Economists Articulation of Environmental Problems and Corresponding Policy Instruments

by Prof. A.T.M. Nurul Amin

1. Introduction

The first principle of economics is that free market with competition produces socially and environmentally desirable results. But many do not know that economists warn that this will not be the case if competition does not prevail in any market.

Economists also concede that free markets are associated with three major inherent problems.
These are: Imbalances and inequities
(Disparities in income distribution internationally, interregional and interpersonally and gender-wise)

Ups and downs in economic growth and business cycles

(Boom, bust, recession, recovery)

Externalities
(Problem arising from non-counting of some costs and benefits by individual consumer and producer. Such costs and benefits are accrued to a third party, i.e., other than the consumers and producers who are directly involved in the production and consumption of a good or service).

Economists have developed theories and policy tools/instruments corresponding to the above problems. For example, the whole sub-branch of development economics has developed to address the particular issue of imbalances and inequalities, particularly in the developing countries.

Similarly, macroeconomics has grown and flourished to deal with the issues of unemployment inflation/price level associated with growth cycles. Fiscal policy, monetary policy and exchange rate policy are key policy instruments that are used for ensuring macroeconomic stability.

Likewise, environmental economics has grown and flourished to address the issue of environmental problems that arise economists believe because existence of externalities, open-access resource and public goods. In this lecture, we limit our elaboration to the last theme, i.e., how economists have articulated the environmental problems and developed corresponding policy instruments to deal with the observed problems.

2. Economists Articulation of Environmental Problems

Three environmental problems that fare prominently in economic analyses are:

Pollution Destruction of natural resources Free-riding of environmental resources.

The above identification of environmental problems and the corresponding economic concepts used for their analyses have led economists to suggest that:

For dealing with the problem of pollution, analyzed by the theory of externalities, environmental policy needs mechanisms to INTERNALIZE EXTERNALITIES. For dealing with the problem of destruction of natural resources, which is seen to take place because of their open-access characteristics, what is needed is: ENSHRINING OF PROPERTY RIGHTS.
For dealing with the problem of free-riding of environmental resources, which is explained by their public goods characteristics, what is needed is to find a mechanism to: INFUSE PRIVATE GOOD CHARACTERISTICS so that pricing of such good is possible and thereby freeriding can be curtailed, if not totally stopped.

Problem
Pollution (air, water, waste, noise)

Analytical Tool
Externalities

Solution
Internalization of externalities

Destruction of Natural Resources (forest, water bodies, ecology) Free-Rider Problem (clean air, water, green area)

Open-Access Resources

Enshrining property rights

Public Goods

Infusing private good characteristics

Some Details on Externalities, Open-Access Resources and Public Goods

2.1 Externalities
2.1.1. External Costs Cost, which do not show up in a firms profit-and loss statement. They are external because, although they are real costs to some members of society, firms do not normally take them into account when they go about making their decisions about output to be produced and prices to be set.

MCs= MCp + EC

MCp Price, Cost

MCs= Marginal Social Cost MCp=Marginal Private Cost EC=External Cost Pm=Market Price

Pm

EC Q2 Q1 Output

Internalization of External Costs (Negative Externalities)

2.1.2. External Benefits The significance of this concept arises from the fact that when the use of an item leads to an external benefit, the market willingness to pay for that item will understate the social willingness to pay.

Price, Benefit

MB2= Marginal benefit including EB MB1=Marginal benefit without EB EB=External Benefit Pm=Market Price

Pm

MB2 MB1 EB

Q1

Q2

Output

Internalization of Positive Externalities

Externalities by Type, Example and Corresponding Policy Goals, Instruments and Their Expected Results
Externality type Example Policy goals Policy instruments Expected results

Positive externality

Education, health Recycling

Promote/ expand the output/ service Reduce/ restrict the production or service that generate pollution

Subsidy

More production of such goods and services.

Negative externality

Pollution

Tax/ charges

Less production of goods and services that generate pollution

2.2 Open-Access Resources An open-access resource is a resource or facility that is open to uncontrolled access by individuals who wish to use the resource. Examples are:

Pasture that is open to anyone to graze animals Forest where anyone may go and cut wood or Public park, open to free access (Field & Field 2000, pp.76-79).

2.3 Public Goods

It is a good that, if made available to one person, automatically becomes available to others. Such goods do not have exclusionary characteristics. Examples: (1) Lighthouse (2) Radio signal Note: public goods will not have to be owned by public (government) sector. A public good is distinguished by the technical nature of the good the non-exclusionary characteristic not by the type of organization making it available.

3. Environmental Management Measures (EMM)

Environmental management measures (EMM) thus can be seen to comprise of three sets:

Economic Instruments (EIs)/ MBIs Regulatory Instruments (RIs)/ CAC Moral suasion

3.1. Some Details of Economic, Regulatory & Suasive Measures

3.1.1. Economic Instruments While Subsidy (to give incentive) and taxation/pollution charges (to create disincentive) are the two fundamental policy instruments, market-based economic instruments include:

(Emission) Charges (Abatement) Subsidies Deposit-Refund System Market Creation

Tradable/Transferable Emission Trade Permits Market Intervention Liability Insurance

Financial Enforcement

3.1.2 Regulatory Instruments

i) Regulatory forms: Laws Licenses Permits Registration Administrative Guidelines Directives Codes of practices. ii) Regulatory Instruments: Emission of effluent standards Environmental quality standards Product controls Process and equipment standards Planning and building controls Extraction restrictions.

Three main types of standards are: a) Ambient Standards b) Emission Standards c) Technology standards
Advantages/ Disadvantages of standards can be briefly noted as: Advantages of standards are: Directness (clearly specified targets), conformity with ethical sense (pollution is bad, thus, need to be stopped). Disadvantages include: Complexity (in measuring and monitoring), problematic (directness and unambiguousness may be misleading).

3.1.3 Suasive Measures

Basic principles of these measures are: Reliance on voluntary compliance by polluters motivated either by the thereat of adverse or the prospect of favorable publicity. Environmental education and awareness raising are key elements of any policy designed around suasive measures.

Requirements for suasive measures to work:

Free flow of information Right to know Demand for quality environment

Recent development centering:

Voluntary environmental certification Strategic environmental management

A T E R

Application of EMM
AIR WATER

SANITATION

Environmental Media Focus in Environmental Policies

LAND

SOLID WASTES

NOISE QUALITY

TRAFFIC CONGESTION

HOUSEHOLD/ WORKPLACE
NEIGHBOURHOOD

COMMUNITY

Spatial Scale of Pursuing Environmental Policies

METROPOLITAN

COUNTRY

REGION GLOBAL

POPULATION

NATURAL RESOURCES

Spheres of Pursuing Environmental Policies

TECHNOLOGY

CONSUMPTION

TRANSPORTATION