What Environmentalists Need to Know About Economics PDF

“Environmentalists need to understand how markets work. This book introduces many of the themes that environmental economists work with, some of which will need to come into play if we’re going to deal with catastrophes like climate change.” —BILL MCKIBBEN , author Earth: Making a Li...

“Environmentalists need to understand how markets work. This book introduces many of the themes that environmental economists work with, some of which will need to come into play if we’re going to deal with catastrophes like climate change.” —BILL MCKIBBEN , author Earth: Making a Life on a Tough New Planet “A vital resource for those who want to understand the economic underpinnings of environmental policy applied to the most pressing problems we currently face. Puts to rest the notion that economics and the environment are at odds; in fact, sound economic policy is the key for environmental solutions.” WHAT ENVIRONMENTALISTS NEED TO KNOW ABOUT ECONOMICS SCORSE —ANN HARRISON , Director of Economic Development Policy, The World Bank “An excellent introduction and overview of the some of the key debates in mainstream economics and policy. Explains in accessible terms the underpinnings of economics which most influence government policies on environmental protection.” —DARA O’ROURKE , Professor at UC-Berkeley and founder of Goodguide “Economics continues to be one of the most powerful, yet misunderstood tools for en- vironmental management and conservation. Moves beyond simple ideas of money to understand how economic factors affect the environment and how the environment affects the economic wellbeing of all people.” —LINWOOD PENDELTON , Director of Ocean and Coastal Policy, The Nicholas Institute at Duke University “An easy-to-read, non-technical primer on how the problems we face today as envi- ronmentalists are fundamentally economic in nature. Excellent background for any- one interested in devising sensible solutions to environmental problems.” —RICHARD E. RICE , Chief Conservation Officer, Save Your World “At this time of environmental destruction from the Gulf of Mexico oil spill, we need a clear understanding of practical economics that this book uniquely provides, to help us move away from policies that undervalue and thus compromise the ecosystems that provide the foundations for our continued economic prosperity.” —DR. JUDITH KILDOW , Director, National Ocean Economics Program (NOEP) A M E R I C A JASON SCORSE is Associate Professor and Chair of the International Environmental Policy Program at the Graduate School of International Policy and Management at the Monterey Institute of International Studies (A graduate school of Middlebury O F College). S T A T E S Front cover design by EUGENE KUO U N I T E D Cover image courtesy of NASA GODDARD SPACE FLIGHT CENTER (NASA-GSFC) T H E I N P R I N T E D w w w. p a l g r a v e. c o m  What Environmentalists Need to Know About Economics 9780230107298_01_previ.indd i 8/23/2010 3:09:31 PM 9780230107298_01_previ.indd ii 8/23/2010 3:09:31 PM  What Environmentalists Need to Know About Economics Jason Scorse 9780230107298_01_previ.indd iii 8/23/2010 3:09:31 PM  WHAT ENVIRONMENTALISTS NEED TO KNOW ABOUT ECONOMICS Copyright © Jason Scorse, 2010. All rights reserved. First published in 2010 by PALGRAVE MACMILLAN® in the United States—a division of St. Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Where this book is distributed in the UK, Europe and the rest of the world, this is by Palgrave Macmillan, a division of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN: 978–0–230–10731–1 paperback ISBN: 978–0–230–10729–8 hardcover Library of Congress Cataloging-in-Publication Data Scorse, Jason. What environmentalists need to know about economics / by Jason Scorse. p. cm. Includes bibliographical references. ISBN 978–0–230–10729–8 1. Environmental economics. I. Title. HC79.E5S347 2010 333.7—dc22 2010013322 A catalogue record of the book is available from the British Library. Design by Newgen Imaging Systems (P) Ltd., Chennai, India. First edition: October 2010 10 9 8 7 6 5 4 3 2 1 Printed in the United States of America. 9780230107298_01_previ.indd iv 8/23/2010 3:09:32 PM  CONTENTS Introduction 1 PART I HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES Chapter 1. The Root Causes of Environmental Problems 7 Chapter 2. Determining the “Optimum” Amount of Pollution 17 Chapter 3. Valuing Ecosystems 27 Chapter 4. Putting Monetary Values on the Environment and Living Things 33 Chapter 5. Valuing Future Generations 41 Chapter 6. Tools to Address Environmental Problems: Taxes, Property Rights, Information, Psychological Insights, and Command and Control Regulation 51 Chapter 7. Environment vs. Economy: Growth Rates, Jobs, and International Trade 71 PART II PUTTING ECONOMIC ANALYSIS TO WORK Chapter 8. Climate Change 83 Chapter 9. Forest and Biodiversity Conservation 101 Chapter 10. Agriculture 121 9780230107298_01_previ.indd v 8/23/2010 3:09:32 PM  vi CONTENTS Chapter 11. Chemical Pollution 137 Chapter 12. Fisheries and the Marine Environment 145 Chapter 13. Population Growth and Technological Change 153 Chapter 14. Demand-Side Interventions 161 Final Thoughts and Additional Resources 167 Notes 169 References 205 9780230107298_01_previ.indd vi 8/23/2010 3:09:32 PM  INTRODUCTION T his book was inspired by the warm reception I received from a short essay I wrote in 2005 entitled, “Why Environmentalists Should Embrace Economics.” I would like to thank the dozens of people from around the world who sent me encouraging messages and convinced me that there was a need for a larger treatment of the issues raised in this piece. The target audience for this book is anyone interested in envi- ronmental issues with an eye toward actually solving them: students, citizens, policy makers, and activists. No economics background is required for this text, although some basic microeconomics knowl- edge is helpful. Even those with more advanced training in econom- ics may find some new perspectives in this volume that they had not considered before. The overarching goal of this book is to demonstrate why a solid grasp of economics is a necessary (though not sufficient) condition for addressing the environmental challenges of the day. For too long, there has been a lingering mistrust and skepticism among many envi- ronmentalists of economics and economists. There are many reasons for this, but one thing is certain: it has been to the detriment of many environmental causes. I am confident that the more environmental- ists understand what economic analysis and reasoning entails, the more they will realize that economics can be one of their greatest allies. The bottom line is that more often than not it is distortions, imperfections, and perversions of economic systems that are the main drivers of environmental degradation. 9780230107298_02_int.indd 1 8/23/2010 3:31:39 PM  2 WHAT ENVIRONMENTALISTS NEED TO KNOW ABOUT ECONOMICS Of the many criticisms of economists, one of the more truthful is that often they are poor communicators (even when they are not presenting complex mathematical models and abstract theories). For this reason I have tried to write this book in a clear and accessible manner with no graphs or charts and no mathematical formulas. The primary objective of these chapters is to help develop the economic intuition necessary to address a wide range of environmental issues; i.e., how to think like an economist in the environmental realm. Given the complexity of the issues dealt with in this volume (each of which individually could span multiple volumes), this treatment provides nothing more than a basic foundation for future study, dis- cussion, and inquiry. I have provided a short list of websites and peri- odicals at the end of the book where interested readers can continue to increase their knowledge of economic approaches to environmen- tal issues. Because I also want this book to be rigorous, I have pro- vided lengthy footnotes for those who want additional information. Part I presents the basic intellectual architecture that underlies how economists think about environmental issues, and the tools and insights that they use to address them. Part II surveys the major environmental issues of the day and presents a range of solutions derived from economic analysis. It is recommended that readers read all of part I before they delve into the specific issues in part II. Part II does not follow any predetermined sequence, and therefore does not require following the chapters in order. Throughout the chapters I try to differentiate the ways in which theory and theoretical conditions may deviate from real-world situa- tions. In such instances, I present the key insights from the theories that are still applicable even if they do not perfectly mirror reality. In addition, because politics is so integral to getting environmental policies enacted and enforced, I provide political commentary where appropriate. All of this is for the purpose of increasing the relevancy of this volume for actually solving the world’s environmental prob- lems, which is the ultimate goal. I would like to thank my advisor at UC–Berkeley, Michael Hanemann, who showed me that economics should always be relevant to real-life issues. Thanks also to all of the students at the Monterey 9780230107298_02_int.indd 2 8/23/2010 3:31:39 PM  INTRODUCTION 3 Institute of International Studies whose insights have helped me to refine my own. And a special thanks to Kira Darlow for her work as my research assistant. I warmly invite all constructive criticism of the contents of this book, for which I am solely responsible. I can be reached at jason. [email protected]. Jason Scorse, Central California, 2010 9780230107298_02_int.indd 3 8/23/2010 3:31:39 PM 9780230107298_02_int.indd 4 8/23/2010 3:31:40 PM  Part I HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES 9780230107298_03_ch01.indd 5 8/23/2010 3:32:10 PM 9780230107298_03_ch01.indd 6 8/23/2010 3:32:11 PM  CHAPTER 1 THE ROOT CAUSES OF ENVIRONMENTAL PROBLEMS E nvironmental problems are extremely complex and varied, yet they almost always share similar features, be it air pollution in Mexico City or a village in Indonesia, habitat loss in Kenya or Brazil, or fisheries collapse in the Indian, Pacific, or Atlantic oceans. Environmentalists trying to make sense of these issues are faced with difficult questions: Why do relatively rational actors buying and selling goods and services rarely take into account the toxic pollution that results from their choices? Why do fishermen routinely overexploit the fisheries that they depend on? Why are the ecological services provided by forests and wetlands, which produce tangible and wide-ranging value for society, usually not taken into account when decisions are made? How can food be so cheap when there is such massive pollu- tion and resource use involved in industrial agriculture? 9780230107298_03_ch01.indd 7 8/23/2010 3:32:11 PM  8 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES Economists have been studying questions like these for many decades and have devised a fairly comprehensive framework for understanding the root causes of environmental problems, which is where we begin. Those who believe that the field of economics rests on an unal- terable faith in the power of markets may be surprised to learn that one of the most robust areas of study within economics concerns the conditions under which markets do not lead to socially optimum out- comes, especially in regard to environmental issues.1 In fact, in the environmental arena market imperfections are ubiquitous and often require some form of government intervention. Readers may also be pleasantly surprised to discover that the economic theories that explain why markets fail also hold the keys to solving the myriad environmental problems we currently face. Virtually all of the environmental policies currently being discussed in the political realm, in the board meetings of environmental orga- nizations, and on environmental websites can be traced to economic theories that date back to the 1940s and continue to be vigorously debated in academic settings. The three most important sources of environmental problems are 1) market failure, 2) the tragedy of the commons, and 3) the underprovisioning of public goods. MARKET FAILURE One of the first principles of free markets is that for them to work effec- tively, the full costs of an activity must be borne by the involved parties. For example, many types of air and water pollutants exact a sig- nificant price on human health and degrade ecosystems, yet they are not included in the costs of production or at the consumer level. These costs, which are borne by society but not the individual pro- ducers and consumers of the goods, are called externalities. Externalities lead to market failure because in order for the market to supply the proper amount of goods and services, the prices must correctly reflect the true costs. Nowhere is this type of market failure more common than in the environmental realm. 9780230107298_03_ch01.indd 8 8/23/2010 3:32:11 PM  ROOT CAUSES OF ENVIRONMENTAL PROBLEMS 9 The following are some specific examples of widespread environ- mental externalities: Heavy metals emitted from power plants that cause can- cer, birth defects, and harm animals and plants, but that most power companies and consumers of electricity are not required to pay for. Greenhouse gas emissions, which have no cost almost any- where in the world (except in the EU and in some sectors of the U.S. power industry), so no matter how much a person or company emits, they pay no penalty for their contribution to global warming. Factory farms that emit more sewage than the entire hu- man population, despoiling nearby waterways, but which are largely unregulated. Biodiversity loss from clear-cut logging, which timber companies can essentially ignore because there is no cost to factor into their decisions, and which consumers can ignore because they do not pay for the negative conse- quences of the forest products they buy. The result of unaccounted for externalities is that prices for many of the most common goods and services are significantly lower than if they included their environmental costs. This leads to a gross misallocation of society’s resources. Economists characterize a situa- tion where the costs of environmental externalities are not included in the price of a good as a form of passive subsidy. Think of it this way: whenever we use power from a coal-fired power plant we receive energy at a price that is much lower than its true cost (once all of the harmful effects are calculated and included). These harmful effects are not simply theoretical; they represent real damages that have real monetary value. In effect, our energy use from coal is being subsidized by all of the people who get sick from the resulting sulfur pollution, by the money lost when our natu- ral heritage and infrastructure are degraded by acid rain, and by the communities whose landscapes are despoiled by mining operations (the worst being mountaintop-removal2). There is little incentive for 9780230107298_03_ch01.indd 9 8/23/2010 3:32:11 PM  10 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES people to switch to wind or solar energy when coal is cheaper, even though the low price of coal is largely illusory; society pays a heavy cost for our reliance on this extremely dirty form of energy. If we lived in a world where prices fully captured environmental costs, our entire economies would look vastly different: we would have different modes of transportation, different layouts for our cities and towns, different dietary habits, and consumer goods would likely con- tain much less toxic material. Prices of environmentally harmful goods would rise and much more R&D would go into alternatives, thereby decreasing their price. In such a world society’s resources would be invested in those things which bring the greatest social value. This book discusses the various policies that can lead individu- als and companies to take these environmental costs into account. Economists refer to this as the process of internalizing the externalities. But externalities are not the only thing that can lead to market failure. In economic models of well-functioning markets, one of the strongest assumptions is that the parties involved have perfect informa- tion about products and services, including the consequences of the consumption and production of these goods. It doesn’t take a critic of economics to realize that this assumption is very strong and is unlikely to be the case in the real world. Nowhere are the deviations from per- fect information more prominent than in the environmental realm. Even with major scientific advances, our knowledge of the inter- action of many industrial chemicals is still incomplete as is our understanding of how ecosystems function. Even what we do know is extremely complex and beyond the comprehension of anyone but the most senior scientists. Producers and consumers of goods, therefore, must often rely on outside sources to make informed decisions about what they produce and what they buy. The market itself is not likely to provide the necessary information for people to make well-informed decisions. As forests are cut down how does this impact the water- sheds and how is this information conveyed to the people that rely on them? How are municipalities supposed to decide whether they want to approve the development of a new factory that emits some quantity of air and water pollution? Precisely what information is needed and what is the best way to provide it? These are difficult questions even 9780230107298_03_ch01.indd 10 8/23/2010 3:32:11 PM  ROOT CAUSES OF ENVIRONMENTAL PROBLEMS 11 with very good information, but almost impossibly difficult questions when the relevant information is poor. A third cause of market failure arises from the incomplete and/or nontransparent distribution of property rights. In situations where it is unclear who has the right to use an environmental resource, there may be little incentive for long-term management. For example, con- sider a country where land rights are uncertain and frequently con- tested. A farmer who currently resides on the land may want to invest significant resources into developing a more environmentally sustain- able management regime. This may include drip irrigation, vegetative buffer zones, and integrated pest management (IPM). However, if she fears that someone may claim her land title, she has little incentive to make these investments. Instead, she may choose to get as much out of the land as quickly as possible and take her chances. Clear property rights are also crucial for assessing liability in the case of environmental damages. If there is not a clearly identifiable party who owns the environmental resource in question or is responsible for its protection, it is difficult to collect damages or enforce regulations to hold them accountable in the event that they are breaking the law. The issue of liability sometimes takes subtle turns that have large environmental consequences. In the famous 1989 Exxon Valdez case, an Exxon tanker spilled more than 11 million gallons of oil into the pristine ecosystem of Prince William Sound in Alaska. One of the key questions that arose was whether Exxon was responsible for the dam- age to this public resource above and beyond the cleanup costs. Put another way, did the public hold the right to Prince William Sound in its pristine state, or was a private company allowed the right to severely damage the resource without compensation, as long as they “cleaned it up”? The courts held that Exxon was liable, and even though the ini- tial case was ultimately settled outside of court,3 the damage esti- mates that were calculated included a measure of compensation to the general public. It is now on record that oil companies operating tankers in U.S. waters are held liable for damages to the public inter- est, which in the Exxon case were estimated in the billions of dollars (Carson et al., 2003). The legislation that the U.S. Congress passed 9780230107298_03_ch01.indd 11 8/23/2010 3:32:11 PM  12 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES in the years immediately following the Exxon Valdez spill was sup- posed to enshrine into law oil companies’ responsibilities in the case of future spills; ironically, the $75 million cap that was placed on liabilities (above and beyond clean-up costs) may have led companies such as BP to cut corners on safety. From a purely economic standpoint, there should be no limit to a company’s liability for environmental damage. Any limit will decrease their incentive to fully take into account the potential risks in their actions. Whether a higher, or even unlimited, liability cap would have led BP to invest in better safety equipment is hard to know (the company has had a terrible safety record for decades), but the 2010 Deepwater Horizon oil spill disaster is a reminder that there are significant hidden costs that come with oil production, one of which is the risk of the environmental catastrophe that is now unfolding. It is important to point out that when economists talk of property rights, they do not necessarily mean private property rights. In the case of market failure, due to a lack of transparent and enforceable property rights, this can sometimes be addressed by assigning prop- erty rights to government agencies or a community organization. These options entail their own set of issues that need to be addressed, but it is not the case that defining property rights always necessitates private ownership. A lack of clear and enforceable property rights leads to the most pronounced forms of environmental degradation in cases of open access resources, which were made famous by ecologist Garrett Hardin (1968), who coined the phrase “the tragedy of the commons.”4 THE TRAGEDY OF THE COMMONS Two of the world’s most important environmental resources are the oceans and the atmosphere. The oceans provide not only huge quan- tities of fish and sea life that humans consume, but also immense quantities of marine biodiversity and critical ecosystem services, upon which much of the world’s terrestrial biodiversity depends. Biochemical interactions in the atmosphere help to regulate climate and temperature, the ozone layer blocks harmful solar radiation 9780230107298_03_ch01.indd 12 8/23/2010 3:32:11 PM  ROOT CAUSES OF ENVIRONMENTAL PROBLEMS 13 from reaching the earth’s surface, while clean air promotes human and ecosystem health. But most of the world’s oceans and atmosphere are devoid of property rights5; that is, there is no body, whether groups of individu- als, private companies, or governments, that can claim ownership over them.6 They are called open access resources, which anyone can use and to whatever extent they wish. From here on I will use this term instead of the term “commons” that Garret Hardin coined, because it is now understood that there are important distinctions between open access resources and those held as commons.7 Hardin’s insights are truer today than when he first discussed them four decades ago. His essential insight is that open access resources will more often than not be exploited at unsustainable levels because there is a wide divergence between the private ben- efits that accrue to the individual users of the resource and the costs, which are diffused over the entire population. When a fishing company decides how much fish to take out of the ocean, it is only thinking of the bottom line: how much profit it can make. It will increase fishing as long as it is profitable to do so. Fish are a renewable resource, but are potentially exhaustible if over- exploited. Every time a fishing boat removes fish, it affects the abil- ity of the species to repopulate and survive. From a sustainable use perspective, the problem is that this cost of reducing the viability of the fish population is spread over all of the fishing companies in the industry, and therefore will likely seem insignificant to the individual fisherman in an industry of thousands of boats and private firms. In addition, given the open access nature of the world’s fisheries, if one company decides to stop fishing in order to allow the species to recover, there is nothing stopping another company from taking the fish for themselves. This produces a very shortsighted “race to the bottom” mentality that we observe in virtually all of the ocean’s inter- national waters, and even domestic waters where property rights are not clearly defined. It is no surprise that fish stocks are at or near levels of collapse globally as a result.8 The atmosphere is a much different type of resource, one that is not actively harvested, but the essential logic holds. Because virtually 9780230107298_03_ch01.indd 13 8/23/2010 3:32:12 PM  14 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES anyone can dump as much greenhouse gases into the atmosphere as they want, there is little incentive for any individual company or nation to restrict their emissions. If they do so they will have to incur all of the costs of restricting their activity, while the benefits of reducing global warming (however marginal) will be spread out over the entire world. Poorer nations, particularly island nations or those at or below sea level, who stand to suffer the most from global warming, have no recourse with which to demand that emissions be restricted, because there is no international body that has jurisdiction over the atmo- sphere.9 While there are ways to address the issue of global warming short of creating property rights to the atmosphere, the key point is that the open access nature of the atmosphere has created the prob- lem in the first place. This brings up another essential point. Some claim that the com- moditization of the environment and living things are the root causes of environmental problems; it is a world that assigns property rights to the world’s environmental heritage and assigns them price tags that is the greatest threat to a more livable future.10 A careful examination, however, of the areas where we see some of the greatest environmental threats leads to the exact opposite conclu- sion. It is the fact that much of the world’s oceans and the atmosphere are freely open to exploitation that drives the unsustainable levels of both fish harvesting and greenhouse gas emissions. The same is true for many areas of the Amazon rain forest, where property rights are nonexistent, nontransparent, or not enforced; as a result we observe massive deforestation.11 None of this is to suggest that addressing the problem of open access resources alone will be sufficient to solve major environmental problems. Market failure can still occur in cases when property rights are well-defined, whether due to the transboundary nature of environ- mental pollution or imperfect information. In addition, there is another serious reason to believe that environmental quality will be underpro- vided in a free-market system and require some form of intervention. PUBLIC GOODS Public goods are a specific class of goods that are nonrival and non- excludable. Put simply, they are goods where one person’s use of the 9780230107298_03_ch01.indd 14 8/23/2010 3:32:12 PM  ROOT CAUSES OF ENVIRONMENTAL PROBLEMS 15 good does not inhibit another’s use of the good (nonrival) and where once the good is provided to one it is by definition provided to all (nonexcludable). There are very few “pure” public goods, mostly because there are ways to exclude people from the enjoyment of what otherwise would be considered entirely public resources. The following are examples of environmental public goods, along with the appropriate caveats: Biodiversity: My enjoyment of biodiversity doesn’t limit your ability to enjoy it, and once biodiversity has been preserved, no one can be excluded from enjoying it (in the abstract; for example, if the blue whale is preserved, we all can take plea- sure in this achievement, but access to viewing these whales will be limited by individuals’ income and leisure time). An intact ozone layer: The protection I get from the ozone layer doesn’t impede anyone else’s protection, and once the ozone layer is protected, it is protected for all (this is close to a pure public good, but in reality, we do have a situation where the remaining hole in the ozone is con- centrated over Australia and New Zealand, which until it is fully restored means that there are populations that are excluded from the full benefits of protection). Clean air: My breathing clean air doesn’t prevent anyone else from breathing clean air, and once clean air is pro- vided to my community, no one in the community can be denied access to it (but yet again, air quality may differ substantially within a community and it may cost more money to live in areas where the air is the cleanest). A climate in which the threat of global warming is greatly diminished: This may be the closest we can get to a pure environmental public good; there is no way to exclude anyone from a nonwarming planet, and one person’s ben- efit from a reduction in the risk of global warming doesn’t conflict with anyone else’s. Because of the nonexcludable nature of environmental public goods (however imperfect), we encounter what economics refers to as the 9780230107298_03_ch01.indd 15 8/23/2010 3:32:12 PM  16 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES “free-rider” problem. It is often difficult to get people to contribute to the provision of public goods because they know that once they’re provided they can get them for free. If the local people of Hawaii decide to protect their coral reefs, all U.S. citizens (and all citizens of the world) get the benefit of this enhanced biodiversity protection, even if they didn’t contribute to this effort. If Brazil decides to fully protect the Amazon rain forest, all the countries of the world get the myriad benefits of rain forest protection for free as well. This is not to suggest that there are not significant reasons for the Hawaiians to protect their marine resources or the Brazilians to protect their forests without outside assistance. There are direct benefits that accrue to the immediate parties, and the Hawaiians currently do a lot to protect their reefs and the Brazilians do a lot to protect their forests. Economic analysis only points out that if others who also benefited from the provision of these resources contributed to their protection, the extent of the conservation efforts would likely be much greater. It is not that public goods result in zero provision in the free market, but that they are often underprovided, which is the key insight. SUMMARY The economics profession is in many ways the study of markets. Markets for many goods and services often work very well and minimal intervention is needed to protect the public interest. But in the envi- ronmental realm, market failure is quite common and markets left to their own devices will not produce anything close to optimum social outcomes. The transboundary nature of environmental resources and pollution, the great complexity of ecosystems, incomplete prop- erty rights, and the highly imperfect information about the effects of toxins on health require adjustments to markets to make them function properly. More precisely, the prices for goods and services should include their full costs, consumers and producers should have the best and most up-to-date information about the products and services they buy and sell, and ownership over resources should be as clear and accurate as possible. 9780230107298_03_ch01.indd 16 8/23/2010 3:32:12 PM  CHAPTER 2 DETERMINING THE “OPTIMUM” AMOUNT OF POLLUTION A t first glance, determining an optimum pollution level may strike many environmentalists as strange or even heretical; there is an obvious “optimum” for pollution (despite what economists may think): zero. Economic theory doesn’t arrive at this conclusion, not because economists are callous to environmental concerns, but because pol- lution is a by-product of many things that we all value; therefore, some amount of pollution is warranted. Take electricity, for example. Electrical generation produces pol- lution; even renewable sources produce some quantity of pollution. All of us benefit greatly from electrical power and would not be will- ing to give it up to decrease this source of pollution to zero. Take another example: agriculture. All forms of agriculture require vast alterations of the natural environment, including vari- ous forms of inputs, organic and/or synthetic. To eat a varied and healthy diet, significant quantities of pollution are often generated even in the most ecologically designed systems. This is especially true when agricultural systems are required to feed large numbers 9780230107298_04_ch02.indd 17 8/23/2010 3:32:53 PM  18 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES of people who reside far from agricultural centers and the costs of transportation are included. These are two basic goods that virtually no one would be willing to forego: electricity and farm-produced food. The list of pollution-causing goods grows exponentially once we start includ- ing the luxuries that most of us in the developed world now take for granted—airplane travel, computers and other electronic goods, furniture, modern houses—and which most in the developing world are striving to acquire as well. Following this logic, it is easy to see why zero pollution is not fea- sible, at least given current modes of living and technology. What about reducing pollution as much as possible? This sounds like a reasonable second-best option. But what does “as much as pos- sible” really mean? In many cases reducing pollution is expensive. How much money should society spend to reduce pollution? And what should it give up in order to achieve these lower levels of pollu- tion? Many people might have opinions on the matter, but how can we judge which views are more reasonable than others? Economic theory provides a way to conceptualize the issue, which, while far from perfect, at least allows us to begin with a methodology that can be applied in a variety of situations and has some objective merit. As we will see, it does not completely solve the problem, and it also raises a host of other issues, but it’s a start. The idea is relatively straightforward (although putting it into practice isn’t): the optimum level of pollution is the amount where the benefits of abating (getting rid of) additional pollution are worth the added cost.1 We can conceive of this from two different angles. First, let’s assume that we are starting in a world with no pollution. We value some things more than having an environment entirely free from pol- lution, and we produce those things up to the point where we decide that additional pollution is no longer worth it. Or, more realistically, if we start from a relatively polluted world, we can ask ourselves how much pollution we would like to get rid of before the costs exceed the benefits of a cleaner environment. 9780230107298_04_ch02.indd 18 8/23/2010 3:32:53 PM  DETERMINING THE “OPTIMUM” AMOUNT OF POLLUTION 19 Since this second perspective more closely mimics the situation we find ourselves in today, we will stick with it. The task we are pre- sented with is determining how much to reduce various forms of pol- lution from their current levels. For example, let’s assume that we’re talking about electrical pro- duction and the toxic emissions from power plants. Abatement can be achieved in many ways: by adding pollution-control equipment (such as scrubbers for sulfur in coal-fired power plants), switching to cleaner energy sources or technologies, or improving efficiency. These different ways of reducing pollution from power plants have very different costs; some may be relatively cheap while others may be very expensive. This means that we may be able to get some quantity of abatement for a relatively low cost, but if we want more, it may cost a lot more. If we have a very dirty power plant with almost no pollution- control equipment, there are likely relatively straightforward and accessible options to help reduce some portion of its pollution. But as the plant becomes cleaner, the technology to improve it even more is likely to become increasingly expensive. The same is true if we think of pollution not at the facility level, but at a regional or national level. The amount that it costs to decrease air pollution in a region becomes increasingly expensive as the area becomes cleaner. Reducing the smog in Los Angeles, while expen- sive, would be less expensive than improving air purity an additional step once most of the smog is removed. Often, it is these last units of pollution abatement that are extremely costly. This phenomena is often referred to as the “low-hanging fruit” theory: there are almost always some pollution-reduction options that are relatively easy (they’re within arm’s reach), but once these are used up, pollution-abatement options become increasingly dif- ficult (they’re way up high near the top branches). The benefits of reducing pollution exhibit the opposite relation- ship: they usually start out high and ultimately decline. Again, let’s examine air pollution. The health and other environmental bene- fits of cleaning up a highly polluted airshed are many; they include 9780230107298_04_ch02.indd 19 8/23/2010 3:32:54 PM  20 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES significantly reduced mortality, reduced respiratory illness, better visibility, and a healthier environment for animals and plants. But once much of the smog has been removed and the air is reasonably clean, removing the remaining particulate matter, while beneficial, does not translate into nearly as much benefit as when the air pollu- tion was at much higher levels. Let’s take a step back and think about all of this together. The starting point is a city with a serious smog problem. The government wants to reduce pollution due to the myriad health and environmental problems through some form of new regulation (later, we will examine the various means of achieving a pollution-reduction target, but for now we’re just interested in the target itself). The city makes some estimates of the damages from the smog and the costs of abating it, and concludes that reducing smog by 50 percent costs only $10 million but leads to benefits of $100 million (for a net benefit of $90 million: 100 minus 10 equals 90). Next, the city considers whether reducing pollution by 75 percent is worth the cost. It determines that the additional 25 percent reduction costs a little more than first 50 percent reduction (another $12 million); the additional benefits are not as great (only $65 million this time), but the net investment is still positive ($53 million: 65 minus 12 equals 53) for going this extra step. The city then examines the scenario of reducing the smog by 90 percent, and here is where the calculation changes dramatically. The additional 15 percent reduction (from 75 percent to 90 per- cent) turns out to be very expensive ($50 million for this incremen- tal improvement), but this additional 15 percent reduction doesn’t yield nearly as many benefits as the last phase of pollution reduc- tion (now only $35 million). The net benefits of this final phase of abatement would actually be negative—to the tune of –$15 million (35 minus 50 equals –15). A case can now be made that 75 percent smog reduction (or perhaps a little more since we didn’t examine the precise scenarios between 75 percent and 90 percent) represents the “optimum” level of smog reduction for this city. We have arrived at this conclusion by quantifying the relative benefits and costs of smog abatement until 9780230107298_04_ch02.indd 20 8/23/2010 3:32:54 PM  DETERMINING THE “OPTIMUM” AMOUNT OF POLLUTION 21 we reached a point where the costs of additional abatement became greater than the additional benefits. Before addressing the many caveats that accompany this logic, it is important to recognize that this is the same logic that we employ when choosing virtually any other good. Take strawberries. Let’s say the price is three dollars per basket. You go into the store and grab the first basket at the cost of three dollars, and then wonder whether you want a second. You decide that you do. Then a third—they are so delicious. A fourth? You think hard about it, but decide that three is enough. What made you stop? Simple, the marginal benefit of the fourth basket was not equal to the marginal cost of three additional dollars. If the additional benefit of that fourth basket was worth more than three dollars to you, you would have bought it (assuming you had the money). Takeaway point: The theory of optimum pollution is premised on the same logic that economists use to analyze the markets for ordi- nary goods and services. However clever this logic may (or may not) appear to you, you might already have questions regarding the actual implementation of this concept. To start, how are the benefits and costs calculated for pollution abatement? And, perhaps more important, how can we translate health and environmental values into dollars, which is what this methodology entails? But first I want to make a couple of additional points about the concept of optimal pollution and its implications for real-world policymaking. REAL-WORLD IMPLICATIONS OF OPTIMUM POLLUTION THEORY The “optimum” quantity of pollution refers to what is most efficient for society as a whole. This is defined as the point at which society gets every bit of pollution abatement where the benefits exceed the costs. What is important to recognize is that while efficiency may be a valid criterion, it is simply one among many. Efficiency says absolutely 9780230107298_04_ch02.indd 21 8/23/2010 3:32:54 PM  22 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES nothing about the distributional impacts of a given level of pollution. For example, an efficient solution could be entirely consistent with a situation where the pollution that is not abated is heavily concen- trated in a poor minority community or in an area with lots of school- age children with asthma. What is efficient, therefore, may conflict with what people con- sider fair, just, or equitable. And in current policy debates, fairness and equity are often what people are most concerned about. This doesn’t mean that efficiency shouldn’t be considered. In cases where what is efficient also corresponds with what the majority thinks is fair, we have a win-win situation. A second key point is that economic models implicitly include costs and benefits that weight the decision-making process in favor of those with greater incomes and wealth. Often, when health effects are calculated, lost productivity is partially determined by the number of sick days; a sick day for an engineer counts more in monetary terms than a sick day for a school- teacher because an engineer’s salary is usually much higher. When the benefits of nature viewing are assessed, the wealthy traveler who spends thousands of dollars to visit a national park counts for a lot more than a person without a car who doesn’t have the money to make such a trip. (One way this issue can be mitigated is to find the average of all people’s values and use this as a representative of the population, which most studies do.) Bottom line: the classical economic view of pollution doesn’t take into account any notion of environmental goods as rights. For example, many people argue that access to clean air and water are human rights that society has an obligation to provide to all of its citizens.2 While efficient solutions, as defined by economics, need not conflict with such notions of rights, they may, and sometimes do. There are cases where economists may use the above framework to define pollution strategies that are optimum, but that do not auto- matically guarantee all members of society some minimum level of environmental quality. As a student of environmental issues for more than two decades, I have noticed that when economists and environmentalists discuss 9780230107298_04_ch02.indd 22 8/23/2010 3:32:54 PM  DETERMINING THE “OPTIMUM” AMOUNT OF POLLUTION 23 controversial issues, the economists often talk about efficient solu- tions, whereas the environmentalists talk about equitable solutions. In many instances there is a great deal of confusion as the parties essen- tially talk past each other. Environmental discussions and debates would benefit greatly if all parties could be explicit about when they are making arguments based on efficiency concerns and when they are making a case based on the distributional consequences of a pol- icy independent of efficiency. In cases where environmentalists want to argue that an efficient strategy for pollution abatement does not meet certain ethical cri- teria, it would be helpful if they acknowledged the potential losses in efficiency that these may entail.3 Economists are used to talking about trade-offs and are not all coldhearted statisticians unable to be swayed by these modes of argumentation. With respect to the earlier hypothetical case where our city’s “optimal” reduction in smog is approximately 75 percent, what if the remaining 25 percent is concentrated in a poor minority com- munity where rates of respiratory illnesses are significantly higher than the regional average? It would be entirely appropriate to make a case that what is optimum in this scenario from an efficiency standpoint may not be just, and imposes too heavy a burden on eco- nomically disenfranchised communities. What is efficient is not the “end all, be all” when determining the ultimate policy outcome. There are other serious limitations of the optimum pollution methodology. When attempts are made to quantify the costs and benefits of pollution reduction, analysts often compare aggregate costs of a given action to improve the environment with aggregate benefits; they usually do not search for the precise pollution level that will be most efficient. And typically, these benefit-cost analyses do not seri- ously examine the distributional consequences.4 Here are some suggestions for environmentalists when con- fronted with these types of studies: Take a close look at the scope of the benefits and the costs that are being examined. This is often where many 9780230107298_04_ch02.indd 23 8/23/2010 3:32:54 PM  24 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES assumptions are made and usually where many short- cuts are taken. Almost always, the direct health benefits comprise the bulk of the benefits side of the calculation, because politicians are usually swayed by these benefits more than benefits to plant and animal life,5 which are in some ways more abstract. If this is the case, and there is a compelling reason to suspect that the effects apart from human health are significant, environmentalists may be justified in insisting that the benefits of the proposed policy are underestimated and may lobby for the inclu- sion of a greater scope of benefits, or at least an acknowl- edgement that the benefit estimates are incomplete.6 Society expends its resources—financial, social, and political—on all sorts of things that it deems important, and which, one hopes, confer signifi- cant benefits to various groups of people within society and/or society as a whole. If we had a completely rational manner of distributing these resources, would it make sense to spend money on a program that cost $1,000,000 for every life saved when another program could save a life for $1,000? Put another way, wouldn’t it make more sense to shift resources from the $1,000,000- per-life-saved program to the one that cost 1/1000th to save a life? With respect to costs, these usually include the direct and indirect costs of actually implementing the regulation. Typically, the bulk of the costs are the costs to industry for altering its production processes. These costs are often estimated based on estimates of the prices given current technology. But there are many examples where the costs of reducing pollution decrease dramatically once incentives 9780230107298_04_ch02.indd 24 8/23/2010 3:32:54 PM  DETERMINING THE “OPTIMUM” AMOUNT OF POLLUTION 25 for pollution reduction are created by new regulation. This often leads to an overestimation of the costs of pol- lution reduction.7 Environmentalists should pay close attention to these costs estimates, and in cases where no account is made for technological progress, make the case that they need to be included. Uncertainty is very difficult to include in a benefit-cost analysis or optimum pollution framework because it is next to impossible to put monetary estimates on the un- known. The current state of our scientific knowledge of the adverse effects of many classes of toxic chemicals is poor or in its infancy, which only compounds the prob- lem.8 It may be reasonable to argue that an additional benefit of reducing pollution is risk reduction. Pollution reduction can be viewed not only as a means to achieve verifiable health and environmental benefits, but also as an insurance policy against many unknowns. Finally, environmentalists would be best served by priori- tizing their environmental goals according to some level of rational calculus. This doesn’t have to come from any central authority that speaks for all environmental organi- zations, nor does it need to be set in stone. But not all en- vironmental goals are created equal. Figuring out which ones can achieve a high level of benefits relative to the costs is one way to couch them in economic terms, which often holds a lot of sway in the political process. If we organized society according to this logic we would do things very differently. We would likely spend less money on maintaining thousands of active nuclear warheads and more money on prenatal and infant nutrition and education (which has huge societal returns). We would also likely shift environmental regulation more toward reductions in heavy metals such as lead, mercury, and benzene, and perhaps focus a little less on reducing chemicals that at current levels don’t offer much more in the way of benefits, such as dietary expo- sure to some low-risk pesticides.9 9780230107298_04_ch02.indd 25 8/23/2010 3:32:54 PM  26 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES WANT TO BE TOUGH ON CRIME? BE TOUGH ON LEAD Recent research makes a persuasive case that lead expo- sure can lead to increases in violent crime (Reyes, 2007), and conversely, that decreasing lead exposure can reduce criminal behavior. With crime rates always capturing a lot of public (and political) attention, this finding is something environmentalists would be wise to follow. If it can be further demonstrated that reducing some of the worst toxic heavy- metal pollutants can also help combat crime, this would pro- vide a very powerful new argument in the environmentalists’ arsenal. SUMMARY Economists approach the issue of pollution in much the same way as they approach the issue of how markets allocate other goods and services. Pollution is a bad thing, but many times it is the result of producing a good thing, or at least a thing that people want. Balancing the good and bad from pollution is similar to balancing the satisfac- tion (the good) we get when we consider buying a product or service against the amount of money we have to give up to get it (the bad). However, this framework is an aggregate framework that does not deal with issues of equity and fairness; just as the market, when left to its own devices, does not guarantee everyone three meals a day and shelter, the market will not guarantee everyone relatively clean air and water. 9780230107298_04_ch02.indd 26 8/23/2010 3:32:55 PM  CHAPTER 3 VALUING ECOSYSTEMS I n addition to addressing issues related to toxic pollution, con- serving ecosystems and the species that inhabit them is the most important issue that confronts environmentalists. Rarely does a month go by without a major news story concerning ecosystems under strain or species facing extinction. Most people, even many who wouldn’t consider themselves environmentalists, believe that we have a moral obligation to protect our natural heritage. For those who directly rely on ecosystems for their livelihood, it is often an issue of survival. The problem, once again, is that preserving environmental resources is not only very difficult in practice, but sometimes also very costly. How do we prioritize what to conserve? What criteria should we use? Once we have answered these questions, we then must determine who should pay for the desired course of action and how these deci- sions will be enforced. But first we need to think about what it is we want to conserve before we can formulate a strategy to get it done. Ecosystems provide a wide range of benefits to society: they pro- vide productive services such as food, fiber, and water; regulating services such as flood and disease control; wildlife services such as recreational and cultural benefits; and supporting services such as nutrient cycling that maintain the conditions for life on Earth. 9780230107298_05_ch03.indd 27 8/23/2010 3:33:24 PM  28 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES While this broad range of services has been acknowledged by sci- entists (and economists) for quite some time, until relatively recently there have been very limited attempts to actually quantify them comprehensively to assign them economic value.1 Unfortunately, the result has been that these benefits are often vastly undervalued in the public policy process. It is one thing to make note of the flood- control potential of a marshlands ecosystem, and another to say that it provides flood-control protection on the order of hundreds of mil- lions or billions of dollars each year.2 The latter is much more likely to get a policymaker’s attention. The absence of specific information on ecosystem services can be thought of as a form of market failure, as discussed in Chapter 1. Markets are very likely to undervalue ecosystem services (and there- fore not preserve them to the extent that they should) if these services are not in some ways quantified and recorded, and the information disseminated. Only then can actors, whether they are private compa- nies, local or national governments, or international organizations, take these values into account when deciding on alternative uses of ecosystems or the activities that will affect them. In order to fill this void, numerous consultants, nongovernmen- tal organizations (NGOs), and academics are busy trying to put mon- etary values on hitherto undocumented ecosystem services.3 This work is going a long way toward demonstrating the tremendous eco- nomic value that ecosystems provide across a wide range of users. Much of this work is uncontroversial, at least conceptually. Ecosystems provide many direct and measurable services, which even if difficult to quantify, are reasonably easy to catalog. For example, if a watershed above a city helps to purify the city’s drinking water, which in turn saves the city the money required to build a water fil- tration plant, it makes sense to assign the value of water purification services to the watershed ecosystem. If a river provides low-cost transportation in an area, then the difference between the cost of shipping goods using the river and the cost of using the next best option is one of the ecosystem ser- vices that the river provides. In economies that are dependent on extracting natural resources from ecosystems, such as timber, food, 9780230107298_05_ch03.indd 28 8/23/2010 3:33:24 PM  VALUING ECOSYSTEMS 29 and medicinal plants, the consumptive value of these goods can be calculated in a relatively straightforward manner and attributed to ecosystem services. In addition, we can often estimate the value of our recreational use of ecosystems because we leave behavioral traces when making use of these services, which can be quantified. Whenever we view wild- life, or go hunting, camping, rafting, surfing, scuba diving, or bird watching, we spend money along the way, which can be recorded and incorporated into an economic valuation. Revenue from tour- ist operations, park fees, the supporting services in the area such as restaurants, stores, and hotels, as well as the distance people travel to seek out nature recreation can be used to more precisely estimate the total economic impact of the demand for nature-based activities. Again, this is relatively uncontroversial, even if the specific tech- niques are complex, imperfect, and require certain behavioral and statistical assumptions. It is reasonable that places people spend lots of money to get to and enjoy, such as Yosemite National Park, the surf breaks of Indonesia, or the dunes of Cape Cod, have more aggregate recreational value than locations that are rarely visited. (Remember, recreational services are but one among many ecosystem services, and a far-removed ecosystem that tourists never visit may still be highly valued for other reasons.) Most controversial are the benefits that we derive passively from ecosystems. There are many places in the world that most of us will never visit, yet we care about what happens to them because we value their existence independent of whether we actually make direct use of them. We are happy to hear that they are being preserved and pro- tected, and saddened when we learn of their destruction. Many of us give charitable contributions to organizations that help protect these distant ecosystems, which we may only ever see in pictures. Part of the value may be based on our desire to pass the natural heritage on to future generations, and perhaps because we want to reserve the option to visit these unique places one day, even if we may not actu- ally get the opportunity. Regardless of the reasons we care about those ecosystems that do not directly affect our daily lives and with which we have no direct 9780230107298_05_ch03.indd 29 8/23/2010 3:33:24 PM  30 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES experience, these passive-use (or nonuse) values are real. If we could somehow quantify them they would likely be very large, both because of the depth of many people’s commitment to ecosystem preservation and simply because there are so many people on the planet. Some may suggest that contributions to conservation organizations capture the full extent of people’s existence value for ecosystems, but this is not the case. Many people believe that it is the role of government, not private charities, to protect our natural heritage. In addition, since nature conservation is a public good, there are many people who are content to let other people pay for ecosystem preservation while they sit back and derive the benefits. If push came to shove, however, and the fate of these ecosystems was dependent on their actions, most of these peo- ple would be willing to pay some amount of money to preserve them. So how do we go about estimating these passive-use values for which we do not observe behavioral traces in everyday activity? This is a very difficult task. The best economists have come up with is to devise surveys that attempt to elicit these values. They inter- view people and present them with hypothetical situations having to do with ecosystem protection or preservation. Ultimately, the par- ticipants are asked how much they would be willing to pay (WTP) to support a given action that will lead to improvements in the ecosys- tem, whether the purchase of new land, restoration efforts, or efforts to limit ongoing damage. This survey technique is called contingent valuation;4 it used throughout the world to estimate the passive-use value of ecosystems. By posing realistic scenarios that confront peo- ple with difficult choices, contingent valuation surveys are able to elicit information that can inform us of the magnitude of the nonuse values, even when the ecosystems in question are distant. Imagine that a government is considering a program to restore a degraded river. A contingent valuation survey would guide partici- pants through a description of the current state of the river and what the government proposes to do to improve the fish and animal popu- lation and water quality. Then the participants might be asked if they would be willing to pay a given amount in extra taxes to enact this program. 9780230107298_05_ch03.indd 30 8/23/2010 3:33:24 PM  VALUING ECOSYSTEMS 31 The most important element of the survey is to convince the par- ticipants that their answer is consequential; that is, if they answer “yes” that they are willing to pay the given amount for the restora- tion project, this will influence the government’s decision whether to proceed with the program and actually enact the tax. 5 If they don’t believe that their answer will have any influence on the final decision, then they may simply answer “yes” to the payment question because it feels like the right thing to do, not believing that they will have to bear any real costs for doing so. The contingent valuation method was famously used to help esti- mate the damage claims against the Exxon Corporation after the Exxon Valdez oil spill in Prince William Sound, Alaska, in 1989.6 In a precedent-setting move, a federal court ruled that lost passive-use val- ues due to the spill needed to be included in the damage estimates. This was the first time that a U.S. court explicitly acknowledged that citizens derive economic value from the mere existence of the ecosys- tems in the government’s care, even if they do not directly use them and may never do so. The contingent valuation survey estimated lost passive-use values of approximately $2.8 billion. The hypothetical scenario posed in the survey—that the government was planning on instituting a system of escort ships to prevent tankers from running aground—was eventu- ally adopted.7 Contingent valuation studies can be very helpful for organiza- tions that want to estimate the willingness to pay for entrance fees to parks or other environmental monuments. In many developing countries entrance fees to incredible natural treasures are often very low, and these nations are foregoing potentially tens of millions in revenue because they do not know the true value of their natural resources. Well-crafted contingent valuation studies can help them more accurately determine pricing and fee structures. SUMMARY Increasingly, efforts are underway to assign monetary values to eco- system services. Some methods are much more straightforward than 9780230107298_05_ch03.indd 31 8/23/2010 3:33:24 PM  32 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES others, both conceptually and in practice, but by using a combination of tools, it is possible to capture a wide range of ecosystem benefits. This work is important because identifying both the source of the values and their approximate magnitude is an important first step in determining how best to preserve and protect ecosystems. But monetary estimates of ecosystem services are just that: esti- mates. In many cases they may be extremely imprecise. At best these tools provide a reasonable range of values. They allow environmen- talists to compare different sources of value, which is often important for figuring out the most effective conservation strategies. If it can be shown that a wetlands ecosystem provides more value for storm protection than duck hunting, a stronger case for conserva- tion may be made working with adjacent landowners than with hunt- ing groups. If both of these services combined provide more value than a proposed industrial development project, then these numbers may be used to sway the agencies in charge of approving the project. Of course, there is always the risk that the ecosystem benefits will actu- ally be less than the value that could be generated by a new develop- ment project. This underlies one of the inherent risks in assigning monetary values to ecosystems: there is no guarantee that the ecosystems will always win in an economic calculus. This is why some environmentalists are deeply suspicious of the race to put monetary values on environmen- tal resources, even if they recognize the powerful economic forces at work that they must contend with. Both the ethical and tactical problems associated with assign- ing monetary values to the environment arise in almost all economic policy responses to environmental issues. Whether they are made explicit or not, they are always just beneath the surface. 9780230107298_05_ch03.indd 32 8/23/2010 3:33:25 PM  CHAPTER 4 PUTTING MONETARY VALUES ON THE ENVIRONMENT AND LIVING THINGS T he first three chapters outlined the basic conceptual frame- work of how economists approach environmental problems. Economists do not begin with the assumption that all pollu- tion and environmental degradation should be eliminated; they believe that society must strike a balance between industrial devel- opment and environmental quality. Much of the methodology that economists employ to help society weigh the trade-offs between envi- ronmental goals and the production of goods and services relies on putting monetary values on the environment and living things. Economists do this for a simple reason: money provides a conve- nient metric. To the extent that we can translate societal costs and ben- efits into monetary values, we can then easily compare them. This can help us choose priorities and make the most cost-effective choices. But money is not the only metric we could use. In fact, there is virtually no limit to the number of metrics we could come up with. 9780230107298_06_ch04.indd 33 8/23/2010 3:33:48 PM  34 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES We could measure things in equivalent amounts of copper or gold, pencils, computers, or children that could be fed. There are many benefits of using money as the metric, as well as some significant drawbacks. The first I have already touched upon; there may be some things that we consider human rights, which should not be decided based on notions of cost-effectiveness. Since access to clean water is considered a human right, we wouldn’t want a government deciding not to build a new water delivery system because the monetary benefits of providing the water (however defined) were found to be less than the costs. Yet even in such a case, it would be reasonable to assess different costs of providing the water and using these to determine the most efficient way to provide this right. The notion that certain levels of environmental quality and access to natural resources should be guaranteed is sometimes used as a way of saying that they are priceless. Many reasonable people argue that environmental treasures, such as our national parks, unique species, and human life are all priceless. But the reality is that they are not; I have proof. Consider the decision a person makes when deciding whether to take a vacation that will cost $1,000. What else could they do with the money? They could give it to charities that help starving children or AIDS patients, or to those like the Nature Conservancy that protect endangered ecosystems. And what if they don’t? What if they decide to go on that vacation? Such a decision makes clear that, according to this person’s calculus, the environment and living things are not priceless, not even close. If they were, they would certainly have sacri- ficed the relatively small sum of money for a luxury good (a vacation), and used it instead to protect and preserve life. The actions of this hypothetical actor are repeated billions of times a day in one way or the other, most of the time with a similar outcome. FOR ECONOMISTS IT IS ACTIONS, NOT WORDS, THAT MATTER MOST1 Some may think that my example is unfair. Let me be clear: the per- son who takes the vacation may care a lot about the disadvantaged 9780230107298_06_ch04.indd 34 8/23/2010 3:33:49 PM  MONETIZING THE ENVIRONMENT 35 and threats to the environment. They may give a lot of money to charity to support these causes. And they are not alone; there are many incredibly charitable people in the world. But there is a point at which virtually all people stop giving. It is at a point well before they reach a simple subsistence lifestyle. We may put a high value on the needs of others and the environ- ment, but not a value that comes close to showing the type of dedica- tion that would constitute a true belief that the well-being of others and the environment are priceless. Even those who are most chari- table still put a premium on a high standard of living for themselves and their families. There are many other ways to demonstrate that virtually no one acts in a way consistent with the view that the environment and human life are priceless. Let’s take the speed limit. In most states in the United States it stands at 65 mph. It used to stand at 55 mph. This increase of 10 mph has probably led to thousands of additional fatal accidents per year, because the speed limit is highly correlated with fatalities;2 the faster we go, the greater chance that we die when we crash—and that we crash in the first place. And many of those killed in these accidents are com- pletely innocent; they are simply the victims of other people’s mistakes. So why did we increase the speed limit in the United States? Because we valued the convenience of getting places faster more than we cared about the loss of life, even innocent life. In fact, if we really wanted to treat life as priceless we would make the speed limit very low, probably in the range of 15 to 25 mph. But how many people would accept this? Close to zero. We can also see trade-offs at work even in the most basic environ- mental activity: nature viewing. Many if not most environmentalists are driven to protect ecosystems by a deep desire to commune with nature. But this desire to visit natural habitats and interact with natu- ral systems exacts a price. The roads that we cut through wilderness areas to reach them, the diseases and invasive species we introduce, and the pollution we generate put strains on fragile ecosystems. If we truly wanted to maximize the survivability of these systems, in many cases we would protect them and leave them alone. But we don’t. 9780230107298_06_ch04.indd 35 8/23/2010 3:33:49 PM  36 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES One of the most dramatic examples in recent memory with respect to damage awards occurred in the decision over how to distribute funds allotted to the families of the victims of 9/11. Kenneth R. Feinberg created a detailed method for cal- culating benefits based on victims’ ages, the nature of their employment, and their projected wealth (Chen, 2004b). This created a major controversy since the spouses of investment bankers received a lot more than the spouses of janitors. If he had to do it all over again, Feinberg said that he would simply give everyone an equal share (Chen, 2004a). In fact, those of us who live in rural settings, perhaps to feel more in tune with nature and away from the hustle and bustle of modern industrial life, often impose more of a negative impact on just those natural systems that we want to protect. It is extremely inefficient and damaging to ecosystems to bisect them with country roads that serve very few people, and which require driving much longer distances to get to work, town, and school. From a pure conservation standpoint, urban living is much more efficient. None of these critiques suggest that there is anything wrong or immoral about treating the environmental and living things as less than priceless. As economists have noted for a long time, humans are self- interested beings. We are often generous, compassionate, and charita- ble, but not in the extreme. We balance our own needs and desires with what we feel are our obligations to others, the environment included. So while there are still problems with putting monetary values on the environment and living things, the “they are priceless” critique is not very persuasive. The biggest issue with monetizing the environment and living things is not philosophical or ethical, but practical: how do we do it in a defensible way? As mentioned in the previous chapter, some methods for assigning monetary values to environmental benefits are relatively 9780230107298_06_ch04.indd 36 8/23/2010 3:33:49 PM  MONETIZING THE ENVIRONMENT 37 uncontroversial. For example, if a fishery creates $50 million per year in revenues for the fishing industry and the surrounding local econ- omy, then this is a reasonable minimum starting point for the total value of the fishery. If smog over a city decreases property values by $100 million, then this tells us something significant about the value that people assign to better views and breathing cleaner air. The most difficult issue we face is putting a dollar value on human life and suffering, which is often necessary when trying to quantify the benefits of a given pollution-reduction policy. For example, if reduc- ing mercury emissions would save fifty lives a year but cost $1 billion to implement, is it worth it? Policymakers face these types of questions all the time. Probably the institution with the most experience dealing with monetary val- ues for life is the court system. Damage claims for loss of life and pain and suffering are ubiquitous, and juries are often faced with the task of granting monetary awards to those who have lost loved ones or suf- fered due to someone else’s negligence.3 Ultimately, there is no completely satisfactory way to place a mon- etary value on human life. One million dollars, ten million, twenty? There is always some degree of arbitrariness to the exercise. What economists have often done, which has filtered into the legal system, is to take the sum of the total of earnings over a person’s lifetime. One way to make this equitable from a societal standpoint is to take the average across all people to determine the average lifetime earnings of the population; this ensures that poor and rich alike are weighted equally in the calculation. This doesn’t address issues of the sorrow and pain that a person’s family feels, but there is essentially no satis- factory way to put a dollar value on this. We could begin to approximate pain and suffering damages by measuring the amount of lost time at work, but this only scratches the surface with respect to the true extent of the damages. In the courts, the accepted range for pain and suffering compensation is up to sev- eral million dollars, depending on the extent of the injuries.4 The problems don’t end here. One of the most interesting aspects of putting monetary values on human life is how dependent it is on the statistical nature of the lives 9780230107298_06_ch04.indd 37 8/23/2010 3:33:49 PM  38 HOW ECONOMISTS APPROACH ENVIRONMENTAL ISSUES in question. For example, let’s go back to the issue of whether reducing mercury pollution that kills fifty people a year would be worth a cost of $1 billion. It is only when we talk about people in the abstract that we can even begin to make this judgment. What if, on the other hand, we knew exactly which fifty people were going to die? Could we then sit down and reasonably argue over whether it was okay to let these fifty people die instead of making the $1 billion investment? I doubt it. The same goes for our desire for the 65 mph speed limit. It would never be acceptable if we actually knew for sure which thousands of citizens would be mangled in the increased number of accidents. But the randomness that comes with the costs of our actions makes them statistical exercises. We know that some people some- where at some future time will die because of certain policy choices, but the uncertainty that surrounds the circumstances allows us to distance ourselves from these otherwise unacceptable costs. This paradox raises some profound questions. Is this apparent contradiction actually beneficial? Does it allow us to bypass our sen- timentality, which might otherwise cripple our material progress? And doesn’t this material progress not also create the conditions for greater life span and prosperity? There are no easy answers to these questions. The bottom line is that putting monetary values on human life will always be problem- atic, somewhat arbitrary, and subject to valid criticism. For this reason, it is often preferable to think about environmen- tal problems from another angle. What are the most cost-effective pol- lution reduction policies that will reduce the loss of life and improve health outcomes? This is often the actual task policymakers face; they are given mandates to reduce mortality and illness from pollution and then must figure out the best ways to achieve these results.5 Where these targets come from is worthy of an entire book unto itself. One of the first things one notices when examining many envi- ronmental targets established by government agencies is that they often come in round, even numbers—for example, reductions in pol- lution of 20 percent or 50 percent; it is rare that a government agency puts forth a plan to cut emissions by 13.7 percent.6 Numbers are often chosen that are easily digestible by the public and that can demon- strate a clear commitment to pollution reduction. 9780230107298_06_ch04.indd 38 8/23/2010 3:33:49 PM  MONETIZING THE ENVIRONMENT 39 However, in most cases there is at least some scientific basis that accompanies the given number. For example, in the 1990 U.S. sul- fur dioxide “cap and trade” program, the goal was to significantly reduce acid rain, and the target chosen was based on an analysis of the reductions required. But even behind this decision lurked an implicit benefit-cost analysis and monetary valuations of human lives and the environment.