Transcript Chapter 6

The Economic Approach to
Environmental and Natural
Resources, 3e
By James R. Kahn
© 2005 South-Western, part of the Thomson Corporation
Part I
Theory and Tools of
Environmental and Resource
Economics
3e
Chapter 6
The Macroeconomics of the
Environment
© 2004 Thomson Learning/South-Western
Introduction
 This chapter examines the relationship between the
environment and the aggregate economy.
 The conceptual discussion of the interrelationship
between the environment and the macro economy
began early in the development of the field of
environmental economics.
 Boulding (1966) made an analogy of the earth to a
spaceship and stressed that our activities were
constrained by our endowment of resources and the
ability of environmental systems to assimilate
wastes.
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Conceptual Model of the Environment
and the Economy
 There are two different ways of
conceptualizing the relationship between the
economy and the environment.
One is to examine the relationship between the
environment and individual actors and then
aggregate up to effects on the total system.
A second is to view the economy and the
environment as two interwoven systems, where the
economic system is embedded in the larger earth
system.
 Which is correct depends on the issue of
concern.
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Interwoven Systems
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The Impact of the Environment on
Economic Productivity
 There are three basic mechanisms by which
the environment and environmental policy
affect economic productivity.
 One has to do with the impact of
environmental regulations on productivity.
 The other two have to do with the impact of
environmental quality on economic
productivity.
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The Negative Impact of Environmental
Regulations
 Environmental policy forces firms to make decisions
that are in the social interest, but not in their private
interest.
 This process of “internalizing an externality”
increases the firm’s costs.
 More importantly, the resources used to reduce
pollution can not be used to produce economic
outputs.
 This will have a negative impact on GDP, especially if
environmental goals are achieved through direct
controls.
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The Positive Impacts of Environmental
Quality on Economic Productivity
 A positive impact on economic productivity
can occur in two different ways.
 First, environmental resources are used in
production processes.
Cleaner resources are more productive resources.
 Second, environmental quality impacts the
productivity of other inputs.
Reduced air pollution increases yield per acre of
many crops.
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The Positive Impacts of Environmental
Quality on Economic Productivity
 Important benefits can also be found through the
impact on health and health care.
 If the population is healthy because they have
cleaner air and water, fewer resources will need to
be devoted to health care.
 Also, if the health care industry is characterized by
increasing average costs, then a reduction in need
for health care should also lead to a reduction in the
average costs of health care.
 Ecological services such as biodiversity, nutrient
cycling, and maintenance of hydrological cycles and
other services also have an important impact.
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Which Effect Dominates?
Theoretically this could be measured by estimating the following
equation:
GDP = f(L1,K1,EQ(GDP,L2,K2)),
 Where:
 L1 is the amount of labor used to produce GDP;
 K1 is the amt. of capital directly used to produce GDP;
 EQ is the level of environmental quality;
 L2 is the labor used to reduce emissions, and
 K2 is the capital used to reduce emissions.
 Unfortunately none of the current empirical studies has
attempted to measure this relationship, primarily because it is
hard to identify one variable to represent environmental quality.
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Which Effect Dominates?
 Lack of the ability to include a comprehensive
environmental measure has shaped empirical
studies.
 Most focus on the negative impacts.
 Examples include Jorgenson and Wilcoxen study
which estimated that the environmental regulations
had reduced GDP by 2.592%.
 Gillis et al. attempted to incorporate potential
positive impacts through the computation of a
general equilibrium model which included the health
benefits of air quality regulations.
 This study found that GDP is approx. 2% higher with
air quality regulations than it would have been
without the regulations.
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Can Environmental Policy Make the
Economy Stronger?
 Michael Porter argues that stricter
environmental policies require firms to cut
waste, increase efficiency with which energy
is used, and result in improved, more
efficient technologies and can lead to
reduced production costs.
 Porter argues that improved efficiencies can
lead to more competitive firms and greater
strength in global competition.
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Can Environmental Policy Make the
Economy Stronger?
 If stricter environmental laws lead to
increased advantages in global competition,
why don’t firms lobby for these laws?
 Simpson (1993) argues that it is important to
consider what happens to variable and fixed
costs with stricter environmental laws.
 New regulations may require new equipment
which increases fixed costs even though this
equipment may lead to production
efficiencies which lower variable costs.
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Can Environmental Policy Make the
Economy Stronger?
 While some would argue that inefficiencies and
short-sightedness are barriers to adoption, it is
difficult to imagine that this oversight would occur
on a systematic basis and that firms would not
pursue profit maximizing choices.
 It is possible that firms would not pursue research
into new technologies if there is not a way to protect
(patent) the technology to assure a level of return on
investment.
 In addition, where the adoption of a new technology
is associated with an uncertain outcome, it may pay
to be a follower and not a leader in changing
production technologies.
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The Impact of the Economy on the
Environment
 Herman Daly argues that it is not enough to impose
a pollution tax to protect the environment if the
number of polluters keep growing.
 He suggests that policy-makers need to consider
limits to the amount of economic activity.
 A counter argument is that it is not the amount of
economic activity that matters, but the nature of the
economic activity.
 Policy could and should focus on both.
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The Impact of the Economy on the
Environment
 One perspective argues that as the economy grows and per
capita income increases, environmental quality will increase
because demand for environmental quality will increase.
 An “Environmental Kuznets Curve” (EKC) has been
hypothesized, based on the Kuznets Curve from development
literature, which argues that low-income countries have little
detrimental impact on the environment because of their
relatively low level of economic activity.
 This impact increases with a rise in income and then, as the
economy grows beyond a certain point, policies are enacted to
protect the environment.
 The conclusion is growth in income will lead to improved
environmental quality.
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Is there evidence of an EKC?
 The World Bank (1992) and Shafik(1994)
looked at data and found empirical evidence
that supported the hypothesis.
 The study looked at air pollution as a
measure of environment quality and
examined this as a function of per capita
income.
 The work showed an inverse U-shaped
relationship existed.
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Is there evidence of an EKC?
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Is there evidence of an EKC?
 Others have argued that one important problem with the
WB/Shafik studies is that studies based on air pollution do not
generalize well to total environmental quality.
 Conventional air pollutants do not represent an environmental
problem that accumulates over time.
 Air pollution is not as damaging to environmental services as
other types of problems.
 Rothman(1998) argued that the environmental impacts should
be measured not on goods produced, but on the goods
consumed. This would pick up imported goods and associated
pollution problems in developing countries.
 A final problem is that income measurements may be flawed
because of the failure to include loss of environmental capital.
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GDP, Sustainability and Environmental
Quality
 Does growth in current income deplete future
income producing capability?
 What is meant by sustainable growth?
 Figure 6.6 presents three growth paths
originally defined by Pezzey (1989) and
further discussed by Pearce and Warford
(1993).
 While these, as defined by the authors,
pertain to social welfare, it is possible to
view GDP the same way.
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GDP, Sustainability and Environmental
Quality
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GDP, Sustainability and Environmental
Quality
 Path A is associated with initial levels of growth and
degradation of the environment, which leads to
lower future income potential.
 Conventional techniques of economic analysis
would look at the present value of this path and view
it as optimal (max. current).
 Path B is similar but less severe and the path
remains above the minimum survivability level.
 Path C is an example of sustainable growth and
sustainable development.
 The well-being of the current generation is improved
without constraining the well-being of future
generations.
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The Role of Capital Accumulation in
Sustainable Development
 Early discussion of sustainability focused on
the accumulation of artificial capital and
natural capital.
 Artificial capital consists of human-made
structures and goods that are used to
produce other goods and not consumed in
the process.
 Natural capital consists renewable and nonrenewable natural resources such as oil,
wood, coal, minerals, and fish.
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The Role of Capital Accumulation in
Sustainable Development
 Barnet and Morse’s (1978) classic book, Scarcity and
Growth, focused on whether we were running out of
extractable resources and the implication for growth.
 Hartwick (1993) derived an axiom know as the
Hartwick Rule that suggests sustainability is
possible as long as economic rents (the difference
between revenue and cost of extraction) are
reinvested in artificial capital.
 The mathematical model used was based on the
substitutability between artificial capital and natural
capital in the production of an output.
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The Role of Capital Accumulation in
Sustainable Development
 Hartwick’s work and others did not consider two
important types of capital, human capital and
environmental capital.
 Environmental capital refers to renewable resource
systems that provide a flow of ecological services.
 The existence of environmental capital implies that
the Hartwick rule cannot be true in the real world.
 The Hartwick rule requires perfect substitutability of
capital and while this may apply to human capital,
artificial capital and natural capital, it does not apply
to environmental capital.
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The Role of Capital Accumulation in
Sustainable Development
 Evidence of the inability to “perfectly” substitute for
environmental capital can be found by looking at the
Mississippi River and the attempt to substitute
human-made levees and other flood control
structures for the natural wetlands (1993’s “25 year”
rain caused a “100 year” flood).
 Human capital couldn’t duplicate the complexity of
the system.
 Would it even be possible to substitute away from
tropical rainforest carbon sequestration toward
human engineered systems?
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The Role of Capital Accumulation in
Sustainable Development
 Sustainable development then requires the
maintenance of a certain stock of
environmental capital, plus growth in other
types of capital.
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Environmental Taxation and
Macroeconomic Benefits
 Would macroeconomic benefits arise if the revenue
associated with an environmental tax was used to
reduce the level of income tax?
 Some argue that there would be a “double dividend”.
 The correction of a market failure associated with
pollution externalities.
 The reduction of the market distortion in the labor market
created by an income tax.
 Environmental taxes penalize something bad for
society while income taxes penalize something that
is good for society (people working).
 The existence of a double dividend of environmental
taxation is the subject of significant debate.
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The Environment and International
Economic Issues
 There are several significant issues
intertwined with international economic
issues. These include:
The global public good nature of environmental
resources,
Transfrontier pollution,
The effect of environmental policy on international
competitiveness, and
The effect of international trade policy on
environmental quality.
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Global Public Goods
 Environmental resources in one country generate
public good benefits for people in other countries, or
environmental resources span the borders of several
countries.
 Examples include rain forest and wetlands, which
create public good benefits for citizens in other
countries and oceans and aquifers, which span
international borders.
 Global public goods result in an international
separation between those who benefit from
environmental resources and those that bear the
costs of preserving those resources.
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Global Public Goods
 Global optimality in preservation of these
environmental resources cannot be
generated without an international
agreement.
 The difficulty is that lower-income countries
bear the cost of preserving the resources
and higher income countries receive the
benefits.
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Transfrontier Pollution
 Transfrontier pollution is pollution generated
in one political jurisdiction that creates
damages in another political jurisdiction.
 The country that generates the pollution
does not consider all the social costs when
devising environmental policy, because
some of the social costs are borne by other
countries.
 International negotiations must be
conducted in order to generate the
appropriate level of emissions.
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Globalization, International Trade and the
Environment
 In recent years the movement towards more
free trade and the “globalization” of
economic activity has been under assault by
critics.
 Increasing trade has both positive and
negative effects on the environment and it is
difficult to ascertain which effects will
dominate.
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Globalization, International Trade and the
Environment
 Potential impacts of increasing trade include:
 If increased trade increases economic activity, holding
everything else constant, the increased activity will be
associated with greater emissions of pollution.
 Increased trade and increased income can give a country
a greater ability to switch to cleaner technologies.
 An increase in trade may change patterns of economic
activity and change the mix of economic activity. The
new mix can be either cleaner or more polluting.
 Elimination of trade barriers may sweep away important
environmental regulations.
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The Impact of International Trade Policy
on the Environment and Environmental
Policy
 A key provision of the General Agreement on
Tariffs and Trade (GATT) is a feature
designed to keep countries from developing
artificial barriers to trade, which many
activists believe prohibits discrimination on
environmental grounds.
 Article XX “authorized deviation from any
GATT doctrines for measures ‘necessary to
protect human, animal or plant life or health’
(XXb) or ‘relating to the conservation of
exhaustible resources’ (XXg).”
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The Impact of International Trade Policy
on the Environment and Environmental
Policy
 The Appellate Body of the Dispute Resolution
Understanding (WTO) has begun to develop a set of
precedents related to trade-environment issues.
 A series of precedents have been used.
 The Tuna-Dolphin dispute between the US and
Mexico involved a situation where the US
implemented an embargo against Mexican tuna
charging that Mexico was not taking sufficient steps
to protect dolphins in the harvest tuna. The WTO
ruled against the US.
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The Impact of International Trade Policy
on the Environment and Environmental
Policy
 In a separate dispute, shrimp exporting countries
charged the US with unfair exclusion because the US
placed an embargo on the importation of shrimp that
were harvested in a fashion that led to sea turtle
mortality.
 The Appellate Body recognized that the protection of
sea turtles anywhere in the world represents a
legitimate environmental concern.
 After an initial ruling against the US, US policy was
modified and the basic structure of the embargo was
accepted as legitimate.
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NAFTA, Trade and the North American
Environment
 There has been much discussion about the potential
effect of NAFTA on environmental quality in the US
and Mexico.
 The primary fear has been that NAFTA would lead to
relocation of industry, lost jobs in the US and
increased pollution in Mexico.
 Ten years after implementation of NAFTA, the worst
fears have not come to pass.
 The implementation process say trade and
environment woven together in an integrated policy,
with US responsibility shared between the office of
the US Trade Representative and the US EPA.
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Summary
 Both microeconomic and macroeconomic
methodologies are important in helping to guide the
development of environmental policy.
 Environmental policy can have both negative and
positive impacts on the economy.
 Previous models have concluded increasing
environmental quality will have a negative impact on
the economy, but these failed to include potential
positive impacts.
 While macroeconomic policies are important, they
should not be the only determinant of environmental
policy.
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