Negotiations

The Coase Theorem

As described in part one, where externalities are present, the uncorrected market mechanism leads to misallocations. The causer of the externality will, at an uncorrected equilibrium, produce an emission level x* at which his profit (utility) is maximized, but the interests of those damaged are left entirely out of account. Perhaps the intuitively readiest response to this calamity is for the government to affect the polluter's emission level through direct controls.

In sharp contradistinction to this approach, Ronald Coase (1960) put the view in his famous essay that the misallocation could be rectified by direct interaction among those involved after the government has defined the rules of this interaction. This idea is often regarded as counterintuitive, but the basic notion can nonetheless be directly derived from the concept of the suboptimality of the uncorrected equilibrium. That is, if the uncorrected emission level x* is not Pareto optimal, then this means by definition that changes in this starting position that leave at least one of those involved better off without any other being worse off are possible. There is thus potential here for welfare improvements, and a clever distribution arrangement can take advantage so as to make all participants better off. This potential runs out only at the optimum allocation. According to Coase, the prospect for achieving these potential improvements in condition, then, constitutes the motor for collaboration by the parties, with the object of bringing about optimality.

Foundations

Object and Methods of Microeconomic Theory

Microeconomics is the science of scarcity and coping with the consequences of scarcity. Scarcity arises because the resources available to meet human needs are not enough to meet all existing desires. The concept of scarcity thus does not (only) refer here to the lack of essentials, but to any divergence between desire and reality. The central concepts of “needs” and “resources” are couched very broadly in modern economics.

The concept of need goes far beyond the area commonly termed “economic” in ordinary speech – namely, food, accommodation, clothing, and transport – to embrace needs often seen as “extraeconomic,” such as those for a clean environment, internal and external security, and indeed even the longing for peace and harmony in a relationship.

Similarly, the concept of resources is no longer confined in modern economics literature to the traditional factors of production – (paid) labor, capital, and land. Instead, natural (exhaustible or renewable) resources, as well as such elements as human knowledge and the work ethic in a society, are now taken into account.

A world of scarcity is necessarily one of conflicts over precious (because they are needed to reduce the scarcity) resources. No society is conceivable without mechanisms and institutions to settle these conflicts. The rules whereby scarce resources can be distributed among the all-too-numerous bearers of the all-too-numerous needs are varied.

In this part, the economics of natural resources and sustainable development are presented in an overview. Specific aspects can be addressed only briefly in the space available here. Following the literature, we divide natural resources into exhaustible and renewable ones. The former are defined by the fact that the total stock of them in the Earth is a constant within the time frame of relevance to human planning. A unit of an exhaustible resource used in the present thus reduces the stock available in the future by precisely one unit. Here the present and the future are in total rivalry over the utilization of the resources.

The standard examples of exhaustible resources come from the area of mining, with fossil fuels and mineral raw materials being frequently mentioned. For exhaustible resources such as metals, the rivalry between present and future utilization can be mitigated by recycling.

Renewable (also called regenerable) resources can be increased in the time frame of relevance to human planning. The growth rate of the stock depends on many determinants, particularly the size of the stock itself. The connection between present utilization and future possibility of utilization is thus more complex for renewable resources than for exhaustible ones. Important examples of resources in this category are forestry and fish stocks.

Resource Exhaustion – The End of Humankind?

Introduction

One of the central questions that excited the public and the scientific world in the 1970s and beyond was: will humanity decline and fall because of a shortage of resources? The debate has slackened somewhat in the meantime, but continually flares up again.

This book's readers have accompanied the author on a long journey through the (sometimes impracticable) terrain of environmental economics. Many thanks for your company: without you (or, more exactly, without the vision of an addressee), I could not have managed it. In conclusion (as a reward?!), we offer you a bird's-eye view of our journey.

The simplest models in economic theory contain only households and firms as actors. The households aim to maximize utility. In doing so, they decide on their demand for consumer goods and the supply of production factors (especially labor) they offer. The objective of firms is seen as profit maximization. They can approach this objective in their role as suppliers of end products and demanders of factors of production. The activities of the individual households and firms are coordinated through markets. On certain conditions, the market mechanism is an extremely efficient instrument for coping with scarcity problems. One (of the many possible) complication(s) is that although many of the economically relevant relations among the actors are market relations, not all of them are. Often, the activity of one decision maker will affect the situation (the welfare) of another decision maker, without the market being the mediating mechanism. Such processes outside the market are called “externalities.” The literature of economics has shown that externalities can encroach severely on the capacity of the market mechanism to increase a society's welfare.

There is no doubt that environmental economics has greatly progressed since the appearance of the second edition of this book in 2000. In fact, it is these advances that persuaded me to thoroughly revise the text and extend it considerably. However, it is not necessary to establish whether environmental economics progressed in the manner cited previously or quite differently, nor do we need to go into the variances between the previous edition and this one in detail. For most readers of this book, the developments that led to the present state are not terribly important. (This is particularly so because the second edition is written in German.) Let us instead take this book as it is.

I investigate environmental pollution and environmental policy using the methods of microeconomics. The aim is to work out the economic structure that underlies the manifold practical problems and the attempts at solving them. Special attention goes to the incentive structure to which those making decisions of relevance to the environment are exposed because of market mechanisms, state regulation, and international institutions.

Environmental Policy with Pollutant Interactions

Pollutant Interactions and Environmental Policy Target Setting

In our economic analysis of the use of environmental policy instruments, we assume in part three that the object of environmental policy was to reduce the quantity of an individual pollutant emitted (or several pollutants that can be considered separately from each other). Under this condition, various instruments of environmental policy were looked at for their ability to reach the environmental policy target cost effectively.

Considering single pollutants in isolation is primarily advisable because it enables a simplified presentation of the complex problems of the use of environmental policy instruments. In the long run, though, analysis in environmental economics cannot ignore the fact that pollutants interact in manifold ways in the media that comprise the environment. Where such interactions are present, environmental policy goals can no longer be defined and pursued independently for individual pollutants because the hazardousness of each individual pollutant depends on the quantity of other pollutants emitted. The consequences arising from this complication for the employment of environmental policy instruments are considered here.

Pollutant interactions may be of very varied natures. The simplest case is where several pollutants jointly consume the environment's assimilative capacity, while the environmental burden effect of each additional unit of each pollutant remains constant. Here the environmental burden B produced by two pollutants x, y comes out as B=a1x+a2y, where a1, a2 (>0) are constant coefficients of damage capacity.

Introduction

In this part, we present and assess the types of environmental policy instruments that play an important part in the academic and political debate.

For a “fair” comparison of the properties of various instruments, it is indispensable for them to be dealt with in the same analytical framework. In particular, it must be assumed that the alternative instruments are being used to attain the same ecological objective. The hypothetical nature of the ceteris paribus construction considered here is consciously accepted for this. It distinguishes this book from one concerned mainly with analyzing practical environmental laws. The uniform objective the instruments are to serve is presumed to be keeping a preset absolute emission ceiling (“aggregate emission standard”) for a particular pollutant i within a certain region (per unit of time). The environmental policy instrument is supposed to make the sum of the absolute emission quantities of all producers of the relevant pollutant in the region concerned not exceed this maximum. To distinguish them from the “internalization strategies” concerned with charging for the (monetized) external damage, the instruments for reaching the objective described are called “standard oriented.”

Let us briefly pause for a “terminological warning”: there is a possible source of confusion in how the term “standard” has been used in the literature. On the one hand, “standard” means an aggregate level of emissions. The goal of environmental policy is to make sure that equilibrium aggregate emissions do not exceed this target.

Introduction

In the discussion so far, we have mostly assumed that the spatial distribution of emissions is of no particular importance for environmental policy. But where its implications were occasionally considered (e.g., in section C.III.7 of part three), we silently assumed that spatial problems could be dealt with in the context of national environmental policy. However, as we know, pollution flows do not stop at national frontiers. The range of international environmental problems runs from the nameless “neighborhood conflict” in areas near frontiers to “downstream–upstream”problems linking several states (e.g., pollution of the Rhine) and phenomena of large-scale pollutant transport (e.g., “acid rain”) to world-embracing (“global”) problems such as the “ozone hole” and the “greenhouse effect.” In particular, the last-named problems have in recent years received considerable attention from science, politics, and society. We accordingly (and for space reasons) want to confine ourselves to the “extreme case of internationality” in the environmental area, namely, global environmental problems. Global pollutants differ from all other pollutants because they are immaterial to their environmental impact where they are produced. Thus, according to current scientific knowledge, the warming of the Earth's atmosphere depends on the total output of greenhouse gases and not on their regional emergence profile. Much the same is true of the effects of chlorofluorocarbon (CFC) output on the ozone hole.

The global environmental load thus depends on the total output of the relevant pollutants (i.e., the sum of pollutant outputs of the individual countries).