Fall 2012

ECO 204

Alternative Economic Perspectives

Prof. Martina Vidovic

Pollution: An Example of Views by CON and LIB CON: Causes of pollution:

Consumer preferences Consumers have a right to vote with their dollars and choose between less expensive but polluting goods or more expensive goods whose higher prices result from pollution controls Corporations cater to consumer preferences which may result in production of pollution intensive goods. (Recall that for CON Pareto economic efficiency means free choice for agents. Free choice implies individual responsibility) Lack of property rights Lack of well-defined property rights over rivers, lakes and atmosphere allows them to be used as free disposal sites Firms want to minimize costs and will take advantage of the public nature of these goods and dump their waste into them If the disposal sites were privately owned then polluters would have to negotiate with the owners Natural resources are largely publicly owned and resource depletion and pollution can be attributed to markets inability to achieve efficiency when public goods are present (Recall that for CON private property rights provide incentives for economic freedom which leads to growth) Transaction costs Citizens willing to pay for a cleaner environment may face transactions costs associated with gathering the information, specifying and enforcing contracts as well as costs of organizing themselves to express their preferences and monitor compliance In the presence of transactions costs, markets fail to establish an optimal level of pollution (Coase Theorem) Lack of development Reject that economic growth is the main cause of pollution but rather that it is the lack of economic development Less developed countries have higher rates of population growth, less education, less efficient use of natural resources and lower technical capacity for protecting the environment Free market is an optimal institution for achieving development

Fall 2012

ECO 204

Alternative Economic Perspectives

Prof. Martina Vidovic

CON: Environmental Policy

(1) Markets can provide higher standard of living which leads to higher disposable incomes by consumers who have met their basic needs and are more likely to value clean environment Corporation cater to these consumers and higher corporate profits will allow firms to adopt cleaner and more efficient technologies As a resource is being depleted, the price of the resource increases in response to its current scarcity but also in response to higher costs of extracting that resource in the future. This will induce consumers and producers to search for cheaper alternatives and develop new technology for producing synthetic substitutes for that resources which leads to more efficient use of resources (emphasis is on free markets, agent free choice, material incentives) (2) Sell public property to private owners once privately owned, owners have an incentive to preserve their private property and will charge for the usage of it or sue for damages (recall public property should be minimal national defense may be the only public property; some also support privatization because private spending more important than public spending) Ronald Coase argued that in the world without transaction costs, the bargaining between polluters and owners of disposable sites would result in an optimal level of pollution regardless of who owns the site. For example, if the government gave the ownership of a lake to a polluting firm, then the citizens could bribe the company to reduce its use of the lake for waste disposal. If a citizen is given property rights to the lake, the corporation could bribe the citizen for the use of the lake as waste disposal. Optimal level of pollution will result because the firm will pay for the right to pollute until the cost of additional pollution to the firm is equal to the additional benefit. The result will be an efficient allocation of resources. However there are problems with transaction costs and also some goods are pure public goods (3) Government action should focus on creating financial incentives for reducing pollution rather than imposing standards (government action restricted to using market based policy instruments) This way economic agents are free to act in their own self interest Example of an incentive type policy is effluent tax or polluter pay principle firms are free to choose a method of reducing the pollution that best suits their production and choose a level of output that maximizes their profits Another policy tradable pollution permits (preferred policy) where the number of permits corresponds to the acceptable level of pollution. Permits are sold to highest bidders (ones with the highest cost of reducing the pollution) forcing the low cost producers to reduce emissions

Fall 2012

ECO 204

Alternative Economic Perspectives

Prof. Martina Vidovic

CON: Government failures

Government lacks detailed information about the private sector to formulate efficient policies and therefore favor uniform standards that are applicable to all industries and easy to enforce Efficiency is more likely to be attained by applying different standards to different industries Government is susceptible to manipulation by special interest groups such as lobbying of environmental organizations such as Sierra Club or Wilderness Society Some argue that the government should pay the owner for financial losses (in terms of forgone profits) every time it imposes a law or a regulation. This will minimize the use of regulations Every regulation should be examined to determine whether its benefits exceed the costs whether the dollar value of protected species exceeds the dollar value of the resources that could be removed from the environment

LIB: Causes of pollution

(Recall that for LIB the presence of market failures serves as a justification for government involvement) Externalities Markets generate externalities in which the price of the good does not reflect all the costs and benefits associated with the production of the good In the presence of externalities, markets are inefficient Lack of information Consumers may not be aware of environmental damage caused by consumption of certain products or disposal of waste and without complete information concerning all costs and benefits, consumers cannot make rational decisions Even if they recognize potential damage they may be ignorant of thresholds beyond which pollution leads to ecological irreversible reactions Lack of full information by the government leads to inadequate regulation Lack of competition Presence of oligopolistic and monopolistic markets diverts resources from their optimal use Corporations may lobby against environmental regulation rather than install pollutioncontrol devices Monopoly power can contribute to unemployment and inflation that causes workers to focus on immediate survival rather than environmental protection

Fall 2012

ECO 204

Alternative Economic Perspectives

Prof. Martina Vidovic

Transactions costs Citizens face huge transactions costs associated with organizing themselves to negotiate with corporations so instead they may leave the polluted area Thus the market encourages exiting (mobility) and creates a community with weak bonds and political action is difficult to achieve

LIB: Environmental Policy

Encourage government intervention because individual citizens have little incentives to make private sacrifices to control pollution since their individual actions have little impact on the level of pollution Government can gather information, assess damage, collect taxes and monitor enforcement much more effectively and efficiently (1) Impose a tax (Pigou) on the polluting firm (tax equals to the amount of the damage) use revenues to subsidize citizens harmed by pollution However this implies that the government has full information regarding the cost to each firm of reducing pollution and the amount of the damage which is unlikely (2) Impose standards instead of taxes promotes equity so that all regions meet the same standards and pollution is not concentrated in a few sites (also reduces problems with free riding) (3) Government action to promote environmental protection can be compatible with growth and increasing standard of living based on Keynesian view, additional spending on environmental protection simulates the economy by creating a greater demand for goods, more jobs, higher income Unemployed workers may be hired to construct pollution control devices or to monitor pollution (recall LIB value growth and full employment) Countries that invest in pollution can export green technology and products to other countries However, they agree that too much growth can harm the environment growth should not exceed levels consistent with the health and well-being of future generations Believe in notion of sustainable development (4) Value both efficiency and equity equity can be achieved by treating the clean environment as human right to which all persons are entitled regardless of their ability to pay while the financial burden of pollution control can be placed on citizens with greater ability to pay (recall that LIB values Utilitarian efficiency which may require redistribution of income from rich to poor in order to achieve maximum societal utility. You can also make an argument based on the diminishing marginal utility of consumption by treating clean environment as a primary good) To promote efficiency favor policies designed to correct market failures (recall LIB also highly values Pareto efficiency) The major method for designing efficient policies is cost benefit analysis gives priority to policies with greatest benefits per dollar of cost (Utilitarian efficiency) To determine the benefit of pollution control they rely on determining the citizens willingness to pay (WTP) Two problems are associated with obtaining WTP: (a) citizens may not reveal their true preferences because they may free ride by enjoying the cleaner environment without
4

Fall 2012

ECO 204

Alternative Economic Perspectives

Prof. Martina Vidovic

paying for it; (b) distribution of wealth affects willingness to pay lower income people have less income to spend and must first satisfy immediate needs such as food and clothing and therefore may seem to be less interested in clean environment. Also, they may welcome factories to their neighborhood because they provide jobs Because most costs and benefits of environmental policy occur in the future must choose a social discount rate to determine the present value of future costs and benefits. The social discount rate can be as high as the current market rate which will put more emphasis on the benefits to the current generation. The future may be valued more highly by the society than by individuals so the policy may justify a lower discount rate than the market discount rate which will value future generations more highly (this can be justified based on the stewardship value which is a social value that competes with efficiency and growth but is accounted for by LIB in policy decisions)

A brief explanation of different approaches to control pollution Command and Control

An alternate approach to environmental regulation is a command and control. This is much more prescriptive than market-based instruments. Command and control regulatory instruments would be emission standards, process/equipment specifications, limits on input/output/discharges, requirements to disclose information, and audits. Command and control approaches have been criticized for restricting technology, as there is no incentive for firms to innovate. Market-based instruments do not prescribe that firms use specific technologies, or that all firms reduce their emissions by the same amount, which allows firms greater flexibility in their approaches to pollution management. However, command and control approaches may be beneficial as a starting point, when regulators are faced with a significant problem yet have too little information to support a market-based instrument. Command and control approaches can also be preferred when regulators are faced with thin markets where the limited potential trading pools mean the gains of a market-based instrument would not exceed the costs (a key requirement for a successful market-based approach). Market-based instruments may also be inappropriate in dealing with emissions with local impacts, as trading would be restricted to within that region. They may also be inappropriate for emissions with global impacts, as international cooperation may be difficult to attain.

Taxes
A market-based tax approach determines a maximum cost for control measures. This gives polluters an incentive to reduce pollution at a lower cost than the tax rate. There is no cap; the quantity of pollution reduced depends on the chosen tax rate. A tax approach is more flexible than permits, as the tax rate can be adjusted until it creates the most effective incentive. Taxes also have lower compliance costs than permits. However, taxes
5

Fall 2012

ECO 204

Alternative Economic Perspectives

Prof. Martina Vidovic

are less effective at achieving reductions in target quantities than permits. Using a tax potentially enables a double dividend, by using the revenue generated by the tax to reduce other distortionary taxes through revenue recycling.

Transferable permits
A market-based transferable permit sets a maximum level of pollution (a 'cap'), but is likely to achieve that level at a lower cost than other means, and, importantly, may reduce pollution below that level due to technological innovation. When using a transferable-permit system, it is very important to accurately measure the initial problem and also how it changes over time. This is because it can be expensive to make adjustments (either in terms of compensation or through undermining the property rights of the permits). Permits' effectiveness can also be affected by things like market liquidity, the quality of the property right, and existing market power. Another important aspect of transferable permits is whether they are auctioned or allocated by grandfathering (given to existing firms). An argument against permits is that formalizing emission rights is effectively giving people a license to pollute, which is believed to be socially unacceptable.