ECONOMICS AND THE ENVIRONMENT

How much is clean air worth? Can you charge somebody for

damaging your air? How much are you willing to pay for

clean air? Should you have to pay for clean air?

Have you ever caught a fish off the UST pier?

Is cutting down the rainforests efficient? What market incentives are there for

research on the environment? How can the environment be priced and

sold? Does Hong Kong have any mechanisms for

valuing its environment?

Lecture Objectives: Review Advantages and Limitations of

Market Economics Understand how economics is creating

new principles and guidelines for business activity.

Comparing: Neo-classical Economics Environmental Economics Ecological Economics

To reveal policy implications

What is an economy supposed to do?

What is the Neo-classical approach?

What is a market?

A system of exchange

What is exchanged?

Resources: land, labor, capital (ie. goods or services in some form)

How does the market work?

Matching of supply and demand

Why is the market such a good system? Optimal use of resources: buyers force

competition on suppliers; greatest return for the efforts of suppliers

Pareto efficiency: “a situation where it is impossible to make one person better off without making anyone else worse off”– Meaning: allocation of resources to the uses

that will bring the greatest overall increase in production and monetary value by matching producers with the highest bidders

What enables the market to work?Price or Value settingProfit motivePrivate propertyGovernment and other

regulating institutions

Does the market operate perfectly?

1. General Market Failures: Monopoly; information asymmetry; missing markets; transaction costs.

Market Failures What company did you buy your air from? How much did you pay for your air? How was that

price set? How clean was the air you bought? How do you

know? How can a company stop other companies from

dirtying its air? What can you do if someone makes your air dirty after you bought it?

What rate of return should a company expect to get from investing in air quality?

2. Environmental Market Failures: Failure to value the environment:

unpriced use values; option values; existence values; bequest values

Lack of information Externalities Common Access Resources/Sinks Discounting the future Missing Markets

Externalities

“An unintended cost or benefit of production or consumption that is not reflected in the price of the related transactions. Externalities are often borne by people who are not parties to the transactions that create them.”

Externalities

Define the externalities of your company: who are the parties to the monetary transaction and who or what pays for the impacts of the transaction

Discounting the Future with Net Present Value

(NPV)NPV = x/(1+.10)nyrs

X + your present money value

.10 = the discount rate

nyrs = the power of how many years down the future you are looking at

NPV of 100 dollars in five years with a discount rate of 10% is 100/(1+.10)5 or $62.09

Environmental & Ecological Economics

1. Why should CLP pay for pollution controls in Guangdong rather than in Hong Kong?

2. Are there any economic tools we can use to value Hong Kong’s environment?

3. Are air-conditioned shopping malls reasonable substitutes for clean air and clean beaches?

4. What impact would the use of the Mai Po conservation area for building houses have on Hong Kong’s net worth?

Cleaner air on horizon by year's end: Liao Improvements to Guangdong power plants will cut

pollution, says minister

Guangdong's biggest cluster of power plants, at Humen in Dongguan - which are blamed for much of Hong Kong's air pollution - are being equipped with desulphurisation devices to cut emissions.

In the longer term, Dr Liao hopes a cross-border emission trading scheme can be set up to  assist other power plants in Guangdong to cut emissions in a more cost-effective manner.

In the meantime, the government has started talks with CLP Power and Hongkong Electric on emission reduction and an emission trading scheme.

Hong Kong administration states preference for system to be used in cross-border emissions trading

…the government says a "cap and trade" method is best for Hong Kong.

Under this system, the government would set an emissions cap as well as a timetable for this to be lowered. The capped quantity of emissions would then be distributed to sources of air pollution, including power plants and large factories, in the form of emission allowances or permits.

Polluters who fail to meet the requirements of the cap would have to buy emissions reduction credits from others who could successfully lower their emissions below the capped level

Environmental Economics: From Market Failure to Government Failure

Limited information of how to deal with specific environmental problems (of area or industry) and of firms’ capability to deal with or hide environmental impact

Limited resources to regulate, monitor and enforce

Command and Control regulations: uniform standards and technologies

Policy Guidelines from Environmental Economics:

I. Benefits of Using the Market (as opposed to CAC)

1. Cost effectiveness: example, emission trading credits

2. Substitution and technological advance: example, green taxes

3. Other institution/market based schemes: deposit refund schemes, environmental bonds, transferable quotas, transfer of development rights.

Policy Guidelines from Environmental Economics II. Better Valuation of Non-

market Valued Assets

1. Financial Costs 2. Averting Behavior 3. Travel Cost Method 4. Hedonic Pricing 5. Contingent Evaluation

For: Better Cost-Benefit Analysis, regulations, fines

Environmental Economics and Ecological Economics

Weak vs. Strong Sustainability

Environmental Economics and Ecological Economics: Weak vs. Strong Sustainability

Efficiency standard vs. ecological standard

Discount rate (growth) driven vs. discount rate (growth) limiting

Resources as inputs & outputs of unlimited economic system vs. economic system as limited subsystem of ecosystem

Substitutability vs. complementarity

The Environmental Economics Trade-off

Economy HM

E E

M

S

Recycle?

Neo-classical Empty World

Figure 1: The Economy as an Open Subsystem of the Ecosystem

(Daly 1996:49).

S = solar energy H = heat M = matter E = energy

natural capital man-made capital

Ecosystem

Ecosystem

Economy

H

M

E E

M

S

Recycle

Environmental Economics World

Ecosystem

Economy

H

M

E E

M

S

Recycle

Environmental Economics World

H

EconomyE

M M

E

SRecycle

Ecological Economics Full World

Figure 1: The Economy as an Open Subsystem of the Ecosystem

(Daly 1996:49).

S = solar energy H = heat M = matter E = energy

natural capital man-made capital

EcosystemEcosystem

Substitutability vs. Complementarity

Manufactured and knowledge capital for natural capital

Land, labor and capital substitutability

Same service by different product

Technological fixes Ecosystem resilience

Manufactured capital depends on natural capital

Uniqueness, uncertainty and irreversibility

Ecosystem services Growth outpaces

substitution Ecosystem fragility

Policy Influences from Ecological Economics

Strict demands for environmental protection reflected in:

Environmental impact assessment Natural preservation areas (parks, reserves) Absolute limitations on chemicals

Policy Guidelines from Ecological Economics

1. Daly Rule 2. Index of Sustainable Economic

Welfare (ISEW) 3. Ecological tariffs on free trade 4. Community based sustainability

through self-sufficiency and diversification

Policy Guidelines from Ecological Economics

1. Daly Rule: "Never reduce the stock of natural capital below a level that generates a sustained yield unless good substitutes are available for the services generated."

Index of Sustainable Economic Welfare

ISEW=total output+ unpaid work - environmental destruction and degradation- environmental improvement measures - depreciation of human-made capital+/- welfare distribution effect

Free Trade Limitations Regional specialization obscures view

of resource exploitation, depresses ecological and social laws, weakens terms of trade and impoverishes landholders

Externalities from the shipping of goods around the world

Therefore, tariffs to compensate or reduce free trade

Community Based Development

Community rather than corporations or government creates social conditions (wants and needs) that limit impacts

Greater self-sufficiency through decentralized control

Local synergies for recycling and energy reduction

Ethical bonds amongst business community

Summing up:

Market success in exchange efficiency Market failures in: valuation, common access,

externalities, and discount rate Environmental economics guidelines: cost

effectiveness and market-based incentives Ecological economics guidelines: limiting

growth to within global and local ecosystems*therefore reducing throughput of

economy within ecological carrying capacity