Section One This first section contains two introductory chapters. The first chapter ilustrates how economics can be used to address environmental problems. The role of incentives is emphasized. Trade-offs between economic growth and the environ- ment are explored, and the concept of a sustainable economy is introduced. The second chapter defines a number of environmental terms used throughout the book and provides a picture of the state of Canada's environment.yee! ideas of economics. You may have thoughe that econ e most. {f shout business decisions and how to make profite irae talist system. This is not the case. Economies is, rather, the study of how and why people—whether they are sboarmets, firms, non-profit organizations, or governmere agencies—make decisions qpout the use of valuable resources: It is divided Ince ‘microeconomics, the study of the behaviour of individuals or small groupe and macroeconomics, the study of the ero fconomles as a whole, Environmental economic, erace Environmental economios makes use of many familiar concepts in economies What is different about mics compared to other economic sub. Kets is the foous on how economle activities alfeer on natural environment—the soaatehere, water, land, and an enormous variety of living species. Economic deci sions made by people, firms, and governments can have deleterious effects on the nat. are euvionment. The dumping of waste products into ee hatural environment Why doce enum and degrades ecosystems. It leads to a non-astinal ee ot Fesources, SLY does this occur in economie systems? Why doa People take into account the ctlcts of their economic activity on the naturel come ooe Environmental eco. Investganatmines these questions. Equally es important, omironn cont ‘economies {RYsetldates and assesses diferent methods of reaching @ se ly optimal use of all resources, including environmental ones 1y remains the cen. tal economists alsoperspec is is not chey are ecisions study of y of the s draws amental issue of portunity canding nic sub- at—the ic deci- che nat- unt the al eco. eof all ped. As ade-offs he cen 5 also examine other eriteria for choosing among alternative policies that attempt to improve the environment—for example, equity or fairness. If economic efficiency cannot be obtained, and environmental targets are established using other criteria, an economic approach can greatly assist decision makers in reaching whatever target is set ‘The objective of this chapter is to aoquaint you with some of the basic ideas and analytical tools of microeconomics that are used in environmental economics. We will illustraté how environmental economics helps answer important questions about our environment and economy with a real-world example. We first consider briefly what we mean by the “economic approach,” then turn to an example—motor vehicle pol- lution, Although this text does not use many macroeconomics tools, we introduce in this first section another example of a key question economists have examined—does economic growth necessarily lead to worsening environmental quality over time? In Chapter 2 we will take a look at the broad linkages existing between economy and environment and define a number of important pollution terms. After that we will be ready to study the economic principles we will need. The Economic Approach Why do people behave in ways that cause environmental destruction? There are sev- eral types of answers to this question. One goes like this: Environmental degradation comes about from human behaviour that is unethical or immoral. Thus, for example, the reason people pollute is because they lack the moral and ethical strength to refrain from the type of behaviour that causes environmental degradation. If this is true, then. the way to get people to stop polluting is somehow to increase the general level of envi- ronmental morality in the society. In fact, the environmental movement has led {great many people to foous on questions of environmental ethics, exploring the moral dimensions of human impacts on the natural environment. These moral questions are obviously of fundamental concern to any civilized society. Certainly one of the main reasons environmental issues have been put on the front burner of social concern 1s the sense of moral responsibility that has led people to take their concems into the political arena. But there are problems with relying on moral reawakening as our main approach to combating pollution. People don’t necessarily have readily available moral buttons to push, and environmental problems are too important to wait for @ long process of moral rebuilding, Nor does a sense of moral outrage by itself help us make decisions about all the other social issues that also have ethical dimensions: poverty, housing, health care, education, crime, and so on. In a world of competing objectives we have to worry about very practical questions: are we targeting the right environmental objectives; can we really enforce certain policies; are we getting the most impact for ‘our money; and so on. But the biggest problem with basing our approach to pollution, control strictly on the moral argument is the basic assumption that people pollute because they are somehow morally underdeveloped. It is not moral underdevelopment that leads to environmental destruction; rather, it is the way we have arranged the economic system within which people go about the job of making their livings. So, a second way of approaching the question of why people pollute is to look at the way the economy and its institutions are set up, and how they lead people to make decisions that result in environmental destruction. Economists believe thatPeople pollute because it is the cheapest way they have of solv. Ing @ certain very practical problem: how to dispose of the waste ‘products remaining after production and consumption of a good. People make these decisions on production, consumption, and disposal within a certain set of economic and social institutions’; these institutions structure the incen- tives that lead people to make decisions in one direction and not in another. An incen- tve is something that attracts or repels people and leads them to mo behaviour in some way. An “economic incentive” is something in the economic that leads people to channel their efforts at production and consumption in certain directions. Economic incentives are often viewed as consisting of payoffs in terms of material wealth; people have an incentive to behave in ways that provide them with \ereased wealth. But there are also non-material incentives that lead people to mod- lty their economic behaviour; for example, self-esteem, the desire to preserve a beau- ful visual environment, or the desire to set a good example for others. What we will study is how incentive processes work, and how to restructure them so that people will be led to make decisions and devel- op lifestyles that have more benign environmental implications. One simplistic incentive-type statement that you often hear is that pollution is a result of the profit motive, According to this view, in private-enterprise economies of industrialized nations people are rewarded for maximizing profits, the difference between the value of what is produced and the value of what is used up in the pro: duction process. Furthermore, the thinking goes, the profits that entrepreneurs try to maximize are strietly monetary profits. In this headlong pursuit of monetary protits, entrepreneurs give no thought to the environmental impacts of their actions because it “doesn't pay.” Thus, in this uncontrolled striving for monetary profits, the only way to reduce environmental pollution is to weaken the strength of the profit motive. But this proposition doesn’t stand up to analysis. It is not only “profit-motivated” corporations that cause pollution; individual consumers are also guilty when they do things like pour paint thinner down the drain or let thelr ears get seriously out of tune. Since individuals don’t keep profit-and-loss statements, it oan’t be profits per se that lead people to pollute. The same can be sald of government agencies, which heave sometimes been serious polluters even though they are not profit-motivated, But the most persuasive argument against the view that the search for profits oauses pollution comes from recent political events in Eastern Europe and the former USSR. With the collapse of these ex-Communist regimes, we have become aware of the enormous environmental destruction that has occurred in some of these reglons—heavily pol- Juted air and water resources in many areas, with major impacts on human health and ecological systems. Many of these problems exceed some of the worst cases of e: ronmental pollution experienced in market-driven countries. But they have happened in an eoonomie system where the profit motive has been entirely lacking. Which means, quite simply, that the profit motive in itself is not the main cause of environ mental destruction, * By ‘tnstaons” we mean the ncaa eof publ and pate organizaos, vs, ard paces at soci) uses wesc is ecanomic acy, rts ae an exon ison fr exam a ar capoaons, ody of comme an, publ pecs. mda0en° 1 within a he incen ‘An incen ify cheir nie world n certain terms of hem with e to mod- re a beau- at we will d devel- tion is a nomies of difference » the pro urs try to Fy proilts, s because only way tivated” n they do st of rune er se that hich have d, But the pollution With che avily pol- realth and es of envi- happened 3g, Which # environ sesio sive ble erie, In the sections and chapters that follow, incentives will play a major role in the analysis of how coonomie systems operate. Any system will produce destructive envi- ronmental impacts if the incentives within the system are not structured to avoid them, We have to look more deeply into any economic system to understand how its ineen- tive systems work and how they may be changed so that we can have a reasonably pro- gressive economy without disastrous environmental side effects, Two concepts thet are Important to an understanding of the Incentives that exist regarding the environment are axtora! affects (also called exteralies) and property rights, These concepts are explained in detail in later chapters, but essentially they involve the question of a lack of ownership of environmental resources. A fundamental point is that ick of ownership rights to environmental resources means that fare are few incentives to take the environmental consequences ‘our actions into account. This point leads to some thought-provoking questions: If no one owns the atmos- phere, how can its waste-disposal services be priced? How ean anyone who does value clean air prevent others from discharging their waste products freely? A Practical Illustration: Smog and Motor Vehicles Canada: meee geal Each year in Canada, automobiles discharge approximately 11 peroent of Canada’s total carbon dioxide emissions, 17 percent of nitrogen oxides, 20 percent of volatile organic compounds, and 47 percent of carbon monoxide? These compounds con- tribute to urban smog, acid precipitation, and global warming, In turn, these environ- mental conditions adversely affect the health of people and our ecosystem, the survival of many species, the cost of producing goods and services, and our overall enjoyment of our surroundings. Environment Cenada’ estimates that 6,000 Canadians die prematurely each year due to air pollutiori, while tens of thousands more suffer from bronchitis exacerbated by pollution. Exposure to urban smog may increase the likelihood of cancers in children by up to 25 percent and raise the chance of getting childhood asthma by 400 percent, Acid precipitation changes aquatic and land-based ecosystems, killing fish, amphibians, and other aquatic species and affecting forest growth. Global warming, while a controversial topic, could lead to massive ecosystem changes with worldwide impact. Motor vehicle use contributes to congestion on our roads. Congestion increases driving times, promotes accidents, and generally makes people very crabby, contributing to “road rage.” Driving one’s car or truck thus affects all sorts of other people (whether they too drive @ motor vehicle or not) and our environment. This is an external effect. When you drive to school or work or to the beach, you get the direct benefit of transporta- tion services. Others—bystanders—receive the negative Impacts of your driving: alr pollution, congestion, and associated impacts, The bystanders don't control your dri ing, And the price you pay for driving your oar, your direot oosts in the form of gaso- line, maintenance, and monthly car payments, do not reflect the negative impacts you impose on others—hence the words externality or external effects to describe this sit- 2 See Envtonment anata (1958) “Caran Passenger Tensporaion” Sal ftw Environment Buln Wo, 885, Song 1958 wre cals SBS ep erent Cara's Wed ste (wv) hen goto Al Quality page ofr abo he inact gallon orAlrCare: ‘weewealroare.ce! uation. We will examine in detail in Section 4 what sorts of initiatives, both individual and with the help of government, can be used to address externalities. For now, let's think a bit more about motor vehicle externalities and what can be done about them. To do so, we look at the concept of incentives. Incentives: Households and Vehicle Use When you drive your car, sport-utlity vehicle (SUV), or truck, the price you pay per Kilometre travelled reflects your private eosts—gasoline, oil, insurance, and so on, These Prices do not take into account the damage the emissions from your car impose on others and the environment; rather, they reflect costs of producing gasoline, retailer markups, and so on. You will respond to changes in these private costs, for example, by driving more when gasoline prices fall and less when they rise. What sort of posi. tive ineentive could we contemplate that would induce drivers to reduce the number of emissions they release? A simple relationship may help us see where incentives could enter. Total quantity of emissions = Number of vehicles x Average Allometres travelled * Emissions per kilometre Incentives oan target the number of vehicles on the road, the average number of Kilometres travelled, and emissions per kilometre. In addition, we might want to con- sider where people drive their vehicles, A car driven in downtown Toronto, Montreal, or Vancouver will have a larger impact on urban smog than that same vehicle being driven in Moose Jaw, Saskatchewan. The release of carbon dioxide will, however, eon- tribute to global warming regardless of where the vehicle is driven. What are some possible incentives to alter people's behaviour? In greater Vancouver, all ears, SUVS, and light trucks must pass an AirCare test once every «wo years. This test checks to see that motor Vehicle exhaust is not emitting more pollu. tants than consistent with government standards. The policy goal is to create an incentive for vehicle owners to regularly service and maintain their vehicles and thereby reduce emissions per kilometre, How would we influence the number of kilo- metres travelled? The economic answer is to increase the cost of driving per kilome- tre. This provides an incentive for people every time they drive their vehicle to minimize the number of trips, thereby reduoing their direct costs. An example of @ direct incentive to increase costs of driving is to tax people on the number of kilome- tes travelled, This could be done using @ tax that is payable annually as people renew their vehicle licence. An indirect incentive Is to tax gasoline, thereby inoreasitig the costs of driving, How would we influence the number of vehicles on the road? This could be done with an annua) tax on vehiéle ownership or a buyback program that ays people to retire their older vehicles. Old vehicles contribute far more per kilo- metre travelled to air emissions than do newer, more fuel-efficient and less pollution- Intensive vehicles. We might also want to think about other incentives that might change behaviour. These could include advertising and education programs that Inform people about how their driving decisions affect air quality and, hence, their Well-being, Are there others? : Incentives for Businesses Incentives can also apply to businesses. Think about the producers of motor vehicles and vehicle parts, All industrial firms work wichin a given set of incentives: to increase rofits if they are firms in market economies. Firms have an incentive to take advan.ndividual now, let's out them, u pay per on. These mpose on e, retailer example, 1 of posi number umber of nt to con- Montreal, cle being ever, con. » greater ore pollu- create an jeles and of kilo- © kilome- ehicle to mple of a f kilome- ple renew asing the ad? This ram that per kilo- ollution- at might ams that ee, their ‘vehicles ce advan- ant Satural Resources “anada Motor ‘hice Fuel ficiency seplloce nrcan. Sofenglsiy wrosremsl Sotorvehicles Perens tage of whatever factors are avalable to better thelr performance in terms of these or taxa One way they have been able to do this historically is to use the services of the Environment for waste disposal, Thé motivation for this practice is that these services have essentially been free, and by using free inputs as much as possible a firm obviously ‘can inerease its profits. The challenge is to find incentives to alter flrms behaviour 50 they treat environmental services as a costly activity rather than a free good. One policy approach is to introduce and then try to enforce laws or regulations that direst the amount of pollution a firm can emit. Canada has company average fuel consumption (CAFC) standards for all new cars and light trucks produced in Canada Vehiole manufacturers have agreed to design their cars and light trucks to meet a tar fet level of gasoline consumption averaged over their entire leet of vehicles produced Bach year. Standards were introduced for cars in 1978 at 19.1 litres per 100 kdlome- (res, chen were tightened to 6.6 litres per 100 kilometres in 1986, where they remain today.* Standards for light trucks were not Introduced until 1990 (at 10 litres per 100 ilometres) and are slated to require greater fuel eificiency over the coming years, Fuel efficiency of all ears on the road has increased from approximately 15 litres per 100 kilometres in 1965 to 8 L/100 km in the late 1990s. ‘The CAFC standards are voluntary, not compulsory. Vehicle manufacturers meet the standards because the United States has the same policy and it is compulsory in that country. The North American automobile industry is completely integrated—cars and light trucks produced in Canada are exported to the United States and vice versa Canadian cars that do not meet the U.S. fuel efficiency standards cannot be sold there ‘There is a clear profit incentive for Canadian manufacgurers to comply with the volun tary standard, Note that CAFC standards require the auto manufacturer to meet the standard on average across all its ears or trucks produced each year. If automakers pro- duce ¢ lot of low-polluting cars, they will more readily meet the target than if they pro- duce high-polluting vehicles such as SUVs. The regulations thus provide an incentive for manufacturers to alter the mix of vehicles produced to reduce the emissions that ‘will ultimately come when drivers purchase and use the vehicles. Canadian govern- ments also regulate the sulphur content of gasoline. The regulations speclty that oll fefiners must produce gasoline containing no more than 150 parts per million (ppm) of Sulphur by the year 2002 and 30 ppm by 2003. Sulphur in gasoline, when combusted, produces sulphur dioxide, a contributor to smog and acid precipitation. The inoentive ttiect here is this: abide by the regulation or you will be fined by the government. ‘A more effective poticy might be to design a system that takes advantage of firms’ normal monetary incentives in such a way as to lead them to pollute less. For exam- ple, oll refiners could be taxed on the basis ofthe sulphur content of their gasoline pro- Guced. This may induce them to switch their production to lower-sulphur fuels so as to avoid the tax. They might increase the proportion of methanol derived from grains in their fuels, Methanol does not contain any sulphur, Gasoline prices are likely to rise, then providing an additional incentive to drivers to reduce their consumption of gaso- line. The essence of the economic incentives approach is to restructure the incentives facing firms and consumers in such a way that it mobilizes their own energy and inge- nuity to find ways of reducing their impacts on the environment. 4 These ae pogoals orate be anda lox casa ight ues war singtnt Incentives in the Pollution-Control Industry The pollution-control industry develops waste recycling techniques, pollution-contrs equipment, and pollution-monitoring technology. It sometimes handles and treo Waste produets, and is often involved in managing waste-disposal sites. It also inclede: firms that develop new environmentally friendly products like low-sulphur gesoline low-phosphate detergents, and rec Pollution-control industry is obviously needed If we are to come to grips effe ail of our present and prospective environmental problems. Thus, one of the soar things environmental economists must study is the incentives facing this industry what causes it to grow or decline, how quickly or slowly it responds to new needs, and ‘0 on. In our example of air pollution from motor vehiclés, the pollution-control indus try could include manufacturers of zero-emission vehicles. These vehicles might rum on fuel cells, on electricity, or use other technologies. Are policies needed to encou: age these industries? One might argue that the existence of Policies that provide incentives to reduce air emissions will be enough to stimulate the development of alternative fuels or engines. However, various governments have also subsidized the research and development costs for these manufacturers either through tax incentives or outright grants of funds. The rationale is that the development of the new tech- nologies will have broad-reaching social benefits, This case illustrates the sort of “economic” thinking that we will be applying to environmental problems. As you proceed through the chapters, you will learn a vart- ety of techniques that will help in this quest for a better environment. Before pro. ceeding, we examine a number of other concepts that are vital to understanding why environmental problems exist and persist. Externalities and Property Rights In Section 4, we will examine the role of property rights in reaching a svcally efficient {eve of poluion. Property rights—or the lack thereof—are crucial in understanding why wwe have today’s environmental problems. The basic point is that environmental resources generally do not have well-defined property rights, No one owns the atmos= phere, our oceans, or large underground aquifers. Two examples illustrate how exter, nalities are connected to property rights Auto emissions. When an SUV releases sulphur dioxide into the atmosphere, you cannot jump out in front of the vehicle and shout “Stop! You are polluting my airl"We all breathe the same air in our communities. For externalities that Involve many different ‘sources of pollution, perhaps spread over large areas, there is no effective way to reach any sort of private agreement to limit the ‘emissions. Designing environmental policy is more challenging the more pervasive the externality is across regions or countries 1d for different sources, Dog waste. You detect your neighbour's dog leaving its waste products on your lawn. This too is an externality. The dog and its owner do not take into account the Impact dog waste Is having on your lawn when they go about their activities. Contrary to thecontro | treats roludes ssoline, with - major ds, and indus- ht run neour- rovide ent of ed the entives / tech fing to a vari- e pro- why “ease of automobile emissions, you and your neighbour would Hite" find It relatively easy to negotiate a mutually agroeable resolution HG -to this problem. The neighbour might agree to keep the dog on a “Teash or to pick up its waste. You may bulld a fence, or get the inelghbour to pay for it, The dog externality is internalized through - A solution that is mutually agreeable to both parties can be worked out; the only difference In possible ‘outcomes Is who pays for them. That is a function of our bargain- ‘ing strengths and other factors. ‘Why is the dog case different from the auto emissions case? You own your property land the dog is essentially trespassing. Laws say you oan keep others off your property. ‘There is also just one other person to bargain with—the dog owner. This case could be more like urban smog if you don't know whose dog is dumping on your lawn, Then you ‘must incur search costs, set up dog surveillance, and so on to detect the perpetrator. Our most serious environmental problems are closer to the vehicle smog case than the case of the wandering dog. They involve lots of possible polluters, with per- hhaps very little knowledge about even the source of emissions or the link between emissions and environmental impact, Soclety members may not recognize that an activity they have been doing for years has a deleterious impact on the environment. For example, manufacturers of leather products in eastern Canada used to use mer- cury in the tanning process. They would simply dump their wastes in streams or on the ground, Over the years, the mercury percolated into groundwater and contami- nated people's drinking water. But people didn't know at the time how toxie mercury is, The tanners themselves suffered from mercury poisoning. This is where the term “mad as a hatter” emerged—mercury poisoning affects brain function. The leather manufacturers are now gone, but mercury stil remains a dangerous pollutant in our ecosystem. How can today’s population engage in any sort of negotiation with the leather producers of 100 years ago to reach a mutually agreeable level of waste dis- posal and compensation for disease, shorter lifespans, and contaminated water and Solls? This example illustrates the difficulties inherent in depending on individuals who act in their own self-interest to reach a socially efficient outcome. Information about potential problems may be imperfect or non-existent. People today cannot be counted on to make decisions that maximize the well-being of generations who follow. ‘When these conditions exist, some form of government intervention Is necessary. Benefit-Cost Analysis In cost-effective analysis, economists are concerned only with the costs of achieving some stated environmental goal, In benefit-cost analysis, both benefits and costs of @ policy or program are measured and expressed in comparable terms. Benefit-cost analysis is the main analytical tool used by economists to evaluate environmental decisions. It was first used in the United States early in the 20th cen- tury to evaluate water-development projects of the U.S. Army Corps of Engineers. In Canada, it is used throughout the public sector—but less so today than in the 1970s, when the technique was often misused to justify large “mega” projects involving nat tural resource use. Benefit-cost analysis can be used as an aid in selecting efficientpolicies, but it can also be used by agencies to Justify what they want to do. As well, officials may use it to try to stop new regulations or weaken old ones. It is such an important and widely used approach that we will devote several chapters to it later In this book (see Chapters 6, 7, and 8). In this type of analysis, as the name implies, the benefits of some proposed action are estirated and compared with the total casts that society would bear if that action were undertaken. If it is a proposal for a public park, for example, the benefits in terms of recreational experiences provided by the park are compared with the expected costs of bullding the park and of using the land in this way rather than in some other way. Or, a proposal to build a solid-waste incinerator ‘would compare the costs of building and operating the incinerator, including the costs, of disposing of the remaining ash and the costs of possible airbomne emissions, with benefits such as reducing the use of landfills for the solid waste ‘The benefit-cost approach implies that we need to consider both the benefits and the costs of environmental programs and policies. This often puts benefit-cost studies squarely in the middle of politcal controversy on many environmental issues. In the political strugales that characterize many environmental problems, groups on one side consist of people whose major concer is with the benefits, while groups on the other side are primarily concerned with costs. The ultimate long-run acceptance of pro: grams to protect the environment depends on people coming to realize that they are worth the cost. The benefit-cost, trade-off type of approach is the best way to accom- plish this. Sustainability of Our Environment and Economy Basic Issues Economists are becoming increasingly aware of the need to link more closely the economy with the natural environment. While the natural environment has always been treated as an essential input into production, few models looked explicitly at the interaction between ecological systems and the economy. A new field called esolagical ‘economics examines these interactions more fully. An important objective of this field is to search for sustainable paths of economic development—actions that do not destroy ecological systems, but allow for increases in real incomes. This field is devel oping, and new insights are occurring all the time. The essential idea is that a sus- {ainable economy is one that has the ability to allow people's well-being to either rise Over thme or at least remain constant (1.e., not fall), To accomplish this, a number of economists argue that current generations cannot “ase up" 20 much of the existing Stocks of natural and environmental resources that future generations will be impov- trished or non-existent, We must examine our economic activities with regard to the carrying capacity of our ecosystem, All economies use natural and environmental resources to sustain life. Rising world population puts increasing pressure on our natural endowments all the time, Many fear that our current path of production and population growth is not sustain- able, What can be done? One possible approach is to argue that each generation ina sustainable economy has the obligation to replace what it uses with investment in social capltel. This is x very broad definition of “capltal.” It includes everything the economy can invest in—physical capital to produce goods and services, education, infrastructure, renewable and non-renewable natural resources, and, of course, theenvironment itself as a stock of capital. When we use up some of our existing capital, the only way the economy can be sustainable over time is to reinvest to keep the social capital stock at least constant, Pollution control and treatment is a means of keeping the environmental capital stock constant. So is reoyoling to some degree. Whether sustainably is achievable depends on the actions of people, industries, and governments, Some questions to contemplate: Will private markets keep the stock of sooial capital constant? Is government intervention necessary? If so, in what form? Sustainability also depends on the degree of substitutability among natural capl- tal (che environment and naturel resources), prodused capital, and labour, Technology and technological change is another vital element in the search for sustainable paths, ‘Technology will influence the degree of substitution among factor inputs and affect the amount of inputs needed to produce a unit of output. Some technologies may promote sustainability, thers not. Economists play important roles in helping to find answers to all these questions, by building models that explicitly incorporate the role of the natural environment and by examining these issues empirically. To recap: A sustainable economy is one in which investment in social cap- ital allows the economy to grow so that people are at least as well off in the future as they are in the present, while sustaining the health of ecological systems. Trade-offs and Sustainability Economists illustrate the trade-offs between output of goods and services and envi ronmental quality by using a production possibility trontier (PPF). A PPF is a way of dia- grammatically depicting the choice faced by a group of people between two desirable Sutcomes—ousput of goods and services and environmental quality. The basic rela tionship is shown in Figure 1-1. The vertical axis has an index of the aggregate eco- nomic output of an economy, the total market value of conventional economie goods sold in the economy in a year. The horizontal axis has an index of environmencal quality, derived from data on different dimensions of the ambient environment; for ‘example, concentrations of airborne pollutants and water-quality data, The curved relationship shows the different combinations of these two outcomes—marketed out- put and environmental quality—that are available to a group of people who have a fixed endowment of resources with which to work, The PPF is shown with a dashed line from an environmental quality below @. Below @, the economy cannot produce any additional geods and services because there are too few environmental resources to sustain production. Ey,,y shows the maximum amount of environmental quality if there is no goods production at all (presumably meaning no human population). The production possibility frontier is determined by the technical capacities in the economy together with the ecological facts—meteorology, hydrology, and so on— of the natural system in which the country is situated, It says, for example, that if the current level of economic output is oj; we can obtain an increase to ¢, only at the cost of a decrease in environmental quality from e, to ¢>. But while the PPF itself is a tech- nical constraint, where a society chooses to locate itself on its PPF is a matter of social choice. And this depends on the relative values that people in that society place on conventional economic output and environmental quality. Economists illustrate social choices with a relationship called a social or community Indifference curve (CIC). Community indifference curves are shown for country A on Figure 1-1, Each point on a CIC shows combinations of environmental quality and goods perceived by society toEnvironmental quality The PPF lusts possible trace-offs between goods produced in tha market and envionment! quality. Asso ty consumas mare goods ges up environmental quality. Below 2 no goods can be produce because env | fonmentl cualy Is too low to sustain producto. Communty narence curves (Cts) indicate a county's oie ofthe mix of goods and ervironmental qual. Country A choosas more gocds less envronmentl quality than country 8, | provide a given level of well being. CICs that lie farther from the origin yield higher levels of well-being than those eloser to the origin. Societies will seek the highest level of well-being that they can attain. This will be where the CIC is tangent to the PPF. For country A, this is CIC,, tangent at point A, with e, environmental quality and c, goods. Another country might have a different set of social preferences that lead to choosing different bundles of environmental quality and goods; for example, at point B, with ¢, and e, being chosen. The choices made by soolety will affect the sustainability of the economy and environment The Environment and Growth: Sustainability over Time Sustainability isn’t just about choice in a given year, but what happens to the econo. my and environment over time. The PPF will not remain in the same Place, as condi tions such as production technology and environmental degradation change over time We illustrate two possibilities. Figure 1-2 shows the possible trade-ofis facing society {n 50 years. Panel (a) presents a pessimistic scenario. Suppose we have depleted large Stocks of natural resources and have not been able to substitute human and physical capital for them. A significant drawing down of environmental capital may have seri. ous negative effects on the ability of the economic system to sustain itself. Or, pollu. tion is so high that it causes irreversible damage, or pollutants are very long-lived and affect future generations. These outcomes may be the result of having chosen to be at‘uso as go wea Aen ues soa pue s9000 o vondunsuoa mo swuweoprep e}oo}ouNDao}anG INO UNS few 4d aL 2ASUARdO ‘uous (@) veg “supop isn avo % pue 2 wea Ye ous\09 JeBu0 ou Ue Kaunco au eM SUEBW AL UOMED -bifepjUeLUesAU8 0 6 BIEN SWS 4d OM YEN UI ‘OURUEDE IWS e swesHd (eee Lad Bul ‘Auenb jequewuouug " % (oueueog onetWindo) 81284 08 Ul id (4) oud ‘Ayjenb jeuewuou0u3 % (oueusog opsiwisseg) $1294 05 U ddd “(®) Joued ‘SOUBUBOS OM] *SIBEA OS UI Sid IRISSOA 22point A on the PPF in Figure 1-1 in preceding years. As a result, the PPF for the year 2080 lies inside of the PPF today. Society, no matter where it chooses to locate, now ‘must consume either fewer goods or have lower environmental quality than is poss! ble today. If we try to keep production of goods at c., environmental quality falls toe, Alternatively, if environmental quality is to stay at e;, itis possible to produce and consume only ¢, goods. Panel (b) is more optimistic. Suppose we develop a new technology to produce substantial amounts of energy from cold fusion. The environmental externalities asso- ciated with this new energy source are negligible. Our PPF for 2000 now shifts out to reflect the ability of society to produce more goods with a higher level of environ- mental quality. Notice that we have skewed the shape of the PPF to show that at c— the same level of output society chose in 2000—we have e, environmental quality rather than e3, because a non-polluting energy source was developed. Alternatively, at ey, production at e, is possible. These cases illustrate that the future is not independ- ent of the choices we make today. Is there any way to tell how a country’s PPF will change over time as the country develops and grows? What is the relationship between economic growth and environ- mental quality? Do higher rates of growth—that Is, increases in our traditional me ures like gross domestic product (GDP)—imply greater environmental degradation, or might the opposite be true? One way to look at these questions is to see how ent ronmental quality varies across countries with different levels of income. Alternatively, one could look at 2 particular country and see how environmental qual- ity has changed over time as per capita incomes grow in that country. How might PPFs look for different countries? Countries differ widely in the per capita incomes of their residents, their overall level of development, and, therefore, the trade-offs they may face between having more environmental quality and more goods and services. Many argue that developing countries simply cannot afford high levels of environmental quality. According to this view, the PPF of a developing country would lie inside that of a developed country, as pictured in Figure 1-3. This situation is per- haps due to past resource exploitation, or population pressures, or less sophisticated technology. To achieve higher levels of income and production of goods and services, developing countries face significantly lower levels of environmental quality than a developed country. For example, for the developing country to reach a level of market- ed output of c, it must trade off environmental quality back to the level ¢3. The devel- oped country, because of the factors mentioned above, can have ¢, of marketed output with « much higher Jevel of environmental quality: ¢ instead of only e,, A key factor in this argument is that output and environmental quality appear to be substitutes for developing countries. Does that have to be the case? Suppose that as countries develop and incomes grow environmental quality and output become more complementary. Technological developments and productivity growth may decouple the resource-using sector from the rest of the economy; we may need fewer primary resources to produce goods and services. Society may be willing and able to spend a greater proportion of its income protecting the environment from degradation and cleaning up past damage. In addition, as people's incomes rise, they may alter their consumption patterns, including more activities that lead to preservation of the natural environment (¢.f,, recreation, birdwatching, hiking) rather than resource- using activities. The environment may be what is called an income eleste good. PeopleFigure 1-8: PPFs in Developed and Developing Countries er Environmental quality Fora given evel of market goods the deveaping country must aoe aft a greater amount of ervronmantal qual iy than a develope county. tc, te emsronmental quay sat rather than eH te developing country’s ime, may be abe to improve envronmartal culty the PPF shifts out toward that of Ue spend proportionately more on goods connected to improving environmental quality as their incomes rise. They can “afford” to do so because they have taken care of their basic needs, such as food, safe water and sanitary facilities, and shelter, They may also pressure their governments to enact stronger environmental regulations that better protect environmental quality. This may lead to sootal choices that result in higher levels of environmental quality. The PPF may begin to shift out toward that of the developed eBuntry. As incomes grow, so might environmental quality. The Environmental Kuznets Curve Economists have examined environmental quality data for countries with different levels of income. The objective is to see if as income levels change, there are system- aio changes also in environmental quality variables, Statistical methods are used to discover any underlying relationships. The studies show a variety of relationships between income levels and different measures of environmental quality. This rela- tionship is called an environmental Kuznets eure (EKG), named after an economist who looked at the relationship between Income and equality. In Figure 1-4, three types of relationships are seen in the EKC estimates: Evvcmetal Kune ures fave als bee eine wn acount oie. The reashgs uncover ar sia 1 tose o ore a0 cui,Figura 1-4: Environmental Kuznets Curves Estimated In the 1060s and 1990s Panel (a) % Inadequate Sanitation, 1997 and the 1980s Sanitation improves continuously as per capita income rises in both time periods, but the percentage with inadequate sanitation falls more sharply in the 1997 estimate. Percentage of population with inadequate sanitation py —— 1 000 8 — 10,000 20,000 80,000 40,000 50, Per capita GDP Panel (b) % Unsate Drinking Water, 1997 and the 1980s Drinking-water supplies improve continuously as per capita income rises. This also occurs at lower per capita incomes in 1997 than in the 1980s. 8 Percentage of population with unsafe drinking water & {qe =10'000 6 10,000 20,000 0,000 40,000 50,000, Per capita GDP EXCs show a relationship betwoen per canta income and anindcatorof environmental quay. A varity of diferent retionshis have bean found as indlcate in each palee igure 1-4 (continued): Environmental Kuznets Gurves Estimated in the 1980s and 19005 Percentage change in forest Micrograms 80, per ¢: =10/000 0 ‘cover 1990 to 1995 be epee 8 Panel (c) % Change in Forest Cover, 1990 to 1995 a ‘0000 er capita GDP. Panel (4) Sulphur Dioxide Emissions in Urban Areas, 1980s and 1980s ‘An inverted curve is found for the EKC for the 1990s. This indicates that over the period of very low to higher per capita income forest ‘cover Is rising then declining. Beyond this point, forest cover is diminishing. 10,000 20,000 20,000 40,000 50,000 0. ‘The EKC for sulphur dioxide is U-shaped for data in the 1980s but becomes negalively sloped overall in the 1980s. Per capita GDP "101000 20/000 30/000 40,000 $0,000‘Figure 1-4 (continued): Environmental Kuznets Curves Estimated in the 1960s and 1990s Panel (2) Per capita CO, Emissions, 1996 7 19808 The EKC for carbon dioxide is an exponentially rising function in the 1980s, but U-shaped for 1996 data with a peak in per capita emissions at just under $20,000 (U.S.) per capita i Kilograms of CO, emissions ‘per capita, 10,000. “10,000 0 101000 20,000 s¢!000 40,000 60,000 Per capita GDP Source: Fr 19808 etna, ators clans For TE esr, ta acid tam he Mel ant (1292, Word velopment Reva, 1882: Development andthe Enironent, p11, 1. EKCS that steadlly decline as incomes Increase. This applies to access to safe water and sanitation facilities, and sulphur dioxide levels in the 1990s, The results for water and sanitation illustrate that these are normal goods—as incomes increase people are willing to pay larger amounts for them. The results for sulphur dioxide in the 1990s could be due to the impact of regulation of these emissions, particularly in the developed countries, ‘EKGs that frst increase but then decrease with income. Examples are SO; in the 1980s and CO, in the 1990s. The pattern for SO, may reflect the fact that early stages of development lead to greater air pollution, but as incomes rise over time there may be a shift in industry type toward cleaner industries, as well as a rising pub- le demand in more well-to-do countries for pollution control. Estimates for CO, are so different between the 1980s and 1990s that one is reluotant to infer much from them. The forestry equation is not good news for the environment. The equation suggests that forest cover rises as incomes rise up to around $20,000 of er capita income (in U.S. dollars), but then starts diminishing again. This is evi- dence of non-sustainable resource use. - EKCs that rise steadily with income, The example shown is CO, emissions per capita for the 1980s.* Rising CO; emissions result from the increasing demand for foss based energy that normally accompanies development—but, as noted above, the EKC may be changing over time, reflecting a reduction in fossil-fuel energy use per unit GDP. ring BAC i. ound in many tues mural ed wa,‘These relationships as pictured are snapshots of the world economy at « point in time. As Figure 1-4 illustrates, the relationships appear to be changing over tme, Sometimes indicating a more optimistic view of the relationship between development and environmental quality. But the BKC results for some indicators warn all countries that continued income growth oan lead to worsening of environmental quality.’ It is tlso important to note that the BKCs look at single indicators of environmental qual- iry, not a measure of the combined effects of many pollutants on ecosystem health ‘This is a major limitation of empirical work trying to link environmental quality to economic variables. Pollution Havens and Halos When examining environmental quality across countries, a natural question to ask is whether the environmental indicator reflects the stringency of environmental policies in that country and whether or not governments compete with one another to attract “dirty” or “clean” industries, ‘Acountry or region within a country might want to besome a pollution haven by ba ing very lax environmental policies. It wants to Induce firms to construct plants with- ints borders to produce high rates of output and employment growth for its people. While developing countries are often seen as most likely to be pollution havens, any country or region that has lower environmental targets than others could be a poten- tial pollution haven. Other countries may wish to attract “clean” industries and appeal to people who value a high level of environmental quality by having very strict envi- ronmental policies. These are the pollution halos. It is surprisingly difficult to get conclusive data on this matter. The empirical results are mixed. Many find no evidence of pollution havens when looking at aggre- gate data, but some detailed studies of individual industries find cases where environ- fmental regulations appear to be a factor contributing to the relocation of pollution-intensive firms to areas where environmental regulations are less stringent.* ‘complication in all this work is that it is dificult to measure just how stringent a reg- ulation is. Developing and developed countries have regulations on the books that ‘appear to place emissions under reasonably strict controls, but in practice enforce ment of the regulations may be weak. The ideal data would measure the emissions per- formance of firms, or groups of firms, before and after they have moved from one region of country to another. But data like these are very hard to obtain. Thus, the Wray economists have to proceed is to identify “dirty” industries, those that emit rela: tively large amounts of pollution, and look at how they have grown or declined in dif- ferent countries or regions within a country. + Sone EKC suis and idence or hon $c As income, potion nda est nase hen cece in ‘ape D en tuns Up agon Specie eases inde catouedpopuaton cow, ims okey t conn Made emission, ada euro ft wren env atsclmeass ima dt crepe cst crsones Ft sone capose el eer vehi es metal sporsto equals designed tot rissa pe vet. This oe~ ving pelo ale Pope spond by citing more klorates. ggg issn anh i, ran Dg Dr vhil Rae ben rasta end, We Nave yl ost much eves of an EXC wit be horaet S.Werans& sii, 2 Sex Lear (198) Toby 100), Carson. onan MeCabin (197); Lucas hee ant Hei (1982) Manan Wri (1S) and sad Co (200) or examples tucson poenavn hype,renner The problem with this approach is that there are many factors besides ex mental regulations that could cause dirty industries to migrate—for example, costs, raw materials availability, Infrastructure availability, and especially the the product cycle, By the last we mean the fact that during the process of g any economy certain industries will tend to expand and decline at different & Certain basie manufacturing industries, which may be “dirty,” will often expand: in a country’s development and decline later as incomes increase. So these indus might be moving around from one country to another (not literally moving, but expanding in some countries and declining in others) in response to where countries are in the product cycle, rather than because of environmental regula 'B study dovig’by Wheeler (2000) looks at the relationship between foreign investment * developing Eduntries and the countries’ pollution levels over time. Three developing ox ites are éxétfined: China, Mexico, and Brazil. Data are avaliable on an important Dolutent=*ebended partculate mater (PM), whichis strongly associated with ness oaths trért@ardiopulmonary condtions.* These three countries account for approx '9}60 porésAt st al foreign direct investment (FO!) in developing countries, so examining if betweel¥FD! and PM is a parsculaly meaningful test ofthe pollution-haven ifthis foreign investment facltted the movement of polution-intensive industry to ® tépidly developing countries, then PM ought tobe rsing—or, at least, not faling. The ‘are shown in Figure 1-5. Graphs are shown for each country. In each case, wile FDI ing (most notably atthe end of he period), PM has been fatin, Atleast for this pos 4nd these regions, the poluion haven hypothessis not supported Questions tls example raises (tor discussion): 41; Would youl expect other pollutants to be similar to PM? (Think about this in the conse ‘0 EKC tnfofmation.) °2:-wmile PMifas declined in these regions, how do the levels compare to those in other "counties or example, Canada and the United States? (Hint: Canadian data for Pat ‘are provided in Chapter 2.) Patel dato Cra san average os 50 mar ies Mase aa ae for Masco Oty—Hs ges rst poled hy ae als te fr Sao Paolo gs nda ly, pa wh vg ees opaluon, These ce soe of hee devaon came tes whee ie sees opin ca xs.8 & 8 Particulate matter in pgims 8 1967 "T9GE 1965 "7590 “6ST "T9e2 Teas 1804" 1885 Year Pane! (b) Mexico City 2 e g 3 : g 2 = a3 s 5s i g 2 20 1 ae TES Teer SS ee Tee ete °F REE TERT VOGT TRE TERS" TOGT TORE TEBE GST Year For al tires counties, potuton inthe form of pariclate mata has ben fling sine the 1980, wh in lac Invent rom ote counts hasbeen rig. These data donot sUppon tne fypoine ‘hese counties ar becoing potion haventae a (continued): Foreign Direct Investment and Particulate Matter Levels in Chim Panel (c) Sao Paulo, Brazil a +4 by g ‘ & E 3 £ Particulate matter in pgm? ‘ears 1088 1667 Taae 19001690" 1651'1002'1999 7008 7095 1606 Year ‘Source: D. Wester (2000, ‘acing tothe Baton? Foreign imesnent at Ar Qa n Developing Counties" Wa ‘ant Werkng Paper November 2000 at cred tam Fis 2 2 and. alee wwe nian Economics and Politics Environmental policy decisions come out of the political process, where, at lease democratic systems, people and groups come together and contend for influence control, and where interests collide, coalitions shift, and biases intrude. Policies & ‘emerge from a process like this may bear litte relationship to what we might thin as efficient approaches to particular environmental problems. Where does this le the environmental economist? Why spend so much time and energy on questions efficiency, cost afectiveness, and equity when the political process most like to override these considerations and go its own way? It is the politician's job to om promise or seek advantage. Scientists and economists can help to serve the politiss process by producing studies that are as clear and objective as possible even thou wwe know that the real world is one of compromise and power. Economists can b determine socially efficient strategies and examine issues of distribution: how ronmental problems and policies afieot different groups within society. Anod important role of economists and soientists is to provide information to poliey-+ on alternative courses of action. For example, what is the likely impact of contin greenhouse gas emissions on climate change? How responsive will consumers be carbon taxes? Although we will foous throughout the book on the most efficient cles or the least-cost courses of action, we need to recognize that in the give-andstsof the political world in which poliey is actually made, choosing among alternatives is always the order of the day. But economists are becoming more important in the envi- ronmental policy process. As society and our politicians come to grips with complex and pressing environmental concerns, they are increasingly turning to economists for policy advice. Policies of the past may not be working well to improve environmental quality. New pollution-control initiatives incorporating eoonomio incentive principles are playing an increasingly important role in local, provincial, and federal environ- ‘mental policies. All the more reason, then, to study and understand the economics of environmental analysis and policy, SUMMARY ‘The purpose of this chapter was to whet your eppetite for the subject of environmental eco nomics by indicating some of the main topics that the field enoompasses, showing very briefly the approach that economists take in studying them. Our focus will be on microeconomic aspects of environmental economles—to see why externalities exist and persist and how to design and analyze economic policy Instruments that can help improve the quality of our envi- ronment. We have provided a brief overview of some of the macroeconomle issues—sustain ability and growth. The analytical tools to study these issues in depth require more sophisticated economics than will be used in this book. Our hope is that you will continue your studies in economies and come back to these macroeconomic questions in another course, \When we get involved in some of the conceptual and theoretical Issues that underlie envi- ronmental economics it is easy to lose sight of what we are'trying to accomplish. We are trying to develop basic principles so that we ean actually use them to address real-world problems such as air and water pollution. Although the principles may appear abstract and odd at first, remember the objective: to achleve a oleaner, healthler, and more beautiful natural environ- iment that can be sustained over time, KEY TERMS Community indifference curve (CIC), 11 ‘Opportunity costs, 2 Cost effectiveness, 22 Pollution halo, 19 Epological cconomies, 10 Pollution haven, 19 Economie efficiency, 2 Private costs, 6 Environmental Kuznete curve (EKC), 15 Production possibility fi Equity, 3 Property rights, S Extemality/external effects, 5 Scarcity, 2 Incentive, 4 Social capital, 10 Income elastic good, 14 Socially eflcient level of pollution, 8 Marginal benefits, 2 Sustainability, 11 Marginal costs, 2 ‘Trade-ots, 2 Normal goods, 18DISCUSSION QUESTIONS - “Annual vehicle testing ofall motor vehicles on the road is not a cost-effective policy.” Do you agree with this statement? Explain why or why not ‘Why would a tax on gasoline provide a larger incentive to reduce air emissions from motor vehicles than an annual tax on owning a vehicle? . The Canadian CAFC standards apply to new vehicles as they come off the assembly line, Provide two reasons why this might have a perverse effect on total emissions from moror vehicles, Explain your arguments. Does Canada need a voluntary CAFC standard when the United States has a mandatory ‘one? Disouss. * What factors influence the trade-offs illustrated in the produetion possibility frontier? How ‘can environmental policy affect these trade-offs? Suppose there Is technologice! change that allows firms to produce goods and services ‘with less pollution. Show graphically and explain how this will slter the PPF and a society's potential choice of where to locate on the PPF. . If produced capital is not readily substitutable for environmental capital (natural resources, ‘it and water quality), how will this affect the trade-offs between economic growth and the 3. Show how different EKCs can be derived from changes in countries’ PPFs over time Why might countries want to become pollution halos?