Economic Analysis & Tools PDF

BLUE UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES DR. DENIS BOISSIN CHAPTER 2 Economic Analysis & Tools  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.1 Understanding the Value of...

BLUE UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES DR. DENIS BOISSIN CHAPTER 2 Economic Analysis & Tools  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.1 Understanding the Value of Environmental Resources ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs & Benefits Individuals have preferences, leading to a hierarchy of choices among goods/services expressed through value what a person is willing/able to sacrifice for one thing = willingness to pay (WTP) ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs & Benefits Ability to pay relies on individual values but also individual’s wealth Diminishing willingness to pay the willingness to pay decreases with the number of units consumed/owned ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources An individual’s WTP is more familiarly expressed through demand curves (price as a function of quantity) which are different for different products and may be parallel or crossing elasticity reflects this difference, and the sensitivity to price changes of a good The aggregate demand curve of a good is simply the summation of individuals’ demand curves ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources price de ma nd qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs & Benefits What about the benefits from buying those goods/services? Economics uses a technical definition of benefits given by what people are willing to pay The more you value something, the more benefits we can consider it brings you Benefits are measured by willingness to pay identified by the area below the demand curve ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources price de ma nd WTP qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs & Benefits But not all benefits can be measured by monetary value The willingness to pay is affected by the ability to pay which brings us back to the question of equity… The total economic value of environmental assets is made of: – the USE value – the OPTION value – the EXISTENCE value ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources the USE value the value people derive from direct use of the good as opposed to NON-USE value: the value people assign to goods, even if they never have and never will use them : the OPTION value value placed for maintaining a good based on uncertainty about future supply and potential future demand even if there is little (or no) likelihood of ever using it the EXISTENCE value value placed on knowing that a particular good exists ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Other non-use values the BEQUEST value value placed on a good that has no use today, so that it is available for future generations the ALTRUISTIC value value placed on a good for which people have no use, so that it can be used by other people ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Pricing When no market exists, we can use surveys to have individuals express how much they would be willing to pay Contingent valuations may use bidding games, direct questioning, trade-off games, priority evaluation Revealed preference methods use Travel Cost Method or Hedonic Price Method ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Benefits are affected by how much you know about something … if you even know about its existence! This goes both ways : – giving a higher value to aspects you ignore – reducing the value from learning about risks or impacts ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Communication/Education From the free-trial application in business to advertisings about sustainable development, it explains the importance of communication/education but we scientifically do not know the true value of most environmental goods and services and/or of environmental degradation ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs On the other side, costs must also be considered The common meaning of costs includes necessary resources traded on markets, including labor… But the economic consideration of costs is wider Opportunity Cost the cost of producing something includes what could have been produced if the productive inputs had not been used in this production ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs the opportunity cost of producing something consists of the maximum value of other outputs we could (and would) have produced had we not used the resources to produce the item in question in practice, opportunity costs are measured by the market value of inputs used in production: all costs must be considered, including those not paid in practice, and those that have no real market the case for most environmental goods/services ! ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs An important distinction exists between private and social costs private costs are experienced by the party making the decisions social costs are all costs, no matter who experiences them they include private costs social costs = private costs + external costs we build marginal and total costs curves that determine total production costs acting as a supply curve ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs $ qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs Costs are influenced by the technology used, the price/value of inputs, time… The most important factor affecting shape of marginal costs function is the technology of the production process Technological progress shifts curves downwards thanks to reduced environmental impact and improved efficiency ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs $ qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs $ ca cb cb < ca qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs $ qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Costs $ qb > qa qa qb qty ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process if you have multiple sources of production (or to achieve a goal), in order to minimize the total cost for a given quantity of output you should distribute production among sources as to equalize marginal costs ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process 12 8 50 50 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process 9 38 62 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process 12 9 8 38 50 50 62 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process 12 c 9 8 a b d e 38 50 50 62 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process 12 c 9 8 a b d e 38 50 50 62 Total cost goes from a+b+c+d to a+d+e ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Understanding the Value of Environmental Resources Equimarginal process This is valuable when aiming for maximum emissions reductions For a given amount of resources, to maximize the total amount produced you should distribute total production among sources as to equalize marginal costs For a given amount of goods, to minimize the total amount of goods consumed and emissions, you should distribute total production among sources as to equalize marginal costs  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.2 Efficiency & Integration of Environmental Markets ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? Under the hypothesis of a competitive markets, where actors behave as "price-takers”, considering no cost of pollution and no regulation… what quantity of pollution/production maximizes profit ? ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? € Pm =m ar gin al p ro f it ymax y ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? € t cos l r na x te ale rgin a = m Ec m y ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? € Pm EC m y* is therefore the optimal quantity of pollution that maximizes the well-being y* ymax y ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? Environmental regulations objective is to set marginal benefits equal to marginal costs so that the social situation is Pareto optimal The goal is not to eliminate all pollution, but to reach the optimal level of pollution if by polluting you increase the social well-being, then pollution is justified as long as the benefits of production exceed the social cost of pollution ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? In a “perfect” world, the supply-demand equilibrium would be identical to the MWTP-MC equilibrium but when environmental values are concerned, there are substantial differences between market values and social values : mostly on the marginal cost evaluation, especially due to externalities (external costs and external benefits) They constitute the market failures that call for public intervention ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? Can this optimal situation occur spontaneously? Can polluted and polluters agree without public intervention? ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets What is the optimal level of pollution? € Pm EC m If the polluter has the rights (2), then the polluted is ready to pay to reach y* 1 2 If the polluted has the rights (1), the polluter is ready to pay to reach y* y* ymax y ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets Coase Theorem According to Coase, whatever the initial distribution of rights, in the absence of transaction costs, the economic equilibrium reached is optimal ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets Coase Theorem The initial allocation of property rights is neutral in terms of results on the well-being reached but it is not in terms of who supports the costs, and who gets the benefits, in terms of the morality of the way to reach this optimal situation ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets € Pm EC m A F B E C D y* ymax y ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets If the polluter has the rights benefits of polluted = ( D + E + F ) – ( D + E ) = F benefits of polluter = ( A + B + C ) + ( D + E ) If the polluted has the rights benefits of polluter = ( A + B + C ) – ( B + C ) = A benefits of polluted = ( D + E + F ) + ( B + C ) Yet the net balance in both cases is A + B + C + D + E + F ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets Optimum Pure and perfect competition allows to reach Pareto optimum but in presence of externalities, the optimum is not reached: a polluter could produce less and therefore pollute less, if victims of pollution compensated the polluter The ethics of such a solution is questionable, yet leads to a better solution for all agents… ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets Optimum When nature can be divided into separate properties that are individually owned, the owners have an incentive to use the property carefully so that they can continue to use it in the future When nature cannot be so divided and many people use the resource together, issues can arise. Resources used by multiple users without rules governing their use will tend to be overexploited ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets Can we yet expect a voluntary restoration of the environment ? ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Efficiency & Integration of Environmental Markets Voluntary restoration of the environment Consider 2 polluters who own a common polluted lake Each has an initial capital of 500 Each attributes a value of 300 to a clean lake If only half the lake is depolluted, the value is 150 The individual cost of depollution is 200 1. Is it socially desirable to depollute the lake ? 2. What is the rational decision of agents ? We conclude that the market left to itself is likely to malfunction and therefore requires public intervention  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.3 Environmental Policy Analysis ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Policy questions include: identifying the level of quality of the environment desired identifying the costs of meeting those goals distributing the costs and the benefits ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Policy questions include: identifying the level of quality of the environment desired (science) identifying the costs of meeting those goals (economics) distributing the costs and the benefits (social choice) ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Policy questions include: identifying the level of quality of the environment desired (science) identifying the costs of meeting those goals (economics) distributing the costs and the benefits (social choice) Keep in mind that an effective policy relies on good information: complete and exact, “perfect ” ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Benefit/Cost Analysis (BCA) To evaluate the desirability of potential actions, we compare the gains and losses from that action If B/C > 1, the decision is to support the action This is very similar in philosophy to a profit-and-loss analysis for a private company though decisions are considered from the standpoint of society and regard non-market outputs ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis BCA BCA involves comparing all of the benefits and all of the costs of a particular public project or program Public environmental programs can be physical projects involving direct public production or regulatory programs aimed at enforcing environmental laws ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis BCA The BCA has no consideration of distribution of costs and benefits: who pays the costs may not be who gets the benefits… In policy-design, distributional matters must be considered along with efficiency issues there are 2 main types of equity : – horizontal – among similar people – vertical – among different people ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis BCA 4 steps : 1. Clearly specify the project/program 2. Describe quantitatively the inputs and outputs of the program 3. Estimate the social costs and benefits of these inputs and outputs 4. Compare these benefits and costs ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Benefit assessment Benefits may be evaluated through the reduced damages the new policy would produce Damages are usually equal to the lesser of the lost value of the resource or the value of restoring the resource though restoration is morally preferred (cf. burnt forests) Benefits can also be valued through costs avoided Yet the main way to value benefits is through the WTP ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Cost assessment Costs are to be estimated through the with/without principle and not the before/after principle We compare costs polluters would have with the new regulation with respect to what their costs would have been in the absence of the policy costs to polluters will generally comprise investment costs and annualized costs : most of these costs are private information, making it difficult to identify exactly ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Enforcement Costs the resources necessary to enforce a new policy should not be forgotten some of those costs are private (bookkeeping, reports, measures…) but most are public ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Cost-effectiveness analysis estimates of the costs of different alternatives with respect to the objective should be considered the cost-effectiveness of different projects to reduce NOx emissions in South Cal. went from 0.38 to 74.52 $/lb ! ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis BCA While benefits are often underestimated, costs are often overestimated To compare costs and benefits that occur at very different points in time, values have to incorporate time through discounting Be careful : an efficient program does not aim at maximizing the benefit-cost ratio ! ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Stern Review on the Economics of Climate Change “There is still time to avoid the worst impacts of climate change, if we take strong action now.” Sir Nicholas Stern (LSE), Head of the U.K. Government Economic Service and Adviser to the Government on the economics of climate change and development 700-page report published on October 2006 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Stern Review on the Economics of Climate Change “This Review has assessed a wide range of evidence on the impacts of climate change and on the economic costs, and has used a number of different techniques to assess costs and risks. From all of these perspectives, the evidence gathered by the Review leads to a simple conclusion: the benefits of strong and early action far outweigh the economic costs of not acting.” ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Stern Review on the Economics of Climate Change “Using the results from formal economic models, the Review estimates that if we don’t act, the overall costs and risks of climate change will be equivalent to losing at least 5% of global GDP each year, now and forever. If a wider range of risks and impacts is taken into account, the estimates of damage could rise to 20% of GDP or more. In contrast, the costs of action (…) can be limited to around 1% of global GDP each year.” ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Stern Review on the Economics of Climate Change The Review considers the economic costs of the impacts of CC, and the costs and benefits of action to reduce emissions of GHGs in three different ways: Using disaggregated techniques considering the physical impacts of climate change on the economy, on human life and on the environment Using economic models, including integrated assessment models that estimate the economic impacts of climate change, and macro-economic models that represent the costs and effects of the transition Using comparisons of the current level and future trajectories of the ‘social cost of carbon’ with the marginal abatement cost ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Stern Review on the Economics of Climate Change This constitutes the most extended and complete attempt of a BCA of climate change 54-pages paper on the identification of the discounting method and discount rates used only… ċ ρ=η +δ c ρ = discount rate η = elasticity of the marginal utility of consumption ċ/c = growth rate of consumption along the path δ = pure time discount rate ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Environmental Policy Analysis Stern Review on the Economics of Climate Change “Climate change presents a unique challenge for economics: it is the greatest and widest-ranging market failure ever seen.” some economists have criticized the method, some have supported it, some have made critical reviews but admitted that the final results should be acceptable (with strong critics from ecological economists) not to mention those challenging the scientific background of CC and the difficulty of addressing uncertainty NB: Stern reviewed the cost to 2% in 2008, and temperature rise to 4°C in 2012  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.4 Environmental Policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES ENVIRONMENTAL POLICIES Public policies are designed to change the way society behaves, on both production and consumption sides, so that the actual level of environmental quality becomes the socially desired optimal level ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES ENVIRONMENTAL POLICIES Public policies 3 public policy approaches are possible : Decentralized policies Command-and-control policies Incentive-based policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES ENVIRONMENTAL POLICIES Public policies 3 public policy approaches are possible : Decentralized policies liability laws, property rights changes, voluntary initiatives… Command-and-control policies Incentive-based policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES ENVIRONMENTAL POLICIES Public policies 3 public policy approaches are possible : Decentralized policies liability laws, property rights changes, voluntary initiatives… Command-and-control policies standards, norms… Incentive-based policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES ENVIRONMENTAL POLICIES Public policies 3 public policy approaches are possible : Decentralized policies liability laws, property rights changes, voluntary initiatives… Command-and-control policies standards, norms… Incentive-based policies taxes, subsidies, transferable permits… ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES ENVIRONMENTAL POLICIES Public policies 3 public policy approaches are possible : Decentralized policies liability laws, property rights changes, voluntary initiatives… Command-and-control policies standards, norms… Incentive-based policies taxes, subsidies, transferable permits… environmental policies are positioned on a continuum from centralized to decentralized approaches new approaches may mix them and there is still room for innovative approaches  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.4 Environmental Policies 2.4.1 Decentralized policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies They refer to policies where agents involved are encouraged to “work it out themselves” Advantages since the parties involved produce and suffer the externalities, they have strong incentives to find solutions the agents involved have the best knowledge of damages and abatement costs, and can therefore find the most efficient solutions ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies LIABILITY LAWS agents are held responsible for the consequences of their behavior so that they may compensate for the damages they cause in amounts appropriate to the extent of the injury these regulations make polluters liable for the damages they cause the purpose is not to establish a compensation, but to encourage more careful decisions and changes of behavior it’s a way to internalize the externalities in the decision-making process ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies LIABILITY LAWS – COMMON LAW common law systems rely on court proceedings in which plaintiffs and defendants meet to make claims and counterclaims for juries to decide on compensation and amounts they build on precedents, and most of the time involve private parties they require burden of proof : to establish a direct causal link between the pollution and the damage show that the pollutant is the cause of the damage show that the pollutant came from the specific defendant they can distinguish strict liability from negligence but require that people have legal standing to proceed ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies LIABILITY LAWS – STATUTORY LAW written regulations passed by public agents (governments, cities…) they address mostly public issues, but tend to be decided after problems are faced they aim at standardized maximum compensations to cover all possible damages that act as sufficient incentives to encourage a change of behavior ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies LIABILITY LAWS – PROPERTY RIGHTS as the Coase theorem demonstrated, if property rights over environmental assets are clearly defined, and bargaining among owners and prospective users allowed, the efficient level of impact will result, irrespectively of the initial allocation of property rights Defining private property rights (not necessarily individual) can establish the conditions under which decentralized bargaining can produce efficient levels of environmental quality ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies VOLUNTARY ACTIONS Agents engage in pollution-control behaviors in the absence of any formal or legal obligation to do so : voluntary labels, certifications, rankings, listings… Despite the lack of market-driven incentive, there are various social forces in operation for these programs to be effective such as moral suasion, informal community pressure… ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies VOLUNTARY ACTIONS – MORAL SUASION appeals to morality in order to influence/change behaviors in the absence of regulation it presents the potential of having widespread spillover effects but different persons react differently to moral arguments it is flexible, it allows to react quickly and it can prepare the institution of future policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies VOLUNTARY ACTIONS – NUDGES Homo oeconomicus does not exist, our rationality is limited Nudges take benefit from a less conscious dimension of your brain : our instinctive/emotional reactions generate cognitive biases which translate into non-optimal behaviours ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies VOLUNTARY ACTIONS – NUDGES Nudges put our biases to the profit of desired behaviours “A nudge (…) is any aspect of the choice architecture that alters people's behavior in a predictable way without forbidding any options or significantly changing their economic incentives. To count as a mere nudge, the intervention must be easy and cheap to avoid.” Thaler & Sunstein, 2008 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies VOLUNTARY ACTIONS – NUDGES Nudges can use : salience : relying on limited attention span simplification : minimize cognitive efforts social norms : use example of peers concretization : immediate materialization of consequences gamification : use game mechanics inertia : use natural preference for statu quo perception bias : use optical illusions And many more !!!! ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Decentralized Policies VOLUNTARY ACTIONS – INFORMAL COMMUNITY PRESSURE This pressure is informal, in the sense that it does not rely on regulations, and is created through the infliction of costs: loss of reputation, loss of markets, loss of value through activities of citizens, media… it relies on information available  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.4 Environmental Policies 2.4.2 Command-and-control policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies Command-and-control (CAC) approaches are those where political authorities mandate the behavior through enforcement to obtain a socially desirable behavior In the case of environmental policy, it relies mostly on standards : standards are mandated levels of performance enforced in law (e.g. speed limits) ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies STANDARDS the optimal level of emissions becomes a mandated upper limit and this standard is enforced with the necessary authorities to measure and detect violations They are popular: simple, direct, clear… and negotiable! (in value and time) They fit the common ethical sense of a limit not to go over, a boundary between legal and illegal ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies STANDARDS But they are far from being the most efficient, both in the compliance and in the enforcement cost and not as clear as one might think! There are 3 main types of standards: Ambient standards Emission standards Technology standards ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies STANDARDS But they are far from being the most efficient, both in the compliance and in the enforcement cost and not as clear as one might think! There are 3 main types of standards: Ambient standards never-exceed levels of pollutants in the ambient environment Emission standards Technology standards ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies STANDARDS But they are far from being the most efficient, both in the compliance and in the enforcement cost and not as clear as one might think! There are 3 main types of standards: Ambient standards never-exceed levels of pollutants in the ambient environment Emission standards never-exceed levels applied directly to emissions per pollution sources Technology standards ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies STANDARDS But they are far from being the most efficient, both in the compliance and in the enforcement cost and not as clear as one might think! There are 3 main types of standards: Ambient standards never-exceed levels of pollutants in the ambient environment Emission standards never-exceed levels applied directly to emissions per pollution sources Technology standards specify the technologies/techniques/practices potential polluters must adopt ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Command-and-Control Policies STANDARDS Ambient standards cannot be enforced directly and linked to specific emissions Emission standards do not affect the number of sources, and therefore the ambient level Technology standards leave no freedom of choice of the way to reduce emissions, lock-in society to specific technologies, do not encourage innovation standards are usually used in combination for a single issue standards seem to give control to regulators, but are more complicated than it may sound…  UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES 2. ECONOMIC ANALYSIS & TOOLS 2.4 Environmental Policies 2.4.3 Incentive-based policies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Incentive-based policies are designed to rectify the drawbacks of standards of treating all sources alike, of locking-in certain technologies and of facing private information Public authorities set overall objectives and rules, and then leave firms enough latitude that their commercial incentives will lead to the adoption of cost-effective pollution-control procedures and technologies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies They are favored by environmental economists : they integrate externalities into markets they lead to cost-effective solutions Yet, despite their significant strengths, they also have weaknesses and there are environmental issues where they may not be as useful as other approaches ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies There are basically 2 types of incentive policies : taxes and subsidies transferable emission permits Both require a centralized policy structure and rely on flexible responses to attain efficient pollution control ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies There are basically 2 types of incentive policies : taxes and subsidies modify the price environmental services transferable emission permits Both require a centralized policy structure and rely on flexible responses to attain efficient pollution control ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies There are basically 2 types of incentive policies : taxes and subsidies modify the price environmental services transferable emission permits create markets for non-market goods and services that allow for interaction among stakeholders Both require a centralized policy structure and rely on flexible responses to attain efficient pollution control ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes & Subsidies the straightforward approach to controlling emissions is to send a price-signal either by : “charging a price” for emissions = taxes “paying for” emission cuts = subsidies ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Pigouvian tax An amount to be paid for every unit emitted The tax is set at the optimal marginal cost, so that the optimal level of emissions is reached If your marginal cost of depollution is below the tax, it is more interesting to depollute than to pay the tax, else you pay the tax ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Pigouvian tax emission taxes or emission charges : “you pay a fixed for every unit of emission” polluters are left to decide of the best way to reduce emissions to reach the point where the marginal cost of additional reductions equals the value of the tax it minimizes the total cost associated and relies in this way on competitive pressure that are already present on markets ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t* emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t A emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t A B emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes provide an incentive for polluters to use the private information they have to find the best way to reduce emissions: internal process changes, inputs changes, recycling, technology changes, emission reduction… the amount of response varies for each competitive firm ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t TOTAL BENEFIT emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M net t benefit emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t tax cost compliance cost emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t tax cost emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € M D AC M t extra-cost “justified” emissions e* ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes control multiple sources of emission in a way that satisfies the equimarginal principle each source reduces its emissions until its own marginal abatement cost equals the charge of the tax and that even though the administering agency knows nothing about the MAC of any of the sources (private information) ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € taxes provide a strong incentive for technological change M AC current technology 1 MA C2 innovative technology t emissions e2 e1 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € taxes provide a strong incentive for technological change M AC 1 MA C2 t b d a c e emissions e2 e1 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes € taxes provide a strong incentive for technological change Cost before R&D (MAC1) M = tax (a+b+c) + compliance (d+e) AC 1 Cost after R&D (MAC2) MA = tax (a) + compliance (c+e) C2 t R&D incentive = b + d b d a c e emissions e2 e1 ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes for emissions to be taxed, they must be measurable at a reasonable cost this rules out non-point source emissions and diffuse pollutants as well as very low quantities unless permanent monitoring technology is available, it relies on declarative values and periodic audits taxes are most often applied on production, easier to monitor than emissions, which reduces the interest for firms to seek innovative solutions that reduce per capita emissions NB: a better alternative is to tax intrants, resources used ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes generate 2 primary impacts on the distribution of wealth: impact on prices and output of goods and services effects from the expenditure of tax funds generated ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes generate 2 primary impacts on the distribution of wealth: impact on prices and output of goods and services the tax generates an extra cost of production to firms passed on to consumers, affecting the Pareto optimal supply-demand equilibrium effects from the expenditure of tax funds generated ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes generate 2 primary impacts on the distribution of wealth: impact on prices and output of goods and services the tax generates an extra cost of production to firms passed on to consumers, affecting the Pareto optimal supply-demand equilibrium effects from the expenditure of tax funds generated those funds should be used for unrelated issues, which could be other environmental initiatives, to avoid any lowering of the marginal emissions tax rate that would be counter-productive ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes among modern consideration, it could be possible to imagine a set level of tax-free emissions to reduce the over-load cost to firms taxes could also be non-uniform to adapt to firms whose emissions are geographically or temporally distant from the affected agents ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Subsidies a public authority would pay a polluter a certain amount per unit of emissions reduced this creates an economic opportunity cost the principle is very similar to a tax, though in “reverse mode”, transforming tax costs into subsidies revenues ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Subsidies € M D AC M s emissions e* e ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Subsidies € M D AC M t TOTAL BENEFIT emissions e* e ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Subsidies € M D AC M net profit s emissions e* e ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Subsidies € M D AC M net profit s extra-benefit compliance cost covered emissions e* e ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Subsidies taxes represent a “polluter pays” approach, while subsidies are a “polluter paid” approach, which is morally less accepted subsidies are not uniform across competitors and result in a competitive advantage which is unfair and unbalances market competitions subsidies can efficiently reduce emissions per firm but do not prevent increase in number of firms especially since it’s making the industry more attractive! ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Taxes and subsidies Both require an intervention from states The optimal situation is reached, but with extra costs, either for producers or consumers deposit-refund systems come back into consideration: they act as a combination of a tax (deposit) and a subsidy (refund) similarly to the French car bonus/malus mentioned in the introduction ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits once an optimal of pollution is identified, it is divided into shares (permits or allowances) and allocated as quotas among polluters who can then use those rights to pollute, as well buy more or sell some in a market according to their actual emissions also called Markets of Rights ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits Those who can avoid pollution at the lowest costs will therefore be encouraged to pollute less in order to sell shares to those whose costs for depolluting are too high since they can generate an additional profit From an economic perspective : the optimal value of pollution is emitted, without unnecessary impacts on producers or consumers, and while minimizing the costs at which pollution is avoided ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits The value at which shares are traded appears as a price determined by the supply and demand of shares of pollution: this is a free market approach that internalizes the externalities The economic basis for providing flexibility is that the marginal cost of reducing emissions differs : flexibility mechanisms reduce the overall cost through the equimarginal principle This is both an incentive-based and a decentralized approach the price is dynamic, as opposed to the tax, and can therefore increase or decrease this incentive ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits There are in reality 2 types of permit trading plans: Credit trading (CRE) programs Cap-and-trade (CAP) programs ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits There are in reality 2 types of permit trading plans: Credit trading (CRE) programs allow firms to sell credits they create by reducing their emissions more than required by existing regulations This compensates the lack of innovation-incentive previously mentioned for standards, norms… those available permits do not allow other firms not to respect regulations: they are available for expansions or new entrants, a reduced number of buyers but a reduction of barriers to entry Cap-and-trade (CAP) programs ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits There are in reality 2 types of permit trading plans: Credit trading (CRE) programs Cap-and-trade (CAP) programs rely on a centralized decision on the aggregate optimal quantity of emissions resulting in permits distributed among sources If the total is less than the current level of emissions, some/all emitters receive fewer permits than needed creating a demand ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits They require a structure to set-up and manage the market (transaction costs) and to control the respect of emissions (control number of permits and quantity of emissions) enforcement costs are not to be neglected but lower than 1-to-1 relations between emitters and government for monitoring and collection of taxes ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits Many questions are raised : How do you allocate the initial quotas? How much? At what cost? How? Who? … ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits Do you give the same number to each competitor? but they may not be of the same size at all… Do you give a number based on current emissions? this does not recognize firms that invested in emission reduction… Is it fair to give them for free? they will instantly have a market-value… Is it fair to sell them? why pay now when it was free before? Usually a grandfathering mechanism with free allocation is common, but auctioning is possible as well give some for free, auction the rest… ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits Who is concerned ? Polluters only, investors, or open to civil society? Do you allow environmental advocacy groups to buy permits and retire them from the market? ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits Who is concerned ? Polluters only, investors, or open to civil society? Do you allow environmental advocacy groups to buy permits and retire them from the market? You should not for 2 reasons: It prevents you from reaching the optimal level of pollution They may buy them at a price that exceeds the true social willingness-to-pay ECONOMIC ANALYSIS & TOOLS UNIVERSITÉ CÔTE D’AZUR | MSC. MARRES Incentive-based Policies Transferable Emission Permits Markets of rights also bring many issues… From an ethical point of view, polluters are given the right to pollute The mechanism encourages society to reach the optimal level of pollution, not to perform better It sets barriers to entry of new competitors in market, as they have to buy all quotas, that may have been given for free at first…