29/08/2014

Environmental and Ecological
Economics
September 1, 2014
GEOS2121 Environmental and
Resource Management

Lecturer: Jeff Neilson

Image Source: www.uvm.edu/giee/

How do economists deal with environmental problems? Environmental Economics

Market Failures
•

• A subset of neoclassical economics?
–
–
–
–

Generally, no physical limits to growth,
Prioritises allocative efficiency over optimal scale,
Hegemony of the market,
Utility accepted as de facto human welfare.

• Principle mode of diagnosis: Environmental problems are caused by market failures.
• Remedy: Assign market values to the environment and incorporate within the economy (this requires an institutional intervention). •
•

Environmental Economics is primarily about addressing market failures.*
Common market failures with environmental impacts include:
– Externalities
– Public goods (non-rivalrous)
– Open Access Common Property (rivalrous)
Markets fail when the price mechanism is unable to function or gives the wrong signal to users
Markets require excludability (property rights) and ecosystem services are not always excludable
*NOTE: Other ‘Market failures’ include ‘information asymmetries’, ‘noncompetitive markets’, and ‘principal-agent problem’

1

29/08/2014

Market Failures and Institutions
•

According to most economists, market failures require institutional interventions (usually by the state) and so therefore depend upon political will.

Recalling , what are institutions?
According to Douglass North (1998: p. 248),
• “Institutions are the humanly devised constraints that structure human interaction. They are made up of formal constraints (for example, rules, laws, constitutions), informal constraints (for example, norms of behaviour, conventions, self-imposed codes of conduct), and their enforcement characteristics. Together they define the incentive structure of societies and, specifically, economies”.

Environmental externalities
•

•

•

•

The uncompensated costs to society and the environment of production and consumption are know to economists as ‘externalities’, and the main objective of environmental economists is to internalise such environmental costs into the price mechanism. Eg. the price of gold mined in Central
Kalimantan does not include the environmental costs of acid-mine drainage, noise and dust pollution, and tailings leakage.
Governments can address these externalities through direct regulation or by intervening to alter price signals in the market (eg. a pollution tax)
The Coase Theorem on externalities: if all parties involved can easily organise compensation payments with each other then an efficient outcome can be reached without government intervention.

Economic policy options to address market failures

“The greatest and widest-ranging market failure ever”
•The Stern Review (2006): Probably the most comprehensive document to date on:
• The economic impacts of climate change, and
• The policy options to address climate change.
•Those responsible for emitting greenhouse gases do not bear the costs of the damage.
“The appropriate response to a substantial market failure is not to abandon markets but to act directly to fix it, through taxes, other forms of price correction, or regulation…. [which] will allow continued and substantial growth and poverty reduction ” (Stern, 2009, p.11)

1.

Direct regulation (eg. standards on unleaded petrol, bans on use of mercury, and building efficiency standards)
Inefficient?
2.
Taxes (pollution tax, carbon pricing, consumption tax)
–
Size of reductions aren’t guaranteed?
–
Socially regressive?
–
‘Stealth’ tax (cigarettes and alcohol)
3.
Cap and trade (emissions trading )
–
Flip-side of taxes,
–
Administratively complex
–
Sector agreements? (transport, EITEIs)
4.
Direct action
–
Picking winners
–
Costly
–

2

29/08/2014

Why economists prefer emissions trading to regulation

Other policy applications of environmental economics • Quota Systems - cap and trade
– Water trading in Australia