Global Public Goods, Inequality and Institutional Change. Understanding the effect of

demographic trends and labour market institutions on the demand for public

environmental protection.

Elisabetta MagnaniSchool of Economics

The Australian School of Business at UNSWSydney, Australia

Acknowledgements

I wish to thank Samuel Bowles, Maurizio Franzini and Stefano Zamagni for helpful comments to previous versions of this paper. Research Assistance by Adeline Tubb is gratefully acknowledged. Please send your comments to e.magnani@unsw.edu.au

The beginning: problems with the concept of Sustainable Development

• The concept of sustainable development: ability to "preserve the welfare capacity of those who come after us" (Brundtland Report, 1987). The loss of environmental quality will decrease welfare of the next generation. This welfare loss will require suitable material and immaterial compensations to increase welfare.

• If environmental damage increase with GDP, this argument sets a very dangerous and potentially endless vicious circle. If the extra production of goods and services further reduces the quality of environmental amenities, more and more goods and services will be necessary to fulfill the notion of sustainable development.

• It is exactly the link between economic growth and environmental quality that poses a serious challenge to the established idea of "sustainability“.

Contribution of this paper• It is exactly the link between economic growth and

environmental quality that poses a serious challenge to the established idea of "sustainability“.

• The emergence of a virtuous link between these two dimensions of economic performance is conditional on the diffusion of public willingness to pay for environmental care.

• The effect of inequality on environmental sustainability depends critically on the institutional setting that structures interactions among agents.

• Shaping institutional settings requires embracing the idea of prospective volition (Bromley, 2006a)

• Drawing upon a number of experimental and behavioural results, this paper outlines a few research questions, which, if addressed, will (hopefully) contribute to a wider debate over which LM institutions are best suited to ensure a global economy that embraces the value of intergenerational solidarity.

Too much emphasis on Prisoner’s Dilemma situations?

The role of institutions

• The literature has widely explored the Prisoner Dilemma problem arising in the face of summation technology of public supply aggregation, the ones where the resulting level of GPG provided depends on the sum of individual offers. One important contribution (e.g., Sandler, 1998) is that non-summation technologies do not necessarily imply Prisoner's Dilemmas where the dominant strategy is "do nothing".

• Thus, a way to address the debate on institutional change for successful management of current challenges vis-a-vis GPG is to consider which institutional framework better creates the necessary conditions for public and political support for environmental protection initiatives even if these initiatives are not fully coordinated at the global level. In other words, can we design institutions that support individuals' willingness to pay for environmental quality?

Environmental quality: the result of individual choices

as well as collective choices. What shapes preferences of environmental quality?• Two major strands of literature on the Environmental Kuznets Curve

(EKC), can be distinguished on the basis of the channel through which the downward sloping segment of an EKC may emerge (Egli and Steger, 2004)).

• The first class of models stresses shifts in the use of production technologies (e.g., Stokey (1998); Smulders and Bretschger (2000).

• The second class of EKC models focuses on abatement expenditure, which captures the fact that pollution can be alleviated by devoting public resources to improve environmental quality (e.g., Selden and Song (1994); Chimeli and Braden (2002); John and Pecchenino (1994).

• All these theoretical developments emphasize the importance of one or both of these factors, namely individual behaviors (e.g., in choosing production technologies, in adopting environment-friendly consumption patterns), and collective decisions (for example policy choices), for the emergence of paths of sustainable development.

What is the intentionality behind labour market Institutional changes?

• The new institutional economics places institutions at the centre of understanding economies because "they are the incentive structure of economies" (North, 2005,p. vii).

• Importantly, North fails to grasp the idea that institutions are not only constraining factors, but rather "means whereby going concerns -family, firms, villages, nation states regularize and channel individual action and interaction" (Bromley, 2006b).

• For North the key to understanding the process of economic change is the intentionality of the players enacting institutional change.

• From here the question: What is the intentionality behind Labour Market Institutional changes?

• The "new institutional" economics evaluates institutions and institutional change only on the basis of their effect on economic "progress" as measured by productivity or GDP growth.

• Is this the only intentionality we can come out with as a global community?

What does LM Institutional Change entail?

• Institutions as in Bromley (2006b): “opportunities to define choice sets -field of action- for members of a political entity“. Are benefit and costs of LM institutional change fully understood?

BENEFITS: Change towards a more limited role of protective LM institutions to access productivity gains. Protective LM institutions are blamed to cause high unemployment and low economic growth. Howell et al., (2007) among many others conclude their critical review of the literature on labour market transitions and institutional change by stressing that there is scanty support to such view.

COSTS: LM institutional change involves increasing risk and uncertainty. (i) Overall earnings inequality has risen in all major world economies

including the US, the UK, and Japan (Acemoglu, 2003). (ii) Inequality has risen also in regard to wage and non-wage

compensation, and workplace disamenities. (iii) A sharp rise in within-group earning inequality implies increasing

uncertainty. Note that this uncertainty is not insurable because we do not know what skill is.

What are the effects of an increasing LM uncertainty upon the provision of GPGs?

• How do LM Uncertainty and Risk impact upon the adoption of environmental friendly technologies?

• According to Sinn (1995) and Bird (1998), there is a risk-taking effect of social safety nets.

• Abundant evidence is provided to support the view that inefficiency in production choices arises following a lack of insurance (e.g., Dercon and Christiaensen (2007), Baerenklau (2005); Engler-Palma and Hoag (2007))

• Experimental economics has yielded an important set of contributions relating uncertainty/risk and the provision of GPG. Brown and Stewart (1999) find that the threat of incurring an undesired outcome (losing money) does not result in individuals overcoming the social dilemma. Importantly, people identified as risk seekers increased their level of cooperation in order to avoid losses, but these effects were offset via reductions in internalization rates by risk averse subjects.

How does LM Inequalityshape collective preferences for GPG?

• What is the impact of rising inequality on individuals' incentives to cooperate for the collective provision of GPG?

• The same institutions responsible for LM rigidity are also relatively successful in achieving economic equality.

• One possible channel through which LM institutions can have spillover effects on the provision of GPG is via the link between inequality and social cohesion (and social capital).

(i) For example, Caramuta (2005) illustrates the dynamics relating inequality, social capital and institutions. Multiple equilibria arise: one equilibrium features a high level of social capital, low inequality and institutions that favor social equality.

(ii) In standard public goods experiments individuals face social dilemmas given the presence of various kinds of uncertainty. Wit and Wilke (1998) examine the effects of Environmental Uncertainty (low, high uncertainty about the provision point) and Social Uncertainty (low, high uncertainty about others' cooperation) in a public goods dilemma. It was predicted and found that Environmental Uncertainty decreases cooperation only under High Social Uncertainty, but not under Low Social Uncertainty.

Summary• In recent years, there has been a huge increase in interest in the environment and its interaction with the economy. • A key feature of this literature is its recognition of the interdependence between the economy and the environment. In general, this interdependence operates in both directions and it is poorly understood. • A rather overlooked issue is how economic institutions affect our ability and willingness to provide GPG such as environment quality. • In addressing Bromley's question "How do we wish the future to unfold for us?", this paper develops an argument according to which future research will need to devote resources to understanding the spillovers between institutional settings and incentives to provide global public goods. • I focus on labour market institutions as labour markets are traditionally the "environment" in which inequality is created and perpetuated at the local and global levels. • Findings from experimental and Behavioural Economics stress that LM institutional design, via its impact on risk and uncertainty, may have sizeable implications on the provision of environmental care.