Natural Resources and Climate Change PDF

Natural Resources and Climate Change Chapter 1: How do economists think about the environment? (Part II) Ariane SALEM September 24, 2024 Contents 1 The interplay between the environment and the economy Environmental services and economic activity Environmental crises S...

Natural Resources and Climate Change Chapter 1: How do economists think about the environment? (Part II) Ariane SALEM September 24, 2024 Contents 1 The interplay between the environment and the economy Environmental services and economic activity Environmental crises Setting a direction 2 History of environmental economics thought The environment at the service of the economy Interdependance of the economy and the environment 3 The economic nature of environmental goods and services History of environmental economics thought Intro Triple concern of efficiency, sustainability and justice has been present in classical economic thought for quite a long time. But with economic growth settling in the long-run (19th ), concern for efficiency overtook the two others. Market-based tools developed by neoclassical economists continue to prevail in environmental economics where most of public actions are about addressing market failures and restoring efficiency. Confronted to current challenges such as climate change where the scale of economy and not its efficiency seems to be the issue, their approach of environmental issues has been challenged and adapted. Triple concern of ecological economics sustainable scale, fair distribution,and efficient allocation (Costanza). 2 Physiocrats: the government of Nature 1750 to French Revolution, belongs to Enlightenment heritage Economy: “government of Nature” based on two principles Governed by natural laws (freedom and property right) control of natural resources (agriculture) generates wealth hence political power First economic liberals: no government intervention needed as economy regulated by natural laws Physiocrats help us to understand the link between natural resources and political power I Ex: French Revolution as first social-ecological conflict of modern history. For Leroy-Ladurie climatic context preceding 1789 (bad weather impacting crops and bread production) may have contributed to foster social unrest Translate this to today’s context of geopolitical struggles over rare earths, minerals, and fossil fuels. 3 Transhumant pastoralism, climate change and conflicts 4 Classical economists: nature’s limits to growth Mid-18th : industrial revolution in Europe. Classical economists are interested in: Source of nations’ wealth? Land (or natural resources in general) Necessary input to production but limited availability Ricardo: various land quality → diminishing return → differential rent on most fertile lands. ⇒ Economic growth is transitory, stationary state is the horizon ⇒ Globalization or technological progress can delay stationary state Mill: finality of economic growth if inevitably threats Earth’s “pleasantness”? In stationary state, humans have the ability to find a new path of “human improvement” where their conquest over nature “become the common property of the species, and the means of improving and elevating the universal lot”. Appropriate institutional arrangements for the develoment of trade and growth? Belief in the efficacy of the market to allocate resources efficiently (Smith and the “invisible hand”) ⇒ fundamental prescription of modern economics, including resource and environmental economics 5 Mill and the amenity value of nature “Those who do not accept the present very early perforce at all times in the presence of his stage of human improvement as its ultimate type species(...) Nor is there much satisfaction in may be excused for being comparatively indifferent contemplating the world with nothing left to the to the kind of economic progress which excites the spontaneous activity of nature: with every rood of congratulations of ordinary politicians: the mere land brought into cultivation, which is capable of increase of production(...) It is only in the growing food for human beings; every flowery backward countries of the world that increased waste or natural pasture ploughed up, all production is still an important object; in those quadrupeds or birds which are not domesticated most advanced, what is needed is a better for man’s use exterminated as his rivals for food, distribution(...) There is room in the world, no every hedgerow or superfluous tree rooted out, and doubt, and even in old countries, for a great scarcely a place left where a wild shrub or flower increase in population, supposing the arts of life to could grow without being eradicated as a weed in go on improving, and capital to increase. But even the name of improved agriculture. If the earth if innocuous, I confess I see very little reason for must lose that great portion of its pleasantness desiring it. The density of population necessary to which it owes to things that the unlimited increase enable mankind to obtain, in the greatest degree, of wealth and population would extirpate from it, all of the advantages both of cooperation and of for the mere purpose of enabling it to support a social intercourse, has, in all the most populous larger, but not a happier or better population, I countries, been attained. A population may be too sincerely hope, for the sake of posterity, that they crowded, though all be amply supplied with food will be content to be stationary long before and raiment. It is not good for man to be kept necessity compels them to it.” Mill (1857), Book IV 6 Lessons from Malthus’ prophecy Rd Malthus principle of population (1798) Pop. growth > resource growth → desynchronization leading to subsistence crises In fact, population and well-being grew together with the advent of the industrial and agricultural revolutions Yet, another threatening desynchronization emerged in the 20th century: CO2 emissions and well-being. Increase in GDP and human development From the 50’s, while human development masks environmental degradation leading paces down and follows pop growth, GDP, eventually to ecological crises resource extraction, and CO2 emissions are Climate change is already curbing racing. well-being in parts of the world. Note : base 1 in 1900. The New Environmental Economics, Laurent, 2020 7 Climate change curbs economic growth Burke, Hsiang, Miguel, in Nature (2015): Relationship between productivity and temperature? Evidence so far : At micro level, strong response of output to temperature. Not apparent at macro level for wealthy countries. Substitution between man-made and natural capital? Non-linear response of productivity? GDP and year temperature of 166 countries over 1960–2010 analysed in panel Non-linear response of productivity to local temperatures in rich and poor countries Reduce average global incomes by 23% by 2100 and widen global income inequality, compared to absence of climate change Source: Burke & al. 2015 8 Uneven impact on well-being of climate change Consequences of climatic risk are unevenly distributed and exacerbate inequalities: Distribution of economic consequences of climatic risk exacerbates territorial inequalities (Hsiang et al., 2017) Mortality risk related to climate change mainly bore by countries in the South Carleton et al. (2020) Disasters trigger in the US outmigration from richest districts (Boustan et al. 2020) CC-related gain and loss of GDP per CC-related mortality risk per country country Source: Carleton et al. (2020), Climate Source: Burke & al. 2015 Impact Lab 9 Neoclassical economists: a theory of exchange Value is determined by exchange and not labour or land embodied in output. Exchange reflects preferences (demand) and costs of production (supply). Foundation of microeconomics: emphasis on the structure of economic activity – its allocative efficiency – rather than on its aggregate level. ⇒ paved the way to the development of welfare economics Resurgence of growth models in the mid-20th century. Introduction of natural resources in production function only in the 70’s with concern of efficient and optimal depletion of resources. ⇒ Emergence of natural resource economics 10 Welfare economics: efficient and optimal allocations How to rank alternative allocations? Which are socially desirable? Ranking possible only under ethical criterion. Classical and neoclassical derives from the utilitarian philosophy: Social welfare aggregates utilities enjoyed by all individuals and firms of a society. What’s an efficient allocation? a situation in which one cannot improve one’s utility without worsening another’s utility. What institutional setting can attain allocative efficiency? Free and competitive markets. Rely on stringent conditions. When they don’t hold: market failure. Externality is one of them → when the action of one person makes another better or worsen off. I Pollution is a particular example. First systematic analysis of pollution and of appropriate policy response is made by Pigou (1920) with the “polluter pay principle”. Welfare economics laid the foundation of environmental economics, most of which is about restoring economic efficiency by dealing with market failures, specifically externalities. 11 From sustainable development to ecological economics 70’s: first oil shock. Bring attention to the Limits to Growth Concept of sustainability emerges (Brundtland report 1987): triple pilars of development (economic, environment and social) 12 From sustainable development to ecological economics 70’s: first oil shock. Bring attention to the Limits to Growth Concept of sustainability emerges (Brundtland report 1987): triple pilars of development (economic, environment and social) Ecological economics appears from a reflexion between economists and natural scientists as a solution to the sustainability probem which resides in the interdependence of the economy and the environment Economy part of a larger system, the environment, implying that economy abides by physical law of thermodynamics Kenneth Boulding, founding father of ecological econ, writes in 1966: change is required from cowboy economy (limitless planet) to spaceman economy (earth as a single spaceship or closed system) Change of paradigm: economic performance best measured by the level of capital stock (natural but also human) rather than by magnitude of material flow (GDP) 12 Ecological economics 13 The economic nature of environmental goods and services Welfarist framework Efficiency in allocation: “An allocation of resources is said to be efficient if it is not possible to make one or more persons better off without making at least one other person worse off.” (Perman et al) Resulting allocation is Pareto-efficient or Pareto-optimal. When an allocation results in gains for one person, without loss for the others, it is Pareto-improving. Efficiency in allocation requires three efficiency conditions: 1 efficiency in consumption I Marginal rate of utility substitution (MRUS) must be equalized 2 efficiency in production I Marginal rate of technical substitution must be equalized 3 product-mix efficiency I MRS must be equal to marginal rate of transformation 14 An efficient allocation of resources is not unique For a society with given resources and given production and utility functions, there will multiple efficient allocations. Efficiency criterion is not enough to identify a particular allocation. The utility possibility frontier shows agent A and B’s utilities combinations that correspond to efficient allocations. Which point is best for society? Moving along utility possibility frontier involves making interpersonal comparisons and efficiency does not provide basis to do so. 15 Source: Perman et al. An efficient allocation is not necessarly optimal Which allocation is most socially desirable? Social welfare function: weighted average of individual utilities in a society. Ranks alternative allocations according to their social desirability. Relative weights are an ethical matter. Optimality: attainable allocation maximizing social welfare → At optimum, efficiency conditions must hold ⇔ efficiency is a necessary condition of welfare maximisation ⇔ whenever there is an inefficient allocation, there is always some other allocation which is both efficient and superior in welfare terms → An efficient allocation is not always optimal. Source: Perman et al. 16 Achieving efficiency Several institutional arrangements can be employed to allocate resources and achieve efficiency: free markets, central planner, dictatorship. Advantage of free-markets: information is decentralized. First welfare theorem Assumptions that agents are maximizers and markets competitive: Markets are complete; markets are perfectly competitive; agents have perfect information; Property rights are assigned to all resources; there are no externalities; there are no public good; utility and production functions are ‘well behaved’ Theorem: A competitive market equilibrium is Pareto-efficient. ⇒ This does not mean that markets will reach a fair, or socially optimal allocation. 17 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. 18 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. Externality: 18 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. Externality: environmental pollution Public good: 18 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. Externality: environmental pollution Public good: air, water, fishery Imperfect information: 18 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. Externality: environmental pollution Public good: air, water, fishery Imperfect information: consequences of climate change 18 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. Externality: environmental pollution Public good: air, water, fishery Imperfect information: consequences of climate change Most of environmental economics is about restoring economic efficiency by dealing with market failures. One usually starts from a simplistic framework where externality is the only market failure and design the appropriate instrument to deal with it. Then considers other market failures that exist and may interact with the externality. Mission is two-fold : evaluate the cost of market failure design instruments to restore economic efficiency and target optimality 18 Environmental services and market failures ’Ideal’ circumstances of competitive markets are extremely stringent, do not describe an actual economy. Departure from ideal conditions are market failures. Externality: environmental pollution Public good: air, water, fishery Imperfect information: consequences of climate change Most of environmental economics is about restoring economic efficiency by dealing with market failures. One usually starts from a simplistic framework where externality is the only market failure and design the appropriate instrument to deal with it. Then considers other market failures that exist and may interact with the externality. Mission is two-fold : evaluate the cost of market failure design instruments to restore economic efficiency and target optimality ! Second-best theorem: if ∃ 2 or more sources of market failure, correcting just one will not necessarly improve efficiency. 18 Externality When the production or consumption decision of one person make another person worse or better off in an unintended way, without compensation by/payment to the first party. From production or from consumption. In case of positive externality, the market will produce too little of it w.r.t. allocative efficiency In the opposite case, the market will produce too much of it w.r.t. allocative efficiency Externalities arise because no property rights were attached to the externality or the absence of externality. ex: right to unpolluted air vs right to pollute leading to bargaining between both agents to reach efficiency (compensation for pollutee vs polluter) To deal with this market failure: put in place the missing feedbacks, compensation/payments, so that the agent takes into account the external effect 19 Simple model of externality Let’s take two individuals A and B living under same roof. A smokes, B has disutility from smoking. The utility of A is U A (M A , S A ) where M A is A’s wealth and S A the amount of cigarettes, with ∂U A /∂M A > 0 and ∂U A /∂S A > 0; The utility of B is U B (M B , S A ), with ∂U B /∂M B > 0 and ∂U B /∂S A < 0; MB is A’s marginal benefit of smoking, and MEC B’s marginal marginal external cost of A’s smoking. MEC is B’s willingness-to-pay for A not smoking. It’s also the price she would required Source: adapted from Perman et al. to compensate the disutility of smoking. MB is A’s willingness-to-pay for smoking if it was necessary. It’s also the compensation that would be required to reduce her smoking. 20 Simple model of externality Equilibrium consumption choice: A chooses S to maximize its utility at point S0. Total utility: a+b+d At point S0 , B’s disutility : b+d+c. ⇒ Not an efficient outcome because MB>MEC ⇒ At S0 B would be willing to pay more for A to decrease her smoking than what she would require to compensate her utility loss of smoking. Problem: absence of legal right on the Source: adapted from Perman et al. externality (right to pollute vs right to clean air), preventing parties to bargain. ⇒ With legal arrangements, market equilibrium would reach S ∗ , where MB=MEC ⇒ Coase theorem (see later in chap. 3) 21 Public goods Ability to supply a good on a market depends on two characteristics: Rivalry (//divisibility): is one agent’s consumption of the good/service at the expense of other agents’ consumption? Excludability: can agents be prevented from consuming the good? ⇒ Both are necessary conditions to attach property rights to the good 22 Public goods Ability to supply a good on a market depends on two characteristics: Rivalry (//divisibility): is one agent’s consumption of the good/service at the expense of other agents’ consumption? Excludability: can agents be prevented from consuming the good? ⇒ Both are necessary conditions to attach property rights to the good Excludable Non-excludable Rivalrous Pure private good Open-access resource Non-rivalrous Congestible resource Pure public good 22 Public goods Ability to supply a good on a market depends on two characteristics: Rivalry (//divisibility): is one agent’s consumption of the good/service at the expense of other agents’ consumption? Excludability: can agents be prevented from consuming the good? ⇒ Both are necessary conditions to attach property rights to the good Excludable Non-excludable Rivalrous Pure private good Open-access resource Cars Fishery in international water Non-rivalrous Congestible resource Pure public good Wilderness Wind harvesting 22 Public goods Ability to supply a good on a market depends on two characteristics: Rivalry (//divisibility): is one agent’s consumption of the good/service at the expense of other agents’ consumption? Excludability: can agents be prevented from consuming the good? ⇒ Both are necessary conditions to attach property rights to the good Excludable Non-excludable Rivalrous Pure private good Open-access resource Cars Fishery in international water Non-rivalrous Congestible resource Pure public good Wilderness Wind harvesting Most of environmental services exhibit non-rivalry and/or non-excludability (up to point where consumption rate does not exceed regeneration rate) 22 Public goods Ability to supply a good on a market depends on two characteristics: Rivalry (//divisibility): is one agent’s consumption of the good/service at the expense of other agents’ consumption? Excludability: can agents be prevented from consuming the good? ⇒ Both are necessary conditions to attach property rights to the good Excludable Non-excludable Rivalrous Pure private good Open-access resource Cars Fishery in international water Non-rivalrous Congestible resource Pure public good Wilderness Wind harvesting Most of environmental services exhibit non-rivalry and/or non-excludability (up to point where consumption rate does not exceed regeneration rate) Many environmental regulations are about preventing breaking such threshold 22 Problems with public goods Non-excludability prevents the good to be traded because one cannot condition access to the good on payment Although excludability is a contextual property conditional on law or technology ⇒ Has to be supplied by a government that can constraint agents to pay the production cost (through tax) 23 Problems with public goods Non-excludability prevents the good to be traded because one cannot condition access to the good on payment Although excludability is a contextual property conditional on law or technology ⇒ Has to be supplied by a government that can constraint agents to pay the production cost (through tax) At what level? 23 Problems with public goods Non-excludability prevents the good to be traded because one cannot condition access to the good on payment Although excludability is a contextual property conditional on law or technology ⇒ Has to be supplied by a government that can constraint agents to pay the production cost (through tax) At what level? Private good: each agent consumes a separate quantity (rivalry) ⇒ Efficiency achieved when each consumer’s individual marginal benefit equals the marginal cost (MRUSA = MRUSB = MRT) 23 Problems with public goods Non-excludability prevents the good to be traded because one cannot condition access to the good on payment Although excludability is a contextual property conditional on law or technology ⇒ Has to be supplied by a government that can constraint agents to pay the production cost (through tax) At what level? Private good: each agent consumes a separate quantity (rivalry) ⇒ Efficiency achieved when each consumer’s individual marginal benefit equals the marginal cost (MRUSA = MRUSB = MRT) Public good: all agents consume same level of the good ⇒ Efficiency achieved when sum of marginal benefits of all consumers equals the marginal cost (MRUSA + MRUSB = MRT) 23 Problems with public goods Non-excludability prevents the good to be traded because one cannot condition access to the good on payment Although excludability is a contextual property conditional on law or technology ⇒ Has to be supplied by a government that can constraint agents to pay the production cost (through tax) At what level? Private good: each agent consumes a separate quantity (rivalry) ⇒ Efficiency achieved when each consumer’s individual marginal benefit equals the marginal cost (MRUSA = MRUSB = MRT) Public good: all agents consume same level of the good ⇒ Efficiency achieved when sum of marginal benefits of all consumers equals the marginal cost (MRUSA + MRUSB = MRT) What are marginal willingness-to-pay of agents? In absence of market, preferences are not revealed → free-rider’s problem Various methods of preference valuation: survey, actual behaviour, voting... (see more in chapter 3) 23