected in the marginal user cost drops to zero and total marginal cost equals the marginal extraction cost4 The increasingcost case differs from the constantcost case in another important way as well In the constantcost case the depletable resource reserve is ultimately completely exhausted In the increasingcost case however the reserve is not exhausted some is left in the ground because it is more expensive than the substitute Up to this point in our analysis we have examined what an efficient allocation would look like in a number of circumstances First we examined a situation in which a finite amount of a resource is extracted at constant marginal cost Despite the absence of increasing extraction cost an efficient allocation involves a smooth transition to a substitute when one is available or to abstinence when one is not The complication of increasing marginal cost changes the time profile of the marginal user cost but it does not alter the basic finding of declining consumption of depletable resources coupled with rising total marginal cost Figure 65 a Increasing Marginal Extraction Cost with Substitute Resource Quantity Profile b Increasing Marginal Extraction Cost with Substitute Resource Marginal Cost Profile Depletable Resource Allocation 133 Can this analysis be used as a basis for judging whether current extraction profiles are efficient As a look at the historical record reveals the consumption patterns of most depletable resources have involved increases not decreases in consumption over time Is this prima facie evidence that the resources are not being allocated efficiently Exploration and Technological Progress Using the historical patterns of increasing consumption to conclude that depletable resources are not being allocated efficiently would not represent a valid conclusion As we have noted earlier the conclusions of any model depend on the structure of that model The models considered to this point have not yet included a consideration of the role of population and income growth which could cause demand to shift upward over time or of the exploration for new resources or technological progress These are historically significant factors in the determination of actual consumption paths5 Consider how these factors might influence the efficient extraction profile The search for new resources is expensive As easily discovered resources are exhausted searches are initiated in less rewarding more costly environments such as the bottom of the ocean or locations deep within the earth This suggests the marginal cost of exploration which is the marginal cost of finding additional units of the resource should be expected to rise over time just as the marginal cost of extraction does As the total marginal cost for a resource rises over time society should actively explore possible new sources of that resource Larger increases in the marginal cost of extraction for known sources trigger larger potential increases in net benefits from finding new sources that previously would have been unprofitable to extract Some of this exploration would be successful new sources of the resource would be discov ered If the marginal extraction cost of the newly discovered resources is low enough these discoveries could lower or at least delay the increase in the total marginal cost of production As a result the new finds would tend to encourage more consumption and more extraction Compared to a situation with no exploration possible the model with exploration would show a smaller and slower decline in consumption while the rise in total marginal cost would be dampened It is also not difficult to expand our concept of efficient resource allocations to include technological progress the general term economists give to advances in the state of knowledge In the present context technological progress would be manifested as reductions over time in the cost of extraction For a resource that can be extracted at constant marginal cost a one time breakthrough lowering the marginal cost of extraction would hasten the time of transition Furthermore for an increasingcost resource more of the total available resource would be recovered in the presence of technological progress than would be recovered without it Why The most pervasive effects of technological progress involve continuous downward shifts in the cost of extraction over some time period The total marginal cost of the resource could actually fall over time if the costreducing nature of technological progress became so potent that in spite of increasing reliance on inferior ore the marginal cost of extraction decreased see Example 61 With a finite amount of this resource the fall in total marginal cost would be transitory since ultimately it would have to rise As we shall see in the next few chapters however this period of transition can last quite a long time Depletable Resource Allocation 134 Market Allocations of Depletable Resources In the preceding sections we have examined in detail how the efficient allocation of substitutable depletable and renewable resources over time would be defined in a variety of circumstances We must now address the question of whether actual markets can be EXAMPLE 61 Historical Example of Technological Progress in the Iron Ore Industry The term technological progress plays an important role in the economic analysis of mineral resources Yet at times it can appear abstract even mystical It shouldnt Far from being a blind faith detached from reality technological progress refers to a host of ingenious ways in which people have reacted to impending shortages with sufficient imagination that the available supply of resources has been expanded by an order of magnitude and at reasonable cost An interesting case from economic history illustrates how concrete a notion technological progress is In 1947 the president of Republic Steel C M White calculated the expected life of the Mesabi Range of northern Minnesota the source of some 60 percent of iron ore consumed during World War II as being in the range from 5 to 7 years By 1955 only 8 years later US News and World Report concluded that worry over the scarcity of iron ore could be forgotten The source of this remarkable transformation of a problem of scarcity into one of abundance was the discovery of a new technique of preparing iron ore called pelletization Prior to pelletization the standard ores from which iron was derived contained from 50 to more than 65 percent iron in crude form A significant percentage of taconite ore containing less than 30 percent iron in crude form was available but no one knew how to produce it at reasonable cost Pelletization a process by which these ores are processed and concentrated at the mine site prior to shipment to the blast furnaces allowed the profitable use of the taconite ores While expanding the supply of iron ore pelletization reduced its cost in spite of its inferior grade There were several sources of the cost reduction First substantially less energy was used the shift in ore technology toward pelletization produced net energy savings of 17 percent in spite of the fact that the pelletization process itself required more energy The reduction came from the discovery that the blast furnaces could be operated much more efficiently using pelletized inputs The process also reduced labor requirements per ton by some 82 percent while increasing the output of the blast furnaces A blast furnace owned by Armco Steel in Middletown Ohio which had a rated capacity of approximately 1500 tons of molten iron per day was able by 1960 to achieve produc tion levels of 27002800 tons per day when fired with 90 percent pellets Pellets nearly doubled the blast furnace productivity Sources Kakela P J 1978 Iron ore Energy labor and capital changes with technology Science 202 December 15 11511157 Kakela P J 1981 Iron ore From depletion to abundance Science 212 April 10 132136 Depletable Resource Allocation 135 expected to produce an efficient allocation Can the private market involving millions of consumers and producers each reacting to his or her own unique preferences ever result in a dynamically efficient allocation Is profit maximization compatible with dynamic efficiency Appropriate Property Rights Structures The most common misconception of those who believe that even a perfect market could never achieve an efficient allocation of depletable resources is based on the idea that producers want to extract and sell the resources as fast as possible since that is how they derive the value from the resource This misconception makes people see markets as myopic and unconcerned about the future As long as the property rights governing natural resources have the characteristics of exclusivity transferability and enforceability Chapter 2 the markets in which those resources are bought and sold will not necessarily lead to myopic choices for the simple reason that myopia would reduce profits By taking marginal user cost into account the producer maximizes profits by acting efficiently A resource in the ground has two potential sources of value to its owner 1 a use value when it is sold the only source considered by those diagnosing inevitable myopia and 2 an asset value when it remains in the ground As long as the price of a resource continues to rise the resource in the ground is becoming more valuable The owner of this resource accrues this capital gain however only if the resource is conserved for later sale A producer who sells all resources in the earlier periods loses the chance to take advantage of higher prices in the future A profitmaximizing producer attempts to balance present and future production in order to maximize the value of the resource and hence profits Since higher prices in the future provide an incentive to conserve a producer who ignores this incentive would not be maximizing the value of the resource Resources sold by a myopic producer would be bought by someone willing to delay extraction in order to maximize its value As long as social and private discount rates coincide property rights structures are well defined no externalities and reliable information about future prices is available a producer who pursues maximum profits simultaneously provides the maximum present value of net benefits for society The implication of this analysis is that in competitive resource markets the price of the resource equals the total marginal cost of extracting and using the resource Thus Figures 62a through 65b can illustrate not only an efficient allocation but also the allocation produced by an efficient market When used to describe an efficient market the total marginal cost curve describes the time path that prices could be expected to follow Environmental Costs Not all actual situations however satisfy the conditions necessary for this harmonious outcome One of the most important situations in which property rights structures may not be well defined occurs when the extraction of a natural resource imposes an environmental cost on society that is not internalized by the producers The aesthetic costs of strip mining the health risks associated with uranium tailings and the acids leached into streams from mine operations are all examples of associated environmental costs The presence of environmental costs is both empirically and conceptually important since it forms one of the bridges between the traditionally separate fields of environmental economics and natural resource economics Suppose for example that the extraction of a depletable resource caused some damage to the environment that was not adequately reflected in the costs faced by the extracting firms Depletable Resource Allocation 136 This would be in the context of discussion in Chapter 2 an external cost The cost of getting the resource out of the ground as well as processing and shipping it is borne by the resource owner and considered in the calculation of how much of the resource to extract The environmental damage however may not be borne by the owner and in the absence of any outside attempt to internalize that external cost will not normally be part of the extrac tion decision How would the market allocation based on only the costs borne by the owner differ from the efficient allocation which is based on all costs regardless of who ultimately bears them We can examine this issue by modifying the numerical example used earlier in this chapter Assume the environmental damage can be represented by increasing the marginal cost by 16 The additional dollar reflects the cost of the environmental damage caused by producing another unit of the resource What effect do you think this external cost would have on the efficient time profile for quantities extracted The answers are given in Figures 66a and 66b The result of including environmental cost in the timing of the switch point is especially interesting because it involves two different effects that work in opposite directions On the demand side the internalization of environ mental costs results in higher prices which tend to dampen demand This lowers the rate of consumption of the resource which all other things being equal would make it last longer All other things are not equal however The higher marginal cost also means that a smaller cumulative amount of the depletable resource would be extracted in an efficient allocation Can you see why As shown in Figures 66a and 66b the efficient cumulative amount extracted would be 30 units instead of the 40 units extracted in the case where environmental costs were not included This supplyside effect tends to hasten the time when a switch to the renewable resource is made all other things being equal Which effect dominatesthe rateofconsumption effect or the supply effect In our numerical example the supplyside effect dominates and as a result the time of transition Figure 66 a Increasing Marginal Extraction Cost with Substitute Resource in the Presence of Environmental Costs Quantity Profile b Increasing Marginal Extraction Cost with Substitute Resource in the Presence of Environmental Costs Price Profile Solid Linewithout Environmental Costs Dashed Linewith Environmental Costs Depletable Resource Allocation 137 for an efficient allocation is sooner than for the market allocation In general the answer depends on the shape of the marginalextractioncost function With constant marginal cost for example there would be no supplyside effect and the market would unambiguously transition later If the environmental costs were associated with the use of the renewable resource rather than the depletable resource the time of transition for the efficient allocation would have been later than the market allocation Can you see why What can we learn from this analysis of the increasing cost case about the allocation of depletable resources over time when environmental side effects are not borne by the agent determining the extraction rate Ignoring external costs leaves the market price of the depletable resource too low too much of the resource would be extracted and the rate at which it would be extracted would be too high relative to an efficient extraction profile Since policies that internalize these external costs can affect both the quantity extracted and price profiles they can sometimes produce unexpected outcomes see Example 62 EXAMPLE 62 The Green Paradox Common sense indicates that when pollution taxes to promote nonpolluting technology are imposed they would lower emissions and improve welfare as long as the taxes werent excessive In an intriguing article Sinn 2008 argues that in the case of global warming these demandreducing policies could trigger under certain conditions price effects that could actually reduce welfare Because this analysis suggests that polices designed to internalize an externality could actually result in lower economic welfare this outcome was labeled the green paradox The basic logic behind this finding is easily explained in terms of the depletable resource models developed in this chapter The specific policy case examined by Sinn was a carbon tax rate that rises over time faster than the rate of interest This carbon tax design changes the relative prices between current and future sales increasing the relative profitability of earlier extraction Remember one reason for delaying extraction was the higher prices extractors would gain in the future With this specific tax profile the aftertax return is falling not rising This policy would not only change the profitmaximizing extraction profile so that more is extracted earlier but the present value of net benefits could fall Notice that this result depends on earlier not larger cumulative damages In the constant MEC model cumulative extraction and hence cumulative damages is fixed so these polices would affect the timing but not the magnitude of the cumulative emissions In the increasing cost MEC case however the cumulative emissions would actually be less the imposition of the carbon tax would ultimately result in more of the depletable resource being left in the ground Is the Green Paradox a serious obstacle to climate policy The early verdict seems to be no van der Ploeg 2013 Jensen et al 2015 but the dearth of empirical evidence pointing either one way or the other leaves the door ajar Sources Sinn HW 2008 Public policies against global warming A supply side approach International Tax and Public Finance 15 360394 van der Ploeg F 2013 Cumulative carbon emissions and the green paradox Annual Review of Resource Economics 5 281300 Jensen Svenn Mohliny Kristina Pittelz Karen Sterner Thomas 2015 An introduction to the green paradox The unintended consequences of climate policies Review of Environmental Economics and Policy 9 246265 doi101093reeprev010 Depletable Resource Allocation 138 This once again demonstrates the interdependencies among the various decisions we have to make about the future Environmental and natural resource decisions are intimately and inextricably linked Summary The efficient extraction profiles for depletable and renewable resources depend on the circum stances In the standard treatments when the resource can be extracted at a constant marginal cost the efficient quantity of the depletable resource extracted declines over time If no substi tute is available the quantity declines smoothly to zero If a renewable constantcost substitute is available the quantity of the depletable resource extracted will decline smoothly to the quantity available from the renewable resource In each case all of the available depletable resource would be eventually used up and marginal user cost would rise over time reaching a maximum when the last unit of depletable resource was extracted The efficient allocation of an increasing marginalcost resource is similar in that the quantity extracted declines over time but differs with respect to the behavior of marginal user cost and the cumulative amount extracted Whereas marginal user cost typically rises over time when the marginal cost of extraction is constant it declines over time when the marginal cost of extraction rises with the cumulative amount extracted Furthermore in the constantcost case the cumulative amount extracted is equal to the available supply in the increasingcost case it depends on the relationship between the marginal extraction cost function and the cost of the substitute some of the resource may be left in the ground unused Introducing technological progress and exploration activity into the model tends to delay the transition to renewable resources Exploration expands the size of current reserves while technological progress keeps marginal extraction cost from rising as fast as it otherwise would If these effects are sufficiently potent marginal cost could actually decline for some period of time causing the quantity extracted to rise In the absence of environmental costs when property rights structures are properly defined market allocations of depletable resources can be efficient In this case profit maximization and efficiency can be compatible When the extraction of resources imposes an external environmental cost however generally market allocations will not be efficient The market price of the depletable resource would be too low the rate of extraction would be excessive and too much of the resource would ultimately be extracted Think of this model when you read about the effects of fracking in Chapter 7 In an efficient market allocation the transition from depletable to renewable resources is smooth and exhibits no overshootandcollapse characteristics Whether the actual market allocations of these various types of resources are efficient remains to be seen To the extent markets negotiate an efficient transition a laissezfaire policy would represent an appropriate response by the government On the other hand when the market is not capable of yielding an efficient allocation then some form of government intervention may be necessary In the next few chapters we shall examine these questions for a number of different types of depletable and renewable resources Discussion Question 1 One current practice is to calculate the years remaining for a depletable resource by taking the prevailing estimates of current reserves and dividing it by current annual consumption How useful is that calculation Why Depletable Resource Allocation 139 SelfTest Exercises 1 To anticipate subsequent chapters where more complicated renewable resource models are introduced consider a slight modification of the twoperiod depletable resource model Suppose a biological resource is renewable in the sense that any of it left unex tracted after Period 1 will grow at rate k Compared to the case where the total amount of a constantMEC resource is fixed how would the efficient allocation of this resource over the two periods differ Hint It can be shown that MNB1MNB2 1 k1 r where MNB stands for marginal net benefit 2 Consider an increasing marginalcost depletable resource with no effective substitute a Describe in general terms how the marginal user cost for this resource in the earlier time periods would depend on whether the demand curve for that resource was stable or shifting outward over time b How would the allocation of that resource over time be affected 3 Many states are now imposing severance taxes on resources being extracted within their borders In order to understand the effect of these taxes on the allocation of the mineral over time assume a stable demand curve a How would the competitive allocation of an increasing marginalcost depletable resource be affected by the imposition of a perunit tax eg 4 per ton if there exists a constantmarginalcost substitute b Comparing the allocation without a tax to one with a tax in general terms what are the differences in cumulative amounts extracted and the price paths 4 For the increasing marginalextractioncost model of the allocation of a depletable resource how would the ultimate cumulative amount taken out of the ground be affected by a an increase in the discount rate b the extraction by a monopolistic rather than a competitive industry and c a perunit subsidy paid by the government for each unit of the abundant substitute used 5 Suppose you wanted to hasten the transition from a depletable fossil fuel to solar energy Compare the effects of a perunit tax on the depletable resource to an equivalent perunit subsidy on solar energy Would they produce the same switch point Why or why not 6 Suppose a tax on the extraction of a depletable resource is enacted and it will first take effect 10 years in the future This resource is assumed to have a renewable constant MEC substitute that will remain untaxed a For a depletable resource characterized by a constant MEC how would if at all this pending law affect the extraction profile over time in terms of both the timing of the extraction and the cumulative amount extracted Why b If the depletable resource is characterized by an increasing MEC how would your answer in a change if at all Why Notes 1 Even renewable resources are ultimately finite because their renewability depends on energy from the sun and the sun is expected to serve as an energy source for only the next 5 or 6 billion years Because the finiteness of renewable resources is sufficiently far into the future the distinction between depletable and renewable resources remains useful as a practical matter 2 The condition that marginal user cost rises at rate r turns out to be true only when the marginal cost of extraction is constant Later in this chapter we show how the marginal user cost is affected when marginal extraction cost is not constant Remember in Chapter 1 how we noted that the outcome of any model depends upon the assumptions that undergird it This is one example of that point Depletable Resource Allocation 140 3 The new marginal cost of extraction is MCt 2 01Qt where Qt is cumulative extraction to date 4 Total marginal cost cannot be greater than the marginal cost of the substitute Yet in the increasing marginal extraction cost case at the time of transition the marginal extraction cost must also equal the marginal cost of the substitute If that werent true it would imply that some of the resource that was available at a marginal cost lower than the substitute would remain unused This would clearly be inefficient since net benefits could be increased by simply using it instead of the more expensive substitute Hence at the switch point in the rising marginalcost case the marginal extraction cost has to equal total marginal cost implying a zero marginal user cost 5 To derive how a rising demand curve over time due to either rising income or population growth would affect the extraction profile complete selftest exercise 2 at the end of this chapter 6 Including environmental damage the marginal cost function would be raised to 3 01Q instead of 2 01Q Further Reading Andre F Cerda E 2006 On the dynamics of recycling and natural resources Environmental Resource Economics 332 199221 This article provides a formal examination of how the recyclability of depletable resources affects extraction profiles and sustainability Banzhaf H Spencer July 2016 The environmental turn in natural resource economics John Krutilla and conservation reconsidered Resources for the Future Discussion paper DP 1627 Available from wwwrfforgfilesdocumentfileRFFDP1627pdf A discussion of how a classic paper in the early twentieth century used economics to unify the traditionally separate views of conservationists and preservationists Conrad J M Clark C W 1987 Natural Resource Economics Notes and Problems Cambridge Cambridge University Press Reviews techniques of dynamic optimization and shows how they can be applied to the management of various resource systems Fischer C Laxminarayan R 2005 Sequential development and exploitation of an exhaustible resource Do monopoly rights promote conservation Journal of Environmental Economics and Management 493 500515 Examines the conditions under which a monopolist would extract a depletable resource more quickly or more slowly than a competitive industry Strand J 2010 Optimal fossilfuel taxation with backstop technologies and tenure risk Energy Economics 322 418422 This article examines the time paths for optimal taxes and extraction profiles for a depletable resource that creates a negative stock externality think climate change involves increasing marginal extraction cost and is subject to competition from an unlimited backstop resource causing no externality Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Depletable Resource Allocation 141 Appendix Extensions of the Constant Extraction Cost Depletable Resource Model Longer Time Horizons and the Role of an Abundant Substitute In the appendix to Chapter 5 we derived a simple model to describe the efficient allocation of a constantmarginalcost depletable resource over time and presented the numerical solution for a twoperiod version of that model In this appendix the mathematical derivations for the extension to that basic model will be documented and the resulting numerical solutions for these more complicated cases will be explained The NPeriod ConstantCost NoSubstitute Case The first extension involves calculating the efficient allocation of the depletable resource over time when the number of time periods for extraction is unlimited This is a more difficult calculation because how long the resource will last is no longer predetermined the time of exhaustion must be derived as well as the extraction path prior to exhaustion of the resource The equations describing the allocation that maximizes the present value of net benefits are 1 0 1 T r a bq c t 1 t t m 1 q Q 1 t t n 2 The parameter values assumed for the numerical example presented in the text are 8 04 2 40 010 and a b c Q r The allocation that satisfies these conditions is q1 8004 q4 5689 q7 2607 T 9 q2 7305 q5 4758 q8 1368 m 27983 q3 6535 q6 3733 q9 0000 The optimality of this allocation can be verified by substituting these values into the above equations Due to rounding these add to 39999 rather than 40000 Practically speaking solving these equations to find the optimal solution is not a trivial matter but neither is it very difficult One method of finding the solution for those without the requisite mathematics involves developing a computer algorithm computation procedure that converges on the correct answer One such algorithm for this example can be constructed as follows 1 assume a value for m 2 using Equation set 1 solve for all qs based upon this m 3 if the sum of the calculated qs exceeds Q adjust m upward or if the sum of the calculated qs is less than Q adjust m downward the adjustment should use information gained in previous steps to ensure that the new trial will be closer to the solution value 4 repeat steps 2 and 3 using the new m 5 when the sum of the qs is sufficiently close to Q stop the calculations As an exercise those interested in computer programming might construct a program to reproduce these results Depletable Resource Allocation 142 Constant Marginal Cost with an Abundant Renewable Substitute The next extension assumes the existence of an abundant renewable perfect substitute available in unlimited quantities at a cost of 6 per unit To derive the dynamically efficient allocation of both the depletable resource and its substitute let qt be the amount of a constant marginalcost depletable resource extracted in year t and qst the amount used of another constantmarginalcost resource that is perfectly substitutable for the depletable resource The marginal cost of the substitute is assumed to be d With this change the total benefit and cost formulas become 2 Total benefit a q q b q q t 2 1 st t st t T 3 Total cost cq dq 1 t t t T 4 The objective function is thus 1 2 2 PVNB r a q q b q q q q cq dq 1 2 2 1 t t st t st t st t st t T 5 subject to the constraint on the total availability of the depletable resource 0 Q q 1 t t T 6 Necessary and sufficient conditions for an allocation maximizing this function are expressed in Equations 7 8 and 9 1 0 1 r a b q q c t T 1 t t st m 7 Any member of Equation set 7 will hold as an equality when qt 0 and will be negative when 0 1 a b q q d t T t st f 8 Any member of Equation set 8 will hold as an equality when qst 0 and will be negative when qst 0 0 Q q 1 t t T 9 For the numerical example used in the text the following parameter values were assumed a 8 b 04 c 2 d 6 Q 40 and r 010 It can be readily verified that the optimal conditions are satisfied by Depletable Resource Allocation 143 8798 7495 5919 8177 6744 2137 5000 0 6 2863 2481 6 for for q q q q q q q t t q 1 3 5 2 4 6 6 s st 1 m The depletable resource is used up before the end of the sixth period and the switch is made to the substitute resource at that time From Equation set 8 in competitive markets the switch occurs precisely at the moment when the resource price rises to meet the marginal cost of the substitute The switch point in this example is earlier than in the previous example the sixth period rather than the ninth period Since all characteristics of the problem except for the availability of the substitute are the same in the two numerical examples the difference can be attributed to the availability of the renewable substitute Taylor Francis Taylor Francis Group httptaylorandfranciscom 145 Energy The Transition from Depletable to Renewable Resources If it aint broke dont fix it Old Maine proverb Introduction Energy is one of our most critical resources without it life would cease We derive energy from the food we eat Through photosynthesis the plants we consumeboth directly and indirectly when we eat meatdepend on energy from the sun The materials we use to build our houses and produce the goods we consume are extracted from the earths crust and then transformed into finished products with expenditures of energy Currently many industrialized countries depend on oil and natural gas for the majority of their energy needs According to the International Energy Agency IEA these resources together supply 59 percent of all primary energy consumed worldwide Adding coal another fossil fuel resource increases the share to 86 percent of the total Fossil fuels are depletable nonrecyclable sources of energy According to depletable resource models oil and natural gas would be used until the marginal cost of further use exceeded the marginal cost of more abundant andor renewable substitute resources In an efficient market path the transition to these alternative sources would be smooth and harmonious Have the allocations of the last several decades been efficient or not Is the market mechanism flawed in its allocation of depletable resources If so is it a fatal flaw If not what caused the inefficient allocations Are the problems correctable In this chapter we shall examine some of the major issues associated with the allocation of energy resources over time and explore how economic analysis can clarify our understanding of both the sources of the problems and their solutions Chapter 7 Energy 146 Natural Gas From Price Controls to Fracking Some Early History In the United States during the winter of 1974 and early 1975 serious shortages of natural gas developed Customers who had contracted for and were willing to pay for natural gas were unable to get as much as they wanted The shortage or curtailments as the Federal Energy Regulatory Commission FERC calls them amounted to 2 trillion cubic feet of natural gas in 19741975 which represented roughly 10 percent of the marketed production in 1975 In an efficient allocation shortages of that magnitude would never have materialized What happened The simple answer is regulation The regulation of natural gas began in 1938 with the passage of the Natural Gas Act This act transformed the Federal Power Commission FPC which subsequently become FERC into a federal regulatory agency charged with maintaining just prices In 1954 a Supreme Court decision forced the FPC to extend their price control regulations beyond pipeline companies to include producers as well Because the process of setting price ceilings proved cumbersome the hastily conceived initial interim ceilings remained in effect for almost a decade before the Commission was able to impose more carefully considered ceilings What was the effect of this regulation By returning to our models in the previous chapter we can anticipate the havoc this would raise The ceiling would prevent prices from reaching their normal levels Since price increases are the source of the incentive to conserve the lower future prices would cause an inefficiently large amount of the resource to be used in earlier years Consumption levels in the earlier years would be higher under price controls than without them Effects on the supply side would also be expected to be significant Producers would produce the resource only when they could do so profitably Once the marginal cost rose to meet the price ceiling no more would be produced regardless of the demand for the resource at that price Thus as long as price controls were permanent less of the resource would be produced with controls than without so production would also be skewed toward the earlier years The combined impact of these demandandsupply effects would be to distort the allocation significantly see Figures 71a and 71b While a number of aspects differentiate this alloc ation from an efficient one several are of particular importance the market would react to price controls by 1 leaving more of the resource in the ground 2 increasing the rate of consumption 3 causing the time of transition to be earlier and 4 creating an abrupt transition with prices suddenly jumping to new higher levels All are detrimental The first effect means we would not be using all of the natural gas available at prices consumers were willing to pay Because price controls would cause prices to be lower than efficient the resource would be depleted too fast These two effects would cause an earlier and abrupt transition to the substitute possibly before the technologies to use it were adequately developed The discontinuous jump to a new technology which results from the fact that price controls eliminate price flexibility can place quite a burden on consumers Attracted by artificially low prices consumers would invest in equipment to use natural gas only to discoverafter the transitionthat natural gas was no longer available One interesting characteristic of price ceilings is that they affect behavior even before they are binding1 This effect is clearly illustrated in Figures 71a and 71b in the earlier years Even though the price in the first year is lower than the price ceiling it is not equal to the efficient price Can you see why Think what effect price controls have on the marginal user cost faced Energy 147 by producers The price ceiling causes a reallocation of resources toward the present which in turn reduces prices in the earlier years It seems fair to conclude that by sapping the economic system of its ability to respond to changing conditions price controls on natural gas created a significant amount of turmoil When this kind of political control occurs the overshoot and collapse scenario can have some validity In this case however it would be caused by government actions rather than any pure market behavior If so the adage that opens this chapter becomes particularly relevant Politicians may view scarcity rent as a possible source of revenue to transfer from producers to consumers As we have seen however scarcity rent is an opportunity cost that serves a distinct purposethe protection of future consumers When a government attempts to reduce scarcity rent through price controls the result is an overallocation to current consum ers and an underallocation to future consumers Thus what appears to be a financial transfer from producers to consumers is in large part also a transfer of the affected commodity from future consumers to present consumers Since current consumers mean current votes and future consumers may not know whom to blame by the time shortages appear price controls are politically attractive Unfortunately they are also inefficient the losses to future consumers and producers are greater than the gains to current consumers Because controls distort the allocation toward the present they are also unfair to future consumers Thus markets in the presence of price controls are indeed myopic but the problem lies with the controls not the market per se After long debating the price control issue Congress passed the Natural Gas Policy Act on November 9 1978 This act initiated the eventual phased decontrol of natural gas prices By January 1993 no sources of natural gas were subject to price controls Fracking Natural gas production remained relatively stable from the mid1970s until the middle of the first decade of the twentyfirst century when a new technology dramatically changed the cost of accessing new sources of natural gas in shale a type of sedimentary rock2 Hydraulic fracturing or fracking as it is known popularly is a form of technical progress that combines Figure 71 a Increasing Marginal Extraction Cost with Substitute Resource in the Presence of Price Controls Quantity Profile b Increasing Marginal Extraction Cost with Substitute Resource in the Presence of Price Controls Price Profile Energy 148 horizontal drilling with an ability to fracture deep shale deposits using a mixture of high pressure water sand and chemicals Not only does the fractured shale release large quantities of natural gas but this extraction process also costs less than accessing more conventional sources The introduction of this new technology has increased production dramatically in the United States and fracked gas is likely to play an even larger role over the next few decades according to the Energy Information Agency the statistical arm of the US Department of Energy If ever there were an example of the profound effect a technical change can have this is it While this production is dramatically changing the energy situation in the United States that change comes with some controversy see Debate 71 Oil The Cartel Problem Much of the worlds oil is currently produced by a cartel called the Organization of the Petroleum Exporting Countries OPEC The members of this organization collude to exercise power over oil production and prices As established in Chapter 2 seller power over resources due to a lack of effective competition leads to an inefficient allocation When sellers have market power they can restrict supply and thus force prices higher than otherwise Though these conclusions were previously derived for products they are valid for depletable resources as well By restricting supply a monopolist can extract more scarcity rent from a depletable resource base than competitive suppliers can The monopolistic transition results in a slower rate of production and higher prices3 The monopolistic transition to a substitute therefore occurs later than a competitive transition While monopolistic exploitation raises the net present value of profits to the sellers it reduces the net present value of net benefits to society Although the slower consumption on balance reduces the social costs associated with climate damages as we shall see in Chapter 17 this outcome is not efficient since many lower cost ways to reduce these social costs are available The cartelization of the oil suppliers has historically apparently been quite effective Smith 2005 Why Are the conditions that make it profitable unique to oil or could oil cartelization be the harbinger of a wave of natural resource cartels What is the outlook for the oil cartel in the future To answer these questions we must isolate those factors that make cartelization possible and profitable Although many factors are involved four stand out 1 the price elasticity of demand in both the long run and the short run 2 the income elasticity of demand 3 the supply responsiveness of the producers who are not cartel members and 4 the compatibility of interests among members of the cartel Price Elasticity of Demand The price elasticity of demand is an important ingredient because it determines how responsive demand is to price When demand elasticities are between 0 and 1 ie when the percentage quantity response is smaller than the percentage price response price increases lead to increased revenue Exactly how much revenue would increase when prices increase depends on the magnitude of the elasticity Generally the smaller is the absolute value of the price elasticity of demand the closer it is to 00 the larger are the gains to be derived from forming a cartel The price elasticity of demand depends on the opportunities for conservation as well as on the availability of substitutes As storm windows cut heat losses the same temperature can Energy 149 Does the Advent of Fracking Increase Net Benefits While fracking will no doubt lower US dependency on energy imports the subject of the next section and provide an economic boost by lowering energy costs in the United States as it displaces more expensive fuels it also comes with some costs The main shortterm concerns involve water contamination fracking chemicals leaking into local wells water depletion the extraction process uses large quantities of water air quality issues some of the toxic fracking chemicals can escape into the surrounding air and leakage methane one of the primary components of natural gas and a powerful greenhouse gas that contributes to climate change can leak into the atmosphere as a result of the fracking process Further over the longer run according to the International Energy Agency an excessive reliance on natural gas would be incompatible with reaching proposed climate policy goals If fracking comes with high benefits and high costs does it make economic sense The simple answer is that we dont know yet For one thing as Chapter 3 reminds us it would depend on the accounting stance geographic scope of the analysis The geographic regions that benefit may not be the same regions that bear the costs Different accounting stances could produce different results More fundamentally even if a national benefitcost analysis could be revealing many of the components of that analysis are not yet known with sufficient certainty to provide much confidence in the answers this early in the game To take just one example of our ignorance if the leakage rate exceeds 32 percent natural gas is apparently no better for the climate than coal or oil Unfortunately we have a firm grasp on the leakage rate for only a few specially studied wells Furthermore the expected costs from the associated water and air contamination are not yet fully known either Finally even if we were able to derive a reasonable answer for the current period prior to much regulation the answer is likely to be much more favorable to fracking once a regulatory framework to reduce the problems is in place Fortunately studies are underway to fill in the information gaps and regulations that control the most negative net benefit aspects of the industry are likely to follow Stay tuned Sources Alvarez R A Pacala S W Winebrake J J Chameides W L Hamburg S P 2012 Greater focus needed on methane leakage from natural gas infrastructure PNAS 109 176435176440 Jackson R B et al 2013 The environmental costs and benefits of fracking Annual Review of Environment and Resources 39 327362 DEBATE 71 Energy 150 be maintained with less heating oil Smaller more fuelefficient automobiles reduce the amount of gasoline needed to travel a given distance The larger the set of these opportunities and the smaller the cash outlays required to exploit them the more priceelastic the demand This suggests that demand will be more priceelastic in the long run when sufficient time has passed to allow adjustments than in the short run The availability of substitutes is also important because it limits the degree to which prices can be profitably raised by a producer cartel Abundant quantities of relatively inexpensive fuels that could substitute for oil can set an upper limit on the cartel price Unless the cartel controls those alternative sources as welland in oils case it doesntany attempts to raise prices above those limits would cause the consuming nations to simply switch to these alternative sources the cartel would have priced itself out of the market Income Elasticity of Demand The income elasticity of demand is important because it indicates how sensitive demand for the cartels product is to growth in the world economy As income grows demand should grow This continual increase in demand fortifies the ability of the cartel to raise its prices The income elasticity of demand is also important however because it registers how sensi tive demand is to the business cycle The higher the income elasticity of demand the more sensitive demand is to periods of rapid economic growth or to recessions Economic downturns led to a weakening of the oil cartel in 1983 as well as to a significant fall in oil prices starting in late 2008 Conversely whenever the global economy recovers the cartel benefits disproportionately Nonmember Suppliers Another key factor in the ability of producer nations to exercise power over a natural resource market is their ability to prevent new suppliers not part of the cartel from entering the market and undercutting the price Prior to fracking OPEC produced about 45 percent of the worlds oil but that is changing due to the increase in production from fracked oil When nonOPEC producers expand their supply dramatically prices can be expected to fall along with OPECs market share If this supply response is large enough the cartelized allocation of oil would approach the competitive allocation Recognizing this impact the cartel must take the nonmembers into account when setting prices Salant 1976 proposed an interesting model of monopoly pricing in the presence of a fringe of small nonmember producers that serves as a basis for exploring this issue His model includes a number of suppliers Some form a cartel Others a smaller number form a competitive fringe The cartel is assumed to set its price so as to maximize its members profit taking the competitive fringe production into account The competitive fringe cannot directly set the price but since it is free to choose the level of production that maximizes its own profits its output does affect the cartels pricing strategy by increasing the available supply What conclusions does this model yield The model concludes first of all that a resource cartel would set different prices in the presence of a competitive fringe than in its absence With a competitive fringe it would set the initial price somewhat lower than the pure monopoly price and allow price to rise more rapidly This strategy maximizes cartel profits by inducing the competitive fringe to produce more in the earlier periods in response to higher demand and eventually to exhaust their supplies Once the competitive fringe has depleted its reserves the cartel would raise the price and thereafter prices would increase much more slowly Energy 151 Thus the optimal strategy from the point of view of the cartel is to hold back on its own sales during the initial period letting the other suppliers exhaust their supplies Sales and profits of the competitive fringe in this optimal cartel strategy decline over time while sales and profits of the cartel increase over time as prices rise and the cartel continues to capture a larger share of the market Another fascinating implication of this model is that the formation of the cartel raises the present value of competitive fringe profits by an even greater percentage than it raises the present value of cartel profits Those without the power gain more in percentage terms than those with the power Though this may seem counterintuitive it is actually easily explained The cartel in order to keep the price up must cut back on its own production level The competitive fringe however is under no such constraint and is free to take advantage of the higher prices caused by the cartels withheld production without cutting back its own production Thus the profits of the competitive fringe are higher in the earlier period which in present value terms are discounted less All the cartel can do is wait until the competitive suppliers become less of a force in the market The implication of this model is that the presence of a competitive fringe matters even if it controls as little as onethird of the production The impact of this competitive fringe on OPEC behavior was dramatically illustrated by events in the 19851986 period In 1979 OPEC accounted for approximately 50 percent of world oil production while in 1986 this had fallen to approximately 30 percent When the recession cut global demand by 10 percent the cartels attempts to keep prices as high as possible by reducing its own production were thwarted by a competitive fringe that simply kept producing The real cost of crude oil imports in the United States fell from 3495 per barrel in 1981 to 1141 in 1986 OPEC simply was not able to hold the line on prices because the necessary reductions in its own production were too large for the cartel members to sustain in the face of continuing supplies from the competitive fringe With global economic growth however the tide was turned In the summer of 2008 the price of crude oil soared above 138 per barrel Strong worldwide demand was coupled with restricted supply from Iraq because of the war However these high prices also promoted the major oil companies search for more unconventional sources of oil including the tar sands in Canada and the use of fracking to extract oil from shale in the United States Once again the cartels power was subject to limits this time imposed by nonmember suppliers Compatibility of Member Interests The final factor we shall consider in determining the potential for cartelization of natural resource markets is the internal cohesion of the cartel With only one seller the objective of that seller can be pursued without worrying about alienating others who could undermine the profitability of the enterprise In a cartel composed of many sellers that freedom is no longer as wide ranging The incentives of each member and the incentives of the group as a whole may diverge Cartel members have a strong incentive to cheat A cheater if undeterred by the other members could lower its price and capture a larger share of the market Formally speaking the price elasticity of demand facing an individual member is substantially higher than that for the group as a whole because some of the increase in individual sales at a lower individual price represents sales reductions for other members When producers face markets characterized by high price elasticities lower prices maximize profits Thus successful cartelization presupposes a means for detecting cheating and enforcing the collusive agreement Energy 152 In addition to cheating however cartel stability is also threatened by the degree to which members fail to agree on pricing and output decisions Oil provides an excellent example of how these dissensions can arise Since the 1974 rise of OPEC as a world power Saudi Arabia has frequently exercised a moderating influence on the pricing decisions of OPEC Why One highly significant reason is the size of Saudi Arabias oil reserves Controlling about 22 percent of OPECs proven oil reserves in 2015 second only to Venezuelas 248 percent Saudi Arabia has an incentive to preserve the value of those resources Setting prices too high would undercut the future demand for its oil As previously stated the demand for oil in the long run is more priceelastic than in the short run Countries with smaller reserves such as Nigeria know that in the long run their reserves will be gone and therefore these countries are more concerned about the near future Countries with small reserves want to extract more rent now but countries with large reserves want to preserve future rent This examination of the preconditions for successful cartelization suggests two things 1 creating a successful cartel is not an easy path for natural resource producers to pursue and 2 it is quite likely that OPECs difficulties in exercising control over the market will only increase in the future Fossil Fuels National Security Considerations Vulnerable strategic imports such as oil have an added cost that is not reflected in the marketplace National security is a classic public good No individual corporate importer correctly represents our collective national security interests in making a decision on how much to import Hence leaving the determination of the appropriate balance between imports and domestic production to the market generally results in an excessive dependence on imports in terms of both climate change and national security considerations see Figure 72 In order to understand the interaction of these factors five supply curves are relevant Domestic supply is reflected by two options The first Sd1 is the longrun domestic supply curve without considering the climate change damages resulting from burning more oil while the second Sd2 is the domestic supply curve that includes these perunit damages While climate change policy is the subject of Chapter 17 we can introduce its relationship to energy choice here All fossil fuels contain carbon When these fuels are combusted unless the resulting carbon is captured it is released into the atmosphere as carbon dioxide a contributor to climate change How much CO2 is released varies with the type of fuel since energy sources contain different amounts of carbon As can be seen from Table 71 among the fossil fuels coal contains the most carbon per unit of energy produced and natural gas contains the least The upward slopes of these supply curves reflect increasing availability of domestic oil at higher prices given sufficient time to develop those resources Imported foreign oil is reflected by three supply curves Pw1 reflects the observed world price Pw2 includes a vulnerability premium in addition to the world price and Pw3 adds in the perunit climate change damages due to consuming more imported oil The vulnerability premium reflects the additional national security costs caused by imports All three curves are drawn horizontally to the axis to reflect the assumption that any single importing countrys action on imports is unlikely to affect the world price for oil As shown in Figure 72 in the absence of any correction for national security and climate change considerations the market would generally demand and receive D units of oil Of this total amount A would be domestically produced and D A would be imported Why Energy 153 Figure 72 The National Security Problem Table 71 Carbon Content of Fuels Pounds of CO2 Emitted per Million Btu of Energy for Various Fuels Coal anthracite 2286 Coal bituminous 2057 Coal lignite 2154 Coal subbituminous 2143 Diesel fuel heating oil 1613 Gasoline 1572 Propane 1390 Natural gas 1170 Source Energy Information Administration Retrieved from httpswwweiagovtoolsfaqsfaq phpid73t11 accessed January 28 2017 Energy 154 In an efficient allocation incorporating the national security and climate change considerations only C units would be consumed Of these B would be domestically produced and C B would be imported Comparing these two outcomes note that because national security and climate change are externalities the market in general tends to consume too much oil and vulnerable imports exceed their efficient level What would happen during an embargo Be careful At first glance you would guess that we would consume where domestic supply equals domestic demand but that is not right Remember that Sd1 is the domestic supply curve given enough time to develop the resources If an embargo hits developing additional resources cannot happen immediately multiple year time lags are common Therefore in the short run the supply curve becomes perfectly inelastic vertical at A The price will rise to P to equate supply and demand As the graph indicates the loss in consumer surplus during an embargo can be very large indeed How can importing nations react to this inefficiency As Debate 72 shows several strategies are available The importing country might be able to become selfsufficient but should it If Figure 72 adequately represents the situation then the answer is clearly no The net benefit from self sufficiency the allocation where domestic supply Sd1 crosses the demand curve is clearly lower than the net benefit from the efficient allocation C How Should Countries Deal with the Vulnerability of Imported Oil Many countries import most of their oil Since oil is a strategic material how can the resulting vulnerability to import disruption be addressed One vision focuses on a strategy of increasing domestic production not only of oil but also of natural gas and coal This vision includes opening up new oil fields in such places as coastal waters or public lands as well as expanding the production of newer sources such as tar sands or oil shale Tax incentives and subsidies could be used to promote domestic production Another vision emphasizes energy efficiency and energy conservation Pointing out that expanded domestic production could exacerbate environmental prob lems including climate change this vision promotes such strategies as mandat ing standards for fuel economy in automobiles enacting energy efficiency standards for appliances and making buildings much more energy efficient Using economic analysis figure out what the effects of these two different strategies would be on the implementing country with respect to 1 oil prices in the short run and the long run 2 emissions affecting climate change and 3 imports in the short run and the long run What strategy or strategies would you like to see chosen by your country Why DEBATE 72 Why you might ask is selfsufficiency so inefficient when embargoes obviously impose so much damage and selfsufficiency could grant immunity from this damage Why would we want any imports at all when national security is at stake Energy 155 The simple answer is that the vulnerability premium is lower than the cost of becoming selfsufficient but that response merely begs the question why is the vulnerability premium lower It is lower for three primary reasons 1 embargoes are not certain eventsthey may never occur 2 steps can be taken to reduce vulnerability of the remaining imports and 3 expanding current domestic production via subsidies would incur a user cost by lowering the domestic amounts available to future users The expected damage caused by one or more embargoes depends on the likelihood of occurrence as well as the intensity and duration This means that the Pw2 curve will be lower for imports having a lower likelihood of being embargoed Imports from countries less hostile to our interests are more secure and the vulnerability premium on those imports is smaller4 For any remaining vulnerable imports certain contingency programs can be adopted to reduce the damage an embargo would cause The most obvious measure is to develop a domestic stockpile of oil to be used during an embargo The United States has taken this route The stockpile called the strategic petroleum reserve was originally designed to contain 1 billion barrels of oil see Example 71 A 1 billion barrel stockpile could replace 3 million barrels a day for slightly less than 1 year or a larger number of barrels per day for a shorter period of time This reserve could serve as a temporary alternative domestic source of supply which unlike other oil resources could be rapidly deployed on short notice It is in short a form of insurance If this protection can be purchased cheaply implying a lower Pw2 imports become more attractive To understand the third and final reason that paying the vulnerability premium would be less costly than selfsufficiency we must consider vulnerability in a dynamic rather than static framework Because oil is a depletable resource a user cost is associated with its efficient use To reorient the extraction of that resource toward the present as a selfsufficiency strategy would do reduces future net benefits Thus the selfsufficiency strategy tends to be myopic in that it solves the shortterm vulnerability problem by creating a more serious one in the future Paying the vulnerability premium creates a more efficient balance between the present and future as well as between current imports and domestic production We have established the fact that government can reduce our vulnerability to imports which tends to keep the risk premium as low as possible Certainly for oil however even after the stockpile has been established the risk premium is not zero Pw1 and Pw2 will not coincide Consequently the government must also concern itself with achieving both the efficient level of consumption and the efficient share of that consumption borne by imports Lets examine some of the policy choices As noted in Debate 72 energy conservation is one possible approach to the problem One way to accomplish additional conservation is by means of a tax on fossil fuel consumption Graphically this approach would be reflected as a shift inward of the aftertax demand curve Such a tax could reduce energy consumption and emissions of greenhouse gases to an efficient level It could not however achieve the efficient share of imports since the tax falls on all energy consumption whereas the security problem involves only imports While energy conservation may increase the net benefit it cannot ever be the sole policy instrument used or an efficient allocation will not be attained Another strategy the expansion of domestic supply is already occurring due to fracking in places such as the Bakken Formation According to the US Geological Service one of the larger domestic discoveries in recent years of unconventional oil can be found in the Bakken and associated formations in Montana and North Dakota Parts of these shale formations extend into the Canadian Provinces of Saskatchewan and Manitoba The introduction of hydraulic fracturing technology to the region in 2008 caused a boom in production and a reduction in imports Energy 156 As Example 72 points out however even a local community that takes advantage of that boom can be in for a rocky ride if its economy depends exclusively or primarily on that single commodity Diagrammatically the effect of the fracking induced expansion in domestic oil production would be portrayed in Figure 72 as a shift of the domestic supply curve to the right Notice EXAMPLE 71 Strategic Petroleum Reserve The US strategic petroleum reserve SPR is the worlds largest supply of emergency crude oil The federally owned oil stocks are stored in huge underground salt caverns along the coastline of the Gulf of Mexico Decisions to withdraw crude oil from the SPR are made by the president under the authority of the Energy Policy and Conservation Act In the event of an energy emer gency SPR oil would be distributed by competitive sale In practice what constitutes an energy emergency goes well beyond embargoes The SPR has been used rarely and no drawdown involved protecting against an embargo Some examples of drawdowns include During Operation Desert Storm in 1991 sales of 173 million barrels were used to stabilize the oil market in the face of supply disruptions arising from the war After Hurricane Katrina caused massive damage to the oil production facilities terminals pipelines and refineries along the Gulf regions of Mississippi and Louisiana in 2005 sales of 11 million barrels were used to offset the domestic shortfall A series of emergency exchanges conducted after Hurricane Gustav followed shortly thereafter by Hurricane Ike reduced the level by 54 million barrels During 2011 3059 million barrels were sold in response to sustained interruptions in global supplies due to civil unrest in Libya President Obama authorized the sale as part of a larger coordinated release of petroleum by International Energy Agency countries Building up the reserve is accomplished by the RoyaltyinKind program Under the RoyaltyinKind program producers who operate leases on the federally owned Outer Continental Shelf are required to provide from 125 to 167 percent of the oil they produce to the US government This oil is either added directly to the stockpile or sold to provide the necessary revenue to purchase oil to add to the stockpile In April 2011 however Congress rescinded all funding for the SPR expansion project Subsequently as part of its 2018 budget the Trump administration proposed to sell off half the oil in the Strategic Petroleum Reserve and use the money to reduce the deficit Do you think this reduction in size improves efficiency Why or why not If you think it is a good idea do you believe it was always too big or have circumstances changed If the latter what circumstances have changed and how has that lowered the optimal level of the strategic petroleum reserve Source US Department of Energy Strategic Petroleum Reserve website httpenergygovfeservices petroleumreservesstrategicpetroleumreserve accessed October 20 2016 Energy 157 that one effect would be to reduce the share of imports in total consumption an efficient result and that is already happening Net energy imports imports minus exports peaked in 2005 Since 2005 imports have declined while exports have increased see Figure 73 The domestic supply expansion would however increase climate change emissions an inefficient result This strategy also tends to drain domestic reserves faster which could make the nation more vulnerable in the long run another inefficient result The expansion of domestic fossil fuels reduces imports but the lower prices and resulting increased consumption also tend to intensify the climate change problem A third approach would tailor the response more closely to the national security problem One could use either a tariff on imports equal to the vertical distance between Pw1 and Pw2 or a quota on imports equal to C B With either of these approaches the price to consumers would rise to P1 total consumption would fall to C and imports would be C B This achieves the appropriate balance between imports and domestic production an efficient result but it does not internalize the climate change cost from increasing domestic production an inefficient result As developed in more detail in Chapter 17 imposing a separate price on carbon would be a necessary component of the package in order to internalize the climate externality EXAMPLE 72 Fuel from Shale The Bakken Experience The boom in oil production made possible by fracking resulted in North Dakota becom ing the most rapidly growing state in the nation Population increased in response to rising wages and lots of retail activity and public infrastructure was built to accommodate the rising population Then in 2014 dropping oil prices in part due to an oil glut resulting from increased production from domestic shale reversed the process As the prices fell small rural towns were hit particularly hard Williston North Dakota for example experienced job losses both in the oil industry and in the retail sectors built up to serve the influx of new workers Not only did the population begin to decline but the investments in public infrastructure made to accommodate the larger population become more difficult to finance During the boom Williston had built a new 57 million high school but declining economic activity caused by the lower prices caused a decline in the tax base needed to pay for that school Boomandbust cycles can be especially devastating to small resourcedependent communities like Williston With little diversification of their economic base they become especially vulnerable to swings in the prices of the resources on which they depend so heavily Sources USGS releases new oil and gas assessment for Bakken and Three Forks formations Retrieved from www2usgsgovblogsfeaturesusgstopstoryusgsreleasesnewoilandgasassessmentforbakkenandthree forksformations Hydraulic fracturing wwwepagovhydraulicfracturing accessed February 4 2016 Oldham Jennifer Philips Matthew 2016 The Bakken bust hits North Dakota hard February 4 wwwbloombergcomnewsarticles20160204thebakkenbusthitsnorthdakotahard accessed October 11 2016 Millsap Adam 2016 What the boom and bust of Williston North Dakota teaches us about the future of cities June 7 wwwforbescomsitesadammillsap20160607 willistonndandtheriseandfallofamericancities66ae277a6c81 accessed October 11 2016 Energy 158 Electricity The Role of Depletable Resources Most observers who think about energy futures see electricity as assuming an increasingly large role in the total energy picture Evolving technologies for using electricity for both heating and cooling heat pumps and transportation electric vehicles figure importantly in this perspective What energy sources should be used to generate that electricity While the industrialized world currently depends on conventional sources of oil coal and gas for most of our energy over the long run in terms of both climate change and national security issues the obvious solution involves a transition to domestic renewable sources of energy that do not emit greenhouse gases What role does that leave for the other depletable resources such as natural gas and uranium which are used to generate electricity Although some observers believe the transition to renewable sources of electricity will proceed so rapidly that using these fuels as a bridge will be unnecessary many others believe that depletable fuels will continue to play a significant transition role In the United States coal previously a contender has been losing out to natural gas due mainly to its lower costs resulting from the expansion of fracking However the increasing focus on reducing greenhouse gases is also a factor since natural gas has a lower carbon content when combusted Although other contenders do exist the fuel other than natural gas receiving the most attention and controversy as a transition fuel is uranium As a potential transition fuel used in nuclear electricalgeneration stations nuclear has its own limitationssafety and economics With respect to safety two sources of concern stand out 1 nuclear accidents or sabotage and 2 the storage of radioactive waste Is the market able to make efficient decisions about the role of nuclear power in the energy mix In both cases the answer is no given the current decisionmaking environment Lets consider these issues one by one Figure 73 Total Energy Production and Consumption 19802040 Source U S Energy Information Administration Annual Energy Outlook 2015 p17 Energy 159 The production of electricity by nuclear reactors involves radioactive elements If these elements escape into the atmosphere and come in contact with humans in sufficient concentra tions they can induce birth defects cancer or death Although some radioactive elements may also escape during the normal operation of a plant the greatest risk of nuclear power is posed by the threat of nuclear accidents or deliberate sabotage As the accident in Fukushima Japan in 2011 made clear nuclear accidents could inject large doses of radioactivity into the environment Unlike other types of electrical generation nuclear processes continue to generate heat long after the reactor is turned off This means that the nuclear fuel must be continuously cooled or the heat levels will escalate beyond the design capacity of the reactor shield If the high heat causes the reactor vessel to fracture clouds of radioactive gases and particulates will be released into the atmosphere An additional concern arises from the need to store nuclear wastes The wastestorage issue relates to both ends of the nuclear fuel cyclethe disposal of uranium tailings from the mining process and spent fuel from the reactorsalthough the latter receives most of the publicity Uranium tailings contain several elements the most prominent being thorium230 which decays with a halflife of 78000 years to a radioactive chemically inert gas radon222 Once formed this gas has a very short halflife 38 days The spent fuel from nuclear reactors contains a variety of radioactive elements with quite different halflives In the first few centuries the dominant contributors to radioactivity are fission products principally strontium90 and cesium137 After approximately 1000 years most of these elements will have decayed leaving the transuranic elements which have substantially longer halflives These remaining elements would remain a risk for up to 240000 years Thus decisions made today affect not only the level of risk borne by the current generationin the form of nuclear accidentsbut also the level of risk borne by a host of succeeding generations due to the longevity of radioactive risk from the disposal of spent fuel Nuclear power has also been beset by economic challenges New nuclear power plant con struction has become much more expensive than previously in part due to the increasing regula tory requirements designed to provide a safer system In the late twentieth century as its economic advantage over coal dissipated the demand for new nuclear plants declined For example in 1973 in the United States 219 nuclear power plants were either planned or in operation By the end of 1998 that number had fallen to 104 a difference due primarily to cancellations The transition to lower carbon fuels has created some renewed interest in the nuclear option The first new nuclear generator in the United States in 20 years entered commercial operation in Tennessee in 2016 a year in which globally nuclear power plants provided a bit over 11 percent of the worlds electricity The World Nuclear Association announced in 2016 that some 440 nuclear power reactors were operating in 31 countries and that over 60 power reactors were currently being constructed in 13 countries China was constructing eight new reactors a year What future role nuclear power will play in other countries after Fukushima remains to be seen Electricity Transitioning to Renewables Ultimately our energy needs will have to be fulfilled from renewable energy sources either because the depletable energy sources have been exhausted or as is more likely the environmental costs of using the depletable sources have become so high that renewable sources will be cheaper Many of these renewable sources of energy such as hydroelectric power wind photovoltaics and ocean tidal power are used to generate electricity These sources not only allow electricity generation to be more sustainable but they reduce the countrys dependence on fossil fuels Energy 160 Renewable energy comes in many different forms Different sources will have different comparative advantages so ultimately a mix of sources will be necessary As Debate 73 suggests the path to greater reliance on renewables is certainly not free of controversy even within the environmental community Dueling Externalities Should the United States Promote Wind Power On the surface the answer seems like a nobrainer since wind power is a renewable energy source that emits no greenhouse gases unlike all the fossil fuels it would be likely to replace Yet some highly visible committed environmentalists including Robert F Kennedy Jr have strongly opposed wind projects Why has this become such a contentious issue Opposition to wind power within the environmental community arises for a variety of reasons Some point out that the turbines can be noisy for those who live camp or hike nearby Others note that these very large turbines can be quite destructive to bats and birds particularly if they are constructed in migratory pathways And a number of opponents object to the way the view would be altered by a large collection of turbines on otherwisepristine mountaintops or off the coast Both the benefits from wind power reduced air pollution including impact on the climate and the costs effects on aesthetics birds and noise are typically externalities This implies that the developers and consumers of wind power will neither reap all of the environmental benefits from reduced impact on the climate nor will they typically bear all the environmental costs Making matters even more difficult some of the environmental costs will be concentrated on a relatively few people those living nearby while the benefits will be conferred on all global inhabitants most of whom will bear absolutely none of these costs Since the presence of externalities typically undermines the ability of a market to produce an efficient outcome it is not surprising that the permitting process for new wind power facilities is highly regulated Regulatory processes generally encourage public participation by holding hearings The concentrated costs imposed on those living nearby may be an effective motivator to attend the public hearings which are likely to be held near the proposed site the diffuse benefits will likely be a less effective motivator for attendance by proponents With environmental externalities lying on both sides of the equation and with many of the environmental costs concentrated on a relatively small number of people it is understandable that these hearings have become so contentious and that the opposition to wind power is so strong Sources Kennedy Jr R F December 16 2005 An ill wind off Cape Cod oped The New York Times Barringer F June 6 2006 Debate over wind power creates environmental rift The New York Times DEBATE 73 Energy 161 The extent to which these sources will penetrate the market will depend upon their relative cost and consumer acceptance New systems are usually initially less reliable and more expensive than old systems Once they mature reliability normally increases and cost declines experience is a good teacher Since the early producers and consumersthe pioneersexperience both lower reliability and higher costs procrastination can be an optimal individual strategy From an individual point of view waiting until all the bugs have been worked out and costs come down reduces the risk of making the investment From a social point of view however if every producer and consumer procrastinates about switching the industry will never be able to reach a sufficient scale of operation and will not be able to gain enough experience to reach the level of reliability and lower cost that will be necessary to reach the specified renewable goals How can these initial barriers be overcome One strategy involves establishing specific renewable resource goals with deadlines for meeting them For example the EU Renewable Resource Directive which establishes an overall policy for the production and promotion of energy from renewable sources in the EU requires at least 20 percent of its total energy needs be filled by renewables by 2020 In addition under the Directive all EU countries must also ensure that at least 10 percent of their transport fuels come from renewable sources by 2020 More recently EU countries have agreed on strengthening their initial renewable target to assure that at least 27 percent of final energy consumption is met from renewables in the EU as a whole by 2030 One of the expanding sources is offshore wind In June 2017 Germany Denmark and Belgium backed a pledge to install 60 gigawatts of new offshore wind power next decade more than five times the worlds existing capacity Another strategy subsidizes pioneer investments via the tax code5 This is commonly done for example with production or investment tax credits Once the market is sufficiently large that it can begin to take advantage of economies of scale and overcome the initial sources of unreliability the subsidies could be eliminated Another common policy approach for overcoming these obstacles involves combining Renewable Portfolio Standards RPS for electricity generation with Renewable Energy Credits RECs Renewable portfolio standards stipulate a minimum percentage of the total electricity that must be generated by each generator from specified renewable sources such as wind hydro or solar The generating entity can either meet that standard directly by generating the requisite proportion from the specified renewable sources or indirectly by purchasing renewable energy credits from independent generators An independent generator of electricity from a renewable source actually produces two saleable commodities The first is the electricity itself which can be sold to the grid while the second is the renewable energy credit that turns the environmental attributes such as the fact that it was created by a qualifying renewable source into a legally recognized form of property that can be sold separately Generally renewable generators create one REC for every 1000 kilowatthours or equivalently 1 megawatthour of electricity placed on the grid Providing this form of flexibility in how the mandate is met lowers the compliance cost not only in the short run by allowing the RECs to flow to the areas of highest need but also in the long run by making renewable source generation more profitable in areas not under a RPS mandate than it would otherwise be By 2013 some 29 states and the District of Columbia had a renewable energy standard with seven more having nonbinding goals Many of those also had REC programs How costeffective have these polices been Example 73 discusses a study that looks specifically at that question Energy 162 Another quite different approach to promoting the use of renewable resources in the generation of electric power is known as a feedin tariff Used more commonly in Europe a feedin tariff specifies the prices received by anyone who installs qualified renewable capacity that sells electricity to the grid The level of these prices typically determined in advance by the rules of the program is based upon the costs of supplying the power Specifically they are set sufficiently high so as to assure installers that they will receive a reasonable rate of return on their investment While in Germany this incentive payment is guaranteed for 20 years for each installed facility each year the magnitude of the payment for newly constructed generators is reduced typically in the neighborhood of 12 percent per year in order to reflect expected technological improvements and economies of scale EXAMPLE 73 The Relative CostEffectiveness of Renewable Energy Policies in the United States The United States depends on both renewable portfolio standards and a suite of produc tion and investment tax credits to promote renewable resources that reduce carbon emissions It also uses a completely different approach to reduce carbon emissions one that puts a price directly on those emissions Although we discuss this carbonpricing approach in some detail in Chapters 15 and 17 here we simply ask how costeffective a comprehensive policy such as carbon pricing is relative to policies that are targeted exclusively on promoting renewable resources Using a highly detailed model of regional and interregional electricity markets Palmer et al 2011 examine this question over a time horizon covering the period from 2010 to 2035 The analysis evaluates each of these policy approaches in terms of their relative effectiveness and costeffectiveness in reducing carbon emissions their effectiveness in promoting renewable resource electricity generation and their effects on electricity prices Between the two renewable resource policies the tax credit was found to be the least costeffective with the renewable portfolio somewhat better Because it involves a subsidy and the other polices do not the tax credit leads to relatively lower electricity prices which supports greater electricity consumption and hence relatively larger emissions This offsetting increase in emissions diminishes the tax credits costeffectiveness However the best policy turned out to be the third a particular form of carbon pricing known as capandtrade As we shall see in more detail in Chapter 17 the price a capandtrade policy puts on emissions creates very costeffective incentives for emissions reduction The dominance of this approach should therefore not be surprising Additionally it is the only considered policy that increases the relative cost of using nonrenewable higher carbon sources Neither the tax credit nor the renewable portfolio standard discourage the use of highcarbon nonrenewable technologies at all they apply only to renewable sources Source Palmer K Paul A Woerman M Steinberg D C 2011 Federal policies for renewable electricity Impacts and interactions Energy Policy 397 39753991 Energy 163 A feedin tariff actually offers two different incentives 1 it provides a price high enough to promote the desired investment and 2 it guarantees the stability of that price over time rather than forcing investors to face the market uncertainties associated with fluctuating fossil fuel prices or subsidies that come and go Of course when higher prices are paid to renewable investors these costs must be borne by someone In Germany the higher costs associated with the feedin tariffs were typically passed along to electricity ratepayers German electricity rates have been as a result relatively high In principle these higher costs should be temporary since rising fossil fuel costs would be expected to rise above the relatively stable prices dictated by feedin tariffs Will that prove to be true in practice Stay tuned Spain took a different approach that produced different results It refused to allow its electric utilities to pass on the increased cost of electricity resulting from the feedin tariffs to consumers As a result its electricity system financial deficit became unsustainable and in 2013 Spain halted new feedin tariff contracts for renewable energy As we have seen so often in other policy circumstances the implementation details matter Electricity Energy Efficiency As the world grapples with creating the right energy portfolio for the future energyefficiency policy is playing an increasingly prominent role An activity is said to be energy efficient if it is produced with the minimum amount of energy input necessary to produce a given level of that activity Activities covered by this definition can be as diverse as heating or lighting a building driving 100 miles or producing a ton of paper In recent years the amount of both private and public money being dedicated to promoting energy efficiency has increased a great deal The role for energy efficiency in the broader mix of energy polices depends of course on how large the opportunity is Estimating the remaining potential is not a precise science but the conclusion that significant opportunities remain seems inescapable The existence of these opportunities can be thought of as a necessary but not sufficient condition for government intervention Depending upon the level of energy prices and the discount rate the economic return on these investments could be too low to justify intervention In that case the costs of the policy intervention would exceed any gains that would result The strongest case for government intervention flows from the existence of externalities Markets are not likely to internalize these external costs on their own The natural security and climate change externalities mentioned above as well as other external cobenefits such as pollutioninduced community health effects certainly imply that the market undervalues investments in energy efficiency The analysis provided by economic research in this area however makes it clear that the case for policy intervention extends well beyond externalities Internalizing externalities is a very important but incomplete policy response Consider just a few of the other foundations for policy intervention Inadequately informed consumers can impede rational choice as can a limited access to capital preventing paying the upfront costs for the more energyefficient choice even when the resulting energy savings would justify the additional expense in present value terms Perverse incentives can also play a role as in the case of someone who lives in a room think dorm or apartment where the amount of energy used is not billed directly resulting in a marginal cost of additional energy use of zero for the occupant Another related case of perverse incentives arises for rental housing units Example 74 Energy 164 EXAMPLE 74 Energy Efficiency in Rental Housing Markets Economic analysis can not only help us understand the empirical finding that rental housing units are typically less energy efficient than owneroccupied units but also help us to understand the relative efficacy of policies to promote less energy waste in rental units To understand the sources of energy waste consider the incentives In an owner occupied unit the owner bears all the costs and receives all the benefits the resulting lower energy costs from an investment in energy efficiency In a typical rental unit however the renter pays for the energy used while the landlord would pay for any energy efficient investments such as insulation or an efficient heating system When prospective renters have no access to credible information on the energy costs associated with this unit a common case the rents for various units would not reflect their energy cost differences Since the costs of investments to reduce energy waste in the rental unit in this case cannot normally be recovered via higher rents a landlord would underinvest in energy efficiency Yet energy efficiency is clearly a costeffective way not only to reduce waste by lowering energy costs but also to lower carbon emissions as well Can these market barriers be overcome A recent experimental economics study addresses this question by examining four policy treatments 1 mandatory and 2 voluntary energyefficiency ratings for the unit similar to energyefficiency stars for appliances 3 a performance regulatory standard similar to energyefficiency standards for appliances and 4 a costsharing arrangement where landlords would be required to pay a fixed percentage of their tenants energy bill In the baseline treatment no policies the authors confirm the theoretical expectation that owners typically invest more in owneroccupied units than landlords invest in rental units Among the policy treatments they find that the availability of verified and cost less information on rental unit energy costs unequivocally reduces waste with manda tory information and voluntary information both achieving a high level of efficiency The regulatory approach was found to result in a higher average investment than the mandatory and voluntary information schemes but it resulted in fewer properties avail able in the market apparently some landlords chose to leave the rental market rather than comply with the regulation A costsharing policy achieves similar efficiency levels as the regulatory standard but a significantly lower level of efficiency than the voluntary and mandatory information schemes The effectiveness of information strategies found by this study is good news indeed but two caveats must be kept in mind First most actual information strategies are not costless to landlords as they were assumed to be in this study To the extent that landlords bear some or all of the costs of providing certified information this study would overesti mate to some unknown degree the effectiveness of these strategies Second experimental economics studies work with participants in a lab not with data based upon actual market choices As noted in Chapter 1 lab results are typically informative but they do not always produce the results drawn from actual field experience Source Burfurd I Gangadharan L Nemes V 2012 Stars and standards Energy efficiency in rental markets Journal of Environmental Economics and Management 642 153168 Energy 165 Could policies to increase energy efficiency such as subsidizing the cost of weatherizing your home trigger offsetting responses that reduce their effectiveness As Example 75 points out in principle they could Electricity Targeted Distributed Energy One characteristic of distributed energy sources such as solar wind or even energy efficiency is that they can be located near users Contrast this with large power plants which are centrally located By locating close to users distributed energy sources can lower the distance and hence the cost of transporting electricity from source to user Could targeting these distributed sources at areas facing transmission constraints eliminate the expense of building new transmission lines and hence be a costeffective component in the energy mix needed by that region As Example 76 points out in the right circumstances it can EXAMPLE 75 Energy Efficiency Rebound and Backfire Effects Energy efficiency policies can trigger offsetting feedbacks that lower their effectiveness The literature distinguishes two possible outcomesthe rebound effect and the backfire effect Consider an example A weatherization subsidy lowers both the amount and cost of energy needed to heat or cool the space in your home Would a homeowner respond to that lower cost by turning up or down the thermostat or heating or cooling more rooms Any increased energy consumed in response to its lower cost is known as a rebound effect The backfire effect occurs when the rebound effect is so large that a weatherization subsidy actually causes an increase in the amount of energy consumed What is the evidence on these effects A review of the studies seeking to answer this question finds that the existing literature does not support claims that energy efficiency gains will be reversed by the rebound effect Gillingham et al 2016 p 85 In other words the existing literature provides little if any support for a backfire effect It does however find evidence of rebound effects that can depending upon the context range as high as 60 percent What does this imply for the effectiveness of energy efficiency policy The authors conclude that this evidence does imply that energy efficiency policies may be less effective in reducing energy and reducing carbon emissions than thought since rebound effects can offset to some degree the direct energyreducing effects of the policy They also however note that the welfare effects of the rebound effects are ambiguouswhile the increased energy use lowers welfare due to the offsetting increase in damaging climate change impacts it raises the welfare arising from having more comfortable homes The existing literature does not provide answers as to which is larger Source Gillingham Kenneth Rapson David Wagner Gernot 2016 The rebound effect and energy efficiency policy Review of Environmental Economics and Policy 101 Winter 6888 Energy 166 Another new niche for distributed energy sources is to supply remote areas that previously have never had access to the electrical grid As Example 77 points out townships in Africa are using solar microgrids and novel technologybased financing models to supply these remote areas EXAMPLE 76 Thinking about Cost Reduction Outside of the Box The Boothbay Pilot Project The Boothbay Harbor region a popular summer tourist destination on the Maine coast at the end of a peninsula has a problem The existing electricity transmission line serving the area does not have the capacity to handle its large and growing summer electrical demand The traditional response upgrading the transmission line would be very expensive Could the problem be solved at lower cost in another way The Maine Public Utilities Commission decided to discover whether nontransmission alternatives NTAssuch as distributed generation efficiency storage and new smart grid technologiescould solve electric grid reliability needs at lower cost and with less pollution than new transmission lines or transmission system upgrades In 2012 the Commission established the Boothbay Smart Grid Reliability Pilot project to test the NTA hypothesis In its first 3year initial phase the Boothbay Pilot sought to provide experience based evidence on whether a portfolio of NTAs could reduce electricity load under peak conditions on specific transmission assets in the Boothbay subregion of Central Maine by 2 megawatts MW thereby avoiding an estimated 18 million transmission line rebuild What did the pilot project show Based upon the results for the initial phase of this project the evidence suggests that the net cost of the accepted NTAs together with administrative and operational expenses is projected to be less than 33 percent of the cost of building a new transmission line and would save ratepayers approximately 187 million including energy savings over the 10year project life through 2025 These results suggest that targeting an integrated package of distributed solutions at those geographic areas facing transmission constraints can produce grid benefits well beyond the direct services they provide to individual customers Source Grid Solar LLC Final report Boothbay SubRegion Smart Grid Reliability Pilot Project January 19 2016 EXAMPLE 77 The Economics of Solar Microgrids in Kenya Entrepreneurs are constructing solar photovoltaic microgrids in remote rural areas of Kenya Microgrids in Kenya are small electricity generation and distribution systems that can operate independently of larger grids Due to their small scale they typically Energy 167 Summary We have seen that the relationship between government and the energy market is not always harmonious and efficient In the past price controls have tended to reduce energy conservation discourage exploration and supply cause biases in the substitution among fuel types that penalize future consumers and create the potential for abrupt discontinuous transitions to renewable sources This important example makes a clear case for less not more regulation This conclusion is not universally valid however Other dimensions of the energy problem such as climate change and national security suggest the need for some government role Insecure foreign sources require policies such as tariffs and strategic reserves to reduce vulnerability and to balance the true costs of imported and domestic sources In addition government must ensure that the costs of energy fully reflect not only the potentially large environmental costs including climate change but also the national security costs associated with a dependence on foreign sources of energy Economic analysis reveals that no single strategy is sufficient to solve the national security and climate change problems simultaneously Subsidizing domestic supply for example would reduce the share of imports in total consumption an efficient result but it would reduce neither consumption nor climate change emissions inefficient results On the other hand energy conservation promoted by a tax on energy consumption for example would reduce energy consumption and the associated emissions efficient outcomes but would not achieve the efficient share of imports an inefficient result since an energy tax falls on all cannot supply electricity as cheaply as the larger grid but for remote areas that do not have access to the larger grid the electricity from solar microgrids is typically cheaper than the other local energy alternatives such as producing electricity via diesel generators Installing these microgrids requires capital investment and these villages are typically poor and do not have access to this capital How do they get around this significant barrier Entrepreneurs supply the capital own the solar panels and sell the electricity to local homes and businesses The product is electricity not panel installation In one financial model cloudbased software keeps track of consumption and pay ments via smart meters The smart meters measure and control power to each customer in town by communicating remotely with payments software Although power is cut off when the prepaid credit is exhausted customers can top up their credit when they wish in amounts as small as a few cents One problem is that the greatest demand for power is at night when the sun is not shining but that problem is overcome with battery storage units that typically hold up to 24 hours of electrical consumption Storage adds to the cost but the cost increase apparently is not enough to eliminate the economic advantages of the microgrid to local residents or the profitability to the entrepreneurs Analysis at the Lawrence Berkeley National Lab suggests that wind and solar can now be economically and environmentally competitive for a large portion of Africa Sources Pearce Fred 2015 African lights Solar microgrids bring power to Kenyan villages October 27 Yale Environment 360 Available at httpe360yaleedufeaturesafricanlightsmicrogridsarebringing powertoruralkenya Lawrence Berkeley National Laboratory 2017 The economic case for wind solar energy in Africa ScienceDaily March 27 Available at wwwsciencedailycom releases201703170327172829htm Energy 168 energy consumption whereas the national security problem involves only imports An energy tax also would fail to produce a fully efficient resolution for climate impacts since it would focus on energy per se not the actual emissions emitted by that energy use a factor that varies widely among fuels A carbon tax not an energy tax would be needed to make this kind of distinction among fuels Given the environmental difficulties with all of the depletable transition fuels tar sands fracked oil and gas as well as coal and uranium energy efficiency and the promotion of renewable sources of energy are now playing and will presumably continue to play a larger role The menu of energy options as the economy transitions to renewable sources offers a large number of choices It is far from clear what the ultimate mix will turn out to be but it is very clear that government policy is a necessary ingredient in any smooth transition to a sustainable energy future Since many of the most important costs of energy use are externalities an efficient transition to these renewable sources will not occur unless the playing field is leveled by internalizing the externalities The potential for an efficient and sustainable allocation of energy resources by our economic and political institutions clearly exists even if historically it has not always been achieved Discussion Questions 1 Should benefitcost analysis play the dominant role a complementary role or no role in deciding the proportion of electric energy to be supplied by nuclear power Why or why not 2 Economist Abba Lerner once proposed a tariff on oil imports equal to 100 percent of the import price This tariff is designed to reduce dependence on foreign sources as well as to discourage OPEC from raising prices since due to the tariff the delivered price would rise twice as much as the OPEC increase causing a large subsequent reduction in consumption Should this proposal become public policy Why or why not 3 Does the fact that the strategic petroleum reserve has never been used to offset shortfalls caused by an embargo mean that the money spent in creating the reserve has been wasted Why or why not SelfTest Exercises 1 During a worldwide recession in 1983 the oil cartel began to lose market share Why would a recession make the cartel likely not only to lose sales but also to lose market share 2 Assume the demand and marginal cost conditions given in the second selftest exercise in Chapter 2 In addition assume that the government imposes a price control at P 803 a Find the consumer and producer surplus associated with the resulting allocation b Compare this price control allocation to the monopoly allocation in part c of that selftest exercise 3 Some time ago a conflict between a paper company and a coalition of environmental groups arose over the potential use of a Maine river for hydroelectric power generation As one aspect of its case for developing the dam the paper company argued that without hydroelectric power the energy cost of operating some specific paper machines would be so high that they would have to be shut down Environmental groups countered that the Energy 169 energy cost was estimated to be too high by the paper company because it was assigning all of the highcost oilfired power to these particular machines That was seen as inappropriate because all machines were connected to the same electrical grid and therefore drew power from all sources not merely the highcost sources They suggested therefore that the appropriate cost to assign to the machines was the much lower average cost Revenue from these machines was expected to be sufficient to cover this average cost Who was right 4 Peaking plants those that are only called into service during times of peak demand are typically cheaper to build compared to baseload plants which operate all of the time but have relatively high operating costs Explain why it makes sense for utilities to use this lowercapital highoperatingcost type of plant for peaking and the highcapital loweroperatingcost type of plant for base load 5 If OPEC raised the price of oil high enough would that be sufficient to promote an efficient energy mix 6 Label the following as true false or uncertain and explain your choice Uncertain means that it can be either true or false depending upon the circumstances a All members of a resource cartel share a common objective namely increase prices as much and as soon as possible b By holding prices lower than they would otherwise be placing a price control on a depletable resource increases both the speed with which the resource is extracted over time and the cumulative amount ultimately extracted c A price control actually has no influence on the extraction path of a depletable resource until such time as the market price actually reaches the level of the price control d Forcing companies that drill offshore for oil to compensate victims of any oil spill from one of its facilities would be an efficient requirement 7 Explain why the existence of a renewable energy credit market would lower the compliance costs for utilities forced to meet a renewable portfolio standard 8 Using Figure 72 show how the level of oil imports and the price level would be affected if the country represented in that figure acted to internalize national security issues but ignored climate change impacts 9 a Some new technologies such as LED light bulbs have the characteristic that they cost more to purchase than more conventional incandescent alternatives but they save energy How could you use the present value criterion to decide how costeffective these new technologies are What information would you need to do the calculations How would the calculations be structured How would you use the results of these calculations to decide on their costeffectiveness b A typical monthly electrical bill has two components 1 a fixed monthly change eg 1000 a month and 2 a usage component eg 014 per kilowatthour consumed If a utility is planning to raise the amount they charge customers for electricity would you expect that increase to discourage encourage or have no effect on the demand for LED light bulbs Does it depend on which component they change Why or why not 10 Electric heat pumps are technologies that in the right circumstances can be costeffective sources of heating In a cold climate they frequently complement more typical energy sources such as oil or natural gas boilers in order to reduce total energy costs In order to be costeffective however the savings on oil and natural gas from using the heat pumps Energy 170 must be large enough to justify both their initial costs and the subsequent cost of the additional electricity to run them Would you expect the number of heat pump sales to be affected by the magnitude of local interest rates Why or why not Notes 1 For a complete early recognition of this point see Lee 1978 2 Although we focus here on the role of fracking in natural gas production from shale as noted in Example 71 it is also being used to increase oil production from shale 3 The conclusion that a monopoly would extract a resource more slowly than a competitive mining industry is not perfectly general It is possible to construct demand curves such that the extraction of the monopolist is greater than or equal to that of a competitive industry As a practical matter these conditions seem unlikely That a monopoly would restrict output while not inevitable is the most likely outcome 4 It is this fact that explains the tremendous US interest in Canadian and Latin American oil in spite of the fact that historically it has not necessarily been cheaper 5 While we focus here on renewable technologies used to generate electricity in general tax credits and other subsides are also used to promote renewable technologies such as biofuels or solar energy installations used to directly heat buildings Further Reading Anthoff D Hahn R 2010 Government failure and market failure On the inefficiency of environmental and energy policy Oxford Review of Economic Policy 262 197224 A selective survey of the literature to highlight what is known about the efficiency of particular kinds of policies laws and regulations in managing energy and environmental risk Gillingham K Newell R G Palmer K 2009 Energy efficiency economics and policy Annual Review of Resource Economics 1 597620 Reviews economic concepts underlying decisionmaking in energy efficiency and conservation and the related empirical literature Gillingham K Rapsony D Wagner G 2016 The rebound effect and energy efficiency policy Review of Environmental Economics and Policy 101 6888 One argument against energy efficiency called the rebound effect occurs when the actual energy savings are lower than initially expected due to offsetting consumption increases This article reviews the outstanding literature on the magnitude and policy implications of the rebound effect Schmalensee R 2009 Evaluating policies to increase electricity generation from renewable energy Review of Environmental Economics and Policy 6 4564 Evaluates policies aimed at increasing the generation of electricity from renewable sources based upon on a review of experience in the United States and the European Union EU Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 171 Recyclable Resources Minerals Paper Bottles and EWaste Man is endowed with reason and creative powers to increase and multiply his inheritance yet up to now he has created nothing only destroyed The forests grow ever fewer the rivers parch the wildlife is gone the climate is ruined and with every passing day the earth becomes uglier and poorer Anton Chekhov Uncle Vanya Act I 1896 Introduction Once used energy resources dissipate into heat They cannot be recycled Other resources in contrast retain their basic physical and chemical properties during use and under the proper conditions can be recycled or reused They therefore represent a separate category for us to examine What is an efficient amount of recycling Will the market automatically generate this amount in the absence of government intervention How does the efficient allocation over time differ between recyclable and nonrecyclable resources We begin our investigation by looking at the role minerals play in production and the economy We then move to describing how an efficient market in recyclable depletable resources would work We then use this as a benchmark to examine recycling in some detail Minerals Minerals including metals such as copper iron aluminum steel and gold are very important in many production processes Figure 81 illustrates the role of nonfuel minerals in the United States The United States Geological Service keeps extensive data on supply demand prices imports and exports of production Chapter 8 Figure 81 The Role of Nonfuel Minerals in the US Economy 2015 Source US Geological Survey and US Department of Commerce httpsmineralsusgsgovmineralspubsmcs2016 mcs2016pdf Recyclable Resources 173 As you can see in Figure 81 domestic raw materials and recycled materials were utilized in production to create mineral materials valued at 630 billion These mineral materials including aluminum brick copper fertilizers and steel plus net imports of processed mineral materials were in turn used by industry adding value of approximately 25 trillion in 2015 Although minerals and metals are finite nonrenewable resources stocks can be supple mented through recycling This point can be illustrated using a simple numerical example Suppose 100 units of a resource are contained in a product with a useful life of 1 year Suppose further that 90 percent of the resource could be recovered and reused after 1 year During the first year the full 100 units could be used At the end of the second year 90 percent of the remaining 90 units could once again be recovered leaving 81 units for the third year and so on How much more of this resource was made available by recycling Algebraically if we let the original stock be A and the recovery rate be a then the total amount used would be an infinite sum of the form A Aa Aa2 Aa3 It turns out that the sum of this series as time becomes infinitely long is A1 a1 Notice that nonrecyclable resources are represented by the special case where a 0 In this case the sum of resource use equals the available stock Whenever a 0 however as it would be when any of the resource was recycled the sum of the resource flows exceeds the size of the original stock The closer a gets to 10 the larger the sum of the resource flows For example if a 09 as it was in our example the sum of the flows is 10 times the size of the stock The effect of recycling is to increase the size of the available resources by a factor of 10 An Efficient Allocation of Recyclable Resources Extraction and Disposal Cost How would an efficient market one devoid of any imperfections allocate a recyclable depletable resource The models developed in Chapter 6 provide a point of departure for answering this question In the earliest periods reliance would generally be exclusively on the virgin ore because it is cheapest As more concentrated ores are extracted the mining industry would turn to the lowergrade ore and foreign sources for highergrade ores In the presence of technological progress the increasing reliance on the lowergrade ores would not necessarily precipitate an increase in cost as was shown in Example 61 at least initially Eventually however as the sources became increasingly difficult to extract a point would be reached at which the costs of extraction and prices of the virgin material would begin to rise At the same time the costs of disposing of the products would probably rise as population density became more pronounced and wealth levels supported higher levels of waste Over the last two centuries the world has experienced a large increase in the geographic concentra tion of people The attraction of cities and the exodus from rural areas led an increasingly large number of people to live in urban or nearurban environments This concentration creates waste disposal problems Historically when land was plentiful and the waste stream was less hazardous the remnants could be buried in landfills But as land became scarce burial became increasingly expensive In addition concerns over environ mental effects on water supplies and economic effects on the value of surrounding land have made buried waste less acceptable The rising costs of virgin materials and of waste disposal increase the attractiveness of recycling By recovering and reintroducing materials into the system recycling not only provides an alternative to virgin ores but also reduces the waste disposal load Recyclable Resources 174 Consumers as well as manufacturers play a role on both the demand and supply sides of the market On the demand side consumers would find that products depending exclusively on virgin raw materials are subject to higher prices than those relying on the cheaper recycled materials Consequently consumers would have a tendency to switch to products made with the recycled raw materials as long as quality is not adversely affected This powerful incentive is called the composition of demand effect As long as consumers bear the cost of disposal they have the additional incentive to return their used recyclable products to collection centers By doing so they avoid disposal costs and reap financial rewards for supplying a product someone wants This highly stylized version of how the market should work has to be complemented by some hard realities when setting up actual markets For the cycle to be complete it is essential that a demand exist for the recycled products New markets may ultimately emerge but the transition may prove somewhat turbulent Simply returning recycled products to the collection centers accomplishes little if they are simply dumped into a nearby landfill or if the supply is increased so much by mandatory recycling laws that prices for recycled materials fall through the floor thereby destroying the incentive to continue supplying them The purity of the recycled products also plays a key role in explaining the strength of demand for them One of the reasons for the high rate of aluminum recycling and much lower rate of plastics recycling is the differential difficulty with which a highquality product can be produced from scrap Whereas bundles of aluminum cans have a relatively uniform quality waste plastics tend to be highly contaminated with nonplastic substances or with plastics of very different types and the plastics manufacturing process has little tolerance for impurities Remaining contaminants in metals can frequently be eliminated by hightemperature combus tion but plastics are destroyed at such high temperatures Finally waste that contains hazard ous materials such as mercury and lead raises additional complexities The rapidly growing stream of electronic waste ewaste contains both hazardous waste and valuable minerals creating complicated dilemmas As we discuss in a subsequent section of this chapter markets for discarded electronics in industrializing countries may lack good enforcement mechanisms to ensure proper disposal of the hazardous components Recycling A Closer Look The model in the preceding section would lead us to expect that recycling would increase over time as virgin ore and disposal costs rose This seems to be the case Take copper for example During 1910 recycled copper accounted for about 18 percent of the total production of refined copper in the United States Today approximately 40 percent of the worlds copper demand is met by recycling In the United States copper in scrap contributed about 31 percent of total supply2 And according to the Bureau of International Recycling an estimated 70 percent of the copper scrap exported by the United States is used by industries in China Other metals being produced using recycled materials include aluminum lead and zinc with recycled material inputs of approximately 33 percent 35 percent and 30 percent respectively For other materials recycling rates are on the rise According to the US EPA the rate of recycling waste in the United States rose to 343 percent in 2013 Figure 82 For certain materials the rates are even higher 99 percent for auto batteries 67 percent for newspapers 55 percent for aluminum beer and soft drink cans and 71 percent for steel cans Plastic poly ethylene terephthalate PET bottles were recovered at a rate of 37 percent highdensity polyethylene HDPE bottles at a rate of 28 percent and glass containers at a rate of 28 percent According to another indicator by 2006 over 8600 curbside recycling programs were in exist ence Twenty years earlier only one curbside program was in place Recyclable Resources 175 In most cases recycling is not cheap While several types of costs are involved transport and processing costs are often especially significant The sources of scrap may be concentrated around cities where most of the products are used while for historical reasons the process ing facilities are near the sources of the virgin ores The scrap must be transported to the processing facility and the processed scrap to the market Labor costs are an important component of the processing costs Collecting sorting and processing scrap is typically very labor intensive Higher labor costs can make the recycled scrap less competitive in the input market Recognizing the importance of labor costs raises the possibility that recycling rates would be higher in regions where labor costs are lower which does seem to be the case Vibrant markets for scrap have emerged in many developing countries Energy costs also matter According to the Bureau of International Recycling BIR recycling offers significant energy savings over production from raw materials For example recycling steel expends 74 percent aluminum 95 percent copper 85 percent paper 64 percent and plastics 80 percent less energy Additionally producing materials via recycling results in less water and air pollution BIR estimates that the production of paper via recycling causes 35 percent less water pollution and 74 percent less air pollution And finally since the processing of scrap as an input into the production process can produce its own environmental consequences compliance with environmental regulations can add to the cost of recycled input In the United States for example relatively low world copper prices coupled with high environmental compliance costs created a cost squeeze that Figure 82 Municipal SolidWaste Recycling Rates 19602013 Source Advancing Sustainable Materials Management 2013 Fact Sheet Figure 2 United States Environmental Protection Agency wwwepagovsmmadvancing sustainablematerialsmanagementfactsandfiguresreport Recyclable Resources 176 contributed to the closure of all US secondary smelters and associated electrolytic refineries by 2001 When recycling markets operate smoothly however scrap becomes a costcompetitive input and rather dramatic changes occur in the manufacturing process Not only do manu facturers rely more heavily on recycled inputs but they also begin to design their products to facilitate recycling Facilitating recycling through product design is already important in industries where the connection between the manufacturer and disposal agent is particularly close Aircraft manufacturers which are often asked to scrap old aircraft may stamp the alloy composition on parts during manufacturing to facilitate recycling The idea is beginning to spread to other industries Ski boot manufacturers in Switzerland for example are beginning to stamp all individual boot parts with a code to identify their composition Recycling and Ore Depletion How does the efficient allocation of a recyclable resource compare with that of a nonrecyclable resource over time Thinking back to the models in Chapter 6 perhaps the most important difference occurs in the timing of the switch point As long as the resource can be recycled at a marginal cost lower than that of the substitute the market tends to rely on the recyclable resource longer than it does on a nonrecyclable resource with an identical extraction cost curve This should not be surprising since one effect of recycling is simply to add more of the resource Recall the simple numerical example presented at the beginning of this chapter with the total amount available A1 a where A is the stock of the resource available and a is the recycling rate This formulation also points out another feature of recycling Unless the recycling rate is 100 percent a 10 the sum of the resource flows is finite This means that while some recycled materials can be recycled forever the amount will become infinitesimally small as time goes on An efficient economic system will orchestrate a balance between the consumption of newly mined and recycled materials between disposing of used products and recycling and between imports and domestic production Example 81 provides an example of how changing economic circumstances can lead to an increase in recycling Factors Mitigating Resource Scarcity Recycling is promoted by resource scarcity but resource scarcity is in turn affected by a number of other factors Three have been particularly important 1 exploration and discovery 2 technological progress and 3 substitution Exploration and Discovery A profitmaximizing firm will undertake exploration activity until the marginal discovery cost equals the marginal scarcity rent received from a unit of the resource sold3 Since the marginal scarcity rentthe difference between the price received and the marginal cost of extractionis the marginal benefit received by the firm engaging in exploration activity the level of activity should be increased to maximize profits until this marginal benefit is equal to the marginal cost An understanding of this relationship between scarcity rent and marginal discovery cost allows us to think about how exploration activity would respond to population and income Recyclable Resources 177 growth Since both of these factors contribute to rising demand over time they raise the marginal user cost and the scarcity rent stimulating producers to undertake larger marginal discovery costs How much this demand pressure is relieved depends upon the amount of exploration activity and the amount of resources discovered per unit of exploration activity undertaken If the marginal discovery cost curve is flat implying a large amount of relatively available resources increases in scarcity rent can stimulate large amounts of successful exploration activity If the marginal discovery cost curve is steeply sloped as would be the case when exploration had to take place in increasingly hostile and unproductive environments increases in scarcity rent stimulate less exploration activity Technological Progress Technological progress reduces the cost of ore through new ways to extract process and use it In Chapter 6 for example we showed the significant impact of pelletization on the cost of producing steel from iron ore The effect was so dramatic that production costs actually fell over time in spite of the need to use a lowergrade ore It is important to realize that the rate and type of technological progress are influenced by the degree of resource scarcity Rising extraction costs create new profit opportunities for the development of new technologies These profit opportunities are largest for technologies that EXAMPLE 81 Lead Recycling The domestic demand for lead has changed significantly over the last 30 years In 1972 dissipative nonrecyclable uses of lead primarily gasoline additives pigments in paint and ammunition accounted for about 30 percent of reported consumption And only about 30 percent of all produced lead came from recycled material Recognition of leads negative health effects especially on children however led to a series of laws limiting the amount of allowable lead in gasoline and paints This has resulted not only in a decline in the total amount of lead used but also in the dramatic decline of the dissipative uses which by 1997 had fallen to only 13 percent of total demand A declining role for dissipative uses implies that an increasing proportion of the production is available to be recycled And in fact more is now recycled By 2012 80 percent of the domestic lead consumption came from recycled scrap The leadacid battery industry continues to be the largest user of lead Old postconsumer scrap accounts for nearly all the total lead scrap recovered Used batteries supply about 90 percent of that old scrap Battery manufacturers have begun entering buyback arrangements with retail outlets both as a marketing tool for new batteries and as a means of ensuring a supply of inputs to their downstream manufacturing operations Contrast this with aluminum for example In 2012 53 percent of recycled aluminum came from new manufacturing scrap while only 47 percent was from old scrap beverage cans and other discarded aluminum products Source US Department of the Interior Minerals Yearbook Retrieved from httpmineralsusgs govmineralspubsmcs Recyclable Resources 178 economize on scarce resources and utilize abundant ones In periods when labor is scarce and capital abundant new technologies tend to use capital and save labor If population growth were to reverse the relative scarcity subsequent technological progress would concentrate on using labor and saving capital In the past when fossilfuel energy was abundant and cheap newly discovered technologies relied heavily on this energy source As fossilfuel supplies decline technological progress can be expected to economize by increasing the amount of useful energy received per unit of fossilfuel input and by replacing fossilfuel energy with forms of renewable energy Substitution The final way in which adverse consequences of resource scarcity can be mitigated is by substituting abundant resources for scarce ones The easier the substitution of abundant depletable or renewable resources the smaller will be the impact of declining availability and rising costs see Figure 83 In the graph three isoquants S1 F1 F2 are plotted An isoquant portrays all the possible combinations of inputs that can produce a given level of output The two rightangled isoquants F1 and F2 depict the fixedproportions case the case in which no input substitution is possible The fixedproportions isoquant nearer the origin F2 refers to a lower output level Figure 83 Output Levels and the Possibilities for Input Substitution Source Adapted from Table 39 in J B Opschoor and Dr Hans B Vos Economic Instruments for Environmental Protection Paris Organisation for Economic Cooperation and Development p 53 Recyclable Resources 179 than the other fixedproportion isoquant F1 The third isoquant S1 does show some possibility for input substitution and is drawn in such a way as to produce the same output level O1 as F1 Naturally it implies a different production technology or set of technologies from F1 We can illustrate the significance of input substitution on output using Figure 83 Assume that the amount of some input Y a depletable resource is reduced from Y1 to Y2 If the technology involved is characterized by S1 the constant output level O1 can be maintained by increasing the amount of the other resource used from X1 to X3 This increase in X compensates for the reduction in Y leaving output unaffected Notice what happens however when the production process is characterized by F1 instead of S1 A reduction in the availability of Y from Y1 to Y2 necessitates a reduction in output from O1 to O2 No substitution of X for Y is possible In addition because inputs must be used in fixed proportions the amount of X would be reduced from X1 to X2 Any more X would be redundant it would not result in any additional output These examples serve to illustrate a basic premisethe wider the array of substitution possibilities the smaller the impact of resource scarcity on output This short review suggests that some factors eg rising population and incomes increase the likelihood of resource scarcity while others eg exploration and discovery technological progress and input substitution mitigate the seriousness of scarcity If resource scarcity is increasing in some sense we should be able to discover that natural resource prices are rising more rapidly than prices in general see Example 82 Resource prices in turn affect incentives to recycle as do the marginal costs of disposal EXAMPLE 82 The Bet In 1980 each of two distinguished protagonists in the scarcity debate put his money where his mouth is Paul Ehrlich an ecologist with a strong belief in impending scarcity answered a challenge from Julian Simon an economist known for his equally strong belief that concerns about impending scarcity were groundless According to the terms of the bet Ehrlich would hypothetically invest 200 in each of any five commodities he selected He picked copper chrome nickel tin and tungsten Ten years later the aggregate value of the same amounts of those five commodities would be calculated in real terms after accounting for normal inflation If the value increased Simon would send Ehrlich a check for the difference If the value decreased Ehrlich would send Simon a check for the difference In 1990 Ehrlich performed the calculations and sent Simon a check for 57607 Real prices for each of the five commodities were lower some were less than half their former levels New sources of the minerals had been discovered substitutions away from these minerals had occurred in many of their uses particularly computers and the tin cartel which had been holding up tin prices had collapsed Would the outcome of the SimonEhrlich wager have been the same if the bet had covered the entire twentieth century According to a subsequent analysis of the data on these same minerals by McClintick and Emmett 2005 despite ups and downs in prices Recyclable Resources 180 Market Imperfections As we discovered in the discussion of the role of oil in national security when mineral imports are critically important and come from risky sources the market perceives a biased price ratio one that fails to incorporate some of the social costs of imports The result is an inefficient and excessive reliance on imports Other market imperfections are apparent as well An unbalanced treatment of waste by producers and consumers can lead to biases in the market choices between recycling and the use of virgin ores Since disposal cost is a key ingredient in determining the efficient amount of recycling the failure of an economic agent to bear the full cost of disposal implies a bias toward virgin materials and away from recycling We begin by considering how the method of financing the disposal of potentially recyclable waste affects the level of recycling Disposal Cost and Efficiency The efficient level of recycling depends on the marginal cost of disposal Suppose for example it costs a community 20 per ton to recycle a particular waste product that can ultimately be sold to a local manufacturer for 10 per ton Can we conclude that this is an inefficient recycling venture because it is losing money No we cannot In addition to earning the 10 per ton from selling the recycled product the town is avoiding the cost of disposing of the product This avoided marginal cost is appropriately considered a marginal benefit from recycling Suppose the marginal avoided disposal cost was 20 per ton In this case the benefits to the town from recycling would be 30 per ton 20 per ton avoided cost plus 10 per ton resale value and the cost would be 20 per ton this would be an efficient recycling venture Both marginal disposal costs and the prices of recycled materials directly affect the efficient level of recycling The Disposal Decision Potentially recyclable waste can be divided into two types of scrap old scrap and new scrap New scrap is composed of the residual materials generated during production For example as steel beams are formed the small remnants of steel left over are new scrap Old scrap is recovered from products used by consumers and is often called postconsumer scrap over the course of the past century Simon would also have won even a centurylong wager Finally how would Simon have fared in decades other than the one covered by the bet Was he just lucky to have picked the 1980s It turns out that to some extent he was lucky Of the ten decades in that century he would have won in five decades the 1900s 1910s 1940s 1980s and 1990s and lost in the remaining five He would have lost by a few dollars in the 1950s and by more significant amounts in the other four decades Does this evidence provide a lesson for the future You be the judge Sources Tierney J December 2 1990 Betting the planet The New York Times Magazine 5253 74 76 78 8081 McClintick D Emmett R B 2005 The SimonEhrlich debate PERC Reports 233 1617 Recyclable Resources 181 To illustrate the relative importance of new scrap and old scrap consider that in the US aluminum industry about 40 percent of the recovered aluminum scrap comes from old scrap The difficulties in recycling new scrap are significantly less than those in recycling old scrap New scrap is already at the place of production and with most processes it can simply be reentered into the input stream without transportation costs Transport costs tend to be an important part of the cost of using old scrap Equally important are the incentives involved Since new scrap never leaves the factory it remains under the complete control of the manufacturer Having the joint responsibility of creating a product and dealing with the scrap the manufacturer now has an incentive to design the product with the use of the new scrap in mind It would be advantageous to establish procedures guaranteeing the homogeneity of the scrap and minimizing the amount of processing necessary to recycle it For all these reasons it is likely that the market for new scrap will work efficiently and effectively Unfortunately the same is not true for old scrap The market works inefficiently because the product users do not bear the full marginal social costs of disposing of their product As a result the market is biased away from recycling old scrap and toward the use of virgin materials The key to understanding why these costs are not internalized lies in the incentives facing individual product users Suppose you had some small aluminum products that were no longer useful to you You could either recycle them which usually means driving to a recycling center or you could toss them into your trash In comparing these two alternatives notice that recycling imposes one cost on you transport cost while the second imposes another disposal cost It is difficult for consumers to act efficiently because of the way trash collection has traditionally been financed Urban areas have generally financed trash collection with taxes if publicly provided or a flatrate fee if privately provided Neither of these approaches directly relates the size of an individuals payment to the amount of waste The marginal cost to the homeowner of throwing out one more unit of trash is negligible even when the cost to society is not The marginal private disposal cost and the cost to society as a whole diverge see Figure 84 When the private marginal cost of disposal MCP is lower than the marginal social cost of disposal MCs the market level of recycling where the marginal cost of recycling MCR is equal to the marginal private disposal cost is inefficient Only if all social costs are included in the marginal cost of disposal will the efficient amount of recycling Qs be attained4 This point can be reinforced by a numerical example Suppose your city provides trash pickup for which you pay 150 a year in taxes Your cost will be 150 regardless within reasonable limits of how much you throw out In that year your additional marginal cost from throwing out these items is zero Certainly the marginal cost to society is not zero and therefore the balance between these alternatives as seen by the individual homeowner is biased in favor of throwing things out5 Littering is an extreme example of what we have been talking about In the absence of some kind of government intervention the cost to society of littering is the aesthetic loss plus the risk of damage to automobile tires and pedestrians caused by sharp edges of discarded cans or glass Tossing used containers outside the car is relatively costless for the individual but costly for society6 Disposal Costs and the Scrap Market How would the market respond to a policy forcing product users to bear the true marginal disposal cost The major effect would be on the supply of materials to be recycled Recycling would now offer consumers a way to avoid disposal costs and possibly even be paid for Recyclable Resources 182 discarded products This would cause the diversion of some materials to recycling centers where they could be reintegrated into the materials process If this expanded supply allows dealers to take advantage of previously unexploited economies of scale this expansion could well result in a lower average cost of processing as well as more recycled materials The total consumption of inputs would increase because the price falls The use of recycled materials increases as well The amount of virgin ore falls Thus the correct inclusion of disposal cost would tend to increase the amount of recycling and extend the useful economic life for depletable recyclable resources Subsidies on Raw Materials Disposal costs are only part of the story Inputs derived from recycling can only compete with raw materials if the playing field is level Subsidies on raw materials are another troubling source of inefficiencies that create a bias away from recycled inputs Subsidies can take many forms One form is illustrated by the US Mining Law of 1872 which was originally passed more than 150 years ago to promote mining on public lands Under this law miners can stake lode claims for subsurface minerals and placer claims for surface minerals for mineral prospecting on public lands A claim can be maintained for a payment of only 100 a year If minerals are discovered in a claim area and at least 500 has been invested in development or extraction the land could actually be bought for 5 an acre on lode claims or 250 an acre on placer claims In 1999 the US Congress enacted a moratorium on land purchases but not on staking claims These prices for access to public lands are so low relative to market prices that they constitute a considerable implicit subsidy As a result of this subsidy not only do taxpayers not receive the true value of the mining services provided by public lands but the subsidy has Figure 84 The Efficient Level of Recycling Recyclable Resources 183 the effect of lowering the cost of extracting these raw minerals As a result raw materials are artificially cheap and can inefficiently undermine the market for recycled inputs Corrective Public Policies Why are recycling rates so low No doubt some of the responsibility lies in improper incentives created by inappropriate pricing Can the misallocation resulting from inefficiently low disposal cost be corrected Payasyouthrow PAYT trash disposal One approach volume or userpay pricing imposes disposal charges based on the amount of trash This type of pricing is meant to reflect the true social cost of disposal Example 83 presents an early example meant to test the cost effectiveness of these types of programs Today there are many PAYT programs in existence and they are usually one of three types Unit pricing per bag or container users must purchase special bags or container tags Partialunit pricing some fixed amount is included in a fee or property taxes Additional bags or containers are priced at a perunit price Variable rate pricing is based on volume andor size of the container EXAMPLE 83 An Early Example Pricing Trash in Marietta Georgia In 1994 the people of Marietta Georgia participated in a demonstration project that changed the way in which waste was priced The traditional 15 monthly fee for trash pickup was cut to 8 per month In addition half of the residents faced a perbag price on waste 075 per bag while the rest faced a monthly fee for pickup that depended on the maximum number of cans per month that the customer wished to have picked up This number was contracted in advance by the customer and did not vary from month to month The fee was 3 or 4 per can depending upon the number Economic theory suggests that while both plans should reduce waste and increase recycling the perbag fee should promote more Can you see why And indeed that is what happened The can program reduced nonrecycled waste by about 20 percent whereas the bag program reduced it by as much as 51 percent Both programs had an equally strong effect on encouraging households to recycle Both programs not only diverted waste into recycling they also reduced the amount of waste generated Could the costs associated with the program be justified in benefitcost terms According to the economists who conducted the study they were The net benefits for the city were estimated to be 586 per day for the bag program and 234 per day for the can program Source Van Houtven G L Morris G E November 1999 Household behavior under alternative payasyouthrow systems for solid waste disposal Land Economics 754 515537 Recyclable Resources 184 Over 6000 communities in the United States and over 200 in Canada use some kind of user fees for trash In Japan 30 percent of municipalities utilize a user pay system Many cities utilize a combined approach with per bag or unit pricing combined with free recycling pickup This provides an added incentive to recycle since it now costs money to throw the materials away A preimplementation concern about volume pricing was that it might impose a hardship on poorer residents Strategies based on higher prices always raise the specter that they will end up placing an intolerable burden on the poor In the case examined by Example 83 that concern was apparently misplaced Under the old system of financing trash collection every household paid the same fee regardless of how much trash it produced Since lowerincome households produce less trash they were in effect subsidizing wealthier households Under the new system lowerincome households pay only a flat fee since they dont need to purchase stickers for additional disposal The expense of these stickers is less than the average cost of disposal which was the basis for the previous fee Poor households have turned out to be better off not worse off under the new pricing system Curbside Recycling Curbside recycling programs are common in many cities Economic theory tells us if the marginal cost of recycling is less than the marginal cost of trash disposal recycling rates will increase Curbside recycling especially in combination with payasyougo trash disposal attempts to achieve an efficient balance between disposal and recycling Curbside recycling programs in the United States grew from 1000 programs in 1988 to over 9000 in 20097 Example 84 looks at the demand and supply sides of curbside recycling Do incentives matter EXAMPLE 84 Does Packaging Curbside Recycling with Incentives Promote Efficiency Municipalities that have landfill constraints or high fees for trash disposal are interested in whether or not they can increase the flow of recyclables supply in order to reduce pressure on landfill space Municipalities considering whether or not to implement curbside recycling programs are also typically interested in which types of incentives are most effective in promoting recycling In one interesting experiment Koford et al 2012 compare two districts in a municipality in Kentucky In one the city provides trash and recycling collection funded via property taxes In this situation curbside recycling has zero marginal cost In the other residents contract privately for trash and recycling services Districts vote on which service they want Koford et al estimated the demand for curbside recycling using a willingness to pay survey that also asked questions about recycling behavior and motivations for recycling The survey was mailed to households in both types of districts In both samples 63 percent of households cited an ethical duty when asked what most encouraged them to recycle Another 37 percent however said that monetary incentives would encourage them to recycle Recyclable Resources 185 Refundable Deposits Another idea for promoting recycling now being applied in many areas is the refundable deposit Already widely accepted for beverage containers such deposits could become a remedy for many other products A refund system is designed to accomplish two purposes 1 the initial charge reflects the cost of disposal and produces the desired composition of demand effect and 2 the refund attainable upon turning the product in for recycling helps conserve virgin materials Such a system is already employed in Sweden and Norway to counter the problem of abandoned automobiles The survey included a hypothetical curbside recycling service followed by a willingnesstopay question in which respondents were asked whether they would be willing to pay a specific dollar amount for the service The dollar amounts varied but the average estimated willingness to pay for curbside recycling was 229 per month Interestingly whether or not the household currently had city service was not significant in influencing willingness to pay For the supply side Koford et al conducted an experiment to understand how households might respond to both monetary and communication incentives to recycle They used three monetary incentives 0 1 2 and four different types of communi cations none informational guilt or feel good for a total of 12 combinations of incen tive and communication The communications were sent monthly to a random sample of Lexington residents The weight of their recycled materials was measured during control weeks no incentive or communication and experimental weeks The experiment had mixed results The communication strategies were relatively ineffective When combined interacted with the monetary incentives the information appeal had a significant impact but the net effect was to reduce recycling Interestingly while small monetary payments did have a positive effect on recycling behavior the incentives necessary to influence significant behavior changes are likely costprohibitive The authors estimate of willingness to pay 229 per household per month is less than the cost to administer the curbside recycling program approximately 240 per household per month In this case the benefits do not outweigh the costs Are these results specific to Lexington Kentucky It appears not In a study of the Western United States Aadland and Caplan 2006 find that the net social benefits of curbside recycling are equal to zero costs equal benefits though the results do vary some by city The relative ineffectiveness of the personal communications is also consistent with other literature that finds that social norms have little impact Viscusi et al 2011 unless the appeals include a comparison with the behaviors of others Ferraro et al 2011 However laws that promote recycling via economic incentives that either reduce the time and inconvenience costs of recycling or through bottle deposits can be very influential Viscusi et al 2011 Sources Aadland D M Caplan A J 2006 Curbside recycling Waste resource or waste of resources Journal of Policy Analysis and Management 254 855874 Ferraro P J Miranda J J Price M K 2011 The persistence of treatment effects with normbased policy instruments Evidence from a randomized environmental policy experiment American Economic Review 1013 318322 Koford B C Blomquist G C Hardesty D M Troske K 2012 Estimating consumer willingness to supply and willingness to pay for curbside recycling Land Economics 884 745763 Viscusi W K Huber J Bell J 2011 Promoting recycling Private values social norms and economic incentives American Economic Review 1013 6570 Recyclable Resources 186 The recycling of aluminum beverage cans has been one clear beneficiary of deposit refund schemes8 Quite a few countries including Germany Finland Norway Denmark Sweden Barbados Canada the state of South Australia and 10 US states and one US territory have container deposit refund programs in place Although not all states have passed bottle bills over 50 percent of aluminum beverage cans are now recycled in the United States As a result aluminum old scrap has become an increasingly significant component of total aluminum supplies Recycling aluminum saves about 95 percent of the energy that is needed to make new aluminum from ore The magnitude of these energy savings has had a significant influence on the demand for recycled aluminum as costconscious producers search for new ways to reduce energy costs Debate 81 explores why only some states have implemented refundable bottle deposits Beverage container deposits also reduce illegal disposal littering because an incentive is created to bring the bottle or can to a recycling center In some cities scavenging and returning these bottles has provided a significant source of income to the homeless One Canadian study found that recycling creates six times as many jobs as landfilling Depositrefund systems are also being used for batteries and tires New Hampshire and Maine for example place a surcharge on new car batteries Consumers in these states receive a rebate if they trade in their used battery for a new one Oklahoma places a 1 fee on each new tire sold and then returns 050 to certified processing facilities for each tire handled Some states in the United States as well as some developing countries also use deposit refund systems to assure that pesticide containers are returned after use These containers usually contain toxic residues after use which can contaminate water and soil so collecting the containers and either reusing them or properly decontaminating them can eliminate this contamination threat Some areas attempt to enlist economic incentives by imposing a disposal or recycling surcharge on the product Paid at the time of purchase of a new product this surcharge would normally be designed to recover the costs of recycling the product at the end of its useful life moredifficulttorecycle products would have larger fees These fees would normally be coupled with a requirement that the revenue be used by sellers to set up recycling systems Assuming these fees correctly internalize the costs of recycling they will provide consumers with incentives to take the recycling and disposal costs into account since easiertorecycle products would have a lower price including the fee Note however that these recycling surcharges do not provide any incentive against illegal disposal since the consumer gets no rebate for dropping the product off at a collection center but they provide no specific incentive for illegal disposal either Since the surcharge is paid up front it cannot be avoided by illegal disposal In this sense the depositrefund system is clearly superior to either recycling surcharges or volume pricing of trash Bottle Bills Economic Incentives at Work Ten US statesCalifornia Connecticut Hawaii Iowa Maine Massachusetts Michigan New York Oregon and Vermontand one US TerritoryGuam have passed bottle bill legislation One city Columbia Missouri also passed legislation but it was repealed in 2002 Delawares bottledeposit DEBATE 81 Recyclable Resources 187 system was repealed in 2010 effective February 2011 Every year several states either have proposed new legislation or proposed expansions of existing legislation More often than not these proposed bills do not pass Bottle deposits in the United States range from 005 to 015 and laws vary on which containers are redeemable for deposits9 While on average US container recycling rates have been below 40 percent recycling rates in bottledeposit states are much higher averaging around 80 percent Michigans 010 beverage can deposit produced recycling rates close to 100 percent Statistics on litter reduction show the largest gains in bottledeposit states Although bottledeposit states have recycling rates double those of states without deposits that is not sufficient evidence to suggest that it would be efficient for all states to have them Economic studies on the efficiency of bottle deposits are limited Porter 1983 estimated the costs and benefits of the then newly passed Michigan bottle bill He found that for most estimates of costs and benefits the bill passed a benefitcost test Ashenmiller 2009 finds that bottle deposits increase the number of recycled containers and reduce waste stream costs by diverting these containers away from curbside programs Using survey data from California she finds between 36 percent and 51 percent of materials at redemption centers would not have been collected using existing curbside programs alone without the complementary depositrefund system Interestingly however some of the success of the California program can be attributed to its designits curbside programs use volumebased pricing for trash This analysis also notes that curbside programs work best in densely populated areas and that cash recycling programs can be an important income source for the working poor Since the efficiency of depositrefund systems depends on their cost they may be efficient for some states but not others Key determinants of the relative costs of bottle deposits vary from state to state Disposal costs depend on landfill availability and return rates depend on population densities and distances to redemption centers States with bottle deposits may incur the extra expense of illegal returns from bottles purchased in nearby states that do not require a deposit Enforcement across state lines is costly and imperfect States with large bottlers like CocaCola are usually opposed to bottle deposits Does your state have a bottle deposit Does that seem like the right choice Sources httpglobalwarminghousegovmediacenterpressreleasesid0126 www containerrecyclingorg Porter R C 1983 Michigans experience with mandatory deposits on beverage containers Land and Economics 59 doi1023073146047 Ashenmiller B August 2009 Cash recycling waste disposal costs and the incomes of the working poor Evidence from California Land Economics 853 539551 Recyclable Resources 188 Plastic Bag Bans and Fees Many cities have implemented plastic bag bans in grocery stores Austin Cambridge Massachusetts Chicago Los Angeles San Fransiciso and Seattle and others have imple mented fees in order to take a plastic bag Boulder Colorado Portland Maine New York City Washington DC and Brownsville Texas are notable examples Between 2015 and 2016 77 bills were proposed in 23 states on the regulation of plastic bags Ireland instituted a hefty fee on plastic bags and found that plastic bag litter dropped by 93 percent and plastic bag use decreased by 90 percent in the year after the Plastic Bag Levy was implemented The fee is now 033 US The impact of the Irish Bag Levy on water pollution is discussed in Chapter 18 Example 182 Advocates of these fees and bans argue that bans significantly reduce plastic bag waste which frequently ends up in storm drains and in oceans creating hazards for marine mammals seabirds and fish They also are piling up in landfills Some opponents of plastic bag fees and bans say that consumers will simply use more paper bags and those have environmental impacts as well as do cotton tote bags What then is the ideal bag policy It is likely a mixed approach a fee on both paper and plastic bags while giving away recycled plastic reusable bags10 Taxes Subsidies and Other Incentives The tax system can also be used to promote recycling by taxing virgin materials and by subsidizing recycling activities The European approach to waste oil recycling reinforced by the high cost of imported crude oil was to require both residential and commercial users to recycle all waste oil they generate Virgin lubricating oils are taxed and the resulting income is used to subsidize the recycling industry As a result many countries collect up to 65 percent of the available waste oil In the United States which does not subsidize waste oil recycling the waste oil market has been rather less successful but it is growing Additionally laws in most states prohibit used oil disposal Many areas are now using tax policy to subsidize the acquisition of recycling equipment in both the public and private sectors Frequently taking the form of salestax exemptions or investment tax credits to private industries and loans or grants to local communities these approaches are designed to get recycling programs off the ground with the expectation that they will ultimately be selfsustaining The pioneers are being subsidized Examining Oregons program can serve to illustrate how a tax approach works From 1981 to 1987 to reduce energy consumption as well as to promote recycling the Oregon Department of Energy granted tax credits to 163 projects Being granted this credit allows companies a 5year period in which to deduct from their taxes an amount equal to 35 percent of the cost of any equipment used solely for recycling Oregon also offers a broader tax credit that covers equipment land and building purchases Paper companies the major recipients of both types of credits have utilized them to increase the capacity to use recycled newsprint and cardboard in the papermaking process According to Shea 1988 these incentives helped to raise Oregons newspaper recycling rate 65 percent to twice the national average Any longrun solution to the solidwaste problem must not only influence consumer choices about purchasing packaging and disposal it must also influence producer choices about product design to increase recyclability product packaging and the use of recycled as opposed to virgin materials in the production process One general approach is called extended producer responsibility and it involves requiring producers to take back packaging and even their products at the end of their useful life see Example 85 Recyclable Resources 189 EXAMPLE 85 Implementing the TakeBack Principle According to the takeback principle all producers should be required to accept responsibility for their productsincluding packagingfrom cradle to grave by taking them back once they have outlived their useful lives In principle this requirement was designed to encourage the elimination of inessential packaging to stimulate the search for products and packaging that are easier to recycle and to support the substitution of recycled inputs for virgin inputs in the production process Germany has required producers and retailers as intermediaries to accept all packaging associated with products including such different types of packaging as the cardboard boxes used for shipping hundreds of toothbrushes to retailers to the tube that toothpaste is sold in Consumers are encouraged to return the packaging by means of a combination of convenient dropoff centers refundable deposits on some packages and high disposal costs for packaging that is thrown away Producers responded by setting up a new private nonprofit corporation the Duales System Deutschland DSD to collect the packaging and to recycle the collected materi als This corporation is funded by fees levied on producers The fees are based on the number of kilograms of packaging the producers use The DSD accepts only packaging that it has certified as recyclable Once certification is received producers are allowed to display a green dot on their product signaling to consumers that this product is accepted by the DSD system Other packaging must be returned directly to the producer or to the retailer who returns it to the producer The law has apparently reduced the amount of packaging produced and has diverted a significant amount of packaging away from incineration and landfills A most noteworthy failure however was the inability of the DSD system to find markets for the recycled materials it collected Some German packaging even ended up in neighboring countries causing some international backlash The circumstance where the supply of recycled materials far exceeds the demand is so commonnot only in Germany but in the rest of the world as wellthat further efforts to increase the degree of recycling will likely flounder unless new markets for recycled materials are forthcoming Despite the initial difficulties with implementing the takeback principle the idea that manufacturers should have ultimate responsibility for their products has a sufficiently powerful appeal that it has moved beyond an exclusive focus on packaging and is now expanding to include the products themselves In 2002 the European Union EU passed a law that makes manufacturers financially responsible for recycling the appliances they produce In 2004 the European Unions Waste Electrical and Electronic Equipment WEEE directive came into effect making it the responsibility of the manufacturers and importers in EU states to take back their products and to properly dispose of them As part of the WEEE program a pilot study was conducted in Beijing Delhi and Johannesburg This study found that ewaste recycling has developed in all three countries as a marketbased activity Sources Rousso A S Shah S P September 1994 Packaging taxes and recycling incentives The German Green Dot Program National Tax Journal 473 689701 Ryan M SeptemberOctober 1993 Packaging a revolution World Watch 2834 Boerner C Chilton K JanuaryFebruary 1994 False economy The folly of demandside recycling Environment 361 615 Widmer R OswaldKrapf H SinhaKhetriwal D Schnellmann M Boni H 2005 Global perspectives on ewaste Environmental Impact Assessment 25 436458 Recyclable Resources 190 A Summary of Corrective Policies As we will continue to see in the pollution chapters later in this book incentives matter The policies we have examined illustrate that financial incentives such as returnable deposits and time or convenience incentives curbside recycling can increase recycling rates One study however by Viscusi et al 2012 finds that the net effect of recycling policies is less than the marginal effect of each policy introduced separately Their study focuses on plastic water bottles but is certainly relevant for other types of recycling as well They suggest that policies should be evaluated at the margin what is the incremental effect rather than on the average performance of the policy They also find that incentives like bottle deposits increase recycling rates because many nonrecyclers become recyclers However as we saw in Example 84 economic efficiency requires that the context be carefully considered and that the design be appropriate for that context Markets for Recycled Materials Successful recycling programs depend to a large extent on the existence of markets buyers for recycled materials Consider plastics for example Currently PET bottles are primarily used in carpet fiber and textiles including fleece Other potential future uses for recycled PET bottles include waterproof shipping containers and coating for paper HDPE plastics are primarily made into bottles and garden products such as lawn edging and lawn chairs The market for plastics is expanding in some areas where the capacity to process the postconsumer waste and the demand for that material is greater than the amount recovered As new uses expand this market can be expected to grow According to the US EPA the American Society for Testing and Materials ASTM is using new test methods that are facilitating the use of recycled plastics in building materials EWaste Ewaste is the fastestgrowing segment of the waste stream bringing with it rising concerns about the environmental and health effects of some of this waste Lead mercury cadmium and brominated flameretardants are all widely used in electronics All of these substances have been linked to health risks especially for children and are considered hazardous waste Did you upgrade your cell phone this year Perhaps you got a new laptop or tablet Or maybe you got a new MP3 player or iPad What happened to the old one As of 2017 there are some 47 billion mobile phone users and 7 billion mobile phones in use The number of users is expected to reach 5 billion by 2019 Sixtythree percent of the worlds population owns a mobile phone expected to be 67 percent by 2019 In China there are 14 billion mobile phones and India is expected to reach over 1 billion by 201911 In the United States there are approxi mately 330 million mobile phones up from 180 million in 2004 and 340000 in 1985 By 2018 50 percent of the worlds mobile phones will be smart phones The US EPA reports that cur rently fewer than 10 percent of the 152 million cell phones discarded in the United States in 2010 were recycled US EPA 2011 and only 19 percent of all electronics Table 81 In the United States a number of states have enacted ewaste legislation To take an early example of this legislation California passed a bill in 2003 that charges consumers a fee for buying computer monitors or televisions and pays recyclers to dispose of the displays safely when users no longer want them Fees depend on the size of the monitor In 2009 the fee to dispose of a monitor smaller than 15 inches was 8 16 if the monitor was 1535 inches and 25 for monitors greater than 35 inches In 2004 California passed a bill that makes it Table 81 EWaste by Unit in 2010 Products Total disposed Trashed Recycled Recycling Rate Units Units Units Computers 51300000 31300000 20600000 40 Monitors 35800000 24100000 11700000 33 Hard copy devices 33600000 22400000 11200000 33 Keyboards and mice 82800000 74400000 7830000 10 Televisions 28500000 23600000 4940000 17 Mobile devices 152000000 135000000 17400000 11 TV peripherals Not included Not included Not included Not included Total in units 384000000 310000000 73700000 19 Whats included here Computer products include CPUs desktops and portables Hard copy devices are printers digital copiers scanners multifunctions and faxes Mobile devices are cell phones personal digital assistants PDAs smartphones and pagers Study did not include a large category of ewaste TV peripherals such as VCRs DVD players DVRs cablesatellite receivers converter boxes game consoles Disposed means going into trash or recycling These totals dont include products that are no longer used but which are still stored in homes and offices Source EPA Recyclable Resources 192 United States is shipped to China and other Asian countries They found that for China and India ewaste is rapidly growing from both domestic sources and illegal imports Kinnaman and Yokoo 2011 reported that levels of air toxins found in and around that ewaste dismantling facilities in China were the highest in the world However there is evidence that this trend is changing Developing countries are beginning to ship more ewaste to developed countries than they are importing Additionally some innovative funding mechanisms are incentivizing the support of recycling programs in the developing world The scrap is valuable but it is not without risk of environmental and human health impacts This toxic and environmental justice issue will be examined in more detail in Chapter 19 Pollution Damage Another situation influences the use of recycled and virgin ores When environmental damage results from extracting and using virgin materials and not from the use of recycled materials the market allocation will be biased away from recycling The damage might be experienced at the mine such as the erosion and aesthetic costs of strip mining or at the point of processing where the ore is processed into a usable resource Suppose that the mining industry was forced to bear the cost of this environmental damage What difference would the inclusion of this cost have on the scrap market The internalizing of this cost results in a leftward shift in the supply curve for the virgin ore This would in turn cause a leftward shift in the total supply curve The market would be using less of the resourcedue to higher pricewhile recycling more Thus the correct treatment of these environmental costs like disposal costs would tend to increase the role for recycling Disposal also imposes external environmental costs in the form of odors pests and contami nants leaching into water supplies obstruction of visual landscapes and so on Kinnaman and Fullerton 2000 note that while the number of landfills in the United States has been decreasing the aggregate capacity of these landfills has been increasing as smalltown facilities are replaced by large regional sanitary landfills Since local opposition from potential host communities is likely to rise with landfill size locating these facilities can be extremely contentious While governments now regulate landfills to protect public safety these regulations rarely eliminate all unpleasant aspects of these landfills for the host communities As a result many communities are all for the existence of these facilities as long as they are not located in their community If every community felt this way locating new facilities could be difficult if not impossible One technique for resolving this Not In My Back Yard NIMBY problem relies on the imposition of host fees Host fees compensate the local community and sometimes surrounding communities for accepting the location of a waste facility within their community This approach gives local communities veto power over the location but it also attempts to share the benefits of the regional facility in such a way that makes the net benefits sufficiently positive for them so the communities will accept the facility In one example Porter 2002 reports that a host fee agreement between Browning Ferris Industries and the township of Salem Michigan involves sharing with the town 25 percent of all landfill revenues and 4 percent of all compost revenues The town also shares in the revenues derived from the sale of landfill gases used for energy and it can use the site free of charge for all town refuse without limit on volume These benefits are estimated to be worth about 400 per person per year apparently enough to overcome local opposition Host fees are not a perfect resolution of the siting problem Note for example that the fact that Salem can dispose of its waste free of charge provides no incentive for source Recyclable Resources 193 reduction In addition it is important to ensure that locating these facilities does not raise environmental justice concerns Although we consider this issue in much greater depth in Chapter 19 let it suffice here to point out that at a minimum the local community has to be fully informed of the risks it will face from a regional sanitary landfill and must be fully empowered to accept or reject the proposed compensation package Additional complexities arise with hazardous wastes Because hazardous wastes are more dangerous to handle and to dispose of special polices have been designed to keep those dangers efficiently low These policies will also be treated in Chapter 19 Summary One of the most serious deficiencies in both our detection of scarcity and our ability to respond to scarcity is the failure of the market system to incorporate the various environmental costs of increasing resource use be they radiation or toxic hazards the loss of genetic diversity or aesthetics polluted air and drinking water or climate modification Without including these costs our detection indicators give falsely optimistic signals and the market makes choices that put society inefficiently at risk As a result while market mechanisms automatically create pressures for recycling and reuse that are generally in the right direction they are not always of the correct intensity Higher disposal costs and increasing scarcity of virgin materials do create a larger demand for recycling This is already evident for a number of products such as those containing copper or aluminum Yet a number of market imperfections tend to suggest that the degree of recycling we are currently experiencing is less than the efficient amount Artificially low disposal costs and tax breaks for ores combine to depress the role that old scrap can and should play Severance taxes could provide a limited if poorly targeted redress for some minerals One cannot help but notice that many of these problemssuch as pricing municipal disposal services and tax breaks for virgin oresresult from government actions Therefore it appears in this area that the appropriate role for government is selective disengagement complemented by some finetuning adjustments Disengagement is not the prescription however for environmental damage due to illegal disposal air and water pollution and strip mining When a product is produced from virgin materials rather than from recycled or reusable materials and the cost of any associated environmental damage is not internalized some government action may be called for The selective disengagement of government in some areas must be complemented by the enforcement of programs to internalize the costs of environmental damage The commonly heard ideological prescriptions suggesting that environmental problems can be solved either by ending government interference or by increasing the amount of government control are both simplistic The efficient role for government in achieving a balance between the economic and environmental systems requires less control in some areas and more in others and the form of that control matters Discussion Questions 1 Glass bottles can be either recycled crushed and remelted or reused The market will tend to choose the cheapest path Which factors will tend to affect the relative cost of these options Is the market likely to make the efficient choice Are the bottle bills passed by many of the states requiring deposits on bottles a move toward efficiency Why Recyclable Resources 194 2 Many areas have attempted to increase the amount of recycled waste lubricating oil by requiring service stations to serve as collection centers or by instituting depositrefund systems On what grounds if any is government intervention called for In terms of the effects on the waste lubrication oil market what differences should be noticed among those states that do nothing those that require all service stations to serve as collection centers and those that implement depositrefund systems Why 3 What are the incomedistribution consequences of fashion Can the need to be seen driving a new car by the rich be a boon to those with lower incomes who will ultimately purchase a better lowerpriced used car as a result SelfTest Exercises 1 Suppose a product can be produced using virgin ore at a marginal cost given by MC1 05q1 and with recycled materials at a marginal cost given by MC2 5 01q2 a If the inverse demand curve were given by p 10 05q1 q2 how many units of the product would be produced with virgin ore and how many units with recycled materials b If the inverse demand curve were p 20 05q1 q2 what would your answer be 2 When the government allows private firms to extract minerals offshore or on public lands two common means of sharing in the profits are bonus bidding and production royalties The former awards the right to extract to the highest bidder while the second charges a perton royalty on each ton extracted Bonus bids involve a single upfront payment while royalties are paid as long as minerals are being extracted a If the two approaches are designed to yield the same amount of revenue will they have the same effect on the allocation of the mine over time Why or why not b Would either or both be consistent with an efficient allocation Why or why not c Suppose the size of the mineral deposit and the future path of prices are unknown How do these two approaches allocate the risk between the mining company and the government 3 As societys cost of disposing of trash increases over time recycling rates should automatically increase as well Discuss 4 Suppose a town concludes that it costs on average 3000 per household to manage the disposal of the waste generated by households each year It is debating two strategies for funding this cost 1 requiring a sticker on every bag disposed of such that the total cost of the stickers for the average number of bags per household per year would be 30 or 2 including the 30 fee in each households property taxes each year a Assuming no illegal disposal which approach would tend to be more efficient Why b How would the possibility of rampant illegal disposal affect your answer Would a depositrefund on some large components of the trash help to reduce illegal disposal Why or why not What are the revenue implications to the town of establishing a depositrefund system Notes 1 Note the similarity of 11 a to the familiar multiplier used in introductory macroeconomics 11 MPC 2 httpsmineralsusgsgovmineralspubscommoditycoppermcs2017coppepdf Recyclable Resources 195 3 This is strictly true only when no uncertainty is associated with exploration 4 According to Figure 84 would 100 percent recycling normally be efficient Does that conclusion make sense to you Why or why not 5 The problem is not that 150 is too low indeed it may be too high The point is that the cost of waste disposal does not increase with the amount of waste to be disposed 6 Using economic analysis would you expect transients or residents to have a higher propensity to litter Why 7 httpsarchiveepagovepawastenonhazmunicipalwebpdfmsw2010factsheetpdf 8 A very strong demand for aluminum scrap was also influential In fact the price for aluminum scrap went so high in 1988 that pilferers were stealing highway signs and guardrails for their aluminum content 9 Many provinces and territories in Canada also have deposits on beverage containers www bottlebillorg 10 Adler 2016 wwwwiredcom201606banningplasticbagsgreatworldrightnotfast 11 wwwstatistacomstatistics274774forecastofmobilephoneusersworldwide 12 Details of each states program can be found at wwwelectronicsrecyclingorgpublicContent Pageaspxpageid14 13 wwwmainegovdeprwmewastemanufacturershtm 14 Ives 2014 In developing world a push to bring ewaste out of shadows Yale Environment 360 httpe360yaleedufeaturesindevelopingworldapushtobringewasteoutof shadows 15 USGS fact sheet 2007 wwwcbinsightscomresearchconsumertechacquisitionmergerdeals Further Reading Ferrara I Missios P 2012 A crosscountry study of household waste prevention and recycling Assessing the effectiveness of policy instruments Land Economics 884 710 744 Using a comprehensive householdlevel data set involving 10251 respondents from a crosssection of 10 countries Australia Canada Czech Republic France Italy Korea Mexico Netherlands Norway and Sweden this study examines waste policy recycling behavior and waste prevention Jenkins R Salvador R Martinez A Palmer K Podolsky M J 2003 The determinants of household recycling A materialspecific analysis of recycling program features and unit pricing Journal of Environmental Economics and Management 45 294318 This study examines a unique householdlevel data set representing middle and uppermiddleincome groups in 20 metropolitan statistical areas across the United States It contains information on the percentage recycled of five different materials glass bottles plastic bottles aluminum newspaper and yard waste Kellenberg D 2012 Trading wastes Journal of Environmental Economics and Management 64 6887 Using bilateral waste trade data and an index of environmental stringency for 92 countries this study finds compelling evidence that waste imports increase for a country whose environmental regulations deteriorate visàvis its trading partner implying that differences in environmental standards play an important role in international waste trade flows for some country pairs Kinnaman Thomas C 2016 Understanding the economics of waste Drivers policies and external costs International Review of Environmental and Resource Economics 834 281320 A thorough review of the literature since 2000 Kinnaman T C Fullerton D 2000 The economics of residential solid waste management In T Tietenberg H Folmer Eds The International Yearbook of Environmental and Resource Economics 20002001 Cheltenham UK Edward Elgar 100147 A comprehensive survey of the economic literature devoted to household solidwaste collection and disposal Recyclable Resources 196 Lifset R Atasu A Tojo N 2013 Extended producer responsibility National international and practical perspectives Journal of Industrial Ecology 172 162166 An introductory summary article of a special issue on extended producer responsibility The articles in this issue provide insights into how and why EPR has evolved into its current form and how it might evolve further Porter R C 2002 The Economics of Waste Washington DC Resources for the Future A highly readable thorough treatment of how economic principles and policy instruments can be used to improve the management of a diverse range of both business and household waste Tilton John E Guzmán Juan Ignacio 2016 Mineral Economics and Policy Reprint Edition Washington DC RFF Press This textbook provides an introduction to the field of mineral economics It covers the behavior of mineral commodity markets and assesses both public and corporate policies in this sector The focus is on metal and nonmetallic commodities rather than oil coal and other energy commodities Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 197 Water A Confluence of Renewable and Depletable Resources When the Wells Dry We Know the Worth of Water Benjamin Franklin Poor Richards Almanack 1746 Introduction To the red country and part of the gray country of Oklahoma the last rains came gently and they did not cut the scarred earth The sun flared down on the growing corn day after day until a line of brown spread along the edge of each green bayonet The clouds appeared and went away and in awhile they did not try anymore With these words John Steinbeck 1939 sets the scene for his powerful novel The Grapes of Wrath Drought and poor soil conservation practices combined to destroy the agricultural institutions that had provided nourishment and livelihood to Oklahoma residents since settlement in that area had begun In desperation those who had worked that land were forced to abandon not only their possessions but also their past Moving to California to seek employment they were uprooted only to be caught up in a web of exploitation and hopelessness Based on an actual situation the novel demonstrates not only how the social fabric can tear when subject to tremendous stress such as an inadequate availability of water but also how painful those ruptures can be1 Clearly problems such as these should be anticipated and prevented as much as possible Water is one of the essential elements of life Humans depend not only on an intake of water to replace the continual loss of body fluids but also on food sources that depend on water to survive This resource deserves special attention In this chapter we examine how our economic and political institutions have allocated this important resource in the past and how they might improve on its allocation in the future Chapter 9 Water 198 We initiate our inquiry by examining the likelihood and severity of water scarcity Turning to the management of our water resources we define the efficient allocation of ground and surface water over time and compare these allocations to current practice particularly in the United States Finally we examine the menu of opportunities for meaningful institutional reform The Potential for Water Scarcity The earths renewable supply of water is governed by the hydrologic cycle a system of continuous water circulation see Figure 91 Enormous quantities of water are cycled each year through this system though only a fraction of circulated water is available each year for human use Of the estimated total volume of water on earth only 25 percent 14 billion km3 of the total volume is freshwater Of this amount only 200000 km3 or less than 1 percent of all freshwater resources and only 001 percent of all the water on earth is available for human consumption and for ecosystems Gleick 2000 If we were simply to add up the available supply of freshwater total runoff on a global scale and compare it with current consumption we would discover that the supply is currently about ten times larger than consumption Though comforting that statistic is also misleading because it masks the impact of growing demand and the rather severe scarcity situation that already exists in certain parts of the world Taken together these insights suggest that in many areas of the world including parts of Africa China and the United States water scarcity is Figure 91 The Hydrologic Cycle Source Council on Environmental Quality 1981 Environmental Trends Washington DC Government Printing Office p 210 Water 199 already upon us Does economics offer potential solutions As this chapter demonstrates it can but implementation is sometimes difficult Available supplies are derived from two rather different sourcessurface water and groundwater As the name implies surface water consists of the freshwater in rivers lakes and reservoirs that collects and flows on the earths surface Groundwater by contrast collects in porous layers of underground rock known as aquifers Though some groundwater is renewed by percolation of rain or melted snow most was accumulated over geologic time and because of its location cannot be recharged once it is depleted According to the UN Environment Program 2002 90 percent of the worlds readily available freshwater resources is groundwater And only 25 percent of this is available on a renewable basis The rest is a finite depletable resource In 2010 water use in the United States was approximately 355 billion gallons per day While this might sound like a lot it is actually 13 percent less than it was in 2005 Of the freshwater withdrawals approximately 76 billion gallons per day came from groundwater Water withdrawals both surface and groundwater vary considerably geographically Figure 92 shows how surface and groundwater withdrawals for the United States vary by state California Texas Arizona and Florida are the states with the largest groundwater withdrawals Thermoelectric power and irrigation are the two largest users of water in the United States accounting for approximately 90 percent of water withdrawn2 The southwestern United States suffers from chronic water shortages Tucson Arizona demonstrates how some Western communities attempt to cope Tucson which averages about 11 inches of rain per year was until the completion of the Central Arizona Project which diverts water from the Colorado River the largest city in the United States to rely entirely on groundwater Tucson annually pumped five times as much water out of the ground as nature put back in The water levels in some wells in the Tucson area had dropped over 100 feet At those consumption rates the aquifers supplying Tucson would have been exhausted in less than 100 years Despite the rate at which its water supplies were being depleted Tucson continued to grow at a rapid rate To head off this looming gap between increasing water consumption and declining supply a giant network of dams pipelines tunnels and canals known as the Central Arizona Project was constructed to transfer water from the Colorado River to Phoenix and Tucson The project took over 20 years to build and cost 4 billion While this project has a capacity to deliver Arizonas 28 million acrefoot share of the Colorado River negotiated by Federal Interstate Compact it is still turning out to not be enough water for Phoenix and Tucson3 Some of this water is being pumped underground in an attempt to recharge the aquifer While water diversions were frequently used to bring additional water to water stressed regions in the West they are increasingly unavailable as a policy response to water scarcity Globally access to clean water is a growing problem Over 1 billion people lack access to clean drinking watermore than half of those people are in Asia4 Relocation of rivers to rapidly growing urban areas is also creating local water shortages China for example built a huge diversion project to help ensure water supply at the 2008 summer Olympics Water demand for agriculture is stripping the supply of groundwater around the world Figure 93 illustrates groundwater aquifers important for farming under stress worldwide Mascarelli 2012 Water demand for energy including fracking is growing at an alarming rate The International Energy Agency predicts that water demand for energy could double by 2035 from 2010 levels to 135 billion cubic meters or four times the size of the largest reservoir in the United States Lake Mead That amount is also equal to the amount of household water Water 200 consumed in the United States over a threeyear period Lavelle Grose 2013 International Energy Agency 20125 Water quality is also a problem Worldwide 24 billion people do not have access to sanitation facilities Much of the available water is polluted with chemicals radioactive Figure 92 Estimated Use of Water in the United States in 2010 Including Surface Water and Groundwater Withdrawals Source United States Geological Survey USGS 2010 Retrieved from httpspubsusgs govcirc1405pdfcirc1405pdf Figure 93 Map of Major Groundwater Aquifers and Areas of Groundwater Stress Water 202 materials salt or bacteria We shall reserve a detailed look at the water pollution problem for Chapter 18 but it is important to keep in mind that water scarcity has an important qualitative dimension that further limits the supply of potable water Depletion and contamination of water supplies are not the only problems Excessive withdrawal from aquifers is a major cause of land subsidence a gradual settling or sudden sinking of the earths surface owing to subsurface movement of the earths materials in this case water Land subsidence has caused millions of dollars in damages in states including California Texas and Florida More than 80 percent of land subsidence in the United States has been caused by human impacts on groundwater6 In Mexico City land has been subsiding at a rate of 1 to 3 inches per year The city has sunk 30 feet over the last century The Monumento a la Independencia built in 1910 to celebrate the hundredth anniversary of Mexicos War of Independence now needs 23 additional steps to reach its base Mexico City with its population of approximately 20 million is facing large water problems Not only is the city sinking but with an average population growth of 350000 per year the city is also running out of water Rudolph 2001 Phoenix Arizona discovered that a section of the canal that carries 80 percent of Central Arizona Project water from the Colorado River has been subsiding reducing the capacity of the canal by approximately 20 percent In a shortterm response the lining of the canal was raised over a 1mile segment As a longerterm response Arizona has been injecting groundwater aquifers with surface water to replenish the groundwater tables and to prevent further land subsidence This process called artificial recharge has also been used in other locations to store excess surface water and to prevent saltwater intrusion but subsidence continues to adversely impact the Project7 What this brief survey of the evidence suggests is that in certain parts of the world groundwater supplies are being depleted to the potential detriment of future users Supplies that for all practical purposes will never be replenished are being mined to satisfy current needs Once used they are gone Is this allocation efficient or are there demonstrable sources of inefficiency Answering this question requires us to be quite clear about what is meant by an efficient allocation of surface water and groundwater The Efficient Allocation of Scarce Water In defining the efficient allocation of water distinguishing whether surface water or groundwater is being tapped is crucial In the absence of storage the allocation of surface water involves distributing a fixed renewable supply among competing users Intergenerational effects are less important because future supplies depend on natural phenomena such as precipitation rather than on current withdrawal practices For groundwater on the other hand withdrawing water now does affect the resources available to future generations In this case the allocation over time is a crucial aspect of the analysis Because it represents a somewhat simpler analytical case we shall start by considering the efficient allocation of surface water Surface Water An efficient allocation of surface water must 1 strike a balance among a host of competing users and 2 supply an acceptable means of handling the yeartoyear variability in water flow The former issue is acute because so many different potential users have legitimate competing claims Some such as municipal drinkingwater suppliers or farmers withdraw Water 203 the water for consumptive use while others such as swimmers or boaters use the water but do not consume it The variability challenge arises because surface water supplies are not constant from year to year or month to month Since precipitation runoff and evaporation all change from year to year in some years less water will be available for allocation than in others Not only must a system be in place for allocating the average amount of water but also aboveaverage and belowaverage flows must be anticipated and allocated With respect to allocating among competing users the dictates of efficiency are quite clearthe water should be allocated so that the marginal net benefit is equalized for all uses Remember that the marginal net benefit is the vertical distance between the demand curve for water and the marginal cost of extracting and distributing that water for the last unit of water consumed To demonstrate why efficiency requires equal marginal net benefits consider a situation in which the marginal net benefits are not equal Suppose for example that at the current allocations the marginal net benefit to a municipal user is 2000 per acrefoot while the marginal net benefit to an agricultural user is 500 per acrefoot If an acrefoot of water were transferred from the farm to the city the farm would lose marginal net benefits of 500 but the city would gain 2000 in marginal net benefits Total net benefits from this transfer would rise by 1500 Since marginal net benefits fall with use the new marginal net benefit to the city after the transfer will be less than 2000 per acrefoot and the marginal net benefit to the farmer will be greater than 500 a smaller allocation means moving up the marginal net benefits curve but until these two are equalized we can still increase net benefits by trans ferring water Because net benefits are increased by this transfer the initial allocation could not have maximized net benefits Since an efficient allocation maximizes net benefits any allocation that fails to equalize marginal net benefits cannot be efficient The bottom line is that if marginal net benefits have not been equalized it is always possible to increase net benefits by transferring water from those users with low net marginal benefits to those with higher net marginal benefits By transferring the water to the users who value the marginal water more the total net benefits of the water use are increased those losing water are giving up less than those receiving the additional water are gaining When the marginal net benefits are equalized no such transfer is possible without lowering net benefits This concept is depicted in Figure 94 Consider a water supply represented by ST where the amount of water available is QT Suppose there are two different users represented by marginal net benefit curve A and marginal net benefit curve B8 These could be a municipality A and an irrigation district B In this figure the municipality has higher demand higher willingness to pay The total aggregate marginal net benefit is the horizontal sum of the two demand curves What is the efficient allo cation of water across these two users with different marginal values for water The optimal allocation is where demand MNBa MNBB equals the total supply of water At that price the optimal allocation occurs where MNB the price or QA and QB Thus the efficient alloca tion would give Q A to user A the municipality and Q B to user B9 For the optimal allocation notice that the marginal net benefit is equal for the two users This allocation maximizes total net benefits or the area under the two demand curves up to their allocation of water Suppose instead however that the state or water authority decides for equity or political reasons to simply divide the available water equally between the two users giving each an amount QA QB ½ QT Can you see how this is inefficient This allocation would result in different marginal net benefits for each user If marginal net benefit is not equalized then we havent maximized net benefits Notice also that the marginal net benefit for both users is positive in Figure 94 This implies that water sales should involve a positive marginal scarcity rent Could we draw Water 204 the diagram so that the marginal net benefit and hence marginal scarcity rent would be zero How Marginal scarcity rent would be zero if water were not scarce If the availability of water as presented by the supply curve was greater than the amount represented by the point where the aggregate marginal net benefit curve intersects the axis water would not be scarce Both users would get all they wanted their demands would not be competing with one another Their marginal net benefits would still be equal but in this case they would both be zero Now lets consider the second problemdealing with fluctuations in supply As long as the supply level can be anticipated the equal marginal net benefit rule still applies but different supply levels may imply very different allocations among users This is an important attribute of the problem because it implies that simple allocation rules such as each user receiving a fixed proportion of the available flow or highpriority users receiving a guaranteed amount are not likely to be efficient Suppose now that we use the same graph in a different way Suppose in this case the total water supply is equal to ½ ST How should the lower water supply be efficiently allocated between the two users The answer is that the first user would get it all Do you see why With ½ ST use B receives no water while use A receives it all since As willingness to pay is everywhere higher than Bs Why does the efficient allocation change so radically between ST and ½ ST The answer lies in the shape of the two demand curves for water The marginal net benefit curve for water in use A lies above that for B implying that as supplies diminish the cost the forgone net benefits of doing without water is much higher for A than for B To minimize this cost more of the burden of the shortfall is allocated to B than A In an efficient allocation users who can most easily find substitutes or conserve water receive proportionately smaller allocations when supplies are diminished than those who have few alternatives In practice this can be handled using a spot market Zarnikau 1994 Groundwater Extending this analysis to encompass groundwater requires that the depletable nature of groundwater supplies be explicitly taken into account When withdrawals exceed recharge Figure 94 The Efficient Allocation of Surface Water Water 205 from a particular aquifer the resource will be mined over time until either supplies are exhausted or the marginal cost of pumping additional water becomes prohibitive The similarity of this case to the increasingcost depletable resource model discussed in Chapter 6 allows us to learn something about the efficient allocation of groundwater over time The first transferable implication is that a marginal user cost is associated with mining groundwater reflecting the opportunity cost associated with the unavailability in the future of any unit of water used in the present An efficient allocation considers this user cost When the demand curve is stable over time not shifting out due to population or income increases the efficient extraction path involves temporally declining use of groundwater The marginal extraction cost the cost of pumping the last unit to the surface would rise over time as the water table fell Pumping would stop either when 1 the water table ran dry or 2 the marginal cost of pumping was either greater than the marginal benefit of the water or greater than the marginal cost of acquiring water from some other source Abundant surface water in proximity to the location of the groundwater could serve as a substitute for groundwater effectively setting an upper bound on the marginal cost of extraction The user would not pay more to extract a unit of groundwater than it would cost to acquire another source of water Unfortunately in many parts of the world where groundwater overdrafts are particularly severe the competition for surface water is already keen a cheap source of surface water doesnt exist In efficient groundwater markets the water price would rise over time The rise would continue until the point of exhaustion the point at which the marginal pumping cost becomes prohibitive or when the marginal cost of pumping becomes equal to the nextleastexpensive source of water At that point the marginal pumping cost and the price would be equal In all three cases the net price the difference between the price of the water and the marginal extraction cost would decline over time reaching zero at the switch point if a substitute were available or the point of exhaustion if it were not In some regions groundwater and surface water supplies are not physically separate For example due to the porous soils in the Arkansas River Valley groundwater withdrawals in the region affect surface water flows near the ColoradoKansas border Bennett 2000 Lack of conjunctive use management led the State of Kansas to sue the State of Colorado for depleted surface water flows at the border Conjunctive use refers to the combined management of surface and groundwater resources to optimize their joint use and to minimize adverse effects of excessive reliance on a single source The hydrologic nature of the water source must be taken into consideration when designing a water allocation scheme if transboundary conflicts like this are to be avoided The Current Allocation System in the United States Regardless of source economically efficient allocations have not resulted for most water sharing situations due to the legal and institutional frameworks governing water resources Complicated laws governing allocation and reallocation prevents water from moving to its highest valued use Riparian and Prior Appropriation Doctrines Within the United States the means of allocating water differ from one geographic area to the next particularly with respect to the legal doctrines that govern conflicts In this section we focus on the allocation systems that prevail in the arid Southwest which must cope with the most potentially serious and imminent scarcity of water Water 206 In the earliest days of settlement in the American Southwest and West the government had a minimal presence Residents were pretty much on their own in creating a sense of order Property rights played a very important role in reducing conflicts in this potentially volatile situation As water was always a significant factor in the development of an area the first settlements were usually oriented near bodies of water The property rights that evolved called riparian rights allocated the right to use the water to the owner of the land adjacent to the water This was a practical solution because by virtue of their location these owners had easy access to the water Furthermore enough sites provided access to water that virtually all who sought water could be accommodated With population growth and the consequent rise in the demand for land this allocation system became less appropriate As demand increased the amount of land adjacent to water became scarce forcing some spillover onto land that was not adjacent to water The owners of this land began to seek means of acquiring water to make their land more productive About this time with the discovery of gold in California mining became an important source of employment With the advent of mining came a need to divert water away from streams to other sites Unfortunately riparian property rights made no provision for water to be diverted to other locations The rights to the water were tied to the land and could not be separately transferred As economic theory would predict this situation created a demand for a change in the property rights structure from riparian rights to one that was more congenial to the need for transferability The waste resulting from the lack of transferability became so great that it outweighed any transition costs of changing the system of property rights The evolution that took place in the mining camps became the forerunner of what has become known as the prior appropriation doctrine The miners established the custom that the first person to arrive had the superior or senior claim on the water Later claimants hold junior or subordinate claims In practice this severed the relationship that had existed under the riparian doctrine between the rights to land and the rights to water As this new doctrine became adopted in legislation court rulings and seven state constitutions widespread diversion of water based on prior appropriation became possible Stimulated by the profits that could be made in shifting water to more valuable uses private companies were formed to construct irrigation systems and to transport water from surplus to deficit areas Agriculture flourished Although prior to 1860 the role of the government was rather minimal it began to changeslowly at first but picking up momentum as the twentieth century began The earliest incursions involved establishing the principle that the ownership of water properly lay with the state Claimants were accorded a right to use known as a usufructuary right rather than an ownership right The establishment of this principle of public ownership was followed in short order by the establishment of state control over the rates charged by the private irrigation companies by imposing restrictions on the ability to transfer water out of the district and by creating a centralized bureaucracy to administer the process A usufructuary right also means that some of the water withdrawn may be owned by someone else down stream since consumptive uses rarely use all water withdrawn For irrigated agriculture for example crops absorb some of the water some evaporates and the rest finds its way back into the river basin This was only the beginning The demand for land in the arid West and Southwest was still growing creating a complementary demand for water to make the desert bloom The tremendous profits to be made from largescale water diversion created the political climate necessary for federal involvement Water 207 The federal role in water resources originated in the early 1800s largely out of concern for the nations regional development and economic growth Toward these ends the federal government built a network of inland waterways to provide transportation Since the Reclamation Act of 1902 the federal government has built almost 700 dams to provide water and power to help settle the West To promote growth and regional development the federal government has paid an average of 70 percent of the combined construction and operating costs of such projects leaving states localities and private users to carry the remaining 30 percent Such subsidies have even been extended to cover some of the costs of providing marketable water services For example according to a 1996 General Accounting Office report irrigators were repaying only approxi mately 47 cents for every dollar of construction costs Interestfree loans and cheap water are additional subsidies Farmers using Central Valley Project water pay approximately 17 per acrefoot of water while urban users pay up to 10 times that amount While the size of these subsidies may on the surface seem enormous the regional benefits are still large enough to allow some projects like the Central Valley Project to pass a benefitcost test Recall the accounting stance from Chapter 3 This in a nutshell is the current situation for water in the southwestern United States Both the state and federal governments play a large role State laws vary considerably especially with respect to groundwater withdrawal and the role of instream flows Though the prior appropriation doctrine stands as the foundation of this allocation system it is heavily circumscribed by government regulations and direct government appropriation of a substantial amount of water Sources of Inefficiency The current system is not efficient The primary source of inefficiency involves restrictions that have been placed on water transfers preventing their gravitation to the highestvalued use though other sources such as charging inefficiently low prices must bear some of the responsibility Restrictions on Transfers To achieve an efficient allocation of water the marginal net benefits would have to be equalized across all uses including nonconsumptive instream uses of the water Figure 94 With a wellstructured system of water property rights efficiency can be a direct result of the transferability of the rights Users receiving low marginal net benefits from their current allocation would trade their rights to those who would receive higher net benefits Both parties would be better off The payment received by the seller would exceed the net benefits forgone while the payment made by the buyer would be less than the value of the water acquired Unfortunately the existing mixed system of prior appropriation rights coupled with quite restrictive federal and state laws has diminished the degree of transferability that can take place Diminished transferability in turn reduces the market pressures toward equalization of the marginal net benefits By itself this indictment is not sufficient to demonstrate the inefficiency of the existing system If it could be shown that this regulatory system were able to substitute some bureaucratic process for finding and maintaining this equalization efficiency would still be possible Unfortunately that has not been the case as can be seen by examining in more detail the specific nature of these restrictions The allocation is inefficient One of the earliest restrictions required users to fully exercise their water rights or else they would lose them The principle of beneficial use was typically applied to offstream consumptive uses It is not difficult to see what this use it or lose it principle does to the Water 208 incentive to conserve Particularly careful users who at their own expense discovered ways to use less water would find their allocations reduced accordingly The regulations strongly discouraged conservation A second restriction known as preferential use attempts to establish bureaucratically a value hierarchy of uses With this doctrine the government attempts to establish allocation priorities across categories of water Within categories irrigation for agriculture for example the priority is determined by prior appropriation first in timefirst in right but among categories the preferentialuse doctrine governs The preferentialuse doctrine supports three rather different kinds of inefficiencies First it substitutes a bureaucratically determined set of priorities for market priorities resulting in a lower likelihood that marginal net benefits would be equalized Second it reduces the incentive to make investments that complement water use in lowerpreference categories for the simple reason that their water could be involuntarily withdrawn as the needs in higher level categories grow Finally it allocates the risk of shortfalls in an inefficient way Although the first two inefficiencies are rather selfevident the third merits further explanation Because water supplies fluctuate over time unusual scarcities can occur in any particular year With a wellspecified system of property rights damage caused by this risk would be minimized by allowing those most damaged by a shortfall to purchase a larger share of the diminished amount of water available during a drought from those suffering less from the shortfall By diminishing and in some cases eliminating the ability to transfer rights from socalled high preferential use categories to lower preferential use categories during times of acute need the damage caused by shortfalls is higher than necessary In essence the preferentialuse doctrine fails to adequately consider the marginal damage caused by temporary shortfalls something a wellstructured system of property rights would do automatically Another factor that makes water difficult to transfer is the fact that only a portion of the water withdrawn from a stream is typically consumed As long as the withdrawal gets put to a use in the same river basin a portion of that water returns to the stream eventually in the form of return flow Crops grown with irrigated water for example use only a portion of water put on the field called the consumptive use portion The remainder either evaporates or flows through the soil eventually finding its way back to the original water source such as a river or irrigation ditch Typically a farmer or another user downstream owns the right to this return flow Since transfers of water cannot as a matter of law adversely affect a downstream owner of that water water courts in the Southwest are very busy and cases can take several years before a ruling is issued Inhibiting transfers has very practical implications Due to low energy costs and federal subsidies agricultural irrigation became the dominant use of water in the West Yet the marginal net benefits from agricultural uses are lower sometimes substantially lower than the marginal net benefits of water use by municipalities and industry A transfer of water from irrigated agriculture to these other uses would raise net benefits It is therefore not surprising that transfers from agriculture to municipalities are becoming more common Federal Reclamation Projects and Agricultural Water Project Subsidies By providing subsidies to approved projects federal reclamation projects have diverted water to these projects even when the net benefits were negative Why was this done What motivated the construction of inefficient projects Some early work by Howe 1986 provides a possible explanation He examined the benefits and costs of constructing the Big Thompson Project in northeastern Colorado With this project the water is pumped to an elevation that allows it to flow through a tunnel to the Water 209 eastern side of the mountains On that side electric power is produced at several points At lower elevations the water is channeled into natural streams and feeder canals for distribution to irrigation districts and frontrange cities Howe calculated that the national net benefits for this project which include all benefits and costs were either 3414 million or 2370 million depending on the number of years included in the calculations The project cost substantially more to construct than it returned in benefits However regional net benefits for the geographic region served by the facility were strongly positive 7669 million or 1187 million respectively This facility was an extra ordinary boon for the local area because a very large proportion of the total cost had been passed on to national taxpayers The local political pressure was sufficient to secure project approval despite its inherent inefficiency This study is still one of the few that looks at costs and benefits ex post or after the project was completed While the very existence of these facilities underwritten by the federal government is a source of inefficiency the manner in which the water is priced is another The subsidies have been substantial Frederick 1989 reported on some work done by the Natural Resources Defense Council to calculate the subsidies to irrigated agriculture in the Westlands Water District one of the worlds richest agricultural areas located on the west side of Californias San Joaquin Valley The Westlands Water District paid about 1012 per acrefoot less than 10 percent of the unsubsidized cost of delivering water to the district The resulting subsidy was estimated to be 217 per irrigated acre or 500000 per year for the averagesized farm Municipal and Industrial Water The prices charged by water distribution utilities do not promote efficiency of use either Both the level of prices and the rate structure are at fault In general the price level is too low and the rate structure does not adequately reflect the costs of providing service to different types of customers Water utilities apply a variety of fees and charges to water Some are better at reflecting cost than others Water fees and charges reflect the costs of storage treatment and distribution of the water to customers Rarely however does the rate reflect the actual value of water In part perhaps because water is considered an essential commodity the prices charged by public water companies are typically too low For surface water the rates are too low for two rather distinct reasons 1 historic average costs are used to determine rates and 2 marginal scarcity rent is rarely included Efficient pricing requires the use of marginal not average cost In order to adequately balance conservation with use the customer should be paying the marginal cost of supplying the last unit of water Yet regulated utilities are typically allowed to charge prices just high enough to cover the costs of running the operation as revealed by figures from the recent past Water utilities are capital intensive with very large fixed costs in the short run This means that shortrun average costs will be falling implying a marginal cost that falls below average cost In this circumstance marginalcost pricing would cause the utility to fail to generate enough revenue to cover costs Can you see why Circumstances may be changing however Now longrun costs may be rising since new supplies are typically much more expensive to develop and the old supplies are limited by their fixed capacity The second source of the problem is the failure of regulators overseeing the operations of water distribution companies to allow a scarcity rent to be incorporated in the calculation of the appropriate price a problem that is even more severe when groundwater is involved For a nonrenewable resource an efficient price should equal marginal cost plus marginal user cost recall the twoperiod model from Chapter 5 One study found that due to a failure to include a user cost rates in Tucson Arizona were about 58 percent too low at that time Water 210 despite recent increases Martin Kulakowski 1991 Debate 91 illustrates the inconsistencies in both agricultural and municipal pricing Both low pricing and ignoring the marginal scarcity rent promote an excessive demand for water Simple actions such as fixing leaky faucets or planting nonnative lawn grasses are easy to overlook when water is excessively cheap Yet in a city such as New York leaky faucets can account for a significant amount of wasted water Instream Flows Conflicts between offstream and instream uses of water are not uncommon Since instream flows are nonconsumptive uses instream flows are not covered by traditional prior appropriation rights What Is the Value of Water As mentioned earlier in this chapter the ColoradoBig Thompson CBT Project moves water from the Colorado River to the eastern slope of Colorado The Northern Colorado Conservancy District distributes the approximately 250000 acrefeet of water per year to irrigators towns cities and industries in northeastern Colorado Irrigators with original rights pay approximately 350 per share A share is on average 07 acrefoot per year Cities pay approximately 7 per share if they hold original rights Shares of CBT water are transferable and are actively traded in the district Market prices have been at a minimum of 1800 per share which translates to approximately 2600 per acrefoot for perpetual supply or about 208 per year using an 8 percent discount rate Prices have also risen as high as 22000 per share Additionally water is available for rent for users who want to sell or buy water on a 1year basis As you would expect those prices tend to be much lower and frequently range from 750 to 25 per acrefoot The cities that use the water charge a variety of prices to their customers Boulder utilizes an increasing block rate structure with an initial block at 319 per thousand gallons for the first zero to 60 percent of the average monthly water budget 425 per thousand gallons for the next 61 to 100 percent 850 per thousand gallons for 101 percent to 150 percent 1275 for 151 percent to 200 percent and 2125 for any usage over 200 percent of the average monthly water budget Ft Collins has some unmetered customers who pay a fixed monthly fee but no marginal cost for additional use Its metered customers pay a fixed charge of 1499 plus water charges determined by an increasing block rate In the first block the charge is 273 per thousand gallons for the first 8000 gallons 357 per thousand gallons for the usage between 8001 and 15000 gallons The highest block rate in Ft Collins is 440 for users consuming more than 15000 gallons per month Longmont has both metered and unmetered customers and utilizes an increasing block rate for its residential customers and a decreasing block rate for its small commercial customers DEBATE 91 Water 211 Consider an important historical case In 2001 the federal government cut off water to farmers in the Klamath River Basin to protect threatened coho salmon which are protected under the Federal Endangered Species Act Farmers responded by forcing open irrigation gates and forming a bucket brigade to dump water on their fields Secretary of the Interior Gale Norton subsequently decided to resume the traditional diversion of water to the more than 1400 farmers using Klamath River water Six months later a huge fish kill estimated to be at least 35000 salmon was blamed on the low flows in the river This dispute which continues to this day provides an illustration of one type of problem that can arise with the current legal and institutional structures governing water resources Without formal recognition of instream flow rights the value of species including salmon cannot be properly incorporated into the allocation decision The presumption would probably be that diverting water to protect species necessarily lowers measured net benefits but that is not always the case A study on the Rio Grande River in New Mexico found that diverting water from upstream agriculture in order to provide minimum instream flows for an endangered minnow species increased net benefits by making more water available for highvalued downstream uses Ward Booker 2003 Other studies have found the recreational value of water another instream use to be higher than that for irrigation water Common Property or OpenAccess Problems The allocation of groundwater must confront one additional problem When many users tap the same aquifer that aquifer can become an openaccess resource Tapping an openaccess resource will tend to deplete it too rapidly users lose the incentive to conserve The marginal scarcity rent will be ignored The incentive to conserve a groundwater resource in an efficient market is created by the desire to prevent pumping costs from rising too rapidly and the desire to capitalize on the higher prices that could reasonably be expected in the future With openaccess resources neither of these desires translates into conservation for the simple reason that water conserved Economic theory not only makes clear that the marginal net benefits for all uses and users of a given water project should be equal but also that the common marginal net benefit metric provides a useful indication of the value of the marginal water unit to all users of this resource What do we make of the huge variation in these prices From an efficiency perspective the only difference in observed prices should be a difference in the marginal cost of delivering water to those customers since marginal net benefit should be the same for all users The prices from the CBT project exhibit much more variation than could be explained by marginal conveyance cost so they clearly are not only inefficient but they are also sending very mixed signals about the value of this water Source Howe C 1998 Forms and functions of water pricing An overview In D D Baumann J J Boland W M Hanneman Eds Urban Water Demand Management and Planning New York McGrawHill 181191 Rate information from the cities of Boulder Longmont and Ft Collins Colorado and the Northern Colorado Conservancy District 2004 Updated prices and rates from wwwwatercoloradocom and https bouldercoloradogovwaterutilityrates Accessed January 2018 Water 212 by one party may simply be used by someone else because the conserver has no exclusive right to the water that is saved Water saved by one party to take advantage of future higher prices can easily be pumped out by another user before the higher prices ever materialize For openaccess resources economic theory suggests several direct consequences Pumping costs would rise too rapidly initial prices would be too low and too much water would be consumed by the earliest users The burden of this waste would not be shared uniformly Because the typical aquifer is bowl shaped users on the periphery of the aquifer would be particularly hardhit When the water level declines the edges go dry first while the center can continue to supply water for substantially longer periods Future users would also be hardhit relative to current users For coastal aquifers salt water intrusion is an additional potential cost of pumping out the aquifer too rapidly Remedies and Reforms Agricultural Water Pricing Getting the prices right would be one avenue for achieving efficiency Recognizing the inefficiencies associated with subsidizing the consumption of a scarce resource the US Congress passed the Central Valley Project Improvement Act in 1992 The act raises prices that the federal government charges for irrigation water though the fullcost rate is imposed only on the final 20 percent of water received Collected revenues will be placed in a fund to mitigate environmental damage in the Central Valley The act also allows water transfers to new uses Dinar et al 2004 review and evaluate actual pricing practices for irrigation water in developing countries Table 91 summarizes their findings with respect to both the types and properties of pricing systems they discovered As the table reveals they found some clear tradeoffs between what efficiency would dictate and what was possible given the limited information available to water administrators Twopart charges and volumetric pricing while quite efficient require information on the amount of water used by each farmer and are rarely used in developing countries The two part charge combines volume pricing with a monthly fee that doesnt vary with the amount of water consumed The monthly fee is designed to help recover fixed costs Individualuser water meters can provide information on the volume of water used but they are relatively expensive Output pricing where the charge for water is linked to agricultural output not water use on the other hand is less efficient but only requires data on each water users production Input based pricing is even easier because it doesnt require monitoring either water use or output Under input pricing irrigators are assessed taxes or fees on waterrelated inputs such as a perunit charge on fertilizer Blockrate or tiered pricing is most common when demand has seasonal peaks Tiered pricing examples can be found in Israel and California Area pricing is probably the easiest to implement since the only information necessary is the amount of irrigated land and the type of crop produced on that land Although this method is the most common it is not efficient since the marginal cost of extra water use is zero Dinar et al 2004 propose a set of water reforms for developing countries including pricing at marginal cost where possible and using blockrate prices to transfer wealth between water suppliers and farmers This strategy would put the burden of fixed costs on the relatively wealthier urban populations who would in turn benefit from less expensive food For water distribution utilities the traditional practice of recovering only the costs of distributing water and treating the water itself as a free good should be abandoned Instead utilities should adopt a pricing system that reflects increasing marginal cost and that includes Water 213 a scarcity value for groundwater Scarce water is not in any meaningful sense a free good Only if the user cost of that water is imposed on current users will the proper incentive for conservation be created and the interests of future generations of water users be preserved Municipal Water Pricing Including this user cost in water prices is rather more difficult than it may first appear Water utilities are typically regulated because they have a monopoly in the local area One typical requirement for the rate structure of a regulated monopoly is that it earns only a fair rate of return Excess profits are not permitted Charging a uniform price for water to all users where the price includes a user cost would generate profits for the seller Recall the discussion of scarcity rent in Chapter 2 The scarcity rent accruing to the seller as a result of incorporating the user cost would represent revenue in excess of operating and capital costs Due to high fixed costs these natural monopolies typically have falling average costs over a significant portion of their production Water utilities have a variety of options to choose from when charging their customers for water knowing they need to balance pricing with revenue stability and water conservation in some cities Figure 95 illustrates the most common volumebased price structures Some utilities still use a flat fee which from a scarcity point of view is the worst possible form of pricing Since a flat fee is not based on volume the marginal cost of additional water consumption is zero ZERO Water use by individual customers is not even metered While more complicated versions of a flatfee system are certainly possible they do not solve the incentivetoconserve problem At least up until the late 1970s Denver Colorado used eight different factors including number of rooms number of persons and number of bathrooms to calculate the monthly bill Despite the complexity of this billing system because the amount of the bill was unrelated to actual volume used water use was not metered the marginal cost of additional water consumed was still zero Volumebased price structures require metering and some include a fixed fee plus the consumptionbased rate and some may include minimum consumption Three common types Table 91 Pricing Methods and their Properties Pricing Scheme Characteristics First Best Volumetric Difficult to implement by easy to control demand Tiered Block Rates Less difficult to implement somewhat easy to control demand TwoPart Pricing Same as tiered rates but longer time horizon to efficiency Water Markets Extremely difficult to implement SecondBest Output Relatively easy to implement somewhat easy to control demand Input Easy to implement somewhat easy to control demand None Per Area Easiest to implement not efficient hard to control demand Source Adapted from Dinar et al 2004 Water 214 of volumebased structures are uniform or linear or flat rates declining block rates and inverted increasing block rates Figure 95 Uniform or flatrate pricing structures are extremely common due to their simplicity Charging customers a flat marginal cost for all levels of consumption suggests that the Figure 95 Overview of the Various Variable Charge Rate Structures Source Four examples of consumption charge models from water rate structures in Colorado How Colorado cities compare in using this important water use efficiency tool September 2004 p 8 by Colorado Environmental Coalition Western Colorado Congress and Western Resource Advocates Copyright 2004 by Western Resource Advocates Reprinted with permission Water 215 marginal cost of providing water is constant Although this rate does incorporate the fact that the marginal cost of water is not zero it is still inefficient Decliningblockrate pricing has historically been much more prevalent than increasing block pricing Declining block rates were popular in cities with excess capacities especially in the eastern United States because they encouraged higher consumption as a means of spreading the fixed costs more widely Since utilities with excess capacity are typically natural monopolies with high fixed costs decreasing block rates reflect the decreasing average and marginal costs of this industry structure Additionally municipalities attempting to attract business may find this rate appealing However as demand rises with population growth or increased use costs will eventually rise not fall with increased use and this rate is inefficient By charging customers a higher marginal cost for low levels of water consumption and a lower marginal cost for higher levels regulators are also placing an undue financial burden on lowincome people who consume little water and confronting highincome people with a marginal cost that is too low to provide adequate incentives to conserve As such many cities have moved away from a decreasingblockrate structure Tables 92 and 93 One way that water utilities are attempting to respect the rate of return requirement while promoting water conservation is through the use of an inverted increasing block rate Under this system the price per unit of water consumed rises as the amount consumed rises This type of structure encourages conservation by ensuring that the marginal cost of consuming additional water is high At the margin where the consumer makes the decision of how much extra water to use quite a bit of money can be saved by being frugal with water use However it also holds revenue down by charging a lower price for the first units consumed This has the added virtue that those who need some water but cannot afford the marginal price paid by more extravagant users can have access to water without placing their budget in as much jeopardy as would be the case with a uniform price For example in Durban South Africa the first block is actually free Loftus 2005 Many utilities base the first block on average winter indoor use As long as the quantity of the first block is not so large that all users remain in the first block this rate will promote efficiency as well as send price signals about the scarcity of water How many US utilities are using increasing block pricing As Table 92 indicates the number of water utilities using increasing block rates is on the rise but the increase has been slow Table 92 Pricing Structures for Public Water Systems in the United States 19822013 1982 1987 1991 1998 2002 2004 2006 2008 2010 201213 Flat Fee 1 3 Uniform Volume Charge 35 32 35 34 37 39 40 32 31 30 Decreasing Block 60 51 45 35 31 25 24 28 19 18 Increasing Block 4 17 17 31 32 36 36 40 49 52 Total 100 100 100 100 100 100 100 100 100 100 Source Raftelis Rate Survey Raftelis Financial Consulting Water 216 What about internationally Global Water Internationals 2016 tariff survey suggests that worldwide the trend is moving toward increasing block rates Table 93 Since their last survey in 2012 the number of increasing or inverted block rates increased from 48 percent to about 52 percent and is the leader in terms of pricing structures Just about all the cities that reported have some sort of volumetric pricing mostly flat and increasing block rates Interestingly nine of the 14 declining block rates are in US cities Other aspects of the rate structure are important as well Efficiency dictates that prices equal the marginal cost of provision including marginal user cost when appropriate Several practical corollaries follow from this theorem First prices during peak demand periods should exceed prices during offpeak periods For water peak demand is usually during the summer It is peak use that strains the capacity of the system and therefore triggers the need for expansion Therefore seasonal users should pay the extra costs associated with the system expansion by being charged higher rates Few current water pricing systems satisfy this condition in practice though some cities in the Southwest US are beginning to use seasonal rates For example Tucson Arizona has a seasonal rate for the months of MaySeptember Also for municipalities using increasing block rates with the first block equal to average winter consumption one could argue that this is essentially a seasonal rate for the average user The average user is unlikely to be in the second or third blocks except during summer months The last graph in Figure 95 illustrates a seasonal uniform rate In times of drought seasonal pricing makes sense but is rarely politically feasible Under extreme circumstances such as severe drought however cities are more likely to be successful in passing large rate changes that are specifically designed to facilitate coping with that drought During the period from 1987 to 1992 Santa Barbara California experienced one of the most severe droughts of the century To deal with the crisis of excess demand the city of Santa Barbara changed both its rates and rate structure 10 times between 1987 and 1995 Loaiciga Renehan 1997 In 1987 Santa Barbara utilized a flat rate of 089 per ccf10 By late 1989 they had moved to an increasing block rate consisting of four blocks with the lowest block at 109 per ccf and the highest at 301 per ccf Between March and October of 1990 the rate rose to 2943 per ccf 748 gallons in the highest block Rates were subsequently lowered but the higher rates were successful in causing water use to drop almost 50 percent It seems that when a community is faced with severe drought and community support for using pricing to cope is apparent major changes in price are indeed possible In response to the more recent severe drought in California Governor Jerry Brown mandated a 25 percent reduction in water use for residential customers From a utility Table 93 World Cities and Rate Structures 2016 Rate Type Number of Cities Percentage Fixed 4 1 Flat Rate or Linear 155 404 Increasing Block Rate 199 518 Declining Block Rate 11 28 Other 16 41 Total 385 100 Source Global Water International 2016 Tarrif survey wwwglobalwaterintelcomtariffsurvey Water 217 perspective however large reductions in consumer use can risk revenue stability and utilities may have trouble covering their large fixed costs Recall that water utilities are natural monopolies with very high fixed costs Example 91 compares an alternative price structure focused on revenue stability with increasing block rates In this case revenue stability can be achieved but at the expense of equitable pricing EXAMPLE 91 The Cost of Conservation Revenue Stability vs Equitable Pricing In January 2014 California Governor Jerry Brown proclaimed a drought state of emergency and asked all Californians to reduce water consumption by 20 percent In April 2015 an executive order was issued that increased this to 25 percent California was experiencing a severe drought and the state was running short of water While these types of mandates do promote conservation of water extreme reductions in water use can wreak havoc on water utility revenues since consumptionbased rates help to cover utility costs As you have learned natural monopolies companies with very high fixed costs and hence declining average and marginal costs must try to balance efficient pricing with covering their costs including the fixed costs Water utilities that charge consumption based rates would suffer from revenue shortfalls when consumers conserve Spang et al 2015 present a theoretical argument for a solution to the problem of revenue stability They recommend a ConsumptionBased Fixed Rate CBFR that divides a consumers bill into three parts Each part is based on a type of utility cost fixed costs fixedvariable costs fixed costs that can rise with expansion for example and purely variable costs Table 94 illustrates these types of costs The CBFR distributes fixedfixed costs across all users while distributing the partial variable and variable costs more proportionally based on a percentage of total water consumed that month that is costs times consumers consumptiontotal water consumed systemwide Table 94 Cost Definitions and Categorization FixedFixed Costs Constant regardless of system use Compliance costs safety checks office personnel treatment plant energy use etc FixedVariable Costs Exist regardless of system use but change in magnitude based on system demand Piping infrastructure chemicals repairs and maintenance etc Variable Costs Depend directly upon consumption levels Water purchases energy for water pumping etc Table 95 Estimated Consumer Bills as a Percentage of Actual under Simulated CBFR System FY 20132014 Highuse consumers 50 hcf Lomita CA IBR System 30 Averageuse 35 hcf Lomita IBR System 40 Lowuse 15 hcf Lomita IBR System 63 Source Adapted from Schmidt and Lewis 2017 Curious about whether or not the CBFR would work in practice Bates College senior Amy Schmidt decided to try and find out For her undergraduate senior thesis Schmidt collected water utility data for two towns one in California and one in Colorado and found that the CBFR does indeed stabilize revenues but at the expense of the low water users In other words the CBFR solves the revenue problem but creates inequities across individual water users Low water users usually lower income users see large bill increases in some cases while high water users benefit significantly with lower water bills Both townsLomita California and Longmont Coloradocurrently use increasing block rates For both towns the CBFR formula provides greater financial savings for highuse versus lowuse consumers This is due to the fact that high fixed costs are split evenly across all consumers For Longmont Colorado medium and lowusers bills actually increase significantly For the lowuse water consumers water bills nearly triple This result is due in part to how costs are categorized at this utility For both towns the CBFR clearly creates some inequities in pricing While solving one problem it creates another The results suggest caution with the CBFR method given the equity considerations It could be useful however during times of severe drought on a temporary basis to mitigate threats of revenue shortfalls Given these equity implications Schmidt and Lewis 2017 simulated a modified CBFR price structure with prices partially weighted by household income Using this proportional pricing method or Scaled ConsumptionBased Fixed Rates highuse consumers face increased water bills and lowuse water consumers will pay approximately 30 percent less They recommend consideration of such an alternative pricing model The Scaled ConsumptionBased Fixed Rate SCBFR appears to be a better option for ensuring revenue stability for the utility without jeopardizing affordability for lowincome households Sources Schmidt A Lewis L 2017 The cost of stability Consumptionbased fixed rate billing for water utilities Journal of Contemporary Water Research and Education 160 524 Spang E S Miller S Williams M Loge F J 2015 Consumptionbased fixed rates Harmonizing water conservation and revenue stability American Water Works Association 107 164173 Water 219 Another corollary of the marginalcost pricing theorem is that when it costs a water utility more to serve one class of customers than another each class of customers should bear the costs associated with its respective service Typically this implies that those farther away from the source or at higher elevations requiring more pumping should pay higher rates In practice utility water rates make fewer distinctions among customer classes than would be efficient As a result highercost water users are in effect subsidized they receive too little incentive to conserve and too little incentive to locate in parts of the city that can be served at lower cost Full Cost Recovery Pricing Another available pricing mechanism is to allow water utilities to earn more than a normal rate of return by charging a full cost recovery FCR price for water services Full cost recovery includes both environmental and resource costs Since allocative efficiency cannot be achieved without users receiving a clear signal regarding the value of water FCR is a potential solution Full cost recovery is one of the pillars of the European Unions Directive on Water Policy This Water Framework Directive states Member States shall ensure that waterpricing poli cies provide adequate incentives for water users to use water resources efficiently and thereby contribute to the environmental objectives of this objective What would implementing FCR pricing mean for member states Reynaud 2016 assesses the impact of full cost recovery pricing on European households in nine countries Austria Bulgaria Czech Republic Estonia France Greece Italy Portugal and Spain In particular he was interested in the impacts of price changes on consumption and also on affordability and equity For the first measure consumption Reynaud estimates the required price increase resulting from implementing FCR pricing and estimates the price elasticity of demand responsiveness to price Not surprisingly the results vary significantly by country For Estonia and Italy prices rise significantly and water consumption decreases by 212 percent and 338 percent respectively For Italy he measures the largest loss of consumer surplus at 812 euros per capita This is likely due to the high price responsiveness of Italian households The results are more moderate for Bulgaria the Czech Republic and Spain and there is very little effect for the others Water affordability is measured as the share of household income that is spent on water and a waterpoor household is one that spends 3 percent or more of its income on water services Of the nine countries examined water affordability only becomes a problem in Bulgaria under FCR pricing since there households would then devote more than 3 percent of income on water services Clearly FCR pricing must be evaluated on a casebycase basis Reynaud suggests that efficiency dictates that all households should pay the efficient price Income redistribution schemes could then be utilized to address water affordability In practice however such schemes might be difficult to implement In the absence of such a scheme subsidies or social pricing will be second best Several European countries have implemented some form of social pricing Pricing and Price Elasticity of Demand Regardless of the choice of price structure water utilities dont only want to know if consumers respond to higher prices by consuming less What utilities most want to know is how much their customers respond to given price increasesprice elasticicty of demand Municipal Water 220 water use is expected to be price inelastic meaning that for a 1 percent increase in price consumers reduce consumption but by less than 1 percent A metaanalysis of 24 water demand studies in the United States Espey Espey Shaw 1997 found a range of price elasticities with a mean of 051 Olmstead and Stavins 2007 find similar results in their summary paper These results suggest that municipal water demand responds to price but is not terribly price sensitive However regional water supply and local climatic conditions influence price elasticity Residential demand for water turns out to be more price elastic in arid climates than in wet ones In arid regions like the southwestern United States a larger portion of total water use is for luxury or outdoor uses These more elastic components of water demand influence price elasticity Yoo et al 2014 measure both shortrun and longrun price elasticity for the city of Phoenix Arizona and also find residential price elasticity of demand to be more price elastic in the long run than the short run Why do you think this is true They also find that lowincome consumers tend to respond more than highincome highvolume users suggesting that a much steeper block rate might be necessary Water Markets Sales Leases and Banks Another reform would reduce the number of restrictions on water transfers The use it or lose it component that often accompanies the prior appropriation doctrine can promote the extravagant use of water and discourage conservation Typically water saved by conserv ation is forfeited Allowing users to capture the value of water saved by permitting them to sell it would stimulate water conservation and allow the water to flow to highervalued uses see Example 92 for an historical example of how this can work EXAMPLE 92 Using Economic Principles to Conserve Water in California In 1977 when thenCalifornia Governor Jerry Brown negotiated a deal to settle one of the states perennial water fights by building a new water diversion project environ mental groups were opposed The opposition was expected What was not expected was the form it took Rather than simply block every imaginable aspect of the plan the Environmental Defense Fund EDF set out to show project supporters how the water needs could be better supplied by ways that put no additional pressure on the environment According to this strategy if the owners of the agricultural lands to the west of the water district seeking the water could be convinced to reduce their water use by adopt ing new watersaving irrigation techniques the conserved water could be transferred to the district in lieu of the project But the growers had no incentive to conserve because conserving the water required the installation of costly new equipment and as soon as the water was saved it would be forfeited under the use it or lose it regulations What could be done On January 17 1989 largely through the efforts of the EDF an historic agreement was negotiated between the growers association a major user of irrigation water and the Metropolitan Water District MWD of California a public agency that supplies Water 221 Water markets and water banks are being increasingly utilized to transfer water seasonally via shortterm leases or on a longterm basis either by multipleyear leases or permanent transfers sales Water markets are one institutional structure that can enhance efficiency by allowing water to flow to its highest valued use While most markets and banks are restricted to certain geographic areas water is allowed to move to its highervalued uses to some extent Buyers and sellers are brought together through bulletin boards water brokers and electronic computer networks Electronic bulletin boards have been used for water sales in California and Colorado for example Droughtyear banks have been successful in California Arizona established a water bank in 1996 that allows Central Arizona Project water to be directly injected into the aquifer underlying Tucson and Phoenix as in lieu recharge which can later be withdrawn Waterstressed southern Nevada has signed the Interstate Banking Agreement 2001 amended 2004 in which the Arizona Water Bank stores 125 million acrefeet of longterm storage rights to be sold to Nevada Nevada pays Arizona 100 million plus storage and recovery costs for these rights Kenney et al 2013 One unique water market in Colorado is explored in Example 93 The transfer of water however can incur high transaction costs both in the time necessary for approval up to 2 years in some cases and in potential downstream impacts One reason for the success of the ColoradoBig Thompson Project market is low transaction costs due to the structure of the water rights and the availability of infrastructure An electronic bank also aids in the transparency of sales The website wwwwatercoloradocom operates like a Craigslist for water bringing buyers and sellers together Basta and Colby 2010 examine markets in Californa Colorado and Texas along with two regions the Pacific Northwest Idaho Oregon and Washington and the Intermountain region Arizona Nevada Utah and New Mexico These are the states in which most water transactions in the US take place Examining trends they find that while prices and volumes transacted vary there are some common themes Both the numbers of sales and the numbers of leases have been rising over time Prices have also followed an upward trend except for lease prices in California and Texas which have been relatively flat The highest average sales water to the Los Angeles area Under that agreement the MWD bears the capital and operating costs as well as the indirect costs such as reduced hydropower of a huge program to reduce seepage losses as the water is transported to the growers and to install new waterconserving irrigation techniques in the fields In return the MWD will get all of the conserved water Everyone stands to gain the district gets the water it needs at a reasonable price the growers retain virtually the same amount of irrigation benefits without being forced to bear large additional expenditures Because the existing regulatory system created a very large inefficiency moving to a more efficient allocation of water necessarily increased the net benefits By using those additional net benefits in creative ways it was possible to eliminate a serious environmental threat The success of this agreement has spawned others For example two watertransfer agreements finalized in October 2003 provide an additional 200000 acrefeet of water annually to the San Diego region as a result of conservation measures taken in the Imperial Valley and financed by the municipal payments for the water Sources Taylor R E 1990 Ahead of the Curve Shaping New Solutions to Environmental Problems New York Environmental Defense Fund San Diego County Water Authority wwwsdcwaorg firstwaterdeliveryconsummateshistoricwatertransfer Water 222 prices are in Colorado over 12000 per acrefoot The highest lease prices are in the Intermountain Range with most lease prices ranging from 500 to 2000 per acrefoot In 2006 the lease price spiked at 14000 per acrefoot and 10000 per acrefoot in 2007 Not surprisingly in the wetter Pacific Northwest prices are lowest for both sales and leases Internationally water marketing is gaining traction in many areas Example 94 assesses water EXAMPLE 93 Water Transfers in Colorado What Makes a Market for Water Work The ColoradoBig Thompson CBT Project highlighted in Debate 91 pumps water from the Colorado River on the west side of the Rocky Mountains uphill and through a tunnel under the Continental Divide where it finds its way into the South Platte River With a capacity of 310000 acrefeet an average of 270000 acrefeet of water is transferred annually through an extensive system of canals and reservoirs Shares in the project are transferable and the Northern Colorado Water Conservancy District NCWCD facilitates the transfer of these CBT shares among agricultural industrial and municipal users An original share of CBT water in 1937 cost 150 Permanent transfers of CBT water for municipal uses have traded for 20002500 Howe Goemans 2003 Prices rose as high as 22000 per share in 2012 wwwwatercoloradocom This market is unique because shares are homogeneous and easily traded the infrastructure needed to move the water around exists and the property rights are well defined return flows do not need to be accounted for in transfers since the water comes from a different river basin Thus unlike most markets for water transaction costs are low This market has been extremely active and is the most organized water market in the West When the project started almost all shares were used in agriculture By 2000 over half of CBT shares were used by municipalities Howe and Goemans 2003 compare the NCWCD market to two other markets in Colorado to show how different institutional arrangements affect the size and types of water transfers They examine water transfers in the South Platte River Basin and the Arkansas River Basin For most markets in the West traditional water rights fall under the appropriation doctrine and as such are difficult to transfer and water does not easily move to its highestvalued use They find that the higher transaction costs in the Arkansas River Basin result in fewer but larger transactions than for the South Platte and NCWCD They also find that the negative impacts from the transfers are larger in the Arkansas River Basin given the externalities associated with water transfers primarily outofbasin transfers and the long court times for approval Water markets can help achieve economic efficiency but only if the institutional arrangements allow for relative ease of transfer of the rights They suggest that the set of criteria used to evaluate the transfers be expanded to include secondary economic and social costs imposed on the area of origin Sources wwwnorthernwaterorgWaterProjectsCBTProjectaspx The Water Strategist 2006 Retrieved from wwwstratwatercom Howe C W Goemans C 2003 Water transfers and their impacts Lessons from three Colorado water markets Journal of the American Water Resources Association 10551065 Water 223 EXAMPLE 94 Water Market Assessment Australia Chile South Africa and the United States Water markets are gaining importance as a water allocation mechanism Do they succeed in moving water to highervalued uses thus helping to equate marginal benefits across uses Grafton et al 2011 utilize 26 criteria to evaluate four established water markets Australias MurrayDarling Basin Chiles Limari Valley South Africa and the western United Statesand a new one in China which due to its limited experience we do not include in this example Eight of the criteria relate to economic efficiency eight relate to institutional underpinnings five relate to equity and the remaining five relate to environmental sustainability These 26 criteria are then melded into a fourpoint scale Focusing on the economic efficiency criteria water markets should be able to transfer water from lowvalued to highervalued uses Defining the size of the market as the volume traded as a percentage of total water rights Grafton et al find that in Chile and Australia for example market size is 30 percentvery high To provide some context for this number gains from trade in Chile are estimated to be between 8 and 32 percent of agricultural contribution to GDP They also define some qualitative variables that they believe capture some of the institutional characteristics such as the size and scope of the market that ultimately could affect how well the market operates by impacting transaction costs as well as the predictability and transparency of prices Australia performs best on these qualitative measures followed by Chile South Africa and the US West have mixed performance One insight that arises from their analysis is that water markets can generate substantial gains for buyers and sellers that would not otherwise occur and these gains increase as water availability declines But they also point out as have others that markets need to be flexible enough to accommodate changes in benefits and instream uses over time The specific structure of water rights plays a role Whereas in the western United States the doctrine of prior appropriation restricts transfers in Australia a system of rights defined by statute not tradition makes transfers easier Ultimately economic efficiency is an important objective in these water markets but they point out that in some basins tradeoffs between equity and efficiency are necessary in both their design and operation Economic efficiency might not even be the primary goal or the main motivation for why a water market developed Finally they point out that Australia has crafted a system within which environmental sustainability goals do not compromise economic efficiency goals These two goals can be compatible Source Grafton R Q Landry C Libecap G D McGlennon S OBrien R 2011 An integrated assessment of water markets A cross country comparison Review of Environmental Economics and Policy 52 210239 Water 224 markets in Australia Chile South Africa and the United States in terms of economic efficiency equity and environmental sustainability Water Markets in Australia Australia has a wellestablished system of water markets as highlighted in Example 94 The Council of Australian Governments facilitated the transition to water marketing starting in 1993 with water reforms that allowed water and land entitlements to be separated This unbundling has improved the efficiency and cost effectiveness of water trading by allowing more flexibility for users in terms of water deliveries Unbundling has created two primary types of water tradeable water access entitlements which are shares of water from a specified consumptive pool sold in perpetuity and tradeable water allocations which refer to a volume of water allocated in a given season National Water Commission 2013 Currently Australia has eight mechanisms for trading water that include posted water markets auctions and the water exchange which allows interstate trade and forward contracts Tisdell 2011 Most of the trading occurs in the MurrayDarling Basin Since 2008 the volume of trades of both entitlements and allocations has risen dramatically in the southern MurrayDarling River system Prices however have fallen in part due to the return to high water availability after severe drought The decision to sell water allocations in any given time period is influenced by economic factors such as the price elasticity of demand for water water prices and input prices as well as noneconomic factors including water availability soil moisture storage and forecasts Water entitlements are similarly influenced but less so the prices for entitlements have fluctuated much less than the prices for allocations National Water Commission 2013 Can you explain why Environmental Water Transactions Achieving a balance between instream and consumptive uses is not easy As the competition for water increases the pressure to allocate larger amounts of the stream for consumptive uses increases as well Eventually the water level becomes too low to support aquatic life and recreation activities Although they do exist water rights for instream flow maintenance are few in number relative to rights for consumptive purposes Those few instream rights that typically exist have a low priority relative to the more senior consumptive rights As a practical matter this means that in periods of low water flow the instream rights lose out and the water is with drawn for consumptive uses As long as the definition of beneficial use requires diversion to consumptive uses as it does in many states water left for fish habitat or recreation is undervalued Yet laws that supersede seniority and allow water to remain instream have caused consider able controversy Attempts to protect instream water uses must confront two problems First any acquired rights are usually public goods implying that others can free ride on their provision without contributing to the cause Consequently the demand for instream rights will be inefficiently low The private acquisition of instream rights is not a sufficient remedy Second once the rights have been acquired their use to protect instream flows may not be considered beneficial use and therefore could be confiscated and granted to others for consumptive use or they could be so junior as to be completely ineffective in times of low flow the times when they would most be needed However in some cases instream flows do have a priority right if the flows are necessary to protect endangered species As Example 95 demonstrates reserving water for instream uses has created controversy on more than one occasion Undervaluation of instream uses is not inevitable Water 225 EXAMPLE 95 Reserving Instream Rights for Endangered Species The Rio Grande River which has its headwaters in Colorado forms the border between Texas and Mexico Watersharing disputes have been common in this waterstressed region where demand exceeds supply in most years In 1974 the Rio Grande silvery minnow was listed as an endangered species by the US Fish and Wildlife Service Once the most abundant fish in the basin its habitat had been degraded significantly by diversion dams that restrict the minnows movement What impact would its protection have Ward and Booker 2006 compare the benefits from two cases 1 the case where no special provision is made for instream flow for the minnow and 2 the case where adequate flows are maintained using an integrated model of economics hydrology and the institutions governing water flow Interestingly they find positive economic impacts to New Mexico agriculture from protecting the minnows habitat Losses to central New Mexico farmers and to municipal and industrial users are more than offset by gains to farmers in southern New Mexico due to increased flows For example losses to agriculture above Albuquerque are approximately 114000 per year and below Albuquerque 35000 per year Losses to municipal and industrial users are 24000 per year Agricultural gains in the southern portion of the basin however are approximately 217000 per year Both agricultural and municipal users in Texas gain Overall a policy to protect the minnow was estimated to provide average annual net benefits of slightly more than 200000 per year to Texas agriculture plus an additional 1 million for El Paso municipal and industrial users The story is different for the delta smelt a tiny California fish In 2007 an interim order issued by a California judge to protect the threatened delta restricts water exports from the Delta to agricultural and municipal users In the average year this means a reduction of 586000 acrefeet of water to agriculture and cities One study Sunding et al 2008 finds that this order causes economic losses of more than 500 million per year or as high as 3 billion in an extended drought The authors note that longrun losses would be less 140 million annually if investments in recycling conservation water banking and water transfers were implemented Protests by farmers about water diversions being halted to protect this species received so much attention in 2009 that the story about the tradeoffs between these consumptive and nonconsumptive uses even made it to comedian Jon Stewarts The Daily Show Instream flows become priority uses when endangered species are involved but not everyone shares that sense of priority Sources Ward F A Booker J F 2006 Economic impacts of instream flow protection for the Rio Grande silvery minnow in the Rio Grande Basin Review in Fisheries Science 14 187202 Sunding D Ajami N Hatchet S Mitchell D Zilberman D 2008 Economic impacts of the Wanger interim order for delta smelt Berkeley Economic Consulting Water 226 Water transactions for the protection of habitat and species are becoming more common especially via short term leases Environmental leases in the US have been most common in California and New Mexico primarily on the Rio Grande Pressures on water supply dry weather population growth put upward pressure on water prices Leases during wet years that can be banked for dry years is one appealing option that can also help cities and agricultural users reduce water expense Water leasing for environmental purposes is necessary for protecting species and habitat Climate change is going to increase the demand for environmental leases Jones and Colby 2010 In England and Scotland markets are relied upon to protect instream uses more than they are in the United States Private angling associations have been formed to purchase fishing rights from landowners Once these rights have been acquired the associations charge for fishing using some of the revenues to preserve and improve the fish habitat Since fishing rights in England sell for as much as 220000 the holders of these rights have a substantial incentive to protect their investments One of the forms this protection takes is illustrated by the Anglers Cooperative Association which has taken on the responsibility of monitoring the streams for pollution and alerting the authorities to any potential problems Desalination and Wastewater Recycling Solving water scarcity issues will become increasingly challenging but desalination technolo gies water reuse and capturing and storing rainwater are all helping to make water supplies more reliable Until recently desalinized seawater has been prohibitively expensive and thus not a viable option outside of the Middle East However technological advances in reverse osmosis nanofiltration and ultrafiltration methods have reduced the price of desalinized water making it a potential new source for waterscarce regions Reverse osmosis works by pumping seawater at high pressure through permeable membranes According to a United Nations World Water Development Report more than 17000 desalting plants are currently operat ing in 150 countries worldwide 2014 These plants produce 21 billion gallons per day Since 2000 desalination capacity has been growing at approximately 7 percent per year Gleick 2006 The current technology is energy intensive and hence very expensive Costs vary considerably but even the lowest cost projects 750 per acrefoot are more than double the cost of groundwater in most places Katz 2014 Costs are expected to continue to fall though not rapidly However many projects are being built at extraordinary cost Example 96 looks at the feasibility of desalination in northern China In the United States Florida California Arizona and Texas have the largest installed capacity However actual production has been mixed In Tampa Bay for example a large desalination project was contracted in 1999 to provide drinking water This project while meant to be a low cost 045m3 stateoftheart project was hampered by difficulties Although the plant became fully operational at the end of 2007 projected costs were 067m3 Gleick 2006 In 1991 Santa Barbara California commissioned a desalination plant in response to the previously described drought that would supply water at a cost expected to be 122m3 Shortly after construction was completed however the drought ended and the plant was never operated In 2000 the city sold the plant to a company in Saudi Arabia It has been decommissioned but remains available should current supplies run out In California desalinated water from the new plant in San Diego costs approximately 2000 per acrefoot much more than the city currently pays for water diverted from the Colorado River and San Joaquin River Delta Water 227 In early 2011 a large desalination project in Dubai and another in Israel were scrapped midconstruction due to lowerthanexpected demand growth and cost respectively These two projects represented 10 percent of the desalination market11 Increased water scarcity and rising cost of alternative sources will eventually level the playing field for this technology Privatization One strategy that has received more attention in the last couple of decades is the privat ization of water supplies The controversies that have arisen around this strategy are intense see Debate 92 However it is important to distinguish between the different types of privatization since they can have quite different consequences Privatization of water supplies creates the possibility of monopoly power and excessive rates but privatization of access rights does not Whereas privatization of water supplies turns the entire system over to the private sector privatization of access rights only establishes specific quantified rights to use the publicly supplied water As discussed earlier in this chapter privatization of access rights is one way to solve the excesses that follow from the freeaccess problem since the amount of water allocated by these rights would be designed to correspond to the amount available for sustainable use And if these access rights are allocated fairly a big if and if they are enforced EXAMPLE 96 Moving Rivers or Desalting the Sea Costly Remedies for Water Shortages In most of northern China freshwater is extremely scarce China has been pursuing immense engineering projects in order to bring new water sources to this desperately dry yet rapidly growing region One threephase project involves the diversion of water from the Yangzi River basin through hundreds of kilometers of canals and pipelines at extraordinary cost 34 billion so far The project is only partially complete The other is a 41 billion power and desalination plant in the port city of Tianjin The Beijing Power and Desalination Plant began operating in 2009 The capacity of the desalination plant will satisfy only a small portion of Chinas demand for water As of 2013 water from the plant cost 8 yuan per cubic meter about 130 to produce Diverted water from the Yangzi is expected to cost about 10 yuan Both of these are at least 60 percent higher than what households currently pay though water rates are rising Even if higher water prices were imposed on consumers prices would be unlikely to cover the true cost of either source Desalination is very energy intensive In China that energy comes mainly from burning dirty coal Diverting water is not without external costs either Diverting water deprives southern China of the water needed to combat drought Developing scarcity in a crucial resource like water can force some tough choices Source Removing salt from seawater might help slake some of northern Chinas thirst but it comes at a high price Economist February 9 2013 Water 228 consistently another big if the security that enforceability provides can protect users including poor or indigenous users from encroachment The question then becomes Are these rights allocated fairly and enforced consistently When they are privatization of access rights can become beneficial for all users not merely the rich Summary On a global scale the amount of available water exceeds the demand but at particular times and in many locations water scarcity is already a serious problem In a number of places current use of water exceeds replenishable supplies implying that aquifers are being irreversibly drained Efficiency dictates that replenishable water be allocated so as to equalize the marginal net benefits of water use even when supplies are higher or lower than normal The efficient allocation of groundwater requires that the user cost of that depletable resource be considered When marginalcost pricing including marginal user cost is used Should Water Systems Be Privatized Faced with crumbling water supply systems and the financial burden from water subsidies many urban areas in both industrialized and developing countries have privatized their water systems Generally this is accomplished by selling the publicly owned water supply and distribution assets to a private company The impetus behind this movement is the belief that private companies can operate more efficiently thereby lowering costs and hence prices and do a better job of improving both water quality and access by infusing these systems with new investment The problem with this approach is that water suppliers in many areas can act as a monopoly using their power to raise rates beyond competitive levels even if those rates are in principle subject to regulation What happened in Cochabamba Bolivia illustrates just how serious a problem this can be After privatization in Cochabamba water rates increased immediately in some cases by 100200 percent The poor were especially hardhit In January 2000 a 4day general strike in response to the water privatization brought the city to a total standstill In February the Bolivian government declared the protests illegal and imposed a military takeover on the city Despite over 100 injuries and one death the protests continued until April when the government agreed to terminate the contract Is Cochabamba typical It certainly isnt the only example of privatization failure Failure in terms of a prematurely terminated privatization contract also occurred in Atlanta Georgia for example The jury is still out on its overall impact in other settings and whether we can begin to extract precon ditions for its successful introduction but it is very clear that privatization of water systems is no panacea and can be a disaster DEBATE 92 Water 229 water consumption patterns strike an efficient balance between present and future uses Typically the marginal pumping cost would rise over time until either it exceeded the marginal benefit received from that water or the reservoir ran dry In earlier times in the United States markets played the major role in allocating water But more recently governments have begun to play a much larger role in allocating this crucial resource Several sources of inefficiency are evident in the current system of water allocation Transfers of water among various users in places like the southwestern United States are restricted so that the water remains in lowvalued uses while highvalued uses are denied Instream uses of water are actively discouraged in many western states Prices charged for water by public suppliers typically do not cover costs and the rate structures are not designed to promote efficient use of the resource For groundwater user cost is rarely included and for all sources of water the rate structure does not usually reflect the cost of service These deficiencies combine to produce a situation in which we are not getting the most out of the water we are using and we are not conserving sufficient amounts for the future In general any solution to water scarcity should involve more widespread adoption of the principles of marginalcost pricing Moreexpensivetoserve users should pay higher prices for their water than their cheapertoserve counterparts Similarly when new muchhigher cost sources of water are introduced into a water system to serve the needs of a particular category of user those users should pay the marginal cost of that water rather than the lower average cost of all water supplied Finally when a rise in the peak demand triggers a need for expanding either the water supplies or the distribution system the peak demanders should pay the higher costs associated with the expansion Subsidies to ensure affordability for low income users should also be incorporated These principles suggest a much more complicated rate structure for water than merely charging everyone the same price However the political consequences of introducing these changes may be rather drastic Affordability for many households is also an issue with efficient pricing Reforms are possible Allowing conservers to capture the value of water saved by selling it would stimulate conservation Creating separate fishing rights that can be sold or allowing environmental groups to acquire and retain instream water rights would provide some incentive to protect streams as fish habitats More utilities could adopt increasing block pricing or full cost recovery pricing as a means of forcing users to realize and to consider all of the costs of supplying the water Water scarcity in many parts of the world is already a serious problem and unless preventive measures are taken it will get worse The problem is not insoluble though to date the steps necessary to solve it have proved insufficient Discussion Questions 1 What pricing system is used to price the water you use at your college or university Does this pricing system affect your behavior about water use length of showers etc How Could you recommend a better pricing system in this circumstance What would it be 2 In your hometown what system is used to price the publicly supplied water Why was that pricing system chosen Would you recommend an alternative 3 Suppose you come from a part of the world that is blessed with abundant water Demand never comes close to the available amount Should you be careful about the amount you use or should you simply use whatever you want whenever you want it Why Water 230 SelfTest Exercises 1 Suppose that in a particular area the consumption of water varies tremendously throughout the year with average household summer use exceeding winter use by a great deal What effect would this have on an efficient rate structure for water 2 Is a flatrate or flatfee system more efficient for pricing scarce water Why 3 One major concern about the future is that water scarcity will grow particularly in arid regions where precipitation levels may be reduced by climate change Will our institutions provide for an efficient response to this problem To think about this issue lets consider groundwater extraction over time using the twoperiod model as our lens a Suppose the groundwater comes from a well you have drilled upon your land that taps an aquifer that is not shared with anyone else Would you have an incentive to extract the water efficiently over time Why or why not b Suppose the groundwater is obtained from your private well which is drilled into an aquifer that is shared with many other users who have also drilled private wells Would you expect that the water from this common aquifer be extracted at an efficient rate Why or why not 4 Water is an essential resource For that reason moral considerations exert considerable pressure to assure that everyone has access to at least enough water to survive Yet it appears that equity and efficiency considerations may conflict Providing water at zero cost is unlikely to support efficient use marginal cost is too low while charging everyone the market price especially as scarcity sets in may result in some poor households not being able to afford the water they need Discuss how blockrate pricing attempts to provide some resolution to this dilemma How would it work Notes 1 Popular films such as The Milagro Beanfield War and Chinatown have addressed similar themes 2 The USGS keeps detailed records on water use by volume and use httpspubsusgsgov circ1405pdfcirc1405pdf 3 One acrefoot of water is the amount of water that could cover 1 acre of land 1 foot deep An Interstate Compact is an agreement negotiated among states along an interstate river Once ratified by Congress it becomes a federal law and is one mechanism for allocating water 4 wwwundporgcontentundpenhomeourworkenvironmentandenergyfocusareaswater andoceangovernancewatersupplyandsanitationhtml 5 International Energy Agency World Energy Outlook wwwworldenergyoutlookorgresources waterenergynexus 6 waterusgsgovogwpubsfs00165 7 wwwcapazcomdocumentspublicinformationsubsidencepdf 8 Remember that the marginal net benefit curve for an individual would be derived by plotting the vertical distance between the demand curve and the marginal cost of getting the water to that individual 9 By construction Q A Q B QT 10 ccf is a hundred cubic feet or approximately 748 gallons 11 Global Water Intelligence 121 wwwglobalwaterintelcomarchive121needtoknow desalmiseryhtml Water 231 Further Reading Colby B G DEstree T P 2000 Economic evaluation of mechanisms to resolve water conflicts Water Resources Development 16 239251 Examines the costs and benefits of various water dispute resolution mechanisms Grafton Q R Ed 2009 The Economics of Water Resources Elgar Reference Collection International Library of Critical Writings in Economics vol 234 Cheltenham UK and Northampton MA Edward Elgar An excellent compilation of articles on topics from water pricing to water markets Griffen Ronald C 2016 Water Resource EconomcsThe Analysis of Scarcity Policy and Projects 2nd ed Cambridge MA MIT Press Excellent coverage of the economics of resource allocation focusing on conservation groundwater water marketing and demand and supply estimation for water Lago M Mysiak J Gómez C M Delacámara G Maziotis A Eds 2015 Use of economic instruments in water policy Insights from international experience Available at wwwspringercomusbook9783319182865 An assessment of Economic Policy Instruments EPIs with case studies from Cyprus Denmark France Germany Hungary Italy Spain and the United Kingdom as well as from Australia Chile Israel and the USA Shaw W D 2005 Water Resource Economics and Policy An Introduction Cheltenham UK Edward Elgar An excellent text that focuses exclusively on water resource economics Von Weizsäcker E U Young O R et al Eds 2005 Limits to Privatization How to Avoid too Much of a Good Thing London Earthscan Case studies on attempts at privatization including but not limited to privatization of water supplies that assess the factors associated with success or failure Young R A Loomis J B 2014 Determining the Economic Value of Water Concepts and Methods 2nd ed Washington DC Resources for the Future A detailed survey and synthesis of theory and existing studies on the economic value of water in various uses Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 233 A Locationally Fixed Multipurpose Resource Land Buy land theyre not making it anymore Mark Twain American Humorist A land ethic reflects the existence of an ecological conscience and this in turn reflects a conviction of individual responsibility for the health of the land Health is the capacity of the land for selfrenewal Conservation is our effort to understand and preserve this capacity Aldo Leopold Sand County Almanac Introduction Land occupies a special niche not only in the marketplace but also deep in the human soul In its role as a resource land has special characteristics that affect its allocation Topography matters of course but so does location especially since in contrast to many other resources lands location is fixed It matters not only absolutely in the sense that the lands location directly affects its value but also relatively in the sense that the value of any particular piece of land is also affected by the uses of the land around it In addition land supplies many services including providing habitat for all terrestrial creatures not merely humans Some contiguous uses of land are compatible with each other but others are not In the case of incompatibility conflicts must be resolved Whenever the prevailing legal system treats land as private property as in the United States the market is one arena within which those conflicts are resolved How well does the market do Are the landuse outcomes and transactions efficient and sustainable Do they adequately reflect the deeper values people hold for land Why or why not Chapter 10 Land 234 In this chapter we shall begin to investigate these questions How does the market allocate land How well do market allocations fulfill our social criteria Where divergences between market and socially desirable outcomes occur what policy instruments are available to address the problems How effective are they Can they restore conformance between goals and outcomes The Economics of Land Allocation Land Use In general as with other resources markets tend to allocate land to its highestvalued use as reflected by the users willingness to pay or willingness to accept payment Consider Figure 101 which graphs three hypothetical land uses residential development agriculture and wilderness1 The lefthand side of the horizontal axis represents the location of the marketplace where agricultural produce is sold Moving to the right on that axis reflects an increasing distance away from the market The vertical axis represents net benefits per acre Each of the three functions known in the literature as bid rent functions records the relationship between distance to the center of the town or urban area and the net benefits per acre received from each type of land use A bid rent function expresses the maximum net benefit per acre that could be achieved by that land use as a function of the distance from the center All three functions are downward sloping because the cost of transporting both goods and people lowers net benefits per acre for more distant locations Figure 101 The Allocation of Land Land 235 According to Figure 101 a market process that allocates land to its highestvalued use would allocate the land closest to the center to residential development a distance of A agriculture would claim the land with the next best access A to B and the land farthest away from the market would remain wilderness from B to C This allocation maximizes the net benefits society receives from the land Although very simple this model also helps to clarify both the processes by which land uses change over time and the extent to which market processes are efficient subjects we explore in the next two sections LandUse Conversion Conversion from one land use to another can occur whenever the underlying bid rent functions shift and apparently in the United States they have shifted a great deal The Economic Research Service of the US Department of Agriculture in their report Major Uses of Land in the United States 2012 found that urban land acreage more than quadrupled from 1945 to 2012 Bigelow and Borchers 2017 Table 2 This increase was about twice the rate of population growth over this period Conversion of nonurban land to urban development could occur when the bid rent function for urban development shifts up the bid rent function for nonurban land uses shifts down or any combination of the two Two sources of the conversion of land to urban uses in the United States stand out 1 increasing migration of both people and productive facilities to urban centers rapidly shifted upward the bid rent functions for urban land including residential commercial industrial and even associated transportation airports highways etc and recreational parks etc uses 2 rising productivity of the agricultural land allowed a smaller amount of land to produce a lot more food Less agricultural land was needed to meet the rising food demand than would otherwise have been the case Agricultural Land A Closer Look While the amount of total land in the United States dedicated to farming has dropped considerably over time since 1920 irrigated acreage has been rising It seems unlikely that simple extrapolation of the decline in agricultural land of the magnitude since 1920 into the future would be accurate Since the middle of the 1970s the urbanization process in the United States has diminished to the point that some urban areas are experiencing declining population This shift is not merely explained by suburbia spilling beyond the boundaries of what was formerly considered urban Furthermore as increases in food demand are accompanied by increasing food prices the value of agricultural land should increase Higher food prices would tend to slow conversion What about agricultural land that is still used for agriculture but not used for growing food Its allocation is affected by the same kinds of factors For example the amount of land to grow corn for the production of ethanol has increased due to a policy that shifted out the demand curve for ethanol In late 2007 Congress passed a new energy bill that included among other things a mandate for renewable fuels including 5 billion gallons of ethanol made from grains primarily corn by 2022 Under that legislation ethanol currently carries a sizable subsidy inducing more farmers to grow corn for ethanol rather than for food or livestock feed While some 14 percent of corn use went to ethanol production in the 20052006 crop year according to the US Department of Agricultures Economic Research Service that share rose to 365 percent by 2016 Even though ethanol represents a very small share of the overall gasoline market its impacts on the agricultural sector are large Land 236 What about irrigation Irrigated acreage is on the rise both domestically and worldwide although the rate of increase has been falling Irrigation can increase yields of most crops by 100400 percent and hence increase the value of the land on which these crops are grown The FAO estimates that over the next 30 years 70 percent of the gains in cereal production will come from irrigated land and by 2030 irrigated land in developing countries will increase by 27 percent However irrigation a traditional source of productivity growth is also running into limits particularly in the western United States As noted in Chapter 9 some traditionally important underground sources used to supply water are not being replenished at a rate sufficient to offset the withdrawals Encouraged by subsidies that transfer the cost to the taxpayers consumption levels are sufficiently high that these water supplies are being exhausted Contamination of the remaining water is also an issue Irrigation of soils with water containing naturally occurring salts causes the salts to concentrate near the surface This salty soil is less productive and in extreme cases kills the crops The Rise of Organic Food Food markets have not only been affected by shifts in agricultural land use they have also been affected by agriculture practices The organic foods industry is the fastestgrowing US food segment Between 2005 and 2011 certified organic pasture and rangeland fluctuated up and down but certified organic cropland expanded nearly 80 percent to 31 million acres Aided by the price premiums that buyers of organic food are willing to pay US sales of organic food and beverages have grown from 1 billion in 1990 to 433 billion in 2015 Nearly 5 percent of all the food sold in the US in 2015 was organic Leading were organic fruits and vegetables now representing over 1 percent of all US fruit and vegetable sales Sources of Inefficient Use and Conversion In the absence of any government regulation are market allocations of land efficient In some circumstances they are but certainly not in all or even most circumstances We shall consider several sets of problems associated with landuse inefficiencies that commonly arise in industrialized countries sprawl and leapfrogging incompatible land uses undervaluation of environmental amenities the effects of taxes on landuse conversion and market power While some of these also plague developing countries we follow with a section that looks specifically at some of the special problems developing countries face Sprawl and Leapfrogging Two problems associated with land use that are receiving a lot of current attention are sprawl and leapfrogging From an economic point of view sprawl occurs when land uses in a particular area are inefficiently dispersed rather than efficiently concentrated The related problem of leapfrogging refers to a situation in which new development continues not on the very edge of the current development but farther out Thus developers leapfrog over contiguous perhaps even vacant land in favor of land that is farther from the center of economic activity Several environmental problems are intensified with dispersed development Trips to town to work shop or play become longer Longer trips not only mean more energy consumed but also frequently imply a change from the least polluting modes of travel such Land 237 as biking or walking to automobiles a much more polluting source When the cars used for commuting are fueled by gasoline engines dispersal drives up the demand for oil results in higher airpollutant emissions levels including greenhouse gases and increases the need for more steel glass and other raw materials to supply the increase in the number of vehicles demanded The Public Infrastructure Problem To understand why inefficient levels of sprawl and leapfrogging might be occurring we must examine the incentives faced by developers and how those incentives affect location choices One set of inefficient incentives can be found in the pricing of public services New development beyond the reach of existing public sewer and water systems may necessitate extending those facilities if the new development is to be served The question is who pays for this extension and how does that choice affect location decisions If the developer is forced to pay for the extension as a means of internalizing the cost he or she will automatically consider this as part of the cost of locating farther out When those costs are passed on to the buyers of the newly developed properties they will also face a higher marginal cost of living farther out and are likely to be willing to pay less for a distant property Suppose however as is commonly the case that the extensions of these services are financed by metropolitanwide taxes When the development costs are subsidized by all taxpayers in the metropolitan area both the developers and potential buyers of the newly developed property find building and living farther out to be artificially cheap This bias prevents developers from efficiently considering the tradeoff between developing the land in currently served areas more densely and building upon the less developed land outside those areas This bias promotes inefficient levels of sprawl Development farther from the center of economic activity can also be promoted either by transportation subsidies or negative externalities As potential residential buyers choose where to live transportation costs matter Living farther out may mean a longer commute or longer shopping trips Implicitly when living farther out means more andor longer trips these transport costs should figure into the decision of where to live higher transportation costs increase the relative net benefits of living closer to the center and therefore the prices buyers are willing to pay for land that offers a shorter commute The implication is that if transportation costs are inefficiently low due to subsidies or uninternalized negative travel externalities the resulting bias will inefficiently favor more distant locations Finding examples of inefficiently low transportation costs is not difficult While we reserve a full discussion of this topic for Chapter 16 on mobilesource pollution for our current purpose consider just two examples pollution externalities and parking subsidies When the social cost associated with pollution from car exhaust is not fully internalized the marginal cost of driving an extra mile is inefficiently low This implies not only that an excessive number of miles will be driven but also that dispersed development will become inefficiently more attractive Many employers provide free employee parking even though providing that parking is certainly not free to the employer Free parking represents a subsidy to the auto user and lowers the cost of driving to work Since commuting costs including parking are typically an important portion of total local transportation costs free parking creates a bias toward more remote residential developments and encourages sprawl Land 238 While these factors can promote sprawl they dont completely explain why developers skip over land that is closer in Economic analysis Irwin Bockstael 2007 has identified some of the factors that promote leapfrogging These include features of the terrain including its suitability for development landuse externalities such as access to scenic bodies of water and government policy such as road building and urban largelot zoning Note that not all of these involve an inefficiency Incompatible Land Uses As mentioned earlier in this chapter the value of a parcel of land will be affected not only by its location but also by the character of the nearby land This interdependence can be another source of inefficiency We know from previous discussions in this book that even in the presence of fully defined property rights private incentives and social incentives can diverge in the presence of externalities When any decision confers external costs on another party the allocation that maximizes net benefits for the decision maker may not be the allocation that maximizes net benefits for society as a whole Negative externalities are rather common in land transactions Many of the costs associated with a particular land use may not accrue exclusively to the landowner but will fall on the owner of nearby parcels For example houses near the airport are affected by the noise and neighborhoods near a toxic waste facility may face higher health risks One current controversial example involves an ongoing battle over the location of large industrial farms where hogs are raised for slaughter Some of the costs of these farms eg odors and water pollution from animal waste fall on the neighbors Since these costs are externalized they tend to be ignored or undervalued by unregulated hog farm owners in decisions about the land creating a bias In terms of Figure 101 the private net benefit curve for hog farms would lie above the social net benefit curve resulting in an inefficiently high allocation of land to hog farms2 One traditional remedy for the problem of incompatible land uses involves a legal approach known as zoning Enacted via an ordinance zoning creates districts or zones with allowable land uses specified for each of those zones Land uses in each district are commonly regulated according to such characteristics as type of use such as residential commercial and industrial density structure height lot size structure placement and activities allowed among others One aspect of the theory behind zoning is that by locating similar land uses together negative externalities can be limited or at least reduced One major limitation of zoning is that it can actually promote urban sprawl By setting stringent standards for all property such as requiring a large lot for each residence and prohibiting multifamily dwellings zoning can mandate a lower density By reducing the allowed residential density it can actually contribute to urban sprawl by requiring more land to accommodate a given number of people3 Undervaluing Environmental Amenities Positive externalities represent the mirror image of the negative externalities described above Many of the beneficial ecosystem goods and services associated with a particular land use may also not accrue exclusively to the landowner Hence that particular use may be undervalued by the landowner Consider for example a large farm that provides both beautiful vistas of open space for neighbors or even for travelers on an adjoining road and habitat for wildlife in its forests Land 239 streams and rangelands The owner would be unlikely to reap all the benefits from providing the vistas because travelers could not always be excluded from enjoying them despite the fact that they contribute nothing to their preservation4 In the absence of exclusion the owners receive only some of the total benefits thereby creating a bias in decisions Specifically in this case land uses that involve more of the undervalued activities will lose out to activities that convey more benefits to the landowner even when from societys perspective that choice is clearly inefficient Consider the implication of these insights in terms of Figure 101 In the presence of externalities a farmers decision whether to preserve agricultural land that provides a number of external benefits or sell it to a developer is biased toward development The owners private net benefit curve for agriculture would be lower than the social net benefit curve The implication of this bias is that the allocation of land to agriculture would inefficiently decrease and the allocation to residential development would expand One remedy for environmental amenities that are subject to inefficient conversion due to the presence of positive externalities involves direct protection of those assets by regulation or statute For example wetlands help protect water quality in lakes rivers streams and wells by filtering pollutants nutrients and sediments They also reduce flood damage by storing runoff from heavy rains and snow melts and provide essential habitat for wildlife Regulations help to preserve those functions by restricting activities that are likely to damage these ecological services For example draining dredging filling and flooding are frequently prohibited in shoreland wetlands As Debate 101 points out however regulations designed to protect social values may diminish the value of the landowners property and that creates controversy about their use The Influence of Taxes on LandUse Conversion Many governments use taxes on land and facilities on that land as a significant source of revenue For example state and federal governments tax estates including the value of land at the time of death and local governments depend heavily on property taxes to fund such municipal services as education In addition to raising revenue however taxes also can create incentives to convert land from one use to another even when such conversions would not be efficient The Property Tax Problem In the United States the property tax a tax imposed on land and facilities on that land is typically the primary source of funding for local governments A property tax has two components the tax rate and the tax base The tax base the value of the land is usually determined either by the market value as reflected in a recent sale or as estimated by a professional estimator called an assessor For our purposes the interesting aspect of this system is that the assessment is normally based upon perceived market value which can be quite different from the value of the land in its current use This distinction implies that when a landintensive activity such as farming is located in an area under significant development pressure the tax assessment may reflect the development potential of the land not its value in farming Since the value of developable land is typically higher potentially much higher the tax payments required by this system may raise farming costs and lower net income sufficiently as to promote a conversion of farmland to development a conversion that would not occur with current use taxation When the tax does not actually reflect the current activitys use of the government services funded by that tax this funding mechanism can create a bias against landintensive activities Land 240 Market Power For all practical purposes the total supply of land is fixed Furthermore since the location of each parcel is unique an absence of good substitutes can sometimes give rise to market power problems Because market power allows the seller to charge inefficiently high prices market Should Landowners Be Compensated for Regulatory Takings When environmental regulations such as those protecting wetlands are imposed they tend to restrict the ability of the landowner to fully develop the land subject to the regulation This loss of development potential frequently diminishes the value of the property and is known in the common law as a regulatory taking Should the landowner be compensated for that loss in value Proponents say that compensation would make the government more likely to regulate only when it was efficient to do so According to this argument requiring governments to pay the costs of the regulation would force them to balance those costs against the societal benefits making them more likely to implement the regulation only where the benefits exceeded the costs Proponents also argue that it is unfair to ask private landowners to bear the costs of producing benefits for the whole society those costs should be funded via broadbased taxes on the beneficiaries Opponents argue that forcing the government to pay compensation in the face of the severe budget constraints which most of them face would result in many if not most of these regulations not being implemented despite their efficiency They also argue that fairness does not dictate compensation when the loss of property value is due to simply preventing a landowner from causing societal damage such as destroying a wetland landowners do not have an unlimited right to inflict social damage Furthermore landowners are typically not expected to compensate the government when regulation increases the value of their land Current judicial decisions tend to award compensation only when the decline of value is so severe as to represent a virtual confiscation of the property 100 percent loss in value Lesser declines are typically not compensated Disagreeing with this set of rulings voters in Oregon in 2004 approved Measure 37 which allowed individual landowners to claim compensation from the local community for any decrease in property value due to plan ning environmental or other government regulations After witnessing the effects of that measure voters passed Measure 49 in 2007 which had the effect of narrowing the impact of Measure 37 Which sets of arguments do you find most compelling Why DEBATE 101 Land 241 power can frustrate the ability of the market to achieve efficiency by preventing transfers that would increase social value One example of this problem is when market power inhibits government acquisitions to advance some public purpose The Frustration of Public Purpose Problem One of the functions of government is to provide certain services such as parks potable drinking water sanitation services public safety and education In the course of providing these services it may be necessary to convert land that is being used for a private purpose to a public use such as creating a new public park or building a new road Efficiency dictates that this conversion should take place only if the benefits from the conversion exceed its costs The public sector could simply buy the land from its current owner of course and that approach has much to recommend it Not only would the owner be adequately compensated for giving up ownership but an outright purchase would make sure that the opportunity cost of the land represented by the inability of the previous owner to continue its current use would be reflected in the decision to convert the land to public purpose If the benefits from the conversion were lower than the cost including the loss of benefits from the previous use as a result of the conversion the conversion would not and from an efficiency point of view should not take place Suppose however the owner of the private land recognizes that his or her ownership of the specific parcel of land most suited for this public purpose creates an opportunity to become a monopolist seller To capitalize on this opportunity he or she could hold out until such time as the public sector paid a monopoly price for the land If and when this occurs it could represent an inefficient frustration of the public purpose by raising the cost to an inefficiently high level5 Sellers with market power could inefficiently limit the amount of land acquired by the public sector to provide public access to such amenities as parks bike paths and nature trails In the United States the traditional device for controlling the frustration of public purpose problem is the legal doctrine known as eminent domain Under eminent domain the government can legally acquire private property for a public purpose by condemnation forced transfer as long as the landowner is paid just compensation Two characteristics differentiate an eminent domain condemnation from a market transac tion First while the market transfer would be voluntary the transfer under eminent domain is mandatorythe landowner cannot refuse Second the compensation to the landowner in an eminent domain proceeding is determined not by agreement of both the public and private parties but by a judicial determination of a fair price Notice that while this approach can effectively eliminate the holdout problem and force the public sector to pay for and hence recognize the opportunity cost of the land it will only be efficient if the conversion is designed to fulfill a legitimate public purpose and the payment does in fact reflect the true opportunity cost of the land Not surprisingly both aspects have come under considerable legal scrutiny The eminent domain determination of just compensation typically involves one or more appraisals of the property provided by disinterested experts who specialize in valuing property In the case of residential property appraisals are commonly based on recent sales of comparable properties in the area suitably adjusted to consider the unique characteristics of the parcel being transferred Since in reasonable circumstances eg a farm in the family for generations this inferred value may not reflect a specific owners true valuation6 it is not surprising that landowners frequently do not agree that the compensation ultimately awarded by this process is fair appeals are common Controversy also is associated with the issue of determining what conversions satisfy the public purpose condition see Debate 102 Land 242 Special Problems in Developing Countries Insecure Property Rights In many developing countries property rights to land are either informal or nonexistent In these cases land uses may be determined on a firstcome first served basis and the occupiers do not actually hold title to the land Rather taking advantage of poorly defined andor poorly enforced property rights they acquire the land simply by occupying it not by buying or leasing it In this case the land is acquired for free but the holders run the risk of eviction if someone else ultimately produces an enforceable claim for the land and mounts a successful action to enforce that claim The lack of clear property rights can introduce both efficiency and equity problems The efficiency aspect is caused by the fact that a firstcome firstserved system of allocating land affects both the nature of the land use and incentives to preserve its value Early occupiers of the land determine the use and since the land cost them nothing to acquire the opportunity cost associated with other potentially more socially valuable uses is never considered Hence lowvalued uses could dominate highvalued uses by default This means for example What Is a Public Purpose The US Constitution only allows the eminent domain power to be used to accomplish a public purpose What exactly is a public purpose Although acquiring land for typical facilities such as parks and jails is settled legal terrain decisions that justify the use of eminent domain to condemn private neighborhoods to facilitate urban renewal by private developers are much more controversial For example in Kelo v City of New London Conn 125 SCt 2655 2005 the court upheld the development authoritys right to use eminent domain to acquire parcels of land that it planned to lease to private developers in exchange for their agreement to develop the land according to the terms of a development plan Those who support this decision point out that largescale private developments face many of the same market power obstacles such as holdouts faced by the public sector Furthermore since largescale private developments of this type provide such societal benefits as jobs and increased taxes to the community eminent domain is seen as justified to prevent inefficient barriers that inhibit development Opponents suggest that this is merely using governmental power to favor one set of private landowners the developers over others the current owners of the land From an economic point of view should publicly regulated private development such as this be allowed to fulfill the public purpose test When it is allowed should the developers be under any special requirements to assure that public benefits are forthcoming DEBATE 102 Land 243 extremely valuable forests or biologically diverse land could be converted to housing or agriculture even when other locations might be much more efficient Does a firstcome firstserved allocation provide incentives to preserve the value of the land or to degrade it Because occupiers with firm property rights could sell the land to others the ability to resell provides an incentive to preserve its value to achieve the best possible price If on the other hand any movement off the land causes a loss of all rights to the land as would be the case with an occupier who does not hold a land title those incentives to preserve the propertys value can be diminished This conflict also has an important equity dimension since the absence of property rights gives occupiers no legal defense against competing claims Suppose for example that some indigenous people have sustainably used a piece of land for a very long period of time but any implicit property rights they hold are simply unenforceable because they hold no legal title to that land If marketable natural resources are discovered on their land enormous political pressure will be exerted to evict the occupants with few protections afforded to their interests so the resources can be exploited Efficiency mandates that landuse conversion should take place only if the net benefits of the new use are larger than the net benefits of the old The traditional means of determining when that test has been satisfied is to require that the current owners be sufficiently compensated such that they would voluntarily give up their land If their rights are not enforceable and hence can simply be ignored the land can be converted and they can be involuntarily displaced even when it is efficient to preserve the land in its current use With formal enforceable property rights current users could legally defend their interests The questionable enforceability of informal rights would make current users holding those rights much more vulnerable The Poverty Problem In many developing countries poverty may constrain choices to the extent that degradation of the land can dominate sustainable use simply as a matter of survival Even when the present value of sustainable choices is higher a lack of income or other assets may preclude taking advantage of the opportunity As Barbier 1997 points out poor rural households in developing countries generally only have land and unskilled labor as their principal assets and thus few human financial or physical capital assets The unfortunate consequence of this situation is that poor households with limited holdings often face important labor land and cash constraints on their ability to invest in land improvements Barbier relates the results of a study he conducted with Burgess in Malawi In Malawi femaleheaded households make up a large percentage 42 percent of the corepoor households They typically cultivate very small plots of land 05 ha and are often marginalized onto the less fertile soils and steeper slopes They are often unable to finance agricultural inputs such as fertilizer to rotate annual crops to use green manure crops or to undertake soil and water conservation As a result poorer female headed households generally face declining soil fertility and crop yields further exacerbating their poverty and increasing their dependence upon the land This degradation of land due to inadequate investment in maintaining it can cause farmers to migrate from that degraded land to other marginal land only to have that land suffer the same fate For similar reasons poverty can exacerbate tropical deforestation promote overgrazing and hasten the inefficient conversion of land to agriculture Land 244 Innovative MarketBased Policy Remedies The previous section identifies a number of sources of market and public sector failure in the allocation of land to its various uses One way to deal with those failures is to establish some kind of complementary role between the economy and the government If the policy remedies are to be efficient however they must be able to rectify the failures without introducing a new set of inefficienciesno small task as we shall see Establishing Property Rights Merely establishing enforceable property rights can rectify some market inefficiencies but the circumstances must be right for the outcome to be efficient In an early highly influential article Harold Demsetz 1967 pointed out that the efficient system of property rights tends to evolve over time in the face of changing circumstances The establishment of formal property rights systems can mitigate or avoid the problems of overexploitation that can occur when land is merely allocated on a firstcome firstserved basis but establishing a legally enforceable system of private property rights is a costly venture In cases where land uses are relatively homogeneous and the land is abundant relative to the demand for it any inefficiency associated with the absence of property rights could well be smaller than the significant cost associated with establishing a property rights system As societies mature and the demand for and value of land increases however a point will normally be reached when the inefficiencies associated with the absence of a property rights system become so large that bearing the additional administrative costs of establishing it become justified By establishing secure enforceable transferable claims adequate property rights systems can encourage both efficient transfer and efficient maintenance of the value of the property since in both cases the seller would benefit directly In the absence of the specific circumstances giving rise to the inefficiencies noted in this chapter establishing secure property rights can cause private and social incentives to coincide Transferable Development Rights Owners of land that efficiency suggests should be preserved are typically opposed to zoning ordinances designed to promote preservation because as noted in Debate 101 they bear the costs of preservation while society as a whole reaps the benefits One approach transferable development rights TDR changes that dynamic TDR programs are a method for shifting residential development from one portion of a community to another without putting all of the costs on the owner of the land designated for preservation Local units of government identify sending areas areas where development is to be prohibited or discouraged and receiving areas areas where development is to be encouraged Landowners in sending areas are allocated development rights based on criteria identified in adopted plans Generally the allocation depends upon the number and quality of developable sites available on their property Landowners seeking to develop in a receiving area must first buy a certain amount of development rights from landowners in a sending area In principle the revenue from selling these rights compensates the sending area owners for their inability to develop their land and hence makes them more likely to support the restrictions7 It seeks to preserve land without burdening either the public budget or the owners of the preserved land see Example 101 Land 245 Grazing Rights In the United States farmers and ranchers have been allowed to graze their livestock on public lands since the early 1900s The Taylor Grazing Act of 1934 attempted to prevent overgrazing by assuring that the amount of grazing was consistent with the carrying capacity of the land8 The law set up a system that involved the issuance of grazing permits to farmers andor ranchers Each permit authorized a certain amount of livestock to be grazed on a specific piece of land for a specified period of time The permits are denominated in animal unit months AUM An AUM is the amount of feed or forage required to maintain one animal unit eg a 1000 lb cow and calf for one month The number of issued permits is based upon the carrying capacity of the land in terms of available forage A grazing fee is charged for each AUM to help to fund the program Conservation Easements One popular approach to preserving land is known as a conservation easement A conservation easement is a legal agreement between a landowner and private or public agency that limits uses of the land in perpetuity in order to protect its conservation values Once created conservation easements can be either sold or donated If a donation benefits the public by permanently preserving important resources and meets other federal tax code EXAMPLE 101 Controlling Land Development with TDRs How transferable development rights TDRs work in practice can be illustrated with an example The New Jersey Pinelands is a largely undeveloped marshy area in the southeastern part of the state encompassing approximately 1 million acres This area provides habitat for several endangered species In an effort to direct development to the least environmentally sensitive areas the Pinelands Development Commission created Pineland Development Credits PDCs a form of transferable development rights Landowners in environmentally sensitive areas received 1 PDC in exchange for every 39 acres of existing preserved farmland 1 PDC for every 39 acres of preserved upland and 02 PDC for every 39 acres of wetlands To create a demand for these credits developers seeking to increase the standard density on land in the receiving area which is specifically zoned for development were required to acquire 1 PDC for every 4 units of density increase The price of credits was set by the market To assure that the market would be vigorous enough the commission also established a Pinelands Development Credit Bank to act as a purchaser of last resort for PDCs at the statutory price of 10000 per credit In 1990 the bank auctioned its inventory at the price of 20200 per PDC By 1997 developers had used well over 100 PDCs As of 2015 the average price per PDC was 832600 Source Anderson R C Lohof A Q 1997 The United States Experience with Economic Incentives in Environmental Pollution Control Policy Washington DC Environmental Law Institute New Jersey Pinelands Development Commission website wwwstatenjuspinelandspdcbank accessed October 13 2016 Land 246 requirements it can qualify as a charitable tax deduction The taxdeductible amount is the difference between the lands value with or without the easement From an economic point of view a conservation easement allows the bundle of rights associated with land ownership to be treated as separable transferable units Separating out the development rights and allowing them to flow to the highestvalued use conservation in this case may allow the value of the entire bundle of rights for the land to be increased while simultaneously preserving the land The value of the bundle of unseparated entitlements would only be maximized if the owner of the property happened to be the one who placed the highest value on each and every entitlementan unlikely possibility Suppose for example a landowner wants to continue to harvest timber from her land but does not want to convert it to housing In the absence of a conservation easement the owner is likely to face property taxes on the land that are based on highestvalued use development rather than its current use timber harvest If however the owner executes an agreement with a public or private entity that can legally administer a conservation easement property taxes will fall since the assessed value is now lower and she will either get a substantial income tax break in the case of a charitable donation of the easement or the revenue in the case of a sale of the easement Meanwhile the land is protected in perpetuity from development and the current owner can use the land for all purposes except those explicitly precluded by the easement agreement Conservation easements have much to recommend them Since they are voluntary transactions no one is forced to part with the development rights consent is required for any transfer This approach also allows land to be protected from unwanted uses much more cheaply than would be possible if the only option for protection were to purchase the land itself rather than just specific rights contained in the easement Easements however can also introduce problems Land uses affected by the conservation easement must be monitored to ensure that the terms of the agreement continue to be upheld and if they are not to bear the costs of a legal action to enforce compliance with the agreement These legal actions are not cheap In addition the perpetual nature of conservation easements could become a problem if and when in the far distant future development becomes the efficient use Land Trusts What kinds of entities can take on the monitoring and enforcement burdens associated with assuring compliance with the easement agreement keeping in mind that these duties may last forever In some cases government performs this role but increasingly legal entities known as conservation land trusts have been created for this purpose A conservation land trust is a nonprofit organization that as all or part of its mission actively works to conserve land using a variety of means It can purchase land for permanent protection or accept donations or bequests of either land or easements Because they are organized as charitable organizations under federal tax laws donations of easements or land to a land trust can entitle the donor to a charitable deduction on their income tax Development Impact Fees Development impact fees are charges imposed on a developer to offset the additional public service costs of new development Normally applied at the time a developer receives a building permit the revenues are dedicated to funding the additional services such as water and sewer systems roads schools libraries and parks and recreation facilities made necessary by the Land 247 presence of new residents in the development Since the costs arising from those fees are presumably passed on to those buying houses in the development in principle they protect against the public infrastructure problem by internalizing the costs of extending services beyond the current service area Internalizing that externality restores the incentives associated with choosing the location of residential development and reduces one distortion that could otherwise promote inefficient leapfrogging and sprawl Property Tax Adjustments Several states offer programs to discount property taxes as a means to protect a socially desired current use particularly when undiscounted taxes are seen as an inefficient bias against that use When property taxes are based upon market value rather than current use the tax structure can put pressure on the owner to convert the land This would be particularly true if the current activities are land intensive farming or a preserved forest for example and the land could be sold for a new residential development This pressure can be inefficient to the extent that it ignores all the positive externalities Under schemes to try to counteract this tax bias eligible property owners seen as conferring uncompensated external benefits on the community are offered specified reductions in their assessed value Programs are typically available to the property owner through an application process run by the local municipality Certain criteria must be met for each program in order for a parcel of land to be eligible and any future changes in the eligibility of the land enrolled in this tax relief program are subject to disqualification and a penalty9 Summary Land is an important environmental resource not only in its own right but also as a complement to many related ecosystems By providing habitat for wildlife recharge areas for aquifers and the foundation for such landintensive activities as forestry and agriculture the allocation of land lies at the core of a harmonious relationship between humans and the environment The market which tends to allocate land to the use that maximizes its value supports land conversion as the relative values of the various land uses change For example in the United States the amount of land allocated to agriculture has declined over time while the allocations within types of agriculture have changed as well In particular relatively more agricultural land is now dedicated to the production of fuel ethanol due to a policy mandate and more has been allocated to certified organic farms due to the price premium their produce can command While in principle the market allocates land to its highest and best use in practice several attributes of land and the allocation process can result in inefficient unsustainable andor unjust outcomes Sources of these problems include not only market problems such as poorly specified property rights market power and externalities but also public sector problems associated with inefficient tax and user fee structures Furthermore by constraining choices poverty can also lead to both inefficient and unfair allocations of land A number of policy instruments some quite novel are available to counteract some of these socially undesirable outcomes They include the formalization of property rights to protect users from intrusion transferable development rights conservation easements and land trusts to both reduce the cost and increase the likelihood that efficient preservation can take place In terms of the public sector policy options include changes in property tax structures and development impact fees to eliminate inefficient incentives thereby promoting Land 248 efficient landuse decisions While this collection of policy options can correct some of the imbalances in the landallocation system most represent at best a movement in the right direction not the full restoration of efficiency or sustainability Discussion Question 1 Air pollution officials in Californias Central Valley have opened a new front in the war against urban sprawl and regulators and environmental advocates throughout the state are watching closely Starting in March 2006 the San Joaquin Valley Air Pollution Control District in California became the first regulatory body in the country to impose fees on new residential and commercial development specifically focused on reducing air pollution Critics argue that this is an ineffective way to control pollution and will mainly drive up housing prices making housing less affordable for the poor Is this policy a good idea For more details on this program see wwwvalleyairorgISRISRHome SelfTest Exercises 1 Suppose a city finds that its express highways into the city are congested and is considering two remedies 1 imposing a congestion charge on all users of its expressways during the peak periods and 2 adding a couple of lanes to the existing expressways Would these be expected to have the same effects on residential land use Why or why not 2 With respect to strategies used by land conservation groups to preserve land conservation easements seem to be expanding more rapidly than buying land for preservation In what respect might conservation easements be relatively more attractive to land conservation groups than acquiring land outright What is the economic incentive for landowners to donate land or conservation easements to the conservation organizations 3 Suppose a state was trying to decide whether to fund primary and secondary education with either a property tax or an income tax What implications might this choice have for land use in the state 4 Changing demographics can also effect changes in land use In the United States the proportion of the population in the 65andolder age bracket is growing What effects might this have on the location and the nature of the residential housing stock 5 In the United States the production of ethanol fuel from corn is subsidized Use bid rent function analysis to suggest what effects this subsidy might be expected to have on land use 6 Increasingly sophisticated communications technology is allowing more people to work at home What effect do you think this might have on landuse patterns specifically the density of residential development Notes 1 For our purposes in this thought experiment wilderness is a large uncultivated tract of land that has been left in its natural state 2 For an economic analysis of the magnitude of this impact see Herriges et al 2005 3 For evidence on the empirical relevance of this point see McConnell et al 2006a 4 Note that the aesthetic value from open space is a public good In many if not most cases exclusion is either impossible or impractical perhaps simply too expensive and the benefits from the view are indivisible Land 249 5 Although we are focusing here on a publicsector action the same logic would apply to a developer trying to buy several pieces of land to build a new large development One of the potential sellers could hold out for an inflated price recognizing that their parcel was necessary for the development to go forward but only the public sector is entitled to condemn property by eminent domain For this reason private developers try to get local governments to act on their behalf See Debate 102 6 In this case true valuation means a price that would have been accepted in a voluntary transaction in the absence of monopoly considerations 7 For an analysis of how a program in Calvert County Maryland has worked see McConnell et al 2006 8 Bureau of Land Managements Grazing Rights website Retrieved from wwwblmgovor resourcesrangelandsindexphp 9 In the farmland program for example if the property no longer qualifies as a farmland tract then the assessed penalty would be an amount equal to the taxes that would have been paid in the last 5 years if it had not been in farmland less the taxes that were originally assessed plus any interest on that balance Further Reading Bell K P Boyle K J Rubin J 2006 Economics of Rural LandUse Change Aldershot UK Ashgate Presents an overview of the economics of rural landuse change includes theoretical and empirical work on both the determinants and consequences of this change Hascic I Wu J 2012 The cost of land use regulation versus the value of individual exemption Oregon ballot measures 37 and 49 Contemporary Economic Policy 302 195214 Examines the effects on land values of the zoning regulations that gave rise to Measure 37 the Oregon program mentioned in Debate 101 Irwin E G Bell K P Bockstael N E Newburn D A Partridge M D Wu J J 2009 The economics of urbanrural space Annual Review of Resource Economics 1 435459 Changing economic conditions including waning transportation and com munication costs technological change rising real incomes and changing tastes for natural amenities have led to new forms of urbanrural interdependence This paper reviews the literature on urban landuse patterns highlighting research on environmental impacts and the efficacy of growth controls and land conservation programs that seek to manage this growth Johnston R J Swallow S K Eds 2006 Economics and Contemporary Land Use Policy Washington DC Resources for the Future Explores the causes and consequences of rapidly accelerating land conversions in urbanfringe areas as well as implications for effective policy responses Magliocca N McConnell V Walls M Safirova E 2012 Zoning on the urban fringe Results from a new approach to modeling land and housing markets Regional Science and Urban Economics 4212 198210 This paper examines the effects of largelot zoning on land conversion land prices and the spatial configuration and density of new development over a 20year period McConnell V Walls M 2009 US experience with transferable development rights Review of Environmental Economics and Policy 32 288303 This article summarizes the key elements in the design of TDR programs and reviews a number of existing markets to identify which have performed well and which have not Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 251 Chapter 11 Storable Renewable Resources Forests There is nothing more difficult to carry out nor more doubtful of success nor more dangerous to handle than to initiate a new order of things For the reformer has enemies in all who profit by the old order and only lukewarm defenders in all those who would profit from the new order The lukewarmness arises partly from fear of their adversaries who have law in their favor and partly from the incredulity of mankind who do not truly believe in anything new until they have had actual experience of it Niccolò Machiavelli The Prince 1513 Introduction Forests provide a variety of products and services The raw materials for housing wood products and paper are extracted from the forest In many parts of the world wood is an important fuel Trees cleanse the air by absorbing carbon dioxide and adding oxygen Forests provide shelter and sanctuary for wildlife and they play an important role in maintaining the watersheds that supply much of our drinking water Although the contributions that trees make to our everyday life are easy to overlook even the most rudimentary calculations indicate their significance Almost onethird of the land in the United States is covered by forests the largest category of land use with the exception of pasture and grazing land As an example of a heavily forested state 95 percent of Maines land area is covered by forest In 2015 the comparable figure for the world was 308 percent Managing these forests is no easy task In contrast to crops such as cereal grains which are planted and harvested on an annual cycle trees mature very slowly The manager must decide not only how to maximize yields on a given amount of land but also when to harvest and whether to replant In addition a delicate balance must be established among the various possible uses of forests Since harvesting the resource diminishes other values such as protecting the aesthetic value of forested vistas or providing habitat for shadeloving species Forests 252 establishing the proper balance requires some means of comparing the value of potentially conflicting uses The efficiency criterion is one obvious method One serious problem deforestation has intensified climate change decreased biodiversity caused agricultural productivity to decline increased soil erosion and desertification and precipitated the decline of traditional cultures of people indigenous to the forests Instead of forests being used on a sustainable basis to provide for the needs of both current and subsequent generations some forests are being cashed in Current forestry practices may be violating both the sustainability and efficiency criteria1 How serious is the problem and what can be done about it In the remainder of this chapter we shall explore how economics can be combined with forest ecology to assist in efficiently managing this important resource We begin by char acterizing what is meant by an efficient allocation of the forest resource when the value of the harvested timber is the only concern Starting simply we first model the efficient decision to cut a single stand or cluster of trees with a common age by superimposing economic considerations on a biological model of tree growth This model is then refined to demonstrate how the multiple values of the forest resource should influence the harvesting decision and how the problem is altered if planning takes place over an infinite horizon with forests being harvested and replanted in a continual sequence Turning to matters of institutional adequacy we shall then examine the inefficiencies that have resulted or can be expected to result from both public and private management decisions and consider strategies for restoring efficiency Characterizing Forest Harvesting Decisions Special Attributes of the Timber Resource While timber shares many characteristics with other living resources it also has some unique aspects Timber shares with many other animate resources the characteristic that it is both an output and a capital good Trees when harvested provide a saleable commodity but left standing they are a capital good providing for increased growth the following year Each year the forest manager must decide whether or not to harvest a particular stand of trees or to wait for the additional growth In contrast to many other living resources however the time period between initial investment planting and recovery of that investment harvesting is especially long Intervals of 25 years or more are common in forestry but not in many other industries Finally forestry is subject to an unusually large variety of externalities which are associated with either the standing timber or the act of harvesting timber These externalities not only make it difficult to define the efficient allocation but they also play havoc with incentives making efficient management harder for institutions to achieve The Biological Dimension Tree growth is conventionally measured on a volume basis typically cubic feet on a particular site This measurement is taken of the stems exclusive of bark and limbs between the stump and a 4inch top For larger trees the stump is 24 inches from the ground Only standing trees are measured those toppled by wind or age are not included In this sense the volume is measured in net rather than gross terms Based on this measurement of volume the data reveal that tree stands go through distinct growth phases Initially when the trees are very young growth is rather slow in volume terms though the tree may experience a considerable increase in height A period of sustained rapid Forests 253 growth follows with volume increasing considerably Finally slower growth sets in as the stand fully matures until growth stops or decline sets in The actual growth of a stand of trees depends on many factors including the weather the fertility of the soil susceptibility to insects or disease the type of tree the amount of care devoted to the trees and vulnerability to forest fire or air pollution Thus tree growth can vary considerably from stand to stand Some of these growthenhancing or growthretarding factors are under the influence of foresters others are not Abstracting from these differences it is possible to develop a hypothetical but realistic biological model of the growth of a stand of trees Our model as shown in Figure 111 is based on the growth of a stand of Douglas fir trees in the Pacific Northwest2 Notice that the figure is consistent with the growth phases listed above following an early period of limited growth in its middle ages with growth ceasing after 135 years The Economics of Forest Harvesting When should this stand be harvested From the definition of efficiency the optimal harvest time age would maximize the present value of the net benefits from the wood The size of the net benefits from the wood depends on whether the land will be perpetually committed to forestry or left to natural processes after harvest For our first model we shall assume that the stand will be harvested once and the land will be left as is following the harvest We also shall assume that neither the price assumed to be 1 per cubic meter nor the harvesting costs 030 per cubic meter vary with time The cost of planting or replanting this forest is assumed to be 1000 This model illustrates how the economic principles of forestry can be applied to the simplest case while providing the background necessary to move to more complicated and more realistic examples Planting costs and harvesting costs differ in one significant waythe time at which they are borne Planting costs are borne immediately while harvesting costs are borne at the time Figure 111 Model of Tree Growth in a Stand of Douglas Fir Forests 254 of harvest In a presentvalue calculation harvesting costs are discounted because they are paid in the future whereas planting costs are not discounted because they are paid immediately Having specified these aspects of the model it is now possible to calculate the present value of net benefits that would be derived from harvesting this stand at various ages see Table 111 The net benefits are calculated by subtracting the present value of costs from the present value of the timber at the chosen age of harvest Three different discount rates are used to illustrate the influence of discounting on the harvesting decision The undiscounted calculations r 00 simply indicate the actual values that would prevail at each age while the positive discount rate takes the time value of money into account Some interesting conclusions can be gleaned from Table 111 First discounting shortens the timing of the efficient harvest Notice that the maximum undiscounted net benefits occur at an age of 135 years when the volume is maximized However when a discount rate of only 002 is used the maximum net benefits occur at an age of 68 years roughly half the age of the undiscounted case Second under these specific assumptions the optimal harvest age is insensitive to changing the magnitude of the planting and harvesting costs You can see this by comparing the age that yields the maximum value in the value of timber row and age that yields the maximum value in the net benefit row Notice that for all discount rates these two maxima occur at the same age Even if both types of costs were zero the optimal harvesting age would not be affected The age that maximizes the value of the timber remains the same Third with high enough discount rates replanting may not be efficient Note that with r 004 the present value of net benefits is uniformly negative due to the assumed 1000 planting cost The harvest age that maximizes the present value of net benefits from a standing forest in this case would occur when the trees were about 40 years old but the present value of costs of replanting would exceed the present value of the benefits so it would not be efficient to replant the harvested forest Higher discount rates imply younger harvesting ages because they are less tolerant of the slow timber growth that occurs as the stand reaches maturity The use of a positive discount rate implies a direct comparison between the increase in the value of nonharvested timber the opportunity cost of harvest and the increase in value that would occur if the forest were harvested and the money from the sale invested at rate r In the undiscounted case using an r of zero implies that the opportunity cost of capital is zero so it pays to leave the money invested in trees as long as some growth is occurring As long as r is positive however the trees will be harvested as soon as the growth rate declines sufficiently that more will be earned by harvesting the trees and putting the proceeds in higheryielding financial investments in other words when g the growth rate in the volume of wood becomes less than r the interest earned on the invested revenue received from the harvest The fact that neither harvesting nor planting costs affect the harvesting period in this model is easy to explain Because they are paid immediately the present value of planting costs is equal to the actual expenditure it does not vary with the age at which the stand is harvested Essentially a constant is being subtracted from the value of timber at every age so it does not change the age at which the maximum occurs it only affects the present value received from that harvest Harvesting costs do not affect the age of harvest for a different reason Since total harvesting costs are assumed proportional to the amount of timber harvested 030 for each cubic foot neither the price nor the marginal cost of a cubic foot of wood varies with age they are also constants In the case of our numerical example this constant net value before discounting is 070 the 1 price minus the 030 marginal harvest cost Regardless of the numerical value assigned to the marginal cost of harvesting this net value before discounting is a constant that Table 111 Economic Harvesting Decision Douglas Fir Age years 10 20 30 40 50 60 68 70 80 90 100 110 120 130 135 Volume cubic feet 694 1912 3558 5536 7750 10104 12023 12502 14848 17046 19000 20614 21792 22438 22514 Undiscounted r 00 Value of Timber 694 1912 3558 5536 7750 10104 12023 12502 14848 17046 19000 20614 21792 22438 22514 Cost 1208 1574 2067 2661 3325 4031 4607 4751 5454 6114 6700 7184 7538 7731 7754 Net Benefits 514 338 1491 2875 4425 6073 7416 7751 9394 10932 12300 13430 14254 14707 14760 Discounted r 001 Value of Timber 628 1567 2640 3718 4712 5562 6112 6230 6698 6961 7025 6899 6603 6155 5876 Cost 1188 1470 1792 2115 2414 2669 2833 2869 3009 3088 3107 3070 2981 2846 2763 Net Benefits 560 97 848 1603 2299 2893 3278 3361 3689 3873 3917 3830 3622 3308 3113 Discounted r 002 Value of Timber 567 1288 1964 2507 2879 3080 3128 3126 3046 2868 2623 2334 2024 1710 1449 Cost 1170 1386 1589 1752 1864 1924 1938 1938 1914 1860 1787 1700 1607 1513 1435 Net Benefits 603 98 375 755 1015 1156 1190 1188 1132 1008 836 634 417 197 14 Discounted r 004 Value of Timber 469 873 1097 1153 1091 960 835 803 644 500 376 276 197 137 113 Cost 1141 1262 1329 1346 1327 1288 1251 1241 1193 1150 1113 1083 1059 1041 1034 Net Benefits 672 389 232 193 237 328 415 438 549 650 737 807 862 904 921 Value of timber price volume1 rt Cost 1000 030 volume1 rt Net benefits value of timber cost Price 1 Forests 256 is multiplied by the volume of timber at each age divided by 1 rt It merely raises or lowers the net benefits curve it does not change its shape including the location of the maximum point Therefore net benefits will be maximized at the same age of the stand regardless of the value of the marginal harvesting cost as long as marginal harvesting cost is less than the price received a rise in the marginal cost of harvesting will not affect the optimal age of harvest What is the optimal harvesting strategy if the marginal cost of harvesting is larger than the price What effect could policy have on the harvesting age Consider the effect of a 020 tax levied on each cubic foot of wood harvested in this simple model Since this tax would raise the aftertax marginal cost of harvesting from 030 per cubic foot to 050 per cubic foot it would have the same effect as a rise in harvesting cost As we have already demonstrated this implies that the tax would leave the optimal harvesting age unchanged but it would lower the aftertax revenue received from that harvest The final conclusion that can be drawn from this numerical example relates to the interaction between discount rates and planting costs on the decision to replant When high discount rates combine with high replanting costs planting trees for commercial harvest would be less likely to yield positive net benefits than would be the case with lower discount rates Notice for example in Table 111 that replanting would be economically desirable only for discount rates lower than r 004 With high discount rates tree growth is simply too slow to justify the planting expense profitmaximizing foresters would favor cutting down an existing forest but not replanting it Extending the Basic Model This basic model is somewhat unrealistic in several respects For one it considers the harvest as a single event rather than a part of an infinite sequence of harvesting and replanting Typically in the infinite planning horizon model harvested lands are restocked and the sequence starts over again in a neverending cycle At first glance it may appear that this is really no different from the case just considered After all cant one merely use this model to characterize the efficient interval between planting and harvest for each period The mathematics tells us Bowes Krutilla 1985 that this is not the correct way to think about the problem and with a bit of reflection it is not difficult to see why The singleharvest model we developed would be appropriate for an infinite planning period if and only if all periods were independent meaning that decisions in any period would be unaffected by anything that went on in the other periods If interdependencies exist among time periods however the harvesting decision must reflect those interdependencies Interdependencies do exist The decision to delay a harvest imposes an additional cost in an infinite planning model that has no counterpart in our singleharvest modelthe cost of delaying the onset of the next planting and harvesting cycle In our singleharvest model the optimum age to harvest occurs when the marginal benefit of an additional years growth equals the marginal opportunity cost of capital In other words when the capital gains from letting the trees grow another year become equal to the return that could be obtained from harvesting the trees and investing the gains the stand is harvested In the infiniteplanning horizon case the opportunity cost of delaying the next cycle which has no counterpart in the singlestand model must also be covered by the gain in tree growth The effect of including the opportunity cost of delay in an infinite horizon model can be rather profound Assuming that all other aspects of the problem such as planting and harvesting costs discount rate growth function and price are the same the optimal time to harvest called the optimal rotation in the infiniteplanning case is shorter in the Forests 257 infiniteplanning case than in the singleharvest case This follows directly from the existence of the opportunity cost of delaying the next harvest The efficient forester would harvest at an earlier age when he or she is planning to replant the same area than when the plot will be left inactive after the harvest This more complicated model also yields some other conclusions different from those in our original model a valuable reminder of a point made in Chapter 1conclusions flow from a specific view of the world and are valid only to the extent that it captures the essence of a problem Consider for example the effect of a rise in planting costs In our singleharvest model this rise would have no effect on the optimal harvest age In the infinitehorizon case the optimal rotation is affected because higher planting costs reduce the marginal opportunity cost of delaying the cycle fewer net benefits are lost by delaying the cycle compared to the case with lower planting costs As a result the optimal rotation the time between planting and harvesting that crop would increase as planting costs increase A similar result would be obtained when harvesting costs are increased The optimal rotation period would be lengthened in that case as well Can you see why Since increased harvesting costs in the infinitehorizon model lengthen the optimal rotation period a perunit tax on harvested timber would also lengthen the optimal rotation period in this model Furthermore lengthening the rotation period implies that the harvested trees would be somewhat older and therefore each harvest would involve a somewhat larger volume of wood Another limitation of our basic model lies in its assumption of a constant relative price for the wood over time In fact the relative prices of timber have been rising over time Introducing relative prices for timber that rise at a constant rate in the infinitehorizon model causes the optimal rotation period to increase relative to the fixedprice case In essence prices that are rising at a fixed rate act to offset ie diminish the effect of discounting Since we have already established that lower discount rates imply longer rotation periods it immediately follows that rising prices also lead to longer efficient rotation periods A final issue with the models as elaborated so far is that they all are concerned solely with the sale of timber as a product In fact forests serve several other purposes as well such as providing habitat for wildlife supplying recreational opportunities and stabilizing watersheds For these uses additional benefits accrue to the standing timber that are lost or diminished when the stand is harvested It is possible to incorporate these benefits into our model to demonstrate the effect they would have on the efficient rotation Suppose that the amenity benefits conveyed by a standing forest are positively related to the age of the forest In the infinitehorizon case the optimal rotation would once again occur when the marginal benefit of delay equaled the marginal cost of delay When amenity values are considered the marginal benefit of delay which includes having these amenity values for another year would be higher than in the models where amenity benefits are not considered For this reason considering amenity benefits would lengthen the optimal rotation If the amenity benefits are sufficiently large it may even be efficient to leave the forest as a wilderness area and never harvest it Sources of Inefficiency The previous section considered the nature of the harvesting decision In this section we shall discover sources of inefficiency in that decision These inefficiencies have the effect of biasing profitmaximizing decisions toward excessive rates of deforestation Forests 258 Perverse Incentives for the Landowner Profit maximization does not produce efficient outcomes when the pattern of incentives facing decision makers is perverse Forestry provides an unfortunately large number of situations in which perverse incentives produce very inefficient and unsustainable outcomes Privately owned forests are a significant force all over the world but in some countries such as the United States they are the dominant force As described next private forest decisions are plagued by external costs of various types Providing a sustainable flow of wood fiber is not the sole social purpose of the forest When the act of harvesting timber imposes costs on other valued aspects of the forest eg watershed maintenance prevention of soil erosion and protection of biodiversity these costs are not borne by the decision maker these amenity costs normally will not be adequately considered in profitmaximizing decisions The fact that the value of the standing forest as wildlife habitat or as a key element in the local ecosystem is an external cost of harvesting which can lead to inefficient decisions that threaten biodiversity Failure to recognize all of the social values of the standing forest provides an incentive not only to harvest an inefficiently large amount of timber in working forests but also to harvest timber even when preservation is the efficient alternative For example the controversy that erupted in the Pacific Northwest of the United States between environmentalists concerned with protecting the habitat of the northern spotted owl and loggers can in part be explained by the different perspectives these two groups bring to habitat destruction Loggers treat the loss of the northern spotted owl as an external cost environmentalists treat the loss of timber harvest that results from habitat protection as an external cost Government policies can also create perverse incentives for landowners Historically the rapid rate of deforestation in the Amazon for example was promoted in part by the Brazilian government When the Brazilian government reduced taxes on income derived from cattle ranching this change made it profitable to cut down forests and convert the land to ranching This system of taxation encouraged higherthanefficient rates of conversion of land from forests to pasture applying the model in Chapter 10 and subsidized an activity that in the absence of tax discrimination would not normally have been economically viable In essence Brazilian taxpayers were unknowingly subsidizing deforestation and thereby depreciating the value of their natural capital stock The Brazilian system of property rights over land also played a role in the early history of deforestation Acquiring the rights to land simply by occupying it had been formally recognized since 1850 A squatter acquired a usufruct right the right to continue using the land by 1 living on a plot of unclaimed public land and 2 using it effectively for the required period of time If these two conditions were met for 5 years the squatter acquired ownership of the land including the right to transfer it to others A claimant received a title for an amount of land up to three times the amount cleared of forest Notice the incentives that this system of property rights created The more deforestation accomplished by the squatter the larger the amount of land he or she acquired In effect landless peasants could only acquire land by engaging in deforestation due to this policy the marginal benefits from clearing land were artificially high In recognition of the consequences of these perverse incentives government policies no longer encourage deforestation by requiring that land be cleared for ownership and the practice of subsidizing cattle has also been abandoned However resettlement programs have also promoted the expansion of paved roads ports waterways railways and hydroelectric power plants into the heavily forested central Amazonia region All of these government policies radically changed the value of land uses that were competing with preserved forest remember Chapter 10 and the result was deforestation Forests 259 As a result of the resettlement program many migrants engage in agriculture Studying the decisions made by these farmers CavigliaHarris 2004 found that as the land conversion model would suggest the degree to which these farmers contribute to deforestation is impacted by market conditions as well as government policies Market forces not only affect incentives to expand the scale of operations but also affect incentives to choose particular forms of agriculture For example her empirical results show that cattle ownership by migrants significantly increases the percentage of deforestation Therefore as the market for cattle and its related productsmilk and meatadvanced deforestation levels also increased Even natural conditions such as rainfall affect land conversion since they affect the profit ability of agriculture Chomitz and Thomas 2003 for example found that the probability that land in Amazonia was used for agriculture or intensively stocked with cattle declined markedly with increasing rainfall other things equal This point is significant since it suggests that due to its prevailing high humidity western Amazonia may be less suitable for agricultural development and therefore could be less vulnerable to the threat posed by the conversion of forested land into agriculture In the Far East and in the United States perverse incentives also take another form Logging is the major source of deforestation in both regions Why wouldnt loggers act efficiently One reason as noted is the fact that many amenity values of the standing forest are external to loggers and hence do not play much if any role in their decision making Another source of inefficiency can be found in the concession agreements which define the terms under which public forests can be harvested To loggers harvesting existing forests has a substantial advantage over planting new forests old growth can be harvested immediately for profit By virtue of the commercial value of larger older trees considerable economic rent called stumpage value in the industry is associated with a standing forest In principle governments have a variety of policy instruments at their disposal to capture this rent from the concessionaires but they have typically given out the concessions to harvest this timber without capturing anywhere near all of the rent3 As a result the cost of harvesting is artificially reduced and loggers can afford to harvest much more forest than is efficient The failure of government to capture this rent also means that the wealth tied up in these forests has typically gone to a few nowwealthy individuals and corporations rather than to the government to be used for the alleviation of poverty or other worthy social objectives The failure to capture the rent from concession agreements is not the only problem Other contractual terms in these concession agreements have a role to play as well Because forest concessions are typically awarded for limited terms concession holders have little incentive to replant to exercise care in their logging procedures or even to conserve younger trees until they reach the efficient harvest age The future value of the forest will not be theirs to capture The resulting logging practices can destroy much of the younger stock by 1 the construction of access roads 2 the felling and dragging of the trees and 3 the elimination of the protective canopy Although sustainable forestry would be possible for many of these nations limitedterm concession agreements make it unlikely4 Finally deforestation can result from illegal activities The first illegal harvesting is the most obvious Illegal harvesters have no incentive to protect future values and act as if their discount rate were infinite Other illegal connections such as narcodeforestation are less obvious According to the authors of one study5 the problem is not the cultivation of the coca plantwhich is processed into cocaine but rather it results from people throughout the spectrum of the drug trade purchasing enormous amounts of land to launder their illegal profits They estimate that cocaine trafficking may account for up to 30 percent of the total forest loss in Honduras Guatemala and Nicaragua over the past decade A total of 30 to 60 percent of the forest Forests 260 losses occurred within nationally and internationally designated protected areas threatening conservation efforts to maintain forest carbon sinks and ecological services The list of losers from inefficient forestry practices frequently includes indigenous peoples who have lived in and derived their livelihood from these forests for a very long time As the loggers and squatters push deeper and deeper into forests the indigenous people who lack the power to stem the tide are forced to relocate further away from their traditional lands Perverse Incentives for Nations Another source of deforestation involves external costs that transcend national borders While it is reasonable to expect individual nations to take action to correct externalities that lie entirely within their borders it is unrealistic to expect national policy to solve the transborder problem Some international action would normally be necessary to restore efficiency in these cases Biodiversity Due to species extinction the diversity of the forms of life that inhabit the planet is diminishing at an unprecedented rate And the extinction of species is of course an irreversible process Deforestation particularly the destruction of the tropical rain forests is a major source of species extinction because it destroys the most biologically active habitats In particular Amazonia has been characterized by Norman Myers the British environmentalist as the single richest region of the tropical biome The quantity of bird fish plant and insect life that is unique to that region is unmatched anywhere else on the planet One of the tragic ironies of the situation is that these extinctions are occurring at precisely the moment in history when we would be most able to take advantage of the gene pool this biodiversity represents Modern techniques now make it possible to transplant desirable genes from one species into another creating species with new characteristics such as enhanced disease resistance or pest resistance But the gene pool must be diverse to serve as a source of donor genes Tropical forests have already contributed genetic material to increase disease resistance of cash crops such as coffee and cocoa and have been the source of some entirely new foods Approximately onequarter of all prescription drugs have been derived from sub stances found in tropical plants Future discoveries however are threatened by deforestations deleterious effects Climate Change Deforestation also contributes to climate change Since trees absorb CO2 a major greenhouse gas deforestation eliminates a potentially significant means of ameliorating the rise in CO2 in the atmosphere Furthermore burning trees an activity commonly associated with agricultural land clearing adds CO2 to the air by liberating the carbon sequestered within the trees Why is deforestation occurring so rapidly when the benefits conferred by a standing forest are so significant by virtually anyones reckoning Understanding the role of externalities provides the key to resolving this paradox Both the climate change and biodiversity benefits are largely external to both the private harvester and to the nation containing the forest while the costs of preventing deforestation are largely internal The loss of biodiversity precipitated by deforestation is perhaps most deeply felt by the industrialized world who have the technology to exploit the diverse gene pool not the countries that host the forests Similarly most of the damage from climate change would be felt outside the borders of the country being deforested Yet stopping deforestation means giving up the jobs and income derived from either harvesting the wood or harvesting the land made available by clearing the forests Therefore it is not surprising that the most vociferous opposition to the loss of biodiversity is mounted in the industrialized nations not the nations hosting tropical forests With global Forests 261 externalities we have not only a clear rationale for market failure but also a clear rationale for why host national governments cannot be expected to solve the problem by themselves While some external costs to individual agents are in fact internalized at the level of the nation meaning those who bear those costs live in the same nation global externalities arent Poverty and Debt Poverty and debt are also major sources of pressure on the forests Peasants see unclaimed forestland as an opportunity to become landowners Nations confronted with masses of peasants see unowned or publicly owned forests as a politically more viable source of land for the landless than taking it forcibly from the rich Without land peasants descend upon urban areas in search of jobs in larger numbers than can be accommodated by urban labor markets Politically explosive tensions created and nourished by the resulting atmosphere of frustration and hopelessness force governments to open up forested lands to the peasants or at least to look the other way as peasants stake their claims In eastern and southern Africa positive feedback loops have created a downward cycle in which poverty and deforestation reinforce each other Most natural forests have long since been cut down for timber and fuelwood and for producing crops from the cleared land As forests disappear the rural poor are forced to divert more time toward locating new sources of fuel Once fuelwood is no longer available dried animal waste is burned thereby eliminating it as a source of fertilizer to nourish depleted soils Fewer trees lead to more soil erosion and soil depletion leads to diminished nutrition Diminished nutrition reinforces the threats to human health posed by an inability to find or afford enough fuel wood or animal waste for cooking and boiling unclean water Degraded health saps energy increases susceptibility to disease and reduces productivity Survival strategies may necessarily sacrifice longterm goals simply to ward off starvation or death the forest is typically an early casualty At the national level poverty takes the form of staggering levels of debt Repaying this debt and the interest payments flowing from it reduces the capacity of a nation to accumulate foreign exchange earnings In periods of high real interest rates servicing these debts commands most if not all foreign exchange earnings Using these foreign exchange earnings to service the debt eliminates the possibility of using them to finance imports for sustainable activities to alleviate poverty According to the debtresource hypothesis large debts owed by many developing countries encourage these countries to overexploit their resource endowments to raise the necessary foreign exchange Timber exports represent a case in point Although a number of studies find empirical support for this hypothesis not all do And the support for extending the hypothesis to natural resources other than forests seems quite weak For example Neumayer 2005 reports We did not find evidence that countries with higher debt levels or higher debt service burdens have higher exploitation of subsoil fossil fuel and mineral resources or higher production of cash crops than other countries p 138 Sustainable Forestry We have examined three types of decisions by landownersthe harvesting decision the replant ing decision and the conversion decisionthat affect the rate of deforestation In all three Forests 262 cases profitmaximizing decisions may not be efficient and these inefficiencies tend to create a bias toward higher rates of deforestation These cases present both a challenge and an oppor tunity The current level of deforestation is the challenge The opportunity arises from the realization that correcting these inefficiencies can promote both efficiency and sustainability Does the restoration of efficiency guarantee sustainable outcomes Lets suppose that we apply the environmental sustainability definition to forestry By this definition sustainable forestry can be realized only when the forests are sufficiently protected that harvests can be maintained perpetually Also sustainable forestry would require harvests to be limited to the growth of the forest leaving the volume of wood unaffected or increasing over time Efficiency is not necessarily compatible with this definition of sustainable forestry Maximizing the present value involves an implicit comparison between the increase in value from delaying harvest largely because of the growth in volume and the increase in value from harvesting the timber and investing the earnings largely a function of r the interest rate earned on invested savings With slowgrowing species the growth rate in volume is small Choosing the harvest age that maximizes the present value of net benefits in slowgrowing forests may well involve harvest volumes higher than the net growth of the forest The search for sustainable forestry practices that are also economically sustainable has led to a consideration of new models of forestry One involves a focus on planting rapidly growing tree species in plantations Rapidly growing species raise the economic attractiveness of replanting because the invested funds are tied up for a shorter time Species raised in plantations can be harvested and replanted at a low cost Forest plantations have been established for such varied purposes as supplying fuelwood in developing countries and supplying pulp for paper mills in both industrialized and developing countries Plantation forestry is controversial however Not only do plantation forests typically involve a single species of tree which results in a poor wildlife habitat they also tend to require large inputs of fertilizer and pesticides In some parts of the world the natural resilience of the forest ecosystem is sufficiently high that sustainability is ultimately achieved despite decades of earlier unsustainable levels of harvest In the United States for example sometime during the 1940s the net growth of the nations timberlands exceeded timber removals Subsequent surveys have confirmed that net growth has continued to exceed harvests in spite of a rather large and growing demand for timber The total volume of forest biomass in the United States has been growing since at least World War II for the country as a whole harvests during that period have been sustainable although the harvests of some specific species in some specific areas have not Public Policy One public policy approach involves restoring efficient incentives The following examples flow naturally from the previous discussion Concessionaires should pay the full cost for their rights to harvest publicly controlled lands including compensating for damage to the forests surrounding the trees of interest The magnitude of land transferred to squatters should not be a multiple of the amount of cleared forest The rights of indigenous peoples should be respected Another approach involves enlisting the power of consumers in the cause of sustainable forestry The process typically involves the establishment of standards for sustainable forestry Forests 263 employing independent certifiers to verify compliance with these standards and allowing certified suppliers to display a label designating compliance For this system to work well several preconditions need to be met The certification process must be reliable and consumers must trust it Additionally consumers must be sufficiently concerned about sustainable forestry to pay a price premium over prices for otherwise comparable but uncertified products that is large enough to make certification an attractive option for forestry companies This means that the revenue should be sufficient to at least cover the higher costs associated with producing certified wood Nothing guarantees that these conditions would be met in general Example 111 examines how certification works in practice including how effective it has been in a country that has experienced a lot of certification activity Most of these changes could be implemented by individual nations to protect their own forests And to do so would be in their interests By definition inefficient practices cost more EXAMPLE 111 Producing Sustainable Forestry through Certification The Forest Stewardship Council FSC is an international notforprofit organization originally headquartered in Oaxaca Mexico with the FSC Secretariat relocating to Bonn Germany in 2003 The FSC was conceived in large part by environmental groups most notably the World Wide Fund for Nature WWF The goal of the FSC is to foster environmentally appropriate socially beneficial and economically viable management of the worlds forests It pursues this goal by being an independent thirdparty certifier of well managed forests The FSC has developed standards to assess the performance of forestry operations These standards address environmental social and economic issues Forest assessments require one or more field visits by a team of specialists representing a variety of disci plines typically including forestry ecologywildlife managementbiology and sociology anthropology Additionally the FSC requires that forest assessment reports be subject to independent peer review Any FSC assessment may be challenged through a formal com plaints procedure FSCcertified products are identified by an onproduct label andor offproduct publicity materials As of February 2017 the FSC had certified 196285056 hectares a hectare equals 247105 acres Is FSC certification effective The evidence is limited but one careful study of defor estation in Mexico using a variety of techniques found that the statistical analysis could not rule out the possibility that it had little effect on deforestation in that country The authors noted however that they did not look at whether it stemmed forest degradation so the effectiveness on that dimension remains untested We await other studies to see whether this analysis is corroborated in other settings and for other forestry dimensions Sources The Forest Stewardship website wwwfscorg accessed April 14 2013 Blackman A Goff L Rivera M 2015 Does ecocertification stem tropical deforestation Forest Stewardship Council certification in Mexico Environment for Development Discussion Paper Series DP 1519 August Forests 264 than the benefits received The move to a more efficient set of policies would necessarily generate more net benefits which could be shared in ways that build political support for the change But what about the global inefficienciesthose that transcend national boundaries How can they be resolved Several economic strategies exist They share the characteristic that they all involve compensating the nations conferring external benefits so as to encourage conservation actions consistent with global efficiency DebtNature Swaps One strategy involves reducing the pressure on the forests caused by the international debt owed by many developing countries One of the more innovative policies that explores common ground in international arrangements has become known as the debtnature swap A debtnature swap involves the purchase at a discounted value in the secondary debt market of a developing countrys debt frequently by an environmental nongovernmental organization NGO The new holder of the debt the NGO offers to cancel the debt in return for an environmentally related action on the part of the debtor nation The first debtnature swap took place in Bolivia in 1987 Since then debtfornature swaps have been arranged or explored in many developing countries including Ecuador the Philippines Zambia Jamaica Madagascar Guatemala Venezuela Argentina Honduras and Brazil A brief examination of the Madagascar case can illustrate how these swaps work Reco gnized as a prime source of biodiversity the overwhelming majority of Madagascars land mammals reptiles and plants are found nowhere else on earth Madagascar is also one of the poorest countries in the world burdened with high levels of external debt Because of its limited domestic financial resources Madagascar could not counter the serious environmental degradation it was experiencing Between 1989 and 1996 Conservation International the Missouri Botanical Garden and the World Wildlife Fund negotiated nine commercial debtnature swaps in Madagascar These arrangements generated 117 million in conservation funds Agreements signed by Madagascars government and the participating conservation organizations identified the programs to be funded One such program trained over 320 nature protection agents who focused on involving local communities in forest management Other arrangements involving different governments and different environmental organizations have since followed this lead The main advantage of these arrangements to the debtor nation is that a significant foreign exchange obligation can be paid off with domestic currency Debtnature swaps offer the realistic possibility to turn what has been a major force for unsustainable economic activity the debt crisis into a force for resource conservation Extractive Reserves One strategy specifically designed to protect the indigenous people of the forest as well as to prevent deforestation involves the establishment of extractive reserves These areas would be reserved for the indigenous people to engage in the traditional huntinggathering activities Extractive reserves have already been established in the Acre region of Brazil Acres main activity comes from the thousands of men who tap the rubber trees scattered throughout the forest a practice dating back 100 years Under the leadership of Chico Mendes a leader of the tappers who was subsequently assassinated four extractive reserves were established in June 1988 by the Brazilian government to protect the rubber tappers from encroaching development Forests 265 Conservation Easements and Land Trusts One private approach to internalizing the forestry benefits that may normally be externalized and hence undervalued in deciding how the resource is to be used involves conservation easements These were discussed at length in Chapter 10 so here it is only necessary to point out that conservation easements provide a means for amenity values to be explicitly considered in forestry decisions In the right circumstances they can facilitate efficient preservation of those values see Example 112 The World Heritage Convention The World Heritage Convention came into being in 1972 with the primary mission of iden tifying and preserving the cultural and natural heritage of outstanding sites throughout the world and ensuring their protection through international cooperation Currently some 178 countries have ratified the convention Ratifying nations have the opportunity to have their natural properties of outstanding universal value added to the World Heritage List The motivation for taking this step is to gain international recognition for this site using the prestige that comes from this designation to raise awareness for heritage preservation and the likelihood that the site can be preserved EXAMPLE 112 Conservation Easements in Action The Blackfoot Community Project Montanas rural and wild Blackfoot Valley has so far escaped the rapid development occurring in many scenic valleys throughout the West Although it offers huge amenity benefits to the surrounding community those benefits are externalities to most potential developers and therefore future private transactions could well be biased against them Recognizing this potential the Nature Conservancy TNC purchased significant tracts of this land a total of 69179 acres as of 2007 from Plum Creek Timber Company a private landowner Their objective however was not to retain ownership but to dispose of the acquired land once they could be assured that the new owners would preserve key amenity assets Since resale provides additional funds to the organization this acquireanddispose strategy allows TNC to protect much more land with the funds at their disposal than would be permitted by retaining ownership of the acquired land Some 32480 acres have been sold to public agencies For example a sale in May 2007 transferred 5234 acres of the western Horseshoe Hills an important wildlife corridor between the Bob Marshall Wilderness and the Blackfoot Clearwater Wildlife Management Area to the US Forest Service The Forest Service had previously purchased the adjacent eastern half of the Horseshoe Hills The Conservancy apparently intends to sell roughly half of its acquired lands to private landowners once conservation easements protecting the amenity benefits are attached to the deeds Source wwwnatureorgourinitiativesregionsnorthamericaunitedstatesmontanastoriesclearwaterblackfoot project1xml accessed October 18 2016 Forests 266 A ratifying nation may receive both financial assistance and expert advice from the World Heritage Committee as support for promotional activities for the preservation of its properties as well as for developing educational materials Responsibility for providing adequate protection and management of these sites falls on the host nations but a key benefit from ratification particularly for developing countries is access to the World Heritage Fund This fund is financed by mandatory contributions from ratifying nations calculated at 1 percent of the countrys contribution to UNESCO the administering agency Annually about 3 million US are made available mainly to lowincome countries to finance technical assistance and training projects as well as for assistance preparing their nomination proposals or to develop conservation projects Emergency assistance may also be made available for urgent action to repair damage caused by humanmade or natural disasters Royalty Payments A potential source of revenue for biodiversity preservation involves taking advantage of the extremely high degree of interest by the pharmaceutical industry in searching for new drugs derived from these biologically diverse pools of flora and fauna Establishing the principle that nations containing these biologically rich resources within their borders would be entitled to a stipulated royalty on any and all products developed from genes obtained from these preserves provides both an incentive to preserve the resources and some revenue to accomplish the preservation Nations harboring rich biological preserves have begun to realize their value and to extract some of that value from the pharmaceutical industry The revenue is in part used for invento rying and learning more about the resource as well as preserving it For example in 1996 Medichem Research an Illinoisbased pharmaceutical company entered into a joint venture with the Sarawak government The organization created by this joint venture has the right to file exclusive patents on two compounds that offer some promise as cancer treatments The agreement specified a 5050 split from royalties once the drug is marketed The Sarawak government was given the exclusive right to supply the latex raw material from which the compounds are derived Furthermore Sarawak scientists are involved in screening and isolating the compounds and Sarawak physicians are involved in the clinical trials This agreement not only provides a strong rationale for protecting the biological source but also enables the host country to build its capacity for capturing the value of its biodiversity in the future Laird ten Kate 2002 These arrangements are particularly significant because they facilitate transboundary sharing of the costs of preservation It is unrealistic to expect countries harboring these preserves to shoulder the entire cost of preservation when the richer countries of the world are the major beneficiaries It may also be unrealistic to assume that pharmaceutical demand is sufficient to fund efficient preservation see Example 113 Debtnature swaps extractive reserves royalty payments and conservation easements all involve recognition of the fact that resolving the global externalities component of deforestation requires a rather different approach from resolving the other aspects of the deforestation problem In general this approach involves financial transfers from the industrialized nations to the tropical nations transfers that are constructed so as to incorporate global interests into decisions about the future of tropical forests Recognizing the limited availability of international aid for the preservation of biodiversity habitat nations have begun to tap other revenue sources Tourist revenues have become an increasingly popular source particularly where the tourism is specifically linked to the resources that are targeted for preservation Rather than mixing these revenues with other public funds nations are earmarking them for preservation see Example 114 Forests 267 EXAMPLE 113 Does Pharmaceutical Demand Offer Sufficient Protection to Biodiversity The theory is clearincentives to protect plants are stronger when the plants are valuable to humans Is the practice equally clear The case of Taxol is instructive Derived from the slowgrowing Pacific yew Taxol is a substance that has proved effective in treating advanced forms of breast and ovarian cancers As of 1998 it was the bestselling anticancer drug ever Since the major site for this tree was in the oldgrowth forests of the Pacific Northwest the hope of environmental groups was that the rise in the importance of Taxol might provide both sustainable employment and some protection for oldgrowth forests In fact that is not how it worked out The Taxol for the chemical trials was derived from the bark of the tree Stripping the tree of its bark killed it And supplying enough bark for the chemical trials put a tremendous strain on the resource Ultimately the private company that marketed Taxol BristolSquibb developed a semisynthetic substitute that could be made from imported renewable tree parts The Pacific yew the original source of one of the most important medical discoveries in the twentieth century was left completely unprotected And the industry that had grown up to supply the bark collapsed In the end its value proved transitory and its ability to support a sustainable livelihood in the Pacific Northwest was illusory Not all seemingly good ideas produce the expected outcomes The details matter Source Goodman J Walsh V 2001 The Story of Taxol Nature and Politics in the Pursuit of an AntiCancer Drug New York Cambridge University Press EXAMPLE 114 Trust Funds for Habitat Preservation How can local governments finance biodiversity preservation when faced with limited availability of both international and domestic funds One option being aggressively pursued involves trust funds Trust funds are moneys that are legally restricted to be used for a specific purpose as opposed to being placed in the general government treasury They are administered by trustees to assure compliance with the terms of the trust Most but not all trust funds are protected endowments meaning that the trustees can spend the interest and dividends from the funds but not the principal This assures the continuity of funds for an indefinite period Where does the money come from Many nations that harbor biodiversity preserves cannot afford to spend the resources necessary to protect them One possibility is to tap into foreign demands for preservation In Belize the revenue comes from a conservation fee charged to all arriving foreign visitors The initial fee 375 was passed by Belizes Forests 268 Summary Forests represent an example of a storable renewable source Typically tree stands have three distinct growth phasesslow growth in volume in the early stage followed by rapid growth in the middle years and slower growth as the stand reaches full maturity The owner who harvests the timber receives the income from its sale but the owner who delays harvest will receive additional growth The amount of growth depends on the part of the growth cycle the stand is in From an economic point of view the efficient time to harvest a stand of timber is when the present value of net benefits is maximizedthat is when the marginal gain from delaying the harvest one more year is equal to the marginal cost of the delay For longerthanefficient delays the additional costs outweigh the increased benefits while for earlierthanefficient harvests more benefits in terms of the increased value of the timber are given up than costs saved For many species the efficient age at harvest is 25 years or older The efficient harvest age depends on the circumstances the decision maker faces When the plot is to be left fallow after the harvest the efficient harvest occurs later than when the land is immediately replanted to initiate another cycle With immediate replanting delaying the current harvest imposes an additional costthe resulting cost of subsequently delaying the next harvestwhich when factored into the analysis makes it more desirable to harvest earlier A number of other factors affect the size of the efficient rotation as well In general the larger the discount rate the earlier the harvest With an infiniteplanning horizon model increases in planting and harvesting costs tend to lengthen the optimal rotation while in a singleharvest model they have no effect on the length of the efficient rotation If the relative price of timber grows at a constant rate over time the efficient rotation is longer than if prices remain constant over time Finally if standing timber provides amenity services such as for recreation or wildlife management in proportion to the volume of the standing timber the efficient rotation will be longer in an infinite planning model than it would be in the absence of any amenity services Furthermore if the amenity value is large enough efficiency would preclude any harvest of that forest parliament in January 1996 raising 500000 in revenues each year for the trust fund These fees along with grants and donations provide the Protected Areas Conservation Trust PACT with a sustainable source of funding for protected areas Currently in Belize some 103 protected areas form a vast national protected areas system with categories that encompass forest reserves nature reserves national parks marine reserves private reserves wildlife sanctuaries natural monuments bird sanctu aries spawning aggregation reserves and archaeological reserves Similar trust funds have been set up in Mexico Honduras and Guatemala Biodiversity preservation that depends on funds from the general treasury becomes subject to the vagaries of budgetary pressures When the competition for funds intensifies the funds may disappear or be severely diminished The virtue of a trust fund is that it provides longterm sustained funding targeted specifically on the protection of biodiversity Source wwwpactbelizeorg accessed October 18 2016 Forests 269 Profit maximization can be compatible with efficient forest management under the right circumstances In particular in the absence of externalities distortions caused by government policy or illegal harvests profitmaximizing private owners have an incentive to adopt the efficient rotation and to undertake investments that increase the yield of the forest because that strategy maximizes their net benefits In reality not all private firms will follow efficient forestmanagement practices because they may choose not to maximize profits they may be operating at too small a scale of operation or externalities or public policy may create inefficient incentives Finally when amenity values are large and not captured by the forest owner the private rotation period may fail to consider these values leading to an inefficiently short rotation period or even harvesting forests that should be preserved Inefficient deforestation has also been encouraged by a failure to incorporate global benefits from standing forests concession agreements can provide incentives to harvest too much too soon and may fail to provide adequate incentives to protect the interests of future generations land property rights systems can make the amount of land acquired by squatters a multiple of cleared forestland and tax systems can discriminate against standing forests Substantial strides toward restoring efficiency as well as sustainability can be achieved simply by recognizing and correcting the perverse incentives actions that can be and should be taken by the tropicalforest nations But these actions will not by themselves provide adequate protection for the global interests in the tropical forests Five schemes designed to internalize some of these transboundary benefitsdebtnature swaps extractive reserves royalty payments forest certification and conservation easementshave already begun to be implemented Discussion Questions 1 Should US national forests become privatized sold to private owners Why or why not 2 In his book The Federal Land Revisited Marion Clawson proposed what he called the pullback concept Under the pullback concept any person or group could apply under applicable law for a tract of federal land for any use they chose but any other person or group would have a limited time between the filing of the initial application and granting other lease or the making of the sale in which to pull back a part of the area applied for The user of the pullback provision would become the applicant for the area pulled back required to meet the same terms applicable to the original application but the use could be what the applicant chose not necessarily the use proposed by the original applicant p 216 Evaluate the pullback concept as a means for conservationists to prevent some mineral extraction or timber harvesting on federal lands SelfTest Exercises 1 Suppose there are two identical forest plots except that one will be harvested and left to regrow while the second will be cleared after the harvest and turned into a housing development In terms of efficiency which one should have the oldest harvest age Why Forests 270 2 In Table 111 when r 002 the present value of the cost rises for 68 years and then subsequently declines Why 3 As our energy structure transitions toward renewable fuels forestbased biomass fuels benefit from this transition What are the likely effects of this transition on consumers producers and the states that host these resources 4 Would a private forest owner normally be expected to reach an efficient balance between using his or her forest for recreation and for harvesting wood Why or why not 5 Compare forest certification and the certification of organic produce in terms of the relative degree to which each type of certification could by itself be expected to produce an efficient outcome 6 Would a rise in the price of timber make sustainable forest practices more or less likely Why Notes 1 In this context sustainability refers to harvesting no more than would be replaced by growth sustainable harvest would preserve the interests of future generations by assuring that the volume of remaining timber was not declining over time This is consistent with the environ mental sustainability criterion discussed in Chapter 5 but is stronger than needed to satisfy the weak sustainability criterion Conceivably the weak sustainability criterion could be satisfied even if the volume of wood were declining over time by providing a compensating amount of some commodity or service that is valued even more 2 The numerical model in the text is based loosely on the data presented in Clawson Marion Decision Making in Timber Production Harvest and Marketing Research Paper R4 Washington DC Resources for the Future p 13 Table 1 The mathematical function relating volume to age stand in Figure 111 is a thirddegree polynomial of the form v a bt ct2 dt3 where v volume in cubic feet t the age of the stand in years and a b c and d are parameters that take on the values 0 40 31 and 0016 respectively 3 One way for the government to capture this rent would be to put timber concessions up for bid Bidders would have an incentive to pay up to the stumpage value for these concessions The more competitive the bidding was the higher the likelihood that the government would capture all of the rent In practice many of the concessions have been given to those with influence in the government at farbelow market rates See Vincent Jeffrey R 1990 Rent capture and the feasibility of tropical forest management Land Economics 662 May 212223 4 Currently foresters believe that the sustainable yield for closed tropical rain forests is zero because they have not yet learned how to regenerate the species in a harvested area once the canopy has been destroyed Destroying the thick canopy allows the light to penetrate and changes the growing conditions and the nutrient levels of the soil sufficiently that even replanting is unlikely to regenerate the types of trees included in the harvest 5 Sesnie Steven E et al 2017 A spatiotemporal analysis of forest loss related to cocaine trafficking in Central America Environmental Research Letters 125 httpsdoiorg101088 17489326aa6fff If we had used a discrete time framework ie l rt were used for discounting instead of e rt then the optimal condition would be the same except r would be replaced by ln1 r You can verify that for the values of r we are using these two expressions are approximately equal Further Reading Amacher G S Ollikainen M Koskela E A 2009 Economics of Forest Resources Cambridge MA MIT Press This book provides an introduction to forest economics and an overview of its development Forests 271 Araujo C Bonjean C A Combes JL Motel P C Reis E J 2009 Property rights and deforestation in the Brazilian Amazon Ecological Economics 6889 24612468 This paper focuses on the impact of property rights insecurity on deforestation in the Brazilian Amazon Pagiola S Bishop J LandellMills N 2002 Selling Forest Environmental Services Marketbased Mechanisms for Conservation and Development London Earthscan Marketbased approaches are thought to offer considerable promise as a means to promote forest conservation and to serve as a new source of income for rural communities Based on extensive research and case studies this book assesses the feasibility and effectiveness of payment systems and their implications for the poor Zhang Daowei 2016 Payments for forestbased environmental services A close look Forest Policy and Economics 72 7884 This paper compares payments for environmental services with other policy and market mechanisms to encourage the efficient provision of environmental services on forested land Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Appendix The Harvesting Decision Forests Suppose that an evenaged stand of trees is to be harvested at an age that maximizes the present value of the harvested timber That age can be found by 1 defining the present value of the harvested timber as a function of the age of the stand and 2 maximizing the function with respect to age Present Value PV t C V t e C h rt p where P the price received per unit of harvested volume Vt the volume of timber harvested at age t Ch the perunit cost of harvesting the timber t the age of the timber and Cp the fixed cost of planting Taking the derivative of the function with respect to age and setting it equal to zero yields t P C dt dV P C V t r b b or rewriting yields V t dt dV t r Translated into English this condition implies that the rate of return from letting the stand grow over the last increment of age should be equal to the market rate of return Forests 272 Note that the fixed planting cost has no effect on the choice of harvesting age While it raises or lowers the present value by the exact amount of the cost of planting it does not change where the function reaches its maximum If it is high enough however it can make the function reach its maximum at a negative number In this case not planting trees would maximize the present value even if that meant no future harvest A present value of zero would be larger than the present value that would necessarily be negative with planting Note also that neither the price nor the harvesting cost affects the optimal choice Mathematically it is because they cancel out in the second equation Economically it is because the neither the price nor the cost of a harvested unit varies with age therefore the change in present value as the stand ages is due to the change in volume not the change in the value of each unit of volume since the change in value is zero 273 Chapter 12 CommonPool Resources Commercially Valuable Fisheries In an overpopulated or overexploited world a system of the commons leads to ruin Even if an individual fully perceives the ultimate consequences of his actions he is most unlikely to act in any other way for he cannot count on the restraint his conscience might dictate being matched by a similar restraint on the part of all others Garrett Hardin Carrying Capacity as an Ethical Concept 1967 Introduction In 2009 the World Bank and the Food and Agriculture Organization of the United Nations FAO released a report called The Sunken Billions The Economic Justification for Fisheries Reform According to this report economic losses in marine fisheries due to overfishing poor management and economic inefficiency are approximately 50 billion per year US Over the last 30 years those losses sum to over 2 trillion The report goes on to argue that well managed marine fisheries could provide sustainable economic benefits for millions of fisheries coastal villages and cities In this chapter we explore the role of economics in designing wellmanaged fisheries Humans share the planet with many other living species How those biological populations are treated depends in part on whether they are commercially valuable and whether the institutional framework set up to manage the harvesting of a given resource provides sufficient conservation incentives to those who are best positioned to protect the resource In this chapter we consider how the process of fisheries management could be reformed to improve both efficiency and sustainability A commercially valuable species is like a double edged sword On one side the value of the species to humans provides a strong and immediate reason for human concern about its future On the other hand its value may promote excessive harvest Commercially exploited biological resources can become depleted to the point of extinction if the population is drawn down beyond a critical threshold Commercially Valuable Fisheries 274 Extinction although important is not the only critical renewable resourcemanagement issue Since any sustainable level of harvest will avoid extinction how do we choose among them What sustainable level of harvest is appropriate Biological populations belong to a class of renewable resources we will call interactive resources wherein the size of the resource stock population is determined jointly by biological considerations and by actions taken by society The postharvest size of the population in turn determines the availability of resources for the future Thus humanitys actions affect the flow of these resources over time Because this flow is not purely a natural phenomenon the rate of harvest has intertemporal effects Tomorrows harvesting choices are affected by todays harvesting behavior Using the fishery as a case study we begin by examining what is meant by an efficient and sustainable level of harvest We then investigate whether efficiency is a sufficiently strong criterion to avoid extinction Will efficient harvests always result in sustainable outcomes Having shown how our two social choice criteria apply to fisheries we turn to an examination of how well our institutions fulfill those criteria Are normal incentives compatible with efficient sustainable harvest levels Unfortunately we shall discover that in many cases normal incentives are compatible with neither efficiency nor sustainability Many commercial fisheries can be classified as open access commonpool resources Chapter 2 and as such suffer from overharvesting The FAO estimates that over 75 percent of the worlds fish stocks are either fully exploited or overexploited World Bank FAO 2016 When the asset value of the resource cannot be protected by existing institutions a tragedy of the commons1 can result As we shall see with so many fisheries experiencing overfishing finding solutions that meet both efficiency and sustainability criteria is challenging Efficient AllocationsBioeconomics Theory The Biological Dimension Like many other studies our characterization of the fishery rests on a biological model originally proposed by Schaefer 1957 The Schaefer model posits a particular average relationship between the growth of the fish population and the size of the fish population This is an average relationship in the sense that it abstracts from such influences as water temperature and the age structure of the population The model therefore does not attempt to characterize the fishery on a daytoday basis but rather in terms of some longterm average in which these various random influences tend to counterbalance each other see Figure 121 The size of the population is represented on the horizontal axis and the growth of the population on the vertical axis The graph suggests that there is a range of population sizes S S where population growth increases as the population increases and a range S S where initial increases in population lead to eventual declines in growth We can shed further light on this relationship by examining more closely the two points S and S where the function intersects the horizontal axis and therefore growth in the stock is zero S is known as the natural equilibrium since this is the population size that would persist in the absence of outside influences Reductions in the stock due to mortality or outmigration would be exactly offset by increases in the stock due to births growth of the fish in the remaining stock and inmigration This natural equilibrium would persist because it is stable A stable equilibrium is one in which movements away from this population level set forces in motion to restore it Commercially Valuable Fisheries 275 If for example the stock temporarily exceeded S it would be exceeding the capacity of its habitat called carrying capacity As a result mortality rates or outmigration would increase until the stock was once again within the confines of the carrying capacity of its habitat at S This tendency for the population size to return to S works in the other direction as well Suppose the population is temporarily reduced below S Because the stock is now smaller growth would be positive and the size of the stock would increase Over time the fishery would move along the curve to the right until S is reached again What about the other points on the curve S known as the minimum viable population represents the level of population below which growth in population is negative deaths and outmigration exceed births and inmigration In contrast to S this equilibrium is unstable Population sizes to the right of S lead to positive growth and a movement along the curve toward S and away from S When the population moves to the left of S the population declines until it eventually becomes extinct In this region no forces act to return the population to a viable level A catch level is said to represent a sustainable yield whenever it equals the growth rate of the population since it can be maintained over time As long as the population size remains constant the growth rate and hence the catch will remain constant as well S is known in biology as the maximum sustainable yield population defined as the population size that yields the maximum growth hence the maximum sustainable yield catch is equal to this maximum growth and it represents the largest catch that can be perpetually sustained Since the catch is equal to the growth the sustainable yield for any population size between S and S can be determined by drawing a vertical line from the stock size of interest on the horizontal axis to the point at which it intersects the function and drawing a horizontal line over to the vertical axis The sustainable yield is the growth in the biomass defined by the intersection of this line with the vertical axis Thus in terms of Figure 121 GS0 is the sustainable yield for population size S0 Since the catch is equal to the growth population size and next years growth remains the same It should now be clear why GS is the maximum sustainable yield Larger catches would be possible in the short run but these could not be sustained they would lead to reduced population sizes and eventually if the population were drawn down to a level smaller than S to the extinction of the species Figure 121 Relationship between the Fish Population Stock and Growth Commercially Valuable Fisheries 276 Static Efficient Sustainable Yield Is the maximum sustainable yield synonymous with efficiency The answer is no Recall that efficiency is associated with maximizing the net benefit from the use of the resource If we are to define the efficient allocation we must include the costs of harvesting as well as the benefits Lets begin by defining the efficient sustainable yield without worrying about discounting The static efficient sustainable yield is the catch level that if maintained perpetually would produce the largest annual net benefit We shall refer to this as the static efficient sustainable yield to distinguish it from the dynamic efficient sustainable yield which incorporates discounting The initial use of this static concept enables us to fix the necessary relationships firmly in mind before dealing with the more complex role discounting plays Subsequently we raise the question of whether or not efficiency always dictates the choice of a sustainable yield as opposed to a catch that changes over time We condition our analysis on three assumptions that simplify the analysis without sacrificing too much realism 1 the price of fish is constant and does not depend on the amount sold 2 the marginal cost of a unit of fishing effort is constant and 3 the amount of fish caught per unit of effort expended is proportional to the size of fish population the smaller the population the fewer fish caught per unit of effort Given these assumptions we can construct the economic model Under assumption 3 we can overlay harvesteffort functions onto the population function in Figure 121 Since the amount of fish caught per unit effort is held constant the relationship between catch and stock for given levels of effort can be portrayed by the linear functions in Figure 122 For the mathematically inclined the formula is Equation 3 in the appendix to this chapter Notice that increasing effort rotates the harvest function up and to the left E2 E1 The sustained yield associated with each level of effort is the point of intersection of these two curves If we plot the series of points associated with the possible levels of effort and the sustained yield associated with each effort level we will have our sustainable yield function defined in terms Figure 122 Relating Equilibrium Effort Harvest and Stock Size Commercially Valuable Fisheries 277 of effort rather than population as portrayed in Figure 123 Effort could be measured in vessel years hours of fishing or some other conventional metric To avoid confusion notice that increasing fishing effort in Figure 122 would result in smaller population sizes and would be recorded as a movement from right to left Because the variable on the horizontal axis in Figure 123 is effort and not population an increase in fishing effort is recorded as a movement from left to right So far so good To turn this into a complete economic model we need to determine benefits and costs or equivalently in this case total revenue and total costs From assumption 1 we know that the shape of the biological function dictates the shape of the revenue function Simply multiplying each sustained yield harvest in Figure 123 by the constant price we can turn the physical units harvest into monetary units total revenue Under assumption 2 we can characterize the final component of our model the linear function that depicts the total cost is simply calculated as the level of effort times the constant marginal cost of each unit of effort The resulting figure 124 portrays the benefits revenues and costs as a function of fishing effort In any sustainable yield annual catches population effort levels and net benefits by definition remain constant over time The static efficient sustainable yield allocation maximizes the constant annual net benefit As sustained levels of effort are increased eventually a point is reached Em at which further effort reduces the sustainable catch and revenue for all years That point of course corresponds to the maximum sustainable yield on Figure 121 S meaning that both points reflect the same population and growth levels Every effort level portrayed in Figures 123 and 124 corresponds to a specific population level in Figure 121 The net benefit is presented in the diagram as the difference vertical distance between benefits price times the quantity caught and costs the constant marginal cost of effort times the units of effort expended The efficient level of effort is Ee or the point in Figure 124 at which the vertical distance between benefits and costs is maximized Ee is the efficient level of effort because it is where marginal benefit which graphically is the slope of the total benefit curve is equal to marginal cost the constant slope of the total cost curve Levels of effort higher than Ee are inefficient because the additional cost associated with them exceeds the additional value of the fish obtained Can you see why lower levels of effort are also inefficient Figure 123 Sustainable Harvest Yield Commercially Valuable Fisheries 278 Now we are armed with sufficient information to determine whether or not the maximum sustainable yield is efficient The answer is clearly no The maximum sustainable yield would be efficient only if the marginal cost of additional effort were zero Can you see why Hint What is the marginal benefit at the maximum sustainable yield Since at Em the marginal benefit is lower than marginal cost the efficient level of effort is less than that necessary to harvest the maximum sustainable yield Thus the static efficient level of effort leads to a larger fish population but a lower annual catch than the maximum sustainable yield level of effort To fix these concepts firmly in mind consider what would happen to the static efficient sustainable yield if a technological change were to occur eg better sonar detection that lowered the marginal cost of fishing The lower marginal cost would result in a rotation of the total cost curve to the right With this new cost structure the old level of effort would no longer be efficient The marginal cost of fishing slope of the total cost curve would now be lower than the marginal benefit slope of the total benefit curve Since the marginal cost is constant the equality of marginal cost and marginal benefit can result only from a decline in marginal benefits This implies an increase in effort The new static efficient sustainable yield equilibrium implies more annual effort a lower population level a larger annual catch and a higher net benefit for the fishery Dynamic Efficient Sustainable Yield The static efficient sustainable yield turns out to be the special case of the dynamic efficient sustainable yield where the discount rate is zero It is not difficult to understand why the static efficient sustained yield is the allocation that maximizes the identical net benefit in every period Any effort levels higher than this would yield temporarily larger catches and net benefit but this would be more than offset by a reduced net benefit in the future as the stock reached its new lower level Thus the undiscounted net benefits would be reduced Figure 124 Efficient Sustainable Yield for a Fishery Commercially Valuable Fisheries 279 The effect of a positive discount rate for the management of a fishery is similar to its influence on the allocation of depletable resourcesthe higher the discount rate the higher the cost in terms of forgone current income to the resource owner of maintaining any given resource stock When positive discount rates are introduced the efficient level of effort increases beyond that suggested by the static efficient sustained yield with a corresponding decrease in the equilibrium population level The increase in the yearly effort beyond the efficient sustained yield level would initially result in an increased net benefit from the increased catch Remember that the amount of fish caught per unit effort expended is proportional to the size of the population However since this catch exceeds the sustained yield for that population size the population of fish would be reduced and future population and catch levels would be lower Eventually as that level of effort is maintained a new lower equilibrium level would be attained when the size of the catch once again equals the growth of the population Colin Clark 1976 has shown mathematically that in terms of Figure 124 as the discount rate is increased the dynamic efficient level of effort is increased until with an infinite discount rate it would become equal to Ec the point at which net benefits go to zero It is easy to see why the use of an infinite discount rate to define the dynamic efficient sus tainable yield results in allocation Ec We have seen that temporally interdependent allocations over time give rise to a marginal user cost measuring the opportunity cost of increasing current effort This opportunity cost reflects the forgone future net benefits when more resources are extracted in the present For efficient interdependent allocations the marginal willingness to pay is equal to the marginal user cost plus the marginal cost of extraction With an infinite discount rate this marginal user cost is zero because no value is received from future allocations Do you see why This implies that 1 the marginal cost of extraction equals the marginal willingness to pay which equals the constant price and 2 total benefits equal total costs2 Earlier we demonstrated that the static efficient sustained yield implies a larger fish population than the maximum sustainable yield Once discounting is introduced it is inevitable that the dynamic efficient sustainable yield would imply a smaller fish population than the static efficient sustainable yield and it is possible though not inevitable that the sustained catch would be smaller Can you see why In Figure 124 the sustained catch clearly is lower for an infinite discount rate The likelihood of the population being reduced below the level supplying the maximum sustainable yield depends on the discount rate In general the lower the extraction costs and the higher the discount rate the more likely it is that the dynamic efficient level of effort will exceed the level of effort associated with the maximum sustainable yield This is not difficult to see if we remember the limiting case discussed earlier When the marginal extraction cost is zero the static efficient sustainable yield and the maximum sustainable yield are equal Thus with zero marginal extraction costs and a positive discount rate the dynamic efficient level of effort necessarily exceeds not only the static efficient level of effort but also the level of effort associated with the maximum sustainable yield Higher extraction costs reduce the static efficient sustainable yield but not the maximum sustainable yield Remember that it is a biological not an economic concept By reducing efficient effort levels higher extraction costs reduce the likelihood that discounting would cause the population to be drawn below the maximum sustainable yield level Could a dynamically efficient management scheme lead to extinction of the fishery As Figure 124 shows it would not be possible under the circumstances described here because Ec is the highest dynamically efficient level possible in this model and that level falls short of the level needed to drive the population to extinction However in more complex models extinction certainly can be an outcome Commercially Valuable Fisheries 280 For extinction to occur under a dynamic efficient management scheme the benefit from extracting the very last unit would have to exceed the cost of extracting that unit including the costs on future generations As long as the fish population growth rate exceeds the discount rate this will not be the case If however the growth rate is lower than the discount rate extinction can occur even in an efficient management scheme if the costs of extracting the last unit are sufficiently low Why does the biomass rate of growth have anything to do with whether or not an efficient catch profile leads to extinction Rates of growth determine the productivity of conservation efforts3 With high rates of growth future generations can be easily satisfied On the other hand when the rate of growth is very low it takes a large sacrifice by current generations to produce more fish for future generations In the limiting case where the rate of growth is zero we have a resource with fixed supply and therefore this fishery would become an exhaustible resource Total depletion would occur whenever the price commanded by the resource is high enough to cover the marginal cost of extracting the last unit We have shown that the dynamic efficiency criterion is not automatically consistent with sustaining constant yields perpetually for an interactive renewable resource since it is mathematically possible for an efficient allocation of a fishery to lead to extinction of the resource How likely are these criteria to conflict in practice It is not as likely as this basic model might imply Actual fisheries differ from the standard model in two key ways First harvesting marginal costs are typically not constant as they are in the model discussed previously but rather increase as the remaining stock size diminishes Second while the model we discussed holds prices constant the size of the harvest can affect prices larger harvests can depress them Both of these modifications of the basic model suggest additional incentives for conserving the stock How empirically important are these incentives Grafton et al 2007 examine their importance for four specific fisheries and find not only that extinction is not the efficient outcome in any of the four fisheries but also in general in this reformulated model the stock level that maximizes the present value of net benefits is actually larger than the stock level that supports the maximum sustainable yield Their results seem to hold both for relatively high discount rates and relatively longlived fish The orange roughy fishery discussed in more detail below was one of the four they studied Appropriability and Market Solutions We have defined an efficient allocation of the fishery over time The next step is to characterize the normal market allocation and to contrast these two allocations Where they differ we can entertain the possibility of various public policy corrective means Lets first consider the allocation resulting from a fishery managed by a competitive sole owner A sole owner would have a welldefined property right to the fish We can establish the behavior of a sole owner by elaborating on Figure 124 as is done in Figure 125 Note that the two panels share a common horizontal axis a characteristic that allows us to examine the effect of various fishing effort levels on both graphs A sole owner would want to maximize his or her profits4 Ignoring discounting for the moment the owner can increase profits by increasing fishing effort until marginal revenue equals marginal cost This occurs at effort level Ee the static efficient sustainable yield and yields positive profits equal to the difference between REe and CEe In ocean fisheries however sole owners are unlikely Ocean fisheries are typically open access resourcesno one exercises complete control over them Since the property rights to Commercially Valuable Fisheries 281 the fishery are not conveyed to any single owner no fisherman can exclude others from exploiting the fishery What problems arise when access to the fishery is completely unrestricted Openaccess resources create two kinds of external costs a contemporaneous external cost and an intergenerational external cost The contemporaneous external cost which is borne by the current generation involves the over commitment of resources to fishingtoo many boats too many fishermen too much effort As a result current fishermen earn a substantially lower rate of return on their efforts The intergenerational external cost borne by future generations occurs because overfishing reduces the stock which in turn lowers future profits from fishing5 We can use Figure 125 to see how these external costs arise6 Once too many fishermen have unlimited access to the same commonpool fishery the property rights to the fish are no longer efficiently defined At the efficient level each boat would receive a profit equal to its share of the scarcity rent This rent however serves as a stimulus for new fishermen to enter pushing up costs and eliminating the rent Open access results in overexploitation Figure 125 Market Allocation in a Fishery Commercially Valuable Fisheries 282 The sole owner chooses not to expend more effort than Ee because to do so would reduce the profits of the fishery resulting in a personal loss to her When access to the fishery is unrestricted a decision to expend effort beyond Ee reduces profits to the fishery as a whole but not to that individual fisherman Most of the decline in profits falls on the other fishermen In an openaccess resource the individual fisherman has an incentive to expend further effort until profits are zero In Figure 125 that point is at effort level Ec at which average revenue and average cost are equal It is now easy to see the contemporaneous external cost too much effort is being expended to catch too few fish and the cost is substantially higher than it would be in an efficient allocation If this point seems abstract it shouldnt Many fisheries are plagued by precisely these problems In a productive fishery in the Bering Sea and Aleutian Islands for example one early study Huppert 1990 found significant overcapitalization While the efficient number of motherships used to take on and process the catch at sea so the catch boats do not have to return to port as often was estimated to be nine the actual level was 140 As a result a significant amount of net benefits was lost 124 million a year Had the fishery been harvested more slowly the same catch could have been achieved with fewer boats used closer to their capacity In Chapter 2 we stated that the resource owner who can exclude others balances the use value against the asset value When access to the resource is unrestricted exclusivity is lost As a result it is rational for a fisherman to ignore the asset value since he or she can never appropriate it and simply maximize the use value In the process all the scarcity rent is dis sipated The allocation that results from allowing unrestricted access to the fishery is identical to that resulting from a dynamic efficient sustainable yield when an infinite discount rate is used Openaccess resources do not automatically lead to a stock lower than S the one that maximizes the sustained yield It is possible to draw a cost function with a slope sufficiently steep that it intersects the benefit curve at a point to the left of Em Nonetheless mature open access fisheries can be exploited well beyond the point of maximum sustainable yield As noted above openaccess fishing may or may not pose the threat of species extinction It depends on the nature of the species and the benefits and costs of an effort level above Em that would have the effect of driving the stock level below the minimum viable population One species that may face that risk is the northern bluefin tuna Considered critically endangered it is still being harvested at unsustainable levels due to the high market price fishermen receive as a result of its popularity in sushi restaurants The threat of extinction cannot be determined purely from theory it must be determined by empirical studies on a casebycase basis Are openaccess resources and commonpool resources synonymous concepts They are not Not all commonpool resources allow unlimited access Informal arrangements among those harvesting the commonpool resource which may be fostered by harvester cooperation can serve to limit access Example 121 presents one such arrangement Openaccess resources generally violate the efficiency criterion and may violate the sustainability criteria If these criteria are to be fulfilled some restructuring of the decision making environment may be necessary The next section examines the possible role for government in accomplishing that outcome Public Policy Toward Fisheries What can be done A variety of public policy responses is possible Perhaps it is appropriate to start with circumstances where allowing the market to work can improve the situation Commercially Valuable Fisheries 283 EXAMPLE 121 Harbor Gangs of Maine and Other Informal Arrangements Unlimited access to commonpool resources reduces net benefits so drastically that this loss encourages those harvesting the resource to band together to restrict access if possible The Maine lobster fishery is one setting where those informal arrangements have served to limit access with some considerable success Key among these arrangements is a system of territories that establishes boundaries between fishing areas Particularly near the offshore islands these territories tend to be exclusively harvested by closeknit disciplined groups of harvesters These gangs restrict access to their territory by various means Some methods although effective are covert and illegal such as the practice of cutting the lines to lobster traps owned by new entrants thereby rendering the traps irretrievable Acheson 2003 found that in every season of the year the pounds of lobster caught per trap and the size of those lobsters were greater in defended areas Not only did the larger number of pounds result in more revenue but also the bigger lobsters brought in a higher price per pound Informal arrangements were successful in this case in part because the Maine lobster stock is also protected by regulations limiting the size of lobsters that can be taken imposing both minimum and maximum sizes and prohibiting the harvest of eggbearing females It turns out that many other examples of community comanagement also offer encour aging evidence for the potential of sustainability One example the Chilean abalone a type of snail called loco is Chiles most valuable fishery Local fishers began cooperating in 1988 to manage a small stretch 2 miles of coastline Today the comanagement scheme involves 700 comanaged areas 20000 artisanal fishers and 2500 miles of coastline While it would be a mistake to assume that all commonpool resources are character ized by open access it would also be a mistake to assume that all informal comanage ment arrangements automatically provide sufficient social means for producing efficient harvests such that stronger public policy would be unnecessary One study Gutiérrez et al 2011 examined 130 fisheries in 44 developed and developing countries It found that comanagement can work but only in the presence of strong leadership social cohe sion and complementary incentives such as individual or community quotas They find that effective communitybased comanagement can both sustain the resource and protect the livelihoods of nearby fishermen and fishing communities The existence of nearby protected areas was also found to be an important determinant of success Sources Acheson J M 2003 Capturing the Commons Devising Institutions to Manage the Maine Lobster Fishery Hanover NH University Press of New England Gutiérrez N L Hilborn R Omar Defeo O 2011 Leadership social capital and incentives promote successful fisheries Nature 470 17 February 386389 Retrieved from wwwnaturecomnaturejournalv470n7334fullnature09689html Raising the Real Cost of Fishing Perhaps one of the best ways to illustrate the virtues of using economic analysis to help design policies is to show the harsh effects of policy approaches that ignore it Because the earliest Commercially Valuable Fisheries 284 approaches to fishery management had a singleminded focus on attaining the maximum sustainable yield with little or no thought given to maximizing the net benefit they provide a useful contrast One striking concrete example is the set of policies originally designed to deal with overexploitation of the Pacific salmon fishery in the United States The five species of Pacific salmon are particularly vulnerable to overexploitation and even extinction because of their migration patterns Pacific salmon are spawned in the gravel beds of rivers As juvenile fish they migrate to the ocean only to return as adults to spawn in the rivers of their birth After spawning they die When the adults swim upstream with an instinctual need to return to their native streams they can easily be captured by traps nets or other catching devices Recognizing the urgency of the problem the government took action To reduce the catch they raised the cost of fishing Initially this was accomplished by preventing the use of any barricades on the rivers and by prohibiting the use of traps the most efficient catching devices in the most productive areas These measures proved insufficient since mobile techniques trolling nets and so on proved quite capable by themselves of overexploiting the resource Officials then began to close designated fishing areas and suspend fishing in other areas for stipulated periods of time In Figure 124 these measures would be reflected as a rotation of the total cost curve to the left until it intersected the total benefits revenue curve at a level of effort equal to Ee The aggregate of all these regulations had the desired effect of curtailing the yield of salmon Were these policies efficient They were not even though they resulted in the efficient catch This statement may seem inconsistent but it is not Efficiency implies not only that the catch must be at the efficient level but also it must be extracted at the lowest possible cost It was this latter condition that was violated by these policies see Figure 126 Figure 126 reflects the total cost in an unregulated fishery TC1 and the total cost after these policies were imposed TC2 The net benefit received from an efficient policy is shown Figure 126 Effect of Regulation Commercially Valuable Fisheries 285 graphically as the vertical distance between total cost and total benefit After the policy however the net benefit was reduced to zero the net benefit represented by vertical distance was lost to society Why The net benefit was squandered on the use of excessively expensive means to catch the desired yield of fish Rather than use traps to reduce the cost of catching the desired number of fish traps were prohibited Larger expenditures on capital and labor were required to catch the same number of fish This additional capital and labor represent one source of the waste The limitations on fishing times had a similar effect on cost Rather than allowing fishermen to spread their effort out over time so the boats and equipment could be more productively utilized fishermen were forced to buy larger boats to allow them to take as much as possible during the shorter seasons As one extreme example Tillion 1985 reported that the 1982 herring season in Prince William Sound lasted only four hours and the catch still exceeded the area quota Significant overcapitalization produced gross inefficiency Regulation imposed other costs as well It was soon discovered that while the above regulations were adequate to protect the depletion of the fish population they failed to curb the incentive for individual fishermen to increase their share of the take Even though the profits would be small because of high costs new technological change would allow adopters to increase their shares of the market and put others out of business To protect themselves the fishermen were eventually driven to introducing bans on new technology These restrictions took various forms but two are particularly noteworthy The first was the banning of the use of thinstranded monofilament net The coarsestranded net it would have replaced was visible to the salmon in the daytime and therefore could be avoided by them As a result it was useful only at night By contrast the thinner monofilament nets could be successfully used during the daylight hours as well as at night Monofilament nets were banned in Canada and the United States soon after they appeared The most flagrantly inefficient regulation was one in Alaska that barred gill netters in Bristol Bay from using engines to propel their boats This regulation lasted until the 1950s and heightened the publics awareness of the anachronistic nature of this regulatory approach The worlds most technologically advanced nation was reaping its harvest from the Bering Sea in sailboats while the rest of the worldparticularly Japan and the Soviet Unionwas modernizing their fishing fleets at a torrid pace Guided by a narrow focus on biologically determined sustainable yield that ignored costs these policies led to a substantial loss in the net benefit received from the fishery Costs are an important dimension of the problem and when they are ignored the incomes of fishermen suffer When incomes suffer further conservation measures become more difficult to implement and incentives to violate the regulations are intensified Technical change presents further challenges to attempts to use costincreasing regulations to reduce fishing effort Technical innovations can lower the cost of fishing thereby offsetting the increases imposed by the regulations In the New England fishery for example Jin et al 2002 report that the introduction of new technologies such as fishfinders and electronic navigation aids in the 1970s and 1980s led to higher catches and declines in the abundance of the stocks despite the extensive controls in place at the time Taxes Is it possible to provide incentives for cost reduction while assuring that the yield is reduced to the efficient level Can a more efficient policy be devised Economists who have studied the question believe that more efficient policies are possible Commercially Valuable Fisheries 286 Consider a tax on effort In Figure 126 taxes on effort would also be represented as a rotation of the total cost line and the aftertax cost to the fishermen would be represented by line TC2 Since the aftertax curve coincides with TC2 the cost curve for all those inefficient regulations doesnt this imply that the tax system is just as inefficient No The key to understanding the difference is the distinction between transfer costs and real resource costs Under a regulation system of the type described earlier in this chapter all of the costs included in TC2 are real resource costs which involve utilization of resources Transfer costs by contrast involve transfers of resources from one part of society to another rather than their dissipation Transfers do represent costs to that part of society bearing them but are exactly offset by the gain received by the recipients Unlike real resource costs resources are not used up with transfers Thus the calculation of the size of the net benefit should subtract real resource costs but not transfer costs from benefits For society as a whole transfer costs are retained as part of the net benefit who receives it is affected but not the size of the net benefit A tax on catch would yield a similar result but in this case the total revenue curve would shrink price minus tax rather than total cost increasing Both types of taxes would help move the equilibrium toward E Can you draw this using Figure 126 In Figure 126 the net benefit under a tax system is identical to that under an efficient allocation The net benefit represents a transfer cost to the fisherman that is exactly offset by the revenues received by the tax collector This discussion should not obscure the fact that as far as the individual fisherman is concerned tax payments are very real costs Rent normally received by a sole owner is now received by the government Since the tax revenues involved can be substantial fishermen wishing to have the fishery efficiently managed may object to this particular way of doing it They would prefer a policy that restricts catches while allowing them to keep the rents Is that possible Catch Share Programs Catch share programs offer this option Catch share programs allocate a portion of the total allowable catch to individuals communities or cooperatives Programs in this category include individual fishing quotas IFQs individual transferable quotas ITQs individual vessel quotas IVQs territorial use rights fisheries TURFs fishing cooperatives and community fishing quotas7 An ITQ program is a specific IFQ program where harvesting privileges can be transferred subsequent to initial allocations IVQs are sometimes transferable while TURFs grant rights to a geographic area All of these create a type of harvest entitlement either in the fishery as a whole or in a specific geographic area8 Catch share programs exist in 22 countries and on all continents Table 121 ITQs Lets first consider individual transferable quotas Several of their identifiable characteristics serve to enhance efficiency 1 The quotas entitle the holder to catch a specified share of the total authorized catch of a specified type of fish 2 The catch authorized by the quotas held by all fishermen should be equal to the efficient catch for the fishery 3 The quotas should be freely transferable among fishermen and markets should send appropriate price signals about the value of the fishery Each of these three characteristics plays an important role in obtaining an efficient allocation Suppose for example the quota was defined in terms of boats rather than in terms Commercially Valuable Fisheries 287 of catchnot an uncommon type of quota With a limit on the number of boats an inefficient incentive still remains for each boat owner to build larger boats to place extra equipment on them and to spend more time fishing These actions would expand the capacity of each boat and cause the actual catch to exceed the target efficient catch In a nutshell the boat quota limits the number of boats fishing but does not limit the amount of fish caught by each boat If we are to reach and sustain an efficient allocation the catch must ultimately be limited While the purpose of the second characteristic setting the right catch quota is obvious the role of transferability deserves more consideration With transferability the entitlement to fish flows naturally to those gaining the most benefit from it because their costs are lower Because it is valuable the transferable quota commands a positive price Those who have quotas but also have high costs find they make more money selling the quotas than using them Meanwhile those who have lower costs find they can purchase more quotas and still make money Transferable quotas also encourage technological progress Adopters of new costreducing technologies can make more money on their existing quotas and make it profitable to purchase new quotas from others who have not adopted the technology Therefore in marked contrast to the earlier regulatory methods used to raise costs both the tax system and the transferable quota system encourage the development of new technologies without threatening the sustainability of the fishery Table 121 Countries with Individual Transferable Quota Systems Country Number of Species Covered Argentina 1 Australia 26 Canada 52 Chile 9 Denmark 1 Estonia 2 Falkland Islands 4 Greenland 1 Iceland 25 Italy 1 Mauritius 1 Morocco 1 Mozambique 4 Namibia 10 The Netherlands 7 New Zealand 97 Portugal 1 South Africa 1 United States 6 Complete species list unavailable Norway Peru and Russia also use ITQ systems as part of their fisheries management Source Adapted from Chu C 2009 Thirty years later The global growth of ITQs and their influ ence on stock status in marine fisheries Fish and Fisheries 10 217230 Arnason R Summer 2012 Property rights in fisheries How much can individual transferable quotas accomplish Review of Environmental Economics and Policy 62 217236 Jardine S L Sanchirico J N 2012 Catch share programs in developing countries A survey of the literature Marine Policy 36 12421254 Commercially Valuable Fisheries 288 How about the distribution of the rent In a quota system the distribution of the rent depends crucially on how the quotas are initially allocated There are many possibilities with different outcomes The first possibility is for the government to auction off these quotas With an auction government would appropriate all the rent and the outcome would be very similar to the outcome of the tax system If the fishermen do not like the tax system they would not like the auction system either In an alternative approach the government could give the quotas to the fishermen for example in proportion to their historical catch The fishermen could then trade among themselves until a market equilibrium is reached All the rent would be retained by the current generation of fishermen Fishermen who might want to enter the market would have to purchase the quotas from existing fishermen Competition among the potential purchasers would drive up the price of the transferable quotas until it reflected the market value of future rents appropriately discounted9 Thus this type of quota system allows the rent to remain with the fishermen but only the current generation of fishermen Future generations see little difference between this quota system and a tax system in either case they have to pay to enter the industry whether it is through the tax system or by purchasing the quotas Worldwide ITQs are currently used by 22 countries to manage hundreds of different species Table 121 The annual global catch taken under ITQs may be as large as a quarter of the global harvest Arnason 2012 The fact that ITQ systems are spreading to new fisheries so rapidly suggests that their potential is being increasingly recognized This expansion does not mean the absence of any concerns In 1997 the United States issued a moratorium on the implementation of new ITQ programs which expired in 2002 Issues about the duration of catch shares whether shareholders need to be active in the fishery and the distributional implications all remain contentious One of the most established ITQ programs is in New Zealand In 1986 a limited ITQ system was established in New Zealand to protect its deepwater trawl fishery Newell et al 2005 Although this was far from being the only or even the earliest application of ITQs it is the worlds largest and provides an unusually rich opportunity to study how this approach works in practice Some 130 species are fished commercially in New Zealand10 The Fisheries Amendment Act of 1986 that set up the program covered 17 inshore species and nine offshore species Because this program was newly developed allocating the quotas proved relatively easy The New Zealand Economic Exclusion Zone EEZ was divided geographically into quota management regions The total allowable catches TACs for the seven basic species were divided into individual transferable quotas by quotamanagement regions By 2000 275 quota markets were in existence Quotas were initially allocated to existing firms based on their average historical catch However because fishing is characterized by economies of scale simply reducing everyones catch proportionately wouldnt make much sense That would simply place higher costs on everyone and waste a great deal of fishing capacity as all boats sat around idle for a significant proportion of time A better solution would clearly be to have fewer boats harvesting the stock That way each boat could be used closer to its full capacity without depleting the population Which fishermen should be asked to give up their livelihood and leave the industry The economicincentive approach addressed this problem by having the government buy back catch quotas from those willing to sell them Initially this was financed out of general revenues subsequently it was financed by a fee on catch quotas Essentially each fisherman Commercially Valuable Fisheries 289 stated the lowest price that he or she would accept for leaving the industry the regulators selected those who could be induced to leave at the lowest price paid the stipulated amount from the fee revenues and retired their licenses to fish for this species It wasnt long before a sufficient number of licenses had been retired and the population was protected Because the program was voluntary those who left the industry did so only when they felt they had been adequately compensated Meanwhile those who paid the fee realized that this small investment would benefit them greatly in the future as the population recovered A difficult and potentially dangerous pressure on a valuable natural resource had been alleviated by the creative use of an approach that changed the economic incentives Toward the end of 1987 however a new problem emerged The stock of one species orange roughy turned out to have been seriously overestimated by biologists Since the total allocation of quotas was derived from this estimate the practical implication was that an unsustainably high level of quotas had been issued the stock was in jeopardy The New Zealand government began buying some quotas back from fishermen but this turned out to be quite expensive with NZ45 million spent on 15000 tons of quotas from inshore fisheries Faced with the unacceptably large budget implications of buying back a significant amount of quotas the government ultimately shifted to a percentageshare allocation of quotas Under this system instead of owning quotas defined in terms of a specific quantity of fish fishermen own percentage shares of a total allowable catch The total allowable catch was determined annually by the government In this way the government could annually adjust the total allowable catch based on the latest stock assessment estimates without having to buy back or sell large amounts of quota This approach affords greater protection to the stock but increases the financial risk to the fishermen By 2004 New Zealands ITQ program had expanded to cover 70 species Newell et al 2005 found that the export value of these species ranged from NZ 700metric ton for jack mackerel to NZ 40000metric ton for rock lobster They also found that by 2000 some 70 percent of quote holders engaged in transactions in the ITQ market Despite this activity some implementation problems have emerged Fishing effort is frequently not very well targeted Species other than those sought known as bycatch may well end up as part of the catch If those species are also regulated by quotas and the fishermen do not have sufficient ITQs to cover the bycatch they are faced with the possibility of being fined when they land the unauthorized fish Dumping the bycatch overboard avoids the fines but the jettisoned fish frequently do not survive Dumping the bycatch represents a double wastenot only is the stock reduced but also the harvested fish are wasted Managers have also had to deal with highgrading which can occur when quotas specify the catch in terms of weight of a certain species but the value of the catch is affected greatly by the size of the individual fish To maximize the value of the quota fishermen have an incentive to throw back the less valuable typically smaller fish keeping only the most valuable individuals As with bycatch when release mortality is high highgrading results in both smaller stocks and wasted harvests Although ITQ systems are far from perfect frequently they offer the opportunity to improve on traditional fisheries management see Example 122 In its 2012 annual report to Congress NOAA reported that 32 stocks have been rebuilt Some 41 stocks 19 percent are still overfished but that is down from 45 just a year earlier Costello Gaines and Lynham 2008 examined the global effectiveness of these polices in over 11000 fisheries from 1950 to 2003 Fisheries with catch share rules including ITQs experienced much less frequent collapse than fisheries without them In fact they found that Commercially Valuable Fisheries 290 EXAMPLE 122 The Relative Effectiveness of Transferable Quotas and Traditional Size and Effort Restrictions in the Atlantic Sea Scallop Fishery Theory suggests that individual transferable quotas will produce more costeffective outcomes in fisheries than traditional restrictions such as minimum legal size and maximum effort controls Is this theoretical expectation compatible with the actual experience in implemented systems In a fascinating study economist Robert Repetto 2001 examined this question by comparing Canadian and American approaches to controlling the sea scallop fishery off the Atlantic coast While Canada adopted a transferable quota system the United States adopted a mix of size effort and area controls The comparison provides a rare opportunity to exploit a natural experiment since scallops are not migratory and the two countries use similar fishing technologies Hence it is reasonable to presume that the differences in experience are largely due to the difference in management approaches What were the biological consequences of these management strategies for the two fisheries The Canadian fishery was not only able to maintain the stock at a higher level of abundance but it was also able to deter the harvesting of undersized scallops In the United States stock abundance levels declined and undersized scallops were harvested at high levels What were the economic consequences of these differences Revenue per seaday increased significantly in the Canadian fishery due largely to the sevenfold increase in catch per seaday made possible by the larger stock abundance In the United States fishery revenue per seaday fell due not only to the fall in the catch per day that resulted from the decline in stock abundance but also to the harvesting of undersized scallops Although the number of Canadian quota holders was reduced from nine to seven over a 14year period 65 percent of the quota remained in its original hands The evidence suggests that smaller players were apparently not at a competitive disadvantage What were the equity implications Both US and Canadian fisheries have traditionally operated on the lay system which divides the revenue among crew captain and owner according to preset Commercially Valuable Fisheries 291 by 2003 the fraction of fisheries with ITQs that had collapsed was only half that of nonITQ fisheries They suggest that this might be an underestimate since many fisheries with ITQs have not had them for very long This large study suggests that welldesigned property rights regimes catch shares or ITQs more specifically may help prevent fisheries collapse andor help stocks of some species recover Chu 2009 examined 20 stocks after ITQ programs were implemented and found that 12 of those had improvements in stock size Eight however continued to decline Apparently ITQs can sometimes help but they are no panacea In the next chapter we will consider whether ITQs can help to conserve different marine species such as whales Catch Share Programs in the United States In the United States the Magnuson Stevens Act authorizes several types of catch share approaches under its limited access privilege program In the United States there are 16 active catch share programs Table 122 Most of these are individual fishing quotas IFQs but more recently cooperatives and community development quotas CDCs have emerged European Common Fisheries Policy The Common Fisheries Policy is the fisheries policy of the European Union It sets total allowable catch TAC for member states Each country receives a national quota based on a percentage of the TAC For each stock different allocation percentages per country are applied EU member countries can trade these quotas with other EU countries Each member state is then responsible for enforcing its quota11 The 2015 TACs covered 36 species12 Territorial Use Rights Fisheries TURFs An alternative to ITQs is to allocate rights to a specific area for a specific species or group of species rather than to a portion of the total allowable catch Such geographicbased rights systems are called territorial use rights fisheries or TURFs Like ITQs TURFs typically grant access rights not ownership rights to harvesters TURFs could allow access to a layer of the water column such as the bottom of the ocean or the surface for example in a specific zone They could also allow access to a specific oyster bed or a raft for mollusks They could be granted to individuals communities corporations or even to nations An economic exclusion zone EEZ is a TURF granted to an individual nation Early examples of operating TURFs can be found in Japan These now wellestablished TURFs allocate zones to local fisher organizations called Fishery Cooperative Associations FCAs Approximately 1300 FCAs now operate in Japan Wilen et al 2012 They can also be found in Chile With its 3000mile shoreline Chile has created management and exploitation percentages after subtracting certain operating expenditures This means that all parties remaining in the fishery after regulation shared in the increasing rents In these fisheries at least it seems that the expectations flowing from the theory were borne out by the experience Source Repetto R 2001 A natural experiment in fisheries management Marine Policy 25 252264 Table 122 CatchShares in the United States by Fisheries Management Region New England MidAtlantic Atlantic Sea Scallops IFQ 2010 Surf Clam Ocean Quahog ITQ 1990 New England Multispecies Sectors 2010 Golden Tilefish IFQ 2009 South Atlantic Pacific Wreckfish ITQ 1991 Pacific Sablefish Permit Stacking IFQ 2001 Pacific Coast Groundfish Trawl Rationalization IFQ 2011 North Pacific Gulf of Mexico Halibut Sablefish IFQ 1995 Red Snapper IFQ 2007 Western Alaska CDQ 1992 Grouper Tilefish IFQ 2010 Bering Sea AFA Pollock Cooperative 1999 Atlantic Highly Migratory Species Groundfish nonPollock Cooperatives 2008 Individual Bluefin Tuna Quota 2015 Bering Sea Crab Tanner Crab IFQ 2005 Central Gulf of Alaska Rockfish Cooperative 2011 Caribbean Western Pacific No catch share programs No catch share programs Source NOAA 2017 Adapted from wwwnmfsnoaagovsfamanagementcatchsharesaboutprogramsbyregionhtml Commercially Valuable Fisheries 293 ITQs or TURFs Species Space or Both ITQs and TURFs can improve economic efficiency and help protect fisheries from overexploitation Is one management method better than another Can they be usefully combined Speciesbased ITQs have proven very popular and they can in theory create efficient harvesting and conservation incentives However in practice enforcement can be challenging and they suffer from several externalities Some of the most prominent externalities including gear impacts on ecosystems spatial externalities and crossspecies interactions might actually be increased by ITQs Lets see how Typically the total allowable catch TAC is divided amongst several perhaps numerous owners Although they do not compete over the size of their catch since that is fixed by their catch share they do still compete over the timing of that catch Timing might matter a great deal when the most productive harvesting periods in terms of reducing the private effort required per unit catch turn out to be precisely the periods that impose the largest external costs say by increasing the likelihood of bycatch or negatively impacting the juvenile stock As such they help solve one problem assuring a sustainable total catch while creating another encouraging a harvest timing that increases external costs The Coase theorem Chapter 2 suggests that these ownership rights should in principle create incentives to solve the remaining externalities as well but in practice the transactions costs of such negotiations are apparently prohibitively high What about TURFs TURFs help solve the problem of managing harvests over time and space and can help protect sensitive areas given that an individual or group has sole rights to that area Local cooperatives have the advantage of being able in principle to manage interspecies interactions and habitat destruction but in practice TURFs tend to suffer from conflict and coordination problems Another common criticism of TURFs is that the scale must match the range of the species and many TURFs do not or cannot achieve this size Rather than framing the issue as whether ITQs or TURFs are the best choice it may be that each has its own niche Certainly in developing countries with weak institutional structures TURFs offer many advantages over species based ITQs TURFs also may be most appropriate for small local populations On the other hand ITQs have been used successfully for many marine fisheries Clearly one size does not fit all for fisheries policy Source Wilen J E Cancino J Uchida H Summer 2012 The economics of territorial use rights fisheries or TURFs Review of Environmental Economics and Policy 62 237257 DEBATE 121 Commercially Valuable Fisheries 294 Aquaculture Having demonstrated that inefficient management of the fishery results from treating it as an openaccess resource one obvious solution is to allow some fisheries to be privately held This approach can work when the fish are not very mobile when they can be confined by artificial barriers or when they instinctively return to their place of birth to spawn The advantages of such a move go well beyond the ability to preclude overfishing The owner is encouraged to invest in the resource and undertake measures that will increase the productivity yield of the fishery For example adding certain nutrients to the water or controlling the temperature can markedly increase the yields of some species The controlled raising and harvesting of fish is called aquaculture Probably the highest yields ever attained through aquaculture have resulted from using rafts to raise mussels Some 300000 kilograms per hectare of mussels for example have been raised in this manner in the Galician bays of Spain This productivity level approximates those achieved in poultry farming widely regarded as one of the most successful attempts to increase the productivity of farmproduced animal protein Japan became an early leader in aquaculture undertaking some of the most advanced aquaculture ventures in the world The government has been supportive of these efforts mainly by creating private property rights for waters formerly held in common The governments of the prefectures which are comparable to states in the United States initiate the process by designating the areas to be used for aquaculture The local fishermens cooperative associations then partition these areas and allocate the subareas to individual fishermen for exclusive use This exclusive control allows the individual owner to invest in the resource and to manage it effectively and efficiently Another market approach to aquaculture involves fish ranching rather than fish farming Whereas fish farming involves cultivating fish over their lifetime in a controlled environment fish ranching involves holding them in captivity only for the first few years of their lives Fish ranching relies on the strong homing instincts in certain fish such as Pacific salmon or ocean trout which permits their ultimate return and capture The young salmon or ocean trout are hatched and confined in a convenient catch area for approximately 2 years When released they migrate to the ocean Upon reaching maturity they instinctually return to the place of their births where they are harvested Fish farming has certainly affected the total supply of harvested fish Aquaculture is currently the fastestgrowing animal food production sector In China aquaculture now represents more than twothirds of fisheries production China has become the largest producer and exporter of seafood producing 62 percent of the global supply of farmed fish Shrimp eel tilapia sea bass and carp are all intensively farmed Aquaculture is certainly not the answer for all fish Today it works well for certain species but other species will probably never be harvested domestically Furthermore fish farming can create intensive environmental problems Salmon farming and shrimp farming especially create negative externalities as do fish farmed in contaminated water see Debate 122 Nonetheless it is comforting to know that aquaculture can provide a safety valve in some regions and for some fish and in the process take some of the pressure off the overstressed natural fisheries The challenge will be to keep aquaculture sustainable Subsidies and Buybacks Excess fleet capacity or overcapitalization is prevalent in many commercial fisheries Overcapacity encourages overfishing Many subsidies exacerbate this effect by encouraging Commercially Valuable Fisheries 295 Aquaculture Does Privatization Cause More Problems Than It Solves Privatization of commercial fisheries namely through fish farming has been touted as a solution to the overfishing problem For certain species it has been a great success Some types of shellfish for example are easily managed and farmed through commercial aquaculture For other species however the likelihood of success is not so clearcut Atlantic salmon is a struggling species in the northeastern United States and for several rivers is listed as endangered Salmon farming takes the pressure off of the wild stocks Atlantic salmon are intensively farmed off the coast of Maine in northeastern Canada in Norway and in Chile Farmed Atlantic salmon make up almost all of the farmed salmon market and more than half of the total global salmon market While farmed salmon offer a good alternative to wild salmon and aquaculture has helped meet the demand for salmon from consumers it is not problemfree Farmed fish escapees from the pens threaten native species pollution that leaks from the pens creates a large externality and pens that are visible from the coastline degrade the view of coastal residents The crowded pens also facilitate the prevalence and diffusion of several diseases and illnesses such as sea lice and salmon anemia Antibiotics used to keep the fish healthy are considered dangerous for humans Diseases in the pens can also be transferred to wild stocks In 2007 the Atlantic Salmon Federation and 33 other conservation groups called on salmon farms to move their pens farther away from sensitive wild stocks And the concerns do not end there Currently many small species of fish like anchovies or herring are being harvested to feed carnivorous farmed fish Scientists argue that this is not an efficient way to produce protein since it takes 35 pounds of smaller fish to produce 1 pound of farmed salmon Pollution externalities associated with the increased production include contaminated water supplies for the fish ponds and heavily polluted wastewater Some farmers raising their fish in contaminated water have managed by adding illegal veterinary drugs and pesticides to the fish feed creating food safety concerns Some tested fish flesh has been found to contain heavy metals including mercury and flame retardants While solving some problems intensive aquaculture has created others Potential solutions include openocean aquaculture moving pens out to sea closing pens monitoring water quality and improving enforcement Clearly sole ownership to the fishery isnt a silver bullet when externalities are prevalent Is shrimp farming any better Over half of the shrimp consumed worldwide are farmed mostly in Asia and Central America while the markets are mostly DEBATE 122 Commercially Valuable Fisheries 296 overcapacity and overcapitalization Fuel subsidies tax exemptions fish price supports and grants for new vessels are common forms of subsidies in fisheries By enhancing profits these subsides create perverse incentives to continue fishing even while stocks are declining A rather different type of subsidy is intended to discourage overfishing If vessel owners do not have alternative uses for their vessels they may resist catch restrictions or other measures meant to help depleted stocks Management options have included buyback or equivalently decommissioning subsidies to reduce fishing capacity In 2004 the US government spent 100 million to buy out 28 of the 260 Alaskan snow crab fishery vessels Payments used to buy out excess fishing capacity are useful subsidies in that they reduce overcapacity but if additional capacity seeps in over time they are not as effective as other management measures If fishermen come to anticipate a buyback they may acquire more vessels than they otherwise would have which would lead to even greater levels of overcapacity Exclusive Economic ZonesThe 200Mile Limit The final policy dimension concerns the international aspects of the fishery problem Obviously the various policy approaches to effective management of fisheries require some governing body to have jurisdiction over a fishery so that it can enforce its regulations Currently this is not the case for many of the ocean fisheries Much of the open water of the oceans is a commonpool resource to governments as well as to individual fishermen No single body can exercise control over it As long as that continues to be the case the corrective action will be difficult to implement In recognition of this fact there is now an evolving law of the sea defined by international treaties One of the concrete results of this law for example has been some limited restrictions on whaling Whether this process ultimately yields a consistent and comprehensive system of management remains to be seen but it is certainly an uphill battle The United Nations Convention on the Law of the Sea grants countries bordering the sea ownership rights that extend some 200 miles out to sea Within these Exclusive Economic Zones EEZs the countries have exclusive jurisdiction and can implement effective management policies These zones are essentially very large TURFs These exclusive zone declarations have been upheld and are now firmly entrenched in international law Thus very rich fisheries in coastal waters can be protected while those in the open waters await the in the United States and China Developing countries that farm shrimp have cut down valuable mangroves in order to create fish farms These mangroves provided storm protection and important coastal habitat recall Example 22 Things are changing however Some shrimp farms are experimenting with inland ponds that treat their own waste They are also exploring using vegetable protein as a food source The challenge will be scale Can new technology be expanded to meet the demand Sources Atlantic Salmon Federation wwwasfcamainhtml Barboza D December 15 2007 Chinas seafood industry Dirty water dangerous fish New York Times Urry Amelia 2014 Grist httpgristorgfoodisthereasustainablefutureforamericas mostpopularseafood Commercially Valuable Fisheries 297 outcome of an international negotiations process The European Union has the largest EEZ in the world Unfortunately EEZs do not sufficiently protect highly migratory fish stocks such as tunas and sharks and as such 58 percent of the ocean the high seas is overexploited and overfished for many species White and Costello 2014 Marine Protected Areas and Marine Reserves Regulating only the amount of catch leaves the type of gear that is used and locations where the harvests take place uncontrolled Failure to control those elements can lead to environ mental degradation of the habitat on which the fishery depends even if catch is successfully regulated Some gear may be particularly damaging not only to the targeted species eg by capturing juveniles that cannot be sold but that dont survive capture but also to nontar geted species bycatch Similarly harvesting in some geographic areas such as those used for spawning might have a disproportionately large detrimental effect on the sustainability of the fishery Conservation biologists have suggested complementing current policies with the establishment of a system of marine protected areas MPAs The US federal government defines MPAs as any area of the marine environment that has been reserved by federal state tribal territorial or local laws or regulations to provide lasting protection for part or all of the natural and cultural resources therein13 Restrictions range from minimal to full protection A marine reserve a marine protected area with full protection is an area that prohibits harvesting and enjoys a very high level of protection from other threats such as pollution Biologists believe that marine protected areas can perform several maintenance and restorative functions First they protect individual species by preventing harvest within the reserve boundaries Second they reduce habitat damage caused by fishing gear or practices that alter biological structures Third in contrast to quotas on single species reserves can promote ecosystem balance by protecting against the removal of ecologically pivotal species whether targeted species or bycatch that could throw an ecosystem out of balance by altering its diversity and productivity Palumbi 2002 Reducing harvesting in these areas protects the stock the habitat and the ecosystem on which it depends This protection results in a larger population and ultimately if the species swim beyond the boundaries of the reserve larger catches in the remaining harvest areas Simply put reserves promote sustainability by allowing the population to recover Their relationship to the welfare of current users however is less clear Proponents of MPAs suggest that they can promote sustainability in a winwin fashion meaning current users benefit as well This is an important point because users who did not benefit might mount political opposition to marine reserve proposals thereby making their establishment very difficult Would the establishment of a marine protected area maximize the present value of net benefits for fishermen If MPAs work as planned they reduce harvest in the short run by declaring areas previously available for harvest offlimits but they increase it in the long run as the population recovers and spills over the boundaries of the protected areas However the delay would impose costs Remember how discounting affects present value To take one concrete example of the costs of delay to harvesters they may have to pay off a mortgage on their boat Even if the bank grants them a delay in making payments total payments will rise due to interest So by itself a future rise in harvests does not guarantee that establishing the reserve maximizes present value unless the rise in catch is large enough and soon enough to compensate for the costs imposed by the delay14 Commercially Valuable Fisheries 298 Since the present value of this policy depends on the specifics of the individual cases a case study can be revealing In an interesting case study of the California sea urchin industry Smith and Wilen 2003 state the following Our overall assessment of reserves as a fisheries policy tool is more ambivalent than the received wisdom in the biological literature We find that reserves can produce harvest gains in an agestructured model but only when the biomass is severely overexploited We also find that even when steady state harvests are increased with a spatial closure the discounted returns are often negative reflecting slow biological recovery relative to the discount rate p 204 This certainly does not mean that MPAs or marine reserves are a bad idea In some areas they may be a necessary step for achieving sustainability in others they may represent the most efficient means of achieving sustainability It does mean however that we should be wary of the notion that they always create winwin situations sacrifices by local harvesters might be required MPA policies must recognize the possibility of this burden and deal with it directly not just assume it doesnt exist Some international action on marine reserves is taking place as well The 1992 international treaty called the Convention on Biological Diversity lists as one of its goals the conservation of at least 10 percent of the worlds ecological regions including but not limited to marine ecoregions Progress has been significant for terrestrial ecoregions but less so for coastal and marine ecoregions One creative proposal to incentivize the creation of new MPAs as well as incentivize sustainable fishing practices is to link ecolabeling to adjacent MPAs Lester et al 2013 propose building on recent surges in demand for green products and sustainable fisheries eco labeling such as the Marine Stewardship Councils MSC label and the Monterey Aquarium Seafood Watch Program They explore providing credit for adjacent MPAs in seafood certification and labeling The impacts of MPAs on fish stocks is clear and could be used to provide sustainability credits They argue that making this link more explicit in labeling could help protect fish stocks EnforcementIllegal Unreported and Unregulated Fishstocks Illegal unreported and unregulated IUU fishing is a growing global problem Approximately 90 percent of the seafood consumed in the United States is imported either caught by foreign fishing vessels or sent abroad for processing and then reimported Half of this is wildcaught seafood It has been estimated that 2032 percent of wildcaught seafood imports into the United States are from IUU sources Pramod et al 2014 The global market is complex and large and when seafood changes hands multiple times it seems likely that even perceived legal imports contain IUU catch Some regulations are difficult to enforce such as the High Seas Driftnet Moratorium Protection Act which specifies that commerce in products caught with driftnets is illegal Monitoring control and surveillance are prohibitively expensive in many cases Another illegal activity is highgrading which can occur when fisherman have already met their quota but then catch larger more valuable fish and discard the lowvalued fish overboard Often quotas specify the catch in terms of weight of a certain species but the value of the catch is affected greatly by the size of the individual fish One possible strategy is simply banning discarding but due to the difficulties of monitoring and enforcement that is not as Commercially Valuable Fisheries 299 straightforward a solution as it may seem Kristofersson and Rickertsen 2009 examine whether a ban on discarding has been effective in the Icelandic cod fishery They use a model of a fishery with an ITQ program and apply it to the Icelandic cod fishery They estimate that longline vessels would discard up to 25 percent of the catch of small cod and gillnet vessels up to 67 percent Their analysis found that quota price did not seem to be an influencing factor but the existence of a system of quotas and the size of the hold in which the harvested fish are kept do matter They suggest that to get the most bang for the buck enforcement efforts should be directed at gillnet vessels and on fisheries with small hold capacities Some fisheries managers have successfully solved both problems by allowing fishermen to cover temporary overages with allowances subsequently purchased or leased from others As long as the market value of the extra fish exceeds the cost of leasing quotas the fishermen will have an incentive to land and market the fish and the stock will not be placed in jeopardy Clearly highgrading and other discards are still a significant problem Zeller et al 2017 estimate discards at 1020 percent of global catch Some of this is highgrading other discards are from catch that is diseased or isnt the target species Poaching illegal harvesting can introduce the possibility of unsustainability even when a legal structure to protect the population has been enacted For example in 1986 the International Whaling Commission set a ban on commercial whaling but under a loophole in this law Japan had continued to kill hundreds of whales each year In November 2007 a fleet embarked on a 5month hunt in the Antarctic despite numerous international protests While originally intending to target humpback whales in response to the protests Japan eventually stopped harvesting that species Since humpback whales are considered vulnerable commercial hunts have been banned since 1966 but Japan had claimed that harvests for research were not covered by this ban Bluefin tuna is another very valuable commerical species that is threatened and has been brought under international control The population of bluefin tuna has plummeted 85 percent since 1970 with 60 percent of that loss occurring in the last decade Much of the decline is due to overfishing and illegal harvesting havesting more than the quota allotment Japan is the largest consumer of bluefin tuna which is prized for sushi Fleets from Spain Italy and France are the primary suppliers In the United States the National Marine Fisheries Service manages the Atlantic Highly Migratory Species regulations which include a catchshare program for the US portion of the International Commission for the Conservation of Atlantic Tunas ICCAT quota of endangered bluefin tuna The 2014 amendment 7 to the 2006 rule allocates US bluefin tuna quota among domestic fishing categories implements measures applicable to the pelagic longline fishery including Individual Bluefin Quotas IBQs two new Gear Restricted Areas closure of the pelagic longline fishery when annual bluefin tuna quota is reached among other rules on bycatch and monitoring15 It also requires vessels to account for incidental bluefin tuna landings and dead discards using individual bluefin quota allocation A rather different approach to protect the species was tried in the international forum In 2009 a petition to ban trade in the Atlantic bluefin tuna went before the UN Convention on International Trade in Endangered Species CITES This was the first time that a major commercial fishery has been addressed by CITES While conservationists and biologists supported the CITES listing many industry groups were opposed The National Fisheries Institute president John Connelly wrote in opposition Commerciallyexploited aquatic species are fundamentally different from the other species that CITES regulates Unlike these other species fish and seafood stocks are not generally threatened with biological extinction While they can and do become Commercially Valuable Fisheries 300 overfished the resulting loss of return on investment for fishermen prevents them from driving commercial fish stocks toward biological extinction Gronewold 2009 In early 2010 CITES voted against the ban In January 2011 a record price was set for a northern bluefin A giant 754pound bluefin brought 325 million yen or nearly 400000 Do you think this price is a sufficient incentive to protect the bluefin tuna from extinction Why or why not See Debate 123 Bluefin Tuna Difficulties in Enforcing HighValue Species The International Commission for the Conservation of Atlantic Tunas ICCAT is responsible for the conservation of highly migratory species including several species of tuna ICCAT reports fish biomass as well as catch statistics and is responsible for setting total allowable catch by species each year Since ICCAT has never successfully enforced their quotas it is not clear that they have a credible enforcement capability Monitoring statistics consistently show catch well above the TAC DEBATE 123 Table 123 Probabilities of Stock Rebuilding at SSBF01 by Years and TAC Levels Percentage TAC 2010 2013 2016 2019 2022 0 0 2 25 69 99 2000 0 1 21 62 99 4000 0 1 18 55 99 6000 0 1 14 47 97 8000 0 0 11 40 92 10000 0 0 9 33 84 12000 0 0 6 26 73 13500 0 0 5 21 63 14000 0 0 4 20 59 16000 0 0 3 14 46 18000 0 0 2 10 34 20000 0 0 1 6 24 Note Gray color highlights the catch at which the 60 percent probability would not be achieved Source Report of the 2010 Atlantic bluefin tuna stock assessment session Table 1 ICCAT wwwiccatinten Commercially Valuable Fisheries 301 Summary Unrestricted access to commercially valuable species will generally result in overexploitation This overexploitation in turn results in overcapitalization depressed incomes for harvesters and depleted stocks Even extinction of the species is possible particularly for populations characterized by easy lowcost extraction Where extraction costs are higher extinction is unlikely even with unrestricted access Both the private and public sectors have moved to ameliorate the problems associated with past mismanagement of commercial fisheries By reasserting private property rights many coun tries have stimulated the development of aquaculture Governments in Canada and the United States have moved to limit overexploitation of the Pacific salmon International agreements have been instituted to place limits on whaling It is doubtful that these programs fully satisfy the efficiency criterion although it does seem clear that more sustainable catches will result Using data from 4713 fisheries worldwide representing 78 percent of global reported fish catch Costello et al 2016 estimate global maximum sustained yield to be 98 million metric tons not including illegal fishing They forecast that businessasusual fisheries management will result in the continued collapse of many of the worlds fisheries They suggest that commonsense reforms could increase both fish abundance and hence food security along with profits Creative strategies for sharing the gains from moving to an efficient level of harvest could prove to be a significant weapon in the arsenal of techniques designed to protect a broad class of biological resources from overexploitation An increasing reliance on individual transferable quotas ITQs and TURFs offers the possibility of preserving stocks without jeopardizing the incomes of those men and women currently harvesting those stocks Strengthening property Additionally international pressure from the fishing industry frequently results in a TAC higher than scientists recommend In 2009 for example having reviewed the current biomass statistics which showed the current stock to be at less than 15 percent of its original stock ICCAT scientists recommended a total suspension of fishing Ignoring their scientists recommendation ICCAT proceeded to set a quota of 13500 tons They did however also agree to establish new management measures for future years that will allow the stock to rebuild with an estimated 60 percent degree of confidence While that sounds good it turns out that if enforcement is less than perfect and the resulting catch is above 13500 the probability that the stock will recover cannot reach the 60 percent level by 2022 Table 123 Sources International Commission for the Conservation of Atlantic Tunas 2009 annual ICCAT meeting press release November 16 2009 ICCAT wwwiccatorg Gronewold G October 14 2009 Is the bluefin tuna an endangered species Scientific American Retrieved from www scientificamericancomarticlecfmidbluefintunastocks threatenedcitesjapanmonaco Draft amendment 7 to the Consolidated Atlantic Highly Migratory Species Fishery Management Plan National Marine Fisheries Service August 2013 Retrieved from wwwscribdcomdoc161801821NOAADraftBluefin TunaAmendment Commercially Valuable Fisheries 302 rights is a key component in generating both efficient and sustainable harvests Approximately 20 percent of developing countries have implemented spacebased mostly in Asia and Pacific regions or quotabased mostly found in African nations allocation systems It would be folly to ignore barriers to further action such as the reluctance of individual harvesters to submit to many forms of regulation the lack of a firm policy governing open ocean waters and the difficulties of enforcing various approaches Whether these barriers will fall before the pressing need for effective management remains to be seen Climate change is already affecting the marine environment so looming challenges remain In this chapter we have focused on fisheries as an example of a renewable biological resource but the models and the insights that flow from them can be used to think about managing other wildlife populations as well This topic will be taken up in the next chapter Discussion Questions 1 Is the establishment of the 200mile limit a sufficient form of government intervention to ensure that the tragedy of the commons does not occur for fisheries within the 200mile limit Why or why not 2 With discounting it is possible for the efficient fish population to fall below the level required to produce the maximum sustained yield Does this violate the sustainability criterion Why or why not SelfTest Exercises 1 Assume that the relationship between the growth of a fish population and the population size can be expressed as g 4P 01P2 where g is the growth in tons and P is the size of the population in thousands of tons Given a price of 100 a ton the marginal benefit of smaller population sizes and hence larger catches can be computed as 20P 400 a Compute the population size that is compatible with the maximum sustainable yield What would be the size of the annual catch if the population were to be sustained at this level b If the marginal cost of additional catches expressed in terms of the population size is MC 2160 P what is the population size that is compatible with the efficient sustainable yield 2 Assume that a local fisheries council imposes an enforceable quota of 100 tons of fish on a particular fishing ground for one year Assume further that 100 tons per year is the efficient sustained yield When 100 tons have been caught the fishery would be closed for the remainder of the year a Is this an efficient solution to the common property problem Why or why not b Would your answer be different if the 100ton quota were divided into 100 transfer able quotas each entitling the holder to catch 1 ton of fish and distributed among the fishermen in proportion to their historical catch Why or why not 3 In the economic model of the fishery developed in this chapter compare the effect on fishing effort of an increase in cost of a fishing license with an increase in a perunit tax on fishing effort that raises the same amount of revenue Assume the fishery is private property Repeat the analysis assuming that the fishery is a freeaccess common property resource Commercially Valuable Fisheries 303 4 When trying to reduce the degree of inefficiency from an openaccess fishery would a regulation that increases the marginal cost of fishing effort by banning certain types of gear or a tax on effort be equally efficient Why or why not 5 a In the typical economic model of an efficient fishery would a fall in the price of fish generally result in a larger or a smaller sustainable harvest Why b Suppose the fishery allowed free access Would a fall in the price of fish generally result in a larger or a smaller harvest Why 6 Suppose that a particular fishery experiences a technological change such that the fixed cost of fishing increases but the marginal cost of fishing decreases The change is such that the before and after total cost curves cross at an effort level higher than that associated with the before efficient sustained yield but lower than the freeaccess level of effort a What would the effect of this technological change be on the static efficient level of effort and the size of the static efficient level of harvest Would they increase or decrease or are the effects ambiguous b What would the effect of this technological change be on the level of effort and the size of the harvest in a freeaccess fishery Would they increase or decrease or are the effects ambiguous Notes 1 Hardin Garrett 1968 The tragedy of the commons Science 162 12431247 2 This is not difficult to demonstrate mathematically In our model the yield h can be expressed as h qES where q is the proportion of the population harvested with one unit of effort S is the size of the population and E is the level of effort One of the conditions a dynamic efficient allocation has to satisfy with an infinite discount rate is P aqS where P is the constant price a is the constant marginal cost per unit of effort and qS is the number of fish harvested per unit of effort By multiplying both sides of this equation by h and collecting terms we obtain Ph aE The lefthand side is total benefits while the right is total cost implying net benefits are zero 3 Note the parallel with the role of the growth rate in efficient timber harvesting in Chapter 11 4 Note that we are ruling out monopoly behavior via our assumption that the price is not affected by effort level 5 This will result in fewer fish for future generations as well as smaller profits if the resulting effort level exceeds that associated with the maximum sustainable yield If the openaccess effort level is lower than the maximum sustainable yield effort level when extraction costs are very high then reductions in stock would increase the growth in the stock thus supplying more fish albeit lower net benefits to future generations 6 This type of analysis was first used in Gordon 1954 7 NOAA Catch Share Policy wwwnmfsnoaagovsfamanagementcatchsharesabout documentsnoaacspolicypdf accessed June 2017 8 NOAA keeps a thorough catch share bibliography on its website wwwnmfsnoaagovsfa managementcatchsharesresourcesreferenceshtml 9 This occurs because the maximum bid from any potential entrant would be the value to be derived from owning that permit This value is equal to the present value of future rents the difference between price and marginal cost for each unit of fish sold Competition will force the purchaser to bid near that maximum value lest he or she lose the quota 10 Ministry of Fisheries New Zealand wwwfishgovtnzennzdefaulthtm 11 European Commission 2017 httpseceuropaeufisheriescfpen 12 httpseceuropaeufisheriessitesfisheriesfilesdocsbodypostertac2015enpdf 13 For information and maps of marine protected areas of the United States see http marineprotectedareasnoaagov For a worldwide atlas see wwwmpatlasorg Commercially Valuable Fisheries 304 14 The distribution of benefits and costs among current fishermen also matters Using a case study on the Northeast Atlantic Cod fishery Sumaila and Armstrong 2006 find that the distributional effects of MPAs depend significantly on the management regime that was in place at the time of the development of the MPA and the level of cooperation in the fishery 15 wwwfederalregistergovdocuments20141202201428064atlantichighlymigratory species2006consolidatedatlantichighlymigratoryspecieshmsfishery Further Reading Acheson J M 2003 Capturing the Commons Devising Institutions to Manage the Maine Lobster Industry Hanover NH University Press of New England An impressive synthesis of theory and empirical work combined with an insiders knowledge of the institutions and the people who run them makes this a compelling examination of the history of one of Americas most important fisheries Adler J H Stewart N 2013 Learning how to fish Catch shares and the future of fisheries conservation UCLA Journal of Environmental Law Policy 311 150197 A useful summary of the history law and economics of catch shares Clark C W 1990 Mathematical Bioeconomics The Optimal Management of Renewable Resources 2nd ed New York WileyInterscience Careful development of the mathematical models that underlie current understanding of the exploitation of renewable resources under a variety of property rights regimes NOAA Catch Share Policy Executive Summary 2013 Retrieved from wwwnmfs noaagov sfadomesfishcatchsharedocsnoaacspolicypdf A useful review of US Fisheries Policy Review of Environmental Economics and Policy 62 Summer 2012 Contains several summary articles from the Symposium RightsBased Fisheries Management Schlager E Ostrom E 1992 Property right regimes and natural resources A conceptual analysis Land Economics 68 249262 A conceptual framework for analyzing a number of property rights regimes the authors use this framework to interpret findings from a number of empirical studies Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Appendix The Harvesting Decision Fisheries Defining the efficient sustainable yield for a fishery begins with a characterization of the biological relationship between the growth for the biomass and the size of the biomass The standard representation of this relationship is 1 g rS k S c m 1 where g the growth rate of the biomass r the intrinsic growth rate for this species S the size of the biomass and k the carrying capacity of the habitat Commercially Valuable Fisheries 305 Since we want to choose the most efficient sustained yield we must limit the possible outcomes we shall consider to those that are sustainable Here we define a sustainable harvest level hs as one that equals the growth of the population Hence 1 h rS k S s c m 2 The next step is to define the size of the harvest as a function of the amount of effort expended This is traditionally modeled as h qES 3 where q a constant known as the catchability coefficient and E the level of effort The next step is to solve for sustained yields as a function of effort This can be derived using a twostep procedure First we express S in terms of E Then we use this newly derived expression for S along with the relationship in Equation 3 to derive the sustained yield expressed in terms of effort To define S in terms of E we can substitute Equation 3 into Equation 2 1 qES rS k S c m 4 Rearranging terms yields 1 S k r qE c m 5 Using S hqE from Equation 3 and rearranging terms to solve for h yields h qEk r q kE 2 2 s 6 It is now possible to find the maximum sustainable effort level by taking the derivative of the righthand side of Equation 6 with respect to effort E and setting the result equal to zero The maximum condition is 2 0 qk r q kE 2 7 So 2 E q r msy 8 where Emsy the level of effort that is consistent with the maximum sustained yield Can you see how to solve for the maximum sustainable yield hmsy Hint Remember how the maximum sustained yield was defined in terms of effort in Equation 6 To conduct the economic analysis we need to convert this biological information to a net benefits formulation The benefit function can be defined by multiplying Equation 6 by P Commercially Valuable Fisheries 306 the price received for a unit of harvest Assuming a constant marginal cost of effort a allows us to define total cost as equal to aE Subtracting the total cost of effort from the revenue function produces the net benefits function Net benefits PqEk r Pq kE aE 2 2 9 Since the efficient sustained effort level is the level that maximizes Equation 9 we can derive it by taking the derivative of Equation 9 with respect to effort E and setting the derivative equal to zero 2 0 Pqk r Pkq E a 2 10 Rearranging terms yields 2 1 E q r Pqk a c m 11 Note that this effort level is smaller than that needed to produce the maximum sustainable yield Can you see how to find the efficient sustainable harvest level Finally we can derive the freeaccess equilibrium by setting the net benefits function in Equation 9 equal to zero and solving for the effort level Rearranging terms yields 1 E q r Pqk a c m Note that this is larger than the efficient sustained level of effort It may or may not be larger than the level of effort needed to produce the maximum sustained yield That comparison depends on the specific values of the parameters 307 Ecosystem Goods and Services Natures Threatened Bounty Bees work for man and yet they never bruise Their Masters flower but leave it having done As fair as ever and as fit to use So both the flower doth stay and honey run George Herbert The Church Introduction In the previous chapters we have learned that economic activity can pose several different types of threats to the natural world ranging from converting land from wildlife habitat to housing introducing substances that either intentionally or unintentionally harm wildlife and overharvesting biological populations to name but a few We have also seen how economic incentives can play a remedial role in preventing or at least reducing these potentially damaging interactions particularly for resources that are commercially valuable Those commercially valuable resources however comprise only a portion of what nature has to offer Many of the remaining ecological functions and services are not only supplied by natural processes but nature charges nothing for their use Examples of these ecological goods and services include pollination by bees the aquifer recharge services by wetlands breathable air biodiversity nitrogen fixation in the soil climate regulation through carbon sequestration as well as aesthetic and recreation services If these services directly benefit at least one person they are called ecosystem services In 1997 a team of researchers attempted to place a monetary global value on ecosystem services Constanza et al 1997 Basing their estimates on previously published studies and a few original calculations they found the 1997 economic value of 17 ecosystem services for 16 biomes to be in the range of US1654 trillion per year with an average of US33 trillion per year approximately 49 trillion in 2014 dollars a number significantly higher than global GDP This article attracted considerable attention Chapter 13 Ecosystem Goods and Services 308 However because the methods they used were controversial the specific estimated values were controversial as well In 2014 Costanza and colleagues updated their 1997 estimates Using the same controversial methods they suggest that the value of total global ecosystem services in 2011 was 125 trillion assuming changes to land areas and 145 trillion assuming no changes to the biomes They also found that since the earlier study in 1997 losses to ecosystem services due to land use changes were 43202 trillionyear What is not controversial however is the fact that ecosystems play a very valuable role in the lives of humans What role can economic analysis play in assuring that the value provided by these ecosystem services is not only recognized but also protected from degradation In this chapter we take up that question focusing on two specific roles 1 refining and improving the methods for quantifying the values received from natural services to increase their reliability and to demonstrate their importance taking care to identify the specific contributions to human welfare and 2 facilitating the design of private public and publicprivate partnership arrangements as well as incentive mechanisms that can help protect these important components of nature from degradation The State of Ecosystem Services In 2001 UN SecretaryGeneral Kofi Annan initiated the Millennium Ecosystem Assessment MA with the goal to assess the consequences of ecosystem change for human wellbeing and to establish the scientific basis for actions needed to enhance the conservation and sustainable use of ecosystems and their contributions to human wellbeing To examine the connections and the linkages between ecosystems and human wellbeing the MA divides ecosystem services into several categories Provisioning services provide direct benefits such as water timber food and fiber Regulating services include flood control water quality disease prevention and climate Supporting services consist of such foundational processes as photosynthesis nutrient cycling and soil formation Cultural services provide recreational aesthetic and spiritual benefits In 2005 the Assessment published four main findings Ecosystems have changed rapidly in the last 50 yearsat a rate higher than any other time period Due to the growing demands on the earths resources and services some of these high rates of change are irreversible Many of the changes to ecosystems while improving the wellbeing of some humans have been at the expense of ecosystem health Fifteen of the 24 ecosystems evaluated are in decline If degradation continues it will be difficult to achieve many of the UN Millennium Development Goals since resources that are vital for certain especially vulnerable groups are being affected1 Further degradation not only intensifies current poverty but it limits options for future generations thereby creating intergenerational inequity Finally the Assessment suggests that reversing the degradation of ecosystems would require significant changes in institutions and policies and it specifically notes that economic instruments can play an important role in this transformation Ecosystem Goods and Services 309 Another report the Economics of Ecosystems and Biodiversity TEEB examines the costs of policy inaction on the decline of biodiversity worldwide It finds that by 2050 under several business as usual scenarios an additional 11 percent of remaining biodiversity could be lost 40 percent of lowimpact agriculture could be converted to intensive agriculture and 60 percent of coral reefs could be gone perhaps as early as 2030 Recognizing the importance of ecosystem services the Intergovernmental Platform on Biodiversity and Ecosystem Services IPBES was established in April 2012 as an independent intergovernmental body open to all member countries of the United Nations IPBES provides a forum for synthesizing reviewing assessing and critically evaluating relevant information and knowledge generated worldwide on biodiversity and ecosystem services Economic Analysis of Ecosystem Services Ecosystem services are flows that are generated from stocks of natural assets and that benefit humans Tropical forests for example are assets that can provide carbon sequestration habitat watershed protection and recreation but also can provide flows of timber The harvest of flows can either be sustainable or unsustainable Economic analysis is helpful both in identifying sources of economic degradation and in evaluating possible approaches to maintain and restore these services Both of these tasks are enhanced by careful valuation of the flows in question One avenue for using these valuations is benefitcost analysis and the scope for these analyses is wider than you might expect They are not limited to traditional evaluation of water or land use projects Bandara and Tisdell 2004 for example use the results of a contingent valuation study on saving the Asian elephant to show that the WTP for the conservation of Asian elephants in Sri Lanka more than compensates for the damage caused by elephants Demonstrating the Value of Ecosystem Services The starting point for economic analysis in reversing ecosystem degradation lies in revealing the economic value forgone by the loss of these services Quantifying those values even imperfectly can make it clear just how much their loss or degradation means Many of the services explored in this chapter are nonmarket goods or services which means that we must use a methodology that does not depend on the availability of market prices to derive their value As discussed in Chapter 4 two main strategies are available for eliciting these values revealed preference methodsattributing value by observing or measuring what people spend on goods and services that contain attributes we wish to value and stated preference methodsusing surveys to ascertain willingness to pay Other methods commonly used for valuing ecosystem services include using adjusted market prices avoidance costs or averting expenditures production function methods or damage costs avoided2 Here we will focus specifically on valuing services that ecosystems provide to humans either directly or indirectly Consider some specific contexts to illustrate both how these techniques can be applied to the valuation of ecosystem services and why the results matter The Value of Reefs Coral reefs are an integral part of an extensive and vital landscape of coastal ecosystems Increasingly they are in jeopardy One of the specific areas benefited by the new field of Ecosystem Goods and Services 310 ecosystems services research is the derivation not only of better estimates of the value of those ecosystem benefits but also the identification of the specific sources of that value While some of the threat to coral reefs is due to pollution or overfishing recently coral reef losses have accelerated significantly due to climate change Specifically rising water temperatures have induced coral bleaching and excessive CO2 dissolution in seawater is causing ocean acidification which in turn hampers reef regeneration What is at stake Just how valuable are the services provided by coral reefs And how much do the four different categories of services contribute to the overall value One wellknown study TEEB 2009 provides some relevant estimates to answer these questions by pulling together the existing literature on values of reefs in a global context Table 131 drawn from that study not only demonstrates that reefs provide valuable ecosystem services but it also divides up the sources of value into the four categories described at the beginning of this chapter Note that this study finds that cultural services particularly tourism and recreation make the largest contribution to value The clear implication is that studies that capture only the provisional services from coral reefs seriously underestimate this value One use of this type of estimate would be in calculating the reef degradation damages from climate change a calculation that would be useful in designing climate change policy Equivalently the estimates could be used to derive the benefits from reducing that damage via greenhouse gas mitigation policy Table 131 Benefits from Ecosystem Services in Coral Reef Ecosystems Coral Reefs Value of ecosystem services in US ha year 2007 values Ecosystem Service Average Maximum Number of Studies Provisioning services Food 470 3818 22 Raw materials 400 1990 5 Ornamental resources 264 347 3 Regulating services Climate regulation 648 648 3 Moderation of extreme events 25200 34408 9 Waste treatment water purification 42 81 2 Biological control 4 7 2 Cultural Services Aesthetic information Amenity 7425 27484 4 Opportunities for recreation and tourism 79099 1063946 29 Information for cognitive development 2154 6461 4 Total 115704 1139190 83 Supporting Services Maintenance of genetic diversity 13541 57133 7 Notes These estimates are based on ongoing analyses for TEEB TEEB Ecological and Economic Foundations Chapter 7 As the TEEB data base and valueanalysis are still under development this table is for illustrative purposes only ha hectare a metric unit of area defined as 10000 square meters Source TEEB 2009 Climate Issues Updated September Table 1 p 7 Ecosystem Goods and Services 311 Because the TEEB study aggregates the results from a number of individual studies it would be helpful to have some sense of what an underlying individual study might look like What does it include What methods are used to derive the estimates What uses are anticipated for these estimates Example 131 provides some insights from one study that help to answer these questions EXAMPLE 131 The Value of Coral Reefs in the US Virgin Islands The United States Virgin Islands USVI are located approximately 100 miles east of Puerto Rico by air The four main islands are St Croix St John Water Island and St Thomas Recognizing the value of the local coral reefs and needing a baseline to provide a quan titative measure with which to compare possible alternative developmentconservation plans a study was commissioned to derive a total economic value TEV for these reefs A TEV framework attempts to measure value from both use and nonuse values This infor mation was also felt to be useful in providing an economic basis for advocating for the preservation of these coral reefs for establishing the basis for any damage compensation and for determining potential user fees for residents and tourists This study focused on valuing the six main uses of coral reefs and adjacent habitats in selected sites on the USVI 1 fishery value 2 tourism value 3 recreational and cultural value 4 real estate value 5 the value of shoreline protection and 6 education research values The study involved a wide range of valuation methodologies including 1 a revealed preference study of the commercial value of the fishery 2 a local resident survey aimed at estimating the local cultural and recreation attachment to the marine environment 3 a tourist survey using both travel cost and choice experiment methods to get a comprehensive insight into the importance of the marine environment for visitors to the USVI 4 an analysis of the coastal protection function of reefs 5 a hedonic pricing analysis to discern the positive impact of healthy reefs on house prices 6 a GIS analysis aimed at preparing value maps of the coral reefs of the USVI and 7 an aggregation of the separate components to produce the estimation of the TEV of these coral reefs This study found the TEV to be 187 million per year with the values of the compo nent parts found to be as follows Reef related tourism96 million Recreation48 million Amenity35 million Coastal protection6 million Support to commercial fisheries3 million Note that tourism and recreation once again comprise the largest sources of value for this individual case as it did for the global total considered previously Source van Beukering P Brander L van Zanten B Verbrugge E Lems K 2011 The economic value of the coral reef ecosystems of the United States Virgin Islands Final report IVM Institute for Environmental Studies Report Number R1106 The Netherlands Amsterdam August 31 Ecosystem Goods and Services 312 Damage Assessments Loss of Ecosystem Services Another area where the quantification of ecosystem valuation can and has played a significant role is in assessing the magnitude of damage to ecosystems caused by human activities Oil spills are a case in point Prior to the catastrophic 2010 Deepwater Horizon spill in the Gulf of Mexico the Oil Pollution Act of 1990 had established a formal legal framework for determining when an oil spill results in a quantifiable adverse change in a natural resource Through a process known as the Natural Resources Damage Assessment NRDA trustees of the affected ecosystem must attempt to quantify the extent of damages caused by a spill in order to seek compensation from the responsible parties In 2016 after a 6year study of the impacts economists estimated the damages to the natural resources from the spill at 172 billion See Chapter 18 Example 184 for more detail3 As a recent report from the National Research Council notes NRC 2013 highlighting the relationship between ecosystem services and the economy can heighten public knowledge of and support for protecting those services That report advocated incorporating a broader ecosystem services approach to assessing damage from the spill rather than focusing only on provisioning services By encompassing the wider array of services this broader approach could end up identifying restoration projects that would benefit not only the trustees and directuse parties but the larger public as well That process of widening the scope of assessment is complex and will ultimately take time As of 2017 according to its records BP had paid out over 30 billion in cleanup and claims but virtually all of that is based upon direct human losses rather than the broader focus suggested by the NRC One exception however involved an oyster reef project in Alabamas Mobile Bay The restoration project was originally focused on a location that would be convenient for fishermen who lost harvests during the spill thereby responding directly to their losses However the ecosystem services provided by oysters are much greater than their direct value to harvesters The filtering action of oysters plays an important role not only in removing suspended sediments from the water column but also in cleansing the water of various pollutants When the broader scope suggested by the NRC was applied a location that was better suited to supply all these ecosystem services was chosen In 2016 BP settled for an additional 208 billion 88 billion of which will go toward environmental restoration efforts including the restoration of coastal marshes in Lousiana Valuing Supporting Services Pollination Ecosystem valuation can also help to raise awareness of extremely valuable but probably underappreciated ecosystem services especially when the continuation of those services is threatened Pollination services supplied by bees is one such valuable ecosystem service Many valuable agricultural crops rely on bees for pollination Some 1000000 honeybee hives or more than 40 percent of all the beehives in the United States are required just for crosspollination of the 2 billion almond crop in California When the almond trees flower managed honeybee hives are moved by flatbed trucks to the San Joaquin Valley to provide sufficient bees to pollinate the crop Ratnieks Carreck 2010 The benefits from pollination however include not only the direct economic impacts of increasing the productivity of agricultural crops but also such nonmarket impacts as aiding in genetic diversity improving ecosystem resilience and providing nutrient cycling Unfortunately these important ecosystem services may be in jeopardy In 2006 the popular press began reporting on what has been called colony collapse disorder an unexplained disappearance of honeybee colonies Beekeeper surveys suggest that Ecosystem Goods and Services 313 33 percent of honeybee colonies in the United States died in the winter of 2010 While the exact causes are as of yet unknown multiple causes are likely to blame Ratnieks and Carreck speculate about economic impact of potential future losses and ask an important question Is the future of US commercial beekeeping going to be based on pollinating a few high value crops If so what will be the wider economic cost arising from crops that have modest yield increases from honey bee pollination These crops cannot pay large pollination fees but have hitherto benefited from an abundance of honey bees providing free pollination The damage caused by loss of pollination services to other parts of the world could be even higher than those in the United States One study argues that possible future global shortages of pollination services are not only likely to be profound but have quite different economic impacts around the globe Example 132 EXAMPLE 132 Valuing Pollination Services Two Illustrations Pollinator services valued in the tens of billions of dollars worldwide are disappearing Declining populations of pollinator insects including wild bees risk losses to agricultural production worldwide with disproportionate impacts on developing countries Wild bees from a nearby tropical forest provide pollination services to aid Costa Rican coffee production While this coffee C arabica can selfpollinate pollination from wild bees has been shown to increase coffee productivity from 15 to 50 percent One study Ricketts et al 2002 examined this relationship and placed an economic value on this particular ecological service They found that the pollination services from bees living in two specific preserved forest fragments 46 and 111 hectares respectively were worth approximately 60000 per year for one large nearby Costa Rican coffee farm As the authors conclude The value of forest in providing crop pollination service alone is of at least the same order of magnitude as major competing land uses and infinitely greater than that recognized by most governments ie zero Although these estimates only partially capture the value of this forest because they consider only a single farm and a single type of ecological service they are apparently sufficient by themselves to demonstrate the economic value of preserving this particular forest Recognizing that this kind of partial analysis which focuses on an individual case should be complemented by studies with a more macro focus has encouraged different methodologies with a more global focus One of these studies which used a multi region computable general equilibrium CGE model of agricultural production and Ecosystem Goods and Services 314 Valuing Supporting Services Forests and Coastal Ecosystems Valuation methods have been used extensively to value forest ecosystem services coastal and marine ecosystem services and biodiversity In his summary of the literature on coastal and marine ecosystem services CMEs valuation Barbier 2012 notes that losses to fishery nurseries mangroves that provide storm protection coral reefs that are a rich source of biodiversity filtering services of wetlands and sea grasses have now been measured worldwide Quantifying the benefits of these services can provide an empirical foundation for decision making and for setting priorities The TEEB 2009 presents several other examples that demonstrate the numerous and diverse possible sources of benefits One such example derives the ecosystem benefits from protecting a forest with high biodiversity in Madagascar Benefits flowing from that resource include medicines estimated net present value of 157 million erosion control estimated NPV of 380000 carbon storage estimated NPV of 105 million recreation and forest products estimated value of 94 million This study also notes the complicated scale dimension of ecosystem services by demonstrating how benefits flow from developing countries to a distant city in this case London These trade examined the global economic impacts of pollinator declines Bauer Wing 2010 CGE models produce numerical assessments of economywide consequences of various events or programs They include not only the direct effects on the crop sector but also the indirect noncrop effects Using this type of model not only allows the authors to estimate the impacts of a decline in pollination services in different geographic regions but also how these impacts are affected by the presence of different local substitutes for pollination services The authors find that the annual global losses to the crop sector attributable to a decline in direct pollination services are estimated to be 105 billion but economy wide losses noncrop sectors are estimated to be much larger namely 334 billion Clearly estimates based only a direct services would seriously underestimate the value of pollination services They also find that some regions of the world especially western Africa are likely to suffer disproportionately Their enhanced vulnerability is due not only to the larger share that pollinatordependent crops make up in western Africas agricultural output but also to the relatively higher importance of the agriculture sector in the African economy Richer countries are not immune In early 2017 the rusty patched bumble bee Bombus affinis a key pollinator of blueberries tomatoes and wildflowers became the first bumble bee and the first wild bee of any kind to be listed on the Endangered Species list in the United States Wild bumble bees are important pollinators of onethird of US crops Pollination services in the United States have been estimated at 3 billion per year Gorman 2017 Source Ricketts T H et al August 24 2002 Economic value of tropical forest to coffee production PNAS Proceedings of the National Academy of Science 10134 1257912582 Bauer D M Wing I S October 2010 Economic consequences of pollinator declines A synthesis Agricultural and Resource Economics Review 393 368383 Gorman S January 11 2017 US lists a bumble bee species as endangered for the first time Scientific American Ecosystem Goods and Services 315 transboundary benefits include medicines fish coffee flood control and existence value Valuing services that simultaneously affect several different scales local regional global can be challenging but not including all scales can produce a serious underestimate Challenges and Innovation in Ecosystem Valuation In order for valuations to be useful their derivations must be based upon consistent methodologies Consistency is important not only to assure that various valuation projects can be directly compared but also so that benefit transfers are facilitated Recall from Chapter 4 that benefit transfer involves using values from one study site to provide the basis for valuing services at another policy site Achieving this kind of consistency requires precise definitions of the services as well as agreement on how these services contribute to value It also requires that the valuation procedures avoid double counting For nonmarket goods and services these issues are especially challenging While market goods have welldefined units based on actual purchases nonmarket goods and services may offer a large variety of attributes each of which could have value If different analysts choose different attributes to value the result will not only be inconsistent valuations but inconsistent valuations make policyrelevant benefit transfer impossible Johnston et al 2005 The Millenium Ecosystem Assessment 2005 provides a classification of ecosystem services that has been widely cited but unfortunately these classifications are vulnerable to double counting Water purification and the provision of freshwater are listed as separate services for example Balmford et al 2011 Boyd Banzhaf 2007 Double counting can also occur if an ecosystem service provides both an intermediate good and a final good When both are separately valued and simply added together a common mistake the resulting values are inflated On the other hand intermediate services cannot simply be ignored since they are one source of the final value Johnston Russell 2011 Given these challenges how do nonmarket valuation methods fare in practice Because ecosystem service valuation is relatively new the quest for clean reliable estimates is still evolving For example Boyd and Krupnick 2009 note in their survey of the stated preference literature that a lack of consistency in definitions is still relatively common Johnston and Russell 2011 also lament the lack of clarity in definitions of final ecosystem goods and services Researchers using stated preference methods are beginning to grapple with this aspect of inconsistencyhow to distinguish between intermediate and final goods The specific challenge for economists using stated preference techniques is to design surveys that identify commodities that are both true to the ecological science and meaningful and understandable to respondents Boyd Krupnick 2009 Johnston et al 2012 This is no easy undertaking Distinctions between inputs and ecological endpoints are crucial for valuation Do people value wetlands themselves input or do they value flood control endpoint A common practice in valuation has been to simplify or map ecological information into outcomes that respondents have experience with An early example is the water quality ladder developed by Resources for the Future which was used in a national contingent valuation study Carson Mitchell 1993 This ladder translates water quality measures into the categories boatable fishable and swimmable This attempt to make the specific services being valued under standable to respondents answering the surveys actually creates another problem Since these terms have no precise ecological definition it becomes unclear how to interpret the resulting willingness to pay measure Boyd Krupnick 2009 Stated preference methods are further challenged when respondents have little experience or knowledge of the service being valued Researchers have tried to overcome this problem by simplifying the scenarios but many times simplicity is achieved at the expense of ecological Ecosystem Goods and Services 316 precision Johnston et al 2012 note some examples where terms like low medium and high are used to characterize levels of biodiversity but those terms have no specific connec tion to a precise level of biodiversity Not only would their assumed meanings likely vary from respondent to respondent but it is also not clear what the results would actually mean for specific levels of biodiversity For revealed preference methods the challenge of properly treating intermediate and final goods is smaller because those methods typically deal only with final goods they rarely attempt to measure intermediate ecological inputs Johnston 2014 However revealed preference methods are only available for a subset of ecosystem services namely those where purchases actually occur Additionally with revealed preference methods even when final goods have been demonstrated to have value it is sometimes difficult to know the specific underlying source of that value For example if a hedonic property value study finds that being near beaches raises land value which attributes of the beaches are the source of that value Is it the beach width The sand quality Both One emerging solution to this dilemma involves combining stated and revealed preference data Note that the study in Example 131 uses both By combining the two methods the source of the revealed preference value can be explored in greater depth using the more specific stated preferences of the respondent The downside is that implementing two studies is obviously more expensive than one Moore et al 2011 provide a useful example of how an attributebased study can bring greater clarity to the question of what is being valued In their study aimed at estimating marginal values of forest protection programs they utilized a stated preference survey that asked respondents to consider two different types of conservation sitesone with distinct use values like recreation and easy access versus another with high ecological values like a richer biodiversity or providing habitat for endangered species Identifying and valuing these specific attributes as opposed to deriving only an overall value for the site allows for the estimation of the marginal value of each type of service Note that estimating separate marginal values for specific ecosystem services also facilitates more precise benefit transfers One response to the high cost of conducting new sitespecific studies for each ecosystem service is to use metaanalysis the technique discussed in Chapter 4 that can draw insights from a large number of previously completed studies This approach has the advantage that not only will the service value be based upon a large number of studies but it can also identify the study characteristics that seem to play a role in the resulting value In one example of this approach Brander et al 2006 conducted a metaanalysis of approximately 190 valuation studies of wetlands They found the most significant determinants of value included socioeconomic variables such as income and population density of the surrounding community Interestingly they found that certain attributes such as water quality had the highest value but they found a negative relationship between size of the wetland and its value Despite the challenges the role for nonmarket valuation is already clear and numerous studies have highlighted the benefits of protection of one or more ecosystem service in ways that have made for better policy Institutional Arrangements and Mechanisms for Protecting Natures Services Valuation is only one of the contributions economic analysis can make to the maintenance and protection of important ecosystem services Another is using economics to help design institutions and policies that can bring economic incentives to bear Ecosystem Goods and Services 317 Payments for Environmental Services One avenue where economic analysis has been helpful in this regard lies in identifying ways to create institutional arrangements in which the providers of ecosystem services can be compensated for nonmarket services This would not only create better incentives for maintaining and enhancing those services but also provide a revenue source that could be used to further that purpose While we have previously provided some examples of these arrangments4 a few additional examples may prove helpful in conveying some sense of the scope of the options Costa Ricas Pago por Servicios Ambientales PSA Program One of the earliest examples of this approach can be found in Costa Rica Built upon an existing forestry law the PSA program includes four specific environmental services provided by forest ecosystems 1 greenhouse gas emission mitigation 2 water services for human consumption irrigation and energy production 3 biodiversity conservation and 4 scenic beauty for recreation and ecotourism For our purposes in this chapter the water services component is the most interesting and we shall focus on it The program started with voluntary agreements involving payments to private landowners from water users in return for conserving certain forested areas that served as recharge or purification areas in the watershed Bottlers municipal water supply systems irrigation water users and hotels have all chosen to participate in these agreements Whereas early agreements saw water users paying for a quarter of conservation costs since water services were only one of four services that the law enumerated as provided by forests in more recent agreements water users are not only paying the entire cost of conservation but the administrative costs as well These agreements typically cover a 5year period As the program has matured a water tariff has been added to finance the payments effectively transforming one aspect of the program from a voluntary one into a mandatory one Interestingly the voluntary agreements are still occurring not only because the payments made under these agreements are deducted from the amounts owed under the tariff but the voluntary agreements give somewhat more control to the signatory over exact how his or her payment will be used Pagiola 2008 reports that the PSA program has been very popular with landowners with requests to participate far outstripping available financing and that recipients had a higher percentage of their forest under conservation than nonrecipients He also points out however that the program does have some specific inefficiencies In particular because the PSA program offers a relatively low undifferentiated and mostly untargeted payment it tends to attract participants whose opportunity cost of participation is low or negative As a result some socially desirable land use practices are not adopted because the payment being offered is insufficient This program also provides a good opportunity to discuss an issue of some importance to these types of programseconomic sustainability Programs will only be successful over the long term if they create the means to sustain themselves financially after the initial enthusiasm This can because either occur 1 the incentives created by the program are large enough to cause private benefits to be higher than costs for both payees and recipients or 2 sufficient required financing is provided by law Indeed some payments for service arrangements including some in the PAS program are funded by limitedterm grants from international organizations These are no doubt helpful in setting up the program and providing some initial successes but many times what happens after these grants run out is not clear In the case of the PSA water services program the existence of the tariff coupled with the apparent private landowner interest in participating suggest that outlook for the economic sustainability of this program seems relatively good Ecosystem Goods and Services 318 Other Watershed Payment Programs Investing in watershed services is a broad category that covers payments for watershed services water quality trading markets see also Chapter 18 instream buybacks and water funds Bennett et al 2013 report on the state of watershed payments and find 205 active programs in 29 countries as of 2011 Sixtyseven of these are in the United States and 61 are in China In 2011 817 billion was transacted though not all payments were in cash Inkind payments training programs or agriculture inputs are also included Of the programs tracked 66 of them include the stacking or bundling of other benefits Most of these include cobenefits of biodiversity Others include the bundling of carbon offsets or aesthetics Concern for endangered species has also been a primary impetus for many of these programs Having users pay for services that they previously received for free can serve to produce an efficient outcome by providing both an incentive and revenue to protect those services Suppose however the provider threatens to cut off supplies of those services unless the desired payments are forthcoming Is this extortion or simply good business see Debate 131 Paying for Ecosystem Services or Extortion The Case of Yasuni National Park Designated a UNESCO Biosphere Reserve in 1989 Yasuni National Park is one of the most biologically diverse places on earth It is also the location for an estimated 846 million barrels of crude oil 20 percent of Ecuadors reserves As a developing country Ecuador was faced with a classic dilemmashould it preserve the parkland or extract the oil To avoid the environmental destruction caused by oil exploration in one of the areas with the greatest biological and cultural diversity of the Amazon the government proposed permanently forgoing oil production in the IshpingoTambocochaTiputini ITT oil fields located in Yasuni if the world community would contribute 50 percent of the forgone income estimated to be US36 billion over a 13year period Supporters argued that the payments would pay for global climate change benefits resulting from the CO2 emissions avoided They calculated 407 million metric tons of CO2 emissions would be saved due to nonextraction and burning of oil and another 800 million metric tons of CO2 from avoided deforestation Detractors suggested that this was extortionpay us or we will destroy the planet Regardless of whether it was a good idea or not it failed In August 2013 Ecuadors president announced that since the initiative had attracted only a fraction of the cash it had aimed to raise he ended it Sources Ecuador Yasuni ITT Trust Fund Retrieved from httpmptfundporgyasuni Ecuador approves Yasuni park oil drilling in Amazon rainforest Retrieved from www bbccouknewsworldlatinamerica23722204 DEBATE 131 Ecosystem Goods and Services 319 Water is not the only service to be involved in a payments scheme and sometimes the payments can be in kind rather than in cash see Example 133 Tradable Entitlement Systems Another program approach recognizes that not only more land but also land better suited for supplying environmental services could be supplied if those services were treated separately in land titles Some land may be especially good at providing environmental services while having a low opportunity cost but other land may have a very high opportunity cost If all land is required to meet the same environmental service provision requirements the cost of the program will soar Suppose however that the landowner has to supply those services but not necessarily on the specific piece of land facing the requirement This is the premise of a number of programs including wetlands banking and carbon sequestration credits EXAMPLE 133 Trading Water for Beehives and Barbed Wire in Bolivia Amboro National Park in Bolivia supports a very biologically diverse ecosystem The park and surrounding areas are under intense pressure from illegal land incursions Migrants from the surrounding highlands with encouragement from local political leaders extract timber from the park and clear areas for agriculture Lack of well defined property rights for local communities leaves few alternative options Due to increased timber harvesting and increased agriculture the Los Neros River dries up earlier than it did in the past causing suffering among the local communities that depend on the river for irrigation Asquith 2006 describes a unique solution to this property rights problem involving payments for environmental services Natura Bolivia an environmental group helped negotiate an agreement through which downstream water users would pay for the protection of native vegetation in the watershed Instead of financial compensation though payment would be in the form of one beehive and training in honey production per 10 hectares of cloud forest protected In 2003 60 beehives were provided to farmers in exchange for 600 hectares of cloud forest conserved In 2004 the municipal government provided another 11 hives to farmers By 2006 2100 hectares had been protected The Los Negros scheme is slowly building a market for environmental services and helping to define property rights in the region In 2006 when contracts were renewed some farmers requested barbed wire instead of beehives in order to help them strengthen their land claims Combining a market mechanism payment for environ mental services with developing a local enforcement mechanism and strengthening local property rights has proven to be a successful scheme so far Source Asquith N December 2006 Bees and barbed wire for water on the Bolivian frontier PERC 244 Available at wwwpercorgarticlesbeesandbarbedwirewater Ecosystem Goods and Services 320 Wetlands Banking Several US administrations both Republican and Democratic have pledged that wetlands should experience no net loss5 Despite these bipartisan pledges to protect wetlands as the pressure on coastal and shorefront properties has increased the economic benefits from developing wetlands and political pressures to remove obstacles to development have significantly increased as well One policy instrument for attempting to preserve wetlands in the face of this pressure is known as Wetlands Mitigation Banking and involves providing incentives for creating offsite equivalent wetlands services when adverse impacts on the original site are unavoidable and when onsite compensation is either not practical or use of a mitigation bank is environmentally preferable to onsite compensation According to the US EPA The objective of a mitigation bank is to provide for the replacement of the chemical physical and biological functions of wetlands and other aquatic resources which are lost as a result of authorized impacts Mitigation banks involve wetlands streams or other aquatic resource areas that have been restored established enhanced or in certain circumstances specifically preserved for the purpose of providing compensation for unavoidable impacts to aquatic resources Mitigation banks involve a form of thirdparty compensatory mitigation in which the responsibility for compensatory mitigation implementation and success is assumed by someone other than the party who by causing an adverse impact to a wetland is required by law to provide mitigation A mitigation bank may be created when a government agency corporation nonprofit organization or other entity undertakes mitigation activities under a formal agreement with a regulatory agency The value of those activities is defined in compensatory miti gation credits In principle the number of credits available for sale is based upon the use of ecological assessment techniques to certify that the credited areas provide the specified ecological functions How has the program performed As one recent review Salzman Ruhl 2006 concludes Despite policies mandating that habitat trading ensure equivalent value and function the experience is that most programs are not administered this way In practice most habitat trades to date in wetlands programs have been approved on the basis of acres in many instances ensuring equivalence in neither value nor function This experience is instructive Merely assuring that the compensation involves a similar number of acres falls short of true equivalence unless the replacement ecological functions supplied by those acres are also the same Carbon Sequestration Credits To the extent that landowners do not receive all the benefits of landownership they may discount or ignore the benefits that accrue to others Carbon sequestration credits are an attempt to rectify one such imbalance Is this an efficient remedy As will be discussed in Chapter 17 carbon dioxide is a greenhouse gas which means that excessive concentrations of carbon dioxide in the atmosphere can contribute to climate change Through photosynthesis trees absorb sequester carbon dioxide thereby removing it from the atmosphere and lowering its threat to the climate Carbon sequestration credits attempt to internalize the carbonabsorption benefit externality by giving forest owners credit for the additional carbon they remove from the Ecosystem Goods and Services 321 atmosphere They can earn this credit by investing in additional carbon sequestration by planting new trees for example This credit or offset can be sold to those who can use these reductions in fulfillment of their legal obligations to meet specified carbon emissions targets Some evidence suggests that reducing carbon in this way would be cheaper than many other measures The Reducing Emissions from Deforestation and Forest Degradation REDD program run by the United Nations is an example of this approach see Example 134 EXAMPLE 134 Reducing Emissions from Deforestation and Forest Degradation REDD A Twofer According to the United Nations deforestation and forest degradation through agricultural expansion conversion to pastureland infrastructure development des tructive logging fires and so on account for nearly 20 percent of global greenhouse gas emissions more than the entire global transportation sector and second only to the energy sector In response the United Nations has set up a program to reduce these emissions by reducing the forest degradation in developing countries REDD is an effort to create a financial value for the carbon stored in forests offering incentives for developing countries to reduce emissions from forested lands and to invest in low carbon paths to sustainable development According to this scheme nations would receive payments for emissionsreduction credits determined on the basis of actual reductions in forest emissions measured against agreedupon baselines These credits can be sold in the international compliance carbon markets where they could be used in combination with domestic reductions to meet assigned national targets or volunt ary carbon markets where they could be used to pursue other organizational goals such as demonstrating carbon neutrality Data from the Forest Trends Ecosystem Marketplace indicate that as of 2016 forest carbon projects are protecting 28 million hectares of forest The promise of this program is that it offers opportunities to make progress on two goals at once 1 reducing forest degradation and 2 reducing emissions that contribute to climate change The challenges which are far from trivial are to establish baselines that are both fair and effective and to assure that monitoring and verification procedures are sufficiently rigorous as to provide reliable accurate measures of actual emissions reductions Otherwise the emissions authorized by the credits might exceed the actual emissions reductions that the credits are based upon Sources Government of Norway 2009 Reducing emissions from deforestation and forest degradation REDD An options assessment report An electronic copy of this report is available at the United Nations REDD website wwwunreddorg Forest Trends Ecosystem Marketplace 2016 View from the understory State of forest carbon finance 2016 Available at wwwforesttrendsorgdocumentsfilesdoc5388pdf accessed February 10 2017 Ecosystem Goods and Services 322 Conflict Resolution in OpenAccess Resources via Transferable Entitlements In Chapter 12 we described how individual transferable quotas ITQs are used in fisheries management When marine resources and services suffer from free access problems ITQs are one option for reducing the overfishing problem Arnason 2012 argues that a properly designed ITQ system could also provide another quite different benefit namely facilitating the resolution of marine resource conflicts between recreational and commercial fisheries as well as conflicts between fishing and other marine resource uses Making the entitlements transferable creates both an economic means and an economic incentive for the entitlements to move to their highest valued use as circumstances change but careful design and adequate enforcement would be key to achieving success in conflict resolution Have ITQs helped to resolve conflicts Not yet but some ITQ holders are beginning to coordinate with other users of marine resources In New Zealand the scallop fishery has formed an association that coordinates activities not only with other openwater fisheries but also with aquaculture Arnason 2012 One difficult international area of conflict involves the management of whale populations Could tradable entitlements possibly help to resolve this conflict see Debate 132 Tradable Quotas for Whales The International Whaling Commission banned whaling in 1986 Yet approximately 2000 are still harvested each yearapproximately 1000 by Japan for scientific purposes 600 by Iceland and Norway who do not recognize the ban and 350 for subsistence Costello et al 2012 In 2010 some nations proposed allowing limited whaling with the hope that taking this step would reduce the number of whales actually harvested This proposal never materialized due to disagreements between whaling and nonwhaling nations Costello et al 2012 argue that this conflict could be reduced using tradable quotas for whale harvesting thus creating a market that would be economically ecologically and socially valuable for whalers and whales alike p 139 Under their scheme both whalers and conservationists could bid for quotas and whalers could earn profits from whaling or from selling their quotas to conservationists They propose allocating whale shares in sustainable numbers to all the member nations of the International Whaling Commission IWC Note that this means that nonwhaling nations would also get a share These shares could only be acquired by the whaling nations by buying them from the nonwhaling nations Shares would be traded in a global market and could be exercised or retired in perpetuity The size of the harvest would depend on who bought the shares and could fall between zero conservationists purchase all and the sustainable total quota Since trades are voluntary in principle this market mechanism has the potential to make all parties better off including the whales DEBATE 132 Ecosystem Goods and Services 323 Ecotourism Ecotourism provides another prominent example of an activity that attempts to create a revenue stream based upon environmental services that can serve to fund protection of those services According to several organizations such as the International Ecotourism Society and International Union for Conservation of Nature ecotourism can be defined as follows Environmentally responsible travel to natural areas in order to enjoy and appreciate nature and accompanying cultural features both past and present that promotes conservation has a low visitor impact and provides for beneficially active socio economic involvement of local peoples The theory behind ecotourism is that it rectifies some of the bias against preserved land by providing an income stream from that land In the language of Chapter 10 it shifts out the private preservation bid rent function thereby bringing it closer to the social preservation bid rent function Not all ecotourism projects turn out to be consistent with this definition Increasing the number of visitors to sensitive natural areas in the absence of appropriate oversight and Opponents note that multiple challenges exist including determining the sustainable quota obtaining agreement on how the shares to this quota would be initially allocated among the parties and creating a trading system with adequate transparency and enforcement Additionally those who oppose putting a price tag on whales as a matter of principle certainly are opposed to this idea However as Costello et al point out this lack of a real price tag could well be what has hindered antiwhaling operations What about costs and benefits Conservation organizations such as Greenpeace spend millions of dollars on antiwhaling campaigns The authors estimate that Greenpeace USA Greenpeace International Sea Shepherd Conservation Society and the World Wildlife Fund spend approximately 25 million annually on antiwhaling activities The estimated profit from one minke whale is approximately 13000 while the profit is 85000 for a fin whale 2012 market prices and costs Costello et al estimate that the 350 whales saved by the Sea Shepherd in 2008 could simply have been purchased for less than 4 million Instead of spending money on antiwhaling these groups would have the option to simply purchase the whales thereby preventing anyone from harvesting them The authors think it could be a winwin situation Do you think they are right Source Costello C Gaines S Gerber L R January 12 2012 Conservation science A market approach to saving the whales Nature 481 139140 Ecosystem Goods and Services 324 control can threaten the integrity of both ecosystems and local cultures see Debate 133 Additionally the possible instabilities in this revenue source posed by climate fluctuations volatile exchange rates and political and social upheaval could make an excessive reliance upon tourism a risky business Another major threat to wildlife comes from poaching Poaching is the illegal taking of game or domestic livestock Normally we consider adequate enforcement to be the solution Does Ecotourism Provide a Pathway to Sustainability One of the ways ecotourism can promote conservation is by providing the necessary funds to implement an effective conservation program Take the example of Bolivias Eduardo Avaroa Reserve This diverse landscape includes hot springs and geysers surrounded by volcanoes and majestic mountains Its freshwater and saltwater lakes provide habitat for yearround flocks of pink flamingos and other birds while nearby 23 types of mammals and almost 200 species of plants flourish in the desertlike environment With over 40000 visitors per year the park is Bolivias most visited When a conservation planning initiative determined that tourism was a major threat to the reserve The Nature Conservancy worked with the Bolivian National Park System to develop a visitorfee system The program which reportedly generated over half a million dollars in new funds allows the reserve to fund efforts to mitigate these tourismrelated threats The visitorfee approach is now being extended across the Bolivian Park System It is estimated that the national protected areas system could generate more than 3 million per year in new income for conservation Quite a different take on ecotourism is provided by a British academic Rosaleen Duffy Speaking about the former British colony of Belizea popular ecotourist destination in Central AmericaDuffy relates stories of how scuba diving and snorkeling visitors have spoiled fragile corals and otherwiseharassed marine wildlife In their pursuit of reefs rainforests and ruins writes Duffy they did not reflect on the environmental impact of the construction of hotels the use of airlines the manufacture of diving equipment the consumption of imported goods or even something as visible as taking a motorboat out to the reef which polluted the water As a Time article on her book notes To Duffy it seems the only good tourist is the one who stays home Sources Duffy D 2002 A Trip too FarEcotourism Politics and Exploitation Washington DC Island Press Bird M A 2002 Ecotourism or egotourism TIME online Retrieved May 24 2007 from httpcontenttimecomtimemagazine article0917133858500html The Nature Conservancy Ecotourism and Conservation Finance Retrieved May 24 2007 from wwwnatureorgaboutustravelecotourism aboutart14824html DEBATE 133 Ecosystem Goods and Services 325 to poaching but in some settings assuring adequate enforcement is easier said than done Can trophy hunting help Consider for example how the economics of poaching might be used to enhance enforcement in the case of African wildlife From an economic point of view poaching can be discouraged if it is possible to raise the relative cost of illegal activity In principle that can be accomplished by increasing the sanctions levied against poachers but it is effective only if monitoring can not only detect the illegal activity but also apply the sanctions to those who engage in it In many places that is a tall order given the large size of the habitat to be monitored and the limited budgets for funding enforcement Example 135 shows however how economic incentives can be enlisted to promote more monitoring by local inhabitants as well as to provide more revenue for enforcement activity EXAMPLE 135 Payments for Ecosystem ServicesWildlife Protection in Zimbabwe In the late 1980s an innovative program was initiated in Zimbabwe that stands out as a success among other African wildlife protection schemes It transformed the role of wildlife from a stateowned treasure to be preserved into an active resource controlled and used by both commercial farmers and smallholders in communal lands The transformation has been good for the economy and the wildlife The initiative is called the Communal Areas Management Program for Indigenous Resources CAMPFIRE It was originally sponsored by several different agencies in cooperation with the Zimbabwean government including the University of Zimbabwes Center for Applied Study the Zimbabwe Trust and the Worldwide Fund for Nature WWF The US federal government currently provides resources to CAMPFIRE principally through USAID Under the CAMPFIRE system villagers collectively utilize local wildlife resources on a sustainable basis Trophy hunting by foreigners is perhaps the most important source of revenue because hunters require few facilities and are willing to pay substantial fees to kill a limited number of large animals The government sets the prices of hunting permits as well as quotas for the number of animals that can be taken per year in each locality Individual communities sell the permits and contract with safari operators who conduct photographic and hunting expeditions on community lands The associated economic gains accrue to the villages which then decide how the revenues should be used The money may either be paid to households in the form of cash dividends which may amount to 20 percent or more of an average familys income or they may be used for capital investments in the community such as schools or clinics In at least one area revenues compensate citizens who have suffered property loss due to wild animals Households may also receive nonmonetary benefits such as meat from problem animals or culled herds By consistently meeting their needs from their own resources on a sustainable basis local communities have become selfreliant This voluntary program has been steadily expanding since its inception and now includes 28 wildlife districts of which 15 are hunting districts Ecosystem Goods and Services 326 Other types of incentives have also proved successful In Kenya for example a compens ation scheme has helped Maasai tribesmen to transition from hunting lions to protecting them Maasai from the Mbirikani ranch are now compensated for livestock killed by pre dators They receive 80 for each donkey and 200 for each cow killed The Mbirikani Predator Fund has compensated herders for the loss of 750 head of livestock each year since the program began in 2003 As an additional collective incentive if any herder kills a lion no one gets paid6 Rearranging the economic incentives so that local groups have an economic interest in preservation can provide a powerful means of protecting some biological populations Open access undermines those incentives The Special Problem of Protecting Endangered Species Suppose a specific species is found to be endangered and listed as such under the US Endangered Species Act ESA How can economics help to create incentivebased programs to enhance the likelihood of survival for this species Conservation biologists have found that one key to reducing the threat to endangered species is to prevent their habitat from become fragmented into smaller parcels In response economists have developed programs that attempt to reduce habitat fragmentation Conservation Banking One such program conservation banking enlists a tailored transferable credits program into endangered and threatened species conservation A conservation bank is a parcel of land The program has been working In 2010 40 elephants were poached In 2015 this number had dropped to five Additionally it has been estimated that households participating in CAMPFIRE increased their incomes by 1525 percent Between 1989 and 2006 CAMPFIRE dividents disbursed to communities was 208 million In 2014 the United States suspended ivory imports from Tanzania and Zimbabwe in an effort to reduce poaching of elephants American clients generally constitute 76 percent of hunters in CAMPFIRE areas for all animals hunted each year The ban resulted in the cancellation of 108 out of 189 57 percent elephant hunts booked by US citizens in CAMPFIRE areas The resulting drop in CAMPFIRE income has been significant Revenues dropped from 23 million in 2013 to 21 million in 2014 to 16 million in 2015 The decreased revenues reduce funds for protection of wildlife and also remove the incentives for community members to protect the elephants While well intended the American ban could backfire if poaching resumes Sources Frost P G Bond I 2008 The CAMPFIRE programme in Zimbabwe Payments for wildlife services Ecological Economics 654 776787 httpcampfirezimbabweorgindexphpnewsspotlight Jonga C and Pangeti G 2015 httpsfirstforwildlifewordpresscom20150818thecampfire programinzimbabwe Barbier E 1992 Community based development in Africa In T Swanson E Barbier Eds Economics for the Wilds Wildlife Diversity and Development Washington DC Island Press 107118 Bojö J February 1996 The economics of wildlife Case studies from Ghana Kenya Namibia and Zimbabwe AFTES Working Paper No 19 The World Bank and the website wwwColbyedupersonalthtietenendzimhtml Ecosystem Goods and Services 327 containing naturalresource values that are conserved and managed in perpetuity through a conservation easement described in Chapter 10 held by an entity responsible for enforcing the terms of the easement Banks of especially suitable land are established for specified listed species under the Endangered Species Act and used to offset impacts to the species occurring on nonbank lands by providing a larger less fragmented habitat for them Access to the habitat services provided by these banks is provided by the creation of saleable quantified credits where each credit provides a specified amount of habitat provision designed to satisy the requirements of the ESA Project proponents are therefore able to complete their ESA obligations through a onetime purchase of credits from the conservation bank see Example 136 The Agglomeration Bonus Another strategy to reduce fragmentation known as the agglomeration bonus has been proposed by Smith and Shogren 2002 The agglomeration bonus is a voluntary incentive EXAMPLE 136 Conservation Banking The Gopher Tortoise Conservation Bank In rapidly growing Mobile County Alabama the gopher tortoise faced survival problems due to the disappearance of its habitat Since the tortoise is federally listed as a threatened species under the Endangered Species Act ESA small landowners were forced to observe some rather severe restrictions on their use of the land Because these restrictions were quite burdensome for the landowners and the resulting fragmented patchy habitat proved ineffective in protecting the tortoise these restrictions created quite a conflict in the community A conservation bank established by the Mobile Area Water and Sewer System MAWSS in 2001 reduced the conflict allowing development to continue in other areas while restoring and permanently protecting a much more suitable large tract of the long leaf pine habitat that the tortoise prefers MAWSS owns a 7000acre forest that buffers and protects the countys water supply Under the terms of its conservation bank MAWSS has agreed to set aside 222 acres forgo any development on that land and manage it in perpetuity for the benefit of gopher tortoises Landowners who want to build on tortoise habitat elsewhere in Mobile County can purchase credits from the bank and thereby be relieved of their ESA responsibilities to set aside a small patch of their land The tortoises benefit because the large tract of contiguous suitable habitat is vastly superior to a network of small unconnected patches of land while the landowners can now develop their land by helping to fund through the purchase of credits this tortoise habitat Source Environmental Defenses Center for Conservation Incentives February 24 2003 Gopher tortoise conservation bank Mobile area landowners and wildlife get help Retrieved from wwwedforg fromsplashcontinuega12020119244017437171469651799 Ecosystem Goods and Services 328 mechanism that is designed to protect endangered species and biodiversity by reuniting fragmented habitat across private land in a manner that minimizes landowner resistance Many states currently have programs that encourage landowners to conserve land but how can these owners be further encouraged to give priority to land that connects with other land Under this bonus payment scheme the landowner receives an additional payment the bonus for each retired acre that shares a common border with another retired acre If both landowners retire land at their common border both can profit from their neighbors retired acres With this bonus each landowner has an explicit incentive to give priority to retiring acres that are adjacent to his or her neighbors retired acres Notice that the agglomeration bonus pays for connected land not any specific piece of landlandowners are free to select any land that shares a common border with other retired land This mechanism provides an incentive for landowners to give preference to land that would form a contiguous reserve across their common border The government agencys role would be to target the critical habitat and to integrate the agglomeration bonus into the compensation package but the landowners would have the ultimate power to decide whether or not to participate An analysis of the properties of this mechanism using experimental economics Parkhurst et al 2002 found that in the lab the absence of a bonus always created fragmented habitat whereas with the bonus players cooperated to establish the optimal habitat reserve Safe Harbor Agreements Safe harbor agreements are a new means of conserving endangered and threatened species on privately owned land7 These agreements approach the problem of landowner incentives from a different perspective mainly seeking to overcome some rather severe unintended consequences that can flow from the Endangered Species Act ESA Under the ESA many landowners are actually inhibited from implementing practices likely to benefit endangered species because of the repercussions that might arise from these apparently benign activities Under the approach taken by the ESA the presence of an endangered species on a property may result in new legally imposed restrictions on any activities deemed harmful to that species Thus if landowners were simply to restore wildlife habitats on their property and those habitats attracted endangered animals they might find themselves faced with many new restrictions on their use of the land As a result some landowners are not only unwilling to take such risks but they may actually actively manage property to prevent endangered species from occupying their land Safe harbor agreements overcome these perverse incentive problems Any landowner who agrees to carry out activities expected to benefit an endangered species is guaranteed that no added ESA restrictions will be imposed as a result A landowners ESA responsibilities are effectively frozen at their current levels for a particular species if he or she agrees to restore enhance or create habitat for that species Safe harbor agreements do not however confer a right to harm any endangered species already present when the agreement is entered into established by the landowners baseline responsibilities Those responsibilities are unaffected by a safe harbor agreement Preventing Invasive Species Invasive species are nonnative plants and animals that have been introduced intentionally or accidentally They have a tendency to spread quickly causing damage to ecosystem and human health The literature on the economics of invasive species is relatively new but there Ecosystem Goods and Services 329 is agreement that prevention is much less expensive than mitigation As such prevention is a preferable policy option to control once a species has taken over a new location see for example Finnoff et al 2007 and Kaiser Burnett 2010 This is frequently called the precautionary principle in economics On the other hand many species have already been introduced or there is a concern they have reached a particular location Example 137 looks at the role of citizen science in the detection and monitoring of invasive species EXAMPLE 137 The Changing Economics of Monitoring and Its Role in Invasive Species Management An old adage states that you cant manage what you dont measure Measurement however has typically not been cheap posing a dilemma for managers who want to make solid decisions with limited budgets One area where this has been true is in fisheries In many cases managers dont even know all the species that inhabit the marine and freshwater environments in their areas New technology may change that Scientists have developed simple techniques involving Environmental DNA or eDNA that allow scientists to extract filtered water from a water course for testing These tests which can be done for anywhere from 50 to 150 a test are powerful enough to detect any species that have been present in that water in the last day or two The presence of a single cell is sufficient These costs are sufficiently low and the results sufficiently reliable that the US Forest Service has launched a project to collect DNA from all rivers and streams across the western USA to create an Aquatic Environmental DNA Atlas Another common use of this approach is to detect the presence of invasive species Researchers at Cornell University faced the daunting task of monitoring New York states 7600 lakes and 70000 miles of rivers and streams for these species The challenge was finding a way to acquire the samples at reasonable cost To meet this challenge they started a citizen science project with cooperating science teachers across the state Detection kits were sent to participating classes The students in those classes gathered the water samples as part of their class and sent the collected samples to the university When the results were returned the students entered them in a database With the low labor costs associated with this form of gathering the samples and the new technology that makes the DNA tests not only possible but simple enough that citizen scientist results can be reliable monitoring can now take place on a scale that was formerly inconceivable And the citizen scientists can participate in handson science Source Robbins Jim 2017 A splash of river water now reveals the DNA of all its creatures Yale Environment 360 March 9 Downloadable at httpe360yaleedufeatures ednariversfishbulltroutforestservice accessed March 9 2017 Ecosystem Goods and Services 330 Moving Forward Ecosystem goods and services may be the ultimate resources that humans rely on This chapter has highlighted some of the ways that economic analysis can place values on these goods and services to assist policymakers in decision making We have also looked at multiple examples of economic incentives and mechanisms to encourage the provision of ecosystem goods and services and to reduce their degradation As we have seen with these examples the theory is relatively straight forward but in practice developing innovative mechanisms like payments for ecosystem services or carbon sequestration credits is challenging especially in developing countries Summary Ecosystems provide a host of services to humans but the continued existence of those services is threatened In this chapter we explore how two different kinds of economic analysis can contribute to protecting maintaining and enhancing these ecosystems The first step involves providing quantitative estimates of the value of these ecosystem services both to demonstrate their importance in general and to provide metrics that can be included in costbenefit analyses that are being used for making choices that affect ecosystems For commercial species such as fish forests and commercial resources such as water the valuation task is made somewhat easier by the ready availability of prices For other ecosystem services the task is more difficult but over time some of those barriers are beginning to fall as techniques such as avoided cost stated preference surveys and travel cost studies are used to value ecosystem services These methodologies are increasingly being applied to such different problems as valuing pollination services assessing the economic impact of ecosystemdegrading events such as oil spills and quantifying the role and economic benefits of natural water purification systems derived from wetlands or stream buffer zones Newer methods such as computable general equilibrium CGE models allow analysts to capture not only the direct values to humans but the indirect values as well These studies not only corroborate and quantify the general sense that ecosystems services are valuable and deserve protection but they also identify the many pathways that provide these provisioning regulating supporting and cultural services This chapter also examines the other main protection avenuedesigning institutions and mechanisms that can eliminate or at least reduce perverse incentives that intensify degradation Specifically we have examined innovative schemes that provide payments from service users to service providers for historically nonmarketed services to assure that the providers have an incentive to refrain from converting the land to some other incompatible use Another category of approaches focuses on creating new transferable entitlements to service flows Not only do they give rise to new markets such as wetlands banking conservation entitlements for fish or carbon sequestration credits that can provide more economic sustainability to these flows by returning revenue to those who protect those services but they also provide a new venue for potentially reducing resource conflicts And finally we note how economic incentives can be used to protect the most vulnerable speciesthose that have already been classified as endangered Environmental organizations have turned to economic approaches such as conservation banking to provide incentives for the market to preserve more of the most suitable endangered species habitat and safe harbor programs to counteract some of the more perverse habitatdestroying incentives for landowners that were inadvertently created by the Endangered Species Act Ecosystem Goods and Services 331 As we point out in this chapter this new subfield is experiencing some growing pains but early successes and new innovations indicate that its future is promising Discussion Questions 1 Consider the issues raised by the debate over Equadors proposal to preserve the Yasuni National Park from oil extraction What is your view Is this simply another payment for ecosystem services or was this extortion Is this case different from some of the other payment for services cases described above If so how is it different 2 Consider the issues raised by the debate over using ecotourism to promote sustainability What is your view Is ecotourism always a pathway to sustainability Never a pathway to sustainability Sometimes a pathway to sustainability Does your view suggest an appropriate role for government in managing ecotourism or should the entire process be left to the private sector Why 3 In 2016 Outside Magazine ran an obituary for the Great Barrier Reef in Australia www outsideonlinecom2112086obituarygreatbarrierreef25millionbc2016 It was meant to be in part a spoof yet recent evidence suggests that while the whole reef is not dead large portions of it are and recovery might not be possible What is the value of the Great Barrier Reef Which ecosystem services values might be lost 4 One approach to protecting ecosystem services involves dedicating specific habitat to wildlife such as parks or reserves a strategy that prohibits residential development in those areas Other strategies wetlands and conservation banking accommodate residential development at a specific site while attempting to offset the adverse effects on that site with requirements for preservation activities at other sites as a condition of allowing development at the original site In your mind does one of these strategies always dominate the other Is so why If not does the context matter How would an economist think about these questions SelfTest Exercises 1 Several of the policy options discussed in this chapter rely on transferable entitlements of one kind or another The prominence of these approaches raises the question of what transferability adds to mix For each of the following options describe why making the entitlement transferable increases its efficiency a Carbon reduction credits b Conservation banking 2 Suppose that a fishery has two sectors 1 a commercial fishery that harvests fish to sell them to a processor and 2 a recreational fishery where boat captains take individuals out to catch some fish for the sport of it Each sector has a catch share Suppose further that the demand for sport fishing goes up considerably relative to the commercial fishery This development would create a conflict because the recreational fishery would no doubt argue that its catch share is now unfairly low Compare how this conflict might be dealt with depending on whether the catch shares are transferable between sectors or not Think about how the incentives of each sector to resolve this conflict are affected by the possibility of intersector transferability of the catch shares Ecosystem Goods and Services 332 Notes 1 The Millennium Development Goals MDGs include reducing the worlds biodiversity losses and loss of environmental resources as well as reducing the number of people without access to such services as safe drinking water 2 For a description of these approaches and the role they play in ecosystem service evaluation see Bateman et al 2011 3 Bishop et al 2017 4 See Example 22 shrimp farming externalities and Example 31 ecological services from preserved forests 5 This section benefited from Salzman Ruhl 2006 6 Conservation International June 21 2007 wwwconservationorgNewsRoompressreleases Pages062107SavingAfricaE28099sFreeRoamingLionsaspx 7 This section benefited from the information in Environmental Defenses Center for Conservation Incentives For more information on safe harbor agreements see the website at www environmentaldefenseorgarticlecfmContentID399 Further Reading Agricultural and Resource Economics Review continues the Northeastern Journal of Agricultural and Resource Economics 421 April 2013 This special issue is devoted entirely to the economics of ecosystem services valuation measurement and analysis Millennium Ecosystem Assessment 2005 Ecosystems and Human Wellbeing A Synthesis Washington DC Island Press A summary of the findings of the UN Ecosystem Assessment National Research Council of the National Academies of Science NRC 2013 An Ecosystem Services Approach to Assessing the Impacts of the Deepwater Horizon Oil Spill in the Gulf of Mexico Washington DC National Academies Press Discusses the benefits and challenges associated with using an ecosystem services approach to damage assessment and offers suggestions for areas of future research Pattanayak S K Wunder S Ferraro P J 2010 Show me the money Do payments supply environmental service in developing countries Review of Environmental Economics and Policy 42 254274 Survey of the literature on payments for ecosystem services with a particular emphasis on their use in developing countries Ruckelshaus M McKenzie E Taillis H Guerry A Daily G Kareiva P Polasky S Ricketts T Bhagabati N Wood S Bernhardt J 2013 Notes from the field Lessons learned from using ecosystem service approaches to inform realworld decisions Ecological Economics httpdxdoiorg101016jecolecon201307009 Offers six lessons from recent assessments of biodiversisty and ecosystem services TEEB September 2009 The economics of ecosystems and biodiversity Climate issues update A report that examines the impacts of climate change on ecosystems and biodiversity with a special emphasis on coral reefs and forests Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 333 Economics of Pollution Control An Overview Democracy is not a matter of sentiment but of foresight Any system that doesnt take the long run into account will burn itself out in the short run Charles Yost The Age of Triumph and Frustration 1964 Introduction In Chapter 2 we introduced a schematic describing the relationship between the natural and economic systems One side depicted the flow of mass and energy to the economic system while the other depicted the flow of waste products back to the environment In the last few chapters we dealt extensively with different types of natural resources and maintaining efficient and sustainable levels for both stocks and flows of those resources Now we turn to examining how a balance can be achieved in the reverse flow of waste products back to the environment Because the waste flows are inexorably intertwined with the flow of mass and energy into the economy establishing a balance for waste flows will have feedback effects on the input flows as well Two questions must be addressed 1 what is the appropriate level of flow of pollution and 2 how should the responsibility for achieving this flow level be allocated among the various sources of the pollutant when reductions are needed In this chapter we lay the foundation for understanding the policy approach to controlling the flow of these waste products by developing a general framework for analyzing pollution control This framework allows us to define efficient and costeffective allocations for a variety of pollutant types to compare these allocations to market allocations and to demonstrate how efficiency and costeffectiveness can be used to formulate desirable policy responses This overview is then followed by a series of chapters that apply these principles by examining the policy approaches that have been adopted in the United States and in the rest of the world to establish control over waste flows Chapter 14 Economics of Pollution Control 334 A Pollutant Taxonomy The amount of waste products emitted determines the load upon the environment The damage done by this load depends on the capacity of the environment to assimilate the waste products see Figure 141 We call this ability of the environment to absorb pollutants its absorptive capacity If the emissions load exceeds the absorptive capacity then the pollutant accumulates in the environment Pollutants for which the environment has little or no absorptive capacity are called stock pollutants Stock pollutants accumulate over time as emissions enter the environment Examples of stock pollutants include nonbiodegradable bottles tossed by the roadside heavy metals such as lead that accumulate in the soils near the emissions source and persistent synthetic chemicals such as dioxin and PCBs polychlorinated biphenyls Pollutants for which the environment has some absorptive capacity are called fund pollutants For these pollutants as long as the emissions rate does not exceed the absorptive capacity of the environment the pollutants do not accumulate Examples of fund pollutants are easy to find Many organic pollutants injected into an oxygenrich stream will be transformed by the resident bacteria into lessharmful inorganic matter Carbon dioxide is absorbed by plant life and the oceans The point is not that the mass is destroyed the law of conservation of mass suggests this cannot be the case Rather when fund pollutants are injected into the air or water they may be transformed into substances that are not considered harmful to people or to the ecological system or they may be so diluted or dispersed that the resulting concentrations are not harmful Pollutants can also be classified by their zone of influence defined both horizontally and vertically The horizontal dimension deals with the spatial domain over which damage from an emitted pollutant is experienced The damage caused by local pollutants is experienced near the source of emission while the damage from regional pollutants is experienced at greater distances from the source of emission The limiting case is a global pollutant where the damage affects the entire planet The categories are not mutually exclusive it is possible for a pollutant to be in more than one category Sulfur oxides and nitrogen oxides for example are both local and regional pollutants The vertical zone of influence describes whether the damage is caused mainly by ground level concentrations of an air pollutant or by concentrations in the upper atmosphere For some pollutants such as lead or particulates the damage is determined mainly by concentrations Figure 141 Relationship between Emissions and Pollution Damage Economics of Pollution Control 335 of the pollutant near the earths surface For others such as ozonedepleting substances or greenhouse gases described in Chapter 17 the damage is related more to their concentrations in the upper atmosphere This taxonomy will prove useful in designing policy responses to these various types of pollution problems Each type of pollutant requires a unique policy response The failure to recognize these distinctions leads to counterproductive policy Defining the Efficient Allocation of Pollution Pollutants are the residuals of production and consumption These residuals must eventually be recycled or returned to the environment in one form or another Since their presence in the environment may depreciate the service flows received an efficient allocation of resources must take this cost into account What is meant by the efficient allocation of pollution depends on the nature of the pollutant Stock Pollutants The efficient allocation of a stock pollutant must take into account the fact that the pollutant accumulates in the environment over time and that the damage caused by its presence increases and persists as the pollutant accumulates By their very nature stock pollutants create an interdependency between the present and the future since the damage imposed in the future depends on current actions The damage caused by pollution can take many forms At high enough exposures to certain pollutants human health can be adversely impacted possibly even leading to death Other living organisms such as trees or fish can be harmed as well Damage can even occur to inanimate objects as when acid rain causes sculptures to deteriorate or when particulates cause structures to discolor It is not hard to establish what is meant by an efficient allocation in these circumstances using the intuition we gained from the discussion of depletable resource models Suppose for example that we consider the allocation of a commodity that we refer to as X Suppose further that the production of X involves the generation of a proportional amount of a stock pollutant The amount of this pollution can be reduced but that takes resources away from the production of X The damage caused by the presence of this pollutant in the environment is further assumed to be proportional to the size of the accumulated stock As long as the stock of pollutants remains in the environment the damage persists The dynamic efficient allocation by definition is the one that maximizes the present value of the net benefit In this case the net benefit at any point in time t is equal to the benefit received from the consumption of X minus the cost of the damage caused by the presence of the stock pollutant in the environment This damage is a cost that society must bear and in terms of its effect on the efficient allocation this cost is not unlike that associated with extracting minerals or fuels While for minerals the extraction cost rises with the cumulative amount of the depletable resource extracted the damage cost associated with a stock pollutant rises with the cumulative amount deposited in the environment The accretion of the stock pollutant is proportional to the production of X which creates the same kind of linkage between the production of X and this pollution cost as exists between the extraction cost and the production of a mineral They both rise over time with the cumulative amount produced The one major difference is that the extraction cost is borne only at the time of extraction while damage persists as long as the stock pollutant remains in the environment Economics of Pollution Control 336 We can exploit this similarity to infer the efficient allocation of a stock pollutant As discussed in Chapter 6 when extraction cost rises the efficient quantity of a depletable resource extracted and consumed declines over time Exactly the same pattern would emerge for a commodity that is produced jointly with a stock pollutant The efficient quantity of X and therefore the addition to the accumulation of this pollutant in the environment would decline over time as the marginal cost of the damage rises The price of X would rise over time reflecting the rising social cost of production To cope with the increasing marginal damage the amount of resources committed to controlling the pollutant would increase over time Ultimately a steady state would be reached where additions to the amount of the pollutant in the environment would cease and the size of the pollutant stock would stabilize At this point all further emission of the pollutant created by the production of X would be controlled perhaps through recycling The price of X and the quantity consumed would remain constant The damage caused by the stock pollutant would persist As was the case with rising extraction cost technological progress could modify this efficient allocation Specifically technological progress could reduce the amount of pollutant generated per unit of X produced it could create ways to recycle the stock pollutant rather than injecting it into the environment or it could develop ways of rendering the pollutant less harmful All of these responses would lower the marginal damage cost associated with a given level of production of X Therefore more of X could be produced with technological progress than without it Stock pollutants are in a sense the other side of the intergenerational equity coin from depletable resources With depletable resources it is possible for current generations to create a burden for future generations by using up resources thereby diminishing the remaining endowment Stock pollutants can create a burden for future generations by passing on damages that persist well after the benefits received from incurring the damages have been forgotten Though neither of these situations automatically violates the weak sustainability criterion they dont automatically satisfy it either Fund Pollutants To the extent that the emission of fund pollutants exceeds the assimilative capacity of the environment they accumulate and share some of the characteristics of stock pollutants When the emissions rate is low enough however the discharges can be assimilated by the environment with the result that the link between present emissions and future damage may be broken When this happens current emissions cause current damage and future emissions cause future damage but the level of future damage is independent of current emissions This independence of allocations among time periods allows us to explore the efficient allocation of fund pollutants using the concept of static rather than dynamic efficiency Because the static concept is simpler this affords us the opportunity to incorporate more dimensions of the problem without unnecessarily complicating the analysis The normal starting point for the analysis would be to maximize the net benefit from the waste flows However pollution is more easily understood if we deal with a mathematically equivalent formulation involving the minimization of two rather different types of costs damage costs and control or avoidance costs To examine the efficient allocation graphically we need to know something about how control costs vary with the degree of control and how the damages vary with the amount of pollution emitted Though our knowledge in these areas is far from complete economists normally agree on the shapes of these relationships Economics of Pollution Control 337 Generally the marginal damage caused by a unit of pollution increases with the amount emitted When small amounts of the pollutant are emitted the incremental damage is quite small However when large amounts are emitted the marginal unit can cause significantly more damage It is not hard to understand why Small amounts of pollution are easily diluted in the environment and the body can tolerate small quantities of substances However as the amount in the atmosphere increases dilution is less effective and the body is less tolerant Marginal control costs commonly increase with the amount controlled For example suppose a source of pollution tries to cut down on its particulate emissions by purchasing an electrostatic precipitator that captures 80 percent of the particulates as they flow past in the stack If the source wants further control it can purchase another precipitator and place it in the stack above the first one This second precipitator captures 80 percent of the remaining 20 percent or 16 percent of the uncontrolled emissions Thus the first precipitator would achieve an 80 percent reduction from uncontrolled emissions while the second precipitator which costs the same as the first would achieve only a further 16 percent reduction Obviously each unit of emissions reduction by the second precipitator costs more than by the first In Figure 142 we use these two pieces of information on the shapes of the relevant curves to derive the efficient allocation A movement from right to left refers to greater control and less pollution emitted The efficient allocation is represented by Q the point at which the damage caused by the marginal unit of pollution is exactly equal to the marginal cost of avoiding it1 Greater degrees of control points to the left of Q are inefficient because the further increase in avoidance costs would exceed the reduction in damages Hence total costs would rise Similarly levels of control lower than Q would result in a lower cost of control but the increase in damage costs would be even larger yielding an increase in total cost Increasing or decreasing the amount controlled causes an increase in total costs Hence Q must be efficient The diagram suggests that under the conditions presented the optimal level of pollution is not zero If you find this disturbing remember that we confront this principle every day Take the damage caused by automobile accidents for example Obviously a considerable Figure 142 Efficient Allocation of a Fund Pollutant Economics of Pollution Control 338 amount of damage is caused by automobile accidents yet we do not reduce that damage to zero because the cost of doing so would be too high The point is not that we do not know how to stop automobile accidents All we would have to do is eliminate automobiles Rather the point is that since we value the benefits of automobiles we take steps to reduce accidents such as using speed limits only to the extent that the costs of accident reduction are commensurate with the damage reduction achieved The efficient level of automobile accidents is not zero The second point is that in some circumstances the optimal level of pollution may be zero or close to it This situation occurs when the damage caused by even the first unit of pollution is so severe that it is higher than the marginal cost of controlling it This would be reflected in Figure 142 as a leftward shift of the damage cost curve of sufficient magnitude that its intersection with the vertical axis would lie above the point where the marginal cost curve intersects the vertical axis This circumstance seems to characterize the treatment of highly dangerous radioactive pollutants such as plutonium Additional insights are easily derived from our characterization of the efficient allocation For example it should be clear from Figure 142 that the optimal level of pollution generally is not the same for all parts of the country Areas that have higher population levels or are particularly sensitive to pollution would have a marginal damage cost curve that intersected the marginal control cost curve close to the vertical axis Efficiency would imply lower levels of pollution for those areas Areas that have lower population levels or are less sensitive should have higher efficient levels of pollution Examples of ecological sensitivity are not hard to find For instance some areas are less sensitive to acid rain than others because the local geological strata neutralize moderate amounts of the acid Thus the marginal damage caused by a unit of acid rain is lower in those fortunate regions than in other less tolerant regions It can also be argued that pollutants affecting visibility are more damaging in national parks and other areas where visibility is an important part of the aesthetic experience than in other more industrial areas Market Allocation of Pollution Since air and water are treated in our legal system as commonpool resources at this point in the book it should surprise no one that the market misallocates them Our previously derived conclusion that freeaccess resources are overexploited certainly also applies here Air and water resources have been overexploited as waste repositories However this conclusion only scratches the surface much more can be learned about market allocations of pollution When firms create products rarely does the process of converting raw material into outputs use 100 percent of the mass The typical firm has several alternatives to control the amount of the residual It can use inputs more completely so that less is left over It can also produce less output so that smaller amounts of the residual are generated Recycling the residual is sometimes a viable option as is removing the most damaging components of the waste stream and disposing of the rest Pollutant damages are commonly externalities to the firms that produce them2 When pollutants are injected into water bodies or the atmosphere they cause damages to those firms and consumers as well as to flora and fauna downstream or downwind of the source not to the source itself These costs are typically not borne by the emitting source and hence not considered by it although they certainly are borne by society at large3 As with other services that are systematically undervalued the disposal of wastes into the air or water becomes inefficiently attractive In this case the firm minimizes its costs when it chooses not Economics of Pollution Control 339 to abate anything since the only costs it bears are the control costs What is cheapest for the firm is not cheapest for society In the case of stock pollutants the problem is particularly severe Uncontrolled markets would lead to an excessive production of the product that generates the pollution too few resources committed to pollution control and an inefficiently large amount of the stock pollutant in the environment Thus the burden on future generations caused by the presence of this pollutant would be inefficiently large The inefficiencies associated with pollution control and the previously discussed inefficiencies associated with the extraction or production of minerals energy and food exhibit some rather important differences For private property resources the market forces provide automatic signals of impending scarcity These forces may be understated as when the vulnerability of imports is ignored but they operate in the correct direction Even when some resources are treated as openaccess fisheries the possibility for a private property alternative fish farming is enhanced When private property and openaccess resources sell in the same market the private property owner tends to ameliorate the excesses of those who exploit openaccess properties Efficient firms are rewarded with higher profits With pollution no comparable automatic amelioration mechanism is evident4 Because this cost is borne partially by innocent victims rather than producers it does not find its way into product prices Firms that attempt unilaterally to control their pollution are placed at a competitive disadvantage due to the added expense their costs of production are higher than those of their less conscientious competitors Not only does the unimpeded market fail to generate the efficient level of pollution control but also it penalizes those firms that might attempt to control an efficient amount Hence the case for some sort of government intervention is particularly strong for pollution control Efficient Policy Responses Our use of the efficiency criterion has helped demonstrate why markets fail to produce an efficient level of pollution control as well as trace out the effects of this lessthanoptimal degree of control on the markets for related commodities It can also be used to define efficient policy responses In Figure 142 we demonstrated that for a market as a whole efficiency is achieved when the marginal cost of control is equal to the marginal damage caused by the pollution This same principle applies to each emitter Each emitter should control its pollution until the marginal cost of controlling the last unit is equal to the marginal damage it causes One way to achieve this outcome would be to impose a legal limit on the amount of pollution allowed by each emitter If the limit were chosen precisely at the level of emission where marginal control cost equaled the marginal damage efficiency would have been achieved for that emitter An alternative approach would be to internalize the marginal damage caused by each unit of emissions by means of a tax or charge on each unit of emissions Either this perunit charge could increase with the level of pollution following the marginal damage curve for each succeeding unit of emission or the tax rate could be constant as long as the rate were equal to the marginal social damage at the point where the marginal social damage and marginal control costs cross see Figure 142 Since the emitter is paying the marginal social damage when confronted by these fees pollution costs would be internalized The efficient choice would also be the costminimizing choice for the emitter5 While the efficient levels of these policy instruments can be easily defined in principle they are very difficult to implement in practice To implement either of these policy instruments Economics of Pollution Control 340 we must know the level of emissions at which the two marginal cost curves cross for every emitter That is a tall order one that imposes an unrealistically high information burden on control authorities Control authorities typically have very poor information on control costs and little reliable information on marginal damage functions How can environmental authorities allocate pollution control responsibility in a reasonable manner when the information burdens are apparently so unrealistically large One approach the choice of several countries including the United States is to select specific legal levels of pollution based on some other criterion such as providing adequate margins of safety for human or ecological health Once these thresholds have been established by whatever means only half of the problem has been resolved The other half deals with deciding how to allocate the responsibility for meeting predetermined pollution levels among the large numbers of emitters This is precisely where the costeffectiveness criterion comes in Once the objective is stated in terms of meeting the predetermined pollution level at minimum cost it is possible to derive the conditions that any costeffective allocation of the responsibility must satisfy These conditions can then be used as a basis for choosing among various kinds of policy instruments that impose more reasonable information burdens on control authorities CostEffective Policies for Uniformly Mixed Fund Pollutants Defining a CostEffective Allocation We begin our analysis with uniformly mixed fund pollutants which analytically are the easiest to deal with The damage caused by these pollutants depends simply on the amount entering the atmosphere Thus the policy can focus simply on controlling the total amount of emissions in a manner that minimizes the cost of control What can we say about the costeffective allocation of control responsibility for uniformly mixed fund pollutants Consider a simple example Assume that two emissions sources are currently emitting 15 units each for a total 30 units Assume further that the control authority determines that the environment can assimilate 15 units in total so that a reduction of 15 units is necessary How should this 15unit reduction be allocated between the two sources in order to minimize the total cost of the reduction We can demonstrate the answer with the aid of Figure 143 which is drawn by measuring the marginal cost of control for the first source from the lefthand axis MC1 and the marginal cost of control for the second source from the righthand axis MC2 Note that a total 15unit reduction is achieved for every point on this graph each point represents some different combination of reduction by the two sources that sums to 15 Drawn in this manner the diagram represents all possible allocations of the 15unit reduction between the two sources The lefthand axis for example represents an allocation of the entire reduction to the second source while the righthand axis represents a situation in which the first source bears the entire responsibility All points in between represent different degrees of shared responsibility What allocation minimizes the cost of control In the costeffective allocation the first source cleans up ten units while the second source cleans up five units The total variable cost of control for this particular assignment of the responsibility for the reduction is represented by area A plus area B Area A is the cost of control for the first source area B is the cost of control for the second Any other allocation would result in a higher total control cost Convince yourself that this is true Economics of Pollution Control 341 Figure 143 also demonstrates the costeffectiveness equimarginal principle introduced in Chapter 3 The cost of achieving a given reduction in emissions will be minimized if and only if the marginal costs of control are equalized for all emitters6 This is demonstrated by the fact that the marginal cost curves cross at the costeffective allocation CostEffective Pollution Control Policies This proposition can be used as a basis for choosing among the various policy instruments that the control authority might use to achieve this allocation Sources have a large menu of options for controlling the amount of pollution they inject into the environment The cheapest method of control will differ widely not only among industries but also among plants in the same industry The selection of the cheapest method requires detailed information on the possible control techniques and their associated costs Generally plant managers are able to acquire this information for their plants when it is in their interest to do so However the government authorities responsible for meeting pollution targets are not likely to have this information Since the degree to which these plants would be regulated depends on cost information it is unrealistic to expect these plant managers to transfer unbiased information to the government Plant managers would have a strong incentive to overstate control costs in hopes of reducing their ultimate control burden This situation poses a difficult dilemma for control authorities The cost of incorrectly assigning the control responsibility among various polluters is likely to be large Yet the control authorities do not have sufficient information at their disposal to make a correct allocation Those who have the informationthe plant managersare not inclined to share it Can the costeffective allocation be found The answer depends on the approach taken by the control authority Emissions Standards We start our investigation of this question by supposing that the control authority pursues a traditional legal approach by imposing a separate emissions limit on each source In the economics literature this approach is referred to as the Figure 143 CostEffective Allocation of a Uniformly Mixed Fund Pollutant Economics of Pollution Control 342 commandandcontrol approach An emissions standard is a legal limit on the amount of the pollutant an individual source is allowed to emit In our example it is clear that the two standards should add up to the allowable 15 units but it is not clear how in the absence of information on control costs these 15 units are to be allocated between the two sources The easiest method of resolving this dilemmaand the one chosen in the earliest days of pollution controlwould be simply to allocate each source an equal reduction As is clear from Figure 143 this strategy would not be costeffective While the first source would have lower costs compared to the costeffective allocation this cost reduction would be substantially smaller than the cost increase faced by the second source Compared to a costeffective allocation total costs would increase if both sources were forced to clean up the same amount When emissions standards are the policy of choice there is no reason to believe that the authority will assign the responsibility for emissions reduction in a costminimizing way This is probably not surprising Who would have believed otherwise Surprisingly enough however some policy instruments do allow the authority to allocate the emissions reduction in a costeffective manner even when it has no information on the magnitude of control costs These policy approaches rely on economic incentives to produce the desired outcome The two most common approaches are known as emissions charges and emissions trading Emissions Charges An emissions charge is a fee collected by the government levied on each unit of pollutant emitted into the air or water The total payment any source would make to the government could be found by multiplying the fee times the amount of pollution emitted Emissions charges reduce pollution because paying the fees costs the firm money To save money the source seeks ways to reduce its pollution How much pollution control would the firm choose A profitmaximizing firm would control rather than emit pollution whenever it proved cheaper to do so We can illustrate the firms decision with Figure 144 The level of uncontrolled emission is 15 units and the emissions charge is T Thus if the firm were to decide against controlling any emissions it would have to pay T times 15 represented by area 0TBC Is this the best the firm can do Obviously not since it can control some pollution at a lower cost than paying the emissions charge It would pay the firm to reduce emissions until the marginal cost of reduction is equal to the emissions charge After that point it is cheaper Figure 144 CostMinimizing Control of Pollution with an Emissions Charge Economics of Pollution Control 343 for the firm to pay the tax since the marginal cost curve rises above the tax The firm would minimize its cost by choosing to clean up ten units of pollution and to emit five units At this allocation the firm would pay control costs equal to area 0AD and total emissions charge payments equal to area ABCD for a total cost of 0ABC This is clearly less than 0TBC the amount the firm would pay if it chose not to clean up any pollution Lets carry this one step further Suppose that we levied the same emissions charge on both sources discussed in Figure 143 Each source would then control its emissions until its marginal control cost equaled the emissions charge Faced with an emissions charge T the second source would clean up five units Since they both face the same emissions charge they will independently choose levels of control consistent with equal marginal control costs This is precisely the condition that yields a costminimizing allocation This is a remarkable finding We have shown that as long as the control authority imposes the same emissions charge on all sources the resulting incentives are automatically compatible with minimizing the costs of achieving that level of control This is true in spite of the fact that the control authority may not have sufficient knowledge of control costs However we have not yet dealt with the issue of how the appropriate level of the emissions charge is determined Each level of a charge will result in some level of emissions reduction Furthermore as long as each firm minimizes its own costs the responsibility for meeting that reduction will be allocated in a manner that minimizes control costs for all firms How high should the charge be set to ensure that the resulting emissions reduction is the desired level of emissions reduction Without having the requisite information on control costs the control authority cannot establish the correct tax rate on the first try It is possible however to develop an iterative trialanderror process to find the appropriate charge rate This process is initiated by choosing an arbitrary charge rate and observing the amount of reduction that occurs when that charge is imposed If the observed reduction is larger than desired it means the charge should be lowered if the reduction is smaller the charge should be raised The new reduction that results from the adjusted charge can then be observed and compared with the desired reduction Further adjustments in the charge can be made as needed This process can be repeated until the actual and desired reductions are equal At that point the correct emissions charge would have been found The charge system not only causes costminimizing sources to choose a costeffective allocation of the control responsibility it also stimulates the development of newer cheaper means of controlling emissions as well as promoting technological progress This is illustrated in Figure 145 The reason for this is rather straightforward Control authorities base the emissions standards on specific technologies As new technologies are discovered by the control author ity the standards are tightened These stricter standards force firms to bear higher costs Therefore with emissions standards firms have an incentive to hide technological changes from the control authority With an emissions charge system the firm saves money by adopting cheaper new technolo gies As long as the firm can reduce its pollution at a marginal cost lower than T it pays to adopt the new technology In Figure 145 MC0 represents the MC before the new technology is adopted and MC1 is the new lower marginal cost with the adoption of the new technology The firm saves A and B by adopting the new technology and voluntarily increases its emissions reduction from Q0 to Q1 With an emissions charge the minimum cost allocation of meeting a predetermined emissions reduction can be found by a control authority even when it has insufficient information on control costs An emissions charge also stimulates technological advances in Economics of Pollution Control 344 emissions reduction Unfortunately the process for finding the appropriate rate takes some experimenting During the trialanderror period of finding the appropriate rate sources would be faced with a volatile emissions charge Emissions charges that kept changing in the search for the right level would make planning for the future difficult for the firms subject to that charge Investments that would make sense under a high emissions charge might not make sense when it falls From either a policymakers or business managers perspective this process leaves much to be desired CapandTrade Is it possible for the control authority to find the costminimizing allocation without going through a trialanderror process It is possible if capandtrade a form of emissions trading is the chosen policy Under this system all sources face a collective limit on their emissions the cap and they are allocated or sold allowances to emit Each allowance authorizes a specific amount of emissions commonly 1 ton The control authority issues exactly the total number of allowances needed to produce the desired emissions level These can be distributed among the firms either by auctioning them off to the highest bidder or by granting them directly to firms free of charge an allocation referred to as gifting However they are acquired the allowances are freely transferable they can be bought and sold Firms emitting more than their holdings would buy additional allowances from firms who are emitting less than authorized Any emissions by a source in excess of those allowed by its allowance holdings at the end of the year would cause the source to face severe monetary sanctions Why this system automatically leads to a costeffective allocation can be seen in Figure 146 This figure treats the same set of circumstances as in Figure 143 Consider first the gifting alternative Suppose that the first source was allocated seven allowances each corresponds to one emission unit Because it has 15 units of uncontrolled emissions this would mean it must control eight units Similarly suppose that the second source was granted the remaining eight allowances It would have to clean up seven units Notice that both firms have an incentive to trade The marginal cost of control for the second source C is Figure 145 Cost Savings from Technological Change Charges versus Standards Economics of Pollution Control 345 substantially higher than that for the first A The second source could lower its cost if it could buy an allowance from the first source at a price lower than C Meanwhile the first source would be better off if it could sell an allowance for a price higher than A Because C is greater than A grounds for trade certainly exist A transfer of allowances would take place until the first source had only five allowances left and controlled ten units while the second source had ten allowances and controlled five units At this point the allowance price would equal B because that is the marginal value of that allowance to both sources and neither source would have any incentive to trade further The allowance market would be in equilibrium Notice that the market equilibrium for an emissionallowance system is the costeffective allocation Simply by issuing the appropriate number of allowances 15 and letting the market do the rest the control authority can achieve a costeffective allocation without having even the slightest knowledge about control costs This system allows the government to meet its policy objective while allowing greater flexibility in how that objective is met How would this equilibrium change if the allowances were auctioned off Interestingly it wouldnt both allocation methods lead to the same result With an auction the allowance price that clears demand and supply is B and we have already demonstrated that B supports a costeffective equilibrium The incentives created by this system ensure that sources use this flexibility to achieve the objective at the lowest possible cost As we shall see in the next two chapters this remarkable property has been responsible for the prominence of this type of approach in current attempts to reform the regulatory process How far can the reforms go Can developing countries use the experience of the industrialized countries to move directly into using these marketbased instruments to control pollution As Debate 141 points out that may be easier said than done Figure 146 CostEffectiveness and Emissions Trading Economics of Pollution Control 346 Should Developing Countries Rely on MarketBased Instruments to Control Pollution Since the case for using marketbased instruments seems so strong in principle some observers have suggested that developing countries should capitalize on the experience of the industrialized countries to move directly to market based instruments such as emissions charges or capandtrade to control pollution The desirability of this strategy is seen as flowing from the level of poverty in developing countries abating pollution in the least expensive manner would seem especially important to poorer nations Furthermore since developing countries are frequently also starved for revenue revenue generating instruments such as emissions charges or auctioned allowances would seem especially useful Proponents also point out that a number of developing countries already use marketbased instruments Another school of thought suggests that the differences in infrastructure between the developing and industrialized countries make the transfer of lessons from one context to another fraught with peril To illustrate their more general point they note that the effectiveness of marketbased instruments presumes an effective monitoring and enforcement system something that is frequently not present in developing countries In its absence the superiority of marketbased instruments is much less obvious Some middle ground is clearly emerging Those who are skeptical do not argue that marketbased instruments should never be used in developing countries but rather that they may not be as universally appropriate as the most enthusiastic proponents seem to suggest They see themselves as telling a cautionary tale And proponents are certainly beginning to see the crucial importance of infrastructure Recognizing that some developing countries may be much better suited by virtue of their infrastructure to implement marketbased systems than others proponents are beginning to see capacity building as a logical prior step for those countries that need it For marketbased instruments as well as for other aspects of life if it looks too good to be true it probably is Sources World Bank 2000 Greening Industry New Roles for Communities Markets and Governments Washington DC World Bank and Oxford University Press Russell C S Vaughan W J 2003 The choice of pollution control policy instruments in developing countries Arguments evidence and suggestions In H Folmer T Tietenberg Eds The International Yearbook of Environmental and Resource Economics 20032004 Cheltenham UK Edward Elgar 331371 DEBATE 141 Other Policy Dimensions Two main pollution control policy instruments rely on economic incentivescharges and capandtrade Both of these allow the control authority to distribute the responsibility for Economics of Pollution Control 347 control in a costeffective manner The major difference between them we have discussed so far is that the appropriate charge can be determined only by an iterative trialanderror process over time whereas for the capandtrade approach the allowance price can be determined immediately by the market Can other differences be identified As it turns out yes The Revenue Effect One of the differentiating characteristics of these instruments is their ability to raise revenue Environmental taxes and auctioned allowances raise revenue but capandtrade programs that gift the allowances to users free of charge do not Does this difference matter It does for at least two reasons7 First a number of authors Parry Bento 2000 Bovenberg Goulder 1996 Goulder 1997 Parry 1995 have noted that the revenue from environmental taxes or auctioned transferable allowances could be substituted for the revenue from distortionary taxes thereby reducing those taxes and their associated distortions When this substitution is made the calculations indicate that it allows an increase in the present value of net benefits from the application of this instrument an effect that has been called the double dividend This effect creates a preference for instruments that can raise revenue as long as both the implementation of a revenueraising instrument and the use of this revenue to reduce distortionary taxes are politically feasible The second important consideration is that the revenue from taxes or auctions could be used to reduce the burden on lowincome households The empirical evidence suggests that gifting allowances produces a regressive distribution of the control burden A regressive distribution is one that places a higher relative cost burden on lowincome households or individuals as a percentage of their income That same evidence has also demonstrated that when the revenue from auctions or taxes is targeted appropriately the regressiveness of the policy can be eliminated A final consequence of raising revenues involves their political feasibility It seems quite clear that until 2008 using a freedistribution gifting approach for the initial allocation of allowances was a necessary ingredient to build the necessary political support for cap andtrade legislation to be implemented Raymond 2003 Existing users frequently have the power to block implementation while potential future users do not This made it politically expedient to allocate a substantial part of the economic rent from these resources to existing users as the price of securing their support sometimes in creative ways see Example 141 While this strategy reduces the adjustment costs to existing users generally it raises them for new users Interestingly in the climate change case the empirical evidence suggests that only a small fraction of the total revenue would be needed to assure that the profits of carbon suppliers would be unchanged by a switch to a revenue raising approach Bovenberg Goulder 2002 Gifting all allowances therefore may not be inevitable in principle even if political feasibility considerations affect the design While the earliest programs gifted the allowances to large emitters later programs have tended to rely more on auctions On January 1 2009 the historic tendency to gift allowances changed with the implementation of the Regional Greenhouse Gas Initiative RGGI in nine Northeastern states from Maryland to Maine This capandtrade program covers CO2 emissions from large fossil fuelfired electricitygenerating plants A number of RGGI states have chosen to auction nearly 100 percent of these allowances using a sealedbid system with the revenue returned to the states Most states have chosen to use the revenue to promote energy efficiency see Example 142 although two statesNew York and New Hampshirechose to siphon off some of the money for budget relief New Jersey also pursued this latter option and subsequently dropped out of RGGI Economics of Pollution Control 348 EXAMPLE 141 The Swedish Nitrogen Oxide Charge One of the dilemmas facing those who wish to use charges to control pollution is that the amounts of revenue extracted from those subject to the tax can be considerable and that additional expense can produce a lot of political resistance to the policy This resistance can be lowered if the revenue is rebated to those who pay it However if all firms know they are getting their money back the economic incentive to limit emissions is lost Is it possible to design a system of rebates that will promote political feasibility without undermining abatement incentives The Swedish nitrogen oxide charge was designed specifically to resolve this dilemma It was first imposed in 1992 on large energy sources Some 120 heating plants and industrial facilities with about 180 boilers were subject to the tax It was intended from the beginning to have a significant incentive effect not to raise revenue Although the charge rate is high by international standards thereby producing an effective economic incentive the revenue from this tax is not retained by the government but rather is rebated to the emitting sources thereby lowering resistance to the policy by the regulated sources It is the form of this rebate that makes this an interesting scheme While the tax is collected on the basis of emissions it is rebated on the basis of energy production In effect this system rewards plants that emit little nitrogen oxide per unit of energy and penalizes plants that emit more per unit of energy Designed in this way it provides incentives to reduce emissions per unit of energy produced As expected emissions per unit of energy produced fell rather dramatically Over the period from 1992 to 2007 the plants were able to reduce the amount of emissions per unit of input energy by 67 percent According to one study OECD 2010 there were three main explanations for this Cumulative energy output produced by the plants increased by 74 percent over the period The expansion in output mostly took place in plants that were relatively emissionefficient Regulated plants invested in NOx mitigation and were therefore able to produce more energy output with fewer emissions Innovations in mitigation technology made it possible to reach even lower emission intensity levels for the same output level Note however that rebating the revenue means that this tax cannot produce a double dividend Sources Organisation for Economic Cooperation and Development 2013 The Swedish tax on nitrogen oxide emissions Lessons in environmental policy reform OECD Environment Policy Paper No 2 OECD 2010 Innovation Impacts of the Swedish NOx Charge Paris OECD Available at wwwoecdorggreengrowthconsumptioninnovation43211635pdf Economics of Pollution Control 349 Using the revenue from auctions to promote investment in energy efficiency reduces the cost of meeting the carbon targets Costs are reduced not only because less energy is used and hence less carbon emitted but also because the lower demand for energy lowers the price not only of the allowances but of electricity too Can you see why It would be hard to overemphasize what a departure from the previous norm this venture into auctioning represents Allowing emitters to pollute up to the emissions standard without paying for the right to pollute the traditional approach implies that emitters have an implicit property right to pollute already they dont have to buy it A capandtrade program with allowance auctions implies in contrast that the atmosphere is held in trust for the community Institutions that use the atmosphere for emissions must therefore pay to acquire that scarce right Notice that this understanding of who actually holds the property right to the atmosphere completely changes the lens through which this regulation is viewed EXAMPLE 142 RGGI Revenue The Maine Example The revenue received by Maine from the quarterly RGGI auctions is received by Efficiency Maine EM a specially created quasiindependent organization The enabl ing statute requires EM to spend most of the RGGI funds on energy efficiency measures such as more efficient lighting motors heating and air conditioning as well as on building weatherization For large customers such as paper mills the money is allocated in response to applications from the large customers for specific projects These are evaluated on the basis of the amount of kilowatthours reduced for electricity or tons of CO2 reduced for fossil fuels per EM dollar expended Notice how focusing on public dollars as opposed to the sum of public and private dollars provides an incentive for cost sharing on the part of companiesputting more of their own money and less public money into the project raises the ratio of the savings per EM dollar and hence increases the likelihood of success of their proposed funding request To be funded all proposals must also pass a benefitcost test to assure the resources are being used efficiently EMs 2016 annual report notes that the FY2016 benefitcost ratios for these large customers were 326 for the electric programs and 316 for the thermal programs The comparable numbers for all EM programs were respectively 263 and 189 The investments in energy efficiency incentivized by these funds have been very cost effective The data demonstrate that at the margin saving energy is cheaper than buying it In other words investing in energy savings actually lowers energy costs Lower energy costs have made participating Maine firms more cost competitive and have saved jobs and bolstered the local economy while reducing emissions of one of the gases that contributes to climate change Sources The Regional Greenhouse Gas Initiative auction results website wwwrggiorgmarketco2auctions resultsstateproceeds accessed June 19 2017 Acadia Center 2016 Regional greenhouse gas initiative status report Part Imeasuring success Available at httpacadiacenterorgdocumentmeasuringrggi success accessed June 19 2017 Efficiency Maine EM 2016 FY2016 Annual Report Available at wwwefficiencymainecomdocsFY2016AnnualReportpdf accessed on June 19 2017 Economics of Pollution Control 350 Responses to Changes in the Regulatory Environment One major additional difference between charges and allowances concerns the manner in which these two systems react to changes in external circumstances in the absence of further decisions by the control authority This is an important consideration because bureaucratic procedures are notoriously sluggish and changes in policies are usually rendered slowly8 We consider three such circumstances growth in the number of sources inflation and technological progress If the number of sources were to increase in a capandtrade program the demand for allowances would shift to the right Given a fixed supply of allowances the price would rise as would the control costs but the amount of emissions would remain the same If charges were being used in the absence of additional action by the control authority the charge level would remain the same This implies that the amount the existing sources would control would be unchanged by the growth Therefore the arrival of new sources would cause a deterioration of air or water quality in the region due to the added emissions by the new sources The costs of abatement would rise since the costs of control paid by the new sources must be considered but by a lesser amount than with capandtrade because of the lower amount of pollution being controlled If the economy is growing the allowance system ensures that emissions will not rise Inflation in the cost of control would automatically result in higher allowance prices in a capandtrade program but with a charge system it would result in lower control Essentially the real charge the nominal charge adjusted for inflation declines with inflation if the nominal charge remains the same We should not however conclude that over time charges always result in less control than allowances Suppose for example technological progress in designing pollution control equipment were to cause the marginal cost of abatement to fall With capandtrade this would result in lower prices and lower abatement costs but the same aggregate degree of control With a charge system the amount controlled would actually increase see Figure 145 and therefore would result in more control than a capandtrade program that prior to the fall in costs controlled the same amount Instrument Choice under Uncertainty Another major difference between allowances and charges involves the cost of being wrong Suppose that we have very imprecise information on damages caused and avoidance costs incurred by various levels of pollution and yet we have to choose either a charge level or an allowance level and live with it What can be said about the relative merits of allowances versus charges in the face of this uncertainty The answer depends on the circumstances Allowances offer a greater amount of certainty about the quantity of emissions while charges confer more certainty about the marginal cost of control Allowance markets allow an aggregate emissions standard to be met with certainty but they offer less certainty about marginal costs When the objective is to minimize total costs the sum of damage cost and control costs allowances would be preferred when the costs of being wrong are more sensitive to changes in the quantity of emissions than to changes in the marginal cost of control Charges would be preferred when control costs were more important What circumstances give rise to a preference for one or the other When the marginal damage curve is steeply sloped and the marginal cost curve is rather flat certainty about emissions is more important than certainty over control costs Smaller deviations of actual emissions from expected emissions can cause a rather large deviation in damage costs whereas control costs would be relatively insensitive to the degree of control Economics of Pollution Control 351 Allowances would prevent large fluctuations in these damage costs and therefore would yield a lower cost of being wrong than charges Suppose however that the marginal control cost curve was steeply sloped but the marginal damage curve was flat Small changes in the degree of control would have a large effect on abatement costs but would not affect damages very much In this case it makes sense to rely on charges to give more precise control over control costs accepting the less dire consequences from possible fluctuations in damage costs Theory is not strong enough to dictate a choice Empirical studies are necessary to establish a preference for particular situations One interesting current application of these insights involves the control of the gases that intensify climate change As we will see in the next chapters the shape of the marginal cost curve matters for the choice of policy instrument For our most complex issue greenhouse gases growing scientific evidence suggests that climatic responses to temperature increases may well be highly nonlinear characterized by thresholds or abrupt changes This understand ing of the science leads to a greater sensitivity of damages to the level of emissions reduction shifting the preference toward capandtrade Keohane 2009 These cases suggest that a preference either for allowances or for charges in the face of uncertainty is not universal it depends on the circumstances Summary In this chapter we developed the conceptual framework needed to evaluate current approaches to pollution control policy We have explored many different types of pollutants and found that context matters Different policy approaches are appropriate for different circumstances Stock pollutants pose the most serious intertemporal problems The efficient production of a commodity that generates a stock pollutant could be expected to decline over time Theoretically a point would be reached when all of the pollutant would be recycled After this point the amount of the pollutant in the environment would not increase The amount already accumulated however would continue to cause damage perpetually unless some natural process could reduce the amount of the pollutant over time The efficient amount of a fund pollutant was defined as the amount that minimizes the sum of damage and control costs Using this definition we were able to derive two propositions of interest 1 the efficient level of pollution would vary from region to region and 2 the efficient level of pollution would not generally be zero although in some particular circumstances it might Since pollution is a classic externality markets will generally produce more than the efficient amount of both fund pollutants and stock pollutants For both types of pollutants this will imply higherthanefficient damages and lowerthanefficient control costs For stock pollutants an excessive amount of pollution would accumulate in the environment imposing a detrimental externality on future generations as well as on current generations The market would not provide any automatic ameliorating response to the accumulation of pollution as it would in the case of natural resource scarcity Firms attempting to unilaterally control their pollution could be placed at a competitive disadvantage Hence the case for some sort of government intervention is particularly strong for pollution control While policy instruments could in principle be defined to achieve an efficient level of pollution for every emitter it is very difficult in practice because the amount of information required by the control authorities is unrealistically high Economics of Pollution Control 352 Costeffectiveness analysis provides a way out of this dilemma In the case of uniformly mixed fund pollutants uniform emissions charges or an allowance system focused purely on emissions could be used to attain the costeffective allocation even when the control authority has no information whatsoever on either control costs or damage costs Uniform emissions standards would not except by coincidence be costeffective In addition either emissions trading or charges would provide more incentives for technological progress in pollution control than would emissions standards The fact that auctioned allowances or taxes can raise revenue is also an important characteristic If the revenue from pollution charges or auctioned allowances can be used to reduce revenue from other more distortionary taxes such as labor or income taxes greater welfare gains can be achieved from revenueraising instruments than instruments that raise no revenue On the other hand historically at least transferring some or all of that revenue back to the sources either by gifting the allowances or including some sort of tax rebate has been an important aspect of securing the political support for implementing the system Revenue use for this purpose of course cannot be used to reduce distortionary taxes or lower the regressive nature of the program The allowance approach and the charge approach respond differently to growth in the number of sources to inflation to technological change and to uncertainty As we shall see in the next few chapters some countries have chosen to rely on emissions charges while others have chosen to rely on capandtrade Discussion Question 1 In his book What Price Incentives Steven Kelman suggests that from an ethical point of view the use of economic incentives such as emissions charges or emissions trading in environmental policy is undesirable He argues that transforming our mental image of the environment from a sanctified preserve to a marketable commodity has detrimental effects not only on our use of the environment but also on our attitude toward it His point is that applying economic incentives to environmental policy weakens and cheapens our traditional values toward the environment a Consider the effects of economic incentive systems on prices paid by the poor on employment and on the speed of compliance with pollutioncontrol lawsas well as the Kelman arguments Are economic incentive systems more or less ethically justifiable than the traditional regulatory approach b Kelman seems to feel that because emissions allowances automatically prevent environmental degradation they are more ethically desirable than emissions charges Do you agree Why or why not SelfTest Exercises 1 Two firms can control emissions at the following marginal costs MC1 200q1 MC2 100q2 where q1 and q2 are respectively the amount of emissions reduced by the first and second firms Assume that with no control at all each firm would be emitting 20 units of emissions or a total of 40 units for both firms Compute the costeffective allocation of control responsibility if a total reduction of 21 units of emissions is necessary Economics of Pollution Control 353 2 Assume that the control authority wanted to reach its objective in 1 by using an emissions charge system a What perunit charge should be imposed b How much revenue would the control authority collect 3 In a region that must reduce emissions three polluters currently emit 30 units of emissions The three firms have the following marginal abatement cost functions that describe how marginal costs vary with the amount of emissions each firm reduces Firm Emissions Reduction Firm 1 Marginal Cost Firm 2 Marginal Cost Firm 3 Marginal Cost 1 100 100 200 2 150 200 300 3 200 300 400 4 250 400 500 5 300 500 600 6 350 600 700 7 400 700 800 8 450 800 900 9 500 900 1000 10 550 1000 1100 Suppose this region needs to reduce emissions by 14 units and plans to do it using a form of capandtrade that auctions allowances off to the highest bidder a How many allowances will the control authority auction off Why b Assuming no market power how many of the allowances would each firm be expected to buy Why c Assuming that demand equals supply what price would be paid for those allowances Why d If the control authority decided to use an emissions tax rather than capandtrade what tax rate would achieve the 14unit reduction costeffectively Why Notes 1 At this point we can see why this formulation is equivalent to the net benefit formulation Since the benefit is damage reduction another way of stating this proposition is that marginal benefit must equal marginal cost That is of course the familiar proposition derived by maximizing net benefits 2 Note that pollution damage is not inevitably an externality For any automobile rigged to send all exhaust gases into its interior those exhaust gases would not be an externality to the occupants 3 Actually the source certainly considers some of the costs if only to avoid adverse public relations The point however is that this consideration is likely to be incomplete the source is unlikely to internalize all of the damage cost 4 Affected parties do have an incentive to negotiate among themselves a topic covered in Chapter 2 As pointed out there however that approach works well only in cases where the number of affected parties is small 5 Another policy choice is to remove the people from the polluted area The government has used this strategy for heavily contaminated toxicwaste sites such as Times Beach Missouri and Love Canal New York as we shall see in Chapter 19 Economics of Pollution Control 354 6 This statement is true when marginal cost increases with the amount of emissions reduced as in Figure 143 Suppose that for some pollutants the marginal cost were to decrease with the amount of emissions reduced What would be the costeffective allocation in that admittedly unusual situation 7 The literature contains a third reason It suggests that unless emitters cover all external costs via a revenueraising instrument the cost of production will be artificially low production will be artificially high and the industry will contain too many firms 8 This is probably particularly true when the modification involves a change in the rate at which firms are charged for their emissions Further Reading Baumol W J Oates W E 1988 The Theory of Environmental Policy 2nd ed Cambridge Cambridge University Press A classic on the economic analysis of externalities Accessible only to those with a thorough familiarity with multivariate calculus Freeman Jody and Kolstad Charles D Eds 2007 Moving to Markets Lessons from Twenty Years of Experience New York Oxford University Press A collection of 16 essays from leading scholars exploring what lessons can be extracted from actual experience with moving to marketbased environmental regulation Harrington W Morgenstern R D Sterner T 2002 Choosing Environmental Policy Comparing Instruments and Outcomes in the United States and Europe Washington DC Resources for the Future Uses paired case studies from the United States and Europe to contrast the costs and outcomes of direct regulation on one side of the Atlantic with an incentivebased policy on the other OECD 1994 Environment and Taxation The Cases of the Netherlands Sweden and the United States Paris OECD Background case studies for a larger research project seeking to discover the extent to which fiscal and environmental policies could be made not only compatible but also mutually reinforcing Sterner T and Muller Adrian Eds 2016 Environmental Taxation in Practice International Library of Environmental Economics and Policy New York Routledge Focusing on environmental taxation in practice this book collects key contributions on a wide range of topics including comparisons in different countries and key aspects of implementation Tietenberg T 2006 Emissions Trading Principles and Practice 2nd ed Washington DC Resources for the Future This book considers how the use of emissions trading to control pollution has evolved looks at how these programs have been implemented in the US and internationally and offers an objective evaluation of the resulting successes failures and lessons learned over the last 25 years Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Economics of Pollution Control 355 Appendix The Simple Mathematics of CostEffective Pollution Control Suppose that each of N polluters would emit un units of emission in the absence of any control Furthermore suppose that the pollutant concentration KR at some receptor R in the absence of control is K a u B 1 n R n n N 1 where B is the background concentration and an is the transfer coefficient This KR is assumed to be greater than Φ the legal concentration level The regulatory problem therefore is to choose the costeffective level of control qn for each of the n sources Symbolically this can be expressed as minimizing the following Lagrangian with respect to the Nqn control variables min C q a u q 1 1 n n n N n n n n N m U F 2 where Cnqn is the cost of achieving the qn level of control at the nth source and A is the Lagrangian multiplier The solution is found by partially differentiating 2 with respect to m and the N qns This yields 0 1 q q C a n N n n n 2 2 m 3 0 a u q B 1 n n n n N U 4 Solving these equations produces the Ndimensional vector q0 and the scalar m Note that this same formulation can be used to reflect both the uniformly mixed and nonuniformly mixed singlereceptor case In the uniformly mixed case every an 1 This immediately implies that the marginal cost of control should be equal for all emitters who are required to engage in some control The first N equations would hold as equalities except for any source where the marginal cost of controlling the first unit exceeded the marginal cost necessary to meet the target For the nonuniformly mixed singlereceptor case in the costeffective allocation the control responsibility would be allocated so as to ensure that the ratio of the marginal control costs for two emitters would be equal to the ratio of their transfer coefficients For J receptors both m and m would become Jdimensional vectors Policy Instruments A special meaning can be attached to m If emissions trading were being used it would be the marketclearing price of an allowance In the uniformly mixed case A would be the price of an allowance to emit one unit of emission In the nonuniformly mixed case m would be the price of being allowed to raise the concentration at the receptor location one unit In the case of taxes m represents the value of the costeffective tax Economics of Pollution Control 356 Note how firms choose emissions control when the allowance price or tax is equal to m Each firm wants to minimize its costs Assume that each firm is given allowances of Ωn where the regulatory authority ensures that a B 1 n n n N X U 5 for the set of all emitters Each firm would want to min c q P a u q 0 n n n n n Xn 6 The minimum cost is achieved by choosing the value of qnqn 0 that satisfies 0 a q C q P n n n n 2 2 7 This condition marginal cost equals the price of a unit of concentration reduction would hold for each of the N firms Because P would equal m and the number of allowances would be chosen to ensure the ambient standard would be met this allocation would be cost effective Exactly the same result is achieved by substituting T the costeffective tax rate for P 357 StationarySource Local and Regional Air Pollution People are very openminded about new thingsas long as theyre exactly like the old ones Charles F Kettering American engineer inventor of the electric starter 18761958 Introduction Attaining and maintaining clean air is an exceedingly difficult policy task In the United States for example an estimated 27000 major stationary sources of air pollution are subject to control as well as hundreds of thousands of more minor sources Many distinct production processes emit many different types of pollutants The resulting damages range from minimal effects on plants and humans to the modification of the earths climate The policy response to this problem has been continually evolving The Clean Air Act Amendments of 1970 set a bold new direction that has been retained and refined by subsequent acts By virtue of this legislation the federal government assumed a much larger and much more vigorous direct role than previously had been the case The US Environmental Protection Agency EPA was created in 1970 to implement and oversee this massive attempt to control the injection of pollutants into the nations air Individually tailored strategies were created to deal with mobile and stationary sources Conventional Pollutants Conventional pollutants are relatively common substances found in almost all parts of the country and are thought on the basis of research to be dangerous only in high concentrations In the United States these pollutants are called criteria pollutants because the Act required the EPA to produce criteria documents to be used in setting acceptable standards for these pollutants These documents summarize and evaluate all of the existing research on the Chapter 15 StationarySource Air Pollution 358 various health and environmental effects associated with these pollutants The central focus of air pollution control during the 1970s was on criteria pollutants The CommandandControl Policy Framework In Chapter 14 several possible approaches to controlling pollution were described and analyzed in theoretical terms The historical approach to air pollution control known popularly as commandandcontrol CAC depended primarily on emissions standards In this section we outline the specific nature of this approach analyze its shortcomings from an efficiency and costeffectiveness perspective and show how a series of reforms based on the logic advanced in the last chapter has worked to rectify some of these deficiencies For each of the conventional pollutants the typical first step is to establish the National Ambient Air Quality Standards NAAQS These standards have to be met everywhere although as a practical matter they are monitored at a large number of specific locations Ambient standards set legal ceilings on the allowable concentration of the pollutant in the outdoor air averaged over a specified time period The allowable concentrations for many pollutants are defined in terms of both a longterm average defined frequently as an annual average and a shortterm average such as a 3hour average Compliance with shortterm averages usually requires that the allowable concentrations be exceeded no more than once a year Control costs can be quite sensitive to the level of these shortterm averages In the United States two ambient standards have been defined The primary standard is designed to protect human health It was the earliest standard to be determined and had the earliest deadlines for compliance All pollutants have a primary standard The primary ambient standards are required by statute to be set at a level sufficient to protect even the most sensitive members of the population without any consideration given to the costs of meeting them The secondary standard is designed to protect other aspects of human welfare from those pollutants having separate effects Currently only three separate secondary standards have been setnitrogen dioxide sulfur oxides and small particulates For some other pollutants the concentration levels allowed by the primary and secondary standards are the same The secondary standards are designed to protect aesthetics particularly visibility physical objects houses monuments and so on and vegetation When a separate secondary standard exists both it and the primary standard must be met1 While the EPA is responsible for defining the ambient standards the primary responsibility for enforcement falls on the state control agencies They exercise this responsibility by developing and executing an acceptable state implementation plan SIP which must be approved by the EPA This plan divides the state into separate airqualitycontrol regions Special procedures were developed for handling regions that cross state borders such as metropolitan New York The SIP spells out for each control region the procedures and timetables for meeting local ambient standards and for abatement of the effects of locally emitted pollutants on other states The required degree of control depends on the severity of the pollution problem in each of the control regions All areas not meeting the deadlines were designated as nonattainment regions Recognizing that it is typically much easier and much cheaper to control new sources rather than existing ones the Clean Air Act established the New Source Review NSR Program This program requires all new major stationary sources as well as those undergoing major modifications in both attainment and nonattainment areas to seek a permit for operation This permit requires compliance with the specified standards more stringent in nonattainment areas than in attainment areas The theory was that as old dirtier plants became obsolete this program would ensure that their replacements would be significantly less polluting As Debate 151 points out the New Source Review Program has stimulated some controversy StationarySource Air Pollution 359 The Efficiency of the CommandandControl Approach Efficiency requires that the allowable concentration levels authorized by the ambient standards are set where the marginal benefit equals the marginal cost To ascertain whether or not the current standards are efficient it is necessary to inquire into five aspects of the standardsetting process 1 the threshold concept on which the standards are based 2 the level of the standard 3 the choice of uniform standards over standards more tailored to the regions Does Sound Policy Require Targeting New Sources via the New Source Review One of the characteristics of the New Source Review program is that it requires large stationary sources that are undergoing major modifications not just routine maintenance to meet the same stringent standards as new sources Routine maintenance does not trigger a need to install the more stringent control technology Due to this routine maintenance exemption a number of older plants have historically avoided the major modification threshold and therefore were never upgraded As a result over time these older plants have become responsible for an increasing share of the total emissions One approach to dealing with this problem was to take enforcement actions against individual companies including numerous electric utilities that own and operate coalfired power plants in the Southeast and Midwest The lawsuits alleged that plants that should have been retired years earlier were being modified and retained past their normal life under the cover of routine maintenance Using this exemption to prop up the plants was seen as an evasion of the principle of improving air quality over time by replacing older plants with modern less polluting plants Opponents of the New Source Review process argue that it has been counterproductive resulting in worse air quality not better and it should be replaced not merely enforced more rigorously According to this view not only has the New Source Review deterred investment in newer cleaner technologies but it has also discouraged companies from keeping power plants adequately maintained lest they trigger the major modification designation The solution they argue is to use capandtrade to create a levelplaying field where all electricity generators old and new would face the same emissions constraint Under this new policy plant owners would pursue the investment andor retirement strategies that secured the required emissions reductions at minimum cost Artificial delay in replacing plants would no longer make any economic sense with the new incentives created by capandtradeprivate and social goals would be harmonized Source Stavins R 2006 Vintagedifferentiated environmental regulation Stanford Environmental Law 251 2963 DEBATE 151 StationarySource Air Pollution 360 involved 4 the timing of emissions flows and 5 the failure to incorporate the degree of human exposure in the standardsetting process The Threshold Concept Since the Clean Air Act prohibits the balancing of costs and benefits some alternative criterion must be used to set the standard For the primary health related standard this criterion is known as the health threshold In principle this threshold is defined with a margin of safety sufficiently high that no adverse health effects would be suffered by any member of the population as long as the air quality was at least as good as the standard This approach presumes the existence of a threshold such that concentrations below that level produce no adverse health effects If the threshold concept presumption were valid the marginal damage function would be zero for concentrations under the threshold and would be positive at higher concentrations In practice this shape is not consistent with the latest evidence Adverse health effects can occur at pollution levels lower than the ambient standards The standard that produces no adverse health effects among the general population which of course includes especially susceptible groups is probably zero or close to it It is certainly lower than the established ambient standards What the standards purport to accomplish and what they actually accomplish are rather different The Level of the Ambient Standard The absence of a defensible health threshold complicates the analysis see Debate 152 Some other basis must be used for determining the level at which the standard should be established Efficiency would dictate setting the standard in order to maximize the net benefit which includes a consideration of costs as well as benefits The current policy explicitly excludes costs from consideration in setting the ambient standards It is difficult to imagine that the process of setting the ambient standard would yield an efficient outcome when it is prohibited from considering one of the key elements of that outcome Unfortunately for reasons that were discussed in some detail in Chapter 4 our current benefit measurements are not sufficiently reliable as to permit the identification of the efficient level with any confidence For example an early EPA study of the Clean Air Act found that the total monetized benefits of the Clean Air Act realized during the period from 1970 to 1990 ranged from 56 to 494 trillion with a central estimate of 222 trillion That is a very large band of uncertainty The study further noted that the central estimate of 222 trillion dollars in benefits might be a significant underestimate due to the exclusion of large numbers of benefit categories from the monetized benefit estimate eg all air toxics effects ecosystem effects numerous human health effects The EPAs estimates suggest that a high degree of confidence can be attached to the belief that government intervention to control air pollution in the United States was economically justified but they provide no evidence whatsoever on whether current policy was or is efficient Uniformity The same primary and secondary standards apply to all parts of the country No account is taken of the number of people exposed the sensitivity of the local ecology or the costs of compliance in various areas All of these aspects of the problem would have some effect on the efficient standard and efficiency would therefore dictate different standards for different regions Uniform ambient standards are inconsistent with an efficient allocation of pollution control resources Spatially differentiated standards that target the level of control so as to reflect the damage caused would produce more damage reduction per dollar of StationarySource Air Pollution 361 abatement cost but populations in less densely populated areas would face worse air quality Spatially differentiated standards are efficient but would they be fair to the people in rural areas That is the policy conundrum Timing of Emissions Flows Because ambient concentrations are important for criteria pollutants the timing of emissions is an important policy concern Emissions concentrated in time are as troublesome as emissions concentrated in space One circumstance that gives rise to this concern involves those relatively rare but devastating occasions when The Particulate and Smog Ambient Standards Controversy During one of its periodic reviews of the ambient airquality standards the US EPA concluded that 125 million Americans including 35 million children were not adequately protected by the existing standards for ozone and particulates More stringent standards were estimated to prevent 1 million serious respiratory illnesses each year and 15000 premature deaths The proposed revisions were controversial because the cost of compliance would be very high No health threshold existed at the chosen level some health effects would be noticed at even more stringent levels than those proposed and the EPA was by law prohibited from using a benefitcost justification In the face of legal challenge the EPA found it very difficult to defend the superiority of the chosen standards from slightly more stringent or slightly less stringent standards In its ruling on the issues raised in this case the US Court of Appeals for the District of Columbia Circuit overturned the proposed revisions In a 21 ruling the threejudge panel rejected the EPAs approach to setting the level of those standards the construction of the Clean Air Act on which EPA relied in promulgat ing the NAAQS at issue here effects an unconstitutional delegation of legislative power Although the factors EPA uses in determining the degree of public health concern associated with different levels of ozone and PM are reasonable EPA appears to have articulated no intelligible principle to channel its application of these factors EPAs formulation of its policy judgement leaves it free to pick any point between zero and a hair below the concentrations yielding Londons Killer Fog Although the threat to the EPAs authority from this decision was ultimately overturned by the US Supreme Court the dilemma posed by the absence of a compelling health threshold remains unresolved DEBATE 152 StationarySource Air Pollution 362 thermal inversions prevent the normal dispersion and dilution of the pollutants The resulting concentration levels can be quite dangerous How should these circumstances be handled From an economic efficiency point of view the most obvious approach is to tailor the degree of control to the circumstances The most stringent control would be exercised when and only when meteorological conditions were relatively stagnant less control would be applied under normal circumstances A reliance on a constant degree of control rather than allowing intermittent controls raises compliance costs substantially particularly when the required degree of control is high The strong stand against intermittent controls in the Clean Air Act however rules out this approach Concentration versus Exposure Presently ambient standards are defined in terms of pollutant concentrations in the outdoor air Yet health effects are closely related to human exposure to pollutants and exposure is determined not only by the concentrations of air pollutants in each of the places in which people spend time but also by the number of people exposed and the amount of time spent in each place Since in the United States only about 10 percent of the populations personhours are spent outdoors indoor air becomes very important in designing strategies to improve the health risk of pollutants To date very little attention has been focused on controlling indoor air pollution despite its apparent importance2 CostEffectiveness of the CommandandControl Approach While empirically determining the magnitude of the inefficiency of the ambient standards is difficult at best determining their costeffectiveness is somewhat easier Although it does not allow us to shed any light on whether a particular ambient standard is efficient or not cost effectiveness does allow us to see whether the ambient standards are being met in the least costly manner possible The theory covered in Chapter 14 makes it clear that the CAC strategy will normally not be costeffective What the theory does not make clear however is the degree to which this strategy diverges from the leastcost ideal If the divergence is small the proponents of reform would not likely be able to overcome the inertia of the status quo If the divergence is large the case for reform is stronger The costeffectiveness of the CAC approach depends on local circumstances such as prevailing meteorology the spatial configuration of sources stack heights and the degree to which costs vary with the amount controlled Several simulation models capable of dealing with these complexities have now been constructed for a number of different pollutants in a variety of airsheds The vast majority of these studies have found that the costs associated with the commandandcontrol approach were considerably higher than a costeffective approach3 As Example 151 points out the commandandcontrol program to control SO2 emissions in Germany did experience some costineffectiveness but not for the traditional reason StationarySource Air Pollution 363 EXAMPLE 151 Controlling SO2 Emissions by CommandandControl in Germany Germany and the United States took quite different approaches to controlling SO2 emissions Whereas the United States used a version of capandtrade Germany used traditional commandandcontrol regulation Theory would lead us to believe that the US approach due to its flexibility would achieve its goals at a considerably lower cost The evidence suggests that it did but the reasons are a bit more complicated than one might suppose Due to the large amount of forest death Waldsterben in Germany in which SO2 emissions were implicated the pressure was on to significantly reduce SO2 emission from large combustion sources in a relatively short period of time Both the degree of control and the mandated deadlines for compliance were quite stringent The stringency of the targets and deadlines meant that sources had very little control flexibility Only one main technology could meet the requirements so every covered combustion source had to install that technology Even if firms had been allowed to engage in allowance trading once the equipment was installed the pretrade marginal costs would have been very similar Since the purpose of trading is to equalize marginal costs the fact that they were very similar before trading left little room for cost savings from trade The main cost disadvantage to the German system however was not found to be due to unequal marginal costs but rather to the temporal inflexibility of the commandand control regulations As Wätzold 2004 notes The nearly simultaneous installation of desulfurization equipment in LCPs Large Combustion Plants all over Germany led to a surge in demand for this equipment with a resulting increase in prices Furthermore because Germany had little experience with the necessary technology no learning effects were achieved shortcomings that should have come to light before the systems were introduced in the entire fleet of power stations had to be remedied in all power stations p 35 This was quite different from the US experience with its sulfur allowance program In the US program described later in this chapter the ability to bank or save allowances for subsequent use provided an incentive for some firms to comply early and the phased deadline allowed much more flexibility in the timing of the installation of abatement controls not all firms had to comply at the same time Source Wätzold F F 2004 SO2 emissions in Germany Regulations to fight Waldsterben In W Harrington R D Morgenstern T Sterner Eds Choosing Environmental Policy Comparing Instruments and Outcomes in the United States and Europe Washington DC Resources for the Future 2340 StationarySource Air Pollution 364 Air Quality Each year the US Environmental Protection Agency publishes emission trends using measurements from monitors located across the country Table 151 shows the reduction in emissions for various pollutants from 1980 to 2015 Notice that every pollutant experienced improvement and in some cases the improvements were dramatic How typical has the US experience been Is pollution declining on a worldwide basis The Global Environmental Monitoring System GEMS operating under the auspices of the World Health Organization and the United Nations Environment Program monitors air quality around the globe Scrutiny of its reports reveals that the US experience is typical for the industrialized nations which have generally reduced pollution both in terms of emissions and ambient outdoor air quality However the air quality in most developing nations has steadily deteriorated and the number of people exposed to unhealthy levels of pollution in those countries is frequently very high4 Since these countries typically are struggling merely to provide adequate employment and income to their citizens they cannot afford to waste large sums of money on inefficient environmental policies especially if the inefficiencies tend to subsidize the rich at the expense of the poor Some costeffective yet fair means of improving air quality that works in the developing country context must be found MarketBased Approaches Fortunately more costeffective approaches are not only available but are being used Since various versions of these approaches have now been implemented around the world we can learn from the experience gained from their implementation Emissions Charges Economists typically envision two types of effluent or emissions charges The first an efficiency charge is designed to force the polluter to compensate completely for all damage caused The second a costeffective charge is designed to achieve a predefined ambient standard or aggregate emissions level at the lowest possible control cost Table 151 Percentage Change in US Emissions 19802015 1980 vs 2015 1990 vs 2015 2000 vs 2015 Carbon Monoxide 71 65 50 Lead 99 80 50 Nitrogen Oxides NOx 58 54 49 Volatile Organic Compounds VOC 54 41 19 Direct PM10 57 17 14 Direct PM25 24 32 Sulfur Dioxide 86 84 77 Source wwwepagovairtrendsairqualitynationalsummary Accessed June 9 2017 StationarySource Air Pollution 365 In Japan the charge is based upon damages to human health As a result of four important legal cases where Japanese industries were forced to compensate victims for pollution damages caused in 1973 Japan passed the Law for the Compensation of PollutionRelated Health Injury According to this law victims of designated diseases upon certification by a council of medical legal and other experts are eligible for medical expenses lost earnings and other expenses they are not eligible for other losses such as pain and suffering Two classes of diseases were funded designated diseases where the specific source is relatively clear and nonspecific respiratory diseases where all polluters are presumed to have some responsibility Victim compensation is funded by an emissions charge on sulfur dioxides and by an auto mobile weight tax The level of the chargetax is determined by the revenue needs of the compensation fund In contrast to capandtrade where allowance prices respond automatically to changing market conditions emissions charges have to be determined by an administrative process When the function of the charge is to raise revenue for a particular purpose charge rates will be determined by the costs of achieving that purpose when the costs of achieving the purpose rise the level of the charge must also rise to secure the additional revenue5 Sometimes that process produces an unintended dynamic In Japan for example the charge is calculated on the basis of the amount of compensation paid to victims of air pollu tion in the previous year While the amount of compensation was increasing the amount of emissions the base to which the charge is applied was decreasing As a result unexpectedly high charge rates were necessary in order to raise sufficient revenue for the compensation system and these had quite a large incentive effect on emissions reduction In 1986 the law was amended to among other changes use the funds for pollution abatement research medical expenses associated with pollutionrelated illnesses and educating the public about research findings Emissions Trading In the early days of pollution control local areas adopted the motto Dilution is the solution As implemented this approach suggested that the way to control local pollutants was to require tall stacks for emissions By the time the pollutants hit the ground according to this theory the concentrations would be diluted making it easier to meet the ambient standards at nearby monitors By the end of the 1980s it had become painfully clear in the United States that the Clean Air Act was illsuited to solving regional pollution problems Revamping the legislation to do a better job of dealing with regional pollutants such as acid rain became a high priority Politically that was a tall order By virtue of the fact that these pollutants are transported long distances due to the tall stacks the set of geographic areas receiving the damage is typically not the same as the set of geographic areas responsible for most of the emission causing the damage In many cases the recipients and the emitters are even in different countries In this political milieu it should not be surprising that those bearing the costs of damages should call for a large rapid reduction in emissions whereas those responsible for bearing the costs of that cleanup should want to proceed more slowly and with greater caution Economic analysis was helpful in finding a feasible path through this political thicket In particular in 1986 a Congressional Budget Office CBO study helped to set the parameters of the debate by quantifying the consequences of various courses of action To analyze the economic and political consequences of various strategies designed to achieve reductions of SO2 emissions from utilities anywhere from 8 to 12 million tons below the emissions levels StationarySource Air Pollution 366 from those plants in 1980 the CBO used a computerbased simulation model that related utility emissions utility costs and coalmarket supply and demand levels to the strategies under consideration The first implication of the analysis was that the marginal cost of additional control would rise rapidly particularly after 10 million tons had been reduced The cost of reducing a ton of SO2 was estimated to rise from 270 for an 8millionton reduction to 360 for a 10millionton reduction and it would rise to a rather dramatic 779 per ton for a 12million ton reduction Costs would rise much more steeply as the amount of required reduction was increased because reliance on the more expensive scrubbers would become necessary Scrubbers involve a chemical process to extract or scrub sulfur gases before they escape into the atmosphere The second insight one that should be no surprise to readers of this book is that the emissions charge would be more costeffective than the comparable CAC strategy Whereas the CAC strategy could secure a 10millionton reduction at about 360 a ton the emissions charge could do it for 327 a ton The superiority of the emissions charge was due to the fact that this approach would result in equalized marginal costs a required condition for costeffectiveness Although the emissionscharge approach may be the most costeffective policy it was not the most popular particularly in states with a lot of old heavily polluting power plants With an emissionscharge approach utilities not only have to pay the higher equipment and operating costs associated with the reductions but also have to pay the emissions charge on all remaining uncontrolled emissions The additional financial burden on utilities associated with controlling acid rain by this means would have been significant Instead of paying the 32 billion for reducing 10 million tons under a CAC approach utilities would be saddled with a 77 billion financial burden with an emissions charge The savings from lower equipment and operating costs achieved because the emissionscharge approach is more cost effective would have been more than outweighed by the additional expense of paying the emissions charges The political dilemma posed by this additional financial burden was resolved by adopting an emissions trading system known as the sulfur allowance trading program Adopted as part of the Clean Air Act Amendments of 1990 this approach was designed to complement not replace the traditional approach Under this program allowances to emit sulfur oxides were allocated to older sulfuremitting electricitygenerating plants The number of allowances was restricted in order to assure a reduction of 10 million tons in emissions from 1980 levels by the year 2010 These allowances which provide a limited authorization to emit 1 ton of sulfur dioxide SO2 were defined for a specific calendar year but unused allowances could be carried forward into the next year They were transferable among the affected sources Any plants reducing emissions more than required by the allowances could transfer the unused allowances to other plants Emissions in any plant could not legally exceed the levels permitted by the allowances allocated plus acquired held by the managers of that plant An annual yearend audit balanced emissions with allowances Utilities that emitted more than authorized by their holdings of allowances were required to pay an excess emissions penalty and were required to forfeit an equivalent number of tons of emissions in the following year equal to the amount of the excess emissions The financial penalty was adjusted annually for inflation An important innovation in this program was the establishment of an auction market for the allowances Each year the EPA withheld an allowance auction reserve of 28 percent of the allocated allowances these went into the sealed bid auction These withheld allowances were allocated to the highest bidders with successful buyers paying their bid price not the StationarySource Air Pollution 367 market clearing price The proceeds were refunded to the utilities from whom the allowances were withheld on a proportional basis One main advantage of this auction is that it made allowance prices publicly transparent By providing more information to investors business investment strategies were facilitated Private allowance holders were also allowed to offer allowances for sale at these auctions Potential sellers specify minimum acceptable prices Once the withheld allowances have been disbursed the EPA then matches the highest remaining bids with the lowest minimum acceptable prices on the private offerings and matches buyers and sellers until the sum of all remaining bids is less than that of the remaining minimum acceptable prices How did the program fare Rather well in many respects but not always for the expected reasons see Example 152 EXAMPLE 152 The Sulfur Allowance Program after 20 Years An ex post analysis published in 2013 provides a thorough retrospective evaluation of the Sulfur Allowance Program It found the following The program was environmentally effective with SO2 emissions from electric power plants decreasing by 36 percent between 1990 and 2004 even though electricity generation from coalfired power plants increased 25 percent over the same period The programs longterm annual emissions goal was achieved early However it turns out that the ecological benefits of the program the original focus were relatively small Reversing the acidification of ecosystems took longer than expected In retrospect more than 95 percent of the benefits from this program were associated not with ecological impacts but rather with human health improvements resulting from reduced levels of small airborne sulfate particles derived from SO2 emissions Due to effective penalties and continuous monitoring of emissions compliance was nearly 100 percent Some evidence suggests that the intertemporal allocation of abatement cost via allowance banking was at least approximately efficient Although the law was clearly more costeffective than a traditional commandand control approach would have been and it produced savings much larger than anticipated before the act was enacted much of this reduced cost was due to an unanticipated consequencethe deregulation of railroad rates in the late 1970s and early 1980s This event which clearly preceded the 1990 enactment of this program allowed more lowsulfur coal to flow eastward at a cheaper price than previously possible In July 2011 the CrossState Air Pollution Rule CSAPR a different regulation resulting from a court decision restricted trading to within states thereby eliminating the scope for costeffective interstate trades The SO2 market collapsed with allowance prices falling to record low levels StationarySource Air Pollution 368 Since the sulfur allowance program a number of other capandtrade programs have been implemented in other nations as well How have these programs fared Schmalensee and Stavins 2017 two economists who have been involved in this evolution review this experience They conclude their review with a cautious but positive assessment Overall we have found that capandtrade systems if well designed and appropriately implemented can achieve their core objective of meeting targeted emissions reductions costeffectively But the devil is in the details and design as well as the economic environment in which systems are implemented are very important The main cautionary caveats include Some of the success can be attributed to factors other than the program The timely arrival of railroad deregulation in the sulfur allowance program noted in Example 152 was one instance but another was the emergence of fracking It expanded the availability of low cost natural gas which made the carbon reductions achieved by the Regional Greenhouse Gas Initiative discussed in Chapter 17 deeper and less expensive than would have otherwise been possible Provisions for allowance banking have proven to be very important for achieving maximum gains from trade and the absence of banking provisions can lead to price spikes and collapses The level of the cap is generally based upon expected emissions Changing economic conditions can either reduce emissions sufficiently below this expectation that the cap becomes nonbinding or increase emissions above expectations and drive allowance prices to politically unacceptable levels As can be seen in more detail in Chapter 17 economists have come up with a means of meeting this challenge by incorporating something called a price collar into the design Price collars reduce price volatility by combining an auction price floor with a price ceiling Summary While air quality has improved in the industrial nations it has deteriorated in the develop ing nations Historically air pollution control has been based upon a traditional The authors note a couple of ironies in this history Although this marketbased costeffective policy innovation capandtrade was championed and implemented by Republican administrations from President Ronald Reagan to President George W Bush in recent years this approach has come to be demonized by current conservative Republican politicians Finally court decisions and subsequent responses by the Obama administration led to the virtual collapse of the SO2 market demonstrating that what the government gives the government can take away Source Schmalensee R Stavins R N 2013 The SO2 allowance trading system The ironic history of a grand policy experiment Journal of Economic Perspectives 271 103122 StationarySource Air Pollution 369 commandandcontrol approach Although this has reduced emissions it has been neither efficient nor costeffective The commandandcontrol policy has not been efficient in part because it has been based on a legal fiction a threshold below which no health damages are inflicted on any member of the population In fact damages occur at levels lower than the ambient standards Sensitive members of the population such as those with respiratory problems are especially vulnerable The attempt to formulate standards without considering control costs has been thwarted by the absence of a scientifically defensible healthbased threshold In addition the traditional policy failed to adequately consider the timing of emissions flows By failing to target the greatest amount of control on those periods when the greatest damage is inflicted the current policy encourages too little control in highdamage periods and excessive control during lowdamage periods Current policy has also failed to pay sufficient attention to indoor air pollution which may well pose larger health risks than outdoor pollution at least in developed countries Unfortunately because the existing benefit estimates have large confidence intervals the size of the inefficiency associated with these aspects of the policy has not been measured with any precision Traditional regulatory policy has not been costeffective either The allocation of responsibility among emitters for reducing pollution has resulted in control costs that are typically several times higher than necessary to achieve the airquality objective This has been shown to be true for a variety of pollutants in a variety of geographic settings The recent move toward marketbased policies is based on the costeffective economic incentives they provide Providing more flexibility in meeting the airquality goals has reduced both the cost and the conflict between economic growth and the preservation of air quality What about the impact of environmental regulation on the diffusion of more environmentally benign technologies Does the evidence suggest that new technologies with reduced environmental impact are being developed and adopted As Example 153 points out for chlorine manufacturing the answer is a definite yes but as we have seen with earlier examples the story of exactly how that happened is a bit more complex than simply observing all firms embracing the new technology EXAMPLE 153 Technology Diffusion in the Chlorine Manufacturing Sector Most of the worlds chlorine is produced using one of three types of cells the mercury cell the diaphragm cell and the membrane cell Generally the mercurycell technology poses the highest environmental risk with the diaphragmcell technology posing the next highest risk Over the last 25 years the mercurycell share of the total production has fallen from 22 to 10 percent the diaphragmcell share has fallen from 73 to 67 percent and the membranecell share has risen from less than 1 percent of the total to 20 percent What role did regulation play One might normally expect that prodded by regulation chlorine manufacturers would have increasingly adopted the more environmentally benign production technique But that is not what happened Instead StationarySource Air Pollution 370 As the zone of influence of pollutants extends beyond local boundaries the political difficulties of implementing comprehensive costeffective control measures increase Pollutants crossing political boundaries impose external costs neither the emitters nor the nations within which they emit have the proper incentives to institute efficient control measures Acid rain is a case in point In the United States the Clean Air Act had had a distinctly local focus until 1990 To control local pollution problems state governments encouraged the installation of tall stacks to dilute the pollution before it hit ground level In the process a high proportion of the emissions were exported to other areas reaching the ground hundreds of miles from the point of injection A focus on local control made the regional problem worse Finding solutions to the acid rain problem was very difficult because those bearing the costs of further control were not those who would benefit from the control In the United States for example opposition from the Midwestern and Appalachian states delayed action on acid rain legislationstumbling blocks included the higher electricity prices that would result from the control and the employment impacts on those states that would suffer losses of jobs in the highsulfur coalmining industry These barriers were overcome by the 1990 Clean Air Act Amendments which instituted the sulfur allowance program This program placed a cap on total emissions from the utility sector for the first time and implemented a flexible costeffective way of reducing emissions to the level specified by the cap Discussion Questions 1 The efficient regulation of hazardous pollutants should take exposure into account the more persons exposed to a given pollutant concentration the larger is the damage caused by it and therefore the smaller is the efficient concentration level all other things being equal An alternative point of view holds that this policy does not treat all citizens fairly Rather according to this point of view fairness requires that all citizens be protected by a safe concentration threshold What are the advantages and disadvantages of each approach Which do you think represents the best approach Why 2 If you were in charge of an agency responsible for designing a costeffective pollution control policy would you prefer an approach based upon an emissions charge or on emissions trading Why other regulations made it beneficial for users of chlorine to switch to nonchlorine bleaches thereby reducing the demand for chlorine In response to this reduction in demand a number of producers shut down and a disproportionate share of the plants that remained open were the ones using the cleaner membranecell production Source Snyder L D Miller N H Stavins R N 2003 The effects of environmental regulation on technology diffusion The case of chlorine manufacturing American Economic Review 932 431435 StationarySource Air Pollution 371 SelfTest Exercises 1 Would imposing the same tax rate on every unit of emissions normally be expected to yield a costeffective allocation of pollution control responsibility Does your answer depend on whether the environmental target is an aggregate emissions reduction or meeting an ambient standard Why or why not 2 Suppose in an emissions trading system the permits are allocated free of charge to emitters on the basis of how much they have historically emitted Can that allocation be consistent with costeffectiveness Does your answer depend at all on whether this allocation scheme was announced well in advance of its implementation Notes 1 The actual standards can be found at wwwepagovcriteriaairpollutantsnaaqstable accessed June 9 2017 2 The most obvious major policy response to indoor air pollution has been the large number of states that have passed legislation requiring smokefree areas in public places to protect nonsmokers 3 For a description of these studies and the sources of the results see Tietenberg T H 2006 Emissions Trading Principles and Practice 2nd ed Washington DC Resources of the Future pp 5560 4 For sulfur oxides for example the GEMS study estimates that only 3035 percent of the worlds population lives in areas where the air is at least as clean as recommended by World Health Organization guidelines 5 While it is theoretically possible depending on the elasticity of demand for pollution abate ment for a rise in the tax to produce less revenue this has typically not been the case Further Reading Ando A W Harrington D R 2006 Tradable discharge permits A studentfriendly game The Journal of Economic Education JEE 372 187201 A classroom exercise to improve understanding of how tradable permits work Blackman A 2010 Alternative pollution control policies in developing countries Review of Environmental Economics and Policy 42 234253 This article reviews the effectiveness of the increasing tendency for developing countries to experiment with alternative approaches to control pollution Harrington W Morgenstern R D Sterner T Eds 2004 Choosing Environmental Policy Comparing Instruments and Outcomes in the United States and Europe Washington DC Resources for the Future A study that compares the evidence on the relative effectiveness of commandandcontrol and economic incentive polices for controlling pollution in Europe and the United States Hendrick W Perry L 2010 Policy monitor Trends in clean air legislation in Europe Particulate matter and low emission zones Review of Environmental Economics and Policy 42 293308 This article describes developments in Europe concerning clean air legislation focusing in particular on particulate matter PM Hubbel B J Crume R V Evarts D M Cohen J M 2010 Policy monitor Regulation and progress under the 1990 Clean Air Act Amendments Review of Environmental Economics and Policy 41 122138 This article describes the 1990 CAA Amendments regulations issued by EPA following their passage progress made in airquality management StationarySource Air Pollution 372 in the nearly 20 years since their enactment and the likely future direction of US air quality management programs at the federal level OECD 2016 The Economic Consequences of Outdoor Air Pollution Paris OECD Publishing httpdxdoiorg1017879789264257474en Covering the period 2015 2060 this report projects the economic consequences of high concentrations of particulate matter PM25 and ground level ozone in the outdoor air that would result from policy inaction Schmalensee R and Stavins R N 2013 The SO2 allowance trading system The ironic history of a grand policy experiment The Journal of Economic Perspectives 271 103 121 Evaluating the Sulfur Allowance Program after 20 years Schmalensee R and Stavins R N 2017 Lessons learned from three decades of experience with cap and trade Review of Environmental Economics and Policy 111 5979 This article examines the design and performance of seven of the most prominent emissions trading systems that have been implemented over the past 30 years Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 373 MobileSource Air Pollution There are two things you shouldnt watch being made sausage and law Anonymous Introduction Like its stationarysource counterpart the control of mobilesource pollution began with a focus on conventional pollutants that imposed a risk to human health As knowledge about climate change increased the regulation of mobile sources began to focus on that challenge as well At first the approach to this new challenge was based simply on an extension and intensification of the policies aimed at health concerns but later it was recognized that to effectively control greenhouse gases the policies needed to be more comprehensive and treat mobile and stationary sources under the same regulatory umbrella In this chapter we deal mainly with regulations designed to protect human health and how those regulations evolved as concerns over climate change heightened In the next chapter we shall consider the policies that focus specifically on climate change Although they emit many of the same pollutants as stationary sources mobile sources require a different policy approach These differences arise from the mobility of the source the number of vehicles involved and the role of the automobile in daily life Mobility has two major impacts on policy On the one hand pollution is partly caused by the temporary location of the sourcea case of being in the wrong place at the wrong time This occurs for example during rush hour in metropolitan areas Since the cars have to be where the people are relocating themas might be done with electric power plantsis not a viable strategy On the other hand it is more difficult to tailor vehicle emissions rates to local pollution patterns since any particular vehicle may end up in many different urban and rural areas during the course of its useful life Mobile sources are also more numerous than stationary sources In the United States for example while there are approximately 27000 major stationary sources well over 250 million motor vehicles have been registered a number that has been growing steadily since the 1960s when there were 74 million Highway vehicle miles traveled VMT reached Chapter 16 MobileSource Air Pollution 374 31 million in 2015 after growing steadily since data started being collected in 1960 US Bureau of Transportation Statistics1 Enforcement is obviously more difficult as the number of sources being controlled increases Additionally in the United States alone 33 percent of carbon emissions from anthropogenic sources come from the transportation sector 60 percent of which comes from the combustion of gasoline by motor vehicles When the sources of pollution are mobile the problem of creating appropriate incentives is much more complex than for stationary sources Where stationary sources generally are large and run by professional managers automobiles are small and run by amateurs Their small size makes it more difficult to control emissions without affecting performance while amateur ownership makes it more likely that emissions control will deteriorate over time due to a lack of dependable maintenance and care These complications might lead us to conclude that perhaps we should ignore mobile sources and concentrate our control efforts solely on stationary sources Unfortunately that is not possible Although each individual vehicle represents a miniscule part of the problem mobile sources collectively represent a significant proportion of three criteria pollutantsozone carbon monoxide and nitrogen dioxideas well as a significant source of greenhouse gases For two of theseozone and nitrogen dioxidethe process of reaching attainment has been particularly slow With the increased use of diesel engines mobile sources are becoming responsible for a rising proportion of particulate emissions Since it is necessary to control mobile sources what policy options exist What points of control are possible and what are the advantages or disadvantages of each In exercising control over these sources the government must first specify the agent charged with the responsibility for the reduction The obvious candidates are the manufacturer and the owner driver The balancing of this responsibility should depend on a comparative analysis of costs and benefits with particular reference to such factors as 1 the number of agents to be regulated 2 the rate of deterioration while in use 3 the life expectancy of automobiles and 4 the availability effectiveness and cost of programs to reduce emissions at the point of production and at the point of use While automobiles are numerous and ubiquitous they are manufactured by a small number of firms It is easier and less expensive to administer a system that controls relatively few sources so regulation at the production point has considerable appeal Some problems are associated with limiting controls solely to the point of production however If the factorycontrolled emissions rate deteriorates during normal usage control at the point of production may buy only temporary emissions reduction Although the deter ioration of emissions control can be combated with warranty and recall provisions the costs of these supporting programs have to be balanced against the costs of local control Automobiles are durable so new vehicles make up only a relatively small percentage of the total fleet of vehicles Therefore control at the point of production which affects only new equipment takes longer to produce a given reduction in aggregate emissions because newer controlled cars replace old vehicles very slowly Control at the point of production produces emissions reductions more slowly than a program securing emissions reductions from used as well as new vehicles Some possible means of reducing mobilesource pollution cannot be accomplished by regulating emissions at the point of production because they involve choices made by the ownerdriver The pointofproduction strategy is oriented toward reducing the amount of emissions per mile driven in a particular type of car but only the owner can decide what kind of car to drive as well as when and where to drive it These are not trivial concerns Diesel and hybrid automobiles buses trucks and motor cycles emit different amounts of pollutants than do standard gasolinepowered automobiles MobileSource Air Pollution 375 Changing the mix of vehicles on the road affects the amount and type of emissions even if passenger miles remain unchanged Clustered emissions cause higher concentration levels than dispersed emissions therefore driving in urban areas causes more environmental damage than driving in rural areas Local control strategies could internalize these location costs a uniform national strategy focusing solely on the point of production could not Timing of emissions is particularly important because conventional commuting patterns lead to a clustering of emissions during the morning and evening rush hours Indeed plots of pollutant concentrations in urban areas during an average day typically produce a graph with two peaks corresponding to the two rush hours2 Since high concentrations are more dangerous than low concentrations some spreading over the 24hour period could also prove beneficial Subsidies and Externalities Vehicles emit an inefficiently high level of pollution because their ownerdrivers are not bear ing the full cost of that pollution This inefficiently low cost in turn has two sources 1 implicit subsidies for road transport and 2 a failure by drivers to internalize external costs Implicit Subsidies Several categories of the social costs associated with transporting goods and people over roads are related to mileage driven but the private costs do not reflect that relationship For example Road construction and maintenance costs which are largely determined by vehicle miles are mostly funded out of tax dollars On average states raise only 38 percent of their road funds from fuel taxes The marginal private cost of an extra mile driven on road construction and maintenance funded from general taxes is zero but the social cost is not Despite the fact that building and maintaining parking space is expensive parking is frequently supplied by employers at no marginal cost to the employee The ability to park a car for free creates a bias toward private auto travel since other modes receive no comparable subsidy Other transport subsidies create a bias toward gasguzzling vehicles that produce inefficiently high levels of emissions In the United States one example not long ago was that business owners who purchased large gasguzzling sport utility vehicles SUVs received a substantial tax break worth tens of thousands of dollars while purchasers of small energy efficient cars received none Ball Lundegaard 2002 Only vehicles weighing over 6000 pounds qualified This tax break was established 20 years earlier for light trucks primarily to benefit small farmers who depended upon the trucks for chores around the farms More recently most purchasers of SUVs considered light trucks for tax purposes have nothing to do with farming Externalities Road users also fail to bear the full cost of their choices because many of the costs associated with those choices are actually borne by others For example MobileSource Air Pollution 376 The social costs associated with accidents are a function of vehicle miles The number of accidents rises as the number of miles driven rises Generally the costs associated with these accidents are paid for by insurance but the premiums for these insurance policies rarely reflect the mileageaccident relationship As a result the additional private cost of insurance for additional miles driven is typically zero although the social cost is certainly not zero Road congestion creates externalities by increasing the amount of time required to travel a given distance Increased travel times also increase the amount of fuel used The social costs associated with greenhouse gas emissions are also a function of vehicle miles These costs are rarely borne by the driver of the vehicle Recent studies have indicated high levels of pollution inside vehicles caused mainly by the exhaust of cars in front Because the social costs of driving are not fully borne by motorists the number of miles driven is inefficiently high3 To elaborate on the congestion point consider Figure 161 As traffic volumes get closer to the design capacity of the roadway traffic flow decreases it takes more time to travel between two points At this point the marginal private and social costs begin to diverge The driver entering a congested roadway will certainly consider the extra time it will take her to travel that route but she will not consider the extra time that her presence imposes on everyone else it is an externality The efficient ratio of traffic volume to road capacity Ve occurs where the marginal benefits as revealed by the demand curve equal the marginal social cost Because individual drivers do not internalize the external costs of their presence on this roadway too many drivers will use the roadway and traffic volume will be too high Vp The resulting efficiency losses would be measured by the triangle ACD the shaded area One recent study estimates that highway congestion in 2014 caused 69 billion hours of delay 31 billion gallons of additional fuel to be used resulting in a cost of 160 billion to highway users4 Figure 161 Congestion Inefficiency MobileSource Air Pollution 377 Consequences Understated road transport costs create a number of perverse incentives Too many roads are crowded Too many miles are driven Too many trips are taken Transport energy use is too high Pollution from transportation is excessive Competitive modes including mass transit bicycles and walking suffer from an inefficiently low demand Perhaps the most pernicious effect of understated transport cost however is its effect on land use Low transport cost encourages dispersed settlement patterns Residences can be located far from work and shopping because the costs of travel are so low Unfortunately this pattern of dispersal creates a path dependence that is hard to reverse Once settlement patterns are dispersed it is difficult to justify highvolume transportation alternatives such as trains or buses Both need highdensity travel corridors in order to generate the ridership necessary to pay the high fixed cost associated with building and running these systems With dispersed settlement patterns sufficiently high travel densities are difficult if not impossible to generate Policy toward Mobile Sources History of US Policy Concern about mobilesource pollution originated in Southern California in the early 1950s following a pathbreaking study by Dr A J HaagenSmit of the California Institute of Technology The study by Dr HaagenSmit identified motor vehicle emissions as a key culprit in forming the photochemical smog for which Southern California was becoming infamous In the United States the Clean Air Act Amendments of 1965 set national standards for hydrocarbon and carbon monoxide emissions from automobiles to take effect during 1968 Interestingly the impetus for this act came not only from the scientific data on the effects of automobile pollution but also from the automobile industry itself The industry saw uniform federal standards as a way to avoid a situation in which every state passed its own unique set of emissions standards something the auto industry wanted to avoid This pressure was successful in that the law prohibits all states except California from setting their own standards By 1970 the slow progress being made on air pollution control in general and automobile pollution in particular created the political will to act In a get tough mood as it developed the Clean Air Act Amendments of 1970 Congress required new emissions standards that would reduce emissions by 90 percent below their uncontrolled levels This reduction was to have been achieved by 1975 for hydrocarbon and carbon monoxide emissions and by 1976 for nitrogen dioxide It was generally agreed at the time the Act was passed that the technology to meet the standards did not exist By passing this tough Act Congress hoped to force the development of an appropriate technology It did not work out that way The following years ushered in a series of deadline extensions In 1972 the automobile manufacturers requested a 1year delay in the implementation of the standards The administrator of the EPA denied the request and was taken to court At the conclusion of the litigation in April 1973 the administrator granted a 1year delay in the 1975 deadline for the hydrocarbon and carbon monoxide standards Subsequently in July 1973 a 1year delay was granted for nitrogen oxides as well5 That was not the last deferred deadline MobileSource Air Pollution 378 The US and EU Policy Approaches The overall design of US policies for addressing mobilesource air pollution has served as a model for mobilesource control in many other countries particularly in Europe The US approach represents a blend of controlling emissions at the point of manufacture with controlling emissions from vehicles in use New car emissions standards are administered through a certification program and an associated enforcement program Certification and Enforcement Programs The certification program tests prototypes of car models for conformity to federal standards Only engine families with a certificate of conformity are allowed to be sold The certification program is complemented by an associated enforcement program that contains assemblyline testing as well as recall and antitampering procedures and warranty provisions If these tests reveal that more than 40 percent of the cars do not conform to federal standards the certificate may be suspended or revoked In addition the EPA conducts inuse onroad testing of vehicles both at low mileage at least 10000 miles and at high mileage more than 50000 miles The EPA has also been given the power to require manufacturers to recall and remedy manufacturing defects that cause emissions to exceed federal standards If the EPA uncovers a defect it usually requests the manufacturer to recall vehicles for corrective action If the manufacturer refuses the EPA can order a recall EU regulators pursue a similar testing approach but EU tests tend to be less restrictive and do not include inuse testing As Example 161 illustrates these certification programs may not always provide the outcomes that they were designed to produce EXAMPLE 161 Monitoring and Enforcement The Volkswagen Experience Onroad testing has some obvious advantages of presale certification It can for example take into consideration how durable the emissions control system is as the car ages On the other hand it is more expensive So from an economic point of view whether the additional cost of onroad testing is worth it becomes of considerable interest The US has chosen to incorporate onroad testing while the EU has not Recently an experience where Volkswagen falsified their testing results has pro vided new information on the added value of onroad testing In September of 2015 Volkswagen admitted to having programmed nearly 11 million vehicles to cheat on tailpipe emissions tests According to the investigation the company created special software that could sense when the car was being tested and would activate equipment that reduced emissions Once software sensed that the testing was concluded it returned the car to a normal driving mode apparently to increase performance and drivability Unfortunately this setting also resulted in emission levels far above legal limits The falsification was actually discovered in the United States via onroad testing Some onroad testing in May 2014 conducted by researchers at West Virginia University MobileSource Air Pollution 379 Lead Phaseout Program Section 211 of the US Clean Air Act provides the EPA with the authority to regulate lead and any other fuel additives used in gasoline Under this provision gasoline suppliers were required to make unleaded gasoline available By ensuring the availability of unleaded gasoline this regulation sought to reduce the amount of airborne lead as well as to protect the effectiveness of the catalytic converter which was poisoned by lead6 In the mid1980s prior to the issuance of new more stringent regulations on lead in gasoline the EPA announced the results of a benefitcost analysis of their expected impact The analysis concluded that the proposed 001 gram per leaded gallon gplg standard would result in 36 billion 1983 dollars in benefits from reduced adverse health effects at an estimated cost to the refining industry of 26 billion These actions followed a highly publicized series of medical research findings on the severe health and developmental consequences particularly to small children of even low levels of atmospheric lead On March 7 1985 the EPA issued regulations imposing strict new standards on the allowable lead content in refined gasoline The primary phaseout of lead was completed by 1986 Although the regulation was unquestionably justified on efficiency grounds the EPA wanted to allow flexibility in how the deadlines were met without increasing the amount of lead used While some refiners could meet early deadlines with ease others could do so only with a significant increase in cost Recognizing that meeting the goal did not require every refiner to meet every deadline the EPA initiated an innovative program to provide additional flexibility in meeting the regulations see Example 162 The program was successful in reducing both lead emissions and the concentration of lead in the ambient air From 1981 to 2001 emissions of lead fell by 93 percent and concentrations of lead in the air fell by 94 percent By contrast the European Union EU banned leaded gasoline in 2000 and implemented stricter emissions standards for lightduty vehicles in 2005 Russia in principle agreed to follow the example of Western Europe in introducing more stringent emissions controls but the phaseout of lead has been much slower By 1995 only eight of Russias 25 oil refineries manufactured unleaded gasoline This made up 40 percent of the gasoline produced in Russia A 2001 World Bank study found that it would cost between 0005 and 002 per liter of led the California Air Resources Board to investigate Volkswagen Ultimately Volkswagen admitted the falsification In September 2015 the US Environmental Protection Agency ordered Volkswagen to recall its American car models with affected engines amounting to nearly 600000 vehicles The vast majority of the carsabout 85 millionare in Europe with much smaller numbers scattered around Asia Africa and South America This example suggests that certification may not always be as reliable as conventionally assumed and onroad testing may have an additional benefitdetecting fraud Sources Gates Gilbert Ewing Jack Russell Karl Watkins Derek March 16 2017 How Volkswagens defeat devices worked The New York Times Available online at wwwnytimescominteractive2015businessinternationalvwdieselemissionsscandal explainedhtmlr0 accessed June 26 2017 Klier Thomas Linn Joshua April 2016 Comparing US and EU approaches to regulating automotive emissions and fuel economy Resources for the Future Policy Brief No 1603 MobileSource Air Pollution 380 gasoline to phase out lead at a less modern refinery in Russia These costs could be cut in half however if the refinerys production were modified to meet market demand7 Fuel Economy Standardsthe US Approach The Corporate Average Fuel Economy CAFE program established in 1975 was designed to reduce American dependence on foreign oil by producing more fuelefficient vehicles Although it is not an emissions control program fuel efficiency does affect emissions The program requires each automaker to meet governmentset milespergallon targets CAFE standards for all its car and light truck fleets sold in the United States each year The unique feature is that the standard is a fleet average not a standard applied to each vehicle As a result automakers can sell some lowmileage vehicles as long as they sell enough high mileage vehicles to raise the average to the standard The CAFE standards took effect in 1978 mandating a fleet average of 18 miles per gallon mpg for automobiles The standard increased each year until 1985 when it reached 275 mpg Most observers believe that the CAFE standards did in fact reduce oil imports During the 19771986 period oil imports fell from 47 to 27 percent of total oil consumption The CAFE standard remained at 275 mpg until 2005 when a new set of rules was announced EXAMPLE 162 Getting the Lead Out The Lead Phaseout Program Under the Lead Phaseout Program a fixed number of lead rights authorizing the use of a fixed amount of lead in gasoline produced during the period were allocated to the 195 or so refineries Due to a loophole in the regulations some new alcohol blender refineries were created to take advantage of the program but their impact was very small The number of issued rights declined over time Refiners who did not need their full share of authorized rights could sell their rights to other refiners Initially no banking of rights was allowed rights had to be created and used in the same quarter but the EPA subsequently allowed banking Once banking was initiated created rights could be used in that period or any subsequent period up to the end of the program in 1987 Prices of rights which were initially about 075 cents per gram of lead rose to 4 cents after banking was allowed Refiners had an incentive to eliminate the lead quickly because early reductions freed up rights for sale Acquiring these credits made it possible for other refiners to comply with the deadlines even in the face of equipment failures or acts of God fighting the deadlines in court the traditional response was unnecessary Designed purely as a means of facilitating the transition to this new regime the lead banking program ended as scheduled on December 31 1987 Sources Nussbaum B D 1992 Phasing down lead in gasoline in the US Mandates incentives trading and banking In T Jones J CorfeeMorlot Eds Climate Change Designing a Tradeable Permit System Paris Organisation for Economic Cooperation and Development Publication 2134 Hahn R W Hester G L 1989 Marketable permits Lessons from theory and practice Ecology Law Quarterly 16 361406 MobileSource Air Pollution 381 CAFE standards however have had their share of problems When Congress instituted the CAFE standards light trucks were allowed to meet a lower fueleconomy standard because they constituted only 20 percent of the vehicle market and were used primarily as work vehicles Light truck standards were set at 172 mpg for the 1979 model year and went up to 207 mpg in 1996 combined twowheel and fourwheel drive With the burgeoning popularity of SUVs which are counted as light trucks trucks now comprise nearly half of the market In addition intense lobbying by the auto industry resulted in an inability of Congress to raise the standards from 1985 until 2004 As a result of the lower standards for trucks and SUVs the absence of any offsetting increase in the fuel tax and the increasing importance of trucks and SUVs in the fleet of onroad vehicles the average miles per gallon for all vehicles declined rather than improved In 2005 the standard for light trucks saw its first increase since 1996 to 21 miles per gallon In 2008 the EPA made an adjustment in how the fleet average is calculated specifically taking the footprint of the vehicle into account Vehicles with a larger footprint are subject to lower fuel economy requirements Since the footprint and fuel economy are now interrelated the recent decline in gasoline prices has reduced the overall level of fuel economy by an estimated 10 percent This is due in part to a shift to larger vehicles Leard et al 20178 The standards have continued their upward trend In 2010 new rules were announced for both fuel efficiency and greenhouse gas emissions These rules cover the 20122016 model years and the CAFE standard was set to reach 341 miles per gallon by 2016 The US EPA and the National Highway Traffic Safety Administration NHTSA calculated benefits and costs of the proposed program for medium and heavyduty trucks Using a social cost of carbon of 22ton and a 3 percent discount rate they find costs to the industry of 77 billion and societal benefits of 49 billion for a total net benefit of approximately 41 billion9 Imagine if they made this calculation using the revised estimate of 37ton for the social cost of carbon In 2012 the standards rose yet again to a target of 545 mpg by 2025 Since new fuel economy standards only affect new vehicles overall fuel economy takes a long time to improveup to 15 years or until all the older cars are off the roads This combined with the rebound effect which says that better fuel economy increases miles driven raises the question of whether fuel taxation is a more efficient policy than a fuel economy standard Anderson et al 2011 Debate 161 and Example 163 look at the evidence CAFE Standards or Fuel Taxes Increasing the fuel efficiency of oil consumption could in principle be accomplished by increasing either fuel taxes or fuelefficiency standards By raising the cost of driving the former would encourage auto purchasers to seek more fuelefficient vehicles while the latter would ensure that the average new vehicle sold was fuel efficient Does it make a difference which strategy is followed It turns out that it does and economics can help explain why Think about what each strategy does to the marginal cost of driving an extra mile Increased fuel taxes raise the marginal cost per mile driven but fueleconomy standards lower it In the first case the marginal cost per mile rises because the tax raises the cost of the fuel In the second case the more fuelefficient cars uses less fuel per mile so the cost has gone down DEBATE 161 MobileSource Air Pollution 382 Following economic logic leads immediately to the conclusion that even if both strategies resulted in the same fuel economy the tax would reduce oil consumption by more because it would promote fewer miles driven On these grounds a tax is better than a fueleconomy standard Austin and Dinan 2005 test these ideas with a simulation model in which they compare an increase in the CAFE standards to a gasoline tax designed to save the same amount of gasoline Using a 12 percent discount rate they estimate that a per gallon tax designed to save the same amount of gasoline as a stipulated fuel economy standard would cost 71 percent less than the comparable change in fueleconomy standards Supporters of fueleconomy standards however counter with two arguments 1 in the United States sufficiently high gasoline taxes to produce that level of reduction could never have passed Congress so the fueleconomy standards were better indeed much better than no policy at all and 2 at least one careful empirical study has found that the increase in driving resulting from the fuel economy standards in practice is likely to be very small and may even be nonexistent This latter finding implies that studies like the one discussed above are likely to considerably overstate the costeffectiveness advantage of a gasoline tax Can you see why Which argument do you find most compelling Sources Austin D Dinan T 2005 Clearing the air The costs and consequences of higher CAFE standards and increased gasoline taxes Journal of Environmental Economics and Management 50 562582 West Jeremy Hoekstra Mark Meer Jonathan Puller Steven L May 2015 Vehicle miles not traveled Why fuel economy requirements dont increase household driving National Bureau of Economic Research Working Paper 21194 EXAMPLE 163 Fuel Economy Standards When Fuel Prices Are Falling Fuel economy standards are designed to reduce reliance on fossil fuels and to reduce emissions from vehicles As we have seen in this chapter fuel prices can counteract some of this effect if lower fuel prices cause increased vehicle miles traveled or if lower prices cause a shift toward the purchase of lower fuel economy cars What about when fuel prices are rising Benjamin Leard Joshua Linn and Virginia McConnell economists at think tank Resources for the Future were curious about this question as well as the question of how standards based on vehicle attributes which also interact with market conditions might affect the overall effectiveness of the standards MobileSource Air Pollution 383 Gas Guzzler Tax The Gas Guzzler Tax is levied on cars that do not meet fuel economy standards Congress established this tax as part of the 1978 Energy Tax Act aimed at reducing the production and consumption of fuel inefficient vehicles The tax is levied on the manufacturers and is over and above any CAFE fines the manufacturer might have to pay for not meeting its CAFE standard requirement The tax is based on a formula that weights highway driving at 55 percent and city driving at 45 percent10 Fuel Economy Standards in the European Union The European Union has tackled the externalities from fuel consumption primarily through gas taxes and has some of the highest gas taxes in the world Fuel economy standards are also higher than in the United States The European Union standards are set to rise annually from the 2012 standard of 45 miles per gallon 5L100 km They also have a carbon dioxide tar get of 130 grams per kilometer The European Union also combines standards with very high fuel taxes which creates a larger demand for small cars Anderson et al 2011 EU countries also tax diesel at lower rates than gasoline and as such diesels share of passenger cars has grown significantly The Netherlands Norway Germany and Sweden used differential tax rates to encourage consumers to purchase and manufacturers to produce lowemitting cars before subsequent regulations required all cars to be low emitting Tax differentiation confers a tax advantage and hence aftertax price advantage on cleaner cars The amount of the tax usually depends on 1 the emissions characteristics of the car heavier taxes being levied on heavily polluting cars 2 the size of the car in Germany heavier cars qualify for larger tax advantages to offset the relatively high control requirements placed upon them and CAFE standards originally were based solely on a vehicles class car or light truck Now however the standards also depend on the footprint of the vehicle Consequently automakers who sell larger vehicles are subject to lower fuel economy requirements lowering overall fuel economy For these more stringent standards if gas prices fall causing an increase in market share of lowfueleconomy cars the manufacturer might have to respond by raising prices on those vehicles in order to meet the standard Likewise when fuel prices rise market share of fuelefficient cars will also rise Using data from 1996 to 2015 Leard et al examine these questions statistically Their data set includes periods of rising fuel prices a period of relatively stable prices a period from about 2008 to 2014 in which prices were quite volatile and most recently when global crude oil prices dropped by about 25 percent Interestingly they find the effect of rising prices on market share of vehicles to be twice as large as falling prices In other words market shares respond more to price increases than price decreases and respond less after a period of prolonged high fuel prices Their results seem to suggest that because gas prices and overall fuel economy market share are interlinked the best policy approach might be to combine the two approaches standards and fuel taxes What do you think Source Leard Benjamin Linn Joshua McConnell Virginia 2017 Fuel prices new vehicle fuel economy and implications for attribute based standards Journal of the Association of Environmental and Resource Economists 43 659700 MobileSource Air Pollution 384 3 the year of purchase the tax differential is declining since all cars will eventually have to meet the standards Apparently it worked In Sweden 87 percent of the new cars sold qualified for the tax advantage while in Germany the comparable figure was more than 90 percent Opschoor Vos 1989 Europe not only has much higher gasoline prices but also it has developed strategies to make better use of transportation capital Its intercity rail system is better developed than the one in the United States and public transit ridership is typically higher within cities Europe was also a pioneer in the use of carsharing arrangements an idea that the United States has now begun to mimic see Example 164 EXAMPLE 164 CarSharing Better Use of Automotive Capital One of the threats to sustainable development is the growing number of vehicles on the road Though great progress has been made since the 1970s in limiting the pollution each vehicle emits per mile of travel as the number of vehicles and the number of miles increase the resulting increases in pollution offset much of the gains from the cleaner vehicles How to limit the number of vehicles One strategy that started in Europe and has migrated to America is carsharing Carsharing recognizes that the typical automobile sits idle most of the time a classic case of excess capacity Studies in Germany suggest the average vehicle use per day is 1 hour Therefore the carsharing strategy tries to spread ownership of a vehicle over several owners who share both the cost and the use Car sharing is now a major industry and there are car sharing programs in 30 countries on five continents The charges imposed by carsharing clubs typically involve an upfront access fee plus fees based both on time of actual use and mileage Use during the peak periods usually costs more Some carsharing clubs offer touchtone automated booking 24hour dispatchers and such amenities as childsafety seats bike racks and roof carriers Swiss and German clubs started in the late 1980s As of 2013 460000 Germans belonged to car sharing clubs up from 20000 in 1997 An estimated 30 percent of customers sell their own cars after joining a car sharing program The greatest con centrations of carsharing vehicles in Europe are in the Netherlands Austria Germany and Switzerland The European idea of carsharing was captured by some US entrepre neurs who started Zipcar a company that now boasts 400000 members and fleets of carsharing vehicles in 50 cities in North America and the United Kingdom Similar carsharing companies can now be found in hundreds of cities The University of California Berkeleys Transportation Sustainability Research Center TSRC and Susan Shaheen have been tracking carsharing developments world wide since 1997 They report that as of January 1 2014 24 US carsharing programs claimed 1228573 members sharing 17179 vehicles MobileSource Air Pollution 385 Fuel Economy Standards in Other Countries Anderson et al 2011 summarize fuel economy standards outside of the United States for countries including Japan China S Korea Australia and the United Kingdom Japan has some of the most stringent standards with different standards for diesel and gasoline vehicles China sets fuel consumption standards that are based on weight External Benefits of Fuel Economy Standards Fuel economy standards create positive externalities in two ways First fuel efficiency lowers emissions Lower carbon dioxide emissions as well as reduced dependence on foreign fuels are both positive externalities that flow from better fuel efficiency These external benefits along with the political feasibility of fuel efficiency makes CAFE standards an appealing option Interestingly in a thorough evaluation of the literature on consumer responses to fuel economy Helfand and Wolverton 2011 find that automakers do not build in as much fuel economy as consumers are willing to purchase Although the literature is so far inconclusive as to why this is the case they posit that uncertainty attribute bundling and the vehicle design process all play a role If manufacturers are risk adverse and returns to fuel economy are uncertain they will provide a lower level of fuel economy Automakers will also invest more in those attributes for which consumers have already exhibited a strong preference These attributes include size and performance Additionally since attributes tend to be bundled consumers can chose a bundle of attributes including color features and so on Fuel economy is not a bundled attribute so it may not be a priorty for manufacturers to vary Finally new designs take time and as such manufacturers many not be as responsive to consumers preferences in the short run Helfand Wolverton 2011 Alternative Fuels and Vehicles Alternative Fuels The Clean Air Act Amendments of 1990 required nonattainment areas to use cleanerburning oxygenated automotive fuels during the winter months in some cases and year round reformulated gasoline in the worst cases Ethanol and methyl tertiary butyl ether MTBE were the two additives most widely used to meet the oxygen content standard What could the contribution of carsharing be to air pollution control in those areas where it catches on It probably does lower the number of vehicles and the resulting congestion Zipcar claims that each Zipcar takes 1520 personally owned vehicles off the road In addition peakhour pricing probably encourages use at the less polluted periods On the other hand it does not necessarily lower the number of miles driven which is one of the keys to lowering pollution The contribution of this particular innovation remains to be clarified by some solid empirical research Source Oliviera Jr Pedro 2013 Car sharing takes off in Germany Available at wwwpriorgstories2013 1004carsharingtakesgermany What do you do when you are green broke and connected You share October 10 2010 The Economist Retrieved from wwweconomistcomnode17249322story id17249322fsrcrss wwwzipcarcom Shaheen Susan Chan Nelson March 2015 Mobility and the sharing economy Impacts synopsisspring 2015 Available at httpinnovativemobility orgprojectmobilityandthesharingeconomyimpactssynopsis2 MobileSource Air Pollution 386 Largely due to cost most nonMidwestern states opted for gasoline with the additive MTBE rather than ethanol MTBE was designed to make gasoline burn cleaner and more efficiently Unfortunately once it entered into widespread use it was discovered to be a source of contaminated groundwater and drinking water Once in soil or water MTBE breaks down very slowly while accelerating the spread of other contaminants in gasoline such as benzene a known carcinogen Once these properties became known several states passed measures to ban or significantly limit the use of MTBE in gasoline The MTBE story provides an interesting case study of the problems that can occur with a strategy that relies on a technical fix to solve air pollution problems Sometimes the effects of the solution can in retrospect turn out to be worse than the original problem Even before the MTBE water contamination issue surfaced questions were also being raised about the costeffectiveness of using oxygenated fuels For example when Rask 2004 compared the oxyfuel smog test results to emissions improvements resulting from emissions system repairs he found increased maintenance and repairs to be a much more costeffective strategy for lowering CO and hydrocarbon emissions than oxyfuels In 1989 the South Coast Air Quality Management District identified 120 options for reducing volatile hydrocarbons The average costeffectiveness of the 68 measures proposed was a stunning 12250 per ton While early estimates such as these should not determine the outcome they certainly did suggest that some caution against proceeding too rapidly down this path would be appropriate Alternative Vehicles In an attempt to foster the development of alternative vehicles and alternative fuels that would be less damaging to the environment Congress and some states have passed legislation requiring their increased use California has pushed the envelope even further In September 1990 the California Air Resources Board CARB passed its zero emission vehicle ZEV regulations Under the ZEV regulation three distinct vehicle designs are considered zero emission though to varying degrees 1 plugin hybrid vehicles which combine a conventional gasolinepowered engine with a battery 2 battery electric vehicles which run entirely on electricity and 3 hydrogen fuel cell vehicles which run on electricity produced from a fuel cell using hydrogen gas The program works by imposing increasingly stringent sales quotas on ZEV vehicles The quotas are expressed as a percentage of new cars and light trucks sold in the state that must be zero emission vehicles The program is implemented using a credit system The program assigns each automaker ZEV credits which represent the companys sales of electric cars and trucks Automakers are then required to maintain ZEV credits equal to a set percentage of nonelectric sales The current percentage is 45 percent of sales in 2018 rising to 22 percent in 202511 Clearly this is an attempt to force automotive technology using a rather innovative methodmandated sales quotas for clean vehicles Notice that selling this number of clean vehicles depends not only on how many are manufactured but also on whether demand for those vehicles is sufficient If the demand is not sufficient manufacturers will have to rely on factory rebates or other strategies to promote sufficient demand Inadequate demand is not a legal defense for failing to meet the deadlines How well has this strategy worked in forcing the development and market penetration of new automotive technologies According to the CARB California is one of the worlds largest markets for lightduty ZEVs According to their data as of Summer 2016 Californians drive 47 percent of all ZEVs on the road in the US while the US comprises about onethird of the world ZEV market12 Of course discerning the specific contribution of this program would require a deeper analysis and not merely a point in time comparison but these data are intriguing MobileSource Air Pollution 387 Transportation Pricing The pricing of transportation falls into several categories fuel taxes congestion pricing emissions pricing pricing of accident externalities pricing of roads and pricing or subsidizing public transport Some of examples of road pricing are highlighted below13 Fuel Taxes As controls on manufacturers have become more common and vehicles have become cleaner attention is increasingly turning to the user Drivers have little incentive to drive or maintain their cars in a manner that minimizes emissions because the full social costs of road transport have not been internalized by current policy How far from a full internalization of cost are we Parry et al 2007 compile estimates from the literature and find the sum of mileagerelated external marginal costs to be approximately 210 per gallon Mileagerelated externalities include local pollution congestion and accidents Fuel external costs such as oil dependency and climate change are another 018 per gallon Figure 162 illustrates current fuel taxes by country These data suggest current fuel taxes would have to be much higher in many countries in order to internalize the full social cost of road transport Figure 162 2066 Fuel Taxes in Selected Countries Source wwwafdcenergygovafdcdata Note Tax rates are federal with the exception of the United States and Canada which include average stateprovincial taxes MobileSource Air Pollution 388 But fuel taxes are not the only way to begin to internalize costs and by themselves they would be a blunt instrument anyway because typically they would not take into account when and where the emissions occurred One way to focus on these temporal and spatial concerns is through congestion pricing Congestion Pricing Congestion is influenced not only by how many vehicle miles are traveled but also where and when the driving occurs Congestion pricing addresses the spatial and temporal externalities by charging for driving on congested roads or at congested times Four different types of congestion pricing mechanisms are in current use 1 cordon area or zonal pricing 2 facilities pricing 3 pricing lanes and 4 high occupancy toll HOT lanes14 Congestion pricing of roads or zones has recently been gaining considerable attention as a targeted remedy for these time and spacespecific pollutant concentrations Anas and Lindsey 2011 note that truly efficient congestion pricing is challenging to implement because the toll not only varies over time but also varies with lane width travel speed and the types of vehicles on the road The amount of information necessary to implement fully efficient tolls may be unrealistically high Toll rings have existed for some time in Oslo Norway and Milan Italy In the United States electronic toll collection systems are currently in place in many states Express lanes for cars with electronic meters reduce congestion at toll booths Reserved express bus lanes during peak hour periods are also common in the United States for congested urban highways Reserved lanes for express buses lower the relative travel time for bus commuters thereby providing an incentive for passengers to switch from cars to buses High occupancy vehicle HOV lanes have also been established for some highways During certain hours vehicles traveling in the HOV lanes must have more than one passenger Honolulu Hawaii has a high occupancy zipper lane The zipper lane is in the middle of the highway in the morning commute hours the traffic travels toward Honolulu and by midafternoon the lane is literally zipped up on one side and unzipped on the other creating an additional lane for the outgoing evening commute Several cities have also undertaken some innovative approaches to congestion charges including London Stockholm and Singapore Perhaps the most farreaching can be found in Singapore Example 165 Bangkok also bars vehicles from transporting goods from certain parts of the metropolitan area during various peak hours leaving the roads available to buses cars and motorized tricycles Beijing is currently evaluating a draft proposal to charge a congestion fee for commuters who enter certain parts of the city In Beijing there are 56 million vehicles more than any other city in the world Linn et al 2015 find that the proposed fee will affect those who make discretionary trips rather than commuters In part that is due to the nature of the affected commuters The commuters most likely to be affected by the charge will be wealthier since they tend to live outside the congestion ring and typically drive to work but they are likely to be less responsive than those with lower incomes would be Safirova et al 2007 compare six different roadpricing instruments all aimed at internalizing the congestion externality These include three types of cordon pricing schemes areabased congestion taxes a distancebased toll on highways a distancebased toll on metro roads only and a gas tax Examining the effectiveness of these instruments for the Washington DC metropolitan area in 2000 they explicitly model how residential choice and hence travel time could be affected by the type of policy instrument employed The question they ask is But how do policies designed to address congestion alone fare once the many other consequences associated with drivingtraffic accidents air pollution oil MobileSource Air Pollution 389 dependency urban sprawl and noise to name a feware taken into account15 They find that using socialcost pricing incorporating the social costs of driving instead of simple congestion pricing affects the outcome of instrument choice Specifically when the policy goal is solely to reduce congestion variable timeofday pricing on the entire road network is the most effective and efficient policy However when additional social costs are factored in the vehicle miles traveled VMT tax is almost as efficient EXAMPLE 165 Zonal MobileSource PollutionControl Strategies Singapore Singapore has one of the most comprehensive strategies to control vehicle pollution in the world In addition to imposing very high vehicleregistration fees this approach also includes the following Central Business District parking fees that are higher during normal business hours than during the evenings and on weekends An arealicensing scheme that requires the display of an areaspecific purchased vehicle license in order to gain entry to restricted downtown zones during restricted hours These licenses are expensive and penalties for not displaying them when required are very steep Electronic peakhour pricing on roadways These charges which are deducted automatically using a smart card technology vary by roadway and by time of day Conditions are reviewed and charges are adjusted every 3 months An option for people to purchase an offpeak car Identified by a distinctive red license plate that is welded to the vehicle these vehicles can only be used during off peak periods Owners of these vehicles pay much lower registration fees and road taxes Limiting the number of new vehicles that can be registered each year In order to ensure that they can register a new car potential buyers must first secure one of the fixed number of licenses by submitting a winning financial bid An excellent masstransit system that provides a viable alternative to automobile travel Has the program been effective Apparently it has been quite effective in two rather different ways First it has provided a significant amount of revenue for the government which the government can use to reduce more burdensome taxes The revenues go into the general treasury they are not earmarked for the transport sector Second it has caused a large reduction in trafficrelated pollution in the affected areas The overall levels of carbon monoxide lead sulfur dioxide and nitrogen dioxide are now all within the humanhealth guidelines established by both the World Health Organization and the US Environmental Protection Agency Source Chia N C Phang SY 2001 Motor vehicle taxes as an environmental management instrument The case of Singapore Environmental Economics and Policy Studies 42 6793 MobileSource Air Pollution 390 Private Toll Roads New policies are also being considered to ensure that road users pay all the costs of maintaining the highways rather than transferring that burden to taxpayers One strategy which has been implemented in Mexico and in Orange County California is to allow construction of new private toll roads The tolls are set high enough to recover all construction and maintenance costs and in some cases may include congestion pricing Parking CashOuts Providing parking spaces for employees costs employers money yet most of them provide this benefit free of charge This employerfinanced subsidy reduces one significant cost of driving to work Since this subsidy only benefits those who drive to work it lowers the relative cost of driving visàvis all other transport choices such as walking biking and public transport Most of those choices create much less air pollution therefore the resulting bias toward driving creates an inefficiently high level of pollution One way to rectify this bias is for employers to compensate employees who do not use a parking space with an equivalent increase in income This would transfer the employers savings in not having to provide a parking spot to the employee and remove the bias toward driving to work Bike Sharing Programs Expensive and hard to find city parking and congestion helps incentivize consumers to find alternative means of transportation Urban bike sharing programs have emerged in cities and are growing in popularity Large cities such as Denver Montreal Minneapolis New Orleans and others have adopted these systems New York Citys Citibike program logs over 60000 riders on some days wwwcitibikenyccom systemdata Common pricing for these bike share programs involves a membership fee plus pricing based on the rental time used Typically 30 minutes or less is free and over 30 minutes is priced at an increasing block rate Data suggests that many riders who are approach ing the 30minute mark will return that bike to a stand and take out another That new bike now has 30 minutes for free This behavior of docking a bicycle to keep trip length under a time limit is called daisychaining Daisychaining adds time to a commute since riders might need to go a short distance out of their way to dock the bike and take out another but the cost savings can be significant depending on the marginal price of the next 30 minutes Pricing Public Transport The common notion is that public transit reduces vehicle miles and hence reduces both emissions and energy use That outcome however is not inevitable and the fares charged on public transit should reflect the actual situation In the absence of congestion public transportation fees should equal the marginal cost of the service minus a subsidy that reflects the external benefits of taking public transportation Anas Lindsey 2011 If the public transport actually turns out to increase congestion however fares should also include a congestion charge The level of the external benefits subsidy should also reflect the local situation Although the subsidy may attract new riders to public transit the source of these riders is important in structuring the fares Did they actually come from personal vehicles Or were they riders that would not otherwise have taken a trip Subsidies may also attract riders that use public transport such as light rail as a complement rather than a substitute for driving Subsidies that were designed by assuming that all public transit trips represent shifts from private vehicles will be excessively high to the extent these other trip sources are prevalent Anas Lindsey 2011 MobileSource Air Pollution 391 Feebates Some research has found that consumers may undervalue fuel economy One study found that consumers only consider the first 3 years of fuel savings when choosing a more fuelefficient vehicle This understates the value of fuel savings by up to 60 percent NRC 2002 To remedy this undervaluation bias among consumers purchasing new vehicles feebates combine taxes on purchases of new highemitting or highfuelconsumption vehicles with subsidies for purchases of new lowemittinglowfuelconsumption vehicles By raising the relative cost of highemitting vehicles it encourages consumers to take the environmental effects of those vehicles into account Feebate system structures are based on a boundary that separates vehicles charged a tax from those entitled to rebates The simplest feebate structure uses a constant dollar rate per gallon of fuel consumed The revenue from the taxes can serve as the financing for the subsidies but previous experience indicates that policies such as this are rarely revenueneutral the subsidy payouts typically exceed the revenue from the fee Feebates are not yet widely used but Ontario Canada and Austria have implemented feebates Greene et al 2005 find that feebates achieve fuel economy increases that are two times higher than those achieved by either rebates or gas guzzler taxes alone Tax Credits for Electric Vehicles Tax credits subsidize the purchase of electric vehicles and can be as high as 7500 per vehicle in the United States Consumers who purchase electric vehicles not only receive a tax credit but also pay less in gasoline and emit fewer greenhouse gases both of which have external benefits However tax credits also have a downsidethey lower tax revenue The loss of revenue due to tax credits has been estimated to be 75 billion through 2019 Yet since they help manufacturers reduce their miles per gallon average for new cars the sales of electric vehicles help them to meet the CAFE standards16 The availability of credits for any particular manufacturers cars expires after that automaker sells 200000 qualified vehicles The theory behind this number is that it should be enough sales to produce sufficient economies of scale to make their unsubsidized price competitive PayasYouDrive PAYD Insurance Another possibility for internalizing an environmental externality associated with automobile travel thereby reducing both accidents and pollution involves changing the way car insurance is financed As Example 166 illustrates small changes could potentially make a big difference Accelerated Retirement Strategies A final reform possibility involves strategies to accelerate the retirement of older polluting vehicles This could be accomplished either by raising the cost of holding onto older vehicles as with higher registration fees for vehicles that pollute more or by providing a bounty of some sort to those retiring heavily polluting vehicles early Under one version of a bounty program stationary sources were allowed to claim emissions reduction credits for heavily polluting vehicles that were removed from service Heavily polluting vehicles were identified either by inspection and maintenance programs or remote sensing Vehicle owners could bring their vehicle up to code usually an expensive proposition or they could sell it to the company running the retirement program Purchased vehicles are usually disassembled for parts and the remainder is recycled The number of emissions reduction credits earned by the company running the program depends on such factors as the remaining useful life of the car and the estimated number of miles it would be driven and is controlled so that the transaction results in a net increase in air quality MobileSource Air Pollution 392 Another accelerated retirement approach was undertaken in 2009 as a means to stimulate the economic recovery while reducing emissions Example 167 explores how well this Cash forClunkers program worked We also have learned some things about what doesnt work very well One increasingly common strategy involves limiting the days any particular vehicle can be used as a means of limiting miles traveled As Example 168 indicates this strategy can backfire EXAMPLE 166 Modifying Car Insurance as an Environmental Strategy Although improvements in automobile technology such as air bags and antilock brakes have made driving much safer than in the past the numbers of road deaths and injuries are still inefficiently high Since people do not consider the full societal cost of accident risk when deciding how much and how often to drive the number of vehicle miles traveled is excessive Although drivers are very likely to take into account the risk of injury to themselves and family members other risks are likely to be externalized They include the risk of injury their driving poses for other drivers and pedestrians the costs of vehicular damage that is covered through insurance claims and the costs to other motorists held up in traffic congestion caused by accidents Externalizing these costs artificially lowers the marginal cost of driving thereby inefficiently increasing the pollution from the resulting high number of vehicle miles Implementing PAYD insurance could reduce those inefficiencies With PAYD insur ance existing rating factors such as age gender and previous driving experience would be used by insurance companies to determine a drivers permile rate and this rate would be multiplied by annual miles driven to calculate the annual insurance premium This approach has the effect of drastically increasing the marginal cost of driving an extra mile without raising the amount people spend annually on insurance Estimates by Harrington and Parry 2004 suggest that calculating these insurance costs on a per mile basis would have the same effect as raising the federal gasoline tax from 0184 to 150 per gallon for a vehicle that gets 20 miles per gallon This is a substantial increase and could have a dramatic effect on peoples transport choices and therefore the pollution they emit despite the fact that it imposes no additional financial burden on them Source Harrington W Parry I 2004 Payasyoudrive for car insurance In R Morgenstern P Portney Eds New Approaches on Energy and the Environment Policy Advice for the President Washington DC Resources of the Future 5356 MobileSource Air Pollution 393 EXAMPLE 167 The CashforClunkers Program Did It Work On July 27 2009 the Obama administration launched the car allowance rebate system CARS known popularly as Cash for Clunkers This federal program had two goals to provide stimulus to the economy by increasing auto sales and to improve the environment by replacing old fuelinefficient vehicles with new fuelefficient ones Under the CARS program consumers received a 3500 or 4500 discount from a car dealer when they traded in their old vehicle and purchased or leased a new qualifying vehicle In order to be eligible for the program the tradein passenger vehicle had 1 to be manufactured less than 25 years before the date it was traded in 2 to have a combined cityhighway fuel economy of 18 miles per gallon or less 3 to be in drivable condition and 4 to have been continuously insured and registered to the same owner for the full year before the tradein The end date was set at November 1 2009 or whenever the money ran out Since the latter condition prevailed the program terminated on August 25 2009 During the programs nearly 1month run it generated 678359 eligible transactions at a cost of 285 billion Using Canada as the control group one research group Li et al 2010 found that the program significantly shifted sales to July and August from other months In terms of environmental effects this study found that the program resulted in a cost per ton ranging from 91 to 301 even including the benefits from reducing criteria pollutants This is substantially higher than the per ton costs associated with other programs to reduce emissions a finding that is consistent with other studies Knittel 2009 Gayer and Parker 2013 In addition the program was estimated to have created 3676 jobyears in the auto assembly and parts industries from June to December of 2009 That effect decreased to 2050 by May 2010 In summary this study found mixed results An increase in sales did occur but much of it was simply shifting sales that would have occurred either earlier or later into July and August And while it did produce positive environmental benefits the approach was not a costeffective way to achieve those benefits This case study illustrates a more general principle namely that trying to achieve two policy objectives with a single policy instrument rarely results in a costeffective outcome Sources United States Government Accountability Office 2010 Report to Congressional Committees Lessons Learned from Cash for Clunkers Program Report GAO10486 Li S Linn J Spiller E 2010 Evaluating CashforClunkers Program Effect on Auto Sales Jobs and the Environment Washington DC Resources for the Future Discussion Paper 1039 Knittel C R August 31 2009 The implied cost of carbon dioxide under the cash for clunkers program Retrieved from httpssrn comabstract1630647 Gayer T Parker E 2013 Cash for Clunkers An Evaluation of the Car Allowance Rebate System Washington DC Brookings Institution MobileSource Air Pollution 394 Summary The current policy toward motor vehicle emissions blends pointofproduction control with pointofuse control It began with uniform emissions standards Gramspermile emissions standards the core of the current approach in the United States and Europe have had in practice many deficiencies While they have achieved lower emissions per mile they have been less effective in lowering aggregate emissions and in ensuring cost effective reductions Aggregate mobilesource emissions have been reduced by less than expected because of the large offsetting increase in the number of miles traveled Unlike sulfur emissions from power plants aggregate mobilesource emissions are not capped so as miles increase emissions increase The efficiency of the emissions standards has been diminished by their geographic uniformity Too little control has been exercised in highly polluted areas and too much control has been exercised in areas with air quality that exceeds the ambient standards Local approaches such as targeted inspection and maintenance strategies and accelerated retirement strategies have had mixed success in redressing this imbalance Since a relatively small number of vehicles are typically responsible for a disproportionately large share of the emissions a growing reliance on remote sensing to identify the most polluting vehicles is allowing the policy to target resources where they will produce the largest net benefit EXAMPLE 168 Counterproductive Policy Design As one response to unacceptably high levels of traffic congestion and air pollution the Mexico City administration imposed a regulation that banned each car from driving on a specific day of the week The specific day when the car could not be driven was determined by the last digit of the license plate This approach appeared to offer the opportunity for considerable reductions in congestion and air pollution at a relatively low cost In this case however the appearance was deceptive because of the way in which the population reacted to the ban An evaluation of the program by the World Bank found that in the short run the regulation was effective Pollution and congestion were reduced However in the long run the regulation not only was ineffective it was actually counterproductive paradoxi cally it increased the level of congestion and pollution This paradox occurred because a large number of residents reacted by buying an additional car which would have a different banned day and once the additional cars became available total driving actually increased Policies that fail to anticipate and incorporate behavior reactions run the risk that actual and expected outcomes may diverge considerably Source Eskeland G S Feyzioglu T December 1995 Rationing can backfire The day without a car program in Mexico City World Bank Policy Research Working Paper 1554 MobileSource Air Pollution 395 The historic low cost of auto travel has led to a dispersed pattern of development Dispersed patterns of development make mass transit a lessviable alternative which causes a downward spiral of population dispersal and low masstransit ridership In the long run part of the strategy for meeting ambient standards will necessarily involve changing landuse patterns to create the kind of highdensity travel corridors that are compatible with effective masstransit use Though these conditions already exist in much of Europe it is likely to evolve in the United States over a long period of time Ensuring that the true social costs of transportation are borne by those making residential and modeoftravel choices will start the process moving in the right direction A couple of important insights about the conventional environmental policy wisdom can be derived from the history of mobilesource control Contrary to the traditional belief that tougher laws produce more environmental results the sanctions associated with meeting the gramspermile emissions standards were so severe that when push came to shove authorities were unwilling to impose them Threatened sanctions will only promote the desired outcome if the threat is credible The largest club does not necessarily produce the best incentive The second insight confronts the traditional belief that simply applying the right technical fix can solve environmental problems The gasoline additive MTBE was advanced as a way to improve the nations air With the advantage of hindsight we now know that its pollution effects on groundwater have dwarfed its positive effects on air quality Though technical fixes can and do have a role to play in environmental policy they also can have large adverse unintended consequences Looking toward the future of mobilesource air pollution control two new emphases are emerging The first involves encouraging the development and commercialization of new cleaner automotive technologies ranging from gaselectric hybrids to fuelcell vehicles powered by hydrogen Policies such as fueleconomy standards gasoline taxes feebates and sales quotas imposed on auto manufacturers for lowemitting vehicles are designed to accelerate their entry into the vehicle fleet The second new emphasis focuses on influencing driver choices The range of available policies is impressive One set of strategies focuses on bringing the private marginal cost of driving closer to the social marginal cost through such measures as congestion pricing and payasyoudrive auto insurance Others such as parking cashouts attempt to create a more level playing field for choices involving the mode of travel for the journey to work Complicating all of these strategies is the increased demand for cars in developing countries In 2007 Tata Motors the Indian automaker introduced the worlds cheapest car the Tata Nano The Nano sells for about 100000 rupees US 2500 Tata Motors expects to sell millions of these affordable strippeddown vehicles Fuel efficiency of these cars is quite good over 50 miles per gallon but the sheer number of vehicles implies sizable increases in the demand for fuel congestion and pollution emissions Appropriate regulation of emissions from mobile sources requires a great deal more than simply controlling the emissions from vehicles as they leave the factory Vehicle purchases driving behavior fuel choice and even residential and employment choices must eventually be affected by the need to reduce mobilesource emissions Affecting the choices facing automobile owners can only transpire if the economic incentives associated with those choices are structured correctly MobileSource Air Pollution 396 Discussion Questions 1 When a threshold concentration is used as the basis for pollution control as it is for air pollution one possibility for meeting the threshold at minimum cost is to spread the emissions out over time To achieve this one might establish a peakhour pricing system that charges more for emissions during peak periods a Would this represent a movement toward efficiency Why or why not b What effects should this policy have on masstransit usage gasoline sales downtown shopping and travel patterns 2 What are the advantages and disadvantages of using an increase in the gasoline tax to move road transport decisions toward both efficiency and sustainability SelfTest Exercises 1 While gasoline taxes and fuel economy standards can both be effective in increasing the number of miles per gallon in new vehicles gasoline taxes are superior means of reducing emissions from the vehicle fleet Discuss 2 Suppose the nation wished to reduce gasoline consumption not only to promote national security but also to reduce the threats from climate change a How effective is a strategy relying on the labeling of the fuel efficiency of new cars likely to be What are some of the advantages or disadvantages of this kind of approach b How effective would a strategy targeting the retirement of old fuelinefficient vehicles be What are some of the advantages or disadvantages of this kind of approach c Would it make any economic sense to combine either of these polices with payas youdrive insurance Why or why not 3 a If a payasyoudrive insurance program is being implemented to cope with automobilerelated externalities associated with driving what factors should be considered in setting the premium b Would you expect a private insurance company to take all these factors into account Why or why not Notes 1 wwwbtsgovproductnationaltransportationstatistics 2 The exception is ozone formed by a chemical reaction involving hydrocarbons and nitrogen oxides in the presence of sunlight Since for the evening rushhour emissions too few hours of sunlight remain for the chemical reactions to be completed graphs of daily ozone concentrations frequently exhibit a single peak 3 Data on vehicle miles traveled for the United States can be found here wwwritadotgovbts sitesritadotgovbtsfilespublicationsnationaltransportationstatisticshtmltable0135html 4 Annual Urban Mobility Report Texas Transportation Institute 2015 httpmobilitytamu eduums and httpsstaticttitamueduttitamuedudocumentsmobilityscorecard2015pdf 5 The only legal basis for granting an extension was technological infeasibility Only shortly before the extension was granted the Japanese Honda CVCC engine was certified as meeting the original standards It is interesting to speculate on what the outcome would have been if the company meeting the standards had been American rather than Japanese MobileSource Air Pollution 397 6 Three tanks of leaded gas used in a car equipped with a catalytic converter would produce a 50 percent reduction in the effectiveness of the catalytic converter 7 Lovei Magolna 2001 Toward an Unleaded Environment World Bank Support to Transition Economies Available at wwwworldbankorghtmlprddrtransmj96art5htm 8 In 2017 the EPA updated the calculations that manufacturers use for fuel economy labels These updates use data that better reflects new technology and the changing composition of manufacturers fleets See wwwepagovfueleconomybasicinformationfueleconomy labeling 9 wwwnhtsagovstaticfilesrulemakingpdfcafeCAFE201418TrucksFactSheetv1pdf October 2010 10 Vehicles subject to the gas guzzler tax in 2016 can be found here httpsnepisepagovExe ZyPDFcgiP100OA3IPDFDockeyP100OA3IPDF 11 wwwucsusaorgcleanvehiclescaliforniaandwesternstateswhatiszevWVEqZsZlmV5 accessed June 26 2017 12 CARB The Zero Emission Vehicle Program wwwarbcagovmsprogzevprogzevproghtm accessed June 29 2017 13 For a nice summary of road pricing see Anas and Lindsey 2011 14 Congressional Budget Office 2009 Using Pricing to Reduce Traffic Congestion Washington DC A CBO Study 15 wwwrfforgrffNewsReleases2008ReleasesMarginalSocialCostTrafficCongestioncfm 16 wwwcbogovpublication43633 Further Reading Anas A Lindsey R 2011 Reducing urban road transportation externalities Road pricing in theory and in practice Review of Environmental Economics and Policy 51 6688 A survey of the literature on road pricing and policy Anderson S T Parry I W H Sallee J M Fischer C 2011 Automobile fuel economy standards Impacts efficiency and alternatives Review of Environmental Economics and Policy 51 89108 A comprehensive summary and assessment of fuel economy standards Harrington W McConnell V 2003 Motor vehicles and the environment In H Folmer T Tietenberg Eds International Yearbook of Environmental and Resource Economics 20032004 Cheltenham UK Edward Elgar 190268 A comprehensive survey of what we have learned from economic analysis about costeffective ways to control pollution from motor vehicles Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 399 Chapter 17 Climate Change Everything should be made as simple as possible but not simpler Albert Einstein Introduction As pollutants flow beyond local boundaries the political difficulties of implementing comprehensive costeffective control measures are compounded Pollutants crossing national boundaries impose external costs neither emitters nor the political jurisdictions within which they emit have the proper incentives for controlling the emissions Compounding the problem of improper incentives is the scientific uncertainty that limits our understanding of these complex problems Our knowledge about various relationships that form the basis for our understanding of the magnitude of the problems and the effectiveness of various strategies to control them is far from complete Unfortunately the problems are so important and the potential consequences of inaction so drastic that procrastination is not usually an optimal strategy To avoid having to act in the future under emergency conditions when the remaining choices have dwindled strategies to preserve options with desirable properties must be formulated now on the basis of the available information as limited as it may be The costs of inaction are not limited to the direct damages caused International cooperation among such traditional allies as the United States Mexico and Canada and the countries of Europe has historically been undermined by disputes over the proper control of transboundary pollution The potential for future international conflicts is heightened by impending climate intensified scarcities water for example and the expected bordercrossing surge of refugees fleeing extreme weatherrelated disasters In this chapter we survey the evidence on the unique challenges and opportunities posed by climate change Having laid the groundwork in the two previous chapters by focusing on Climate Change 400 national strategies targeted respectively on stationary and mobile sources in this chapter we consider not only the additional important aspect of the international context associated with climate change but also more comprehensive strategies and policies that treat mobile and stationary sources together in a way that enhances the costeffectiveness of the policy approach The Science of Climate Change One class of global pollutants greenhouse gases absorb the longwavelength infrared radiation from the earths surface and atmosphere trapping heat that would otherwise radiate into space The mix and distribution of these gases within the atmosphere is in no small part responsible for both the hospitable climate on the earth and the inhospitable climate on other planets changing the mix of these gases however can modify the climate Although carbon dioxide is the most abundant and the most studied of these greenhouse gases many others have similar thermal radiation properties These include the chlorofluorocarbons nitrous oxide and methane The current concern over the effect of this class of pollutants on climate arises not only because emissions of these gases are increasing over time changing their mix in the atmosphere but also because many of them have very long residence times in the atmosphere Once emissions enter the atmosphere they can affect climate for a very long time By burning fossil fuels leveling tropical forests and injecting more of the other greenhouse gases into the atmosphere humans are creating a thermal blanket capable of trapping enough heat to raise the temperature of the earths surface The Intergovernmental Panel on Climate Change IPCC the body charged with compiling and assessing the scientific information on climate change reported its findings in 2013 on the sources of climate change It noted the following Warming of the climate system is unequivocal and since the 1950s many of the observed changes are unprecedented over decades to millennia Most aspects of climate change will persist for many centuries even if emissions of CO2 are stopped It is extremely likely that human influence has been the dominant cause of the observed warming since the midtwentieth century This is evident from the increasing greenhouse gas concentrations in the atmosphere positive radiative forcing observed warming and understanding of the climate system Scientists have also uncovered evidence to suggest that climate change may occur rather more abruptly than previously thought Since the rate of temperature increase is a significant determinant of how well ecosystems can adapt to temperature change abrupt climate change has become a matter of intensified concern An example that raises this concern is the large quantities of methane trapped in the frozen tundra of the north As temperatures warm the tundra can thaw releasing the trapped methane Since methane is a powerful greenhouse gas this release accelerates the rate of warming These climate changes are expected to result in adverse human health impacts including heat waves and the migration of disease vectors to new areas in rising sea levels that when coupled with storm surges could inundate coastal areas in precipitating more intense storms in triggering an increase in both droughts and floods and in intensifying ocean acidification among other impacts Climate Change 401 While most scientists accept this view of the state of the science not all observers do And some are even willing to put their money where their mouth is Example 171 EXAMPLE 171 Betting on Climate Science In 2011 Economist Chris Hope was at a conference at Cambridge UK As he describes the situation in an article in The Guardian most of the participants were skeptical about the influence of humans on the climate I took the microphone and asked if any of them would care to make a 1000 bet with me about whether 2015 would be hotter than 2008 Two brave souls Ian Plimer and Sir Alan Rudge agreed Cole then found a climate scientist James Annan who was willing make a side bet that would give Cole 5 to 1 odds against 2015 being cooler than 2008 Specifically if 2015 were warmer Cole would pay Annan 666 and if 2015 were colder Annan would pay Cole 3333 Although the numbers look a bit odd in fact this side bet provided a perfect hedge for Cole He would win 1333 if 2015 were cooler than 2008 and 1334 if it were warmer This side bet had shifted the downside risk the risk of losing to Annan who was willing to accept it due to his confidence that this risk was very small We now know that 2015 was hotter than 2008 and Plimer and Rudge each lost 1000 which was split between Cole 1334 and Annan 666 based upon their side bet Did the specific starting and ending dates matter in this bet While global temperatures have in general been rising it turns out this was a particularly bad set of dates for betting against climate change To start with 2008 was a relatively cool year According to the NASA Goddard Institute for Space Studies a strong cyclical effect known as La Niña caused much of the Pacific Ocean to be cooler than the longterm average for that year In contrast the ending year 2015 was the hottest year on record up to that time Notice that every bet against a warmer temperature involving an ending date of 2015 would have lost Would a different set of 7year intervals involving earlier starting and ending dates have produced a different result Gather the data do the calculations and find out for yourself Start with 1998 and examine every 7year period ending with the 2008 period used in this bet In general what do these data show about the wisdom of betting against climate change Sources Hope Chris July 28 2016 Making a safe bet on climate change In his Keeping an Eye on Climate Change blog Available at wwwchrishopepolicy com201607makingasafebetondangerousclimatechange NASA Goddard Institute for Space Studies GISS February 23 2009 2008 was earths coolest year since 2000 Available at wwwnasa govtopicsearthfeatures2008tempshtml Climate Change 402 Negotiations over Climate Change Policy Characterizing the Broad Strategies What can be done Three strategies have been identified 1 climate engineering 2 adaptation and 3 mitigation Climate engineering or alternatively geoengineering approaches can be divided into two very different categories carbon dioxide removal and solarradiation management While approaches in the former category such as direct air capture or ocean fertilization seek to reduce the concentrations of greenhouse gases approaches in the second category such as injecting stratospheric aerosols aim to cool the planet by reflecting a fraction of the incoming sunlight away from earth Some propose that one or more of these strategies could provide a costeffective alternative to mitigation but recent other reviews have emphasized that such approaches are fraught with uncertainties and have potential adverse effects Thus they cannot currently be considered a reasonable substitute for comprehensive mitigation until such time as it is too late for conventional policies Research continues while the ultimate role for geoengineering remains to be determined Adaptation strategies involve efforts to modify natural or human systems in order to minimize harm from climate change impacts Examples include modifying development planning to increase the resilience of damageprone areas such as relocating transportation systems and waste treatment facilities away from areas vulnerable to sealevel rise and preparing public health facilities to handle the larger burdens resulting from the changing disease impacts of a warmer climate Mitigation attempts to moderate the temperature rise by using strategies designed to reduce emissions or to increase the planets natural capacity to absorb greenhouse gases In this chapter we shall focus mainly on mitigation and adaptation The most significant mitigation strategy deals with our use of fossilfuel energy Combustion of fossil fuels results in the creation of carbon dioxide Carbon dioxide emissions can be reduced either by using less energy or by using alternative energy sources such as wind photovoltaics or hydro that produce less or no carbon dioxide Any serious reduction in carbon dioxide emissions would involve significant changes in our energyconsumption patterns and those changes could come with an economic cost Thus the debate over how vigorously this strategy is to be followed is a controversial publicpolicy issue Another possible strategy involves encouraging activities that increase the amount of carbon that is absorbed by trees or soils As Debate 171 points out however the desirability of this approach is also heavily debated in current climate change negotiations Finding a global solution to climate change is certainly one of the most challenging and pressing problems of our time but it is not the first global pollutant to be the subject of international negotiations As we shall examine more closely subsequently in this chapter the negotiations aimed at reducing ozonedepleting gases broke the ice Game Theory as a Window on Global Climate Negotiations One area of economics that has been used to study the incentives in situations such as this where participant outcomes are jointly determined is game theory Outcomes are jointly determined in the sense that the payoff to any nation from its participation in an international agreement or not depends not only on its decisions but also on the decisions of other nations One particularly interesting strain of game theory investigates the conditions that support selfenforcing agreements Barrett 1994namely those where the incentives are sufficient Climate Change 403 to encourage both joining the agreement and once a member continuing to abide by the rules Since no country can be forced to sign an international agreement and signatories can always withdraw after signing selfenforcing agreements are those where the incentives are most likely to create successful stable coalitions A main difficulty in constructing selfenforcing agreements is the freerider effect Climate change involves a global pollutant and the effects of emissions reductions are a public good All nations receive the benefits of emissions reductions whether those nations contributed to Should Carbon Sequestration in the Terrestrial Biosphere Be Credited Both forests and soils sequester store a significant amount of carbon Research suggests that with appropriate changes in practices they could store much more Increased carbon sequestration in turn would mean less carbon in the atmosphere Recognition of this potential has created a strong push in the climate change negotiations to give credit in carbon markets or toward carbon taxes for actions that result in more carbon uptake by soils and forests Whether this should be allowed and if so how it would be done are currently heavily debated Proponents argue that this form of carbon sequestration is typically quite costeffective Costeffectiveness not only implies that the given goal can be achieved at lower cost but also it may increase the willingness to accept more stringent goals with closer deadlines Allowing credit for carbon absorption may also add economic value to sustainable practices such as limiting deforestation or preventing soil erosion thereby providing additional incentives for those practices Proponents further point out that many of the prime beneficiaries of this increase in value would be the poorest people in the poorest countries Opponents say that our knowledge of the science of carbon sequestration in the terrestrial biosphere is in its infancy so the amount of credit that should be granted is not at all clear Obtaining estimates of the amount of carbon sequestered could be both expensive if done right and subject to considerable uncertainty Because carbon absorption could be easily reversed at any time from wildfires by cutting down trees or by changing agricultural practices continual monitoring and enforcement would be required adding even more cost Even in carefully enforced systems the sequestration is likely to be temporary even the carbon in completely preserved forests for example may ultimately be released into the atmosphere by decay And finally the practices that may be encouraged by crediting sequestration will not necessarily be desirable as when slowgrowing oldgrowth forests are cut down and replaced with fastgrowing plantation forests in order to increase the amount of carbon uptake DEBATE 171 Climate Change 404 those reductions or not Individual nations therefore bear all of the costs of their reductions but gain only a portion of the resulting benefits This means the private marginal benefit for any nations reduction effort is lower than the social marginal benefit which is the sum of the marginal benefits received by all nations Therefore when an individual nation reduces emissions until its private marginal cost of reduction is equal to its private marginal benefit this private optimum results in too little reduction The Barrett model assumes that signatories choose their strategies in order to maximize their collective net benefits In the structure of this game when a country joins the international agreement the other signatories respond by increasing their abatement levels and hence reward the country for participating in the agreement when a country withdraws the remain ing signatories reduce their abatement levels and hence punish the country for withdrawing from the agreement These punishments and rewards are credible because the signatories always choose their levels in order to maximize their collective net benefits The questions of interest are under what conditions is a stable successful coalition achieved and how well do these conditions fit the current climate negotiations The Barrett analysis finds that a stable successful agreement can only be achieved when the difference between the cooperative where all nations actually cooperate so that collective net benefits are maximized and noncooperative outcomes where each nation simply acts independently in pursuit of its own selfinterest is small Why Unless the freerider effect is small in this agreement it seriously undermines cooperation Unfortunately this analysis demonstrates that in precisely those cases where the gains from cooperation are greatest the incentives for individual nations to become freeriders are also greatest thereby inhibiting the formation of a stable successful agreement More recent work Barrett 2013 has focused on whether the existence of a catastrophe threshold known as a tipping point ups the ante sufficiently so that cooperation is more likely This analysis finds that when the specifics of a climate catastrophe threshold are known with certainty and the benefits of avoiding catastrophe are high relative to the costs self enforcing treaties can coordinate countries behavior so as to avoid the catastrophe Where the net benefits of avoiding catastrophe are lower relative to the costs however agreements typically fail to avoid catastrophe only modest cuts in emissions are sustained This analysis also finds that uncertainty about the magnitude of the temperature rise that would trigger the catastrophic threshold normally causes coordination to collapse as well Since our under standing of the precise temperatures that trigger various tipping points is limited this is a concerning result Another game theory study Jacquet 2013 which relies on a lab experiment reveals even more barriers to cooperationthe nature and timing of the payoffs to cooperation At the start of this experiment which is played with real money for ten rounds each of six participants is allotted a fixed amount of money 40 euros to invest in a climate account Each round these players choose how much of their allotted money they want to put into the account At the end of ten rounds if the climate account grows to 120 euros from the contribu tions made by the six players over the ten rounds the participants in that game are deemed to have won their game averted dangerous climate change Each participant in a game that successfully averts dangerous climate change receives a bonus in addition to the money they each have leftover after their contributions to the climate account However if after ten rounds the climate account ends up smaller than 120 euros the participants in that game are deemed to have lost the game and they receive no bonus The game was played with three different sets of rules The first treatment involved ten groups while the second and third involved 11 In the first scenario where the earned bonus 45 euros would be received the next day seven out of the ten groups averted dangerous Climate Change 405 climate change In the second scenario where the earned bonus still 45 euros would be received seven weeks later only four of the 11 groups succeeded In the final scenario where the bonus was used to plant oak trees in order to sequester carbon and thus provide the greatest benefit to future generations none of the 11 groups reached the target Apparently the fact that payoffs from action on climate change occur with a lag is yet another factor that makes successful agreements harder to achieve In general these results are very discouraging because they suggest that under precisely the conditions currently prevailing in the climate policy arena a close examination of the incentives facing nations seeking to form stable effective agreements to mitigate greenhouse gases suggests that global cooperation is at best an elusive outcome Fortunately the current climate arena also includes some aspects of international co operation that are not included in these models but that suggests somewhat greater possibilities for success One such area involves cobenefits the benefits that are derived from mitigating other nontargeted pollutants in the process of mitigating greenhouse gases One important example is the reduction in adverse human health impacts from reduced particulate pollution when low or nocarbon fuels are substituted for coal Since all the health benefits from mitigating these local pollutants are received by the mitgating nation the freerider effect does not come into play Cobenefits can add a powerful additional incentive for individual participants receiving those cobenefits to mitigate Some argue that this can explain for example Chinas recent increased interest in reducing greenhouse gases Another strategy designed to improve the odds of a successful agreement involves issue linkage in which countries simultaneously negotiate a climate change agreement and a linked economic agreement Typical candidates for linkage are agreements on trade liberalization or cooperation on either research and development RD or international debt The intuition behind this approach is that some countries gain from resolving the first issue while others gain from the second Linking the two issues increases the chances that cooperation may result in mutual gain and hence increases the incentives to join and abide by the combined agreement To understand how this works consider a researchanddevelopment example from Cararro 2002 To counteract the incentive to free ride on the benefits from climate change suppose only ratifiers of both agreements share in the insights gained from research and development in the ratifying countries The fact that this benefit can only be obtained by ratifying both the climate change agreement and the RD agreement provides an incentive to ratify both since these benefits do not create a freerider effect Nations choosing not to ratify can be excluded from the researchanddevelopment benefits they would have to join the agreement to gain this benefit Another strategy for encouraging participation involves transfers from the gainers to the losers Some countries have more to gain from an effective agreement than others If the gainers were willing to share some of those gains with reluctant nations who have more to lose the reluctant nations could be encouraged to join Some interesting early work Chandler Tulkens 1997 has shown that it is possible to define a specific set of transfers such that each country is better off participating than not participating That is a powerful comforting result but is it practical In terms of operationalizing the concept of using transfers as an inducement to join the agreement the Bali Climate Change Conference in 2007 established a funding mechanism for adaptation It was established to finance specific adaptation projects and programs in developing countries that are parties to the Kyoto Protocol wwwadaptationfundorg The fund which falls under the auspices of the Global Environmental Facility is financed primarily from a 2 percent levy on proceeds from Clean Development Mechanism projects Note that Climate Change 406 while this fund is directed toward adaptation rather than mitigation the fact that it is available only to parties to the agreement provides an incentive for potential holdouts to participate As a complementary measure the Conference of Parties COP to the United Nations Framework Convention on Climate Change UNFCCC decided in 2010 to also establish the Green Climate Fund which would raise significantly more funding This fund is intended to provide support to developing countries as they limit or reduce their greenhouse gas emissions and as they adapt to the impacts of climate change focusing especially on those developing countries that are particularly vulnerable to the adverse effects of climate change1 As of July 2016 some 50 proposals had been approved with the funds having been disbursed for ten of them And finally choosing costeffective policies can positively affect the level of participation Since costeffective policies reduce the cost but not the benefits of participation those policies should make participation more likely by increasing the net benefits from joining the agreement How have all of these factors interacted in the process of seeking agreements Historically climate change agreements have been based upon a topdown approach where the goals and responsibilities were defined collectively by the agreement itself That was not producing the intended results because many of the worlds countries especially the developing countries remained on the sidelines The Paris Accord which was passed in December 2015 and went into force in October 2016 shifted to a more bottomup approach Each individual country was asked to define their own contribution called a nationally determined contribution NDC to achieve the worldwide goal The NDCs are not binding enforceable as a matter of international law After the Paris Accord was concluded experts did the calculations to find out if the sum of all NDCs would be large enough to meet the temperature increase goals embodied in the agreement assuming that all counties lived up to their commitments in their NDC The experts found that the sum of the NDCs would be insufficient to keep global emissions within levels necessary to stay within the temperatureincrease targets Additionally soon after he won the 2016 US presidential election Donald Trump announced his intention to withdraw the United States from the Paris Accord Apparently so far it seems that the public good effects outweigh the effects of cobenefits linkages and financial transfers The Precedent Reducing OzoneDepleting Gases Fortunately not all international agreements designed to manage global pollutant challenges have had such a dismal experience Are there lessons to be learned from those earlier agreements Consider the experience of the Montreal Protocol which was designed to control ozonedepleting gases In the stratosphere the portion of the atmosphere lying just above the troposphere rather small amounts of ozone present have a crucial positive role to play in determining the quality of life on the planet In particular by absorbing the ultraviolet wavelengths stratospheric ozone shields people plants and animals from harmful radiation and by absorbing infrared radiation it is a factor in determining the earths climate Chlorofluorocarbons CFCs which are greenhouse gases also deplete the stratospheric ozone shield as a result of a complicated series of chemical reactions These chemical compounds were used as aerosol propellants and in cushioning foams packaging and insulating foams industrial cleaning of metals and electronics components food freezing Climate Change 407 medical instrument sterilization refrigeration for homes and food stores and airconditioning of automobiles and commercial buildings The major known health effect of the increased ultraviolet radiation resulting from tropospheric ozone depletion is an increase in nonmelanoma skin cancer Other potential effects such as an increase in the more serious melanoma form of skin cancer suppression of the human immunological systems damage to plants eye cancer in cattle and an acceleration of degradation in certain polymer materials were suspected but not as well established Responding to the ozonedepletion threat an initial group of 24 nations signed the Montreal Protocol in September 1988 A subsequent series of new agreements generally broadened the number of covered substances and established specific schedules for phasing out their production and use Currently some 96 chemicals are controlled by these agreements to some degree In terms of reducing its target emissions the protocol is generally considered to have been a noteworthy success As of 2008 more than 95 percent of listed ozonedepleting substances have been phased out and the ozone layer was expected to return to its pre1980 levels no later than 2075 How did this treaty avoid the freerider pitfalls identified previously One reason for the success of this approach was an early recognition of the need to solicit the active participation of developing countries One component of the success in eliciting that participation resulted from offering later phaseout deadlines for developing countries Another involved the creation of a Multilateral Fund In 1990 the parties agreed to establish the Multilateral Fund which was designed to cover the incremental costs that developing countries incur as a result of taking action to eliminate the production and use of ozonedepleting chemicals Contributions to the Multilateral Fund come from the industrialized countries The fund has been replenished multiple times As of April 2013 the contributions made to the Multilateral Fund by some 45 countries including countries with economies in transition or CEIT countries totaled over US 309 billion The fund promotes technical change and facilitates the transfer of more environmentally safe products materials and equipment to developing countries Developing countries that have ratified the agreement have access to technical expertise information on new replacement technologies training and demonstration projects and financial assistance for projects to eliminate the use of ozonedepleting substances The existence of the Multilateral Fund however does not deserve the bulk of the credit for the success of the Montreal Protocol The success of ozone protection was possible in no small measure because producers were able to develop and commercialize alternatives to ozonedepleting chemicals In many cases the companies that would be forced to stop producing ozonedepleting chemicals were the same companies that would produce the substitutes Countries and producers ended the use of CFCs faster and cheaper than was originally anticipated due both to the availability of these substitutes and the fact that profit from their sale would offset any losses from stopping production of the ozonedepleting chemicals In retrospect we now know that one class of the substitutes HFCs had a detrimental side effectit turned out to be a potent greenhouse gas Although HFCs have a shorter residence time in the atmosphere than carbon dioxide they turn out to be a much more powerful greenhouse gas on a pound for pound basis Responding to this challenge a deal to phaseout HFCs was reached in Kigali Rwanda in October 2016 that could on its own prevent a 05C 09F rise in temperature by 2100 and hence be a healthy complement to the Paris Accord Climate Change 408 Economics and the Mitigation Policy Choice Early in climate change negotiations it became clear that using costeffective mitigation strategies was a priority For reasons explained in Chapter 15 and the fact that they simultaneously control both mobile and stationary sources the policy choices quickly narrowed down to a carbon tax and the capandtrade version of emissions trading In general historically Europe tended to favor carbon taxes while the United States preferred capandtrade In practice as shown in Table 171 we now have experience with both approaches Providing Context A Brief Look at Two Illustrative Carbon Pricing Programs Emissions trading and a carbon tax are both forms of carbon pricing but they operate rather differently In emissions trading the government sets the magnitude of allowed emissions and allows the market to determine the price while the carbon tax sets the price on emissions and allows the market to determine the amount of emissions To provide some feel for how these two types of programs work in practice consider two examples 1 the British Columbia carbon tax and 2 the European Unions Emissions Trading Scheme British Columbia Carbon Tax Program Since 2008 British Columbia has imposed a carbon tax on each metric ton of carbon dioxide equivalent CO2e emissions from the combustion of fuel The tax rose from 10 Canadian dollars per ton of carbon dioxide in 2008 to 30 dollars by 2012 This program affects an estimated 77 percent of British Columbias total greenhouse gas GHG emissions Under this program CO2e is defined as the amount of CO2 methane and nitrous oxide N2O released into the atmosphere with the methane and N2O emission levels adjusted to a CO2e basis that accounts for their impact on global warming relative to CO2 Certain fuels such as fuel for commercial aviation and ships are exempted To facilitate implementation the carbon tax is applied and collected at the wholesale level using the traditional administrative Table 171 Selected Carbon Markets and Carbon Taxes Carbon Markets Carbon Taxes The Kyoto Protocols Clean Development and Joint Finland 1990 Implementation Mechanisms 2005 Sweden 1991 The European Union Emissions Trading Scheme 2005 Norway 1991 Regional Greenhouse Gas Initiative US 2009 United Kingdom 2001 New Zealand 2010 Denmark 2005 California USA 2013 Alberta Canada 2007 Quebec Canada 2013 Switzerland 2007 British Columbia Canada 2008 Peoples Republic of China Pilot Programs 2013 and National Program 2017 India 2010 Japan 2012 South Korea 2015 Climate Change 409 channels for collecting motor fuel taxes The cost of the tax is ultimately passed forward to consumers via higher prices This carbon tax program is revenue neutral ie all revenue generated is returned to British Columbians through rebates or cuts in other taxes To help protect lowincome households the Low Income Climate Action Tax Credit program provides adult residents with lump sum tax credits that are reduced by 2 percent of net family income above specified income thresholds After 4 years in effect BCs per capita consumption of fuels subject to the tax was found to have declined by 19 percent compared to the rest of Canada while its economy kept pace with the rest of Canada When a new government took over in 2012 it retained the program but it stopped the annual rise in the tax rate Carbon emissions in BC started rising again after the province froze the tax In part the new government did not want to get too far ahead of other nations lest they start losing their competitive edge Since then Canadian Prime Minister Justin Trudeau has established his national climate plan which requires all provinces and territories to put in place either a carbon tax or a cap andtrade plan by 2022 European Union Emissions Trading Scheme EU ETS Launched in 2005 the EU ETS operates in 31 countries and is the largest emissions trading system in the world The program establishes a cap on the total amount of certain GHGs that can be emitted from installations covered by the system Under this cap companies receive emission allowances which they can sell to or buy from one another as needed At the end of the year each company must surrender enough allowances to cover all its emissions or pay penalties on any excess Companies can bank any spare allowances for future sale or for covering their future needs The cap and hence the number of allowances is reduced over time so that total emissions will fall The EU ETS operates in all 28 EU countries plus Iceland Liechtenstein and Norway It limits emissions from more than 11000 heavy energyusing installations power stations and industrial plants as well as airlines operating between these countries and it covers around 45 percent of the EUs greenhouse gas emissions Emissions in the EU were reduced by 22 percent between 1990 and 2015 while the economy grew by 50 percent over the same period According to the European Environment Agency EEA the decrease was mostly driven by emissions reductions in power generation Emission reductions slowed down in the later period as an excess of allowances for sale developed Carbon Markets and Taxes How Have These Approaches Worked in Practice Cost Savings Two types of studies have conventionally been used to assess cost savings ex ante analyses based on computer simulations and ex post analyses which examine actual implementation experience A substantial majority though not all of the large number of ex ante analyses have found that a change from more traditional regulatory measures based upon sourcespecific limits to more costeffective marketbased measures such as emissions trading or pollution taxes could potentially achieve either similar reductions at a much lower cost or much larger reductions at a similar cost The evidence also finds as the theory would lead us to expect that these two instruments typically produce more emissions reduction per unit expenditure than other types of polices such as renewable resource subsidies or mandates Climate Change 410 Although the number of existing detailed ex post studies is small they typically also find however that the cost savings from shifting to these marketbased measures are positive but less than would have been achieved if the final outcome had been fully costeffective In other words while both taxes and emissions trading are fully costeffective in principle they fall somewhat short of that in practice Emissions Reductions In one study that attempts to control for other factors that could affect emissions outcomes Lin and Li 2011 compared the change in per capita CO2 emissions over time between countries that do and do not use a carbon tax They found that in general carbon taxes have reduced emissions but the role of carbon taxes was statistically significant only for Finland The authors attributed this lack of statistical significance for the other countries to the relatively common practice of granting tax exemptions to certain energy intensive industries Among emissions trading markets as noted above emissions in the EU were reduced by 22 percent between 1990 and 2015 In the Northeastern US the Regional Greenhouse Gas Initiative RGGI emissions from all covered sources were reduced 37 percent during the 20082015 period despite a rather weak cap While the recession played some role the main sources of the RGGI reductions were 1 substituting to renewable resources and lower carbon fossil fuels such as natural gas aided considerably by lower natural gas prices and 2 energy efficiency investments that reduced the amount of energy used per unit of output Not all countries or regions regulate their greenhouse gases of course and that raises the specter of leakage When leakage occurs it means that the actual emissions reductions are smaller than those recorded at the regulated site because some emissions have been merely transferred to another location not reduced Leakage can occur when pressure on the regulated source to reduce emissions results in a diversion of emissions to unregulated or lesser regulated locations Common channels for this diversion involves firms moving their polluting factories to countries with lower environmental standards or consumers increasing their reliance on imported products from countries with unregulated sources Generally to date however the evidence suggests that actual carbon leakage effects have been rather small despite initial concerns that they might be quite large Three Carbon Pricing Program Design Issues Using the Revenue Offsets and Price Volatility Using the Revenue Either form of carbon pricing can raise revenue while reducing emissions What difference do the various choices about revenue use make Revenues could be used to reduce the financial burden of the policy on lowincome populations to boost the economy to increase the magnitude of the emissions reductions to aid workers displaced by the policy and even to increase the likelihood that a carbonpricing policy might be enacted in the first place While in some cases particular revenue choices can simultaneously achieve multiple objectives others require political tradeoffs Various strategies have been designed to achieve one or more of these objectives They include 1 giving the revenue back to households in the form of a lumpsum rebate on a per capita basis 2 lowering various taxes such as the corporate tax the income tax the capital gains tax the payroll tax and so on 3 subsidizing further emissions reductions or 4 helping workers who are displaced by the shift to a lowercarbon energy supply Some of these revenue strategies can be designed to be revenueneutral By definition no revenue from a revenue neutral policy can be used to fund new or expanded programs Climate Change 411 Revenue neutrality can be achieved either by rebating all the carbonpricing revenues to households or by lowering other tax rates such that the lost revenue to the government from the lower rates is equal to the revenue derived from carbon pricing Revenue neutrality is also seen as helpful in building support for the policy among those who do not want to see an increase in the size of government Issuing lumpsum rebates to households for example a fixed monthly check for each mem ber of every eligible household up to four is an effective strategy for reducing the burden from carbon pricing on lowerincome populations Indeed economic studies find that of the various strategies lumpsum rebates are the most effective choice in pursuing this particular objective and they boost the economy but they are not the most effective choice for boosting the economy Economists have found that using the revenue to lower tax rates on such taxes as the capital gains tax or the corporate income tax would produce the largest boost to the economy but because the beneficiaries from these approaches are primarily upperincome groups they would have the least effect on reducing the burden on the lowincome populations Some programs that are not revenue neutral use the revenue to incentivize greater emissions reductions Common strategies include using the revenue to pick up part of the cost for those households or businesses who invest in energy efficiency or in renewable energy such as wind or solar Some energy efficiency programs have been shown to boost the economy in high energy cost regions not only by lowering the energy costs but also by keeping the revenue in the local area rather than exporting it to import fuels Studies find however that they are not as effective in boosting the economy as lowering the capital gains or corporate tax rates Although energy efficiency programs frequently target some of the subsidies at the poor and the resulting investments do lower participants energy cost they are not particularly effective at lowering the burden on lowincome populations in general since only those that choose to participate actually benefit Finally carbonpricing policies induce a shift away from highcarbon fuels and toward low or zerocarbon fuels While employment in the low or zerocarbon fuel industries would rise employment in the highcarbon fuel industries would fall Studies indicate that the coal industry would be the hardest hit Some of the revenue could be targeted specially at helping these displaced coal workers make the transition This strategy could be useful in reducing the burden on this specific population and potentially in reducing the opposition to carbon pricing in coalmining regions Fortunately economic studies have also found that it is not necessary to make an eitheror decision among these revenue using choices Because substantial revenue is commonly involved in carbon pricing programs some strategies can be used simultaneously thereby covering several bases at once Offsets While both emissions trading and a carbon tax cover emissions from sources specifically subject to those programs offsets allow emissions reductions from sources that are not subject to either the tax or the cap to be certified as offsets Offsets like allowances can be used to cover emissions in a capandtrade program sold or used to reduce the tax base in carbon taxation Offsets or offset tax credits perform several roles in pricing GHGs First increasing the number of reduction opportunities lowers the cost of compliance Second lowering the cost in this manner could increase the likelihood of enacting a carbon pricing program by making compliance easier Third offsets extend the reach of a program by providing economic incentives for reducing sources that are not covered by the tax or cap Climate Change 412 Finally because offset credits separate the source of financing from the source providing the reduction it secures some reductions in developing countries for example that for affordability reasons might not be secured otherwise The challenge for establishing an effective offset program is assuring that the primary requirements namely that the reductions be quantifiable enforceable and additional are all met One obstacle is the tradeoff between the administrative costs associated with verifying the validity of offsets and the degree of offset validity Assuring valid offsets is not cheap In response to concerns over the validity of offsets most programs now try to limit their use One historical approach has been to restrict the use of offsets domestic foreign or both to some stipulated percentage of the total required allowances In the Regional Greenhouse Gas Initiative RGGI in the Northeastern US states for example CO2 offset allowances may be used to satisfy only 33 percent of a sources total compliance obligation during a control period although this may be expanded to 5 percent and 10 percent if certain CO2 allowance price thresholds are reached In contrast in 2011 Germany announced that it would not allow any offsets to be used to pursue its reduction goals The Role of Price Volatility A tax system fixes prices and unless some administrative intervention changes those fixed prices price volatility is not an issue This is not the case with emissions trading in either principle or practice Experience not only validates the concern that emissions trading can be plagued by volatile prices but also demonstrates that price volatility is not a rare event In the EU ETS case two early price declines were attributable to inadequate public knowledge of actual emissions relative to the cap and a failure to permit allowances in the first phase to be banked for use in the second phase A subsequent dramatic price decline in 2012 stemmed from an over allocation of permits recession and longterm uncertainty about the stability of climate policy This experience demonstrates that the design of an emissions trading system is vulnerable to unstable prices in two rather fundamental ways First because the cap establishes a fixed supply of allowances demand shifts due for example to other regulatory actions recessions or shifts in prices of lower carbon fuels can trigger large changes in allowance prices since supply cannot respond Second the demand for allowances is derived from satisfying compliance obligations Changing circumstances due either to external factors or simply greater than anticipated success in lowering carbon emissions can create a surplus of allowances This surplus may cause the price to drop precipitously since lower prices do not stimulate any increase in the quantity demanded Both the RGGI and the EU ETS markets have experienced precisely this kind of pricedropping surplus One approach called a price collar is included in Californias capandtrade program as a means of dealing with price volatility It couples a safety valve price ceiling backed by an allowance reserve with a price floor Establishing a safety valve ceiling allows sources to purchase additional allowances from a reserve at a predetermined price one that is set sufficiently high to make it unlikely to have any effect unless unexpected spikes in allowance prices occur In 2013 the three fixedprice tiers in California were 40 45 and 50 but they would rise over time with inflation To prevent these purchases from causing the emissions Climate Change 413 cap to be exceeded the reserve is established by allocating a specified percentage of allowances originally 4 percent from each annual budget between 2013 and 2020 As of 2016 the reserve had not been used and market prices were below the reserve tier prices but the mere fact it exists serves to reduce price uncertainty Controversy The Morality of Emissions Trading Emissions trading has not avoided controversy One element of that controversy raises the rather important question of whether the greenhouse gas trading concept violates conventional norms of international ethics see Debate 172 Is Global Greenhouse Gas Trading Immoral In a December 1997 editorial in the New York Times Michael Sandel a Harvard government professor suggested that greenhouse gas trading is immoral He argued that treating pollution as a commodity to be bought and sold not only removes the moral stigma that is appropriately associated with polluting but also trading reductions undermines an important sense of shared responsibilities that global cooperation requires He illustrated the point by suggesting that legitimizing further emission by offsetting it with a credit acquired from a project in a poorer nation would be very different from penalizing the firm for emitting even if the cost of the credit were equal to the penalty Not only would the nowauthorized emission become inappropriately socially acceptable but also the wealthier nation would have met its moral obligation by paying a poorer nation to fulfill a responsibility that should have been fulfilled by a domestic emissions reduction Published responses to this editorial countered with several points First it was pointed out that since it is voluntary international emissions trading typically benefits both nations one nation is not imposing its will on another Second the historical use of these programs has resulted in much cleaner air at a much lower cost than would otherwise have been possible so the ends would seem to justify the means Third with few exceptions virtually all pollutioncontrol regulations allow some emission that is not penalized this is simply a recognition that zero pollution is rarely either efficient or politically feasible Source Sandel M J December 17 1997 Its immoral to buy the right to pollute With replies by Steven Shavell Robert Stavins Sanford Gaines and Eric Maskin New York Times excerpts reprinted in Stavins R N Ed 2000 Economics of the Environment Selected Readings 4th ed New York WW Norton Company 449452 DEBATE 172 Climate Change 414 Mitigation Policy Timing Most studies find that taking action to mitigate emissions enhances rather than reduces future economic wellbeing Not only do we know how to design costeffective carbon pricing strategies that hold the cost of action down but the savings from avoided damages are potentially huge A recent OECD study found for example that a climatefriendly policy package could increase longrun output by up to 28 percent on average across the G20 nations by 2050 and if avoided climate damage is also taken into account this rises to nearly 5 percent2 How does the timing of the action matter The US withdrawal from the Paris Accord seems likely to at least delay the timing of global emissions reductions What can economics say about the optimal level of current investments in greenhouse gas reduction and how the costs are affected by delay in implementing those investments The earliest benefitcost studies of options for controlling climate change suggested a go slow or waitandsee policy The reasons for these results are instructive First the benefits from current control are experienced well into the future while the costs occur now The presentvalue criterion in benefitcost analysis discounts future values more than current values Second both energyusing and energyproducing capital are longlived Replacing them all at an accelerated pace now would be more expensive than replacing them in sequence closer to the end of their useful lives Finally the models anticipate that the number of new emissionsreducing technologies would be larger in the future and due to this larger menu of options the costs of reduction would be lower if actions are delayed until those technologies emerge Two concerns about that earlier conclusion however strengthen the case for beginning the process now The use of benefitcost analysis in climate change discussion is controversial due to the role of the presentvalue criterion Although as we demonstrated earlier this approach is not inherently biased against future generations their interests will only be adequately protected if they are adequately compensated for the damage inflicted on them The uncertainty associated with this particular solution place the interests of future generations in maintaining a stable climate in jeopardy raising an important ethical concern Portney Weyant 1999 Second while the reasons for caution have economic merit they do not necessarily imply a waitandsee policy Spreading the capital investment decisions over time implies that some investments take place now as current capital is replaced Furthermore the expectation that future technical change can reduce costs will only be fulfilled if the incentives for producing the technical change are in place now In both cases waiting simply postpones the process of change As time has passed the case for waitandsee has diminished even further The rise in atmospheric emissions can mean that the costs of mitigation rise as well A recent study by the MIT Joint Program on the Science and Policy of Global Change found that delaying the abatement policy would substantially increase the mitigation cost To be specific they found that delaying the start of policy to 2030 as opposed to starting it in 2010 would raise the mitigation costs in 2050 and 2100 by 520 percent and 264 percent respectively3 Another powerful consideration in the debate over the timing of control investments involves uncertainty about both the costs and the benefits of climate change Governments must act without complete knowledge How can they respond reasonably to this uncertainty As economic analysis points out the risks of being wrong are clearly asymmetric If it turns out in retrospect that policy controlled more emissions than necessary current generations could bear a largerthannecessary cost On the other hand if the problem turns out to be as serious as the worst predictions indicate catastrophic and largely irreversible damage to the Climate Change 415 planet could be inflicted on future generations The second error clearly imposes higher costs than the former Yohe Andronova and Schlesinger 2004 investigate both consequences of being wrong using a standard wellrespected global climate model Their model assumes that decision makers would choose global mitigation policies that would be in effect for 30 years but after 30 years the policymakers would be able to modify the policies to take into account the better understanding of climate change consequences that would have been afforded by the intervening years The specific source of uncertainty in their model results from our imperfect knowledge about the relationship between the atmospheric greenhouse gas concentrations and the resulting change in climate impacts The specific question they examine is What is the best strategy now They found at that time that a hedging strategy that involved modest reductions dominated a waitandsee strategy Not only did current action initiate the capital turnover process and provide incentives for technical change but also it allowed the avoidance of very costly and potentially irreversible mistakes later If at the end of 30 years for example scientists discover that greenhouse gas concentrations must be stabilized at a more stringent level than previously thought to avoid exceeding important thresholds such as the methane example discussed previously that may not only be much more difficult and much more expensive to do later but it may actually be impossible due to the residence time in the atmosphere of past emissions Now that we have higher concentrations in the atmosphere most studies are indicating that the longer we wait to take action the more costs will rise The Role of Adaptation Policy Whereas mitigation strategies try to limit damage by limiting the emissions that cause the impacts adaptation tends to limit damage by reducing the damage caused by the impacts that do occur The two strategies are complements in the sense that the optimal policy response contains both adaptation and mitigation Since the marginal cost function for each strategy is upwardsloping this normally means that an optimal strategy would employ both mitigation and adaptation Deviating from this optimum necessarily means that costs would be higher than necessary In another equally meaningful sense the two strategies are also substitutes more of one typically means less is needed of the other To understand how they can be substitutes remember that the optimal level of either strategy would be to invest up to the point where the marginal cost of an additional unit of that strategy is equal to the marginal damages reduced by that unit So for either strategy higher marginal damages imply a higher demand for investing more in that strategy If the strategies are substitutes a reduction in the marginal cost of mitigation for example should lower the demand for adaptation Why Lets think this through In an optimal policy a lower marginal cost of mitigation with an unchanged marginal damage would imply a higher optimal level of mitigation This increased level of mitigation would lower the resulting marginal damage not only for additional units of mitigation but for additional units of adaptation as well The lower resulting marginal damages for adaptation would lower the demand for it In this sense mitigation and adaptation are substitutes increase the amount of one and you decrease the efficient amount of the other If you peruse the web you will discover that some pundits think about mitigation and adaptation as an eitheror choice They further suggest that policymakers should choose the one that is cheaper Economic analysis points out that this is a false choice Climate Change 416 First of all as noted above upwardsloping marginal cost functions for each strategy normally mean that an optimal approach would employ both strategies Deviating from this optimum means that costs would be higher than necessary Second to the extent that adaptation and mitigation are substitutes they are not perfect substitutes Adaptation strategies are necessarily targeted at specific problems in specific geographic areas whereas mitigation strategies have broader damagereduction effects around the globe Third to some extent their timing may differ Mitigation is necessarily done early to prevent emissions from building up in the atmosphere Some adaptation can be done early as well but some can also be delayed until a better understanding of the intensity and location of damages emerges As one World Bank study put it There is a need for an integrated portfolio of actions ranging from avoiding emissions mitigation to coping with impacts adaptation and to consciously accepting residual damages However some irreversible losses cannot be compensated for Thus mitigation might be in many cases the cheapest longterm solution to climate change problems and the most important to avoid thresholds that may trigger truly catastrophic consequences4 What forms can adaptation strategies take They range from largescale infrastructure changessuch as building sea walls to protect against sealevel riseto behavioral shifts as when individuals waste less water farmers plant different crops and households relocate their dwellings to higher land for flood protection They can also involve a mix of public and private strategies with private strategies ranging from improved early warning systems to building codes that prohibit new structures that are inefficiently vulnerable and would only be purchased by an uninformed buyer One way to think about the optimal respective roles for the public and private sectors is to look closely at the role private decision makershouseholds and businessescan be expected to play and indeed have already played in response to climate threats that have already occurred Will private agents adapt to a modified climate Are those reactions likely to be both effective and sufficient or is there a role for the public sector to fill in gaps A review of economic research in this this area by Fankhauser 2016 makes it clear that the answer to the first question is a resounding yes Private agents do adapt One of the most studied sectors agriculture reveals clear differences in agricultural practices such as crop choices under different climate conditions In the longer term farmers also respond to weather fluctuations by adjusting the size of their farm or moving into nonfarm activities Although few studies examine business investments in adaptation the fact that households adjust their energy consumption to climatic factors is well documented Both energy demand and the demand for associated products like air conditioning units are found as expected to vary both seasonally and across climate zones Further these private responses have been found to produce substantial social benefits in terms of reduced mortality and enhanced wellbeing So while the literature does provide compelling evidence that private agents do adapt it does not provide compelling evidence that these responses are either completely effective or sufficient To start with the number of adaptation investment situations that have been studied is very limited Further few of those that have been studied focus on adaptation to the kinds of major damages that are expected from a changing climate More importantly Climate Change 417 however the literature documents a number of barriers that inhibit private actions thereby reducing the effectiveness of a purely private adaptation strategy Property rights matter Remember earlier discussion about the differences in energy efficiency investment incentives between renters and owners Because they would incur the losses caused by property damages renters also have lower incentives than owners to invest in adaptation In general ambiguous or compromised property rights can be a barrier to effective private action Effective private action depends on good information on both the nature of risks and options for adapting to them Much of this information about future risks is a public good which means that it will be undersupplied unless the government supplies it or participates in its supply Adaptation choices can also be limited by affordability including how a low income diminishes the ability to borrow Finally much of the adaptation would involve public capital like roads or public transportation systems and the desirability of many private adaptation responses would be affected by those public adaptation responses Even this brief list suggests a multifaceted role for governments It should identify circumstances that lead to adaptation market failures and adopt policies that correct or remove the distortions in incentives that lead to the failures It should provide public information on the risks being posed by a changing climate It should provide financial mechanisms for assisting populations facing affordability problems with adaptation It should develop adaptation plans for publicly owned capital such as the transportation infrastructure Summary The first global pollutant problem confronted by the international community arose when ozonedepleting gases were implicated in the destruction of the stratospheric ozone shield that protects the earths surface from harmful ultraviolet radiation Because these are accumulating pollutants an efficient response to this problem involves reducing their emissions over time To restrict their accumulation in the atmosphere the international agreements on ozone depleting substances created a system of limits on production and consumption Internationally this system is considered a success in part because the Multilateral Fund and other incentives such as delayed compliance deadlines facilitated the participation of developing countries and in part because the losses imposed on producers of ozonedepleting chemicals when those chemicals were phased out were offset by the profits gained by many of the same producers as they produced and sold the substitutes Climate change is appropriately considered an even more difficult problem Not only must policy cope with the freerider problem and the fact that the current generation bears the costs while the benefits accrue in the future but climate change presents some additional challenges At the top of the list is the fact that in this case controlling greenhouse gases means controlling energy use from fossil fuels the lynchpin of modern society Climate Change 418 Fortunately economic analysis of the climate change problem not only defines the need for action but also sheds light on effective forms that action might take The empirical studies suggest that it makes sense to take action not only to mitigate emissions but to develop and implement adaptation strategies Economics also sheds light on the barriers to effective participation in climate change agreements and some potential solutions as well Game theory studies reveal that the freerider effect is a significant barrier to participation as is the long horizon over which the effects of current polices are felt Game theory studies with a broader scope however point out specific strategies such as international transfers and issue linkage that can be used to build stronger incentives for participation Some international cost sharing is also likely to be as necessary an ingredient in a successful attack on the climate problem as it was in the ozonedepletion case Since carbon pricing is the main form of costeffective policy on climate change the fact that the number of existing regional and national carbon pricing programs is growing and the list of participating countries includes some important players is good news indeed The evidence demonstrates that these programs are achieving emissions reductions in a relatively costeffective manner but some issues such as volatile prices and the appropriate role for offsets are still in the process of being resolved During the next few decades options must not only be preserved they must be enhanced Responding in a timely and effective fashion to global and regional pollution problems will not be easy Our political institutions are not configured in such a way as to make decision making on a global scale simple International organizations exist at the pleasure of the nations they serve Only time will tell if the mechanisms of international agreements described in this chapter will prove equal to the task Discussion Questions 1 Concerned individuals can now seek to reduce their carbon footprint by buying offsets Air travelers for example are now asked if they wish to purchase offsets when they buy their ticket Is this a complement or substitute for a national climate change policy Why 2 What is your national regional or state government doing about climate change Has it adopted a form of carbon pricing If so how is it working out Is anyone working on an adaptation plan in your area Do the basics of those approaches seem consistent with some of the characteristics of an efficient strategy discussed in this chapter Why or why not SelfTest Exercises 1 Explain why a climate policy using emissionscharge revenue to provide capital and operating subsidies for carbon capture technologies is less costeffective than an emissions charge policy alone 2 The revenues from an emissionscharge approach to controlling climate change would be unusually large in comparison to other pollutants What circumstances would lead to high revenues 3 Label the following as true false or uncertain and explain your choice Uncertain means that it can be either true or false depending upon the circumstances a The imposition of a tax on currently uncontrolled greenhouse gas emissions would represent a move toward efficiency Climate Change 419 b Relying on a series of regional systems like the EU ETS rather than a true global system for controlling greenhouse gases increases the importance of the leakage problem 4 Suppose two countries with domestic capandtrade polices are considering linking their two systems Country A has a cap of 20 tons of emissions a domestic marginal cost of abatement of 10 and an uncontrolled emissions level of 60 tons while Country B has a cap of 40 tons a domestic marginal cost of abatement of 1q where q the tons of emission abatement and an uncontrolled emissions level of 80 tons a Before linkage what would be the prices in the two separate markets and how much abatement would each country choose b If these two markets were linked by allowing each country to buy from and sell allowances to the other what would be the prices in the two markets How much would each country abate Describe the transfer of allowances if any that would take place between the two countries 5 In negotiations over a public good such as a greenhouse gas emissions reduction a cooperative agreement always produces higher aggregate benefits than a noncooperative agreement so cooperation will dominate noncooperation Discuss Notes 1 How difficult these negotiations are can be illustrated by the fact that the magnitude of US pledges to the Green Climate Fund was one example President Trump gave of the USs unfair burden under the Paris Accord Although the Green Climate Fund actually precedes the Paris Accords by about 5 years it wasnt until 2013 that the GCF started its first round of fundraising 2 OECD 2017 Investing in Climate Investing in Growth Paris OECD Publishing 3 Chen YH H Babiker M Paltsev S Reilly H 2016 Costs of climate mitigation policies MIT Joint Program on the Science and Policy of climate Change Report 292 Available at httpsglobalchangemitedupublication15766 accessed June 14 2017 4 Shalizi Z and Lecocq F August 2010 To mitigate or to adapt Is that the question Observations on an appropriate response to the climate change challenge to development strategies The World Bank Research Observer 252 295321 p 295 Further Reading Calvo E Santiago J R 2012 Dynamic models of international environmental agree ments A differential game approach International Review of Environmental and Resource Economics 6 289339 A survey of dynamic models of international environmental agreements Fankhauser Sam 2016 Adaptation to climate change Grantham Research Institute on Climate Change and the Environment Working Paper No 255 Available at wwwlse acukGranthamInstitutepublicationadaptationtoclimatechange Last accessed on April 1 2017 A survey of the economics of adaptation Fell Harrison Burtraw Dallas Morgenstern Richard D Palmer Karen L 2012 Soft and hard price collars in a capandtrade system A comparative analysis Journal of Environmental Economics and Management 642 183198 Compares price collars price ceilings and floors in a capandtrade system involving uncertainty with respect to the level of baseline emissions and costs Climate Change 420 Mendelsohn R Dinar A et al 2006 The distributional impacts of climate change on rich and poor countries Environment and Development Economics 11 159178 This economic analysis concludes that poor countries will suffer the bulk of the damages from climate change due primarily to their location Metcalf G E 2009 Designing a carbon tax to reduce US greenhouse gas emissions Review of Environmental Economics and Policy 31 6383 Describes considerations for designing a carbon tax to control greenhouse gas emissions in the United States Stavins R N 2008 Addressing climate change with a comprehensive US capandtrade system Oxford Review of Economic Policy 242 298321 Describes considerations for designing a capandtrade policy to control greenhouse gas emissions in the United States Stern N 2008 The economics of climate change American Economic Review 982 137 As assessment by the former chief economist of the World Bank Tietenberg T H Summer 2013 ReflectionsCarbon pricing in practice Review of Environmental Economics and Policy 7 313329 A review of the existing carbon pricing programs that considers their effectiveness and the emerging design lessons US Environmental Protection Agency 2016 Climate change indicators in the United States 2016 4th ed EPA 430R16004 wwwepagovclimateindicators This report presents 37 indicators to help readers understand changes observed from longterm records related to the causes and effects of climate change the signicance of these changes and their possible consequences for people the environment and society Williams III Roberton C June 2016 Environmental taxation Resources for the Future Discussion Paper 1624 Available at wwwrfforgfilesdocumentfileRFFDP1624pdf This paper evaluates the economic and environmental effects of potential environmental tax reforms based on a review of recent economic research Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 421 Chapter 18 Water Pollution It was the best of times it was the worst of times it was the age of wisdom it was the age of foolishness it was the epoch of belief it was the epoch of incredulity Charles Dickens A Tale of Two Cities 1859 Introduction While various types of pollution share common attributes important differences are apparent as well These differences form the basis for the elements of policy unique to each pollutant We have seen for example that although the types of pollutants emitted by mobile and stationary sources are often identical the policy approaches differ considerably Water pollution control has its own unique characteristics as well The following stand out as having particular relevance for policy 1 Recreation benefits are much more important for water pollution control than for air pollution control 2 Large economies of scale in treating sewage and other wastes create the possibility for large centralized treatment plants as one control strategy while for air pollution onsite control is the standard approach 3 Many causes of water pollution are more difficult to trace to a particular source Runoff from streets and agriculture as well as atmospheric deposition of pollutants are major diffuse sources of water pollution Control of these sources adds additional complexities for water pollution control These characteristics create a need for yet another policy approach In this chapter we explore the problems and prospects for controlling this unique and important form of pollution Water Pollution 422 Nature of Water Pollution Problems Types of WasteReceiving Water Three primary types of water are susceptible to contamination The first surface water consists of the rivers lakes and oceans covering most of the earths surface Historically policymakers have focused almost exclusively on preventing and cleaning up lake and river water pollution Groundwater once considered a pristine resource has been shown to be subject to considerable contamination from toxic chemicals Groundwater is water beneath the earths surface in soils or rocks or in geological formations that are fully saturated The third oceans have only recently begun receiving attention While surface water serves as a significant source of drinking water it has many other uses as well Recreational benefits such as swimming fishing and boating are important determinants of surface water policy in areas where the water is not used for drinking Groundwater is used primarily for irrigation and as a source of drinking water Sources of Contamination For pollution policy purposes it is useful to distinguish between two sources of contamination point and nonpointeven though the distinction is not always crystal clear Point sources generally discharge into surface waters at a specific location through a pipe outfall or ditch while nonpoint sources usually affect the water in a more indirect and diffuse way Examples of nonpoint source pollution include the runoff of fertilizers and pesticides from lawns and Figure 181 The Decreasing Frequency of Oil Spills from Tankers and Barges Source International Tanker Owners Pollution Federation Limited website wwwitopf cominformationservicesdataandstatisticsstatisticsindexhtml Water Pollution 423 Table 181 Notable Oil Spills from Tankers Rank Spill Size tons Ship Name Year Location 1 287000 Atlantic Empress 1979 Off Tobago West Indies 2 260000 ABT Summer 1991 700 nautical miles off Angola 3 252000 Castillo de Bellver 1983 Off Saldanha Bay South Africa 4 223000 Amoco Cadiz 1978 Off Brittany France 5 144000 Haven 1991 Genoa Italy 6 132000 Odyssey 1988 700 nautical miles off Nova Scotia Canada 7 119000 Torrey Canyon 1967 Scilly Isles the United Kingdom 8 115000 Sea Star 1972 Gulf of Oman 9 100000 Irenes Serenade 1980 Navarino Bay Greece 10 100000 Urquiola 1976 La Coruna Spain 11 95000 Hawaiian Patriot 1977 300 nautical miles off Honolulu 12 94000 Independenta 1979 Bosphorus Turkey 13 88000 Jakob Maersk 1975 Oporto Portugal 14 85000 Braer 1993 Shetland Islands the United Kingdom 15 74000 Aegean Sea 1992 La Coruna Spain 16 72000 Sea Empress 1996 Milford Haven the United Kingdom 17 70000 Khark 5 1989 120 nautical miles off Atlantic coast of Morocco 18 70000 Nova 1985 Off Kharg Island Gulf of Iran 19 67000 Katina P 1992 Off Maputo Mozambique 20 63000 Prestige 2002 Off Galicia Spain 35 131 37000 11000 Exxon Valdez Hebei Spirit 1989 2007 Prince William Sound Alaska USA South Korea Source International Tanker Owners Pollution Federation Limited website updated June 2017 www itopfcomknowledgeresourcesdatastatisticsstatisticsmajor Reprinted with permission from ITOPF farms after rainstorms From the policy point of view nonpoint sources are more difficult to control because both the source and timing are hard to predict and as such they have received little legislative attention until recently As a result of the gains made in controlling point sources nonpoint sources now compose over half of the waste load borne by the nations waters Contamination of groundwater occurs when polluting substances leach into a water saturated region Many potential contaminants are removed by filtration and adsorption as the water moves slowly through the layers of rock and soil Toxic organic chemicals are one major example of a pollutant that may not be filtered out during migration Once these substances enter groundwater very little if any further cleansing takes place Moreover since the rate of replenishment for many groundwater sources relative to the stock is small very little mixing and dilution of the contaminants occur Three primary sources of ocean pollution are oil spills ocean dumping and trash primarily plastics that ends up in the ocean Oil spills from tankers have become less frequent and have decreased in magnitude since 1970 see Figure 181 Spills however are still not uncommon as shown in Table 181 and offshore drilling has increased those risks as the recent BP spill in the Gulf of Mexico illustrated Various unwanted byproducts of modern life have also been dumped into ocean waters based upon the mistaken belief that the vastness of the Water Pollution 424 oceans allows them to absorb large quantities of waste without suffering noticeable damage Dumped materials have included sewage and sewage sludge unwanted chemicals trace metals and even radioactive materials More recently vast amounts of plastics have been found in the ocean Much of this plastic gets ingested by sea life and kills thousands of marine birds and mammals each year Types of Pollutants For our purposes the large number of water pollutants can be usefully classified by means of the taxonomy developed in Chapter 14 Fund Pollutants Fund pollutants are those for which the environment has some assimilative capacity If the absorptive capacity is high enough relative to the rate of discharge they may not accumulate at all One type of fund water pollutant is called degradable because it degrades or breaks into its component parts within the water Degradable wastes are normally organic residuals that are attacked and broken down by bacteria in the stream The process by which organic wastes are broken down into component parts consumes oxygen The amount of oxygen consumed depends upon the magnitude of the waste load All of the higher lifeforms in watercourses are aerobic they require oxygen for survival As a streams oxygen levels fall fish mortality increases with the less tolerant fish becoming the first to succumb The oxygen level can become low enough that even the aerobic bacteria die When this happens the stream becomes anaerobic and the ecology changes drastically This is an extremely unpleasant circumstance because the stream takes on a dark hue and the stream water stinks1 To control these waste loads two different types of monitoring are needed 1 monitoring the ambient conditions in the watercourse and 2 monitoring the magnitude of emissions or effluent as it is commonly labeled for water pollutants One measure commonly used to keep track of ambient conditions for these conventional fund pollutants is dissolved oxygen DO The amount of dissolved oxygen in a body of water is a function of ambient conditions such as temperature stream flow and the waste load The measure of the oxygen demand placed on a stream by any particular volume of effluent is called the biochemical oxygen demand BOD Using modeling techniques effluent measured as BOD at a certain point can be translated into DO measures at various receptor locations along a stream This step is necessary in order to implement an ambient permit system or an ambient emissions charge If we were to develop a profile of dissolved oxygen readings on a stream where organic effluent is being discharged that profile would typically exhibit one or more minimum points called oxygen sags These oxygen sags represent locations along the stream where the dissolved oxygen content is lower than at other points An ambient permit or ambient charge system would be designed to reach a desired DO level at those sag points while a capandtrade or effluent charge system would simply try to hit a particular BOD reduction target The former would take the location of the emitter into account while the latter would not Later in this chapter we examine studies that model these systems on particular watercourses A second type of fund pollutant thermal pollution is caused by the injection of heat into a watercourse Typically thermal pollution is caused when an industrial plant or electric utility uses surface water as a coolant returning the heated water to the watercourse This heat is dissipated in the receiving waters by evaporation By raising the temperature of the water near the outfall thermal pollution lowers the dissolved oxygen content and can result in dramatic ecological changes in that area Water Pollution 425 Yet another example is provided by a class of pollutants such as nitrogen and phosphorus that are plant nutrients These pollutants stimulate the growth of aquatic plant life such as algae and water weeds In excess these plants can produce odor taste and aesthetic problems A lake with an excessive supply of nutrients is called eutrophic The various types of fund pollutants could be ordered on a spectrum On one end of the spectrum would be pollutants for which the environment has a very large absorptive capacity and on the other end pollutants for which the absorptive capacity is virtually nil The limiting case with no absorptive capacity is stock pollutants Near the end of that spectrum is a class of inorganic synthetic chemicals called persistent pollutants These substances are called persistent because their complex molecular structures are not effectively broken down in the stream Some degradation takes place but so slowly that these pollutants can travel long distances in water in a virtually unchanged form These persistent pollutants accumulate not only in the watercourses but also in the food chain The concentration levels in the tissues of living organisms rise with the order of the species Concentrations in lower lifeforms such as plankton may be relatively small but because small fish eat a lot of plankton and do not excrete the chemical the concentrations in small fish would be higher The magnification continues as large fish consume small fish concentration levels in the larger fish would be even higher Because they accumulate in the food chains persistent pollutants present an interesting monitoring challenge The traditional approach would involve measurements of pollutant concentration in the water but that is not the only variable of interest The damage is related not only to its concentration in the water but its concentration in the food chain as well Although monitoring the environmental effects of these pollutants may be more compelling than for other pollutants it is also more difficult Infectious organisms such as bacteria and viruses can be carried into surface water and groundwater by human and animal wastes and by wastes from such industries as tanning and meatpacking These live organisms may either thrive and multiply in water or their population may decline over time depending upon how hospitable or hostile the watercourse is for continued growth Most recently medicinal waste has been found in watercourses and in fish tissue In 2002 the USGS tested 139 rivers in 30 states and found that 80 percent of the streams sampled resulted in evidence of residuals from drugs such as birthcontrol pills and antidepressants Residuals from soaps perfumes and caffeine were also found While the magnitude of the damage that will ultimately be caused by these substances is not yet clear it is certainly a challenge for water pollution control policy Stock Pollutants The most troublesome cases of pollution result from stock pollutants which merely accumulate in the environment No natural process removes or transforms stock pollutants the watercourse cannot cleanse itself of them Inorganic chemicals and minerals comprise the main examples of stock pollutants Perhaps the most notorious members of this group are the heavy metals such as lead cadmium and mercury Extreme examples of poisoning by these metals have occurred in Japan One oceandumping case was responsible for Minamata disease named for the location where it occurred Some 52 people died and 150 others suffered serious brain and nerve damage Scientists puzzled for years over the source of the ailments until tracing it to an organic form of mercury that had accumulated in the tissues of fish eaten three times a day by local residents In the United States mercury contamination of fish has led to consumption advisories for many freshwater and migratory fish Women of childbearing age and children especially are Water Pollution 426 Toxics in Fish Tissue Do Fish Consumption Advisories Change Behavior Since mercury persists and bioaccumulates the concentrations of mercury rise as you move up the food chain Ingested mercury has been linked to neurological disorders in infants and children In January 2001 the Food and Drug Administration FDA released an advisory on methyl mercury in fish An updated advisory was issued in 2004 and again in 2006 Part of that advisory reads as follows However nearly all fish and shellfish contain traces of mercury For most people the risk from mercury by eating fish and shellfish is not a health concern Yet some fish and shellfish contain higher levels of mercury that may harm an unborn baby or young childs developing nervous system The risks from mercury in fish and shellfish depend on the amount of fish and shellfish eaten and the levels of mercury in the fish and shellfish Therefore the Food and Drug Administration FDA and the Environmental Protection Agency EPA are advising women who may become pregnant pregnant women nursing mothers and young children to avoid some types of fish and eat fish and shellfish that are lower in mercury The FDA targeted women planning on becoming pregnant within 6 months pregnant women and nursing women to receive information about the new advisory on methyl mercury Using the Bureau of Labor Statistics Consumer Expenditure Survey Shimshack Ward and Beatty 2007 examined the effectiveness of advisories in affecting consumer choices In particular they looked at the effects of the advisory on the consumption of canned fish during 19992002 a time period that includes 2 years before and 2 years after the advisory They examined whether the groups targeted reduced their consumption of canned fish and what determined the responses Comparing target households those with young children to nontarget households they found that targeted consumers significantly reduced their canned fish consumption as a result of the warning Collegeeducated consumers responded quite strongly Additionally they found that newspaper DEBATE 181 cautioned against eating large amounts of certain species Debate 181 examines the effects of fish consumption advisories on consumer behavior In another case in Japan known as the itai itai literally ouchouch disease scientists traced the source of a previously undiagnosed extremely painful bone disease to the ingestion of cadmium Nearby mines were the source of the cadmium which apparently was ingested by eating contaminated rice and soybeans Water Pollution 427 As is typical with persistent pollutants some of the stock pollutants are difficult to monitor Those accumulated in the food chains give rise to the same problem as is presented by persistent pollutants Ambient sampling must be supplemented by sampling tissues from members of the food chain To further complicate matters the heavy metals may sink rapidly to the bottom remaining in the sediment While these could be detected in sediment samples merely drawing samples from the water itself would allow these pollutants to escape detection Traditional Water Pollution Control Policy Water pollution control policies vary around the world In this section we begin with a detailed discussion of US policy which provides a rich example of a typical legal approach to regulation Later in the chapter we will look at the European approach which has depended more heavily on economic incentives US policy for water pollution control predates federal air pollution control We might suppose that the policy for water pollution control would therefore be superior since authorities have had more time to profit from early mistakes Unfortunately that is not the case The US Experience Early Legislation The first federal legislation dealing with discharge into the nations waterways occurred when Congress passed the 1899 Refuse Act Designed primarily to protect navigation this act focused on preventing any discharge that would interfere with using rivers as transport links All discharges into a river were prohibited unless approved by a permit from the Chief of the US Engineers Most permits were issued to contractors dredging the rivers and they dealt and magazine readership were significant in influencing the postadvisory reduction in fish consumption but health consciousness was not Interestingly they also found evidence of spillover effects nontargeted consumers also reduced their consumption of canned fish Access to information is clearly important to the success of a health advisory Atrisk consumers who were less educated and nonreaders did not significantly reduce consumption The authors suggest that this particular group is also less likely to be able to withstand negative health shocks What is the best way to get information to different population groups Unequal access to information creates unevenly distributed health risks and might be labeled an environmental justice issue Sources Shimshack J P Ward M B and Beatty T K M 2007 Mercury advisories Information education and fish consumption Journal of Environmental Economics and Management 532 158179 wwwfdagov wwwcfsanfdagovdmsadmehg3html Water Pollution 428 mainly with the disposal of the removed material This act was virtually unenforced for other pollutants until 1970 when this permit program was rediscovered and used briefly with little success as the basis for federal enforcement actions The Water Pollution Control Act of 1948 represented the first attempt by the federal government to exercise some direct influence over what previously had been a state and local function A hesitant move since it reaffirmed that the primary responsibility for water pollution control rested with the states it did initiate the authority of the federal government to conduct investigations research and surveys Early hints of the current approach are found in the amendments to the Water Pollution Control Act which were passed in 1956 Two provisions of this Act were especially important 1 federal financial support for the construction of waste treatment plants and 2 direct federal regulation of waste discharges via a mechanism known as the enforcement conference The first of these provisions envisioned a control strategy based on subsidizing the construction of a particular control activitywaste water treatment plants Municipalities could receive federal grants to cover up to 55 percent of the construction of municipal sewage treatment plants This approach not only lowered the cost to the local governments of constructing these facilities but also it lowered the cost to users Since the federal government contribution was a grant rather than a loan the fees users were charged did not reflect the federally subsidized construction portion of the cost The user fees were set at a lower rate that was high enough to cover merely the unsubsidized portion of construction cost as well as operating and maintenance costs The 1956 amendments envisioned a relatively narrow federal role in the regulation of discharges Initially only polluters contributing to interstate pollution were included but subsequent laws have broadened the coverage By 1961 discharges into all navigable water were covered The mechanism created by the amendments of 1956 to enforce the regulation of discharges was the enforcement conference Under this approach the designated federal control authority could call for a conference to deal with any interstate water pollution problem or it could be requested to do so by the governor of an affected state The fact that this authority was discretionary and not mandatory and that the control authority had very few means of enforcing any decisions reached meant that the conferences simply did not achieve the intended results The Water Quality Act of 1965 attempted to improve the process by establishing ambient water quality standards for interstate watercourses and by requiring states to file implementation plans This sounds like the approach currently being used in air pollution control but there are important differences The plans forthcoming from states in response to the 1965 Act were vague and did not attempt to link specific effluent standards on discharges to the ambient standards They generally took the easy way out and called for secondary treatment which removes 8090 percent of BOD and 85 percent of suspended solids The fact that these standards bore no particular relationship to ambient quality made them difficult to enforce in the courts since the legal authority for them was based on this relationship Subsequent Legislation Point Sources As discussed in the preceding chapters an air of frustration regarding pollution control pervaded Washington in the 1970s As with air pollution legislation this frustration led to the enactment of a very tough water pollution control law The tone of the 1972 Ammendments to the Water Pollution Control Act now commonly called the Clean Water Pollution 429 Water Act CWA is established immediately in the preamble which calls for the achievement of two goals 1 that the discharge of pollutants into the navigable waters be eliminated by 1985 and 2 that wherever attainable an interim goal of water quality which provides for the protection and propagation of fish shellfish and wildlife and provides for recreation in and on the water be achieved by June 1 1983 The stringency of these goals represented a major departure from previous policy This Act also introduced new procedures for implementing the law Permits were required of all dischargers replacing the 1899 Refuse Act which because of its navigation focus was difficult to enforce The permits would be granted only when the dischargers met certain technologybased effluent standards The ambient standards were completely bypassed as these effluent standards were uniformly imposed and hence could not depend on local water conditions2 According to the CWA the effluent standards were to be implemented in two stages By 1977 industrial dischargers as a condition of their permit were required to meet effluent limitations based on the best practicable control technology currently available BPT In setting these national standards the EPA was required to consider the total costs of these technologies and their relation to the benefits received but not to consider the conditions of the individual source or the particular waters into which it was discharged In addition all publicly owned treatment plants were to have achieved secondary treatment by 1977 By 1983 industrial discharges were required to meet effluent limitations based on the presumably more stringent best available technology economically achievable BAT while publicly owned treatment plants were required to meet effluent limitations that depended on the best practicable waste treatment technology The program of subsidizing municipal water treatment plants begun in 1956 was continued in a slightly modified form by the CWA Whereas the 1965 Act allowed the federal government to subsidize up to 55 percent of the cost of construction of waste treatment plants the 1972 Act raised the ceiling to 75 percent The 1972 Act also increased the funds available for this program In 1981 the federal share was returned to 55 percent The 1977 amendments to the CWA continued this regulatory approach but with some major modifications This legislation drew a more careful distinction between conventional and toxic pollutants with more stringent requirements placed on the latter and it extended virtually all of the deadlines in the 1972 Act For conventional pollutants a new treatment standard was created to replace the BAT standards The effluent limitations for these pollutants were to be based on the best con ventional technology and the deadline for these standards was set at July 1 1984 In setting these standards the EPA was required to consider whether the costs of adding the pollution control equipment were reasonable when compared with the improvement in water quality For unconventional pollutants and toxics any pollutant not specifically included on the list of conventional pollutants the BAT requirement was retained but the deadline was shifted to 1984 The final modification made by the 1977 amendments involved the introduction of pretreatment standards for waste being sent to a publicly owned treatment system These standards were designed to prevent discharges that could inhibit the treatment process and to prevent the introduction of toxic pollutants that would not be treated by the waste treatment facility Nonpoint Sources In contrast to the control of point sources the EPA was given no specific authority to regulate nonpoint sources This type of pollution was seen by Congress as a state responsibility Section 208 of the CWA authorized federal grants for stateinitiated planning that would provide implementable plans for areawide wastetreatment management Section 208 further Water Pollution 430 specified that this areawide plan must identify significant nonpoint sources of pollution as well as procedures and methods for controlling them The reauthorization of the Clean Water Act passed over President Reagans veto during February 1987 authorized an additional 400 million for a new program to help states control runoff but it still left the chief responsibility for controlling nonpoint sources to the states The main federal role for controlling nonpoint sources has been the Conservation Reserve Program run by the US Department of Agriculture rather than the EPA Designed to remove some 4045 million acres of highly erodible land from cultivation this act provides subsidies to farmers for planting grass or trees These subsidies are designed to result in reduced erosion and to reduce loadings of nitrogen phosphorus and total suspended solids Since the late 1980s efforts focused on nonpoint sources have increased dramatically Voluntary programs and costsharing programs with landowners have been the most common tools Section 319 of the Clean Water Act specifies guidelines for state implementation of nonpoint sourcemanagement plans In 2003 the EPA devoted a large portion of its Section 319 funds 100 million to address areas where nonpoint source pollution has significantly impaired water quality3 Another recent role for municipalities has been the separation of storm water and sewer drains so that sewage treatment plants do not overflow during rainstorms Federal subsidies have also assisted with these projects The TMDL Program In 1999 recognizing the problems with both the technologybased national effluent standards and the growing importance of nonpoint pollution control the US EPA proposed new rules designed to breathe fresh life into the previously unenforced Total Maximum Daily Load TMDL program of the Clean Water Act A TMDL is a calculation of the maximum amount of a pollutant that a water body can receive and still meet water quality standards as well as an allocation of that amount to the pollutants sources The calculation must include a margin of safety to ensure that the water body can be used for its designated purpose The calculation must also account for seasonable variation in water quality The TMDL program moves water pollution control toward the ambient standard approach long used to control air pollution Under this program water quality standards are promulgated by states territories andor tribes The promulgated standards are tailored to the designated uses for each water body such as drinking water supply or recreational uses such as swimming andor fishing The states must then undertake strategies for achieving the standards including significantly bringing nonpoint source pollutants under control The Safe Drinking Water Act The 1972 Act focused on achieving water quality sufficiently high for fishing and swimming Because that quality is not high enough for drinking water the Safe Drinking Water Act of 1974 issued more stringent standards for community water systems The primary drinking water regulations set maximum allowable concentration levels for bacteria turbidity muddiness and chemicalradiological contaminants National secondary drinking water regulations were also established to protect public welfare from odor and aesthetic problems that may cause a substantial number of people to stop using the affected water system The secondary standards are advisory for the states they cannot be enforced by the EPA The 1986 Amendments to the Safe Drinking Water Act required the EPA to 1 issue primary standards within three years for 83 contaminants and by 1991 for at least 25 more 2 set standards based on the BAT and 3 monitor public water systems for both regulated Water Pollution 431 and unregulated chemical contaminants Approximately 60000 public water systems are subject to these regulations Civil and criminal penalties for any violations of the standards were also increased by the amendments More recent drinking water rules and standards cover MTBE arsenic radon lead microbials and disinfection byproducts In 2007 the EPA issued a final ruling on lead and copper in drinking water two contaminants that enter through plumbing materials Many older homes have faucets or fittings of brass which contain some lead lead pipes or copper pipes with solder The Clean Water Rule The Clean Water Rule enacted by the Obama administration in 2017 was designed to take the existing federal protections on large water bodies and expand them to include the wetlands and small tributaries that flow into these larger waters This rule closed loopholes that had left streams wetlands at risk for pollution In 2015 The EPA and the US Department of the Army issued a report examining the costs and benefits of expanding the definition of the waters of the United States Their estimate concluded that the water protections would indeed come at an economic costbetween 236 million and 465 million annually but the report also concluded that the economic benefits of preventing water pollution would be much greater between 555 million and 572 million As we have seen throughout this book estimating both the costs and the benefits informs decision making on environmental policy Ocean Pollution Oil Spills The Clean Water Act prohibits discharges of harmful quantities of oil into navigable waters Since the EPA regulations define harmful to include all discharges that violate applicable water quality standards or cause a film or sheen upon the surface of the water virtually all discharges are prohibited Industry responsibilities include complying with Coast Guard regulations which deal with contingency planning in case of a spill and various accident avoidance requirements and assuming the financial liability for any accident If a spill does occur it must be immediately reported to the Coast Guard or the EPA Failure to report a spill can result in a fine up to 10000 andor imprisonment for up to 1 year In addition to giving notice the discharger must either contain the spill or pay the cost of cleanup by a responsible government agency The dischargers liability for the governments actual removal cost is limited to 50 million unless willful negligence or willful misconduct can be proved Successful proof of willful negligence or willful misconduct eliminates the liability limit In addition to cleanup costs removal costs also include compensation for damages to natural resources Natural resource damages are defined as any costs or expenses incurred by the federal government or any state government in the restoration or replacement of natural resources damaged or destroyed as a result of a discharge of oil Example 184 later in this chapter presents damage estimates for the Deepwater Horizon oil spill Ocean Dumping Except for oil spills which are covered by the Clean Water Act and the Oil Pollution Act of 1990 discharges to the ocean are covered by the Marine Protection Research and Sanctuaries Act of 1972 This act governs all discharges of wastes to ocean waters within US territorial limits and discharges of wastes in ocean waters by US vessels or persons regardless of where the dumping occurs With only a few exceptions no ocean Water Pollution 432 dumping of industrial wastes or sewer sludge is now permitted Radiological chemical and biological warfare agents and highlevel radioactive wastes are specifically prohibited by the statute Under the amended statute the only oceandumping activities permitted are the disposal of dredged soil fish wastes human remains and submerged vessels This dumping is subject to specific regulations and is approved on a casebycase basis Ocean Trash Similar to nonpoint source pollution floating trash found in the ocean comes from a variety of sources and is almost impossible to attribute to a particular location Marine debris in particular plastics are harmful to marine life that frequently mistakes plastics for food Ingesting the plastic objects many of which contain toxics kills thousands of sea birds and other sea life each year Sea turtles and albatross have both been known to mistake the plastics for food and feed pieces to their young The Great Pacific Garbage Patch also known as the Pacific Trash Vortex is a giant floating mass of marine garbage located in the North Pacific Ocean Scientists are not sure of its exact size but all of the estimates are enormous Few laws govern ocean trash except for explicit dumping Some states and countries have bans or fees for the use of plastic bags in grocery stores Hawaii has a statewide ban on plastic bags though it is difficult to enforce4 Efficiency and CostEffectiveness Recall that the efficient allocation of uncontaminated water requires marginal net benefits to be equalized across all uses as was illustrated in Figure 93 However if return flows are contaminated this can alter the efficient allocation5 Figure 182 demonstrates the effect of return flow contamination on the efficient allocation in the case of two users an upper basin UB user and a downstream lower basin LB user Efficiency dictates that water should be allocated at the point of equal marginal net benefits across the two users If the two users have identical marginal net benefits for uncontaminated water the two users should receive equal amounts of water recall Figure 94 However subtracting the effect of contaminated return flows from the upper basin marginal net benefit function MBUB internalizing this externality changes the efficient allocation to one with unequal sharing In particular more water would be allocated to the lower basin user QLB and less to the upper basin user QUB See Bennett 2000 for a more detailed discussion Accounting for water quality can be an important and oftenoverlooked factor in allocation decisions Ambient Standards and the ZeroDischarge Goal The 1956 amendments to the Water Pollution Control Act defined ambient standards as a means of quantifying the objectives being sought A system of ambient standards allows the control authority to tailor the quality of a particular body of water to its use Water used for drinking would be subject to the highest standards swimming the next highest and so on Once the ambient standards are defined the control responsibility could be allocated among sources Greater efforts to control pollution would be expended where the gap between desired and actual water quality was the largest Unfortunately the early experience with ambient standards for water was not reassuring Rather than strengthening the legal basis for the effluent standards while retaining their connection to the ambient standards Congress chose to downgrade the importance of ambient standards by specifying a zerodischarge goal Additionally the effluent standards were given Water Pollution 433 their own legal status apart from any connection with ambient standards The wrong inference was drawn from the early lack of legislative success In his own inimitable style Mark Twain 1893 put the essential point rather well We should be careful to get out of an experience only the wisdom that is in itand stop there lest we be like the cat that sits down on a hot stove lid She will never sit down on a hot stove lid againand that is well but also she will never sit down on a cold one anymore p 125 The most fundamental problem with the current approach is that it rests on the faulty assumption that the tougher the law the more that is accomplished The zerodischarge goal provides one example of a case in which passing a tough standard in the hopes of actually achieving a weaker one can backfire Kneese and Schultze 1975 point out that in the late 1960s the French experimented with a law that required zero discharge and imposed severe penalties for violations The result was that the law was never enforced because it was universally viewed as unreasonable Less control was accomplished under this stringent but unenforceable law than would have been accomplished with a less stringent but enforceable one Figure 182 Economic Efficiency When Return Flows Are Contaminated Source Adapted from Bennett L L 2000 The integration of water quality into transboundary allocation agreements Lessons from the southwestern United States Agricultural Economics 24 113125 Water Pollution 434 Is the US case comparable It appears to be In 1972 the EPA published an estimate of the costs of meeting a zerodischarge goal assuming that it was feasible They concluded that over the decade from 1971 to 1981 removing 8590 percent of the pollutants from all industrial and municipal effluents would cost 62 billion Removing all of the pollutants was estimated to cost 317 billion more than five times as much and this figure probably understates the true cost Kneese Schultze 1975 Is this cost justified Probably not for all pollutants though for some it may be Unfortunately the zerodischarge goal makes no distinction among pollutant types For some fund pollutants it seems extreme Perhaps the legislators realized this because when the legislation was drafted no specific timetables or procedures were established to ensure that the zerodischarge goal would be met by 1985 or for that matter anytime National Effluent Standards The first prong in the twopronged congressional attack on water pollution was the national effluent standards Deciding on the appropriate levels for these standards for each of the estimated 60000 sources is not a trivial task Not surprisingly difficulties arose Challenges with enforcement and allocating control responsibility were so prevalent that it took many years for the types of economic incentives we have seen for air pollution to emerge for water pollution In allocating the control responsibility among various sources the EPA was constrained by the inherent difficulty of making unique determinations for each source and by limitations in the Act itself such as the need to apply relatively uniform standards We know from Chapter 14 that uniform effluent standards are not costeffective but it remains an open question whether or not the resulting increases in cost are sufficiently large to recommend an alternative approach such as effluent charges or allowances The fact that the cost increases are large in the control of stationarysource air pollution does not automatically imply that they are large for water pollution control as well Municipal Wastewater Treatment Subsidies The second phase of the twopronged water pollution control program involves subsidies for wastewater treatment plants This program has run into problems as well ranging from deficiencies in the allocation of the subsidies to the incentives created by the program The Allocation of Funds Since the available funds were initially allocated on a firstcome firstserved basis it is not surprising that the funds were not spent in areas having the greatest impact It was not uncommon for example for completed treatment plants to dump effluent that was significantly cleaner than the receiving water Also federal funds have traditionally been concentrated on smaller largely suburban communities rather than on the larger cities with the most serious pollution problems The 1977 CWA amendments attempted to deal with this problem by requiring states to set priorities for funding treatment works while giving the EPA the right after holding public hearings to not only veto a states priority list but also to request a revised list This tendency to ensure that the funds are allocated to the highestpriority projects was reinforced with the passage of the Municipal Wastewater Treatment Construction Grant Amendments of 1981 Under this Act states were required to establish project priorities for targeting funds to projects with the most significant water quality and public health consequences Water Pollution 435 Operation and Maintenance This approach subsidized the construction of treatment facilities but provided no incentive to operate them effectively The existence of a municipal wastewater treatment plant does not by itself guarantee cleaner water The EPAs annual inspection surveys of operating plants in 1976 and 1977 found only about half of the plants performing satisfactorily Later surveys found that the general level of wastewater treatment performance had remained substantially unchanged from previous years When sewage treatment plants chronically or critically malfunction the EPA may take a city to court to force compliance with either a direct order or a fine Because of various constitutional legal barriers it is very difficult to force a city to pay a fine to the federal treasury Without an effective and credible sanction the EPA is in a difficult position to deal with municipalities Therefore the end of the treatmentplant malfunction problem cannot yet be pronounced with any assurance Capital Costs Due to the federal subsidies local areas ended up paying only a fraction of the true cost of constructing these facilities Since much of the money came from federal taxpayers local communities had less incentive to hold construction costs down The Congressional Budget Office 1985 estimated that substantially increasing the local share could reduce capital costs by as much as 30 percent Local areas would be expected to be more careful with their own money Pretreatment Standards To deal with untreatable hazardous wastes entering municipal wastewater treatment plants the EPA has defined pretreatment standards regulating the quality of the wastewater flowing into the plants These standards suffer the same deficiencies as other effluent standards they are not costeffective The control over wastewater flows into treatment plants provides one more aspect of environmental policy where economic incentive approaches offer yet another unclaimed opportunity to achieve equivalent results at a lower cost Nonpoint Source Pollution Nonpoint source pollution has become in many areas a significant part of the total problem In some ways the government has tried to compensate for this uneven coverage by placing more intensive controls on point sources Is this emphasis efficient It could conceivably be justified on two grounds If the marginal damages caused by nonpoint sources are significantly smaller than those of point sources then a lower level of control could well be justified Since in many cases nonpoint source pollutants are not the same as point source pollutants this is a logical possibility Or if the costs of controlling nonpoint sources even to a small degree are very high this could justify benign neglect as well Are either of these conditions met in practice Costs The research on economic incentives for nonpoint source pollution control is relatively thin as cost information is relatively scarce Some of the casespecific studies available however can give us a sense of the economic analysis Most of the available studies focus on nonpoint source pollution from agriculture McCann and Easter 1999 measured the size of transaction costs associated with various agricultural nonpoint source pollution control policies Transaction costs the administrative costs associated with implementing a policy are an important consideration for nonpoint source pollution control because monitoring costs tend to be much higher than for point Water Pollution 436 sources The net gain from implementing a policy is the abatement cost savings minus the transaction costs if the transaction costs are too high they can offset all or a major part of the abatement cost gains from implementing the policy McCann and Easter looked specifically at the Minnesota River where severe water quality problems made the river unswimmable unfishable and uncanoeable near the Twin Cities Four policies aimed at reducing agricultural sources of phosphorus were considered education about best management practices a conservation tillage requirement expansion of a program that obtained permanent development rights and a tax on phosphorus fertilizers They found that a tax on phosphorus fertilizers had the lowest transaction costs 094 million Educational programs had the secondlowest transaction costs at 311 million Conservation tillage and expansion of the conservation easement program had the highest transaction costs at 785 million and 937 million respectively In terms of transaction costs their results suggest a comparative advantage for input taxes relative to the other approaches However since the price elasticity of demand for phosphorus fertilizers is low it has been estimated at between 025 and 029 a considerable tax increase would be needed to guarantee the desired level of waterquality improvements Schwabe 2001 examines various policy options for nonpoint source pollution control for the Neuse River in North Carolina He compares costeffectiveness of both the initial and final proposed rules considered by the State of North Carolina In 1998 nutrient loads in the Neuse River basin were so high that the basin received a nutrient sensitive waters classification6 In the 2 years prior to his study two large swine waste spills caused major algal blooms and killed 11 million fish The state of North Carolina initially proposed a rule requiring all farms with land adjacent to a stream to install vegetative filter strips This was compared to a uniform rollback that measured loadings by county with the objective of a 30 percent reduction in total nitrogen loadings Using a leastcost mathematical programming model Schwabe finds that the uniform rollback is the more costeffective strategy especially since the 30 percent reduction target would be unlikely to be met using the vegetative strips However the author notes that the dominance of the uniform strategy is specific to this particular setting and should not be taken as a general proposition Despite this evidence the regulatory reform movement that played such an important role for air pollution control has been much slower to emerge for water pollution control An early attempt at trading was implemented for the Fox River in Wisconsin but only one trade was completed in the first 10 years after implementation WatershedBased Trading More recently watershedbased trading programs have been gaining attention In 1996 the EPA began exploring trading programs for the TarPamlico River in North Carolina Long Island Sound Chesapeake Bay and the Snake and Lower Boise rivers in Idaho Dozens more followed Worldwide 57 trading programs are now in various stages of operation 26 active 21 under development and ten inactive All but six of these are in the United States Selman et al 2009 Trading for water pollution control typically involves point source polluters meeting water quality standards by purchasing reductions from other sources point or nonpoint sources that have lower marginal costs of abatement Most of the markets currently in place focus on either nitrogen or phosphorus trading and most are too new to evaluate but at least 23 US water trading programs have carried out at least one trade for some examples see Table 182 The six trading programs outside of the United States include four in Australia three of which are active and one under development one in Canada and one in New Zealand Selman et al 2009 Water Pollution 437 Table 182 Summary of NPDES Trading Programs that Have Traded at Least Once as of June 2007 PointPoint Trades Pollutants Traded PointNonpoint Trades Pollutants Traded Long Island Sound CT Total Nitrogen Wayland Center MA Total Phosphorus Bear Creek CO Total Phosphorus Croton Watershed NY Total Phosphorus Neuse River NC Total Nitrogen Pinnacle DE Total Nitrogen Total Phosphorus Charlotte Mecklenburg NC Total Phosphorus Rahr Malting MN Offset Biological Oxygen Demand with Total Phosphorus Cobb County GA Total Phosphorus Southern MN Beetsugar Cooperative MN Total Phosphorus City of Newman GA Total Phosphorus Red Cedar River WI Total Phosphorus MN General Permit Total Phosphorus Great Miami River OH Total Nitrogen Total Phosphorus Las Vegas Wash NV Total Ammonia Total Phosphorus Taos Ski Valley NM Total Nitrogen Carlota Copper AZ Copper Clean Water Services OR Temperature Cherry Creek CO Total Phosphorus Chatfield Res CO Total Phosphorus Lake Dillon CO Total Phosphorus Source Table from Summary of NPDES Trading Programs that have Traded at Least Once as of June 2007 Retrieved from wwwecosystemmarketplacecompagesdynamicarticlepagephp pageid5335sectionhomeeod1 Reprinted with permission of Ecosystem Marketplace EXAMPLE 181 Effluent Trading for Nitrogen in Long Island Sound Long Island Sound experiences severe hypoxia low levels of dissolved oxygen during the summer months This eutrophication is caused primarily by excess nitrogen discharges from municipal sewagetreatment plants As discussed earlier in this chapter most past policies for water pollution control focused on technology standards to control discharges Economic theory suggests that lower costs can be achieved by providing flexibility to the plants via a permittrading program In the late 1990s Connecticut New York and the US EPA began exploring this possibility for sewage treatment plants with discharges reaching Long Island Sound The plan targeted trading Water Pollution 438 to certain management zones The overall goal of this management plan was a 585 percent reduction in nitrogen over 15 years beginning in 1999 Bennett et al 2000 estimate the costs associated with the proposed scheme whereby trading is restricted to the 11 management zones designated by the Long Island Sound Study They then estimate the cost savings of alternative programs that expand the zone of trading to 1 trading among sources and across zones but within state boundaries and 2 trading across all sources For each trading scenario polluting sources are grouped into trading bubbles that are based on geographic location Trading is allowed to take place within each bubble but not among bubbles Bennett et al find what economic theory would predictthat cost savings rise and rise substantially as the scope of trading expands meaning fewer bubbles Expanding trading across the two state bubbles could save up to 20 percent or 156 million based on their estimates The following table is reproduced from their results Number of Trading Bubbles Present Value of Total Costs million Cost Savings Relative to 11 Bubbles million Percentage Savings 11 78144 2 74055 4089 523 1 62514 15630 2000 Not all discharges have the same impact In fact discharges from zones in the eastern portion of Long Island Sound and the northern parts of Connecticut do not have as detrimental effects as those closer to New York City Despite differences in abatement cost the proposed management plan recommends that each management zone be responsible for an equal percentage of nitrogen reduction While marginal abatement costs vary widely across management zones suggesting that trades could reduce costs the marginal contributions to damages also vary widely thus ruling out a simple system of tonforton effluent trades As Chapter 14 pointed out more complicated ambient trades would be required to achieve costeffectiveness for this nonuniformly mixed pollutant Currently in recognition of this complexity trading is not being considered across the boundaries of the 11 management zones despite the apparent potential cost savings Between 2002 and 2004 Connecticuts Long Island Sound program reduced more total nitrogen via trading than was needed to meet the TMDL requirement Between 2002 and 2009 155 million nitrogen credits were exchanged at a total value of 459 million Cost savings through trading are estimated at 300 to 400 million The credit price in 2002 was 165 and rose to 454 in 2009 As it turns out however the price is set by the state and trades go through the nitrogen credit exchange so potential gains from trade resulting from allowance price fluctuations are not captured Source Bennett L L Thorpe S G Guse A J December 2000 Costeffective control of nitrogen loadings in Long Island Sound Water Resources Research 3612 37113720 Kibler V Kasturi K 2007 Status of water quality trading programs today Katoomba Groups Ecosystem Marketplace Retrieved from wwwecosystemmarketplacecom Connecticut Department of Environmental Protection 2010 Retrieved from wwwctgovdeepcwpview aspa2719q325572deepNavGID163520 Water Pollution 439 Ex ante studies however suggest that the economic benefits can be large Example 181 illustrates the potential for tradable effluent cost savings for treating hypoxic low levels of dissolved oxygen conditions in Long Island Sound Allowing firms the flexibility to exploit economies of scale in pollutioncontrol technology can provide for large savings This point point trading program has resulted in cheaper and faster cleanup The EPA supports marketbased programs for certain pollutants if they can help meet Clean Water Act goals In 2008 the EPA issued a Water Quality Trading Evaluation and found significant cost savings and nutrient nitrogen and phosphorus reductions for the trading programs they evaluated Comparing across programs is somewhat challenging however since they do not all rely on the same trading mechanism Some trades are casebycase while others are openmarket trades Some rely on a broker while others operate through direct negotiations And some are not based on market mechanisms at all7 Watershedbased trading is complicated by the difficulties of accounting for spatial distribution of pollutants thus requiring complicated trading ratios Olmstead 2010 A trading ratio ensures that the reduction in pollution after a trade is equal to the required reduction Important features of the trading ratio are the location of the sources the distance between buyers and sellers uncertainty if nonpoint source pollutants are involved and whether or not the pollutant is equivalent after discharge Complicated trading ratios may be one barrier to trade Using the Upper Ohio River Basin as a case study Farrow et al 2005 demonstrate that social costs can be minimized if trading ratios are based on relative damages between sources Of course calculating the damages remains a challenge Water quality trading is frequently complicated by measurement and enforcement challenges especially for nonpoint sources abatement cost differentials sufficient trading volumes and trading flexibility FisherVanden Olmstead 2013 Where markets are thin few traders or when cost differentials are slight there will be very few feasible trades Large differences in marginal abatement costs can result in the largest gains from trade the most significant gains are likely to come from pointnonpoint source trades Lack of flexibility in trading over time and space has also inhibited water quality trading FisherVanden Olmstead 2013 The fact that point and nonpoint sources have received such different treatment from the EPA however suggests the possibility that costs could be lowered by a more careful balancing of these control options Point sources have received the most attention and have cleaned up considerably Nonpoint sources have received very little attention This suggests that perhaps the marginal cost of additional abatement for point sources is now sufficiently high that it justifies moving control toward nonpoint sources Figure 183 portrays the current situation The marginal cost of abatement of point sources MCPS is everywhere lower than the marginal cost of abatement of nonpoint sources MCNPS However with policy focus on the point source the point source has cleaned up meaning that source is on a higher portion of its marginal cost curve Without policy addressing the nonpoint source the nonpoint source is still at zero cleanup Now comparing the two at their different cleanup levels the nonpoint source has a lower marginal cost of abatement Consider a scenario in which point sources have already cleaned up 50 percent of their discharges point d in Figure 183 and the nonpoint source has cleaned up none Suppose the regulatory agency is seeking additional cleanup of 10 percent Can you see how the total cost of this additional abatement would be less for the nonpoint source than the point source The point source could clean up 10 percent at a total cost of area defg Or the nonpoint source could clean up the same amount for the smaller cost of area 0abc In other words the total cost for the point source of additional cleanup or area defg is more than the total cost for the same amount of cleanup from the nonpoint source 0abc These two sources can reduce total cost by trading until marginal cost is equalized at the dotted line After that point all gains from trade would be eliminated Water Pollution 440 Such a scenario also offers an incentive for point sourcenonpoint source trading One situation like this happened in Colorado An Industrial Economics Inc 1984 study of phosphorus control in the Dillon reservoir in Colorado provides empirical support that such pointnonpoint trading could be more costeffective In this reservoir four municipalities constitute the only point sources of phosphorus while numerous uncontrolled nonpoint sources are in the area The combined phosphorus load on the reservoir from point and nonpoint sources was projected to exceed its assimilative capacity The traditional way to rescue the projected phosphorus load would be to impose even more stringent controls on the point sources The study found however that by following a balanced program controlling both point and nonpoint sources the desired phosphorus target could be achieved at a cost of approximately 1 million a year less than would be spent if only point sources were controlled more stringently The more general point to be carried away from this study is that as point sources are controlled to higher and higher degrees rising marginal control costs will begin to make controlling nonpoint sources increasingly attractive As the list of 13 pointnonpoint trades in Table 182 demonstrates we have apparently already reached that point Trades can sometimes achieve greater effluent reductions in addition to cost savings Kibler and Kasturi 2007 describe one case for which reductions have actually been much greater than anticipated When the Southern Minnesota Sugar Beet Industry needed to offset 6500 pounds of total phosphorus per year they actually achieved 15767 pounds per year reductions by trading Does your state have a water pollutant trading program Water Quality WatershedBased Trading and GIS Land use change see Chapter 10 significantly affects watershed health8 Agricultural and urban runoff into rivers streams and estuaries is the largest contributor to water pollution Hascic and Wu 2006 use digital land use maps to examine the relationship between land use and water quality They find that the levels of nutrient and conventional water pollutants are significantly affected by the amount Figure 183 Potential Cost Savings with Trading across Point and Nonpoint Sources Water Pollution 441 of land in agriculture and urban development while the level of toxic pollution is dependent on land in transportation or mining Their results suggest that water quality trading programs should take into account land uses within the watershed as well as the overall watershed health GIS technology is a powerful tool for understanding these relationships Atmospheric Deposition of Pollution An additional complexity comes in the form of the nonpoint source pollution from the atmosphere that ends up in water bodies Airborne pollutants such as sulfur dioxide mercury and nitrogen eventually find their way to rivers and lakes via atmospheric deposition Wet deposition refers to pollutants that travel to the ground with rainfall Dry deposition occurs when pollutants become too heavy and fall to the ground even in the absence of precipitation Debate 181 highlighted some of the issues surrounding one approach to dealing with air borne depositionfish consumption advisories due to mercury levels found in many fish A quite different complication for water pollution control stems from a lack of coordination with air quality regulations Simply put they may or may not take into consideration the impacts of the air quality regulation on the soil or in the water The external benefits from air quality improvements are likely to be quite large What does this suggest about the optimal level of air quality and the fact that air and water quality are controlled by separate offices within EPA The European Experience European water legislation originated in the 1970s with standards for drinking water and set targets for fish and shellfish bathing and groundwater In 1988 a second phase of water legislation began with the adoption of the Urban Waste Water Treatment Directive a Nitrates Directive and a revised Drinking Water Objective In 1996 a Directive for Integrated Pollution and Prevention Control IPPC was adopted to address pollution from large industrial installations9 Economic incentives have been important in water pollution control in Europe where effluent charges play a prominent role in a number of countries These charge systems have taken a number of forms One common approach illustrated by the former Republic of Czechoslovakia used charges to achieve predetermined ambient standards Others such as the former West Germany used charges mainly to encourage firms to control more than their legal requirements A third group illustrated by Hungary and the former East Germany combined charge systems with effluent standards The former Republic of Czechoslovakia used effluent charges to maintain water quality at predetermined levels for several decades A basic charge was placed on BOD and suspended solids and complemented by a surcharge ranging from 10 to 100 percent depending upon the contribution of the individual discharge to ambient pollutant concentrations The basic rates could be adjusted to reflect the quality of the receiving water This system is conceptually very close to the ambient emissions charge system known to be costeffective The charge system in the former West Germany was announced in 1976 and implemented in 1981 The level of charge was related to the degree of compliance with the standards Firms failing to meet their required standards paid a charge on all actual emissions If according to the issued permit federal emissions standards which are separately defined for each industrial sector were met the charge was lowered to 50 percent of the base rate and was applied to the level of discharge implied by the minimum standard If the discharge was lower than 75 percent of minimum standards onehalf of the base rate was applied to the lower actual discharge level The charge was waived for 3 years prior to the installation of new pollution Water Pollution 442 control equipment promising further reductions of at least 20 percent Revenues from the charges could be used by the administering authorities for administrative costs and financial assistance to public and private pollution abatement activities The approach used in Hungary and the former East Germany combined effluent charges with effluent standards The charges are levied on discharges in excess of fixed effluent limits In the Hungarian system the level of the charge is based on the condition of the receiving waters among other factors Initially the Hungarian charges had little effect but when the charge levels were raised a flurry of wastewater treatment activity resulted France charges an effluent tax that is proportional to the quantity of the pollution The revenues are then used for subsidizing wastewater treatment Though these European approaches differ from one another and are not all costeffective their existence suggests that a variety of effluent charge systems are possible and practical The German Council of Experts on Environmental Questions estimated the German effluent charge policy to be about onethird cheaper for the polluters as a group than an otherwise comparable uniform treatment policy Furthermore it encouraged firms to go beyond the uniform standards when it was costjustified In a very different approach Bystrom 1998 examines reducing nonpoint source nitrogen pollution by constructing wetlands in Sweden where reducing nitrogen loads to the Baltic Sea is an important policy goal Although it is well known that wetlands can help reduce nitrogen concentrations through the uptake of biomass how costeffective is this approach when it is compared to alternative more traditional methods of control To answer this question Bystrom estimates nonpoint source abatement costs for constructed wetlands and compares them to the costs of reducing nitrogen by means of landuse changes such as the planting of fuel woods This study finds that marginal abatement costs for wetlands are lower than transitioning to different crops but still higher than the marginal costs of simply reducing the use of nitrogen fertilizer The European Water Framework Directive WFD was adopted in October of 2000 with a goal of achieving good status for all ground and surface waters rivers lakes transitional waters and coastal waters in the EU by 2015 Ek and Persson 2016 evaluate the implementation of the WFD in Sweden and find that costeffectiveness is challenged by the complexities of water management While the directive emphasizes the role of economic tools the goals are not based on economic efficiency The absolute targets make designing an effective economic instrument challenging at best The existing system in Sweden is also based primarily on command and control In the Netherlands and in France charges have been used for heavy metals and other discharges with revenues going toward water infrastructure Olmstead 2010 Effluent is not the only water pollution problem Plastics are a growing source of pollution much of which ends up in the ocean Ireland was the first country to tax the use of plastic bags Example 182 examines the effect of the Irish bag levy Developing Country Experience The move from commandandcontrol regulations to economic incentives for water pollution control has not seen as rapid a transition in developing countries Several attempts to use discharge fees and marketable permits have failed This may be due to lack of regulatory capacityfor example lack of technical political and financial means to set up and monitor a fee or permit program effectively Noncompliance and lack of infrastructure have hampered many programs Example 183 explores Colombias experience with a discharge fee program one case deemed successful Water Pollution 443 For developing countries water pollution control is further complicated by poverty lack of enforcement and lack of technology Deaths from waterborne diseases are much more frequent in developing countries Of the 16 million deaths in 2003 attributed to water and sanitation 90 percent were children under 5 and most were from developing countries In 2004 2331 EXAMPLE 182 The Irish Bag Levy Rapid economic growth in Ireland in the 1990s was marked by a significant increase in the amount of solid waste per capita The lack of adequate landfill sites resulted in escalating costs of waste disposal which in turn led to more illegal dumping and littering It was feared that tourism one of Irelands largest industries would be negatively affected as a consequence of the degradation of the environment The food industry which based a significant amount of its marketing strategies on a healthy wholesome reputation also suffered as a result of the public perception of its role in the increased litter The most visible element of litter was plastic bags so in 2002 the government introduced the Plastic Bag Environmental Levy on all plastic shopping bags the PlasTax with a few exceptions that were sanctioned for health and safety reasons Retailers were charged a fee of 15 cents per plastic bag which they were obliged by the government to pass on to the consumer This levy was designed to alter consumer behavior by creating financial incentives for consumers to choose more environmentally friendly alternatives to plastic such as bagsforlife Bagsforlife are heavyduty reusable cloth or woven bags which were made available in all supermarkets at an average cost of 127 Expectations that this levy would bring about a 50 percent reduction in the number of plastic bags used were exceeded when the estimated actual reduction turned out to be 95 percent In a single year Irish consumers reduced their consumption of plastic bags from 126 billion to 120000 while concurrently raising approximately 10 million in revenue for the government Placed in the Environmental Fund this revenue finances environmental initiatives such as recycling waste management and most importantly antilitter campaigns This levy has been viewed as a major success by the government and environmental groups alike It has also been enthusiastically embraced by Irish consumers thanks to an intensive environmentalawareness campaign that was launched in conjunction with the levy Irish retailers although skeptical in the beginning have also recognized the huge benefits of this levy Estimates suggest that their costs were offset by the savings from no longer providing disposable bags to customers free of charge as well as the profit margin earned on the sale of bagsforlife whose sales have increased by 600700 percent since the introduction of the levy The amount of plastic being sent to Irish landfills has been dramatically reduced bringing about a clear visual improvement The success of this case has promoted the diffusion of this idea For example in 2008 China banned superthin plastic bags and imposed a fee on other plastic bags Source Dungan L What were the effects of the plastic bag environmental levy on the litter problem in Ireland Retrieved from httppersonalcolbyedupersonaltthtietenlitterhtm Water Pollution 444 EXAMPLE 183 Economic Incentives for Water Pollution Control The Case of Colombia In 1997 Colombia experimented with a new nationwide program of pollution discharge fees Polluters would be charged per unit of pollution emitted Colombia has 33 regional environmental authorities CARs some of which had discharge fees in place for 30 years This was the first nationwide program This new program mandated that CARs would first collect and map out data on all discharging facilities that generated biological oxygen demand BOD and total suspended solids TSS They were then to set 5year reduction goals for aggregate discharge in each basin and charge a fee per unit of BOD and TSS The ministry set a minimum fee but CARs could adjust this fee upward every 6 months if reduction targets were not being met The program ran into several problems including uneven levels of implementation across CARs incomplete coverage of dischargers and widespread noncompliance by municipal sewage authorities Between the start of the program in 1997 and 2003 municipal sewage authorities were assessed over 30 percent of all discharge fees but only paid 40 percent of what they were charged Given that some CARs were raising fees based on meeting reduction targets noncompliance by one group of dischargers was responsible for large rate hikes for others Was the Colombia program thus unsuccessful Surprisingly evidence actually suggests it was successful In a number of basins discharges dropped significantly between 1997 and 2003 BOD discharge from point sources in the program dropped by 27 percent and TSS discharges fell by 45 percent One suggested reason for the apparent success of the program is that previously lacking enforcement had to be improved simply to set up a discharge program Collecting infor mation on discharge amounts and locations is also a necessary component for successful implementation Increased transparency over commandandcontrol programs contrib uted to the programs success The author of this study suggests that one of the most important components of a successful program is adequate infrastructure Source Blackman A Spring 2006 Economic incentives to control water pollution in developing countries How well has Colombias wastewater discharge fee program worked and why Resources 2023 deaths from cholera occurred in Africa No deaths from cholera were recorded in the Americas According to the World Health Organization improved water supply reduces diarrhea morbidity by 625 percent and improved sanitation reduces diarrhea morbidity by 32 percent A study on the costs and benefits of meeting the United Nations Millennium Development Goal of halving the proportion of people without sustainable access to improved water supply and sanitation determined it would definitely bring economic benefits ranging from US3 to US34 per US dollar invested depending on the region Additional improvement of drinking water quality such as Water Pollution 445 pointofuse disinfection in addition to access to improved water and sanitation would lead to benefits ranging from US5 to US60 per US dollar invested Hutton Haller 2004 China has implemented a different approach to enforcement than the type of sanction commonly used in the United States and Canada China imposes a graduated pollution levy where the perunit fine rises with the level of noncompliance Wang Wheeler 2005 China also relies on selfreporting Wang and Wheeler examine data from 3000 Chinese factories and estimate a model that incorporates the joint determination of levy and emissions They show that progressive penalties combined with selfreporting are a significant deterrent Regional variation in local enforcement however is a factor and inhibits universal compliance Oil SpillsTankers and OffShore Drilling One of the chief characteristics of the current approach to oil spills is that it depends heavily on the ability of the legal system to internalize the costs of a spill through liability law In principle the approach is straightforward Consider how liability for spills might affect the incentives for a tanker fleet Forcing the owner of a vessel to pay for the costs of cleaning up the spill including compensation for natural resource damages creates a powerful incentive to exercise care But is the outcome likely to be efficient in practice One problem with legal remedies is their high administrative cost assigning the appropriate penalties is no trivial matter Even if the court were able to act expeditiously the doctrines it imposes are not necessarily efficient since the financial liability for cleaning up spills is limited by statute This point is demonstrated in Figure 184 which depicts the incentives of a vessel owner to take precautions The owner will minimize costs by choosing the level of precaution that equates the marginal cost of additional precaution with the resulting reduction in the marginal expected penalty The marginal reduction in expected penalty is a function of two factors the likelihood of a spill and the magnitude of financial obligation it would trigger This function slopes downward because larger amounts of precaution are presumed to yield smaller marginal reductions in both the likelihood and magnitude of resulting accidents Figure 184 Oil Spill Liability Water Pollution 446 The vessel owners costminimizing choice with unlimited liability is shown as Q As long as the imposed penalty equaled the actual damage and the probability of having to pay the damage once an accident occurred was 10 this outcome would normally be efficient The external costs would be internalized The owners private costs would be minimized by taking all possible costjustified precaution measures to reduce both the likelihood and the seriousness of any resulting spill taking precautions would simply be cheaper than paying for the cleanup Limited liability however produces a different outcome With limited liability the expected penalty function rotates inward for levels of precaution lower than that level that would produce an accident resulting in damages exactly equal to the limit10 Lower levels of precaution imply damages that exceed the limit but the vessel owner would not have to pay anything above the limit The only benefit to the vessel owner faced with limited liability of increasing precaution at lower levels of precaution is the reduction in the likelihood of a spill in this range increasing precaution does not reduce the magnitude of the financial payment should a spill occur The deviation in the magnitude of the limited expected penalty function from the normal expected penalty function is greatest at lower levels of precaution it declines to zero at that precaution level where the expected magnitude of an accident is equal to the liability limit What is the effect of limited liability on the vessel owners choice of precaution levels As long as the liability limit is binding which appears to routinely be the case with recent spills the owner will choose too little precaution The owners choice is shown as Q in Figure 183 Both the number and magnitude of resulting spills would be inefficiently large11 GarzaGil et al 2006 estimate the economic losses from the Prestige oil spill off the Spanish city of Galicia Ultimately 63000 tons were spilled Table 181 and the tanker sank This spill was considered one of the worst tanker spills due not only to the size of the spill but also to the black tides caused by the spill in valuable tourist regions of Northern Spain and Southern France GarzaGil et al consider shortterm immediately following the spill damages to the fishing industry and the tourism sector and find losses of almost 200 million euros Including cleanup and restoration costs brings the total to 762 million euros They were not able to include lost recreation opportunities or passive usevalue losses The current international liability framework does not allow for the inclusion of these values Recall the importance of these for the Exxon Valdez damage estimates discussed in Chapter 4 What effect would omitting these values be expected to have on the incentives for riskaversion by tanker owners While the frequency of spills from tankers has diminished significantly offshore drilling has been increasing the risk of spills In 2010 the Deepwater Horizon a rig operated by British Petroleum BP exploded in the Gulf of Mexico spewing 134 million gallons of oil the largest spill on record in the United States Example 184 examines the economic damages from this spill Increasing interest in offshore drilling especially in the Arctic waters raises the risk of more spills like this one An Overall Assessment Although the benefit estimates from water pollution control are subject to much uncertainty they do exist One early study concluded that the net benefits from water pollution control policy were positive but were likely to become negative as costs escalate in the future Relying on benefits estimates derived from contingent valuation Carson and Mitchell 1993 estimated that aggregate benefits from water pollution control in 1990 exceeded aggregate costs by 64 billion They also found however that projected aggregate costs would exceed projected Water Pollution 447 EXAMPLE 184 Deepwater Horizon BP Oil SpillEstimating the Damages In the spring of 2010 the Deepwater Horizon a rig operated by British Petroleum BP in the Gulf of Mexico exploded and began spewing oil By the time the leaking well was capped in August 2010 an estimated 134 million gallons had been spread through the Gulf of Mexico almost 20 times greater than the Exxon Valdez spill and the largest maritime spill in US history In 2016 after a sixyear study of the impacts economists estimated the damages to the natural resources from the spill at 172 billion This number represents the benefits to the public to protect against damages that could result from a future oil spill in the Gulf of a similar magnitude12 Using the first nationally represented stated preference survey recall from Chapter 4 Bishop et al 2017 estimated the monetary value of natural resource damages from the spill They interviewed a random sample of American adults Respondents were told about the state of the Gulf prior to the spill and about the accidentcauses and injuries They were then told about a proposed program for preventing a similar accident Respondents were asked how much their household would be willing to pay for a one time tax based on their income to prevent future spills The money would be used to pay for a second pipe safety feature intended to prevent a spill like this There were two versions of the survey Version A described the harm to three items birds brown pelicans northern gannets and royal terns marshes and recreation Version B described harm to more animals and plants including snails sea turtles and bottlenose dolphins13 Using stateoftheart survey design techniques they used a combined approach of both mail surveys and facetoface interviews They specifically tried to reduce bias including social desirability bias Social desirability bias occurs when respondents try to present themselves in a favorable light the common example being voters claiming to have voted when they did not Survey administrators were concerned that respondents might over exaggerate their willingness to pay given the scenario The alternative was that they might underestimate or protest their willingness to pay given that taxation for Americans is frequently seen as socially undesirable They did not receive a large number of protest votes even though the payment vehicle was increased taxes The Oil Pollution Act of 1990 specifies that both use and nonuse values be included in natural resource damage assessments and these assessments can inform settlements It also allows for damages to be assessed for the losses experienced by the entire US population The calculation of total economic loss is conducted by multiplying the estimated population lower bound marginal willingness to pay MWTP by the appropriate number of households For Version A the point estimate of economic losses is 15332412434 112647215 households multiplied by 13611 For Version B the point estimate of economic losses is 17236150367 112647215 households multiplied by 15301 The case was settled in 2016 for 208 billion of which 88 billion was for natural resource damages This amount is in addition to the approximately 30 billion already spent on cleanup Sources wwwfwsgovdoiddatadwhardocuments980DWHAR0290376apdf wwwfwsgov doiddatadwhardocuments980DWHAR0290122apdf wwwfwsgovdoiddatadwh ardocuments980DWHAR0302133pdf Bishop R C et al 2017 Putting a value on injuries to natural assets The BP oil spill Science 3566335 253254 Water Pollution 448 aggregate benefits because of the high marginal costs and the low marginal benefits associated with bringing the remaining bodies of water up to swimmable quality Griffiths and Wheeler 2005 summarize the costs and benefits of the most economically significant14 water quality rules that are subject to benefitcost analysis For the five rules that relate to surface water they find that two of them do not pass a benefitcost analysis and for the other three the range of benefits estimates bounds the costs They point out that policies do not necessarily have to pass a benefitcost test to be adopted benefitcost calculations are simply one source of information for the decisionmaking process Using costeffective policies rather than the current approach it would be possible to reduce costs substantially without affecting the benefits Costeffectiveness would require the development of better strategies for point source control and for achieving a better balance between point and nonpoint source control The resulting reduction in costs probably would allow net benefits to remain positive even with the more stringent control levels envisioned for the future Even positive net benefits would not necessarily make the policy efficient however because the level of control might still be too high or too low meaning the present value of net benefits would not have been maximized Unfortunately the evidence is not rich enough to prove whether the overall level of control maximizes the net benefit In addition to promoting current costeffectiveness economic incentive approaches would stimulate and facilitate change better than a system of rigid technologybased standards Russell 1981 assessed the importance of the facilitating role by simulating the effects on the allocation of pollutioncontrol responsibility in response to regional economic growth changing technology and changing product mix Focusing on the steel paper and petroleumrefining industries in the 11county Delaware Estuary Region his study estimated the change in permit use for three water pollutants BOD total suspended solids and ammonia that would have resulted if a marketable permit system had been in place over the 19401978 period The calculations assume that the plants existing in 1940 would have been allocated permits to legitimize their emissions at that time that new sources would have had to purchase permits and that plant shutdowns or contractions would free up permits for others to purchase This study found that for almost every decade and pollutant a substantial number of permits would have been made available by plant closing capacity contractions productmix changes andor by the availability of new technologies In the absence of a marketable permit program a control authority would not only have to keep abreast of all technological developments so emissions standards could be adjusted accordingly but it would also have to ensure an overall balance between effluent increases and decreases so as to preserve water quality This tough assignment is handled completely by the market in a tradable permit system thereby facilitating the evolution of the economy by responding flexibly and predictably to change Tradable effluent permits encourage as well as facilitate this evolution Since permits have value in order to minimize costs firms must continually be looking for new opportunities to control emissions at lower cost This search eventually results in the adoption of new technologies and in the initiation of changes in the product mix that result in lower amounts of emissions The pressure on sources to continually search for better ways to control pollution is a distinct advantage that economic incentive systems have over bureaucratically defined standards Water Pollution 449 Summary Historically policies for controlling water pollution have been concerned with conventional pollutants discharged into surface waters More recently concerns have shifted toward toxic pollutants which apparently are more prevalent than previously believed toward groundwater which traditionally was thought to be an invulnerable pristine resource and toward the oceans which were mistakenly considered immune from most pollution problems because of their vast size Early attempts at controlling water pollution followed a path similar to that of air pollution control Legislation prior to the 1970s had little impact on the problem Frustration then led to the enactment of a tough federal law that was so ambitious and unrealistic that little progress resulted There the similarity ends Whereas in air pollution a wave of recent reforms have improved the process by making it more costeffective little parallel exists for control of water pollution Policy toward cleaning up rivers and lakes was based upon the subsidization of municipal wastetreatment facilities and national effluent standards imposed on industrial sources The former approach was hampered by delays by problems in allocating funds and by the fact that about half of the constructed plants were not performing satisfactorily The latter approach gave rise to delays and to the need to define the standards in a series of court suits In addition effluent standards have assigned the control responsibility among point sources in a way that excessively raises cost Nonpoint pollution sources have until recently been virtually ignored Technological progress is inhibited rather than stimulated by the current approach This lack of progress could have been avoided It did not result from a lack of toughness Rather it has resulted from a reliance on direct regulation rather than on emissions charges or tradable effluent permits which are more flexible and costeffective in both the dynamic and static sense Recognizing this deficiency watershedbased new trading programs are now gaining attention The European Water Framework Directive by contrast has focused on economic tools but not necessarily economic efficiency It is largely the court system that controls oil spills in that it ensures that those responsible for the spills assume the financial liability for cleaning up the site and compensating for any resulting damages to natural resources While in principle this approach can be efficient in practice it has been hampered by liability limitations and the huge administrative burden an oil spill trial entails Discussion Questions 1 The only permanent solution to water pollution control will occur when all production byproducts are routinely recycled The zerodischarge goal recognizes this reality and forces all dischargers to work steadily toward this solution Less stringent policies are at best temporary palliatives Discuss 2 In exercising its responsibility to protect the nations drinking water the government needs to intervene only in the case of publicwater supplies Privatewater supplies will be adequately protected without any government intervention Discuss 3 The Deepwater Horizon BP oil spill in the Gulf of Mexico was the largest spill in US history How do natural resource damage assessments such as the one presented in Example 184 help decision makers who may be grappling with increased wellpermitting requests Do the benefits outweigh the risks Water Pollution 450 SelfTest Exercises 1 Consider the situation posed in Problem 1a in Chapter 14 a Compute the allocation that would result if ten tradable effluent permits were given to the second source and nine were given to the first source What would be the market permit price How many permits would each source end up with after trading What would the net permit expenditure be for each source after trading b Suppose a new source entered the area with a constant marginal cost of control equal to 1600 per unit of emission reduced Assume further that it would add ten units in the absence of any control What would be the resulting allocation of control responsibility if the cap of only 19 total units of effluent allowed were retained How much would each firm clean up What would happen to the permit price What trades would take place 2 Suppose you have three production facilities that are polluting a river Each emits ten units of pollution Their marginal cost functions for reducing emissions are respectively MC1 3 MC2 4 and MC3 5 a If the objective is to cut emissions in half to 15 costeffectively how much reduction should be assigned to each firm b What would be the total variable cost of controlling these emissions c What would be the total variable cost that would result from forcing each facility to control onehalf of its emissions Is this different from the cost associated with the costeffective allocation Why or why not Notes 1 The danger of anaerobic conditions is highest in the late summer and early fall when temperatures are high and the stream flow is low 2 Actually the ambient standards were not completely bypassed If the uniform controls were not sufficient to meet the desired standard the effluent limitation would have to be tightened accordingly 3 US Federal Register Vol 68 No 205 October 2003 4 For a full list of legislation on plastic bags see wwwncslorgissuesresearchenvresplastic baglegislationaspx 5 Return flow is a measure of the unused portion of water For example in agriculture water withdrawal is the amount of water taken from a source and applied to a field Consumptive use is the amount actually used by the plant Return flow is the unconsumed portion that will eventually return to the watercourse and is frequently claimed by a downstream user Return flows will bring with them leached contaminants pesticides fertilizers and salts from the soil 6 Nutrient sensitive waters are defined as waters subject to excessive plant growth and requiring limitations on nutrient inputs 7 US EPA Water Quality Trading page wwwepagovnpdeswaterqualitytrading 8 The US EPA maintains digital data by watershed with indicators of conventional ambient water quality toxic ambient water quality and other waterquality indicators See wwwepa govsurf 9 httpeceuropaeuenvironmentwaterwaterframeworkinfointroenhtm 10 To avoid confusion note that the marginal expected penalty for additional precaution when the damage would exceed the liability limit is not zero While further precaution does not lower the ultimate penalty in this range it does lower the likelihood of an accident and hence the expected penalty Water Pollution 451 11 Suppose at the efficient level of precaution the magnitude of a resulting spill was less than the liability limit How would this be depicted graphically Would you expect the vessel owners choice to be efficient 12 wwwsciencedailycomreleases201704170420141825htm 13 wwwfwsgovdoiddatadwhardocuments980DWHAR0290122apdf 14 Defined as rules with an economic impact of more than 100 million Further Reading Brouwer R Pearce E Eds 2005 Cost Benefit Analysis and Water Resources Management Cheltenham UK Edward Elgar A collection of benefitcost analysis case studies for water pollution control projects flood control and water allocation Most of the cases occurred in Europe FisherVanden K Olmstead S Winter 2013 Moving pollution trading from air to water Potential problems and prognosis Journal of Economic Perspectives 271147 172 An analysis of water quality trading programs to date and the challenges that remain to implementing water quality trading Olmstead S M Winter 2010 The economics of water quality trading Review of Environmental Economics and Policy 41 4462 A thorough review of the literature on the economics of water quality Selman M Greenhalgh S Branosky E Jones C Guiling J March 2009 Water quality trading programs An international overview WRI Issue Brief 1 WRI World Resources Institute An overview and analysis of 57 water quality trading programs worldwide Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg Taylor Francis Taylor Francis Group httptaylorandfranciscom 453 Chapter 19 Toxic Substances and Environmental Justice The fact that a problem will certainly take a long time to solve and that it will demand the attention of many minds for several generations is no justification for postponing the study Our difficulties of the moment must always be dealt with somehow but our permanent difficulties are difficulties of every moment T S Eliot Christianity and Culture 1949 Introduction In one of the ironies of history the place that focused public attention in the United States on toxic substances is called the Love Canal Love is not a word any impartial observer would choose to describe the relationships among the parties to that incident The Love Canal typifies in many ways the dilemma posed by toxic substances Until 1953 Hooker Electrochemical subsequently Hooker Chemical a subsidiary of Occidental Petroleum Corporation dumped waste chemicals into an old abandoned waterway known as the Love Canal near Niagara Falls New York Hooker was acquired by Occidental in 1968 At the time it seemed a reasonable solution since the chemicals were buried in what was then considered to be impermeable clay In 1953 Hooker deeded the Love Canal property for 1 to the Niagara Falls Board of Education which then built an elementary school on the site The deed specifically excused Hooker from any damages that might be caused by the chemicals Residential development of the area around the school soon followed The site became the center of controversy when in 1978 residents complained of chemicals leaking to the surface News reports emanating from the area included stories of spontaneous fires and vapors in basements Medical reports suggested that the residents had experienced abnormally high rates of miscarriage birth defects and liver disease Toxic Substances and Environmental Justice 454 Similar contamination experiences befell Europe and Asia In 1976 an accident at an F HoffmannLa Roche Co plant in Sevesco spewed dioxin over the Italian countryside Subsequently explosions in a Union Carbide plant in Bhopal India spread deadly gases over nearby residential neighborhoods with significant loss of life and water used to quell a warehouse fire at a Sandoz warehouse near Basel Switzerland carried an estimated 30 tons of toxic chemicals into the Rhine River a source of drinking water for several towns in Germany In 2010 an explosion and fire at the BPDeepwater Horizon drilling rig off Louisianas coast in the Gulf of Mexico killed 11 people and ruptured an underwater pipe that caused a massive oil spill In previous chapters we touched on a few of the policy instruments used to combat toxic substance problems Emissions standards govern the types and amounts of substances that can be injected into the air Effluent standards regulate what can be discharged directly into water sources and pretreatment standards control the flow of toxics into wastewater treatment plants Maximum concentration levels have been established for many substances in drinking water This impressive array of policies is not sufficient to resolve the Love Canal problem or others having similar characteristics As Flint Michigans water contamination disaster demonstrated in 2015 for example by the time violations of the standards for drinking water are detected the water is already contaminated Specifying maximum contaminant levels helps to identify when a problem exists but it does nothing to prevent or contain the problem The various standards for air and water emissions that do protect against point sources do little to prevent contamination by nonpoint sources Furthermore most waterborne toxic pollutants are stock pollutants not fund pollutants they cannot be absorbed by the receiving waters Therefore temporally constant controls on emissions a traditional method used for fund pollutants are inappropriate for these toxic substances since they would allow a steady rise in the concentration over time Finally controlling accidental discharges may require a rather different set of policies Some additional form of control is necessary In this chapter we describe and evaluate the main policies that deal specifically with the creation use transportation and disposal of toxic substances and how those policies affect environmental justice Many dimensions will be considered what are appropriate ways to dispose of toxic substances How can the government ensure that all waste is appropriately disposed of in a way that does not disproportionately disadvantage some socioeconomic groups How do we prevent surreptitious dumping Who should clean up old sites and how should the cleanup be financed Should victims be compensated for damages caused by toxic substances under the control of someone else If so by whom What are the appropriate roles for the legislature and the judiciary in creating the proper set of incentives Nature of Toxic Substance Pollution A main objective of the current legal system for controlling toxic substances is to protect human health although protecting other forms of life is a secondary objective The potential health danger depends upon the toxicity of a substance to humans and their exposure to the substance Toxicity occurs when a living organism experiences detrimental effects following exposure to a substance In normal concentrations most chemicals are not toxic Others such as pesticides are toxic by design Yet in excess concentrations even a benign substance such as table salt can be toxic While a degree of risk is involved when using any chemical substance there are benefits as well The task for public policy is to define an acceptable risk by balancing the costs and benefits of controlling the use of chemical substances Toxic Substances and Environmental Justice 455 Health Effects Two main health concerns associated with toxic substances are risk of cancer and effects on reproduction Cancer While many suspect the mortality rate for cancer may be related to increased exposure to carcinogens proving or disproving this link is very difficult due to the latency of the disease Latency refers to the state of being concealed during the period between exposure to the carcinogen and the detection of cancer Latency periods for cancer run from 15 to 40 years and have been known to run as long as 75 years In the United States part of the increase in cancer has been convincingly linked to smoking particularly among women As the proportion of women who smoke has increased the incidence of lung cancer has increased as well Smoking does not account for all of the increase in cancer however Although it is not entirely clear what other agents may be responsible one suggested cause is the rise in the manufacture and use of synthetic chemicals since World War II A number of these chemicals have been shown in the laboratory to be carcinogenic That evidence is not necessarily sufficient to implicate them in the rise of cancer however because it does not take exposure into account The laboratory can reveal through animal tests the relationship between dosage and resulting effects To track down the significance of any chemical in causing cancer in the general population would require an estimate of how many people were exposed to specific doses Currently our data are not extensive enough to allow these kinds of calculations to be done with any confidence Reproductive Effects Tracing the influence of environmental effects on human reproduction is still a new science A growing body of scientific evidence however suggests that exposure to smoking alcohol and chemicals known as endocrine disruptors may contribute to infertility may affect the viability of the fetus and the health of the infant after birth and may cause genetic defects that can be passed on for generations Problems exist for both men and women In men exposure to toxic substances has resulted in lower sperm counts malformed sperm and genetic damage In women exposure can also result in sterility or birth defects in their children These are not the only health concerns however since exposure to toxic substances can have much more pervasive effects Muir and Zegarac 2001 found for example that at least 10 percent and up to 50 percent of the cumulative costs in Canada and the United States associated with four specific health problemsdiabetes Parkinsons disease PD neurodevelopmental effects and hypothyroidism and deficits in intelligence quotient IQ are environmentally induced1 Policy Issues Many aspects of the toxic substance problem make it difficult to resolve Three important aspects that add to this difficulty are the number of substances involved latency and uncertainty Number of Substances Of the tens of millions of known chemical compounds approximately 100000 are actively used in commerce Many exhibit little or no toxicity and even a very toxic substance represents little risk as long as it is isolated The trick is to identify problem substances and to design appropriate policies as responses The massive number of substances involved makes that a difficult assignment Toxic Substances and Environmental Justice 456 Latency The period of latency exhibited by many of these relationships compounds the problem Two kinds of toxicity are exhibited acute and chronic Acute toxicity is present when a shortterm exposure to the substance produces a detrimental effect on the exposed organisms Chronic toxicity is present when the detrimental effect arises from exposure of a continued or prolonged nature One size does not fit all The process of screening chemicals as potentially serious causes of chronic illness is even more complicated than that of screening for acute illness The traditional technique for determining acute toxicity is the lethaldose determination a relatively quick test performed on animals that calculates the dose that results in the death of 50 percent of the animal population This test is less well suited for screening substances that exhibit chronic toxicity The appropriate tests for discovering chronic toxicity typically have involved subjecting animal populations to sustained lowlevel doses of the substance over an extended period of time These tests are very expensive and time consuming If the EPA were to perform these tests given its limited resources it could only test a few of the estimated 700 new chemicals introduced each year If the industries were to do the tests the expense could preclude the introduction of many potentially valuable new chemicals that have limited specialized markets Uncertainty Another dilemma inhibiting policymakers is the uncertainty surrounding the scientific evidence on which regulation is based Effects uncovered by laboratory studies on animals are not perfectly correlated with effects on humans Large doses administered over a 3year period may not produce the same effects as an equivalent amount spread over a 20year period Some of the effects are synergisticthat is their effects are intensified or diminished by the presence of other variable factors Asbestos workers who smoke are 30 times more likely than their nonsmoking fellow workers to get lung cancer for example Once cancer is detected in most cases it does not bear the imprint of a particular source Policymakers have to act in the face of limited information see Example 191 From an economic point of view how the policy process reacts to this dilemma should depend on how well the market handles toxic substance problems To the extent that the EXAMPLE 191 The Arduous Path to Managing Toxic Risk Bisphenol A One example of a potentially toxic substance that is working its way through the government regulatory bureaucracy is Bisphenol A BPA The food industry was using more than 6 billion pounds of BPA every year to make the resins that line food cans and the polycarbonate plastics used to make baby bottles and many other products The Centers for Disease Control and Prevention CDC says that 95 percent of us carry measurable amounts of BPA in our blood In April 2008 the National Toxicology Program NTP at the National Institutes of Health NIH expressed some concern that exposure to BPA during pregnancy and childhood could impact the developing breast and prostate hasten puberty and affect behavior in American children Not long after those concerns were expressed the Canadian government moved to ban polycarbonate infant bottles containing BPA the most popular type of bottle on the market Toxic Substances and Environmental Justice 457 market generates the correct information and provides the appropriate incentives policy may not be needed On the other hand when the government can best generate information or create the appropriate incentive intervention may be called for As the following sections demonstrate the nature and the form of the most appropriate policy response may depend crucially on how the toxic source and the affected party or parties are related Market Allocations and Toxic Substances Toxic substance contamination can arise in a variety of settings In order to define the efficient policy response we must examine what responses would be forthcoming in the normal operation of the market Lets look at three possible relationships between the source of the contamination and the victim employeremployee producerconsumer and producerthird party The first two involve normal contractual relations among the parties while the latter involves noncontracting parties whose connection is defined solely by the contamination Occupational Hazards Many occupations involve risk including for some people exposure to toxic substances Do employers and employees have sufficient incentives to act in concert toward achieving safety in the workplace Despite the absence of any such ruling from the US government after the Canadian move the US market reacted Major BPA manufacturers including Playtex which makes bottles and cups and Nalgene which makes portable water bottles announced a shift to BPAfree products Major retailers including Walmart and Toys R Us announced they would quickly phase out BPAcontaining baby bottles Furthermore since 2009 13 states and the District of Columbia enacted further restrictions In January 2010 the US Food and Drug Administration FDA which had previously found BPA to be safe announced On the basis of results from recent studies using novel approaches to test for subtle effects both the National Toxicology Program at the National Institutes of Health and FDA have some concern about the potential effects of BPA on the brain behavior and prostate gland in fetuses infants and young children In July 2012 the agency announced that it would no longer allow BPA in baby bottles and childrens drinking cups The agency did not restrict its use in other consumer products How this risk was handled in the United States is especially noteworthy in that both the market and the states reacted before federal regulation was in place but the federal government did ultimately follow their lead Sources The National Institutes of Health website wwwniehsnihgovhealthtopics agentssyabpa accessed December 5 2016 Food and Drug Administration website wwwfdagovNewsEventsPublicHealthFocusucm064437htm accessed May 23 2013 Environmental Working Group website wwwewgorgbpa accessed December 5 2016 Toxic Substances and Environmental Justice 458 The caricature of the market used by the most ardent proponents of regulation suggests not In this view the employers desire to maximize profits precludes spending enough money on safety Sick workers can simply be replaced Therefore the workers are powerless to do anything about it if they complain they are fired and replaced with others who are less vocal The most ardent opponents of regulation respond that this caricature overlooks or purposefully ignores significant market pressures such as employee incentives and the feedback effects of those incentives on employers When the full story that includes these pressures is considered regulation may be unnecessary or even counterproductive According to this market incentives worldview employees will only accept work in a potentially hazardous environment if appropriately compensated for taking that risk Riskier occupations should call forth higher wages The increase in wages should be sufficient to compensate them for the increased risk otherwise they will work elsewhere These higher wages represent a real cost of the hazardous situation to the employer They also produce an incentive to create a safer work environment since greater safety would result in a lower risk premium and hence lower wages One cost could be balanced against the other What was spent on safety could be recovered in lower wages see Figure 191 The first type of cost the marginal increase in wages is drawn to reflect the fact that the lower the level of precaution the higher the wage bill Two such curves are drawn to reflect highexposure and lowexposure situations The highexposure case assumes larger numbers of workers are exposed than in the lowexposure case The lowexposure cost curve rises more slowly because the situation is less dangerous at the margin The second type of curve the marginal cost of providing precaution reflects an increasing marginal cost The two different curves depict different production situations A firm with a few expensive precautionary options will face a steeply sloped marginal cost curve while a Figure 191 Market Provision of Occupational Safety Toxic Substances and Environmental Justice 459 firm with many cheaper options will face a lower marginal cost at every comparable degree of precaution chosen The graph depicts four possible outcomesone for each possible combination of these four marginal cost curves Note that very different choices will be made depending on the circumstances Also note that the level of risk chosen as indicated by the marginal damage labeled MD and the degree of precaution are not perfectly correlated The highest marginal risk is MD2 but the associated level of precaution Q2 is not the largest The reason of course is that the cost of taking precautions matters and sometimes it is cheaper to accept the risk and compensate for it than it is to prevent it Because the marginal increased wages curve accurately reflects marginal damages since the higher wages are demanded by workers to compensate them for damages these market equilibria are also efficient Thus the efficient resolution of the occupational hazards problem varies not only from substance to substance but also from plant to plant As long as this stylized view of the world is correct the market will tailor the appropriate degree of precaution to the situation Proponents of this view point out that this allocation would also allow more choices for workers than would for example a system requiring all workplaces to be equally safe With varying occupational risk those occupations with more risk such as working to clean up toxic spills would attract people who were less averse to risk These workers would receive higher thanaverage wages to compensate them for the increased risk but paying these higher wages would be cheaper to the firm and hence consumers than requiring every workplace to meet the same risk standard The riskaverse workers would be free to choose less risky occupations Do wages actually reflect risk Existing empirical studies make clear that wages in risky occupations in countries like the United States do contain a risk premium Viscusi Aldy 2003 Two conclusions about these risk premiums seem clear from these studies 1 the willingness to pay for apparently similar risk reductions varies significantly across individuals and 2 the revealed willingness to pay for risk reduction is substantial In those cases where wages accurately reflect risk is there any appropriate role for the government in controlling contamination in the workplace Perhaps The efficient solution may not always be considered the most ethical solution a point that has been addressed in the courts For example if the employee is a pregnant woman and the occupational hazard involves potential damage to the fetus does the expectant mother have the right to risk the unborn child or is some added protection for the fetus needed Furthermore if the lowest cost solution is to ban pregnant or even fertile women from a workplace that poses a risk to a fetus is that an acceptable solution or is it unfair discrimination against women As Example 192 suggests these are not idle concerns Ethical concerns are not the only challenges for market solutions Wages may not reflect the actual risk The ability of the worker to respond to a hazardous situation depends on his or her knowledge of the seriousness of the danger With toxic substances that knowledge is likely to be incomplete in general but completely inadequate in settings such as developing countries Consequently the marginal increased wages function may be artificially rotated toward the origin In this case the employer would choose too little precaution and the market will not provide sufficient pressure to rectify this worker hazard By having access to the health records of all employees the employer could potentially be in the best position to assess the degree of risk posed but the employer also has an incentive to suppress that information since publicizing the risk would mean demands for higher compensatory wages and possible lawsuits Information on the dangers posed by exposure to a particular toxic substance is a public good to employees each employee has an incentive to be a free rider on the discoveries of others Individual employees do not have an incentive to bear the cost of doing the necessary Toxic Substances and Environmental Justice 460 EXAMPLE 192 Susceptible Populations in the Hazardous Workplace An Historical Example Some employees are especially susceptible to occupational hazards Pregnant women and women in the childbearing years are particularly vulnerable When an employer attempts to manage a work situation that poses a hazardous threat either the susceptible population can be separated from the hazard or the hazard can be controlled to a sufficient level that its risk is acceptable to even the most susceptible employees The economic aspects of this choice are easily deduced from Figure 191 Suppose that the firm has few control options and is on the uppermost of the two marginal cost of precaution curves By removing the susceptible population it could face the low exposure curve Removal of the susceptible population results in lower marginal risk to the workers lower costs to the firm and less precaution taken But is it fair to those who are removed from their jobs This issue came to a head in 1978 when American Cyanamid decided to respond to an occupational risk by banning all fertile women from jobs in the section manufacturing lead chromate pigment at Willow Island West Virginia After reviewing the decision the Occupational Safety and Health Administration OSHA cited the company under the general duty clause of the Occupational Safety and Health Act which requires an employer to provide a workplace free of hazards and fined it 10000 That was not the end of the story In early 1980 the Oil Chemical and Atomic Workers Union sued the company under the 1964 Civil Rights Act on the grounds that the company had discriminated unfairly against women In March 1991 the Supreme Court ruled that banning fertile women from any workplace posing a risk to a fetus was not an acceptable way to control risk The workplace must be made safe for all Source International Union v Johnson Controls 499 US 187 1991 research to uncover the degree of risk Thus it seems neither employers nor employees can be expected to produce the efficient amount of information on the magnitude of risk2 As a result the government may play a substantial role in setting the boundaries on ethical responses in stimulating research on the nature of hazards and in providing for the dissemination of information to affected parties It does not necessarily follow however that the government should be responsible for determining the level of safety in the workplace once this information is available and the ethical boundaries are determined For situations that are sufficiently dangerous that no rational worker would voluntarily choose to work there the role of the government would be to set and enforce a safety threshold This analysis suggesting that the market is not likely to provide an efficient level of information on occupational risk is consistent with the enactment of righttoknow laws in several states These laws require businesses to disclose to their employees and to the public any potential health hazards associated with toxic substances used on the job Generally employers are required to 1 label toxic substance containers 2 inventory all toxic substances used in the workplace and 3 provide adequate training on the handling of these substances to all affected employees Significantly proponents of these laws suggest that the targets are Toxic Substances and Environmental Justice 461 not the large chemical companies which generally have excellent disclosure programs but the smaller largely nonunion plants Product Safety Exposure to a hazardous or potentially hazardous substance can also occur as a result of using a product as when eating food containing chemical additives Does the market efficiently supply safe products One view holds that the market pressures on both parties consumers and producers are sufficient to yield an efficient level of safety Safer products are generally more expensive to produce and carry a higher price tag If consumers feel that the additional safety justifies the cost they will purchase the safer product Otherwise they wont Producers supplying excessively risky products will find their market drying up because consumers will switch to competing brands that are safer despite their higher price Similarly producers selling excessively safe products meaning they eliminate at great cost risks consumers are perfectly willing to take in return for a lower purchase price find their markets drying up as well Consumers will choose the cheaper riskier product This theory also suggests that the market will not and should not yield a uniform level of safety for all products Different consumers will have different degrees of risk aversion While some consumers might purchase riskier but cheaper products others might prefer safer but more expensive products3 Under this worldview it would be common to find products with various safety levels supplied simultaneously reflecting and satisfying different consumer preferences for risk Forcing all similar products to conform to a single level of risk would not be efficient Uniform product safety is no more efficient than uniform occupational safety If this view of the market were completely accurate government intervention to protect consumers would not be necessary to ensure the efficient level of risk By the force of their collective buying habits consumers would protect themselves The problem with the markets ability to provide such selfregulation is once again the availability of information on product safety The consumer generally acquires his or her information about a product either from personal experience or from labels and warnings With toxic substances the latency period may be so long as to preclude any effective market reaction arising from personal experience Even when some damage results several years later it is difficult for the consumer to associate it with a particular source While an examination of the relationships between purchasing patterns of a large number of consumers and their subsequent health might well reveal some suggestive correlations it would be difficult for any individual consumer to deduce this correlation Furthermore it may be that the risk is so large that no knowledgeable consumer would accept that risk so that banning the product is the appropriate remedy Note that banning was the choice of several states in managing the risk from BPA as described in Example 191 In situations where adequate information is available on the risks consumers should have a substantial role in choosing the acceptable level of risk through their purchases but varying levels of access to information can make this problematic Recall Debate 181 on fish consumption advisories Third Parties The final case involves third parties victims who have no contractual relationship to the source Oil spills are one example Another occurs when groundwater is contaminated by a Toxic Substances and Environmental Justice 462 neighboring wastewater treatment facility by surreptitious dumping of toxic wastes or by a neighbors improper application of a pesticide In all of these examples the victims are third parties Since in thirdparty situations the affected party cannot bring any direct market pressure to bear on the source the case for additional government intervention is stronger This does not necessarily imply however that executive or legislative remedies are appropriate The most appropriate response may come from simply requiring better information on the risk or from using the judicial system to impose liability Liability law provides one judicial avenue for internalizing the external costs in thirdparty situations If the court finds 1 that damage occurred 2 that it was caused by a toxic substance and 3 that a particular source was responsible for the presence of the substance the source can be forced to compensate the victim for the damages caused Unlike regulations that are uniformly and hence inefficiently applied a court decision can be tailored to the exact circumstances involved in the suit Furthermore the impact of any particular liability assignment can go well beyond the parties to that case A decision for one plaintiff can remind other sources that they should take the efficient level of precaution now to avoid paying damages later In principle liability law can force potential sources of toxic discharges including nonpoint sources to choose efficient levels of precaution Unlike regulation liability law can provide compensation to the victims Bringing suit to recover damages however is a costly process so these administrative costs must be balanced against the potential gains in efficiency when choosing the appropriate remedy for any particular situation Using liability law to resolve toxic situations can also take a long time In the famous case of Flint Michigan decisions made as early as 2007 resulted in lead contamination of the citys water supply A flurry of lawsuits followed but it wasnt until March 2017 that a federal judge approved a 97 million settlement The Incidence of Hazardous Waste Siting Decisions Flint Michigans population is 566 percent African American and 41 percent of the population live below the poverty line Did the fact that this was largely a poor minority community play any role in what happened and how long it took to resolve the problem For some historical context for thinking about the possible linkages between race and exposure to toxic substances it may be instructive to review what we know about the role of race in the siting of toxic waste facilitates History In 1979 Robert Bullard then a sociologist at Texas Southern University completed a report describing a futile attempt by an affluent African American neighborhood in Houston Texas to block the location of a hazardous waste site within their community His analysis suggested that race not just income status was a probable factor in this local land use decision Environmental justice as revealed though the siting of hazardous waste plants became a national issue in 1982 when some 500 demonstrators protested against the location of a proposed PCB landfill in a predominantly lowincome community in North Carolina On returning from the protests Walter Fauntroy the District of Columbia congressional delegate asked the General Accounting Office GAO to study the characteristics of hazardous waste sites in the EPAs Region 4 Georgia Florida Mississippi Alabama Kentucky Tennessee North Carolina and South Carolina The 1983 study found that three out of four commercial Toxic Substances and Environmental Justice 463 hazardous waste facilities were in predominantly African American communities and the fourth was in a lowincome community In 1987 the United Church of Christ Commission for Racial Justice examined the issue of hazardous waste siting for the nation as a whole According to their statistical analysis of communities with commercial hazardous waste facilities they determined that Race proved to be the most significant among the variables tested in association with the location of commercial hazardous waste facilities This represented a consistent national pattern In 1994 the Center for Policy Alternatives issued Toxic Wastes and Race Revisited An Update of the 1987 Report That study found that commercial toxic waste facilities were even more likely to be located in minority communities at that time than in 1980 despite growing national attention to the issue Not all studies have reached this conclusion but in a detailed review of the literature Hamilton 2003 found that for most US studies lowincome and minority residents do indeed face higher risks from hazardous waste facilities Less detailed information exists on the exposure of these populations to hazardous waste risks in other industrialized countries Environmental Justice Research and the Emerging Role of GIS The application of geographic information systems GIS technology has allowed studies of the distributional inequities with respect to either pollution or hazardous waste site location to become more sophisticated GIS technology also allows analyses to be conducted at the facility level the city level or another geographical area Most regional offices of the EPA for example now use demographic data from the US Census Bureau combined with GIS mapping This technique allows for the overlay of census data onto concentric rings around a hazardous waste facility or a Superfund site for example in order to discover who lives in close proximity to the site The distribution of risks can also be estimated by combining assumptions about the radius of the externalities around a facility with data from epidemiological studies Hamilton 2006 What have these studies found The results from these studies are quite varied but they demonstrate that using only one measure of equity such as low income could prove misleading Hamilton and Viscusi 1999 for example consider multiple measures of equity including racial distribution mean household income and potential cancer risks and their work demonstrates how sensitive the results are to the specific measure that is used Other studies have utilized the EPAs Toxic Release Inventory TRI data This data set contains selfreported information on toxic releases from all plants that are required to report Studies using these data have found that demographic groups most likely to face the threat of exposure to toxic air emissions include minorities renters people with incomes below the poverty line and individuals with fewer years of schooling Studies have also found significant negative effects of pollution on house values and incomes in New England states Example 193 What explains these findings What do these findings imply for policy The Economics of Site Location One point of departure is to understand the dynamics of hazardous waste treatment site location and how both income and race might play a role Our analysis begins by recognizing Toxic Substances and Environmental Justice 464 that hazardous waste facilities are generally unpopular neighbors Even if the treatment of hazardous waste makes sense for society as a whole all potential recipient communities must face the NIMBY Not in My Backyard opposition Understanding the economics of site location requires consideration of the incentives facing both the owners of the proposed facility and the incentives of the host community Since the owners want to maximize profits they will look for a site that can process the wastes at a low cost Being located near the sources of the waste would be attractive as a means of holding down transport costs Lower land costs would also be attractive since these facilities are frequently landintensive Finally the site should pose as few liability risks as possible in order to limit future payouts The host community has its own agenda in order to ensure that it reaps benefits that outweigh costs They would want to ensure insofar as possible that the site was safe for both employees and the inhabitants of the surrounding community They would also want adequate compensation for assuming the risk of being near these sites This compensation could take many forms for example employment enhanced tax revenues or new public services What does efficiency suggest about the characteristics of host communities Lowincome communities become attractive as disposal sites not only because land prices are relatively low in those communities but also because those communities will typically require less compensation in order to accept the risk Targeting lowincome communities would be the expected not the exceptional outcome Furthermore once hazardous waste facilities are located in a community the composition of that community is likely to become even poorer due to migration and the negative effects on surrounding property values Assuming that the EXAMPLE 193 Do New Polluting Facilities Affect Housing Values and Incomes Evidence from New England Combining census data for New England for 1980 and 1990 with Toxics Release Inventory TRI data for manufacturing firms that began operations during that period Hanna 2007 explores the effect of polluting facilities on the surrounding neighborhoods The study looks specifically at how prices wages pollution and incomes vary among census tracts in the New England states Hanna uses data on new plants with an index of pollution exposure calculated as a weighted sum of the distance between the census tract and the pollution source times the TRIreported releases for that pollution source Some 167 New England sites were in the TRI data Ten percent of the new plant emissions were of dichloromethane an airborne contaminant classified as a probable human carcinogen Significant negative effects of pollution on house values and incomes were found Their estimates suggest that a house located 1 mile closer to a polluting manufacturing plant has its value reduced by 19 percent Source Hanna B G 2007 House values incomes and industrial pollution Journal of Environmental Economics and Management 54 100112 Toxic Substances and Environmental Justice 465 willingness to pay for riskavoidance is higher for higherincome families more lowerincome families may be attracted by the unusually low land prices or rents while higher income families may depart for less risky neighborhoods Even if the community were not low income at the time of the siting it is likely to become more so over time While even an efficient siting process might target a disproportionate share of these facilities in lowincome communities it is much more difficult to develop a clear economic rationale for why race is a more important predictor than income Explaining that finding requires greater attention to market failures Efficient location requires both full information and adequate enforcement of agreements In the absence of full information host communities can fail to fully understand the risk and therefore are likely to undervalue it One hypothesis explains the importance of race by noting that minority communities have less access to full information than comparably situated white communities This would imply they are more likely to be unwittingly subject to flawed agreements that are biased against them Another hypothesis is that they lack the power to enforce community will perhaps because of underrepresentation on governing boards This hypothesis implies that even potentially efficient agreements may be inefficiently implemented EXAMPLE 194 Which Came FirstThe Toxic Facility or the Minority Neighborhood Pastor et al 2001 explore which came first in Los Angeles County Using data from 1970 to 1990 they explore whether toxic storage and disposal facilities TSDFs moved into a minority neighborhood or whether the TSDF was there first Using geocoded site locations and GIS they were able to identify affected census tracts By mapping the facility location and creating circular buffers of onequarter mile and 1 mile they were able to determine the potentially affected residents Their data set contains 83 TSDFs 39 of which are high capacity and handle most of the waste Some 55 census tracts were within onequarter mile of these facilities and 245 tracts were within 1 mile They find that areas receiving TSDFs during this time period were indeed low income minority areas with a disproportionate number of renters After the TDSFs were in place however increases in minority residents occurred but were not disproportionate to the rest of the moveins In other words prior to any siting decision neighborhoods with belowaverage incomes and aboveaverage percentages of Latinos and African Americans were more likely to receive a TSDF After the siting decision little evidence suggests disproportionate inmigration along racial or ethnic lines The authors acknowledge two limitations of this study One is that any analysis at the neighborhood level does not capture individual exposure rates which may vary within the neighborhood A second limitation arises from the fact that the perceived risks of living near a site are not certain Some evidence suggests that people are more worried about hazards to which they have been exposed involuntarily Source Pastor Jr M Sadd J Hipp J 2001 Which came first Toxic facilities minority movein and environmental justice Journal of Urban Affairs 23 121 Toxic Substances and Environmental Justice 466 Bullard 1990 Taken as a whole this evidence on the prominence of race as an independent predictor variable over and above income suggests not only that the current siting process may be discriminatory but also that it is not efficient Until such time as recipient communities can be guaranteed both full information and the capability to enforce the communitys will the hazardous waste siting process will remain seriously flawed One lingering issue of debate has to do with the direction of causality Consider two quite different possibilities In the first case these population groups could face higher exposures because a hazardous facility was attracted by low land prices In the other case attracted by lower land andor housing prices people could have moved in after the hazardous waste site located in that community This chickenandegg question has been explored in a few studies4 Example 194 illustrates one such study in Los Angeles The Policy Response Environmental Justice and Hazardous Waste Sites In recognition of the problems associated with locating hazardous waste sites the Office of Environmental Equity was officially established within the US Environmental Protection Agency on November 6 1992 Its mandate is to deal with environmental impacts affecting people of color and low income communities Although the issue that precipitated the creation of this office was largely focused on the siting of hazardous waste facilities the concerns of this office go well beyond that Initial efforts are focused on gathering more information about the problem and strengthening enforcement inspections and compliance monitoring in impacted communities In 1994 President Clinton issued Executive Order 12898 Federal Action to Address Environmental Justice in Minority Populations and LowIncome Populations The goal of this order was to make sure that minority groups and lowincome populations are not subjected to an unequal or disproportionately high level of environmental risks How effective has the order been In 2004 the EPA issued an evaluation report of this Executive Order and did not award a good grade In fact the report suggests that Executive Order 12898 has not been fully implemented and that the EPA has not consistently integrated environmental justice into its daytoday operations The report also states that the EPA has not identified populations addressed in the Executive Order and has neither defined nor developed criteria for determining the disproportionately impacted5 In 2014 Dr Robert Bullard summed up his sense of what had been the result of Executive Order 12898 on the twentieth anniversary of its enactment After decades of hard work struggle and some victories along the way the quest for environmental justice for all communities has yet to be achieved Even in 2014 the most potent predictor of health is zip code Race and poverty are also powerful predictors of students who attend schools near polluting facilities the location of polluted neighborhoods that pose the greatest threat to human health hazardous waste facilities urban heat islands and access to healthy foods parks and tree cover6 Simultaneous exposures to various types of risk make discerning the causal relationships even more complex Those with lower incomes may live close to a plant with high emissions but lower incomes are also associated with a poorer diet and less access to health care both of which can also be associated with increased levels of illness Hamilton 2006 Toxic Substances and Environmental Justice 467 Environmental Justice in Canada and Europe The number of empirical studies outside the United States is rather limited but some case studies have been conducted particularly in Canada and Europe These case studies are useful in helping to discern what kinds of strategies can be effective in the quest to achieve environmental justice in the siting of hazardous waste facilities Public participation has been cited as an important factor in the successful siting of hazardous waste facilities in the Canadian provinces of Alberta and Manitoba Successful in this case means not only that the facility was able to find a home but also that no environmental justice concerns have arisen after the fact in the host communities The siting process in these provinces is not only voluntary but it also provides multiple stages at which the community can exercise veto power over the project Interestingly the resulting locations are not always in lowincome neighborhoods In fact one such location the town of Swan Hills has an average household income significantly higher than the average in the province and one of the lowest levels of unemployment Why would any community accept such a facility Potential jobs at the facilities are apparently one large factor as is the property tax revenue that might accrue One corollary of the jobs hypothesis might be that we would expect the presence of local high unemployment to increase the likelihood a community would accept a hazardous waste facility That seems to be the case In a survey of successful sitings in France Hungary Italy the Netherlands and Spain for example Dente et al 1998 found that areas with higher unemployment are as expected more likely to accept facilities They also found however that communities are more likely to accept waste if it is seen as local since in that case the residents of the host community will also be reaping the benefits from employment in the plants generating the waste The Role of Risk Perception The NIMBY attitude has been explored in both the economics and cognitive psychology literatures Delving into the psychology of risk perception Messer et al 2006 summarize the results of a study that evaluated the benefits of hazardous waste cleanup under the Comprehensive Environmental Response Compensation and Liability Act CERCLA more commonly known as Superfund Although this legislation was passed in 1980 legal complexities in the Act have delayed the cleanup of many Superfund sites These authors wanted to know if the length of delay affected the ultimate recovery of property values after the cleanup The authors examined four Superfund sites Operating Industries a landfill in Los Angeles Montclair West Orange and Glen Ridge Townships in New Jersey formerly the site of US Radium Corporation Industriplex and Water Wells GH in Woburn Massachusetts and Eagle Mine in Colorado Cleanup was significantly delayed andor hampered at all of these sites They found that the designation of the site as a Superfund site the cleanup itself and the associated news items all negatively affected the property values Media announcements were found to affect public perceptions of risk so profoundly that a shunning of the property may result Current owners may not be willing to stay in their homes if their perceived costs of remaining are greater than the value of their homes and potential buyers are likely to be few and far between In this study property values continued to fall over time as cleanup was delayed If cleanup were delayed for 20 years for example they found that the benefits of cleanup measured by the recovery of property values would be negligible in present value economic terms since it would take another 5 to 10 years for property values to recover Toxic Substances and Environmental Justice 468 Compensation as a Policy Instrument One policy device for attempting to achieve environmental justice is paying compensation or host fees to communities accepting hazardous waste facilities In principle this would serve to make sure that benefits not merely costs accrue to the local community Additionally paying the compensation would internalize the cost of the environmental risk as that cost was passed on to those whose waste was being treated While compensation frequently is an effective device for finding common ground as Debate 191 suggests that is not always the case The Toxic Release Inventory The Toxic Release Inventory TRI was enacted by the US Congress in January 1986 as a part of the Environmental Protection and Community Right to Know Act EPCRA EPCRA was enacted partially in response to two incidents In 1984 methyl isocyanate killed thousands of people in Bhopal India A chemical release at a sister plant in West Virginia happened soon after The publics workers and community members demand for information about toxic chemicals was the impetus for EPCRA Together with the Pollution Prevention Act PPA of 1990 it mandates the collection of data on toxic chemicals that are treated onsite recycled and combusted for energy recovery The TRI is a publicly available database designed to provide information to the public on releases of toxic substances into the environment Most of the substances involved are not themselves subject to release standards TRI states that firms that use 10000 or more pounds of a listed chemical in a given calendar year or firms that import process or manufacture 25000 or more pounds of a listed chemical must file a report on each of the chemicals in existence within the plant if they also have ten or more fulltime employees Approximately 650 chemicals are covered in the TRI Most recently the TRI has been expanded to include lower reporting thresholds for certain persistent bioaccumulative toxic PBT chemicals PBT chemicals are stock pollutants and can accumulate in body tissue PBT chemicals include mercury pesticides and dioxins Reporting of emissions or use of listed chemicals is accomplished annually For the data see wwwepagovtritridataindexhtm The reports include such information as the name of the company the name of the parent company if it exists the toxic released and fre quency of release and the medium in which the chemical is released Data by state are also available and all data are available to the public Firms must also separately report emissions to their state and local authorities as well as to fire and emergency officials Several other countries now use similar reporting mechanisms known as Pollutant Release and Transfer Registers PRTR All have slight variations on the TRI In Japan the PRTR includes data on diffuse sources eg automobiles The Canadian PRTR called the National Pollutant Release Inventory NPRI also collects data on the number of employees at each facility The Mexican PRTR is voluntary and so data are limited Australia the Czech Republic Norway and the United Kingdom also all have PRTRs with onsite release data Has the existence of the TRI reduced toxic emissions into the environment EPAs annual reports reveal that substantial reductions have occurred Although careful examination of the filings eg Natan Miller 1998 found that some of these reductions merely reflect a change in definition other reductions have been found to be genuine Apparently the reported magnitude of the reductions is overstated but real reductions have occurred Among the chemicals that are reported to TRI about 180 are known or suspected carcinogens In 2011 the EPA reported that the air releases of these carcinogens decreased by 50 percent between 2003 and 2011 Toxic Substances and Environmental Justice 469 Does Offering Compensation for Accepting an Environmental Risk Always Increase the Willingness to Accept the Risk One week before a referendum in Switzerland on the siting of a nuclear waste repository a survey was conducted in the community where the repository was to be located Researchers found that an offer of compensation to accept the facility reduced willingness to accept it Specifically Frey and OberholzerGee 1997 and Frey et al 1996 found that when asked whether they would accept a nuclearwaste repository without compensation 508 percent of the respondents said yes This rate dropped to 246 percent when compensation was offered The researchers suggest that acceptance rates drop with compensation because offering the compensation crowds out a feeling of civic duty If respondents feel that accepting a facility is part of his or her civic duty he or she will be less likely to feel this sense of responsibility once a payment is introduced In this context the authors believe that the compensation was viewed as a morally unacceptable bribe and hence should be rejected An alternative explanation might suggest that compensation could play a signaling role Perhaps the risks are perceived as being small until such time as compensation is offered At that moment introducing compensation into the mix might be taken by the community as a signal that the risks are much higher than previously thoughtindeed so high that compensation must be paid How common is this outcome In a very different setting Japan Lesbirel 1998 examined the siting of energy plants In this context the author found that compensation did as expected actually facilitate the siting of these plants He interprets his findings as consistent with the belief that in Japan institutional structures facilitate participatory negotiations on risk management strategies that result in productive bargaining between the plants and host communities This process effectively removes the moral stigma and eliminates the signaling role of compensation Whether this characterization of the Japanese process continues to be valid following the Fukushima nuclear accident remains to be seen What is the moral of the story This evidence suggests that compensation does not automatically increase the likelihood of a community accepting a hazardous facility but it might The context matters Sources Frey B S OberholzerGee F 1997 The cost of price incentives An empirical analysis of motivation crowding out American Economic Review 874 746755 Frey B S OberholzerGee F Eichenberger R 1996 The old lady visits your backyard A tale of morals and markets Journal of Political Economy 1046 DEBATE 191 Toxic Substances and Environmental Justice 470 Proposition 65 Proposition 65 the Safe Drinking Water and Toxic Enforcement Act of 1986 was established in the state of California by popular vote in November 1986 following the inception of the Toxic Release Inventory by the EPA Proposition 65 is intended to protect California citizens and the states drinking water sources from toxic chemicals Proposition 65 requires companies producing using or transporting one or more of the listed chemicals to notify those who are potentially impacted Chemicals are listed as carcinogenic or as causing reproductive harm When their use or potential exposure levels exceed safe harbor numbers established by a group of approved scientists the impacted people must be notified The safe harbor threshold is uniquely determined for each chemical and depends upon its intrinsic potency or the potency of a released mixture Proposition 65 also requires the governor of California to publish at least annually a list of chemicals known to the state to cause cancer or reproductive toxicity The program involves three forms of notification 1 warning labels must be placed on all products that will cause adverse health effects when used for a prolonged period of time 2 a company whose toxic emissions to air ground or water exceed levels deemed safe for prolonged exposure must provide public notification and 3 workers must be warned of the potential danger if toxic chemicals defined by Proposition 65 are used in manufacturing a product or are created as a byproduct of manufacturing Only companies with ten or more fulltime workers are required to notify people of exposure Nonprofit organizations like hospitals recycling plants and government organizations which account for over 65 percent of Californias pollution are not required to comply with Proposition 65 Under the proposition private citizens other industry members and environmental groups can sue companies that fail to notify people of exposure appropriately Plaintiffs who make a successful legal claim can keep a substantial portion of the settlement this encourages private enforcement of the law and reduces the need for government monitoring Industry members also have a strong incentive to monitor each other so that one company does not cheat and look greener than its rivals Did this program change behavior At least in controlling exposure to lead it clearly did see Example 195 International Agreements One of the issues erupting during the 1990s concerned the efficiency and morality of exporting hazardous waste to areas that are willing to accept it in return for suitably large compensation A number of areas particularly poor countries appear ready to accept hazardous waste under the right conditions The right conditions usually involve alleviating safety concerns and providing adequate compensation in employment opportunities money and public services so as to make acceptance of the wastes desirable from the receiving communitys point of view Generally the compensation required is less than the costs of dealing in other ways with the hazardous waste so the exporting nations find these agreements attractive as well A strong backlash against these arrangements arose when opponents argued that communities receiving hazardous waste were poorly informed about the risks they faced and were not equipped to handle the volumes of material that could be expected to cross international boundaries safely In extreme cases the communities were completely uninformed as sites were secretly located by individuals with no public participation in the process at all Toxic Substances and Environmental Justice 471 EXAMPLE 195 Regulating through Mandatory Disclosure The Case of Lead Rechtschaffen 1999 describes a particularly interesting case study involving how Proposition 65 produced a major reduction in the amount of lead exposure by promoting new technologies productionprocess changes and pollutionprevention measures He even goes so far as to suggest that Proposition 65 seemed even more effective than federal law in addressing certain lead hazards from drinking water consumer products and other sources Rechtschaffen identifies several characteristics about Proposition 65 that explain its relative success We mention two here First despite periodic calls for such an integrated strategy no coordinated federal approach to controlling lead hazards had emerged Rather lead exposures were regulated by an array of agencies acting under a multitude of regulatory authorities In contrast the Proposition 65 warning requirement applies without limitation to any exposure to a listed chemical unless the exposure falls under the safe harbor standard regardless of its source Thus the coverage of circumstances leading to lead exposure is very high and the standards requiring disclosure are universally applied Second unlike federal law Proposition 65 is selfexecuting Once a chemical is listed by the state as causing cancer or reproductive harm Proposition 65 applies This contrasts with federal statutes where private activity causing lead exposures is permitted until and unless the government sets a restrictive standard Whereas under the federal approach fighting the establishment of a restrictive standard made economic sense by delaying the date when the provisions would apply under Proposition 65 exactly the opposite incentives prevail In the latter case since the provisions took effect soon after enactment the only refuge from the statute rested on the existence of a safe harbor standard that could insulate small exposures from the statutes warning requirements For Proposition 65 at least some subset of firms had an incentive to make sure the safe harbor standard was in place delay in implementing the standard was costly not beneficial Source Rechtschaffen C 1999 How to reduce lead exposure with one simple statute The experience with Proposition 65 Environmental Law Reporter 29 1058110591 The Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal was developed in 1989 to provide a satisfactory response to these concerns Under this convention the 24 nations that belong to the Organisation for Economic Cooperation and Development OECD were required to obtain written permission from the government of any developing country before exporting toxic waste there for disposal or recycling This was followed in 1994 by an additional agreement on the part of most but not all industrialized nations to completely prohibit the export of toxic wastes from any OECD country to any nonOECD country With the huge growth in sales of electronic devices and the valuable materials in the postconsumer ewaste resulting from these sales enforcement of laws on exporting toxic materials in ewaste is getting more difficult recall the ewaste discussion in Chapter 8 Toxic Substances and Environmental Justice 472 Some used electronic goods exported to developing countries become electronic waste ewaste that is usually disassembled in those developing countries The concern is that the recovery process can be dangerous to the health of the disassemblers particularly if it is done without the proper safeguards Ewaste often contains toxic substances such as lead mercury cadmium and flame retardants Kinnaman and Yokoo 2011 report on studies that have found the following Ambient dioxin and furan concentrations in the air around an ewaste dismantling site in China are the highest in the world As a result blood lead levels in children within proximity to this Chinese dismantling site significantly exceed the Chinese mean Concentrations of lead dioxins and furans in ewaste dismantling sites in India also exceed World Health Organization guidelines A bill titled the Responsible Electronics Recycling Act which would have banned US exports of electronic waste was introduced in Congress in 2011 but not enacted Summary The potential for contamination of the environmental asset by toxic substances is one of the most complex environmental problems The number of substances that are potentially toxic is in the millions Some 100000 of these are in active use Although it is not always sufficient to provide an efficient outcome the market provides a considerable amount of pressure toward resolving toxic substance problems as they affect employees and consumers With reliable information at their disposal all parties have an incentive to reduce hazards to acceptable levels This pressure is absent however in cases involving third parties Here the problem frequently takes the form of an external cost imposed on innocent bystanders The efficient role of government can range from ensuring the provision of sufficient information so that participants in the market can make informed choices to setting exposure limits on hazardous substances Unfortunately the scientific basis for decision making is weak Only limited information on the effects of these substances is available and the cost of acquiring complete information is prohibitive Therefore priorities must be established and tests developed to screen substances so that efforts can be concentrated on those substances that seem most dangerous In contrast to air and water pollution the toxic substance problem is one in which the courts may play a particularly important role Liability law not only creates a market pressure for more and better information on potential damages associated with chemical substances but also it provides some incentives to manufacturers of substances the generators of waste the transporters of waste and those who dispose of it to exercise precaution Judicial remedies also allow the level of precaution to vary with the occupational circumstances and provide a means of compensating victims Judicial remedies however are insufficient They are expensive and illsuited for dealing with problems affecting large numbers of people The burden of proof under the current American system is difficult to surmount although in Japan some radical new approaches have been developed to deal with this problem Furthermore court cases may take a considerable amount of time to resolve Is the burden posed by environmental risks and the policies used to reduce them distributed fairly Apparently not The siting of hazardous waste facilities seems to have resulted in a Toxic Substances and Environmental Justice 473 distribution of risks that disproportionately burdens lowincome populations and minority communities This outcome suggests that current siting policies are neither efficient nor fair The responsibility for this policy failure seems to lie mainly with the failure to ensure informed consent of residents in recipient communities and very uneven enforcement of existing legal protections The theologian Reinhold Niebuhr once said Democracy is finding proximate solutions to insoluble problems That seems an apt description of the institutional response to the toxic substance problem Our political institutions have created a staggering array of legislative and judicial responses to this problem that are neither efficient nor complete They do however represent a positive first step in what must be an evolutionary process Discussion Questions 1 Did the courts resolve the dilemma posed in Example 192 correctly in your opinion Why or why not 2 Over the last several decades in product liability law there has been a movement in the court system from caveat emptor buyer beware to caveat venditor seller beware The liability for using and consuming risky products has been shifted from buyers to sellers Does this shift represent a movement toward or away from an efficient allocation of risk Why 3 Would the export of hazardous waste to developing countries be efficient Sometimes Always Never Would it be moral Sometimes Always Never Make clear the specific reasons for your judgments 4 How should the public sector handle a toxic gas such as radon that occurs naturally and seeps into some houses through the basement or the water supply Is this a case of an externality Does the homeowner have the appropriate incentives to take an efficient level of precaution SelfTest Exercises 1 Firms whose economic activity might pose an environmental risk are sometimes required to post performance bonds before the activity is allowed to commence The amount of the required bond would be equal to the present value of anticipated damages Any restoration of the site resulting from a hazardous waste leak could be funded directly and immediately from the accumulated funds Any unused proceeds would be redeemable at specified dates if the environmental costs turned out to be lower than anticipated What is the difference in practice between an approach relying on performance bonds and one imposing strict liability for cleanup costs on any firm for a toxic substance spill 2 Is informing the consumer about any toxic substances used in the manufacture of a product sufficient to produce an efficient level of toxic substance use for that product Why or why not Toxic Substances and Environmental Justice 474 Notes 1 Muir T Zegarac M 2001 Societal costs of exposure to toxic substances Economic and health costs of four case studies that are candidates for environmental causation Environmental Health Perspectives 109Suppl 6 885903 2 Unions would be expected to produce more efficient information flows since they represent many workers and can take advantage of economies of scale in the collection interpretation and dissemination of risk information Available evidence suggests that the preponderance of wage premiums for risk has been derived from data involving unionized workers 3 A classic example is provided by the manner in which Americans choose their automobiles It is quite clear that some larger cars are safer and more expensive than smaller cheaper ones at least to their owners Some consumers are willing to pay for this additional level of safety and others are not 4 Boyce 2007 reviews some of the debate on the direction of environmental protection 5 Report of the Office of the Inspector General March 1 2004 6 Bullard Robert 2014 New report tracks environmental justice movement over five decades Available at wwwnrdcorgexpertsalberthuang20thanniversarypresidentclintons executiveorder12898environmentaljustice Accessed December 7 2016 Further Reading Jenkins R R Klemicky H Kopitsz E Marten A 2012 Policy monitorUS Emergency response and removal Superfunds overlooked cleanup program Review of Environmental Economics and Policy 62 278297 Describes and evaluates a key component of the nations response capability regulations to respond to actual and threatened hazardous releases including deliberate releases by terrorists the Superfund Emergency Response and Removal ERR Program Mendelsohn R Olmstead S 2009 The economic valuation of environmental amenities and disamenities Methods and applications Annual Review of Environment and Resources 34 325347 Reviews the evolution of our ability to estimate the economic value of environmental amenities and disamenities over the last four decades Sigman H Stafford S 2011 Management of hazardous waste and contaminated land Annual Review of Resource Economics 3 A review of the hazardouswaste management from an economic perspective Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 475 Chapter 20 The Quest for Sustainable Development The challenge of finding sustainable development paths ought to provide the impetus indeed the imperativefor a renewed search for multilateral solutions and a restructured international economic system of cooperation These challenges cut across the divides of national sovereignty of limited strategies for economic gain and of separated disciplines of science Gro Harlem Brundtland Prime Minister of Norway Our Common Future 1987 Introduction Delegations from 178 countries met in Rio de Janeiro during the first 2 weeks of June 1992 to begin the process of charting a sustainable development course for the future global eco nomy Billed by its organizers as the largest summit ever held the United Nations Conference on Environment and Development known popularly as the Earth Summit sought to lay the groundwork for solving global environmental problems The central focus for this meeting was sustainable development What is sustainable development According to the Brundtland Report which is widely credited with raising the concept to its current level of importance Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs World Commission on Environment and Development 1987 But that is far from the only possible definition Part of the widespread appeal of the concept according to critics is due to its vagueness Being all things to all people can build a large following but it also has a substantial disadvantage close inspection may reveal the concept to be vacuous As the emperor discovered about his new clothes things are not always what they seem In this chapter we take a hard look at the concept of sustainable development and whether or not it is useful as a guide to the future What are the basic principles of sustainable The Quest for Sustainable Development 476 development What does sustainable development imply about changes in the way our system operates How could the transition to sustainable development be managed Will the global economic system automatically produce sustainable development or will policy changes be needed What policy changes Sustainability of Development Suppose we were to map out possible future trends in the longterm welfare of the average citizen Using a timescale measured in centuries on the horizontal axis see Figure 201 four basic culture trends emerge labeled A B C and D with t0 representing the present D portrays continued exponential growth in which the future becomes a simple repetition of the past Although this scenario is generally considered to be infeasible it is worth thinking about its implications if it were feasible In this scenario not only would current welfare levels be sustainable but also growth in welfare would be sustainable Our concern for intergenerational justice would lead us to favor current generations since they would be the poorest Worrying about future generations would be unnecessary if unlimited growth were possible The second scenario C envisions slowly diminished growth culminating in a steady state where growth diminishes to zero Each future generation is at least as welloff as all previous generations Current welfare levels are sustainable although current levels of welfare growth would not be Since the level of welfare of each generation is sustainable artificial constraints on the process would be unnecessary To constrain growth would injure all subsequent generations The third scenario B is similar in that it envisions initial growth followed by a steady state but with an important differencethose generations between t1 and t2 are worse off than the generation preceding them Neither growth nor welfare levels are sustainable at current levels and the sustainability criterion would call for policy to transform the economy so that earlier generations do not benefit themselves at the expense of future generations Figure 201 Possible Alternative Futures Per Capita Welfare Time D C B A t 2 t 0 t 1 The Quest for Sustainable Development 477 The final scenario A denies the existence of sustainable per capita welfare levels suggesting that the only possible sustainable level is zero All consumption by the current generation serves simply to hasten the end of civilization These scenarios suggest three important dimensions of the sustainability issue 1 the existence of a positive sustainable level of welfare 2 the magnitude of the ultimate sustainable level of welfare visàvis current welfare levels and 3 the sensitivity of the future level of welfare to actions by previous generations The first dimension is important because if posi tive sustainable levels of welfare are possible scenario A which in some ways is the most philo sophically difficult is ruled out The second is important because if the ultimately sustainable welfare level is higher than the current level radical surgery to cut current living standards is not necessary The final dimension raises the issue of whether the ultimate sustainable level of welfare can be increased or reduced by the actions of current generations If so the sustainability criterion would suggest taking these impacts into account lest future generations be unnecessarily impoverished by involuntary wealth transfers to previous generations The first dimension is relatively easy to dispense with The existence of positive sustainable welfare levels is guaranteed by the existence of renewable resources particularly solar energy as well as by natures ability to assimilate a certain amount of waste1 Therefore we can rule out scenario A Scenarios B and C require actions to assure the maintenance of a sustainable level of welfare They differ in terms of how radical the actions must be Although no one knows exactly what level of economic activity can ultimately be sustained the ecological footprint measurements discussed later in this chapter suggest that current welfare levels are not sustainable If that controversial assessment is valid more stringent measures are called for If scenario C is more likely then the actions could be less drastic but still necessary Current generations can affect the sustainable welfare levels of future generations both positively and negatively We could use our resources to accumulate a capital stock providing future generations with shelter productivity and transportation but machines and buildings do not last forever Even capital that physically stands the test of time may become economically obsolete by being ill suited to the needs of subsequent generations One lasting contribution to future generations would come from what economists call human capitalinvestments in people Though the people who receive education and training are mortal the ideas they bring forth are not knowledge endures2 Current actions could also reduce future welfare levels however Fossil fuel combustion could modify the climate to the detriment of future generations Current chlorofluorocarbon emissions can by depleting the atmospheres ozone raise the incidence of skin cancer The storage of radioactive wastes could increase the likelihood of genetic damage in the future The reduction of genetic diversity in the stock of plants and animals could well reduce future medical discoveries Suppose that higher levels of sustainable welfare are feasible Would our market system automatically choose a growth path that produces sustainable welfare levels or could it choose one that enriches current generations at the expense of future generations Market Allocations Market imperfections including intertemporal externalities openaccess resources and market power create incentives that can interfere in important ways with the quest for sustainable development Allowing open access to resources can and commonly does promote unsustainable allocations When resources are allocated by open access even the existence of renewable The Quest for Sustainable Development 478 resources cannot assure sustainability Diminished stocks are left for the future In the extreme it is even possible that some harvested species would become extinct Intertemporal externalities also undermine the ability of the market to produce sustainable outcomes Emissions of greenhouse gases impose a cost on future generations that is external to current generations Current actions to reduce the gases will impose costs on this generation but the bulk of the benefits would not be felt until significantly later Economic theory clearly forecasts that too many greenhouse gas emissions would be forthcoming for the sustainability criterion to be satisfied While market imperfections normally do exacerbate the problem of unsustainability the more general conclusion that they always promote unsustainability however is not correct Markets can sometimes provide a safety valve to ensure sustainability even when the supply of a renewable resource is threatened Fish farming is one example where declining supplies of a renewable resource trigger the availability of an alternative renewable substitute Even when the government intervenes detrimentally in a way that benefits current generations at the expense of future generations the market can in the right circumstances limit the damage by making substitutes available The flexibility and responsiveness of markets to scarcity can be an important component of the transition to sustainability but the notion that markets would if left to their own devices automatically provide for a sustainable future is naïve despite their apparent success in providing for generations in the past Efficiency and Sustainability Suppose future governments were able to eliminate all market imperfections restoring efficiency to the global economic system In this idealized world intertemporal and contemporaneous externalities would be reduced to efficient levels Access to common resources would be restricted to efficient levels and excess harvesting capacity would be eliminated Competition would be restored to previously cartelized natural resource markets Would this package of policies be sufficient to achieve sustainability or is something more required One way to examine this question is to examine a number of different models that capture the essence of intertemporal resource allocation For each model the question becomes Will efficient markets automatically produce sustainable development The conclusion to be drawn from these models is very clear restoring efficiency is not always sufficient to produce sustainability Take the allocation of depletable resources over time Imagine a simple economy where the only activity is the extraction and consumption of a single depletable resource Even when the population is constant and demand curves are temporally stable the efficient quantity profiles show declining consumption over time In this hypothetical world later generations would be unambiguously worse off unless current generations transferred some of the net benefits into the future Even an efficient market allocation would not be sustainable in the absence of transfers The existence of an abundant renewable backstop resource would not solve the problem Even in this more congenial set of circumstances the quantity profile of the depletable resource would still involve declining consumption until the backstop was reached In the absence of compensating transfers even efficient markets would use depletable resources to support a higher current standard of living than could ultimately be permanently supported In an historically important article Dasgupta and Heal 1979 found a similar result for a slightly more realistic model They assume an economy in which a single consumption good The Quest for Sustainable Development 479 is produced by combining capital with a depletable resource The finite supply of the depletable resource can either be used to produce capital or it can be used in combination with capital to produce the consumption good The more capital produced the higher is the marginal product of the remaining depletable resource in making the consumption good They prove that a sustainable constant consumption level exists in this model The rising capital stock implying a rising marginal product for the depletable resource would compensate for the declining availability of the depletable resource They also prove however that the use of any positive discount rate would necessarily result in declining consumption levels a violation of the sustainability criterion Discounting of course is an inherent component of dynamically efficient allocations In this model sustainable development is possible but it is not the choice made by markets even efficient markets Why not What would it take to ensure sustainable allocations Hartwick 1977 shows that the achievement of a constant per capita consumption path which would satisfy our definition of sustainability results when all scarcity rent is invested in capital None of it should be consumed by current generations Would this be the normal outcome No it would not Positive discount rates imply that some of the scarcity rent is consumed thereby violating the Hartwick rule The point is profound Restoring efficiency will typically represent a move toward sustainability but it may not by itself always be sufficient Additional policies must be implemented to guarantee sustainable outcomes Not all economic models reach this discouraging conclusion Specifically a class of models with endogenous technical progress allows the possibility that efficient markets will produce sustainable outcomes Endogenous technical progress means that the economic incentives inherent in the growth process produce a rate of technological progress that benefits future generations remember that technological process shifts out the production possibilities If the resulting rate is large enough to offset the declines to future generations caused by previous generations efficient markets can produce sustainable outcomes Can we count on the fact that the endogenous rate of technological progress will be sufficiently high to generate a sustainable outcome It is not guaranteed In Chapter 5 we pointed out that maintaining a nondeclining value of the capital stock both physical and natural provided an observable means of checking on the sustainability of current activity If the value of the capital stock is declining the activity is unsustainable Can we automatically conclude that a nondeclining value of the capital stock implies the sustainability of current consumption levels According to early work by Asheim 1994 and elaborated on by Pezzey 1994 we cannot Rising net wealth can coincide with unsustainability when the capital stock is being valued at the wrong ie unsustainable prices When nonrenewable resources are being used up too rapidly prices are driven down by the excess current supply Using these artificially depressed prices can create the false impression that the value of the depletion is less than the value of the additional investment and therefore that the value of the capital stock is rising In fact at the correct prices the value of the capital stock may be falling Another study by Howarth and Norgaard 1990 reaches a similar conclusion from a different perspective They derive competitive resource allocations across generations assuming that each generation is assigned a specific share of the available depletable resources This share is then varied and a new allocation calculated for each to reveal the effect of this intertemporal assignment of property rights to resources among generations For our purposes two of their conclusions are relevant 1 the resulting allocations are sensitive to the initial allocation of the resource rights across generations and 2 assigning all of the rights to the first generation would not produce a sustainable outcome This study provides yet another The Quest for Sustainable Development 480 perspective underlying the conclusion that efficient allocations of depletable resources do not necessarily produce sustainable outcomes How about with renewable resources At least renewable resource flows could in principle endure forever Are efficient market allocations of renewable resources compatible with sustainable development John Pezzey 1992 has examined the sustainability of an allocation of a single renewable resource such as corn over time Sustained growth of welfare can occur in this model but only if two conditions hold 1 the resource growth rate exceeds the sum of the discount rate and the population growth rate and 2 the initial food supply is sufficient for the existing population The first condition is sometimes difficult to meet particularly with rapid population growth and slowgrowing biological resources A main moral of this finding is that sustainable development of renewable resources is much harder in the presence of rapid population growth rates because the pressure to exceed sustainable harvest rates becomes harder to resist The second condition raises a more general and a more difficult concern It implies the distinct possibility that if the starting conditions are sufficiently far from a sustainable path sustainable outcomes may not be achievable without outside intervention The simplest way to see this point is to note that a poor country that is reduced to eating all the seed corn to survive sacrifices its future in order to survive in the present The double message that can be derived from these results is that 1 it is important to ensure by acting quickly that conditions do not deteriorate to the extent that survival strategies preclude investment and 2 foreign aid is likely to be an essential part of sustainability policies for the poorest nations We must be careful to distinguish between what has been said and what has not been said Restoring efficiency may well result in an improvement in sustainability but efficiency may be neither necessary nor sufficient for sustainability Three different cases can emerge In the first case the private inefficient outcome is sustainable and the efficient outcome is also sustainable In this case restoring efficiency will raise wellbeing but it is not necessary for sustainability This case might prevail when resources are extraordinarily abundant relative to their use In the second case the private inefficient equilibrium is unsustainable but the efficient outcome is sustainable In this case restoring efficiency not only increases current wellbeing but it is also sufficient to ensure sustainability In the final case neither the private inefficient outcome nor the efficient outcome is sustainable In this case restoring efficiency will not be enough to produce a sustainable outcome Some sacrifice by current generations would be necessary to ensure adequate protection for the wellbeing of future generations While efficient markets cannot always achieve sustainable development paths this does not mean that unsustainability would be the norm Indeed the historical record suggests that the incompatibility of the efficiency criterion and the sustainability criterion has been the exception not the rule Capital accumulation and technological progress have expanded the ways in which resources could be used and have increased subsequent welfare levels in spite of a declining resource base Nonetheless the two criteria are certainly not inevitably compatible As resource bases diminish and global externalities increase the conflict between these criteria will become intensified Trade and the Environment One of the traditional paths to development involves opening up the economy to trade Freer international markets provide lower prices for consumer goods due to the availability of and competition from imported products and the opportunity for domestic producers to serve foreign markets The law of comparative advantage suggests that trade can benefit both The Quest for Sustainable Development 481 parties One might suspect correctly that as one moves from theory to practice the story would become a bit more complicated The Role of Property Rights From our previous studies in this book it should be clear that trade can certainly inflict detrimental and inefficient effects on the environment One case is when some nations presumably those in the less developed South have poorly defined property rights or have not internalized their externalities such as pollution In this kind of situation the tragedy of the commons can become greatly intensified by freer trade Poorly defined property rights in the exporting nations encourage the importing nations by artificially lowering prices to greatly expand their consumption of the underpriced resources In this scenario trade intensifies environmental problems by increasing the pressure on openaccess resources and hastening their degradation One example is the effect of trade on endangered wildlife such as elephants The current approach to meeting this challenge involves a ban on ivory trading Could a limited relaxation of that ban actually increase protection against elephant poaching See Debate 201 Would the Protection of Elephant Populations be Enhanced or Diminished By Allowing Limited International Trade in Ivory Since elephant populations were being endangered by poaching and other illegal activities in 1990 a crossborder ivory ban was imposed by CITES the Convention on International Trade in Endangered Species That ban has not been sufficient to solve the problem since Central Africa has lost 64 percent of its elephants in a decade One proposed change suggests allowing trade in ivory from stockpiled sources Since no elephants are harmed in its collection CITES considers this stockpiled ivory legal to hold along with the ivory from elephants shot for justifiable management reasons such as controlling problem animals The proposed trade would be based on regular auctions of legal ivory from African countries that have stable elephant populations and are motivated enough to organize credible recovery and stockpiling systems The proceeds would be used to bolster currently unfunded elephant conservation pro grams Buying countries would be limited to those that have transparent enforcement and are equally motivated to prevent illicit trafficking CITES could revoke a countrys selling or buying status at any time Opponents maintain that the assumption that the ivory collected from Africas elephant populations through natural mortality and sustainable management practices can supply enough to satisfy demand is naïve Currently they note the majority of African countries with elephant populations oppose the trade in ivory If legal supply is based merely on supply from a handful of countries that support trade other populations in DEBATE 201 The Quest for Sustainable Development 482 Pollution Havens and the Race to the Bottom The failure to control externalities such as pollution provides another possible route known as the pollution havens hypothesis for trade to induce or to intensify environmental degradation According to this hypothesis producers affected by stricter environmental regulations in one country will either move their dirtiest production facilities to countries pollution havens with less stringent environmental regulations presumed to be lowerincome countries or face a loss of market share due to the cheaper goods produced in the pollution havens Pollution levels in the pollution havens can change for three different reasons 1 the composition effect 2 the technique effect or 3 the scale effect According to the composition effect emissions change as the mix of dirty and clean industries changes as the ratio of dirty to clean industries increases emissions increase even if total output remains the same Note that this is the expected outcome from the pollution havens hypothesis The technique effect involves the ratio of emissions per unit output in each industry Emissions could increase in pollution havens via this effect if each firm in the pollution haven became dirtier as a result of openness to trade And finally the scale effect looks at the role of output level on emissions even if the composition and technique effects were zero emissions could increase in pollution havens simply because output levels increased In addition to suggesting a channel for degradation the pollution havens hypothesis if correct could provide a justification for developing countries to accept lower environmental standards In this view lower environmental standards protect against job loss In other words it suggests a race to the bottom feedback mechanism where competitive incentives among nations force developing countries to keep environmental standards weak in order to attract jobs and jobs move to those locations in search of the lower costs resulting from lower standards What is the evidence on the empirical validity of the pollution havens hypothesis and its race to the bottom implication Early surveys of the empirical work such as Dean 1992 found absolutely no support for the effect of environmental regulation on either trade or countries that oppose trade will continue to be targeted and the illegal market will continue to thrive They further suggest that distinguishing between legal and illegal ivory trade is too difficult to manage as demonstrated by the fact that existing permitting and regulation systems clearly do not work Opponents also argue that whats needed is not reopening a limited ivory market but better regulation and enforcement of the existing ban If you were on the CITES governing board how would you vote Why Sources Scriber Brad August 18 2014 100000 elephants killed by poachers in just three years landmark analysis finds National Geographic Available at httpnews nationalgeographiccomnews201408140818elephantsafricapoachingcites census Rice Mary October13 2014 The case against a legal ivory trade It will lead to more killing of elephants Environment 360 Available at httpe360yaleedu featurecounterpointthecaseagainstalegalivorytradeitwillleadtomore killingofelephants2815 Walker John Frederick October 13 2014 The case for a legal ivory trade It could help stop the slaughter Environment 360 Available at httpe360yaleedufeaturepointthecaseforalegalivorytradeitcould helpstoptheslaughter2814 The Quest for Sustainable Development 483 capital flows Jaffe et al 1995 reach the same conclusion in their survey of the effect of environmental regulations on US competitiveness More recent studies reviewed by Copeland and Taylor 2004 however have begun to find that environmental regulation can influence trade flows and plant location all other things being equal though the effects were still small Has there been a discernible exodus of dirty industries to developing countries Apparently not Studies that attempt to isolate composition technique and scale effects generally find that the composition effect the most important effect for confirming the pollution havens hypothesis is small relative to scale effects Furthermore in practice technique effects nor mally result in less not more pollution Hettige Mani Wheeler 2000 Though trade can increase pollution through the scale effect these findings are quite different from what we would expect from a race to the bottom Actually these results should not be surprising Because pollution control costs comprise a relatively small part of the costs of production it would be surprising if lowering environ mental standards could become a major determinant of either firm location decisions or the direction of trade unless the costs of meeting those standards became a significant component of production cost The Porter Induced Innovation Hypothesis The story does not end there Michael Porter 1991 a Harvard Business School professor has argued that more environmental protection can under the right circumstances promote jobs not destroy them Now known as the Porter induced innovation hypothesis this view suggests that firms in nations with the most stringent regulations experience a competitive advantage rather than a competitive disadvantage Under this nontraditional view strict environmental regulations force firms to innovate and innovative firms ultimately tend to be more competitive This advantage is particularly pronounced for firms producing pollution control equipment which can then be exported to firms in countries subsequently raising their environmental standards but it might also be present for firms that find in retrospect that meeting environmental regulations actually lowered their production costs Some specific instances of regulationinduced lower production costs have been recorded in the historic literature Barbera McConnell 1990 but few studies have found the Porter hypothesis to be universally true While it seems clear that innovation induced by environmental regulation could simultaneously increase productivity lower costs and lower emissions it is less clear why this would necessarily always or even normally be the case And if it were universally true it is not clear why all firms would fail to adopt these techniques even in the absence of regulations The Porter hypothesis is valuable because it reminds us that a particularly ingrained piece of conventional wisdom environmental regulation reduces firm competitiveness can be wrong It would be a mistake however to use the Porter hypothesis as confirmation of the much stronger proposition that environmental regulation is universally good for competitiveness The Environmental Kuznets Curve EKC Although its proponents have come to recognize the potential problems for the environment posed by free trade particularly in the face of externalities or poor property right regimes in the exporting countries they tend to suggest that these problems will be selfcorrecting Specifically they argue that as freer trade increases incomes the higher incomes will promote more environmental protection The specific functional relationship underlying this view comes from some earlier work by Simon Kuznets a now deceased Harvard professor and so has become known as the Environmental Kuznets Curve According to this relationship environmental degradation increases with higher per capita incomes up to some income level the turning point After The Quest for Sustainable Development 484 the turning point however higher incomes result in reductions in environmental degradation Some apparent confirmation of this view came from early studies that plotted variables such as SO2 concentrations against per capita incomes using countries as the units of observation data points The notion that increasing income from trade involves a selfcorrecting mechanism would have quite a different meaning if part of that correction involved exporting the pollution intensive industries to other countries This would change the meaning of the Kuznets curve considerably since it would involve a transfer of pollution not a reduction of pollution This conjecture is especially important in a finite world because it implies that developing countries would never experience the Kuznets turning point Since they would have nowhere to go the pollutionintensive industries could not be transferred again How is the EKC relationship affected by trade Cole 2004 examines this question and finds that explicit consideration of trade effects in estimating the EKC relationship does not eliminate the turning point for most pollutants but it does affect the timing In particular controlling for the transfer of pollutionintensive industries makes the actual turning point occur later than without considering these effects How about the general proposition that pollution problems are selfcorrecting with development In general that proposition has little empirical support Neumayer 2001 Pasten Figueroa 2012 The early studies used different nations as data points but the interpretation suggested that an individual country would eventually increase environmental protection as its income increased Studies that looked specifically at how environmental protection varied over time as income increased within an individual country frequently did not find the expected relationship Deacon Norman 2006 Vincent 1997 Other studies found that it seemed to apply to some pollutants such as SO2 but not to others such as CO2 List Gallet 1999 World Bank 1992 And finally as Example 201 illustrates some case studies in countries that have experienced considerably freer trade regimes have generally experienced intensified not reduced environmental degradation What are we to make of this evidence Apparently environmental regulations are not yet a major determinant of either firm location decisions or the direction of trade This implies that reasonable environmental regulations should not be held hostage to threats that polluters will leave the area and take their jobs with them with few exceptions firms that are going to move will move anyway while firms that are not going to move will tend to stay whatever the regulatory environment When deterioration is caused by inadequate local property right regimes or inadequate internalization of externalities it may not be necessary or desirable to prevent trade but rather to correct these sources of market failure These inefficiencies associated with trade could be solved with adequate property regimes and appropriate pollution control mechanisms On the other hand if establishing appropriate property regimes or pollution control mechanisms is not politically feasible other means of protecting the resources must be found including possibly restricting detrimental trade However caution must be used in imposing these trade restrictions since they are a secondbest policy instrument in this case and can even be counterproductive3 While the foregoing argument suggests that the starkest claims against the environmental effects of free trade do not bear up under close scrutiny it would be equally wrong to suggest that opening borders to freer trade inevitably results in a gain in efficiency andor sustainability The truth it seems depends on the circumstances so pure ideology does not get us very far The context matters Since new trade institutions are now emerging new issues with enormous implications for the environment are emerging with them Of particular interest are the environmental The Quest for Sustainable Development 485 consequences of international trade rules under the General Agreement on Tariffs and Trade GATT and the World Trade Organization WTO Trade Rules under GATT and the WTO The General Agreement on Tariffs and Trade GATT the international agreement that laid the groundwork for the World Trade Organization WTO was first signed in 1947 EXAMPLE 201 Has NAFTA Improved the Environment in Mexico The North American Free Trade Agreement NAFTA took effect in 1994 By lowering tariff barriers and promoting the freer flow of goods and capital NAFTA integrated the United States Canada and Mexico into a single giant market The agreement has apparently been successful in promoting trade and investment Has it also been successful in promoting environmental protection in Mexico According to a study by Kevin Gallagher 2004 it has not although not necessarily due to the forces identified by the pollution havens hypothesis Some effects clearly resulted in less pollution and others more although on balance air quality has deteriorated The pollution havens hypothesis might lead us to expect a relocation of heavily polluting firms from the United States to Mexico but that apparently did not happen None of the numerous statistical tests performed by the author supported that hypothesis In terms of positive effects on air quality from trade Gallagher found significant shifts in Mexican industry away from pollutionintensive sectors the posttrade Mexican industrial mix was less polluting than the pretrade industrial mix the opposite of what would be expected from the pollution havens hypothesis He even found that some Mexican industries specifically steel and cement were cleaner than their counterparts in the United States a fact he attributes to their success in securing new investment for more modern plants with cleaner technologies The largest traderelated source of air quality degradation was the scale effect Although the posttrade industrial mix generally shifted away from the most polluting sectors meaning fewer average emissions per unit output the promotion of exports increased output levels considerably Increased output meant more emissions in this case almost a doubling One expectation emanating from the Environmental Kuznets Curve is that the increased incomes from trade would result in more environmental regulation which in turn would curb emissions That expectation was not met either Gallagher found that both real government spending on environmental policy and the number of Mexican plantlevel environmental compliance inspections fell by 45 percent after NAFTA despite the fact that income levels reached the turning point expected by the pretrade studies Source Gallagher K P 2004 Free Trade and the Environment Mexico NAFTA and Beyond Palo Alto CA Stanford University Press The Quest for Sustainable Development 486 That agreement provided an international forum for encouraging free trade between member states by regulating and reducing tariffs on traded goods and by providing a common mechanism for resolving trade disputes Having now replaced the GATT forum the WTO is the sole global international organization dealing with the rules of trade between nations As an organization devoted to freer trade the WTO adjudicates disputes among trading nations through the lens of its effect on trade Domestic restrictions on trade of any kind including environmental restrictions are suspect unless they pass muster To decide whether they pass muster or not the WTO has evolved a set of rules to define the border between acceptable actions and unacceptable actions These rules examine for example such things as differential treatment A disputed environmental action that discriminates against goods from another country rather than holding imports and domestically produced goods to the same standard is deemed differential treatment and is unacceptable Disputed actions that are not the lowestcost and least injurious to trade action that could have been taken to address the particular environmental problem are also unacceptable One of the most controversial rules involves a distinction between product concerns and process concerns see Debate 202 At the risk of oversimplification regulations that address product concerns such as mandating the highest acceptable residual pesticide levels in foods are acceptable but regulations addressing the process by which the product was made or harvested such as banning steel from a particular country because it is manufactured in coalburning plants are not acceptable In the latter case the steel from coalburning plants is considered by the WTO to be indistinguishable from steel made by other processes so the product is considered to be homogeneous and treating it as different is unacceptable The inability of any country to address process concerns in its imports clearly limits its ability to internalize externalities In light of this interpretation one way to internalize externalities in other countries would be to use means other than trade international agreements to limit carbon emissions for example Another as Debate 202 points out is to use ecolabeling as a means of putting at least some market pressure on the disputed practices How far that labeling can go without triggering a negative WTO ruling remains to be seen Should an Importing Country Be Able to Use Trade Restrictions to Influence Harmful Fishing Practices in an Exporting Nation Yellowfin tuna in the Eastern Tropical Pacific often travel in the company of dolphins Recognizing that this connection could be exploited to more readily locate tuna tuna fishermen used it to increase their catch with deadly effects for dolphins Having located dolphins tuna vessels would use giant purse seines to encircle and trap the tuna capturing and frequently killing dolphins at the same time In response to public outrage at this technique the United States enacted the Marine Mammal Protection Act MMPA This act prohibited the importation of fish caught with commercial fishing technology that results DEBATE 202 The Quest for Sustainable Development 487 Natural Disasters One threat to sustainability comes from natural disasters such as hurricanes floods and wildfires In its 2012 report The National Research Council notes In 2011 the United States was struck by multiple disastersincluding 14 related to weather and climatethat caused more than 55 billion in economic damages breaking all records since these data were first reported in 1980 Nearly 600 Americans died and many thousands more were displaced The report goes on to suggest that building a culture of resilience could reduce the nations vulnerability to disasters as well as the costs they impose What exactly is resilience According to the report Resilience is the ability to prepare and plan for absorb recover from and more successfully adapt to adverse events How much difference could an increase in resilience make A study conducted by the Multihazard Mitigation Council found that for every dollar spent on predisaster investments in resilience to prepare for earthquakes wind and flooding about 4 were saved in post disaster damages Readers of this book will recognize some of the strategies that could promote resilience One involves providing better information to homeowners businesses and governments to apprise them of both the risks being faced and costeffective ways of mitigating those risks Another would be to implement policies that provide incentives for private risk reduction investments One instrument that can be used to promote resilience in the face of flood risk is flood insurance A flood is one of the most prevalent and most costly types of natural disaster In principle a welldesigned flood insurance program could both reduce the economic damages in the incidental kill or serious injury of ocean mammals in excess of US standards In 1991 a GATT panel ruled on an action brought by Mexico asserting that US law violated GATT rules because it treated physically identical goods tuna differently According to this ruling countries could regulate products that were harmful as long as they treated domestic and imported products the same but not the processes by which the products were harvested or produced in foreign countries Using domestic regulations to selectively ban products as a means of securing change in the production or harvesting decisions of other countries was ruled a violation of the international trade rules The United States responded by mandating an ecolabeling program Under this law tuna caught in ways that killed dolphins could be imported but those imports were not allowed to use the dolphinsafe label Tuna caught with purse seines could only use the dolphinsafe label if special onboard observers witnessed no dolphin deaths Disputes over some of the technical aspects of how this program is implemented are continuing Source The official history of the case can be found at wwwwtoorgenglishtratope dispuecaseseds381ehtmtop accessed December 21 2016 The Quest for Sustainable Development 488 caused and provide funds to lower the recovery time following a flood With climate change intensifying flood risks enhanced resilience could be very costeffective As Example 202 points out however the policy has to be both welldesigned and implemented appropriately if it is to be effective otherwise it can end up increasing the damages The devil really is in the details EXAMPLE 202 Enhancing Resilience Against Natural Disasters with Flood Insurance Among other characteristics an efficient flood insurance design requires 1 premium levels high enough to cover the claims and 2 a structure of premiums that reflects the actual severity of the risk faced by the individual premium payers In the United States the National Flood Insurance Program NFIP was set up in 1968 NFIP flood insurance isnt mandatory but homes and businesses in designated floodprone areas must carry flood insurance to qualify for federally backed mortgages Maps are used not only to designate areas that are floodprone but also to characterize their degree of risk Does this program meet the two efficiency tests In a nutshell it does not Premium levels have historically been too low to cover the claims In 2016 the NFIP debt resulting from claims exceeding premium revenue was 23 billion Furthermore attempts by Congress to raise premiums produced a backlash resulting in a political inability to raise premiums to the efficient level An added factor involves the maps that are used to characterize the risk Since climate change is intensifying flood risk older maps necessarily underestimate the risk Unfortunately the process of updating the maps has not kept pace so underestimates are common Some problems with the structure of premiums have emerged as well In efficient policy designs policyholders who undertake measures that lower the risk to their structures should face lower premiums to reflect the lower risk These premium discounts would provide the motivation for homeowners and businesses to reduce risks As Kousky and Shabman 2016 report the NFIP has been offering substantial premium reductions for elevating the structures but not for other effective flood mitigation measures As a result those other measures are underutilized and damages are higher than necessary As a practical matter the program mainly enables people to rebuild in the same areas without doing enough to mitigate future risks One would expect that these incentives would lead to higher future claims A study by the Natural Resources Defense Council found that some 2109 NIFP covered properties across the United States have flooded more than ten times and the NFIP paid to rebuild them after each flood One covered home has flooded 40 times and received a total of 428379 in flood insurance payments The mere existence of a flood insurance program is not by itself evidence of efficient resilience Sources National Research Council 2012 Disaster Resilience A National Imperative Washington DC The National Academies Press Kousky Carolyn Shabman Leonard A July 29 2016 The role of insurance in promoting resilience This blog is available at wwwrfforgblog2016roleinsurancepromotingresilience Moore Rob August 11 2016 Flood rebuild repeat The need for flood insurance reforms This blog is available at wwwnrdcorg The Quest for Sustainable Development 489 The Natural Resource Curse One especially intriguing possible barrier to development might plague resourceabundant nations Common sense suggests that those countries blessed with abundant resource endowments would be more likely to prosper In fact the evidence suggests the opposite resourceabundant countries are less likely to experience rapid development see Example 203 EXAMPLE 203 The Natural Resource Curse Hypothesis Perhaps surprisingly robust evidence suggests that countries endowed with an abund ance of natural resources are likely to develop less rapidly than countries with a more modest natural resource base And it is not merely because resourcerich countries are subject to volatile commodity prices Why might a large resource endowment exert a drag on growth Several possibilities have been suggested Most share the characteristic that resourcerich sectors are thought to crowd out investment in other sectors that might be more likely to support development One popular explanation known as the Dutch Disease is usually triggered by a significant increase in revenues from raw material exports The resulting boom draws both labor and capital out of traditional manufacturing and causes it to decline Another explanation focuses on how the increase in domestic prices that typically accompanies the resource boom impedes the international competitiveness of manufactured exports and therefore exportled development A third explanation suggests that the large rents to be gained from the resource sectors in resourceabundant countries would cause entrepreneurial talent and innovation to be siphoned away from other sectors Thus resourcerich countries could be expected to have lower rates of innovation which in turn results in lower rates of development Finally countries endowed with natural resources can give rise to domestic institutions in which autocratic or corrupt political elites finance themselves through physical control of the natural resources While countries with large resource endowments may not experience the development success that might have been expected it is encouraging to note that lots of countries without large resource endowments have not been precluded from achieving significant levels of development Sources Sachs J D Warner A M 2001 The curse of natural resources European Economic Review 4546 827838 Auty R M Sustaining Development in Mineral Economies The Resource Curse Thesis London Routledge Kromenberg T 2004 The curse of natural resources in the transition economies Economics of Transition 123 399426 Frankel J A April 2012 The natural resource curse A survey of diagnoses and some prescriptions Harvard Kennedy School Faculty Research Working Paper Series RWP12014 The Quest for Sustainable Development 490 The GrowthDevelopment Relationship Has economic growth historically served as a vehicle for development Has growth really made the average person better off Would the lowestincome members of the United States and the world fare better with economic growth or without it These turn out to be difficult questions to answer in a way that satisfies everyone but we must start somewhere One appropriate point of departure is clarifying what we mean by development Some of the disenchantment with development can be traced to the way that development is measured It is not so much that all growth is bad but that increases in conventional indicators of development are not always good Some of the enthusiasm for constrained economic growth stems from the fact that economic development as currently measured can be shown to have several undesirable characteristics Conventional Measures A true measure of development would increase whenever we as a nation or as a world were better off and decrease whenever we were worse off Such a measure is called a welfare measure and no conventional existing measure is designed to be a welfare measure In contrast the conventional measures of national accounting we currently use are output measures which attempt to indicate how many goods and services have been produced not how well off we are Measuring output sounds fairly simple but it is not The measure of economic development with which most are familiar is based upon the GDP gross domestic product This number represents the sum of the outputs of goods and services produced by the economy in any year Prices are used to weight the importance of these goods and services in GDP Conceptually this is accomplished by adding up the value added by each sector of the production process until the product is sold Why weight by prices Some means of comparing the value of extremely dissimilar commodities is needed Prices provide a readily available system of weights that takes into account the value of those commodities to consumers From early chapters we know that prices should reflect both the marginal benefit to the consumer and the marginal cost to the producer GDP is not a measure of welfare and was never meant to be one Therefore increases in this indicator growth may not represent increases in development or wellbeing One limitation of this indicator as a measure of welfare is that it includes the value of new machines that are replacing wornout ones rather than increasing the size of the capital stock To compensate for the fact that some investment merely replaces old machines and does not add to the size of capital stock a new concept known as net domestic product NDP was introduced NDP is defined as the gross domestic product minus depreciation NDP and GDP share the deficiency that they are both influenced by inflation If the flow of all goods and services were to remain the same while prices doubled both NDP and GDP would also double Since neither welfare nor output would have increased an accurate indicator should reflect that fact To resolve this problem national income accountants present data on constantdollar GDP and constantdollar NDP These numbers are derived by cleansing the actual GDP and NDP data to take out the effects of price rises Conceptually this is accomplished by defining a market basket of goods that stays the same over time Each year this same basket is repriced If the cost of the goods in the basket went up 10 percent then because the quantities are held constant we know that prices went up by 10 percent This information is used to remove the The Quest for Sustainable Development 491 effects of prices on the indicators remaining increases should be due to an increased production of goods and services This correction does not solve all problems For one thing not all components of GDP contribute equally to welfare Probably the closest though still deficient we could use in the existing system of accounts would be consumption the amount of goods and services consumed by households It leaves out government expenditures investments exports and imports The final correction that could easily be made to the existing accounts would involve dividing real consumption by the population to get real consumption per capita This correction allows us to differentiate between increases in output needed to maintain the same standard of living for a growing population and increases indicating more goods and services consumed by the average member of that population Real consumption per capita is about as close as we can get to a welfareoriented output measure using conventional accounting data Yet it is a far cry from being an ideal welfare indicator In particular changes in real consumption per capita fail to distinguish between economic growth resulting from a true increase in income and economic growth result ing from a depreciation in what economists have come to call natural capital the stock of environmentally provided assets such as the soil the atmosphere the forests wildlife and water The traditional definition of income was articulated by Sir John Hicks 1939 The purpose of income calculations in practical affairs is to give people an indication of the amount they can consume without impoverishing themselves Following out this idea it would seem that we ought to define a mans income as the maximum value which he can consume during a week and still expect to be as well off at the end of the week as he was at the beginning p 172 While humancreated capital such as buildings and bridges is treated in a manner consistent with this definition natural capital is not As humancreated physical capital wears out the accounts set aside an amount called depreciation to compensate for the decline in value as the equipment wears out No increase in economic activity is recorded as an increase in income until depreciation has been subtracted from gross returns That portion of the gains that merely serves to replace wornout capital is not appropriately considered income No such adjustment is made for natural capital in the standard national income accounting system Depreciation of the stock of natural capital is by default therefore incorrectly counted as income Development strategies that cash in on the endowment of natural resources are in these accounts indistinguishable from development strategies that do not depreciate the natural capital stock the returns from both are treated as income Consider an analogy Many highquality private educational institutions in the United States have large financial endowments When considering their budgets for the year these institutions take the revenue from tuition and other fees and add in some proportion of the interest and capital gains earned from the endowment Except in extraordinary circumstances standard financial practice however does not allow the institution to attack the principal Drawing down the endowment and treating this increase in cash flow as income is not allowed Yet that is precisely what the traditional national accounts allow us to do in terms of natural resources We can deplete our soils cut down our forests and douse ocean coves with oil and the resulting economic activity is treated as income not as a decline in the endowment of natural capital The Quest for Sustainable Development 492 Because the Hicksian definition is violated for natural capital policymakers can be misled By relying upon misleading information policymakers are more likely to undertake unsustainable development strategies Adjusting the national income accounts to apply the Hicksian definition uniformly to humanmade and natural capital could in resourcedependent countries make quite a difference Motivated by a recognition of these serious flaws in the current system of accounts a number of other industrial countries have now proposed or in a few cases have already set up systems of adjusted accounts including Norway France Canada Japan the Netherlands and Germany Significant differences of opinion on such issues as whether the changes should be incorporated into a complementary system of accounts or into a complete revision of the standard accounts remain to be resolved Alternative Measures Are we fulfilling the sustainability criterion or not Although that turns out to be a difficult question to answer a number of indicators have now been designed to allow us to make some headway These indicators differ in both their construction and the insights that can be derived from them Ecological Footprint One example of an indicator the Ecological Footprint differs considerably from the others in that it is based upon a physical measure rather than an economic measure The Ecological Footprint indicator attempts to measure the amount of renewable and nonrenewable ecologically productive land area that is required either to support the resource demands or to absorb the wastes of a given population or specific activities4 The footprint is expressed in global acres Each unit corresponds to 1 acre of biologically productive space with world average productivity Every year has its own set of equivalence factors since landuse productivities change over time By comparing this footprint to the amount of ecologically available land deficits or surpluses can be uncovered This indicator calculates national consumption by adding imports to and subtracting exports from domestic production This balance is computed for 72 categories such as cereals timber fishmeal coal and cotton The footprint in terms of acres for each category of resource uses is calculated by dividing the total amount consumed in each category by its ecological productivity or yield per unit area In the case of carbon dioxide CO2 emissions the footprint is calculated by dividing the emissions by the average assimilative capacity of forests to find the number of acres necessary to absorb the pollutants According to this indicator the industrialized nations have the most unsustainable consumption levels meaning that their consumption requires more ecologically productive land than is domestically available This analysis also suggests that current global consumption levels cannot be sustained indefinitely by the current amount of ecologically productive land we are in a deficit situation The Genuine Progress Indicator Another alternative indicator that has been developed is the Genuine Progress Indicator GPI While GDP is a measure of current production the GPI is designed to measure the economic welfare generated by economic activity essentially counting the depreciation of community capital as an economic cost GPI starts with Personal Consumption Expenditures a major component of GDP but adjusts that data using 24 different components including income distribution environmental costs and negative activities like crime and pollution among others GPI also adds positive components that are The Quest for Sustainable Development 493 not included in the GDP including the benefits of volunteering and household labor Following an extensive analysis of the GPI both over time and across counties Kubiszewski et al 2013 find a significant variation among these countries but some major trends over the 19502003 period Global GPIcapita peaked in 1978 about the same time that global Ecological Footprint exceeded global biocapacity Life Satisfaction in almost all countries has also not improved significantly since 1975 Globally GPIcapita does not increase beyond a GDPcapita of around 7000capita The Human Development Index One reason for dissatisfaction with all of these measures of wellbeing is their focus on an average citizen To the extent that the most serious problems of deprivation are not experienced by the average member of society this focus may leave a highly misleading impression about wellbeing To rectify this problem in 1990 the United Nations Development Program UNDP constructed an alternative measure the Human Development Index HDI This index has three major components longevity knowledge and income Though highly controversial because both the measures to be included in this index and the weights assigned to each component are rather arbitrary the UNDP 2015 has drawn some interesting conclusions Major progress has been made over the last 25 years with 2 billion people lifted out of low human development levels Between 1990 and 2014 the number of people living in countries with very high values of human development index more than doubled from 05 billion to 12 billion people as 34 countries moved up to this category Human development as measured by the Human Development Index HDI continues to improve but at a slower pace The HDI for developing countries grew by 12 percent annually between 2000 and 2010 but by only 07 percent annually for the period 20102014 Economic growth does not automatically translate into higher human development For example Equatorial Guinea and Chile have similar incomes but very different HDIs 0592 and 0847 respectively The top five countries in rank order of HDI are Norway 0944 Australia 0935 Switzerland 0930 Denmark 0923 and the Netherlands 0922 There are no changes from 2014 in these rankings The bottom five countries in rank order of HDI are Niger 0348 Central African Republic 0350 Eritrea 0391 Chad 0392 and Burundi 0400 Gross National Happiness Bhutan is a small Asian country situated at the eastern end of the Himalayas It shares borders with India and the Peoples Republic of China In November 2008 the country adopted the Gross National Happiness index as an alternative to more conventional measures to guide its development strategy This single number Gross National Happiness index which is based upon an extensive survey of the citizens of Bhutan is based upon nine core dimensions that are regarded as components of happiness and wellbeing in Bhutan The nine dimensions are as follows 1 Psychological wellbeing 2 Time use 3 Community vitality The Quest for Sustainable Development 494 4 Culture 5 Health 6 Education 7 Environmental diversity 8 Living standard 9 Governance Gross national happiness is deemed to have risen over time if sufficient achievements in these nine dimensions have been obtained Since it is new how well this index serves its intended purpose remains to be seen Some results from 2015 indicate that overall fewer women are happy than men people living in urban areas are happier than rural residents single and married people are happier than the widowed divorced or separated more educated people are happier than their lesseducated counterparts and finally farmers are less happy than other occupational groups How important is money to happiness It seems like a simple question but that simplicity can be deceptive see Example 204 Summary Sustainable development refers to a process for providing for the needs of the present generation particularly those in poverty without compromising the ability of future generations to meet their own needs Market imperfections frequently make sustainable development less likely Intergenerational externalities such as climate modification impose excessive costs on future generations Free access to biological common property resources can lead to excessive exploitation and even extinction of the species Even efficient markets do not necessarily guarantee development that can be sustained Restoring efficiency is desirable and helpful but can be insufficient as a means for producing sustainable welfare levels While in principle dynamically efficient allocations can produce extraction profiles for depletable resources that are compatible with the interests of future generations in practice this is not necessarily the case When trade is used as part of the development strategy it must be used carefully The effects of trade on the environment are neither universally benign nor universally detrimental Context matters We have examined a series of indicators that attempt to shed light on the degree to which current national practices are sustainable Though all of these indicators are both incomplete and flawed they all convey some important insights The Ecological Footprint provides helpful reminders that scale does matter and that the earth on which we all depend is ultimately limited in its ability to fulfill our unlimited wants Though the Ecological Footprint finding that we have already exceeded the earths carrying capacity is controversial it does usefully lay to rest the naïve view that our ability to consume is limitless and emphasize that we had better start thinking about how to stay within natural limits The Ecological Footprint is also helpful in pointing out that affluence is fully as big a challenge to sustainability as poverty The Human Development Index reminds us that the relationship between income growth and the wellbeing of the poorest citizens of the world is far from a sure thing in contrast to what some would have us believe While national income growth can provide a means for empowerment for the poor it can only do so when accompanied by appropriate policy measures such as ensuring universal health care and education and limiting the perverse effects The Quest for Sustainable Development 495 EXAMPLE 204 Happiness Economics Does Money Buy Happiness In recent years economists and psychologists have become interested in what has become known as the economics of happiness What is it that makes people happy and what role does income play A psychologist and an economist Kahneman Deaton 2010 analyzed the responses of more than 450000 US residents surveyed in 2008 and 2009 to several questions about their subjective wellbeing Their results suggest a rather complex answer to this question suggesting that it is sensitive to how wellbeing is measured The authors defined two rather different subjective measures of wellbeing One measure labeled Emotional WellBeing refers to the emotional quality of an individuals everyday experiencethe frequency and intensity of experiences of joy fascination anxiety sadness anger and affection that make ones life pleasant or unpleasant In this study emotional wellbeing is captured by two variables The first which deals with aspects of positive wellbeing sums three binary 1 or 0 variables measuring selfreported happiness enjoyment and frequent smiling and laughter The second capturing a blue effect takes the average of two binary variables measuring stress and worry All questions asked the respondent to respond relative to his or her experience the previous day The second measure which the authors label Life Evaluation has the respondent rate his or her current life on a ladder scale in which 0 is the worst possible life for you and 10 is the best possible life for you Unlike the previous measure which focuses on a snapshot of feelings at a specific point in time this question is a more overarching measure of wellbeing Before getting to the statistical results of how income affects these measures of well being consider some comparative observations revealed by these data The authors found that most people were quite happy and satisfied with their lives These results indicate that the US population ranks high on the Life Evaluation Index ninth after the Scandinavian countries Canada the Netherlands Switzerland and New Zealand and also does well in terms of happiness 5th but much less well on worry 89th from least worried sadness 69th from least sad and anger 75th Americans report very high levels of stress 5th among 151 countries In terms of income the present study finds that a lack of money brings both emotional misery and low life evaluation Beyond 75000 in 20082009 in the contemporary United States however higher income is neither the road to experienced happiness nor the road to the relief of unhappiness or stress although higher income continues to improve individuals life evaluations p 16491 Sources Bruni L Porta P L 2005 Economics and Happiness Framing the Analysis Oxford Oxford University Press Kahneman D Deaton A 2010 High income improves evaluation of life but not emotional wellbeing Proceedings of the National Academy of Sciences 10738 1648916493 The Quest for Sustainable Development 496 of corruption The Human Development Index identifies a number of lowincome countries that have made great strides in ensuring that the fruits of development do reach the poor New sustainable forms of development are possible but they will not inevitably be adopted Economic incentive policies can facilitate the transition from unsustainable to sustainable activities The search for solutions must recognize that market forces are extremely powerful Attempts that ignore those forces are probably doomed to failure Nonetheless it is possible to harness those forces and channel them in directions that enhance the possibilities of sustainable outcomes To take these steps will require thinking and acting in somewhat unconventional ways Whether the world community is equal to the task remains to be seen Discussion Questions 1 Consider a possible mechanism for controlling population According to an idea first put forth by Kenneth Boulding in 1964 each individual would be given the right to produce one and only one child Because this scheme over a generation allows each member of the current population to replace himself or herself births would necessarily equal deaths and population stability would be achieved This scheme would award each person a certificate entitling the holder to have one child Couples could pool their certificates to have two Every time a child was born a certificate would be surrendered Failure to produce a certificate would cause the child to be put up for adoption Certificates would be fully transferable Is this a good idea What are its advantages and disadvantages Would it be appropriate to implement this policy now in the United States For those who believe that it would what are the crucial reasons For those who believe it is not appropriate are there any circumstances in any countries where it might be appropriate Why or why not 2 Every molecule of a nonrenewable energy resource used today precludes its use by future generations Therefore the only morally defensible policy for any generation is to use only renewable resources Discuss 3 Future generations can cast neither votes in current elections nor dollars in current market decisions Therefore it should not come as a surprise to anyone that the interests of future generations are ignored in a market economy Discuss 4 Trade simply represents economic imperialism where one country exploits another The environment is the inevitable victim Discuss 5 Suppose someone developed a highquality synthetic ivory that could be used in products currently made from natural ivory What effect might a legal trade in synthetic ivory have on the price of natural ivory Would you support trade in synthetic ivory Why or why not SelfTest Exercises 1 Because export taxes are frequently seen as falling on foreign consumers they tend to be favored as revenue sources by many countries What assumptions are necessary for export taxes to be borne entirely by foreign consumers How likely is it that this set of assumptions characterizes the current world market for food commodities such as coffee or oranges 2 If a natural disaster such as the 2010 drought in Russia hits food production use supply and demand analysis to figure out how this affects consumers and producers Does everyone lose or are some groups better off Why The Quest for Sustainable Development 497 3 Suppose the United States imposed a tariff on imported sugar What are the consequences of this on consumers domestic and foreign producers and land use Notes 1 One study estimates that humans are currently using approximately 1925 percent of the renewable energy available from photosynthesis On land the estimate is more likely 40 percent Vitousek et al 1986 2 While it is true that ideas can last forever the value of those ideas may decline with time as they are supplanted by new ideas The person who conceived of horseshoes made an enormous contribution to society at the time but the value of that insight to society has diminished along with our reliance on horses for transportation 3 Barbier and Schulz 1997 note a case in which a trade restriction designed to protect against deforestation from excessive export logging produced the opposite effect Apparently the policy sufficiently lowered the value of the forest that the land was deforested to facilitate its conversion to agriculture 4 The details about this indicator can also be found on the Global Footprint Network web site at wwwfootprintnetworkorgenindexphpgfnpagefootprintbasicsoverview accessed December 21 2016 Anyone can have his or her own ecological footprint calculated by answering a few questions at wwwfootprintnetworkorgenindexphpGFNpagecalculators accessed December 21 2016 Further Reading Copeland B R Taylor M S March 2004 Trade growth and the environment Journal of Economic Literature 42 771 An excellent survey of the lessons to be derived from the theory and empirical work focusing on the relationship between trade and the environment Deacon R T Norman C S 2006 Does the environmental Kuznets curve describe how individual countries behave Land Economics 822 291315 Examining time series data within countries the authors find weak evidence of the existence of a Kuznets curve for SO2 in wealthier countries but no evidence for a Kuznets curve for other pollutants and for poorer countries De Soysa I Neumayer E 2005 False prophet or genuine savior Assessing the effects of economic openness on sustainable development 19801999 International Organization 593 731772 Estimates the effects of a dependence on trade and foreign direct investment on sustainability as measured by the genuine saving rate They find openness enhances sustainability Fischer C 2010 Does trade help or hinder the conservation of natural resources Review of Environmental Economics and Policy 41 103121 This article reviews and takes stock of the lessons from the recent economics literature on the links between trade and the conservation of natural resources Frankel J A April 2012 The natural resource curse A survey of diagnoses and some prescriptions Harvard Kennedy School Faculty Research Working Paper Series RWP12 014 This paper reviews the literature on the Natural Resource Curse focusing on six channels of causation that have been proposed Kubiszewski I Costanza R Franco C Lawn P Talberth J Jackson T Aylmer C 2013 Beyond GDP Measuring and achieving global genuine progress Ecological Economics 93 5768 A synthesis of estimates of GPI over the 19502003 time period for 17 countries for which GPI has been estimated and analysis of the results The Quest for Sustainable Development 498 Layard R 2005 Happiness Lessons from a New Science New York Penguin Press Using integrated insights from psychology economics neuroscience and sociology a distinguished British economist explores the sources of human happiness Pasten R Figueroa E B 2012 The environmental Kuznets curve A survey of the theoretical literature International Review of Environmental and Resource Economics 63 195224 This paper reviews and summarizes most of the literature on the Environmental Kuznets Curve Speth James Gustave 2016 Getting to the Next System Guideposts on the way to a new political economy The Next System Project Report 2 Available at httpthenextsystem orggettowhatsnext A vision of how we might move toward a more just sustainable and democratic future Additional references and historically significant references are available on this books Companion Website wwwroutledgecomcwTietenberg 499 Chapter 21 Visions of the Future Revisited Distinguishing the signal from the noise requires both scientific knowledge and self knowledge the serenity to accept the things we cannot predict the courage to predict the things we can and the wisdom to know the difference Nate Silver The Signal and the Noise Why So Many Predictions FailBut Some Dont 2012 Introduction We have now come full circle Having begun our study with two lofty but conflicting visions of the future we proceeded to dissect the details of the various components of these visions the management of depletable and renewable resources pollution and the development process itself During these investigations we gained a number of useful insights about individual environmental and natural resource problems Now it is time to step back and coalesce those insights into a systematic assessment of the two visions Addressing the Issues In Chapter 1 we posed a number of questions to serve as our focus for the overarching issue of growth in a finite environment Those questions addressed three major issues 1 How is the problem correctly conceptualized 2 Can our economic and political institutions respond in a timely and democratic fashion to the challenges presented 3 Can the needs of the present generation be met without compromising the ability of future generations to meet their own needs Can shortterm and longterm goals be harmonized The next three segments of this section summarize and interpret the evidence Visions of the Future Revisited 500 Conceptualizing the Problem At the beginning of this book we suggested that if the problem is characterized as an exponential growth in demand coupled with a finite supply of resources the resources must eventually be exhausted If those resources are essential society will collapse when the resources are exhausted These are big ifs We have seen that this is an excessively harsh and somewhat misleading characterization of the situation we face The growth in the demand for resources is not insensitive to their scarcity Prices matter Price is not the only factor that retards demand growth Declines in population growth also play a significant role Since the developed nations appropriate a disproportionate share of the worlds resources the dramatic declines in population growth in those countries has had a disproportionate effect on slowing the demand for resources On the other hand the rapidly rising consumption levels in highgrowth densely populated countries like China and India are having the opposite effect Characterizing the resource base as finitethe second aspect of the modelis also excessively harsh 1 this characterization ignores the existence of a substantial renewable resource base and 2 it focuses attention on the wrong issue In a very real sense a significant portion of the resource base is not finite Plentiful supplies of renewable resources including significantly energy are available The normal market reaction to increasing scarcity of individual depletable resources such as oil is to switch to renewable resources That is clearly happening The most dramatic examples can be found in the transition to wind hydro solar and hydrogen fuel cells In addition labeling the resource base as finite is also misleading because it implies that our concern should be with running out In fact for most resources we shall never run out Millions of years of finite resources are left at current consumption rates For most of these resources the rising cost including environmental cost of extracting and using those resources is the chief threat to future standards of living not the potential for their exhaustion The limits on our uses of these resources are not determined by their scarcity in the crust of the earth but rather by the costs of extracting them including the environmental costs that accompany their use The implications of climate change including rising sea level heat extremes droughts and storm surges are potentially so severe as to force a major reevaluation of our carbonbased energy choices Similarly the loss of biodiversity which would be intensified by climate change could irreversibly alter our ecosystems and reduce their resilience to future shocks Resource scarcity can be countered without violating sustainability by finding new sources of conventional materials as well as discovering new uses for unconventional materials including what was previously considered waste We can also stretch the useful life of existing reserves by reducing the amount of materials needed to produce the products or the services they provide Striking examples include the diminishing size of a typical computer system needed to process a given amount of information and the substantially diminished amount of energy needed to heat a welldesigned home For energy sources the issue is whether the transition to lowcarbon fuels can proceed with sufficient speed and effectiveness so as to maintain economic wellbeing while preventing serious climate change damages That question has been raised most starkly in the United States with the election of President Trump who is dismantling the existing carbonreduction policies and exiting the global agreement to hold this risk in check Paradoxically some of the most obvious cases of intensifying scarcity involve renewable resources rather than depletable resources Demand pressure whether driven by population growth or rising incomes is a key contributor to this phenomenon Expanding demand forces the cultivation of marginal lands and the deforestation of large biologically rich tracts The Visions of the Future Revisited 501 erosion of overworked soils diminishes their fertility and ultimately their productivity Demand pressure can also contribute to the overexploitation of biological resources such as fisheries even to the point of extinction Trade can intensify these processes especially when property regimes do not adequately protect the resources For many resources the problem is not their finiteness but the way in which they have been managed It is important to recognize that renewable and sustainable are not synonyms Correct conceptualization of the resource scarcity problem suggests that both extremely pessimistic and extremely optimistic views are wrong Impenetrable proximate physical limits on resource availability are typically less of a problem than the adverse atmospheric and biological consequences of their use Transitions to renewable resources recycled resources carbonfree fuels and more efficient use of resources have already begun Whether the pace of the transition is sufficient remains to be seen Institutional Responses One of the keys to understanding how society will cope with increasing resource scarcity and environmental damage lies in understanding how social institutions will react Are market systems with their emphasis on decentralized profitdriven decision making and democratic political systems with their commitment to public participation and majority rule equal to the challenge Our examination of the record seems to suggest that while our economic and political systems are far from infallible and have some rather glaring deficiencies some serious flaws have been revealed by our historical experience but no fatal ones yet On the positive side markets have responded swiftly and automatically to deal with those resources experiencing higher prices Demand has been reduced and both substitution and reducing wasteful use have been encouraged Markets for recycling are growing and consumer habits are changing Green buildings with more efficient lighting and heating systems are proliferating Renewable energy sources are being developed Although government incentives may increase the pace the government is typically not the principal driver As long as property rights are well defined the market system provides incentives for consumers and producers to respond to scarcity in a variety of useful ways see Example 211 As compelling as the evidence is for this point of view it does not support the stronger conclusion that left to itself the market would automatically choose a dynamically efficient or a sustainable path for the future Market imperfections frequently make sustainable development less likely Treating resources such as the fish we eat the air we breathe and the water we drink as freeaccess resources can undermine their sustainable use Left to its own devices a market will overexploit freeaccess resources substantially lowering the net benefits received by future generations In the absence of sufficient compensating increases in net benefits elsewhere in the economy such exploitation could result in a violation of the sustainability criterion Externalities are also a barrier in the transition to sustainability When many of the costs of using unsustainable resources are borne by someone other than those making the resource choices private and social costs will not align and the market process will be biased Only when the externalities are internalized can sustainable resources compete on a level playing field The pressing need for an effective climate change policy is an obvious case in point Even efficient markets do not necessarily produce sustainable development Restoring efficiency is frequently a desirable but often insufficient means for producing sustainable welfare levels While in principle dynamically efficient allocations can produce extraction profiles for depletable resources that are compatible with the interests of future generations as we have seen in practice this is not automatically or even normally the case The market Visions of the Future Revisited 502 EXAMPLE 211 Private Incentives for Sustainable Development Can Adopting Sustainable Practices Be Profitable Motivated by what it perceived to be great inefficiencies associated with its industry the Interface Corporation a carpet manufacturer founded by Ray Anderson totally transformed the nature of its business How it managed this transformation is instructive First the company recognized that unworn carpet usually under furniture did not need to be replaced In response the company switched from selling traditional wallto wall carpet to selling a carpet tile system Whereas in traditional practice wear in any part of the carpet meant that the entire carpet had to be replaced with carpet tiles only those specific tiles showing wear are replaced As an added benefit the reduction in carpet replacement simultaneously reduces the amount of potentially harmful glue fumes being released into the indoor air Next Interface totally changed its relationship with its customers Rather than selling carpet Interface leased it In effect it became a seller of carpet services rather than a seller of carpets Carpet tiles can be easily replaced overnight by Interface employees eliminating the loss of productivity that could occur from halting company activities during the day The cost to consumers is substantially lower not only because less carpet is replaced but also because leasing allows tax advantages Leased carpet is treated by the tax code as an expense not an asset and hence lowers taxes The environment also benefited In traditional industry practice most used carpet was transported to landfill Much of the rest was remanufactured into muchlower valued uses Seeing that as a waste of resources Interface created an entirely new product that when recycled at the end of its useful life could be remanufactured back into carpet Not only was this production process less wasteful in terms of its drain on energy and raw materials the product was also reportedly highly stainresistant four times as durable as regular carpet material and easily cleaned with water These moves toward more sustainable manufacturing did not result from government mandates Rather an innovative company found that it could benefit itself and the environment at the same time The Interface story is a compelling one Fifteen years after Andersons initiative Interface has Cut greenhouse gas emissions by 94 percent Cut fossil fuel consumption by 60 percent Cut waste by 80 percent Cut water use by 80 percent Invented and patented new machines materials and manufacturing processes Increased sales by 66 percent doubled earnings and raised profit margins Source Hawken P Lovins A Lovins L H 1999 Natural Capitalism Creating the Next Industrial Revolution Boston MA Little Brown and Company Anderson Ray with Robin White 2011 Business Lessons from a Radical Industrialist New York St Martins Griffin Visions of the Future Revisited 503 does have some capacity for selfcorrection The decline of overexploited fish populations for example led to the rise of private aquaculture In this case the artificial scarcity created by imperfectly defined property rights gave rise to incentives for the development of a private property substitute This capacity of the market for selfhealing while comforting is not always adequate In some cases government action to prevent the deterioration of the original natural resource base is both cheaper and more effective Preventive medicine is frequently superior to corrective surgery In other cases such as when our air is polluted no adequate private substitutes are available To provide an adequate response it is sometimes necessary to complement market decisions with regulatory actions The case for government intervention is especially compelling in controlling pollution Uncontrolled markets not only produce too much pollution but also they tend to underprice commodities such as coal that contribute to pollution either when produced or consumed Firms that unilaterally attempt to control their pollution in the absence of regulations run the risk of pricing themselves out of the market Government intervention is needed to ensure that firms that neglect environmental damage in their operating decisions do not thereby gain a competitive edge Significant progress has been made in reducing the amount of pollution particularly conventional air pollution Regulatory innovations such as the sulfur allowance program and the California Global Warming Solutions Act represent major steps toward the development of a flexible but powerful framework for controlling air pollutants By making it less costly to achieve environmental goals these reforms can limit the potential for a backlash against the policy They have brought perceived costs more in line with perceived benefits It would be a great mistake however to assume that government intervention has been uniformly benign The acidrain problem for example was almost certainly made worse by an initial policy structure that focused on local rather than regional pollution problems and using MTBE as a gasoline additive to reduce air pollution ended up contaminating water supplies While the former encouraged the export of pollution via tall stacks the latter simply shifted the problem from air to water One aspect of the policy process that does not seem to have been handled well is the speed with which improvement has been sought Public opinion polls have unambiguously shown that the general public supports efficient environmental protection even when it raises costs and lowers employment Historically as shown by the early regulation of automobile pollu tion policymakers reacted to this resolve by writing very tough legislation designed to force rapid technological development Common sense suggests that tough legislation with early deadlines can achieve environ mental goals more rapidly than weaker legislation with less tight deadlines In the automobile pollution case common sense was frequently wrong Writing excessively tough legislation with unreasonably early deadlines had the opposite effect Those regulations were virtually impossible to enforce Recognizing this situation polluters repeatedly exploited this weakness by seeking and receiving delays in compliance In this particular regulatory regime it was frequently better from the polluters point of view to spend resources to change the regulations than to comply with them This would not have been the case with less stringent regulations since the firms would have had no legally supportable grounds for delay As in most things however the need is for balance The message is not slow is always better Sometimes timely responses are a crucial part of the efficient solution The classic example is climate change policy where analysis has made clear that delays in taking action will raise the cost Another flagrant example of counterproductive government intervention is to be found in treatment of both energy and water By imposing price ceilings on natural gas and oil the Visions of the Future Revisited 504 government removed much of the normal resiliency of the economic system With price con trols the incentives for expanding the supply are reduced and the time profile of consumption is tilted toward the present A similar story can be told about water By holding water prices below the marginal cost of supply water authorities have subsidized excess use In summary the record compiled by our economic and political institutions has been mixed It seems clear that simple ideological prescriptions such as leave it to the market or let the government handle it simply do not bear up under a close scrutiny of the record The relationship between the economic and political sectors has to be one of selective engage ment complemented in some areas by selective disengagement Each problem has to be treated on a casebycase basis As we have seen in our examination of a variety of environmental and natural resource problems the efficiency and sustainability criteria allow such distinctions to be drawn and those distinctions can serve as a basis for policy reform Sustainable Development Historically increases in inputs and technological progress have been important sources of economic growth in the industrialized nations In the future some factors of production such as labor will not increase as rapidly as they have in the past at least in the developed world The effect of this decline on growth depends on the interplay among the law of diminishing marginal productivity substitution possibilities and technological progress The law of diminishing marginal productivity suggests slower growth rates while technological progress and the availability of substitutes counteract this drag One view suggests that the development of new technologies such as selfdriving cars and manufacturing robots will act as labor substitutes and hence will reduce the drag caused by diminishing labor supplies Another view foresees limits to technological progress imposed by the second law of thermodynamics implying that the growth process must culminate in a steady or stationary state where growth ultimately but inevitably diminishes to zero The economy is currently being transformed It is not business as usual The increasing corporate focus on sustainability is playing a role Additionally as citizens become better informed about the consequences of their choices they are beginning to use their power as consumers employees shareholders and voters to let companies know that they support business behavior that is compatible with sustainable outcomes Recognizing that conventional measures of economic growth shed little light on the question some crude attempts have been made to estimate whether or not growth in the industrialized countries has historically made the citizens of those countries better off Results of some of these studies suggest that because growth has ultimately generated more leisure longer life expectancy and more goods and services it has on balance been beneficial Yet other measures such as the ecological footprint convey a more cautionary story They remind us that our inability to measure precisely the earths carrying capacity for supporting human activity in no way diminishes the existence and importance of those potentially existential limits Our examination of the evidence suggests that the notion that all of the worlds people are automatically benefited by economic growth is naïve Economic growth has demonstrably benefited some citizens but that outcome is certainly not inevitable for all people in all settings Expanding pollution and diminishing access to crucial resources such as water or land can offset or even more than offset the gains for at least some subset of the population New sustainable forms of development are possible and desirable but they will not automatically be adopted in either the highincome or the lowincome nations The economic incentives approach to environmental and natural resource regulation has become a significant component of environmental and natural resource policy Instead of Visions of the Future Revisited 505 mandating prescribed actions such as requiring the installation of a particular piece of pollution control equipment this approach achieves environmental objectives by changing the economic incentives of those doing the polluting Incentives can be changed by fees or charges transferable entitlements disclosure strategies or even liability law By changing the incentives an individual agent faces that agent can be encouraged to use his or her typically superior information to select the best means of meeting his or her assigned responsibility When it is in the interest of individuals to change to new forms of development the transformation can be amazingly rapid Public policy and sustainable development must proceed in a mutually supportive relationship In some cases that relationship takes the form of publicprivate partnerships that involve explicit agreements between government and the private sector regarding the provision of public services or infrastructure see Example 212 In other cases it involves government regulatory action to ensure that the market is sending the right signals to all participants so that the sustainable outcome is compatible with other business objectives Economicincentive approaches are a means of establishing that kind of compatibility The experience with the various versions of this approach used in the United States Europe and Asia suggests that allowing business great flexibility within a regulatory framework that harmonizes private and social costs in general is both feasible and effective EXAMPLE 212 PublicPrivate Partnerships The Kalundborg Experience Located on an island 75 miles off the coast of Copenhagen the city of Kalundborg has achieved a remarkable symbiosis among the various industries that provide the employ ment base for the city The four main industries along with small businesses and the municipal government began developing cooperative relationships in the 1970s designed to lower disposal costs attain less expensive input materials and receive income from their waste products A coalfired power plant Asnaes transports its residual steam to a refinery Statoil In exchange Statoil gives Asnaes refinery gas that Asnaes burns to generate electricity Asnaes sells excess steam to a local fish farm to a heating system for the city and to a pharmaceuticals and enzyme producer Novo Nordisk Continuing the cycle the fish farm and Novo Nordisk send their sludge to farms to be used as fertilizer Produced fly ash is sold to a cement plant and gypsum produced by its desulfurization process is sold to a wallboard manufacturer Statoil the refinery sells the sulfur removed from its natural gas to a sulfuric acid manufacturer Kemira This entire process resulted not from centralized planning but simply because it was in the individual best interests of the public and private entities involved Although the motives were purely financial this synergetic situation has clear environmental benefits It is therefore likely to be economically as well as environmentally sustainable Sources Desroches P Ecoindustrial parks The case for private planning Report RS 001 Political Economy Research Center Bozeman MT 59718 Kalundborg Symbiosis website wwwsymbiosisdken accessed December 23 2016 Visions of the Future Revisited 506 How about global environmental problems Economicincentives approaches could be helpful here as well Pollution pricing facilitates cost sharing among participants while ensuring costeffective responses to the need for additional control By separating the question of what control is undertaken from the question of who ultimately pays for it the government significantly widens the control possibilities and lowers compliance costs Conferring property rights for biological populations on local communities can provide an incentive for those communities to protect the populations Strategies for reducing debt can diminish the pressure on natural resources that might otherwise be cashed in to pay off the debt Europe British Columbia and parts of Asia have more experience with effluent or emissions charges This approach places a perunit fee on each unit of pollution discharged Faced with the responsibility for paying for the damage caused by their pollution firms recog nize it as a controllable cost of doing business This recognition triggers a search for possible ways to reduce the damage including changing inputs changing the production process transforming the residuals to lessharmful substances and recycling byproducts The exper ience in the Netherlands Sweden and Japan countries where the fees are higher than in most other countries suggests that the effects can be dramatic Fees and auctioned allowances also raise revenue Successful development particularly sustainable development requires a symbiotic partnership between the public and private sectors To function as an equal partner the public sector must be adequately funded If it fails to raise adequate revenue the public sector becomes a drag on the transformation pro cess but if it raises revenue in ways that distort incentives that too can act as a drag Effluent or emissions charges and auctioned allowances offer the realistic opportunity to raise revenue for the public sector while reducing the drag from more distortionary taxes Whereas other types of taxation discourage growth by penalizing legitimate development incentives such as taxing wages emissions or effluent charges provide both incentives and revenue to support sustainable development Some work from the United States suggests that the drag on development avoided by substituting carbon pricing for more traditional revenueraising mechanisms such as capital gains income and sales taxes could be significant Incentives for forwardlooking public action are as important as those for private action The current national income accounting system provides a perverse economic signal Though national income accounts were never intended to function as a device for measuring the welfare of a nation in practice that is how they are used National income per capita is a common metric for evaluating how welloff a nations people are Yet the current construction of those accounts produces information that can be highly misleading Rather than recognizing oil spills for what they are namely a source of decline in the value of the endowment of natural resources in the area under current accounting procedures cleanup expenditures increase measured national income spills actually boost GDP But the reason of course is that no account is taken of the consequent depreciation of the natural environment The traditional system of accounts makes no distinction between growth that is based upon drawing down or degrading its natural resource endowment with a consequent irreversible decline in its value and sustainable development where the value of the natural endowment remains intact Only when suitable corrections are made to these accounts will governments be judged by the appropriate standards The power of economic incentives is certainly not inevitably channeled toward the achievement of sustainable development They can be misapplied as well as appropriately applied Tax subsidies to promote cattle ranching on the fragile soil in the Brazilian rain forest not only stimulated an unsustainable activity but also imposed irreparable damage on an ecologically significant area Incentive approaches must be used with care Visions of the Future Revisited 507 A Concluding Comment Our society is evolving When a complementary relationship among the economic system the court system and the legislative and executive branches of government can be maintained we can make progress As the high degree of partisanship in the US illustrates however we are not yet out of the woods Significantly not only must politicians learn to work together to produce bipartisan or nonpartisan solutions to our most pressing problems but we the public must learn that part of the responsibility is ours Solutions are unlikely to prevail without our significant participation and support Not all behavior can be regulated It costs too much to catch every offender Our law enforcement system works because most people obey the law whether anyone is watch ing or not A high degree of voluntary compliance is essential for the system to work smoothly The best resolution of the toxic substance problem for example is undoubtedly for all makers of potentially toxic substances to be genuinely concerned about the safety of their products and to bite the bullet whenever their research raises questions The ultimate res ponsibility for developing an acceptable level of risk must rest on the integrity of those who make use transport and dispose of the substances The government can assist by penalizing and controlling those few who fail to exhibit this integrity but regulation can never completely substitute for integrity We cannot and should not depend purely upon altruism to solve these problems but we should not underestimate its importance either We also need to recognize that markets serve our preferences as consumers Making sure our purchases and investments reflect environmental values will help markets move in the right direction Zeroemission automobiles will enter the market much faster if many consumers demand them Sustainably harvested fisheries will proliferate once consumers shun fish from those fisheries that are managed unsustainably It is easy to see large corporations as villains but it is tougher to notice the villains in our mirrors The notion that we are at the end of an era may well be true But we are also at the beginning of a new one With foresight the decline of civilization can be avoided but success will require its transformation The road may be strewn with obstacles and our social institutions may deal with those obstacles with less grace and less finesse than we might have hoped but we can make progress Discussion Questions 1 Are you optimistic or pessimistic about the future Why 2 In thinking about the appropriate balance between the market and the government in achieving sustainability do you think the government needs to take a stronger role or would you favor reducing government influence over the market Why Further Reading Anderson Terry and Leal Donald Eds 2015 Free Market Environmentalism for the Next Generation London Palgrave Macmillan This book provides a freemarket vision for environmentalisms future based on the success of environmental entrepreneurs around the world It explores the next generation of environmental market ideas Visions of the Future Revisited 508 Hawken P 2010 The Ecology of Commerce Revised Edition A Declaration of Sustainability New York Harper Collins A classic in the field this book makes the case for why business success and sustainable environmental practices need notand for the sake of our planet must notbe mutually exclusive any longer Speth James Gustave 2012 America the Possible Manifesto for a New Economy New Haven CT Yale University Press Speth presents a vison of the future from the progressive point of view He finds that we have let conditions of life in America deteriorate across a broad front and are headed straight to a place we would not want for our children and grandchildren He presents a vison of how we could chart a better course 509 Answers to SelfTest Exercises Chapter 1 1 A shortage would promote higher prices thereby lowering demand until it equaled the new smaller supply Since this acts to reduce rather than intensify the shortage it is a negative feedback loop If consumers anticipate these higher prices however thereby buying and hoarding extra amounts before the prices rise this is an example of a positive feedback loop because it intensifies the shortage Chapter 2 1 a This is a public good so add the 100 demand curves vertically This yields P 1000 100q This demand curve would intersect the marginalcost curve when P 500 which occurs when q 5 miles b The economic surplus is represented by a right triangle where the height of the triangle is 500 1000 the point where the demand curve crosses the vertical axis minus 500 the marginal cost and the base is 5 miles The area of a right triangle is 12 base height 12 500 5 1250 2 a Set MC P so 80 1q 1q Solving for q finds that q 40 and P 40 b Consumer surplus 800 Producer surplus 800 Consumer surplus plus producer surplus 1600 economic surplus c The marginal revenue curve has twice the slope of the demand curve so MR 80 2q Setting MR MC yields q 803 and P 1603 Using Figure 28 producer surplus is the area under the price line FE and over the marginalcost line DH This can be computed as the sum of a rectangle formed by FED and a horizontal line drawn from D to the vertical axis and a triangle formed by DH and the point created by the intersection of the horizontal line drawn from D with the vertical axis The area of any rectangle is base height The base 803 and the 3 160 3 80 3 80 Height P MC Therefore the area of the rectangle is 64009 The area of the right triangle is 2 1 3 80 3 80 9 3200 Answers to SelfTest Exercises 510 9 3200 9 6400 9 9600 2 1 3 80 3 80 9 3200 Producer surplus Consumer surplus 9 1 9 800 2 9 3200 800 3 9 12800 1600 2 1 1 600 3 The policy would not be consistent with efficiency As the firm considers measures to reduce the magnitude of any spill it would compare the marginal costs of those measures with the expected marginal reduction in its liability from reducing the magnitude of the spill Yet the expected marginal reduction in liability from a smaller spill would be zero Firms would pay X regardless of the size of the spill Since the amount paid cannot be reduced by controlling the size of the spill the incentive to take precautions that reduce the size of the spill will be inefficiently low 4 If better means efficient this common belief is not necessarily true Damage awards are efficient when they equal the damage caused Ensuring that the award reflects the actual damage will appropriately internalize the external cost Larger damage awards are more efficient only to the extent that they more closely approximate the actual damage Whenever they promote an excessive level of precaution that cannot be justified by the damages awards that exceed actual cost are inefficient Bigger is not always better 5 a Descriptive It is possible to estimate this linkage empirically b Normative A descriptive analysis could estimate the impacts of expenditures on endangered species but moving from that analysis to a conclusion that expenditures would be wasted requires injecting values into the analysis c Normative A descriptive analysis could compare the effects of privatized and nonprivatized fisheries but moving from these results to a conclusion that the fisheries must be privatized to survive normally requires an injection of values If the data revealed that all privatized fisheries survived and none of the others did the move to must would have a very strong descriptive underpinning d Descriptive This linkage could be estimated empirically directly from the data e Normative This statement could be descriptive if it was stated as birth control programs actually contribute to a rise in population since this is an empirical relationship that could be investigated However as stated it allows a much wider scope of aspects to enter the debate and weighing the importance of those aspects will normally require value judgments Answers to SelfTest Exercises 511 6 a A pod of whales is a commonpool resource to whale hunters It is characterized by nonexclusivity and divisibility b A pod of whales is a public good to whale watchers since it is characterized by both nondivisibility and nonexclusivity c The benefits from reductions of greenhouse gas emissions are public goods because they are both nondivisible and nonexclusive d For residents a town water supply is a commonpool resource because it is both divisible and nonexclusive to town residents It is not a commonpool resource for nonresidents since they can be excluded e Bottled water is neither it is both divisible and exclusive In fact it is a private good Chapter 3 1 With risk neutrality the policy should be pursued because the expected net benefits 085 4000000 010 1000000 005 10000000 3000000 are positive Related Discussion Question Looking at these numbers do you think risk neutrality is how you would actually think about this situation Or would you be more risk averse and weigh the third outcome more heavily than its expected likelihood 2 a Costeffectiveness in this case according to the second equimarginal principle requires that that target be met 10 fish removed and the marginal costs of each method be equal We know that q1 q2 q3 10 and that MC1 MC2 MC3 The key is to reduce this to one equation with one unknown Since MC1 MC2 we know that 10q1 will equal 5q2 or q1 5q2 Similarly MC2 MC3 so 5q2 25q3 or q3 2q2 Substituting these values into the first equation yields 5q2 1q2 2q2 10 So q2 1035 286 to two decimal places That means q1 143 and q3 572 The fact that this adds to 1001 rather than 1000 is due to rounding b All three of these methods have a marginal cost that increases with the amount removed Thus the cost of removing the first fish for each is cheaper than removing the second fish with that method and so on Consider the marginal cost of removing the last fish if all fish are removed by method three In that case the marginal cost would be 25 10 or 25 Notice that the costeffective allocation the cost of removing the last fish when the marginal costs are equal using q1 for the calculation is 10 143 1430 In the case of increasing marginal costs using a combination is much cheaper c In this case you would only use method three because the marginal cost of removing each fish would be 25 This is lower than the MC for method 1 10 and lower than the MC for method 2 5 Note that the marginal costs only have to be equal for the methods that are actually used The marginal costs for unused methods will be higher 3 Since the benefit cost test requires that the present value of benefits be greater than the present value of the costs we can find the maximum allowable current cost by calculating the present value of the benefits This can be calculated as 5000000000001 r50 where r is either 010 or 002 Whereas with a 10 percent discount rate the present value is approximately 43 billion with a 2 percent discount rate it is approximately 1858 billion Clearly the size of the discount rate matters a lot in determining efficient current expenditures to resolve a longrange problem Answers to SelfTest Exercises 512 Chapter 4 1 In order to maximize net benefits Coast Guard oilspill prevention enforcement activity should be increased until the marginal benefit of the last unit equals the marginal cost of providing that unit Efficiency requires that the level of the activity be chosen so as to equate marginal benefit with marginal cost When marginal benefits exceed marginal cost as in this example the activity should be expanded 2 a According to the figures given the perlife cost of the standard for unvented space heaters lies well under the implied value of life estimates given in the chapter while perlife cost implied by the proposed standard for formaldehyde lies well over those estimates In benefitcost terms the allocation of resources to fixing unvented space heaters should be increased while the formaldehyde standard should be relaxed somewhat to bring the costs back into line with the benefits b Efficiency requires that the marginal benefit of a life saved in government programs as determined by the implied value of a human life in that context should be equal to the marginal cost of saving that life Marginal costs should be equal only if the marginal benefits are equal and as we saw in the chapter risk valuations and hence the implied value of human life depend on the risk context so it is unlikely they are equal across all government programs 3 a The total willingness to pay for this risk reduction is 200 million 50 per person 4 million exposed people The expected number of lives saved would be 40 1100000 risk of premature death 4000000 exposed population The implied value of a statistical life would be 5000000 200000000 total willingness to pay40 lives saved b The program is expected to save 160 lives 6100000 2100000 4000000 According to the value of a statistical life in a the program will have more benefits than costs as long as it costs no more than 800000000 5000000 value per life 160 lives saved Chapter 5 1 a Ten units would be allocated to each period b P 8 04q 8 4 4 c User cost P MC 4 2 2 2 Because in this example the static allocations to the two periods those that ignore the effects on the other period are feasible within the 20 units available the marginal user cost would be zero With a marginal cost of 400 the net benefits in each period would independently be maximized by allocating 10 units to each period In this example no intertemporal scarcity is present so price would equal a 400 marginal cost 3 Refer to Figure 52 In the second version of the model the lower marginal extraction cost in the second period would raise the marginal net benefit curve in that period since marginal net benefit is the difference between the unchanged demand curve and the lower MC curve This would be reflected in Figure 52 as a parallel leftward shift out of the curve labeled Present Value of Marginal Net Benefits in Period 2 This shift would immediately have two consequences it would move the intersection to the left implying relatively more would be extracted in the second period and the intersection would take Answers to SelfTest Exercises 513 place at a higher vertical distance from the horizontal axis implying that the marginal user cost would have risen 4 a The higher discount rate would lower the present value of the net benefit function in the second period This would be reflected as a rotation of that function downward to the right The new function would necessarily cross the PVMNB1 function at a point further to the right and lower than before the discount rate change The fact that the intersection is further to the right implies that more is being allocated to period 1 and less to period 2 The fact that the intersection is lower implies that the present value of the marginal user cost has declined b Since a higher discount rate lowers the present value of allocations made to the second period allocating relatively more of the resources to the first period will increase the present value derived from them The present value of the marginal user cost is lower since the marginal opportunity cost of using the resources earlier has gone down 5 a Increasing the second period demand is reflected in the twoperiod model by a shift not a rotation in the PVMNB2 curve upward and to the left After the shift this new function will necessarily intersect the PVMNB1 curve closer to the lefthand axis and higher up on the Yaxis This implies an increase in the relative amount allocated to the second period thereby reducing the amount allocated to the first period and a higher present value of the marginal user cost b When demand is increasing in the future hence making the marginal resources relatively more valuable it makes sense to save more for the future This is accomplished by a rise in the marginal user cost which results in higher prices The higher prices provide the incentive to save more for the future More is consumed in the second period despite the higher prices because the demand curve has shifted out Chapter 6 1 From the hint MNB1MNB2 1 k1 r Notice that when k 0 this reduces to MNB2 MNB11 r the case we have already considered When k r then MNB1 MNB2 the effect of stock growth exactly offsets the effect of discounting and both periods extract the same amount If r k then MNB2 MNB1 If r 6k then MNB2 MNB1 2 a With a demand curve shifting out over time the marginal net benefits from a given future allocation increase over time This raises the marginal user cost since it is the opportunity cost of using the resource now and hence the total marginal cost Thus the initial user cost would be higher b Less of the resource would be consumed in the present more would be saved for the future 3 a This turns out to have the same effect as the environmental cost pictured in Figures 66a and 66b The tax serves to raise the total marginal cost and hence the price This tends to lower the amount consumed in all periods compared to a competitive allocation b The tax also serves to reduce the cumulative amount extracted because it raises the marginal cost of each unit extracted Some resources that would have been extracted without the tax would not be extracted with the tax their aftertax cost to the producer exceeds the cost of the substitute The price would be higher with the tax Answers to SelfTest Exercises 514 in all periods prior to the withouttax switch point After that time the price would be equal to the price of the substitute with or without the tax 4 The cumulative amount ultimately taken out of the ground is determined by the point at which the marginal extraction cost equals the maximum price consumers will pay for the depletable resource In this model the maximum price is the price of the substitute Neither the monopoly nor the discount rate affects either the marginal extraction cost or the price of the substitute so they will have no effect on the cumulative amount ultimately extracted The subsidy however has the effect of lowering the net price price minus subsidy of the substitute The intersection of marginal extraction cost and the net price will therefore occur when a smaller cumulative amount has been extracted than would be the case in the absence of the subsidy 5 They would not produce the same switch point The switch would be faster under the subsidy While they would result in the same cumulative amount of the depletable resource being extracted the speed with which it would be extracted would be faster with the subsidy By raising the aftertax price the tax would reduce demand and hence the speed with which the depletable resource would be used up while the subsidy would by lowering the marginal user cost increase demand and hence increase the rate at which the depletable resource was extracted 6 a The impending tax would lower the aftertax perunit revenue to the extractors of the depletable resource once it was enacted In anticipation of this change suppliers would have an incentive to shift extraction to periods before the tax is imposed relatively more would be extracted earlier Because the cumulative amount extracted is determined by the price of the substitute which is not changed by the act the total amount extracted would remain unchanged Only the timing would be affected b In this case the pending tax would have the same incentive to shift extraction earlier as in a but the cumulative amount extracted of the depletable resource would go down The rising marginal cost including the tax would hit the marginal cost of the abundant resource at a lower level of cumulative extraction Chapter 7 1 During a recession the demand curve shifts inward causing downward pressure on prices If price is supported then the quantity supplied must be reduced Since the burden of holding the price up falls on the cartel while the competitive fringe can keep on producing the demand reduction causes production to fall most heavily in OPEC nations This causes the cartel market share to fall To protect their individual market shares members start cutting prices In growing markets cartel market shares can be protected without cutting prices 2 a 9 3200 9 9600 3 80 3 80 Producer surplus Consumer surplus P MC q b This is the mirror image of the monopoly allocation The net benefits are identical in the two allocations but they are distributed among producers and consumers rather differently With this form of price control the consumer surplus is larger and the Answers to SelfTest Exercises 515 producer surplus is smaller than the corresponding concepts when the allocation is governed by a monopoly Essentially the rectangle discussed in the answer to part b of the second problem in Chapter 2 goes to consumers with price ceilings and to producers in a monopoly 3 The paper company The highcost energy is appropriately assigned to the five paper machines because that is the energy cost that would be eliminated if the machines were shut down The company would not shut down all energy sources in proportion it would shut down the most expensive sources In making a shutdown decision therefore it is essential that the machines in question cover the cost of the energy that would be saved if the machines were shut down otherwise the company is losing money 4 Peaking plants run only a small percentage of the time so the capital expenditures remain unused most of the time Operating costs are incurred only when they are needed It makes sense therefore for utilities to design peaking plants so as to keep capital costs as low as possible even if it means incurring higher operating cost Baseload plants on the other hand run almost continuously so the capital costs are prorated over a very large number of kilowatthours and therefore are less of a burden 5 No This could internalize some of the externalities associated with oil but it would not internalize the climate change externalities of other fuels such as coal and indeed might exacerbate them as consumers switched from oil to coal 6 a False While cartel members with small stocks of the depletable resource would be generally supportive cartel members holding large reserves would be afraid that the high early price increases would force an earlier switch to renewables leaving them with unsold stocks b False By holding prices lower than they would otherwise be placing a price control on a depletable resource would increase the speed with which the resource is extracted over time but it would lower the cumulative amount ultimately extracted c False By lowering the marginal user costs a price control influences the extraction path of a depletable resource well before the time that the market price actually reaches the level of the price control d Uncertain While internalizing the externality as proposed here is generally a move toward efficiency the details do matter For example the level of compensation could be too high or too low Remember that for efficiency the payments should exactly equal the damages caused Excessive compensation can be inefficient because by raising the expected cost of future operations above the efficient levels it could preclude some efficient oil drilling On the other hand inadequate compensation by ultimately understating the future expected cost could promote excessive oil drilling 7 The existence of a renewable energy credit market would lower the compliance costs associated with meeting a renewable portfolio standard by providing more flexibility to compliance units For example without such a market utilities would have to assure that they supplied the requisite amount of renewable power within their market area regardless of whether that market area was suitable for that renewable power or not With a renewable energy credit market producers can create the renewable power in those areas that are most suitable eg have the requisite wind flow water flow or solar flux and sell any excess to jurisdictions that could only generate their own renewable power at a much higher cost Substituting this more efficiently produced and hence lowercost power for the more inefficiently produced and hence highercost power allows the standard to be met at a lower cost Answers to SelfTest Exercises 516 8 Incorporating national security concerns but ignoring climate change impact means that domestic production is determined by the intersection of Sd1 with Pw2 and total consumption is determined by the intersection of Pw2 with domestic demand Note that this results in a lower price level Pw2 rather than Pw3 more domestic production since domestic producers are ignoring the climatechange impact and more domestic consumption due to the lower price 9 a When comparing two bulbs that give the same amount of light you would need to specify 1 the planning horizon how many years will be covered by the analysis 2 the cost of each type of bulb 3 how much the bulbs can be expected to be used on average per year 4 how long the bulbs will last before they need to be replaced 5 how much electricity is used by each type of bulb and 6 the per kilowatthour cost of the electricity The planning horizon would be no longer than the useful life of an LED bulb Each year in the planning horizon would be a column and each row would be either one of the data items used in the calculation or the results of the calculations for that yeartwo rows would contain the amount spent on the purchase of bulbs each year for each type of bulb another two rows would contain the amount spent on electricity to run each bulb during the periods of use and the two primary rows would contain the present value of cost of each bulb for that year The present value of cost for each bulb would be found by summing the individual year present value results over all the years of the planning horizon The most cost effective bulb would be the one that has the lowest present value of cost over that planning horizon b It depends crucially on which component is changed Changing the monthly charge would affect both bulb calculations the same and hence not change the difference between them Changing the kilowatthour charge however would hit the incandescent bulb much harder since that type of bulb consumes more electricity Therefore an increase in the kilowatthour charge would relatively discourage incandescent bulbs and encourage LED bulbs 10 Yes you would expect the magnitude of interest rates to affect the decision especially for those who borrow the money to finance the purchase Not only does it increase the financing cost of purchasing the heat pump but this interest rate would typically be used as the discount rate in calculating the costeffectiveness of the purchase A higher discount rate lowers the relative importance of the energy savings in the decision since they are spread out over the future years whereas the cost of the purchase occurs in the first year Chapter 8 1 a Assume that only virgin ores are used In this case P MC1 so 10 05q1 05q1 or q1 10 This implies MC1 5 The marginal cost of producing any units using recycled products is clearly higher than 5 so none will be used Therefore 10 units would be produced and all of them would be produced using virgin ores b With the higher demand curve the price will be high enough to stimulate the producer to make some of the product with recycled materials The key to solving this problem is recognizing that the producer will equate the marginal costs of products made with recycled materials and those made with virgin ores Using this fact we can set 05q1 5 01q2 or q1 10 02q2 Substituting this into the demand function yields Answers to SelfTest Exercises 517 P q 20 0510 02 q 2 2 or 15 06 P q2 Solving for P MC yields 15 06 5 01 7 100 orq q q 2 2 2 and 10 02 7 100 7 90 q1 c m The solution can be verified by showing 7 45 P MC MC 1 2 2 a They will not have the same effect Because the royalty is a perton fee it raises the marginal cost of extraction to the firm but the bonus bid which does not affect the marginal cost of extraction does not If the mineral has an increasing marginal cost of extraction less will be extracted with a royalty system than with a bonus bid system because the marginal cost of extraction including the royalty payment will hit the backstop price at a smaller cumulative amount extracted b The bonus bid is consistent with efficiency because it does not distort the allocation over time The allocation that maximized firm profits before the bonus bid will still maximize it after the bonus bid While the government shares the profits it does so without distorting incentives By raising the marginal cost of extraction royalty schemes distort incentives c With a bonus bid scheme the firm bears the risk The government gets a fixed payment The firm can either win big or lose big depending on how valuable the deposit turns out to be With the royalty scheme the risk is shared If the mine turns out to be very valuable profits and government fees both go up If the deposit turns out not to be very valuable the firm gains little but so does the government 3 Rising societal disposal cost is certainly one of the factors that should stimulate higher recycling rates but it is by no means the only one And as long as it is not the only factor recycling rates will not automatically increase in response First this higher social cost must be reflected in increasing marginal disposal costs facing individuals in order to provide the incentive to recycle rising social costs do not automatically result in rising individual marginal costs Second markets must exist for the recycled materials Collecting them does no good if they cant be put to good use 4 a The sticker system would tend to be more efficient Because the property tax approach to financing is not related to the amount of trash disposed of the marginal cost of disposing of an additional bag under this system is zero This is considerably lower than the cost to the town of disposing of the waste The marginal cost to the consumer does not reflect the marginal cost to the town In contrast the sticker system imposes a marginal cost per bag that could if the sticker price were calculated correctly exactly equal the marginal cost to the town b Since the cost of the sticker does not have to be paid for illegally disposed trash requiring stickers could promote illegal dumping People do of course have to pay Answers to SelfTest Exercises 518 any imposed fines if they get caught If illegal disposers tend not to get caught so illegal disposal is rampant it could raise the costs to the town above 30 to recover and process the dispersed trash and would undermine the efficiency of the sticker system A property tax financing system provides no incentives for illegal disposal since the cost is paid however a household chooses to manage its trash Imposing a depositrefund on some large components of the trash would help to reduce illegal disposal because illegal disposal would now cost somethingthe consumer loses the deposit However a deposit refund system would raise no revenue for the town to cover its disposal costs since the deposit is returned to the consumer once the object is transported to the collection site Chapter 9 1 Since the amount of capacity needed would depend on the maximum flow during the year the extra cost of expanding capacity during this highflow period should be reflected in higher prices charged to users during these periods 2 Assuming the rate was correct the flat rate would be more efficient because it would confront the user with a positive marginal cost of further consumption The marginal cost of further consumption with a flat fee is zero 3 a For the case in which the groundwater comes from a private well that taps a private aquifer with perfect information the owner would have an incentive to extract the water at an efficient rate The private owner would face all costs both present and future and be able to balance them accordingly The social present value of marginal net benefit curves for both periods would be identical to the private present value of marginal net benefit curves for both periods Note however the very important perfect information caveat If the owner doesnt know what is there he or she cant very well allocate it efficiently regardless of how good the incentives are b For the case in which the groundwater is obtained from your private well that is drilled into an aquifer that is shared with many other users who have also drilled private wells an efficient allocation would not be expected Perverse incentives would arise both within any particular time period and over time Because this is a divisible resource within a time period each user would know that any unit not extracted by him or her could well be extracted by a neighbor The incentive is to take more than the efficient amount to avoid losing it Over time the users would act as if the marginal user cost is zero since the tradeoff between the present and the future that characterizes the situation in part a is lost Whereas in a private well whatever I dont use now I can simply use later that is not true in a shared aquifer Water not used by me now may well be used by someone else and be gone forever This particular institutional arrangement encourages the overuse of water and thereby serves to intensify any problems of scarcity 4 The key to using the tiered system for this purpose is to distinguish water needs by monthly volume Specifically the first block could contain a basic amount of water that fulfills essential purposes while the second block contains all other water above that amount The first block would be priced at a low level while the second block price would reflect all of the scarcity rent generated by the marginal user cost as well as the marginal cost of extraction and distribution Since the positive marginal user cost means that the marginal revenue for that block would be above the marginal extraction plus Answers to SelfTest Exercises 519 distribution cost the utility could still cover its expenses despite the low cost of the first units Meanwhile because most households would consume at least some more water than allowed in the first block the price they would face for the additional water would be the efficient marginal cost price in the second block The fact that the price for the additional water would be the efficient price would preserve incentives to conserve an efficient amount Chapter 10 1 The congestion charge would raise the cost of transportation for commuters while the increased number of lanes would reduce it considering travel time According to the bid rent function analysis the congestion charge would make the residential bid rent function steeper and encourage more density in the urban area and less expansion into the suburban areas served by those expressways Conversely the new lanes would make the bid rent function less steep and encourage more people to move into the suburbs 2 Land confers a bundle of entitlements to the owner Conservation easements allow the transfer of only the specific entitlements of interest typically the development rights For land conservation organizations buying only the entitlements of interest is considerably cheaper than buying the land itself Therefore conservation groups could stretch a given budget over many more pieces of land with conservation easements than by buying the land outright Donors may value some specific entitlements more than any market price they could get for them and hence want to retain them an option afforded by conservation easements but for other entitlements the market price or the value of the tax deduction may be higher making sale or donation the best option An owner of a forest for example may wish to continue to harvest wood from that land while being willing to donate the development rights when he or she has little or no interest in selling the forest to a developer anyway 3 The simplest difference is that relative to an income tax property tax funding would make land and the improvements on that land more expensive to own This in turn would raise the cost of all landintensive activities such as forestry or farming relative to activities requiring much less land It might also cause all firms engaging in landintensive activities to consider if they could get away with using less land It might cause some residents for example to downsize to smaller units 4 Many answers of course are possible for this question but here are a few possibilities a In this age group we could expect to have a smaller household size as any children are grown and gone thereby lowering the need for housing space We might expect some of these households to downsize to smaller dwelling units b We might expect some movement back into urban areas as the need for space declines and difficulties with mobility arise c Access to schools could become less important and access to medical facilities more important d In the face of diminishing human energy to do landscaping and maintenance condominiums could become relatively more attractive since all their landscaping and maintenance is handled by the association in return for a monthly fee Since most condominium units are smaller than owners previous housing this is also a way to downsize Answers to SelfTest Exercises 520 e As health problems commonly rise with age assisted living facilities should become more common and some retirees will move to be closer to their children f As older households are likely to be less constrained by either work or parenting schedules they are freer to move to locales offering especially highquality age appropriate leisuretime activities g Since household net worth is probably higher after a lifetime of earning this wealth might well also promote more seasonal secondhome sales Notice that many of these hypotheses are testable by examining the appropriate data Are condos becoming a greater percent of the residential housing stock Are older households moving back into urban areas Has secondhome buying become more prevalent Sounds like a good research project 5 Because the ethanol subsidy raises the profitability of growing corn as a fuel it should 1 increase the amount of domestic land allocated to agriculture since more per acre is now earned 2 increase the amount of domestic agricultural land allocated to fuel corn since the net benefits per acre of that specific land use have increased and 3 lower the amount of domestic land allocated to producing food crops as farmers in response to these net benefit peracre changes allocate more land to fuel and less to food crops most obviously but not only corn 6 Working at home reduces the amount of commuting and hence the cost of commuting One implication is a lower incentive to locate close to work If workplaces are densely located working at home should make more remote locations relatively more attractive Hence according to this effect the density of development might be expected to decline Chapter 11 1 The plot being turned into a housing development would have the shortest rotation period youngest age because the cost of delaying the harvest would be greatest in this case It would include an additional costthe cost of delaying the construction of the housing developmentthat would have to be factored in causing net benefits to be maximized at an earlier harvest age 2 The cost trend is the result of two offsetting trends Harvesting cost is a function of the volume of wood so it increases as the volume of wood increases Since these costs are discounted however costs further in the future are discounted more When the tree growth gets small enough the discounting effect dominates the growth effect and the present values of the costs decline 3 A relative increase in the demand for forestbase biomass fuels would increase the value of wood used for this purpose To the extent that this added supply of fuel holds household energy costs lower than they would otherwise have been consumers benefit but they might lose if they use wood for other purposes as its price would be likely to rise The producers of this fuel will benefit but producers of more traditional fuels would lose Producers of products from wood other than fuels say paper mills using the wood for pulp would lose as their costs would rise To the extent that this domestic biomass fuel substitutes for imported fuel the state can expect an income increase as the funds formerly sent abroad are now spent locally where they have a higher multiplier effect 4 The market would be expected to reach an efficient balance if the owner was actively engaged in selling both recreation and harvested wood In this case the forest owner compares the marginal net benefits reflected in their respective revenue streams of various combinations of harvesting and recreation and chooses the combination that Answers to SelfTest Exercises 521 yields the highest net benefit If however as is common the private owner sells only harvested wood recreational uses would be undervalued 5 Certification is especially effective when the benefits being protected by the certification process are directly received by the purchaser It is less effective when conveying benefits that do not directly affect the purchaser Both certification systems convey a considerable amount of information that is about externalities For forests for example it can convey whether the wood is sustainably harvested but sustainably harvested wood is apparently indistinguishable from unsustainably harvested wood in terms of its ability to be used to build a house construct furniture and so on The real benefits are indirect and psychologicalknowing that the harvesting process is not degrading the environment Organicproduce certification produces many of those same indirect psychological benefits but in addition this form of certification conveys some information the absence of pesticide residues for example that directly can affect the consumer For this reason organicproduce certification is probably a bit more likely to produce a more efficient outcome all other things being equal 6 A rise in the price of timber would make it more likely that harvested forests would be replanted and would make land conversion to another use less likely Both of these reinforce components of sustainable forestry On the other hand it would also make the rewards from illegal harvesting higher which is incompatible with sustainable forestry Hence the answer depends upon the likelihood of illegal activity Chapter 12 1 a The maximum sustainable yield is obtained when the marginal benefit of an additional reduction in the population size is zero 20P 400 0 or P 20000 tons The maxi mum sustainable yield can then be calculated using the g equation g 420 01202 40 tons b The efficient sustained yield can be found by setting marginal cost equal to marginal benefit 20P 400 2160 P therefore P 327 which is a larger population than the one that would produce the maximum sustainable yield 2 a No despite the fact that this approach yields the efficient sustainable yield this would not be an efficient solution Net benefits would not be maximized because costs would be too high Everyone would have an incentive to capture as large a share of the quota for him or herself as quickly as possible This would lead to excessively large boats and would not guarantee that the fishermen who could catch the fish most cheaply would do the harvesting The net benefits would be smaller than possible b Yes this would be efficient This quota system creates exclusive property rights and therefore eliminates the need to catch as much as possible and as soon as possible Each fisherman can proceed on the most individually appropriate schedule because his or her share of the catch is guaranteed Since the need to rush harvesting is eliminated the need for excessively large boats is also eliminated Fishermen with high harvesting costs would find it in their interest to sell their quotas to fishermen with low harvesting costs in order to maximize their return from their quota These transfers guarantee that the fish are caught by those with the lowest harvesting costs so net benefits are maximized 3 The increase in the license fee is represented as a parallel upward shift of the total cost line whereas the perunit tax on effort is represented as a leftward rotation of the total Answers to SelfTest Exercises 522 cost curve around the zeroeffort point The latter increases the marginal cost of fishing effort while the former has no effect on the marginal cost In the privateproperty fishery the license fee will have no effect on effort unless it is so high as to make fishing unprofitable in which case the effort will drop to zero while the tax on effort will unambiguously reduce effort In the freeaccess fishery both will reduce effort by exactly the same amount Remember in the freeaccess fishery the equilibrium occurs where total cost equals total benefit Since these two policy instruments raise the same revenue both affect total cost by the same amount 4 When trying to reduce the degree of inefficiency from an openaccess fishery a regulation that increases the marginal cost of fishing effort by banning certain types of gear would be less efficient than a tax on effort Although they both rotate the total cost of effort upward the tax imposes a transfer cost which is compatible with efficiency because it does not waste net benefits and the gear restriction is incompatible with efficiency because in this case the net benefits are simply lost not merely transferred 5 a In answering this question remember that the benefits are defined as price times the quantity of fish harvested A fall in the price of fish would be reflected as a movement inward of that benefit curve In the typical economic model of an efficient fishery a fall in the price of fish would generally result in a smaller sustainable harvest The efficient level of effort is determined where MB MC A fall in the price of fish lowers MB but leaves MC unchanged The only way to reestablish MB MC is by increasing MB by lowering effort which because the efficient point is to the left of the maximum sustained yield would lower the sustainable harvest b If the fishery allows free access the effect is a bit more complex Remember that for a freeaccess fishery the equilibrium level of effort occurs where TB TC In this case because the TB curve has shifted downward the effort level is reduced That effect is the same as in a However in this case because the freeaccess equilibrium is normally to the right of the maximum sustained yield effort level lowering the effort level means a higher sustained harvest In essence in this case taking the pressure off the fish population allows that population to experience more sustained growth which means that more fish can be caught with less effort 6 a This change is such that the after curve has a flatter slope but a higher intercept with the Yaxis For the static efficient level of effort where MB MC the MC would have fallen Reestablishing MB MC would be accomplished by expanding effort thereby lowering MBremember MB is the tangent to or slope of the TB curve until it once again equaled MC Increasing effort on this side of the maximum sustained yield point would necessarily increase the size of the sustained harvest b In a freeaccess fishery since the total cost is lower after the change effort would expand However since this level of effort is to the right of the maximum sustained yield point this increased effort would result in a smaller sustained yield Chapter 13 1 a Carbon reduction credits are generally created in developing countries that do not have a cap on their emissions Since their purpose is to be used as one means of complying with emissions limits imposed by a cap they have no value in the country Answers to SelfTest Exercises 523 of origin Making them transferable across national boundaries allows them to be sold to the highest bidder This transferability provides incentives for the credit supplier to create the credits and to sell them to the highest bidders The buyers who acquire the credits are likely to have the most to gain from their acquisition Efficiency is enhanced because both the buyer and the seller gain from the transaction and so net benefits are increased b Conservation banking allows landowners to fulfill their conservation obligations on one site by acquiring the requisite conservation entitlements from a much larger project on another site If these entitlements were not transferable from one site to another the original owner would have to fulfill the obligation on her own land Because that approach would likely be smaller in scale typically would involve less suitable fragmented habitat and would be more expensive transferability allows the obligation to be met with lower cost and at a better less fragmented scale while making more appropriate habitat available to the endangered species 2 With a rise in demand in the recreational fishery its members are likely to want to increase their catch shares In the absence of intersector transferability this is likely to occur only if an administrative process changes the historical catch shares to allocate more to the recreational fishery and less to the commercial fishery Any such change is likely to be opposed by the commercial fishery members since each share transferred represents a monetary loss for them With intersector transferability however the recreational fishery members would have to buy the additional shares They would do this by offering a higher price for catch shares resulting in a shift in some shares from the commercial to a recreational fishery Transferability reduces conflict because the transactions are voluntary and in this case the sellers gain not lose Chapter 14 1 In a costeffective allocation of emissions reduction the marginal control costs should be equal So 200q1 100q2 Furthermore the total reduction is 21 units so q1 q2 21 Solving the first of these equations for q1 yields q1 05q2 Substituting this into the second yields 05q2 q2 21 Solving this for q2 results in q2 14 and q1 7 2 a From the text we know T MC1 MC2 From Problem 1a we know MC1 MC2 1400 Therefore T 1400 b Revenue T20 q1 T20 q2 140013 14006 26600 3 a The control authority would auction off 16 allowances 30 which is the current level of emissions minus 14 which is the required reduction b The marketclearing price would be 4 Since demand would equal supply and marginal abatement costs would be equal for all firms a 4 marginal abatement cost produces the required 14 units of reduction c With a 4 price Firm 1 would reduce emissions by 7 units so it would need to buy 3 allowances Firm 2 would reduce emissions by 4 units and hence would need to buy 6 allowances and firm 3 would reduce 3 units of emissions and therefore it would need to buy 7 allowances Note that this produces the required 14 units of reduction and accounts for the 16 allowances that were made available by the control authority d We know that the costeffective allocation is achieved when the MC1 MC2 MC3 4 This allocation will be achieved with an emissions charge if the firms set their MCs equal to 4 Hence the required tax rate is 4 Answers to SelfTest Exercises 524 Chapter 15 1 Imposing the same tax rate on every unit of emissions would normally be expected to yield a costeffective allocation of pollutioncontrol responsibility if the environmental target were specified in terms of aggregate emissions In that case costeffectiveness requires the marginal cost of emissions reduction to be equalized across emitters and that can be achieved with a uniform tax rate A uniform tax rate would not however be compatible with a costeffective allocation of each control responsibility if the environmental target were an ambient standard In this case you want the marginal costs of concentration reduction not emissions reduction to be equalized across emitters Since the location of emissions matters in this case not merely the amount of emissions a uniform tax rate will not be costeffective 2 Permitting the allowances to be traded after the allocation occurs is the process that achieves costeffectiveness so this allocation and any others that allocated the correct number of total allowances would be compatible with costeffectiveness Any costineffectiveness remaining after the initial allocation would be removed by the trading However if firms have advance knowledge that more permits will be allocated to those with higher emissions this creates a costineffective incentive to emit more during this interim period in order to qualify for additional allowances once the system begins Since these additional emissions make the goal harder and more expensive to meet costs are raised above the minimum Chapter 16 1 Taxes do have two advantages in achieving aggregate emissions reductions First by lowering the cost per mile traveled fuel economy standards can encourage more miles traveled Gasoline taxes increase the cost per mile traveled Second fuel economy standards apply only to new vehicles while gasoline taxes apply to the whole fleet of vehicles Since new vehicles are only a small proportion of the fleet taxes will likely produce a quicker result Obviously however this advantage accrues to taxes only if implementing them is politically feasible and the tax rates are high enough to produce the desired change 2 a Labeling has the virtue that it seems to be politically feasible and it can encourage a more fuelefficient new vehicle fleet However it only affects new cars and it has no effect on how many miles the cars are driven Furthermore as we have noted in earlier chapters labeling works best when it affects attributes that directly affect consumers Saving energy certainly directly affects consumers but some of the benefits of this approach particularly those relating to national security and climate change are externalities and are therefore probably not likely to be completely internalized by prospective purchasers These disadvantages would compromise its effectiveness b Older fuelinefficient vehicles do typically disproportionately contribute to the problem and therefore they are a useful target of opportunity but they are still only part of the problem By itself this strategy does not internalize the large number of other externalities associated with the purchase of new automobiles or reducing emissions from the fleet of automobiles that are not old enough to be affected by this program Furthermore many of these older automobiles are owned by lowerincome households Depending on how these vehicles are retired not compensating owners for example taking away their transportation could impose a considerable burden on the poor particularly the rural poor who have no mass transit option Answers to SelfTest Exercises 525 c Payasyoudrive insurance could probably be a useful complement because unlike the others it focuses on internalizing some of the externalities associated with miles driven Thus it addresses a component that would not otherwise be addressed 3 a From a social point of view efficiency would require that the marginal premium per mile driven include all costs that are specifically related to miles driven These would include potential accident damage contributions to climate change greenhouse gas emissions and national security damages stemming from import dependence b A private company would be concerned about recovering the costs related to the claims it will have to pay outaccident damages not the others Internalizing the other damages would require the participation of the government Chapter 17 1 The emissions charge equalizes marginal cost a required condition for costeffectiveness The subsidies induce utilities to choose options with a higher marginal cost By equalizing their aftersubsidy marginal costs utilities will minimize their outlays This will not minimize total costs of control since a greater reliance on carboncapture technologies will result than would be costeffective 2 High revenues in this context arise from a combination of high charges and large amounts of uncontrolled emissions This circumstance arises when the marginal cost of control function rises steeply at relatively low levels of control Since the charge is equal to the marginal cost of control high marginal control costs imply a high charge rate Furthermore if the function rises steeply at relatively low levels of control then there are large amounts of emissions to which this high rate of charge is applied Multiplying a high charge times a large amount of uncontrolled emissions yields high revenues 3 a Uncertain Although in most circumstances being discussed this would be true since a tax would internalize the external costs associated with the damages caused by greenhouse gases it does depend on the level of the tax It is possible to set a tax rate so high as to force the benefits from its imposition to be lower than the costs b True Regional systems control only emitters in their jurisdictions so unless all possible regions have control systems in place some emitters will remain uncontrolled Leakage results from the flow of business from controlled entities to uncontrolled entities because they can produce at lower cost and hence charge lower prices This flow of business from controlled to uncontrolled emitters results in an increase in emissions that at least partially offsets the reductions achieved within the region A truly global system that included all emitters in the same emissions trading system or facing the same greenhouse gas emissions tax would exempt no one and hence eliminate the problem of leakage 4 a Since PA MCA and PB MCB at the level of reduction where each domestic cap is met the price would be 10 in Country A and 40 in Country B Each country would be reducing 40 tons b In the linked case P MCA MCB because allowance can flow from one market to the other until the prices are equalized Because Country A can abate at a fixed marginal cost of 10 that will be the MC and the price for both markets Can you see why Achieving the desired 60 tons overall reduction implies that Country B will abate 10 tons MCB 1 10 10 and Country A will abate 50 MCA 10 tons Thus Country A would use 20 tons of its 50 ton abatement to satisfy its cap and export Answers to SelfTest Exercises 526 the remaining 30 tons of allowances to Country B Country B would apply its 10 ton reduction to its cap and import 30 tons of abatement allowances from Country A 5 Although the cooperative outcome would be collectively preferred it is not the most likely outcome due to the freerider effect Although collectively nations would be better off if everyone cooperated individual nations can well be better off if they choose not to join the agreement This paradox about the divergence between individual and collective incentives can arise because nonjoiners can still obtain any of the benefits of the agreement and avoid the abatement cost obligations that accrue to those who join Chapter 18 1 a The price would be 1400 In the final allocation the first source would control 7 units and would hold 13 permits whereas the second source would control 14 units and hold 6 permits The first source would have to purchase 4 permitsthe 13 it needs to minimize cost minus the 9 it was initially givenat a total cost of 5600 The second source would sell 4 permits thereby moving from the 10 held initially to the 6 it needs to minimize costs so it would gain 5600 from the sale b We know that in the final equilibrium the marginal control cost will be equal Since for the third source the marginal control cost is constant at 1600 this will determine the final marginal control cost The final permit price will be 1600 The control allocation can be found for the first and second sources by choosing the level of control that yields a marginal control cost equal to 1600 Thus 1600 200q1 so q1 8 and 1600 100q2 so q2 16 The third source will have to clean up sufficient additional emissions to meet the target Uncontrolled emissions were stated to be equal to 50 The first two sources would clean up 24 units leaving 26 units uncontrolled Since the target emissions level is stated as 19 units the third source would have to clean up the remaining 7 units q3 7 The third source would have to purchase three permits since it received no initial allocation Two would be purchased from the second source and one would be purchased from the first 2 a With these constant marginal cost functions costeffectiveness is achieved by securing as much reduction as possible from the facility or facilities with the lowest marginal cost In this case that means securing the first 10 units of reduction from the first facility and the next 5 from the second facility b The total variable cost in this case is simply the sum of the marginal costs for each unit of reduction Therefore the cost from reducing at the first facility would be 30 10 units 3 and the cost of the reductions at the second unit would be 20 5 units 4 so the total variable cost would be 50 c The total variable cost if all 3 facilities were forced to reduce 5 units would be 15 5 units 3 20 5 units 4 25 5 units 5 60 The extra 10 over the costeffective allocation results from the fact that this allocation of responsibility substitutes 5 units at 5 for the 5 units at 3 The extra 20 per unit reduced accounts for the additional 10 Answers to SelfTest Exercises 527 Chapter 19 1 One main difference in practice between an approach relying on performance bonds and one imposing strict liability for cleanup costs on any firm for a toxic substance spill is that the former requires money to be deposited in an escrow account before the operation commences For the firm the performance bond ties up capital for the period the bond is in effect a cost it does not incur with strict liability For the government a performance bond assures the availability of funds to clean up the toxic substance immediately should the need arise This availability can make a significant difference if the firm responsible for the spill turns out to not have sufficient funds to be able to fund the cleanup this is known as the judgmentproof firm problem In that case imposing strict liability would have little effect since the firm would be unable to fulfill its legal obligations 2 Informing the consumer about any toxic substances used in the manufacture of a product is likely to represent a move toward efficiency for those risks actually borne by consumers However risks borne by the workers making the product or the workers recycling or disposing of the product after its useful life are externalities to the consumer and informing the consumer is not likely to internalize those risks sufficiently to produce an efficient outcome Chapter 20 1 Export taxes will only be completely passed forward to the consumer if the demand is perfectly inelastic In that case the consumer will simply pay the higher price including the tax If it is less than perfectly elastic however demand for that product will be reduced and the domestic producer will bear some of the burden in the form of lower sales In world food markets it is unlikely that demand will be perfectly inelastic Not only can consumers choose to consume less as the price rises but they can switch to other suppliers or even to different food products 2 A natural disaster such as the 2010 drought in Russia would shift the supply curve to the left and raise prices Consumers would be unambiguously worse off as their net benefits would be reduced Suppliers who lost their entire crop would be unambiguously worse off but the effects on other suppliers could actually be positive All of those suppliers foreign suppliers for example whose crops were completely unaffected would be better off as the higher prices for their crops would raise their producer surplus For suppliers that lost some but not all of their crops it would depend on how the magnitude of the losses from the destroyed crops compared to the magnitude of the gain from selling the remainder at a higher price 3 The US tariff on imported sugar would raise the domestic cost of sugar to domestic consumers would cause a relative increase in their consumption of domestically raised sugar and it follows from that a reduction in the amount of sugar imported from abroad The increased profitability of the domestic sugar industry would allow it to compete for more land and other local resources To follow up on a specific example of this phenomenon examine the controversies surrounding the effects of the Florida Sugar industry on the Everglades Taylor Francis Taylor Francis Group httptaylorandfranciscom 529 Glossary Absorptive CapacityThe ability of the environment to absorb pollutants without incurring damage Acid RainThe atmospheric deposition of acidic substances Acute ToxicityThe degree of harm caused to living organisms as a result of shortterm exposure to a substance Adjusted Net SavingsAn indicator that attempts to measure whether an economy is acting sustainably when judged by the weak sustainability criterion Formerly called genuine savings AerobicWater containing sufficient dissolved oxygen concentrations to sustain organisms requiring oxygen Age Structure EffectChanges in the age distribution induced by the rate of population growth Agglomeration BonusA voluntary incentive mechanism that is designed to protect endangered species and biodiversity by reuniting fragmented habitat across private land in a manner that minimizes landowner resistance Alternative FuelsUnconventional fuels such as ethanol and methanol Ambient Allowance SystemA type of transferable permit system in which allowances are defined in terms of the right to affect the concentration at a receptor site by a given amount This design can achieve a costeffective allocation of control responsibility when the objective is to achieve a prespecified concentration objective at a specific number of receptor locations Ambient StandardsLegal ceilings placed on the concentration level of specific pollutants in the air soil or water AnaerobicWater containing insufficient dissolved oxygen concentrations to sustain life AnthropocentricHumancentered AquacultureThe controlled raising and harvesting of fish Called mariculture when as is the case with some salmon fisheries the facilities are in the ocean Aquaculture can provide the opportunity to create a privateproperty regime for affected fisheries AssetAn entity that has value and forms part of the wealth of the owner Assigned Amount ObligationsThe level of greenhouse gas emissions that ratifying nations are permitted under the Kyoto Protocol Asymmetric InformationA source of market failure that can arise when all of the economic agents involved in a transaction do not have the same level of information Automobile Certification ProgramThe testing of automobiles at the factory for conformity to federal emissions standards AverageCost PricingWhen prices charged for resource use are based on average costs Sometimes used by regulatory agencies to ensure that regulated firms make zero economic profits but it is not normally efficient Glossary 530 BaseLoad PlantsElectric generators that produce virtually all the time They generally have high fixed costs but low variable costs BenefitCost AnalysisAn analysis of the quantified gains benefits and losses costs of an action Benefits TransferTransferring benefits estimates developed in one context to another context as a substitute for developing entirely new estimates Best Available Technology Economically AchievableA more stringent effluent standard than best practicable control technology which has been defined by the EPA as the very best control and treatment measures that have been or are capable of being achieved Bid Rent FunctionThis function relates the maximum price per unit of land as a function of distance from the urban center that would be offered for a type of land use such as residential or agricultural Biochemical Oxygen DemandThe measure of the oxygen demand placed on a stream by any particular volume of effluent Block PricingA form of pricing in which the charge per unit consumption is held fixed until a threshold is reached where a new perunit charge is imposed for all consumption beyond the threshold For increasing block pricing the perunit charge after the threshold is higher BycatchUntargeted fish that are unintentionally caught as part of the harvest of targeted species CapandTrade SystemA form of emissions trading where the government specifies a cap on emissions and allocates allowances to emission sources either by gifting or auctioning based upon this cap These allowances are freely transferable among sources Distinguished from the earlier credit form of emissions trading Carbon TaxA policy that would control climate modification by placing a perunit emissions tax on the carbon content of carbonemitting sources Carrying CapacityThe level of population a given habitat can sustain indefinitely CartelA collusive agreement among producers to restrict production and raise prices In this case the group tends to act like a monopolist and to share the gains from collusive behavior Chapter 11A provision in the North American Free Trade Agreement that protects investors from government regulations that decrease the value of their investments Choke PriceThe maximum price anyone would be willing to pay for a unit of the resource At prices higher than the choke price the demand for that resource would be zero Chronic ToxicityThe degree of harm caused to living organisms as a result of continued or prolonged exposure to a substance Clean Development MechanismAn emissions trading mechanism set up under the Kyoto Protocol that allows industrialized countries to invest in greenhousegasreducing strategies in developing countries and to use the resulting certified reductions to meet their assigned amount obligations Closed SystemNo inputs enter the system and no outputs leave the system Coase TheoremA remarkable proposition named after Nobel Laureate Ronald Coase that suggests that in the absence of transaction costs an efficient allocation will result regardless of the property rule chosen by the court Cobweb ModelA theory in which long lags between planting decisions and harvest can influence farmers production decisions in such a way as to intensify or dampen price fluctuations Command and ControlControlling pollution via a system of governmentmandated legal restrictions Under this approach the government has the responsibility not only for setting Glossary 531 the environmental targets but also for allocating the sourcespecific responsibilities for meeting those targets CommonPool ResourceA resource that is shared among several users CommonProperty RegimesA property rights system in which resources are managed collectively by a group Community Land TrustAn organization set up to acquire and hold land for the benefit of a community Frequently used to provide affordable access to land for members of the community Comparative AdvantageIn trade theory a comparative advantage prevails for products that have the lowest opportunity cost of production Compensating VariationA method for evaluating the welfare effects of a price increase It is the increase in income it would take to make the consumer as well off as he or she was before the price increase Competitive EquilibriumThe resource allocation at which supply and demand are equal when all agents are price takers Composite AssetAn asset made up of many interrelated parts Composition of Demand EffectShifts in demand brought about by changes in the relative cost of inputs For example rising costs of ores coupled with stable prices for recycled inputs could make the products of firms relying more heavily on recycled inputs relatively less expensive and hence more attractive to consumers Congestion ExternalitiesHigher costs imposed on others resulting from an attempt to use resources at a higherthanoptimal capacity Commonly used with reference to traffic flows Congestion PricingCharging higher tolls during peak hours to discourage vehicle traffic and the resulting air pollution and encourage public transit ridership Conjoint AnalysisA surveybased technique that derives willingness to pay by having respondents choose between alternate states of the world where each state of the world has a specified set of attributes and a price Conjunctive UseThe combined management of surface and groundwater to optimize their joint use and to minimize the adverse effects of excessive reliance on a single source Conservation EasementsLegal agreements between landowners and land trusts or government agencies that permanently limit uses of land in specifically defined ways in order to protect its conservation value Constant DollarOutput measures that have been purged of increases due to price rises Consumer SurplusThe value of a good or service to consumers above the price they have to pay for it Calculated as the area under the demand curve that lies above the price ConsumptionThe amount of goods and services consumed by households Consumptive UseIn water law this refers to water that is removed from the source without any return Contingent RankingA valuation technique that asks respondents to rank alternative situations involving different levels of environmental amenity or risk These rankings can then be used to establish tradeoffs between more of the environmental amenity or risk and less or more of other goods that can be expressed in monetary terms Contingent ValuationA survey method used to ascertain willingness to pay for services or environmental amenities Conventional PollutantsRelatively common substances found in most parts of the country and presumed to be dangerous only in high concentrations Glossary 532 Corporate Average Fuel Economy CAFE StandardsMinimum average milespergallon standards imposed on each auto manufacturer for new vehicles sold in a specific vehicle class Autos are in one class and SUVs and light trucks in another Criteria PollutantsConventional air pollutants with ambient standards set by the Environmental Protection Agency includes sulfur oxides particulate matter carbon monoxide ozone nitrogen dioxide and lead Current ReservesKnown resources that can profitably be extracted at current prices Damped OscillationIn the absence of further supply shocks the amplitude of price and quantity fluctuations decreases to the point of equilibrium DebtNature SwapThe purchase and cancellation of developingcountry debt in exchange for environmentally related action on the part of the debtor nation Deep EcologyThe view that the environment has an intrinsic value a value that is independent of human interests DegradablePollutants that are capable of being decomposed chemically or biologically Demand CurveA function that relates the quantity of a commodity or service consumers wish to purchase to the price of that commodity DepositionPollution that transfers from the air to the earths surface land or water Development Impact FeesOnetime charges designed to cover the additional public service costs of new development Differentiated RegulationImposing more stringent regulations on one class of sources such as new vehicles than on others such as used vehicles Discount RateThe rate used to convert a stream of benefits andor costs into its present value Dissolved OxygenOxygen that naturally occurs in water and is usable by living organisms Divisible ConsumptionOne persons consumption of a good diminishes the amount available for others For example if I use some timber to build my house you receive no benefits from that timber Double DividendA second welfare advantage that accrues to revenueraising pollution control policy instruments over and above the welfare gain due to pollution reduction when the revenue is used to reduce distortionary taxes thereby reducing the welfare losses associated with those taxes Downward Spiral HypothesisA positive feedback loop in which increasing population triggers a cycle of sustained reinforced environmental degradation Dry DepositionOccurs when air pollutants get heavy and fall to the earths surface land or water as dry particles Dynamic EfficiencyThe chief normative economic criterion for choosing among various allocations occurring at different points in time An allocation satisfies the dynamic efficiency criterion if it maximizes the present value of net benefits that could be received from all possible ways of allocating those resources over time Dynamic Efficient Sustained YieldThe sustained yield that produces the highest present value of net benefits Ecological FootprintA sustainability indicator that attempts to measure the amount of ecologically productive land that is required to support the resource demands and absorb the wastes of a given population and their economic activities Economies of ScaleThe percentage increase in output exceeds the percentage increase in all inputs Equivalently average cost falls as output expands Ecosystem ServicesServices supplied by nature that directly benefit at least one person EcotourismA form of tourism that appeals to ecologically minded travelers It can serve as a source of revenue to protect the local ecosystem Glossary 533 Efficient PricingA system of prices that supports an efficient allocation of resources Generally efficient pricing is achieved when prices are equal to total marginal cost Emission ChargeA charge levied on emitters for each unit of a pollutant emitted into the air or water Emission StandardA legal limit placed on the amount of a pollutant an individual source may emit Emissions Allowance SystemA type of transferable permit system in which the permits are defined in terms of the right to emit a stipulated amount of emissions This design can be used to achieve a costeffective allocation of control responsibility for uniformly mixed pollutants Emissions BankingFirms are allowed to store emissions reduction credits or allowances for subsequent use or sale Emissions Reduction Credit ERCPart of a transferable permits system Any source reducing emissions beyond required levels can receive a credit for excess reductions These can be banked for future use or sold to other sources Emissions TradingAn economic incentivebased alternative to the commandandcontrol approach to pollution control Under emissions trading a regulatory agency specifies an allowable level of pollution that will be tolerated and allocates emission authoriza tions among sources of pollution Total emissions authorized by these allowances cannot exceed the allowable level Pollution sources are free to buy sell or otherwise trade allowances Energy Efficiency InvestmentAn investment that is designed to reduce the amount of energy input required to supply a given amount of useful energy services such as lighting or heating EnforceabilityProperty rights should be secure from involuntary seizure or encroachment from others EntropyAmount of energy not available for work Environmental Kuznets CurveAn empirical relationship that shows environmental degradation first increasing then decreasing as per capita income increases Environmental SustainabilityThis definition of sustainability is fulfilled if the physical stocks of designated resources do not decline over time Equivalent VariationA method for evaluating the welfare effects of a price increase It is the reduction in income that would leave a consumer indifferent between accepting the income reduction or accepting the price increase Estate TaxA tax paid on the fair market value of property after the owners death EutrophicA body of water containing an excess of nutrients EWasteWaste involving used electronics such as TVs tablets or mobile phones ExclusivityAll benefits and costs accrued as a result of owning and using the resources should accrue to the owner and only the owner either directly or indirectly by sale to others Expected Present Value of Net BenefitsThe sum over possible outcomes of the present value of net benefits for a policy where each future outcome is weighted by its probability of occurrence Expected ValueIn situations where the value of a resource depends on which of several outcomes might prevail the expected value of a resource is the sum over all outcomes of the likelihood of each outcome multiplied by the value that would prevail in that outcome Extended Producer ResponsibilityThe belief that manufacturers of products should have the responsibility to take the packaging and the products back at the end of their useful Glossary 534 lives in order to promote efficient packaging and recycling Also called the takeback principle External DiseconomyThe affected party is damaged by an externality For example my well is polluted by chemicals from a factory next door External EconomyThe affected party is benefited by an externality For example my neighbor decides not to develop a wetland that serves as a recharge area for my water supply ExternalityThe welfare of some agent either a firm or household depends on the activities of some other agent The externality can take the form of either an external economy or external diseconomy FeebatesA system that combines taxes on purchases of new highemitting vehicles with subsidies for new purchases of lowemitting vehicles The revenue from the taxes is supposed to serve as the primary source of funding for the subsidies Feedback LoopA closed path that connects an action to its effect on the surrounding conditions that in turn can influence further action First Law of ThermodynamicsNeither energy nor matter can be created or destroyed Fixed CostCosts that do not vary with output Fleet Average StandardUsed in the Corporate Average Fuel Economy Standards this standard is imposed on the sales weighted average of vehicles sold rather than forcing every vehicle to meet it FreeRider EffectWhen a good exhibits both the consumptive indivisibility and non excludability properties consumers may enjoy the benefits of goods purchased by others without paying anything themselves For example countries that decide not to take any steps to control global warming can free ride on the steps taken by others FuelEconomy StandardsA government program that mandates how many miles per gallon a manufacturers new cars must achieve by specific deadlines FullCost PricingIn water management this pricing system seeks to recover not only all of the costs of providing water and sewer services but also the cost of replacing the depreciated capital in older water systems Fund PollutantsPollutants for which the environment has some absorptive capacity if the rate of emission exceeds this capacity then fund pollutants accumulate Gaia HypothesisAn example of a negative feedback loop suggesting that within limits the world is a living organism with a complex feedback system that seeks an optimal physical and chemical environment Genetically Modified OrganismsA term that designates crops that carry new traits that have been inserted through advanced genetic engineering methods involving the manipulation of DNA Genuine Progress IndicatorA sustainability indicator that attempts to establish the trend of wellbeing over time by taking into account the effects of development on resource depletion pollution damage and distribution of income Global Environmental FacilityAn international organization loosely connected to the World Bank that provides loans and grants to developing countries to facilitate projects that contribute to solving such global problems as protecting the oceans preserving bio diversity protecting the ozone layer and controlling climate modification The fund uses the marginal external cost rule to allocate funds Government FailureAn inefficiency produced by some government action Greenhouse GasesGlobal pollutants that contribute to climate modification by absorbing the longwave infrared radiation thereby trapping heat that would otherwise radiate into space Includes carbon dioxide methane and chlorofluorocarbons among others Glossary 535 Green ParadoxAn effect that occurs when a program which is designed to reduce emissions paradoxically either speeds up the flow of emissions or increases the total amount of emissions GroundwaterSubsurface water that occurs beneath a water table in soils rocks or fully saturated geological formations Groundwater ContaminationPollution that leaches into a watersaturated region Hartwick RuleThe weak sustainability criterion can be fulfilled if all scarcity rent from depletable resources is invested in capital Health ThresholdA standard to be defined with a margin of safety sufficiently high that no adverse health effects would be suffered by any member of the population as long as the pollutant concentration is no higher than the standard Hedonic Property ValuesThe values of environmental amenities or risks that are determined from differences in the values of property exposed to different levels of the amenities or risks Hedonic Wage StudiesA valuation technique that allows the value of an environmental amenity or risk to be determined from differences in the values of wages paid to workers exposed to different levels of the amenity or risk HighGradingDiscarding lowvalue fish such as juveniles in favor of highvalue fish in order to increase the income derived from a harvest quota Host FeesFees collected from disposers that are used to compensate a community hosting a regional landfill Designed to increase the willingness of communities to host these facilities Human Development IndexA socioeconomic indicator constructed by the United Nations Development Program that is based upon longevity knowledge and income Hypothetical BiasIllconsidered responses that may arise in surveys based on contrived rather than actual situations or choices Impact AnalysisAn analysis that attempts to make explicit to the extent possible the consequences of proposed actions May mix quantitative with qualitative information and monetized with nonmonetized information Income ElasticityMeasures the percentage change in demand for commodities or services in response to a 1 percent change in income Individual Transferable Quotas ITQsA means of protecting a fishery and the income derived from it by limiting the number of fish caught Individual fishermen are allocated quotas that entitle them to portions of the authorized total allowable catch These quotas can be transferred to other fishermen or used to legalize their harvest Indivisible ConsumptionOne persons consumption of a good does not diminish the amount available for others For example the benefits I receive from controlling greenhouse gases do not diminish the benefits you receive Information BiasArises when contingent valuation survey respondents are forced to value attributes with which they have little or no experience Intangible BenefitsBenefits that cannot be easily assigned a monetary value Interactive ResourcesThe size of the resource stock is determined jointly by biological considerations and actions taken by humans IsoquantA curve showing possible combinations of two inputs that produce the same output level Joint ImplementationA projectbased emission trading mechanism set up under the Kyoto Protocol in which an investor from one industrialized country can get emission reduction credits for certified greenhouse gas reductions resulting from investments in a project in another industrialized country Glossary 536 Junior ClaimsUsed in water management this class of rights for specified amounts of water is subordinate to senior claims In times of water scarcity these rights become valid once the senior claims have been fulfilled Kyoto ProtocolAn international agreement to control greenhouse gases that went into effect in February 2005 Land TrustAn organization specifically established to hold conservation easements and to ensure that the use of land conforms to the terms of the easements LatencyThe period between exposure to a toxic substance and the detection of harm caused by that substance Law of Comparative AdvantageA country or region should specialize in the production of those commodities for which it has a comparative advantage Law of Diminishing Marginal ProductivityIn the presence of a fixed factor successively larger additions of variable factors will eventually lead to a decline in the marginal productivity of the variable factors Law of Diminishing ReturnsThe relationship between inputs and outputs when some inputs are increased and others are fixed eventually leading to the decreased productivity of the variable inputs Lead Phaseout ProgramA transferable permit program designed to lower the costs of phasing out lead in gasoline as well as to eliminate lead earlier than otherwise would have been possible It allocated transferable rights to use lead in refining gasoline to refiners The number of rights declined over time until at the end of the program they expired LeapfroggingRefers to a situation where new development takes place not at the edge of current development but further out skipping over tracts of land that are closer in Liability RulesRules used in courts that award monetary compensation from an injurer to an injured party after damage has occurred LowEmission VehiclesA class of vehicles that emit fewer emissions per mile driven than conventional vehicles Marginal Cost of ExplorationThe marginal cost of finding additional units of the resource MarginalCost PricingBasing the prices charged for resource use upon marginal costs This pricing scheme is generally consistent with efficiency Marginal External Cost RuleUsed by the Global Environmental Facility to disperse funds According to this rule the facility will fund additional expenses associated with investments that contribute to the global environment produce positive global net benefits but cannot be justified domestically since the domestic marginal costs exceed domestic marginal benefits Countries are expected to pick up that portion of the expenses that can be justified domestically where the domestic marginal benefits exceed domestic marginal costs Marginal Extraction CostThe cost of mining an additional unit of resource Marginal Opportunity CostThe additional cost of providing the last unit of a good as measured by what is given up Marginal User CostPresent value of forgone future opportunity costs at the margin Marginal Willingness to PayThe amount of money an individual is willing to pay for the last unit of a good or service Marine ReserveA specific geographic area that prohibits harvesting of fish and enjoys a high level of protection from other threats such as pollution Market EconomyAn economic system in which resource allocation decisions are guided by prices that result from the voluntary production and purchasing decisions by private consumers and producers Market FailureAn inefficient allocation produced by a market economy Glossary 537 Maximum Sustainable YieldThe maximum harvest that could be sustained forever MicrogridA group of interconnected electrical loads and distributed energy resources with clearly defined boundaries that acts as a single controllable entity Depending on the situation microgrids may be either connected to a larger electrical grid or operate completely independently Minimum Viable PopulationThe level of population below which regeneration is negative leading ultimately to extinction ModelFormal or informal framework for analysis that highlights some areas of the problem in order to better understand complex relationships MonopolyA situation in which the seller side of the market is dominated by a single producer Montreal ProtocolAn international agreement to control ozonedepleting gases Multilateral FundA fund set up by the parties to the Montreal Protocol to help developing countries meet the phaseout requirements for ozonedepleting gases MyopiaNearsightedness excessive concern for the present Natural CapitalThe endowment of environmental and natural resources Natural EquilibriumStock levels of biological populations that persist in the absence of outside influences Natural Resource Curse HypothesisSuggests that countries with abundant natural resources are likely to grow more slowly than their lesser endowed counterparts Negative Feedback LoopA closed path of action and reaction that is selflimiting rather than selfreinforcing NegligenceA doctrine in tort law suggesting that the party responsible for a tortious act owes a duty to the affected party to exercise due care Failure to fulfill that duty can lead to a requirement for the injurer to pay compensation to the victim Net BenefitThe excess of benefits over costs resulting from some allocation New ScrapWaste composed of the residual materials generated during production Also called preconsumer scrap New Source Review ProcessAll large new or expanding sources are subject to preconstruction review and permitting These firms are typically subjected to more stringent requirements The specific requirements depend on whether the source is attempting to locate in an attainment or a nonattainment area Nonattainment RegionA region in which the pollution concentrations exceed the ambient standards so more stringent environmental regulations are in effect Noncompliance PenaltyA charge used to reduce the profitability of noncompliance with pollution control requirements It is designed to eliminate all the economic advantage gained from noncompliance Nonconsumptive UseIn water law this refers to a use that does not involve diverting the water from the source or that does not diminish its availability Swimming for example NonexcludabilityNo individual or group can be excluded from enjoying the benefits a resource may confer whether they contribute to its provision or not Nonpoint SourcesDiffuse sources such as runoff from agricultural or developed land Nonrenewable ResourcesResources that cannot be reproduced during a human timescale so their supply is considered finite and limited Nonuniformly Mixed PollutantsFor these pollutants the damage they cause is a function not only of the amount of emissions but also the location of the emissions sources Examples include particulates and lead Nonuse PassiveUse ValuesResource values that arise from motivations other than personal use Glossary 538 Normative EconomicsThe branch of economics that is concerned with evaluating the desirability of alternative resource allocations It is concerned with what ought to be Nutrient Sensitive WatersWater bodies that have excessive levels of nutrients causing algal blooms low oxygen levels and increased fish kills Occupational HazardsRisks undertaken during the course of a job Old ScrapWaste recovered from products used by consumers Also called postconsumer scrap OpenAccess ResourcesCommonpool resources with unrestricted access Open SystemA system that imports and exports matter or energy Opportunity CostThe net benefit forgone because the resource providing the service can no longer be used in its nextmostbeneficial use OptimalBest or most favorable option Optimization ProcedureA systematic method for finding the optimal means of accomplishing an objective Option ValueThe value people place on having the option to use a resource in the future Output MeasureA measure currently used in national income accounting to indicate how many goods and services have been produced OverallocationMore than the optimal level of a resource is dedicated to a given use or time period Overshoot and CollapseA forecast that involves exceeding the natural carrying capacity of the environment with the consequence that society collapses Oxygen SagA point of low dissolved oxygen concentration generally located around effluent injection points OzoneDepleting GasesGlobal pollutants that destroy the stratospheric ozone layer Includes chlorofluorocarbons and halons among others Pareto OptimalityAn allocation such that no reallocation of resources could benefit any person without lowering the net benefits for at least one other person Named after economist Vilfredo Pareto PayasYouDrive PAYD InsuranceA system in which an individuals annual premium for automobile insurance is calculated by multiplying a rating factor times the number of miles driven It is designed to reduce inefficiency by internalizing those costs of accidents that are related to the amount of driving Peaking UnitsThose electricityproducing facilities used only during peak periods They generally have low fixed costs but high variable costs PeakLoad PricingCharging resource users during the peak period the higher cost of supplying resources during that period The surcharge during the peak period is designed to cover the cost of expansion since the need to expand is triggered by increased demands during the peak period Peak PeriodsTimes of especially high resource demand For example the demand for electricity during the hottest part of the summer when airconditioning is in heavy use Pecuniary ExternalitiesExternal effects that are transmitted through higher prices For example the value of my land increases because surrounding employers expand their operations thereby creating a scarcity of housing in the immediate area Unlike most externalities pecuniary externalities do not generally result in inefficient allocations Performance BondAn amount of money required to be placed into a trust fund by those initiating risky projects to cover the costs of any anticipated damages Persistent PollutantsInorganic synthetic pollutants with complex molecular structures that are not effectively broken down in water Glossary 539 Planning HorizonThe time period over which the benefits and costs are considered in time related decisions For a specific investment such as a power plant for example the planning horizon might correspond to the useful life of the project For forestry it could either correspond to the age of the stand of trees when harvested the finite planning horizon or extend forever the infinite planning horizon Point SourcesSources of pollution that discharge effluent through a readily identifiable emission point such as an outfall or discharge pipe Most industrial and municipal sources are point sources Pollution Havens HypothesisStricter environmental regulations in one country either encourage domestic production facilities to locate in countries with less stringent regulations or encourage increased imports from those countries Porter Induced Innovation HypothesisFirms facing stringent environmental regulations derive a competitive advantage because they are forced to innovate Innovation typically increases productivity Positive EconomicsThe branch of economics that is concerned with describing alternative resource allocations without forming a judgment as to their desirability Concerned with what is Positive Feedback LoopA closed path of action and reaction that is selfreinforcing rather than selflimiting Potential ReservesThe amount of resource reserves potentially available at different price levels Present ValueThe current discounted value of a stream of benefits andor costs over time Present Value CriterionResources should be allocated to those uses that maximize the present value of the net benefits received from all possible uses of those resources Price ControlsThe establishment of maximum or minimum prices by the government Primary EffectsThe direct measurable effects of an action Primary StandardAn ambient air pollution standard designed to protect human health Prior Appropriation DoctrineEntitlements for water are allocated to the agent who diverts and first puts water to a beneficial use Private Marginal CostThe cost of producing an additional unit of the resource that is borne by the producer Producer SurplusThe value of a good or service to producers above the cost to them of producing it Calculated as the area below the demand curve that is above marginal cost Product ChargesA charge imposed on a product that is associated with emissions such as a gasoline tax This indirect form of controlling emissions is used when placing the charge directly on emissions proves difficult Property RightsA bundle of entitlements defining the owners rights privileges and limitations for use of the resource Property RulesLegal rules that govern the initial allocation of entitlements Valuation of the entitlements is left to the market Property TaxA tax on the value of land and the improvements on it Proposition 65A California law that requires companies producing using or transporting one or more of the specified substances in amounts over the safe harbor threshold to notify those who are potentially impacted Public GoodA resource characterized by nonexclusivity and indivisibility Real Consumption Per CapitaConstantdollar consumption divided by population RealResource CostsAs opposed to transfer costs these are costs borne by both private parties and society as a whole because they involve the loss of net benefits not merely their transfer Glossary 540 Rebound EffectAn increase in consumption that results from an energy efficiency investment ie lowers the amount of input energy necessary to product a given level of useful energy services Examples including driving more miles after acquiring a fuelefficient car or turning up the target temperature after making your house more energy efficient Receiving AreasThose areas under a transferable development rights system where rights acquired from owners in the sending area can be used Recycling SurchargeImposed at the time of commodity purchase this charge attempts to recover from the consumer the cost of recycling andor disposal of the commodity after its useful life Regional PollutantsPollutants that can cause damage some distance from the emission source Examples include the precursors for acid rain and tropospheric ozone Regressive DistributionNet benefits from a policy received by various income groups represent a larger portion of the income of the rich than of the poor Renewable Energy CreditAn official record granted to producers of qualified renewable energy that can be sold separately from the energy to allow the recovery of the extra costs associated with renewable power It can be used to prove compliance with a renewable portfolio standard Renewable Portfolio StandardsThese standards specify enforceable targets and deadlines for producing specific proportions of electricity from renewable resources Renewable ResourcesResources that can be naturally regenerated over time on a human timescale Rent SeekingThe use of resources in lobbying and other activities directed at securing increased profits through protective regulation or legislation Res Nullius RegimeA property rights system in which no one owns or exercises control over resources Resources covered by this regime can usually be exploited on a firstcome first served basis Resource EndowmentThe natural occurrence of resources in the earths crust and atmosphere Resource TaxonomyA classification system used to characterize the nature of natural resource stocks in terms of the certainty of the stock estimates and the economic likelihood of their recovery Return FlowA term used in water management that refers to the unconsumed portion from an upstream users water allocation that will eventually return to the watercourse and hence be available to a downstream user RevenueNeutral Tax or FeeA government charge that does not add to the total government revenue This can be achieved by such means as rebating the revenue back to households or lowering the rates on existing charges such that the decrease in revenue from those sources equals the increase in revenue from the revenueneutral source leaving total revenue unchanged Riparian RightsAllocates the right to use water to the owner of the land adjacent to the water as long as no adverse effects are imposed on other rights holders RiskFree Cost of CapitalRate of return earned on an investment when the risk of earning more or less than expected returns is zero RiskNeutralityAn agent who has no preference between options that produce the same expected value Risk PremiumAdditional rate of return required to compensate the owners of the capital when the expected and actual returns may differ It represents compensation for a willingness to undertake some risk Scale EffectsHow the size of an operation affects average costs Glossary 541 Scarcity RentProducers surplus that persists in longrun equilibrium due to fixed supply or increasing costs Secondary EffectsIndirect consequences of an action beyond primary effects Secondary StandardAn ambient standard designed to protect those aspects of human welfare other than health Second Law of ThermodynamicsEntropy the energy not available for work increases Sending AreasAreas where the owners of land can sell rights in a transferable development rights system that can be used in receiving areas but not the sending areas Senior ClaimsUsed in water management this class of claims entitles the holder to a priority for specified amounts of water These rights have a higher priority in times of low water availability than junior claims Social Cost of CarbonThe additional economic damage that would accrue from emitting one more ton of CO2 or CO2equivalent into the atmosphere Socialist EconomyA centrally planned economy where the means of production are controlled by the government Social Marginal CostThe cost of producing an additional unit of the resource that is borne by society at large Generally includes private marginal costs plus external marginal costs SprawlAn inefficient land use pattern where the uses are excessively dispersed Stable EquilibriumA level of stock that will be restored following temporary shocks StartingPoint BiasArises when a contingent valuation survey respondent is asked to check off his or her answer from a predetermined range of possibilities and the answers depend on the range specified by the survey instrument Static EfficiencyThe chief normative economic criterion for choosing among various allocations when time is not an important consideration An allocation satisfies the static efficiency criterion if it maximizes the net benefits from all possible uses of the resource Static Efficient Sustained YieldThe sustained catch level in a fishery that produces the largest annual recurring net benefit Stationary SourceAn immobile pollution source Factories for example as opposed to automobiles Statistically SignificantObserved differences are unlikely to result from pure chance Stock PollutantsPollutants that accumulate in the environment because the environment has little or no absorptive capacity for them Strategic BiasA respondent provides a biased answer to a contingent valuation survey in order to influence a particular outcome Strategic Petroleum ReserveA petroleum stockpile established by an importing nation to minimize the damage that could be done by an embargo imposed by a foreign supplier It would serve as an alternative source of supply for a short period StratosphereThe atmosphere that lies above the troposphere It extends to about 31 miles above the earths surface Strict LiabilityA tort law doctrine requiring that the party responsible for pollution contamination compensate victims for damage caused Differs from negligence in that the victim does not have to prove that the injurer was negligent Strong SustainabilityThis definition of sustainability is fulfilled if the value of the natural capital stock does not decline Suboptimal AllocationAn allocation that could be rearranged so that one or more people could be made better off while no one was made worse off Also called an inefficient allocation SubsidiesPayments or tax breaks from the government that make the cost to the buyer lower than the marginal cost of production Glossary 542 SubstitutionReplacing one resource with another May occur for example when the original resource is no longer costeffective or is diminishing in quantity or quality Sulfur Allowance AuctionRun by the Chicago Board of Trade this annual auction requires utilities to place a proportion of these allowances up for sale each year The proceeds are returned to the utilities This is called a zero revenue auction since the government derives no revenue from it It ensures the continual availability of permits and provides good public information on prices Sulfur Allowance ProgramA transferable permit program targeted at electric utilities that was designed to reduce sulfur emissions from 1980 levels by 10 million tons Involves an auction and an emissions cap Surface WaterThe freshwater in rivers lakes and reservoirs that collects and flows on the earths surface Sustainability CriterionA criterion for judging the fairness of allocations of resources among generations Generally requires that resource use by any generation should not exceed a level that would prevent future generations from achieving a level of wellbeing at least as great Sustainable ForestryForestry practices that are consistent with one of the definitions of sustainability though most commonly this term refers to compatibility with the environmental sustainability criterion Sustainable YieldHarvest levels that can be maintained indefinitely achieved by setting the annual harvest equal to the annual net growth of the population SynergisticThe doseresponse relationship is dependent upon several interrelated factors TakeBack PrincipleThe belief that manufacturers of products should have the responsibility to take the packaging and the products back at the end of their useful lives in order to promote efficient packaging and recycling Also called extended producer responsibility Tangible BenefitsBenefits that can reasonably be assigned a monetary value Technological ProgressAn innovation in process or technique that allows more output or services to be derived from a given set of inputs Thermal PollutionPollution caused by the injection of heat into a watercourse Third PartiesVictims who have no contractual relationship to a pollution source They are neither consumers of the product produced by the source nor employed by the source Total CostThe sum of fixed and variable costs ToxicityThe degree of harm caused to living organisms as a result of exposure to the substance Toxic Release InventoryA system for reporting toxic emissions releases from individual facilities in the United States By making the data public it was designed to warn communities of the risks they face and to encourage reductions prior to regulation Transactions CostsCosts incurred in attempting to complete transactions For example in buying a home these might include payments to the broker for arranging the sale to the bank for onetime special fees and to the government for the required forms The value of the time expended in negotiating would also be a transactions cost TransferabilityProperty rights can be exchanged among owners on a voluntary basis Transfer CoefficientA coefficient used in simulating pollutant flows It relates the degree to which pollution concentrations at a specific receptor site are increased by a oneunit increase in emissions from a specific source Transfer CostA cost to a private party that is not a cost to society as a whole because it involves a transfer of net benefits from one private party to another Glossary 543 TroposphereThe atmosphere that is closest to the earth Its depth ranges from about 10 miles over the equator to about 5 miles over the poles TwoPart ChargeAs used in water management this type of charge combines volume pricing with a monthly fee that doesnt vary with the amount used The monthly fee is designed to help cover fixed costs UnderallocationLessthanoptimal levels of a resource are dedicated to a given use or time period Uniform Emission ChargeA charge on effluent that applies the same perunit rate to all sources regardless of their size or location Uniform TreatmentA strategy to reduce effluent levels by the same specified percentage at each emissions level Uniformly Mixed PollutantsFor these pollutants the damage done to the environment depends on the amount of emissions that enters the atmosphere The location of emissions is not a matter of policy concern Examples include ozonedepleting gases and greenhouse gases User CostOpportunity cost created by scarcity It represents the value of an opportunity forgone when the resource can no longer be used in its nextbest use For example for a unit of a depletable resource used now the user cost is the net benefits that would have been received by saving it and using it during the next time period Usufruct RightHolders of this right may use a resource normally subject to restrictions but do not have full ownership rights such as the privilege of being able to sell it to someone else Variable CostProduction costs that vary with output Volume PricingMaking the cost of the service a function of the volume used Used in both trash disposal and water distribution Weak SustainabilityResource use by previous generations should not exceed a level that would prevent future generations from achieving a level of wellbeing at least as great This definition of sustainability is fulfilled if the total capital stock natural capital plus physical capital does not decline over time Welfare MeasureA measure that reflects whether economic activity increases or decreases societys wellbeing Wet DepositionOccurs when air pollutants fall to land or water during rain or snow events Zero DischargeNo emissions of the targeted pollutant are allowed Zero Emission VehicleAutomobiles that directly emit no air pollutants Examples include vehicles powered by solar energy and fuel cells Zoned Effluent ChargeA charge on effluent that applies different perunit rates to sources depending on their location Generally sources closer to and upstream from locations with more serious pollution problems face higher rates Taylor Francis Taylor Francis Group httptaylorandfranciscom 545 Index Locators in italics refer to figures and those in bold to tables when continuous with the text figures and tables are not indexed separately absorptive capacity 334 accounting stance benefitcost analysis 56 57 acid rain 335 338 366 370 acute toxicity 456 adaptation strategies climate change 402 405406 415417 aerobic conditions 424 age structure effect 274 298 see also generational context population agglomeration bonus 327328 aggregation benefitcost analysis 57 agriculture deforestation 259 irrigation 209 211 236 land use 235 valuing the environment 238239 water prices 212213 water use 209 211 air pollution 357 368370 commandand control approaches 358363 conventional pollutants 357364 marketbased policies 364368 see also mobilesource air pollution air quality 364 Alaska Permanent Fund 114 allocation climate change 154 depletable resources 123124 134138 dynamic efficiency 107114 fisheries 274282 intertemporal 127134 pollution 335341 recyclable resources 173176 177 renewable resources 123124 resource taxonomy 124127 static efficiency 2122 3133 sustainable development 115116 117118 477478 toxic substances 457462 twoperiod model 108112 127128 water 202212 alternative vehiclesfuels 386387 391 ambient standards air pollution 360 water pollution 432434 anaerobic conditions 424 aquaculture 294 295296 asset environment as 1819 see also ecosystem goods and services asymmetric information 34 atmospheric deposition water pollution 441 attributebased methods 83 Australia water markets 223 224 automobiles see cars average cost pricing 209 213 229 averting expenditures 93 backfire effects 165 Bali Climate Change Conference 405406 banks water 220224 Barrett model 404 Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal 471 beaches preferences case study 9091 behaviors experimental economics 10 beneficial use principle 207208 benefit transfer 80 9192 benefitcost analysis across time 4950 5051 carbon dioxide emissions 5455 estimation issues 5658 fracking 149 human life 9798 100101 legislation 5155 limitations 6466 pollution control 5153 risk 5859 tradeoffs approach 46 see also valuing the environment bequest value 77 best available technology BAT 429 best practicable control technology BPT 429 Index 546 bias valuing the environment 7980 bid rent functions ecotourism 323 land 234235 bike sharing problems 390 biochemical oxygen demand BOD 424 bioeconomics fisheries 274280 forests 252257 biological diversity economics 3031 3334 ecotourism 323326 fisheries 273274 280 293 297298 forests 258 260 266 267 invasive species 328329 pollination 312314 trust funds 265 267268 see also conservation ecosystem goods and services endangered species Bisphenol A BPA 456457 Blackfoot Community Project 265 block pricing 215 bluefin tuna case study 299 300301 Bolivia Amboro National Park 319 Boothbay Pilot Project 166 bottledeposit systems 186187 BP oil spill 7374 447 British Columbia Carbon Tax Program 408409 Brundtland Report 475476 buybacks fisheries 294296 bycatch fishing 289 293 297 299 California Air Resources Board CARB 386 recycling 190191 water accessibility 217218 220221 Canada discount rates 61 toxic substances legislation 467 cancer toxic substances 455 capandtrade 344346 349 capital stocks measures 491 sustainability 115 117118 sustainable development 477 479 types of capital 492 carbon dioxide emissions forests 260261 policy options 341346 348350 pollution taxonomy 335 pricing 408413 science of climate change 400402 sequestration 402 taxation 408413 tradeoffs 5455 see also climate change carbon sequestration credits 320321 carrying capacity 2 11 245 275 496 cars alternative fuels and vehicles 386387 391 congestion 375 376377 388391 394 emissions regulation 374 externalities 375377 fuel economy standards 380385 and land 237238 377 mobilesource air pollution 373375 parking for free 237 375 391 PayasYouDrive PAYD insurance 391 392 retirement of older vehicles 391393 road pricing 387390 subsidies 375 carsharing 384385 cartels 34 149152 see also monopolies CashforClunkers Program 393 catastrophe thresholds 404 catch share programs fisheries 285293 causality environmental justice 464466 certification forests 262263 mobilesource air pollution 378379 chemicals see toxic substances Chile water markets 223 China desalination 227 water pollution 445 chlorine manufacturing case study 369370 chlorofluorocarbons CFCs 406407 choice experiments 79 8388 choke price 129 chronic toxicity 456 Clean Air Act 1990 air pollution 357 358 360 365 lead phaseout 379380 mobilesource air pollution 377 pollution control 51 5253 Clean Development Mechanism 406 Clean Water Act 430 431 436439 climate change 399400 417418 adaptation strategies 402 405406 415417 carbon sequestration credits 320321 as challenge 24 coral reefs 310 emissions trading 413 forests 260 fossil fuels 152 153 mitigation strategies 408413 414415 policy negotiations 402406 policy options 341346 347350 reducing ozonedepleting gases 406407 science 400401 and water accessibility 5 see also carbon dioxide emissions pollution control climate engineering 402 closed systems 19 coal 158 Coase theorem 3738 293 coastal ecosystems 314315 see also fisheries coffee labelling example 41 Colombia water pollution 444 Colorado water markets 222 combined approach benefitcost analysis 58 commandandcontrol approaches air pollution 358363 pollution 342 Index 547 commonpool resources economics 2830 ecotourism 323326 fisheries 273274 280282 283 296297 tragedy of the commons 2830 274 transferable entitlements 322323 water 211212 see also public goods commonproperty regimes 28 Communal Areas Management Program for Indigenous Resources CAMPFIRE 325326 comparative advantage 435436 480481 compensating variation 8081 compensation toxic substances 469 competitive equilibrium 24 composite assets 18 composition of demand effect 174 congestion 375 376377 388391 394 conjunctive use 205 conservation banking 326327 biological diversity 3031 3334 easements 245246 265 fisheries 297298 forests 262268 land use 240 water accessibility 217218 220221 see also biological diversity endangered species constant dollar 391 491 consumer preferences 507 consumer surplus 2122 consumptive use water 203 206 207208 224225 contingent Ranking 85 contingent valuation 78 7983 84 Convention on International Trade in Endangered Species CITES 299300 conventional pollutants 357358 see also pollution coral reefs valuing 309311 310 Corporate Average Fuel Economy CAFE program 380381 383 Costa Rica ecocertification 41 Pago por Servicios Ambientales 317 costbenefit analysis see benefitcost analysis costeffectiveness analysis air pollution 361363 pollution 67 340346 355356 tradeoffs 6667 water pollution 432433 435436 447448 costs carbon pricing 408413 energy production 175 fisheries management 283285 labor costs 175 plastic bag bans 188 see also valuing the environment criteria pollutants 357358 361362 374 see also pollution cultural context ecosystem goods and services 310 323326 selfextinction premise 3 curbside recycling 184185 current reserves 124 Czechoslovakia water pollution 441 damage see harm to environment debt forests 261 264 debtnature swaps 264 266 decisionmaking see tradeoffs deep ecology 75 defensive expenditures 93 deforestation carbon dioxide emissions 260261 carbon sequestration credits 320321 climate change 260 forestry practices 252 harvesting decisions 252257 inefficiencies 257261 policy 262268 degradable pollutants 424 demand see price elasticity of demand supply and demand demand curves allocation 78 89 109 127128 benefitcost analysis 46 efficiency 2122 25 31 energy 154 155 water 203 204 205 demographics see generational context population depletable resources allocation 123124 134138 coal 158 electricity 158159 energy resources 158159 natural gas 146149 nuclear energy 158159 resource taxonomy 124126 security considerations 152157 158 visions of the future 2 500501 water scarcity 198202 see also oil desalination 226227 developing countries forests 261 land use 242243 water pollution 442445 development impact fees 246247 developmentgrowth relationship 490492 504505 see also sustainable development discards fishing 298299 discount rates benefitcost analysis 6063 carbon dioxide emissions 54 54 fisheries 278279 present value 50 private and social 6366 sustainable development 479 disposal see waste dissolved oxygen DO 424 distance decay 9697 distribution benefitcost analysis 60 Index 548 diversity biological see biological diversity divisibility economics 28 double dividend 347 drought 216217 221 see also water accessibility dry deposition 441 dynamic efficiency 117118 fairness of allocations 113114 fisheries 276277 278280 intertemporal fairness 112115 policy implications 117 pollution 335 sustainable development 107108 114117 tradeoffs 51 twoperiod model 108112 Easter Island 3 ecocertification 41 ecological economics 78 Ecological Footprint 492493 494 Economic Exclusion Zone see Exclusive Economic Zones economic impact analysis 60 economic rent fisheries 288 forests 259 rent seeking 35 42 economics as approach 17 1921 42 asymmetric information 34 efficiency 2122 3641 environmental justice 463464 environmental vs ecological 78 externalities 2527 government failure 3435 government intervention 3941 humanenvironment relationship 1821 imperfect markets 3134 legislation 3940 models 89 property rights 2324 2730 3639 public goods 3034 visions of the future 9 11 see also tradeoffs valuing the environment The Economics of Ecosystems and Biodiversity TEEB 309 311 314 economies of scale 161 182 288 421 436 ecosystem goods and services 1819 307308 330331 demonstrating value 307308 309316 economic analyses 309 ecotourism 317 323326 endangered species 326329 future of 330 protection institutions and mechanisms 316319 state of 308309 tradable entitlement systems 319323 valuing the environment 74 7778 ecotourism 317 323326 efficiency air pollution 359362 curbside recycling 184185 disposal costs 180182 economics 2122 3641 environmental justice 464466 fisheries 274282 forests 253 257261 262 government failure 3435 government intervention 4041 imperfect markets 3134 land use 236243 optimal outcomes 4849 pollution 335338 349 property rights 2224 recyclable resources 173176 177 sustainable development 478480 tradeoffs 4849 51 visions of the future 502503 water allocation 202205 204 207212 water pollution 432434 447448 water prices 216 see also dynamic efficiency static efficiency efficient pricing 31 209 Ehrlich Paul 179180 elasticity see income elasticity of demand price elasticity of demand electric cars 386387 391 electricity depletable resources 158159 renewable resources 159167 elephant trade example 481482 emissions see carbon dioxide emissions mobilesource air pollution pollution emissions charges air pollution 364365 carbon pricing 408413 pollution control 342344 emissions standards 341342 emissions trading air pollution 365368 capandtrade 344346 349 climate change 413 Emotional WellBeing measures 495 endangered species Convention on International Trade in Endangered Species 299300 instream flows 225226 protection institutions and mechanisms 326329 Endangered Species Act ESA 328 energy costs of production 175 visions of the future 500501 and water 199200 energy efficiency discount rates 6162 electricity 163165 microwave oven rule 55 energy resources 145 167168 depletable resources 158159 natural gas 146149 oil 148152 renewable resources 159167 security considerations 152157 158 enforcement fisheries policy 298301 mobilesource air pollution 378379 property rights 23 engineering benefitcost analysis 58 geoengineering 402 entropy 19 environmental economics 78 Index 549 environmental goods see ecosystem goods and services environmental harms see harm to environment environmental justice toxic substances 462472 Environmental Kuznets Curve EKC 483485 Environmental Protection Agency EPA air pollution 264 357 358 360 366367 air quality 364 environmental justice 466 mobilesource air pollution 377 pollution control 20 51 5253 357 toxic substances 466472 water pollution 427432 434437 environmental sustainability 118 see also sustainable development equitable pricing water 217218 equity analysis distribution 60 equivalent variation 81 ethanol and methyl tertiary butyl ether MTBE 385386 ethics occupational safety 459461 Europe toxic substances 467 water pollution 441443 European Common Fisheries Policy 291 European Union Emissions Trading System EU ETS 409 lead phaseout 379380 mobilesource air pollution 383385 Water Framework Directive 442 eutrophication 425 437438 ewaste 189 190192 471472 Exclusive Economic Zones 296297 exclusivity property rights 23 existence value 77 experimental economics 10 exploration recyclable resources 176177 technological progress 133134 external benefits 26 external costs 26 externalities economics 2527 land use 238 mobilesource air pollution 375377 pollution 26 338339 350 renewable resources 160 sustainable development 502 extinction fisheries 280 see also biological diversity extraction efficiency 133 138 marginal extraction costs 131133 recyclable resources 173174 technological progress 133134 extractive reserves 264 Exxon Valdez oil spill 73 74 84 farming see agriculture fisheries federal reclamation projects 208209 feebates 391 feedback loops 67 feedin tariffs 162163 First Equimarginal Principle 49 fisheries 273274 allocation 274282 aquaculture 294 295296 bioeconomics 304306 catch share programs 285293 enforcement of policies 298301 Exclusive Economic Zones 296297 market solutions 280282 marketbased policies 283286 optimal outcomes 47 policy overview 282 301302 protected areas 297298 subsidies 294296 taxation 286287 trade 485486 transferable entitlements 322323 valuing the environment 89 water pollution 425 426427 food illegal activities 298299 325 labelling 41 land use 235 236 property rights 2829 water pollution 425427 see also agriculture fisheries Forest Stewardship Council FSC 263 forests 251252 harvesting decisions 252257 271272 inefficiencies 257261 262 policy 262268 poverty 261 sustainability 261263 valuing the environment 314315 see also deforestation fossil fuels security 152157 158 see also depletable resources natural gas oil fracking 147149 157 free riders 31 freerider effects climate change 403404 405 fuel compositions 385386 fuel economy standards European Union 383384 external benefits 385 other countries 385 United States 380383 see also mobilesource air pollution fuel taxes 381382 383384 387388 fund pollutants 334 336338 424 future visions of 1 499 507 challenges 912 499507 climate change 34 5 414417 overview of book 1213 selfextinction 13 912 societies response 67 water accessibility 45 see also generational context Gaia hypothesis 7 game theory climate change 402405 gas see natural gas Index 550 Gas Guzzler Tax 383 General Agreement on Tariffs and Trade GATT 485486 generational context environmental challenges 56 intertemporal allocation 127134 intertemporal externalities 478 intertemporal fairness 112115 pollution 336 sustainable development 476477 479480 see also future visions of population genetic diversity 30 Genuine Progress Indicator GPI 492 geoengineering 402 geographic context see spatial context Geographic Information Systems environmental justice 463 valuing the environment 9293 94 watershedbased trading 440441 Germany air pollution 363 energy efficiency 163 publicprivate partnerships case study 505 water pollution 441442 Gibbon Edward 12 global warming see climate change goods see ecosystem goods and services Gopher Tortoise Conservation Bank 327 government failure 3435 government intervention 3941 503 see also regulatory context grazing rights 245 Green Climate Fund 406 Green Paradox 137 greenhouse effect 34 400402 see also climate change gross domestic product GDP 490492 493 Gross National Happiness 493494 groundwater allocation 204205 pollution 422423 supply of 199 200 201 see also water growthdevelopment relationship 490492 504505 Gulf of Mexico oil spill 7374 447 habitats ecosystem goods and services 326327 trust funds 267268 see also biological diversity happiness economics 493494 495 harbor gangs 283 harm to environment allocation 135138 ecosystem goods and services 312 pollution 335 337339 valuation 7374 76 Hartwick Rule 115 harvesting see deforestation fisheries forests Haveman Robert 6465 66 hazardous pollution see pollution toxic substances health and safety see safety health impacts toxic substances 455 hedonic property value 8991 94 hedonic wage methods 8991 highgrading fishing 298299 historical context mobilesource air pollution 377 natural gas 146147 toxic substances siting 462463 water 205207 211 honeybee populations 312314 319 house prices environmental justice 464 houses energy efficiency 164 human behavior experimental economics 10 Human Development Index 493 humanenvironment relationship economics 1821 valuing human life 97102 see also tradeoffs Hungary water pollution 442 hydrologic cycle 198 198199 see also water Icelandic cod case study 299 illegal activities fishing 298299 harvesting 259260 poaching 325 impact analysis 20 55 60 68 income economics 4041 happiness economics 493494 495 sustainable development 491492 income elasticity of demand 150 income elasticity value of statistical life 102 individual fishing quotas IFQs 286288 individual transferable quotas ITQs 287291 292293 322323 individual vessel quotas IVQs 286 indivisibility economics 30 Induced Innovation hypothesis 483 industrial water uses 209210 information asymmetric 34 labelling 3941 occupational safety 459461 valuing the environment 79 infrastructure land use 237238 marketbased policies 246247 pollution 346 institutions ecosystem goods and services 316319 visions of the future 501504 instream flows 210 225226 insurance cars 391 392 insurance natural disasters 488 Index 551 intangible benefits benefitcost analysis 57 Integrated Pollution and Prevention Control IPPC 441 interactive resources fisheries 274 280 Intergovernmental Panel on Climate Change IPCC 400 Intergovernmental Platform on Biodiversity and Ecosystem Services IPBES 309 internalizing externalities 3839 International Commission for the Conservation of Atlantic Tunas ICCAT 300301 international cooperation environmental challenges 56 toxic substances 470472 intertemporal allocation 127134 intertemporal externalities 478 intertemporal fairness 112115 interviewer bias 80 invasive species 328329 Ireland plastic bag taxes 443 irrigation 209 211 236 ivory trade example 481482 Japan air pollution 365 aquaculture 294 justice environmental justice 462472 intertemporal fairness 112115 Kalundborg case study 505 Kenya solar energy 166167 Kuznets curve 483485 labelling products 3940 labor costs recyclable resources 175 land 233234 247248 allocation 234236 and car ownership 237238 377 inefficiencies 236243 marketbased policies 244247 watershedbased trading 440441 land trusts 246 latency 456 lead phaseout 379380 470 471 lead recycling 177 leapfrogging land 236238 leases water 220224 226 legislation see regulatory context liability efficiency 3639 oil spills 445446 toxic substances 462 Life Evaluation measures 495 logging see deforestation forests Lomborg Bjørn 11 longrun competitive equilibrium 24 Love Canal 453 454 Maine habor gangs 283 Regional Greenhouse Gas Initiative 349 Malthus Thomas 2 marginal control costs pollution 337 marginal cost curves 2930 marginal costs sustainable development 476477 490491 toxic substances 458459 water 216 217 219 water pollution 439440 marginal damage MD 459 marginal discovery costs 176177 marginal extraction costs 111 128 130 131133 146147 marginal net benefits depletable resources 132 inefficiencies 207 208 present value 109110 111 water 203204 211 marginal opportunity cost curve 46 marginal user costs allocation 110111 128129 transportation 376 water 205 marine protected areas MPAs 297298 marine reserves 297298 market context air pollution 364368 allocation 3134 110112 134138 dynamic efficiency 111112 fisheries 280282 283286 imperfect structures 3134 land 234236 240241 244247 pollution 338339 346 recyclables market imperfections 180190 recyclables markets 190192 sustainable development 477478 502 toxic substances 457462 see also valuing the environment market equilibrium capandtrade 345 fisheries 288 property rights 2324 market failure externalities 2526 government failure 35 trade 485 maximum sustainable yield 275280 282 284 Mayan society 3 meta analysis valuing the environment 9192 microgrids 166167 microwave oven rule 55 migration deforestation 258259 land use 235 Millennium Development Goals water pollution 444445 Millennium Ecosystem Assessment MA 308 315 minerals 171173 174177 minimum viable population 275 282 Index 552 mitigation strategies climate change 408413 414417 Mobile Area Water and Sewer System MAWSS 327 mobilesource air pollution 373375 alternative fuels and vehicles 385386 391 bike sharing problems 390 European Union policies 383385 externalities 375377 feebates 391 historical context of policies 377 other countries policies 385 parking cashouts 390 PayasYouDrive PAYD insurance 391 392 public transport 390391 retirement of older vehicles 391393 road pricing 387390 subsidies 375 United States policies 378383 models uses of 89 monopolies imperfect markets 3134 34 oil 148152 water 213 Montreal Protocol 406407 mortality risk valuation 98 Multilateral Fund 407 municipal water pricing 213219 treatment subsidies 434435 uses 209210 219220 myopia 135 Naess Arne 75 National Ambient Air Quality Standards NAAQS 358 national effluent standards 434 National Environmental Policy Act 1969 68 national parks paying for 318 319 valuing the environment 8788 nationally determined contributions NDCs 406 natural capital 115116 118 491492 natural disasters sustainable development 487489 natural equilibrium 274 natural gas 146149 natural resource curse 489 Natural Resources Damage Assessment NRDA 312 Nature Conservancy example 33 Nauru sustainable development 116 negative feedback loops 7 negligence 431 neighborhoods environmental justice 462472 net benefits fisheries 276 277 278279 285 forests 253 254256 262 microwave oven rule 55 pollution control 52 tradeoffs 46 47 4849 net domestic product NDP 490491 new scrap 180181 New Source Review NSR Program 358 359 NIMBYism Not in My Backyard 192 464 467 nitrogen pollution 437438 442 nonattainment regions 358 nonconsumptive use value 77 nonexcludability 30 nonexclusivity 28 nonpoint source pollution toxic substances 454 water 422423 429430 435436 nonrenewables see depletable resources nonuse values 75 7778 8384 87 92 9697 9899 normative economics 1920 4551 6869 North American Free Trade Agreement NAFTA 485 Nperiod constantcost case 128129 141 nuclear energy safety 158159 occupational safety see safety ocean dumping 431 ocean pollution 431432 ocean trash 432 offsetting carbon dioxide emissions 410412 offstream flows 210 oil energy resources 148152 security considerations 152157 158 oil spills harm to environment 312 toxic substances 461462 valuing the environment 7374 83 84 water pollution 422424 431 445446 OPEC 150152 openaccess resources see commonpool resources open systems 19 opportunity costs depletable resources 127130 132 ecosystem goods and services 317 319 fisheries 279 forests 254 256257 land 241 242243 scarcity rent 147 sustainability 110 tradeoffs 46 62 6364 water 205 optimality efficiency 4849 forests 255256 pollution 337338 339 see also efficiency optimization procedure costeffectiveness analysis 67 option value 77 ore depletion 176 organic foods labelling 3941 land use 236 Organic Foods Production Act OFPA 40 Index 553 output measures 490492 oxygen content of fuels 385386 ozonedepleting gases 406407 Pacific salmon fisheries 284 295296 Pareto efficiency 49 parking for free 237 375 390 partial values 94 9899 99 particulates ambient standards 361 see also air pollution passiveuse value 75 7778 8384 87 92 9697 9899 pay as you throw PAYT 183 PayasYouDrive PAYD insurance 391 392 pecuniary externalities 26 persistent bioaccumulative toxic PBT 469 persistent pollutants 425 petroleum see oil pharmaceutical industry forests 266 267 water pollution 425 plantation forests 262 plastic bag waste 188 443 poaching 325 point source pollution water 422423 428429 439440 polar bears value study 9899 policy see regulatory context pollination valuing the environment 312314 pollution efficiency 3639 externalities 26 338339 350 recyclable resources 192193 valuing the environment 7374 76 see also air pollution climate change mobilesource air pollution toxic substances water pollution pollution control 333 351352 cost effectiveness analysis 67 340346 355356 economics 20 efficient allocation 335338 Green Paradox 137 legislation 3940 market allocation 338339 policy 339351 taxonomy 334335 tradeoffs 5153 uniformly mixed fund pollutants 340346 visions of the future 503 pollution havens 482483 population fisheries 274275 selfextinction premise 12 500501 see also generational context Porter Induced Innovation hypothesis 483 positive economics 1920 positive feedback loops 67 potential reserves 124 poverty forests 261 land use 243 precautionary principle 328329 preferential use principle 208 present value benefitcost analysis 4950 5051 dynamic efficiency 109 forests 253254 262 271272 price controls natural gas 146147 price elasticity of demand 148 energy 149150 water pollution 436 water prices 219220 224 pricing carbon dioxide emissions 408413 volatility 412413 water 212228 see also benefitcost analysis costs primary benefits benefitcost analysis 56 prior appropriation doctrine 206 207 private discount rates 6366 privatization fisheries 294 295296 water 227228 228 producer surplus 22 24 33 product safety 461 profit maximization depletable resources 123 138 forests 258 261262 269 property rights allocation 135 developing countries 242243 economic approaches 2324 2730 3639 establishment of 244 exclusivity 2526 riparian rights 206 sustainable development 481 see also commonpool resources property taxes 239 247 Proposition 65 470 471 protected areas see also conservation protected areas fisheries 297298 public goods economics 3034 34 land 241242 245 support for environmental regulation 503507 see also commonpool resources public infrastructure see infrastructure public transport mobilesource air pollution 390391 quotas fishing 285293 race to the bottom pollution 482483 racial issues environmental justice 462472 radioactivity 158159 random utility methods 89 90 raw material subsidies 182183 Rawls John 112 real consumption per capita 491 Index 554 rebound effects 165 recreational value revealed preference methods 8991 recyclable resources 171 efficient allocation 173176 market imperfections 180190 markets for 190192 minerals 171173 174176 mitigating resource scarcity 176180 resource taxonomy 124126 wastewater 226227 Reducing Emissions from Deforestation and Forest Degradation REDD program 321 refundable deposits 185187 Regional Greenhouse Gas Initiative RGGI 347349 regulatory context air pollution 358363 364368 benefitcost analysis 5155 carbon dioxide emissions 5455 climate change mitigation 408413 414417 climate change negotiations 402406 costeffectiveness analysis 6667 dynamic efficiency 117 economics 3941 ecosystem goods and services 316319 forests 262268 impact analysis 68 land use 244247 microwave oven rule 55 mobilesource air pollution 377394 pollution control 51 5253 339351 private and social discount rates 65 public support 503507 recyclable resources 175176 toxic substances 455457 466472 trade agreements 485487 waste 183190 water pollution 427432 441444 see also under fisheries regulatory takings 240 Renewable Portfolio Standards RPS 161 renewable resources allocation 123124 129131 energy resources 159167 fisheries 274 280 forests 251252 resource taxonomy 126127 solar energy 166167 sustainable development 480 water scarcity 198202 wind power 160 rent see economic rent rent seeking 35 42 rental housing energy efficiency 164 reproductive health toxic substances 455 res nullius property resources 28 resource endowment 124 resources allocation 123124 134138 taxonomy 124127 visions of the future 2 500501 504505 see also depletable resources renewable resources return flows water pollution 432434 revealed preference methods 79 8991 316 revenue effect pollution 347 revenue stability water 217218 riparian rights 206 risk discount rates 62 private and social discount rates 6365 toxic substances 456457 458461 467 469 tradeoffs 5860 valuing human life 97102 riskneutrality 5960 road pricing 387390 Roman society 12 royalty payments forests 266 Safe Drinking Water Act 430431 safe harbor agreements 328 safety nuclear energy 158159 toxic substances 457461 valuing human life 9798 sales water 220224 see also market context salmon fisheries case study 284 295296 scale pollution 334 scarcity recyclable resources 176180 193 water 198202 scarcity rent 2425 2829 176 scrap disposal costs 180182 as recyclable resource 171173 174176 scrubbers 366 sea scallop case study 290291 sea urchin case study 298 seasonality water prices 216 221 Second Equimarginal Principle 67 secondary benefits benefitcost analysis 56 selfextinction premise 13 1012 500501 sensitive receptors 338 services see ecosystem goods and services shrimp farming example 27 Simon Julian 179180 Singapore mobilesource air pollution 388 389 smog ambient standards 361 social costs carbon dioxide emissions 5455 57 discount rates 62 transportation 376 social discount rates 6366 society consumer preferences 507 response to environmental challenges 610 selfextinction premise 13 1012 support for environmental regulation 503507 solar energy 166167 Index 555 South Africa water markets 223224 spatial context carbon dioxide emissions 57 environmental justice 462472 see also Geographic Information Systems land sprawl land use 236238 standards in pollution control see ambient standards state implementation plan SIP 358 stated preference methods 7879 315316 stateproperty regimes 2728 static efficiency 3133 consumer surplus 2122 fisheries 276277 278280 imperfect markets 3134 tradeoffs 48 steel industry example 2526 3639 stock pollutants 334 335336 339 425427 strategic petroleum reserve SPR 156 strong sustainability 116 118 stumpage value 259 subsidies fisheries 294296 mobilesource air pollution 375 public transport 390391 raw materials 182183 recyclable resources 188189 water treatment 434435 substitutes allocation 129131 141143 recyclable resources 178190 sulfur dioxide emissions 365368 supply and demand allocation 111 127 energy 154 recyclable resources 174 surface water allocation 202204 pollution 422 supply of 199 200 see also water survey approach benefitcost analysis 58 sustainability ecotourism 324 forests 261263 visions of the future 501503 sustainable development 475477 494496 allocation 115116 117118 477478 alternative measures 492494 495 dynamic efficiency 107108 114117 efficiency 478480 growthdevelopment relationship 490492 natural disasters 487489 natural resource curse 489 trade 480487 visions of the future 504507 sustainable yield fisheries 275 275280 Swedish nitrogen oxide charge 348 takeback principle 189 see also recyclable resources tangible benefits benefitcost analysis 5657 taxation carbon dioxide emissions 408413 electric vehicles 391 fisheries 286287 fuel 381382 383384 387388 Gas Guzzler Tax 383 land use 239 245246 247 recyclable resources 188189 technological progress air pollution 363 369370 depletable resources 126 extraction 133134 fisheries 285 287 fracking 147149 pollution control 343344 recyclable resources 176178 temporal context air pollution 36361362 allocation 128133 141143 benefitcost analysis 4950 5051 carbon dioxide mitigation 414417 discount rates 6263 intertemporal allocation 127134 intertemporal externalities 478 intertemporal fairness 112114 revealed preference methods 89 9091 see also generational context territorial use rights fisheries TURFs 286 291293 296297 thermal pollution 424 thermodynamic laws 19 third parties toxic substances 461462 threshold concept air pollution 360 timber resources 252 see also forests time see temporal context tipping points 404 toll roads 388 390 total allowable catch TAC 291 Total Maximum Daily Load TMDL program 430 total willingness to pay 22 7778 see also willingness to pay tourism 317 323326 Toxic Release Inventory TRI 463 469 toxic substances 453454 472473 environmental justice 462472 health effects 455 market allocation 457462 nature of pollution 454 policy 455457 466472 toxicity 454 456 tradable entitlement systems 319323 trade sustainable development 480487 tradeoffs benefitcost analysis 46 4950 5051 carbon dioxide emissions 5455 costeffectiveness analysis 6667 discount rates 6063 distribution 60 dynamic efficiency 51 efficiency 4849 estimation issues 5658 impact analysis 68 normative criteria 4551 6869 optimal outcomes 4749 pollution control 5153 private and social discount rates 6366 risk 5860 see also valuing the environment Index 556 traffic volumes 375 376377 388391 tragedy of the commons 2830 274 transaction costs efficiency 39 water pollution 435436 transboundary waste 471472 transferability property rights 23 transferable development rights TDR 244 transferable entitlements 322323 transportation externalities 375377 land use 237238 mobilesource air pollution 373375 public transport 390391 subsidies 375 see also cars travelcost methods 89 9091 tropospheric ozone depletion 407 Trump Donald President 55 trusts land 246 265 267268 twoperiod model 108112 127128 uncertainty climate change 399 414415 pollution control 350351 toxic substances 456457 uniformity air pollution 361 uniformly mixed fund pollutants 340346 United Nations Development Program UNDP 493 United Nations Framework Convention on Climate Change UNFCCC 406 United States air pollution 5253 357 358 360361 363 364 catch share programs 291 292 discount rates 61 63 energy 146 149 151 155 158160 162 labelling products 40 minerals 171175 mobilesource air pollution 373374 378383 national parks 8788 property rights 2829 recycling 184185 186188 190191 toxic substances 453 456457 462472 466467 value of statistical life 101102 water markets 220 223 water pollution 427432 432437 water scarcity 199202 USDA National Organic Program 40 use value 77 usufructuary rights 206 value of statistical life VSL 98 101102 valuing the environment 7374 102 benefit transfer and meta analysis 9192 challenges 9397 choice experiments 79 8388 contingent valuation methods 7983 ecosystem goods and services 307308 309316 Geographic Information Systems 9293 94 human life 97102 land use 238239 methods overview 7577 78 reasons for 7475 revealed preference methods 8991 stated preference methods 7879 types of value 7778 water 210211 vehicles see cars mobilesource air pollution public transport transportation veil of ignorance 112 Virgin Islands coral reefs 311 visualizations Geographic Information Systems 94 Volkswagen case study 378379 wages hedonic wage methods 8991 see also income waste disposal costs 173174 180182 humanenvironment relationship 19 legislation 183190 ocean pollution 431432 optimal outcomes 48 plastic bags 188 443 water contamination 422424 water treatment 435 see also recyclable resources toxic substances Waste Electrical and Electronic Equipment WEEE waste 189 190192 472 wastewater recycling 226227 wastewater treatment 434435 461462 see also water pollution water 197198 228229 allocation 202212 ecosystem goods and services 318 319 efficiency 202205 207212 hydrologic cycle 198199 pricing 212228 scarcity potential 198202 water accessibility as challenge 4 and climate change 5 conservation 217218 220221 valuing the environment 95 Water Framework Directive 442 water pollution 421 449 atmospheric deposition 441 developing countries 443445 efficiency and costeffectiveness 432 435436 446448 European context 441442 nature of problems 422427 nonpoint source 422423 429430 435436 oil spills 423424 431 445446 point source 422423 428429 439440 policy 427432 standards 433434 435 subsidies for treatment 434435 United States 427432 434435 watershedbased trading 436441 Index 557 Water Pollution Control Act 428 water quality 200202 toxic substances 470 watershedbased trading 440441 see also water pollution Water Quality Act 428 watershed payment programs 318 watershedbased trading 436441 weak sustainability 116 117118 welfare measures 490492 wet deposition 441 wetlands banking 320 whaling 322323 willingness to accept comparison to willingness to pay 8182 toxic substances 469 valuing the environment 80 8182 willingness to pay 22 choice experiments 85 comparison to willingness to accept 8182 contingent valuation 7981 84 ecosystem goods and services 309 human life 100 land 234235 location 9697 national parks example 8788 producers and consumers 22 revealed preference methods 89 stated preference methods 7879 types of value 7778 wind power 160 see also renewable resources with and without principle 56 wood resources 252 see also forests World Heritage Convention 265266 World Trade Organization WTO 485486 Yasuni National Park case study 318 zero emission vehicle ZEV 386 zerodischarge goals water 434 Zimbabwe wildlife protection case study 325 zoning fisheries 291293 296297 land use 238 244245 road pricing 388390 Taylor Francis eBooks wwwtaylorfranciscom A single destination for eBooks from Taylor Francis with increased functionality and an improved user experience to meet the needs of our customers 90000 eBooks of awardwinning academic content in Humanities Social Science Science Technology Engineering and Medical written by a global network of editors and authors TAYLOR FRANCIS EBOOKS OFFERS A streamlined experience for our library customers A single point of discovery for all of our eBook content Improved search and discovery of content at both book and chapter level REQUEST A FREE TRIAL supporttaylorfranciscom Taylor Francis Group Taylor Francis Group Taylor Francis Group Routledge ROUTLEDGE as informa business CRC Press CRC