Economic Policies for

Sustainability
“Our economies have been trading one form of capital, Earth’s
riches, for another - human riches. Without accounting
accurately for this trade-off, we will continue to have a false
impression of economic progress and growth. That is as
dangerous as flying an aeroplane into the night without
navigation tools or instruments.” – Edward Barbier
 How Can Economics Hurt the
Environment?
• Reason 1
– External social cost of economic activity is not included in
the price
• Reason 2
– Discounting gives less importance to the future - difficult
to justify decisions with long-term benefits
• Reason 3
– Assumption of perfect substitutabiliy between natural and
economic capital causes loss of NC
• Reason 4
– Ignoring the physical basis of the economy takes nature
for granted

Sustainable Engineering: Principles and Practice

 Command & Control
• Environmental regulations restrict emissions

http://www.epa.gov/oppt/greenengineering/pubs/whats_ge.html
Sustainable Engineering: Principles and Practice
 Disadvantages of Regulations
• Difficult to know acceptable level of pollution
• Economically inefficient
– There may be better ways to control pollution than those
specified by the government
– Stifles innovation
• Source of conflict between government and industry

Sustainable Engineering: Principles and Practice

 Environmental Tax
• External Social Cost of petroleum use
Type of externality Ozone and National Gasoline Greenhouse
particulate security and air gas
damage pollution
ESC, $/bl $12 $10 $6 $2

• Average external social cost = $15 /barrell

• Externality may be internalized by adding ESC to
marginal cost
• Environmental or Pigouvian tax

Sustainable Engineering: Principles and Practice

 Pigouvian Tax
• Include cost of $70
externality in 60
Demand Curve, P
economic 50 Marginal

Dollars per barrel

analysis 40 Social Cost

– MSC = MC + ESC 30 27 $15: external

20 social cost
– External social
Marginal Cost
cost for petro- 10
17
leum = $15/bl 0
0 5 10 15 20 25 30
– Optimum price is 35 Billion barrels per year
$ 27/bl at consum-
ption of 17 billion barrels
• Resulting economic efficiency
is good for producer, consumer and society
• Estimating ESC is difficult

Sustainable Engineering: Principles and Practice

 Property Rights - Coase
• Assigning property rights will eliminate externality
problem
• Example – Coal Utility vs. Laundry
– Coal utility emits particulate matter that dirties the laundry's
air dried clothes
– If the laundry has the right to clean air, utility can
compensate the laundry
– If utility has the right to pollute, laundry can pay the utility
to clean up
– Assume that reducing emissions costs $5,000; Loss to
laundry $10,000
– In either case, optimal solution is to reduce emissions
– What if costs are reversed?

Sustainable Engineering: Principles and Practice

 Property Rights - Coase
• Coase showed that the market equilibrium is
independent of ownership
• Externalities can be dealt with without government!
• Assumptions underlying Coase's theorem
– No transaction costs (legal fees, cost of bargaining)
– Few individuals on each side
– Both parties can pay
– Perfect competition
• Assumptions are commonly violated

Sustainable Engineering: Principles and Practice

 Tradeable Emissions Permits
• Approach that combines regulation, environmental
taxes and property rights
– Society sets a quota for the maximum allowable amount of
pollution or resource depletion
– Distribute quota among polluters in the form of permits or
individual quotas - “right to pollute”
– Firms may buy or sell permits
– Buy permits if that is cheaper than reducing emissions
– Newer processes will be cleaner and will sell permits
– Anyone can buy permits to take them off the market
– Quotas are often gradually decreased over time to reduce
total pollution

Sustainable Engineering: Principles and Practice

 Trading SO2 Emissions
• Approach
– Launched in 1990 to reduce SO2 emissions
– EPA holds annual auctions to sell permits
– Quota of emissions is lowered periodically
– Smokestack monitors wired to EPA computers
• Effects (Good)
– Tremendous improvements in SO2 scrubber technology
– SO2 emissions have indeed decreased
– Expected to cost 30-50% less than regulations
– Hailed as a success of market based system

Sustainable Engineering: Principles and Practice

 Trading SO2 Emissions
• Effects (Not so good)
– Many old plants are still operating resulting in hotspots of
SO2 emissions
– Acidity of lakes and streams has not recovered
– Changes in quota is controlled by Congress, not EPA
• Not been aggressive enough
– Reducing SO2 causes increase in other pollutants like CO2

• http://epa.gov/airmarkets
• http://nadp.slh.wisc.edu

Sustainable Engineering: Principles and Practice

Sustainable Engineering: Principles and Practice
 Trading Carbon
• Integral part of Kyoto protocol, signed in 1997
• US signed in 1998, but rejected in 2001; 7%
reduction from 1990 levels was required
• Fully operation in EU since 2005
– Encourages use of “offsets”
• Offsets are a lower cost alternative to permits
– Pay for carbon sequestration projects elsewhere to offset
your own emissions
– Wind farms in China, landfill gas in Brazil …
– Allows cleaner technology in developing countries while
helping EU meet Kyoto obligations
• Far from perfect, but a good start

Sustainable Engineering: Principles and Practice

 Local Carbon Trading Schemes
• Many local carbon trading schemes are functioning
• USA
– Regional Greenhouse Gas Initiative (Northeast)
– California’s cap and trade program
– Midwest Greenhouse Gas Reduction Accord
– Western Climate Initiative (US and Canada)
• New Zealand emissions trading scheme
• Tokyo metropolitan trading scheme
• New South Wales greenhouse gas abatement
scheme (Australia)
• Efforts are being made to expand and connect these
schemes to develop a global market

Sustainable Engineering: Principles and Practice

 Payment for Ecosystem Services
• Video clip (https://www.youtube.com/watch?v=gzNWnREZ2xI)

• Examples of Self-Organized Deals

– Perrier Vittel discovered it would be cheaper to invest in
conserving the farmland surrounding their aquifers than to
build a filtration plant to address water quality issues found
in 1990
– Accordingly, they purchased 600 acres of sensitive habitat
and signed long-term conservation contracts with local
farmers. Farmers in the Rhine-Meuse watershed in
northeastern France received compensation to adopt less
intensive pasture-based dairy farming, improve animal
waste management, and reforest sensitive filtration zones.
– http://www.iied.org/NR/forestry/documents/Vittelpaymentsforecosystemservices.pdf

http://www.unep.org/pdf/PaymentsForEcosystemServices_en.pdf
Sustainable Engineering: Principles and Practice
 Payment for Ecosystem Services
• Example of Public Payments
– The Public Redistribution Mechanism in Paraná, Brazil offers
an example of a public payment. The State allocated funds
to municipalities to protect forested watersheds and
rehabilitate degraded areas. Also in Paraná, as well as in
Minas Gerais, 5% of the revenues received from the
Circulation of Goods and Services (ICMS) — an indirect tax
charged on the consumption of all goods and services — is
distributed either to (1) municipalities with conservation
units or protected areas or (2) municipalities that supply
water to neighboring municipalities. The State allocates
more revenues to those municipalities with the greatest
amount of area under environmental protection
• Water quality trading in Ohio
– http://wqt.epri.com/overview.html

http://www.unep.org/pdf/PaymentsForEcosystemServices_en.pdf
Sustainable Engineering: Principles and Practice
 Trading Natural Capital
• The future may have markets for natural capital
• Companies are already being established
– Ecosystemmarketplace.org
• Farm of the future may have portfolio of NC

Commodity % of Income Customer

Biodiversity credits 5 Conservation trust
CO2 offset credits 10 Steelmaker
Renewable electricity 15 Power market
Certified sustainable 20 Specialty market
Timber
Water credits 20 World market
Wheat 15 World market
Wool 15 World market
Sustainable Engineering: Principles and Practice
 How Can Economics Hurt the
Environment?
• Reason 1
– External social cost of economic activity is not included in
the price

• Reason 2
– Discounting gives less importance to the future - difficult to
justify decisions with long-term benefits

• Reason 3
– Assumption of perfect substitutabiliy between natural and
economic capital causes loss of NC

• Reason 4
– Ignoring the physical basis of the economy takes nature
for granted
Sustainable Engineering: Principles and Practice
 How Can Economics Hurt the
Environment?
• Reason 1
– External social cost of economic activity is not included in
the price

• Reason 2
– Discounting gives less importance to the future - difficult to
justify decisions with long-term benefits

• Reason 3
– Assumption of perfect substitutabiliy between natural and
economic capital causes loss of NC

• Reason 4
– Ignoring the physical basis of the economy takes nature
for granted
Sustainable Engineering: Principles and Practice
 Determining Extent of
Substitutability
• Traditional economics assumes perfect
substitutability
• Ecologists need to determine “critical natural capital”
- cannot be substituted
• Need collaboration between ecologists and
economists
• Appreciation of reliance of economic activities on
ecosystems

Sustainable Engineering: Principles and Practice

 How Can Economics Hurt the
Environment?
• Reason 1
– External social cost of economic activity is not included in
the price

• Reason 2
– Discounting gives less importance to the future - difficult to
justify decisions with long-term benefits

• Reason 3
– Assumption of perfect substitutabiliy between natural and
economic capital causes loss of NC

• Reason 4
– Ignoring the physical basis of the economy takes nature
for granted
Sustainable Engineering: Principles and Practice
 Inclusive Wealth
• Measures the wealth of nations by carrying out a
comprehensive analysis of a country’s productive
base
• It measures all of the assets from which human
well-being is derived
– Manufactured
– Human
– Natural capital
• It measures a nation’s capacity to create and
maintain human well-being over time.

http://inclusivewealthindex.org
Sustainable Engineering: Principles and Practice
 IW Approach
 Sustainability is defined as positive change in
human well-being

 A country’s inclusive wealth is the social value (not

dollar price) of all its capital assets, including
natural capital, human capital and produced capital

 If inclusive wealth is positive, then well-being

across generations is positive

Sustainable Engineering: Principles and Practice

 IW Approach

Manufactured Human Capital Natural Capital

Capital •Population by age and •Fossil fuels
•Investment gender •Minerals
•Depreciation rate •Mortality probability by •Forest resources
•Assets lifetime age and gender
•Agricultural land
•Output growth •Discount rate
•Fisheries
•Population •Employment
•Productivity •Educational attainment
•Employment
compensation
•Labour force by age
and gender
Sustainable Engineering: Principles and Practice
IW Results

Sustainable Engineering: Principles and Practice

 Policy Lessons from IW
• Improve well-being sustainably by focusing on IW
not GDP
• Investments in human capital (education) would
generate higher returns for IW growth
• Investments in natural capital can increase IW and
improve agricultural resiliency and food security
• Investments in renewable energy can produce a
triple dividend: increase IW directly, improve energy
security and reduce risk due to price fluctuations,
reduce global carbon emissions
• Investments in research and development to
increase total factor productivity can immediately
contribute to growth in inclusive wealth

Sustainable Engineering: Principles and Practice

 Pros and Cons of IW
• Pros
– Incorporates physical basis of the economy
– Considers all kinds of capital
– Data challenges can be overcome

• Cons
– Assumes substitutability between types of capital
– Does not consider need for ecosystem services as
fundamental
– Data and social value calculations can be controversial

Sustainable Engineering: Principles and Practice

 Efficiency
• Many disciplines focus on maximizing efficiency
– Engineering: technological efficiency
– Economics: market efficiency for allocating resources
– Natural resource management: efficient yield of wood, fish

• All disciplines and decisions are influenced by the

push for economic efficiency

• In a “full world” resources are limited and scale of

economic activity has to be constrained
– Ignored in conventional economics

• How about a definition that encourages

sustainability?
Sustainable Engineering: Principles and Practice
 Comprehensive Efficiency Identity
• Product of manmade capital (MMK) requires sacrifice
of natural capital (NK)
• CEI = (Gain in MMK) / (Sacrifice of NK)

• Gain Gain MMK Throu- NK

in MMK = in MMK x stock x ghput x stock
NK sac- MMK thru- NK NK sac-
rificed stock put stock rificed

Service Maintenance Ecosystem

CEI Growth
efficiency efficiency capacity
and
(technical, (durability) harvest
allocation,
efficiency
design)
Daly and Farley, 2004
Sustainable Engineering: Principles and Practice
 Summary
• Free markets are effective for achieving optimum
consumption, production, pollution
– Regulations
– Environmental taxes
– Property rights
– Tradeable permits
• Good governance and global cooperation are
essential
• Many new business and research opportunities and
challenges
– Resolving uncertainty
– Determining prices and quotas
– Markets for natural capital

Sustainable Engineering: Principles and Practice