Pollution and Resource

Degradation as Externalities

Introduction

Any economy depends on the ecological system in which it is embedded in two fundamental ways. Humans:rely on the environment as a source of raw

materialsexploit the environment as a sink for waste

materials Sources and sinks form “natural capital,”

the input that nature provides for our production and consumption processes

Pollution, Resource Degradation and Externalities Pollution is the overuse of sinks Resource degradation is the

overharvesting of sources These two are flip sides of the same

process: the excessive exploitation of natural capital

Economists define “pollution” as a negative externality: a cost of a transaction not borne by the buyer or seller

Three Examples of Pollution? Tyler is eating in a smoky restaurant. Is he

exposed to pollution? Karen routinely comes in contact with low-

level radioactive waste while working at a nuclear power plant. Is she exposed to pollution?

Marilyn is trying to get some sleep while his neighbor Tipper blares the sound system. Is he exposed to pollution?

The Answers Maybe, maybe, and yes If Tyler is the one smoking and he is aware of the

damage it causes, then he is balancing pleasure against risk and is not being exposed to pollution

If Karen is aware of the risk posed to her by radioactive waste and is accepting this risk in exchange for a salary then she is not being exposed to pollution

Marilyn is clearly a victim of pollution. He is involuntarily being exposed to a by-product of Tipper’s listening experience

Why Market Systems Create Pollution From an economist’s point of view, market

systems generate pollution because many natural inputs (e.g. air and water) are “underpriced”

Because no one owns these resources, in the absence of government regulation or legal protection for pollution victims, business will use them up freely, neglecting the external costs imposed on others

Internalizing the Externality If businesses were forced to compensate

victims of pollution for damages they impose, firms would, in effect, be paying for the “underpriced” natural inputs they useThis would lead firms to conserve on its

resource use and to seek cleaner production methods

This is known as “internalizing” the externality and is one way of dealing with the both the problems of pollution and resource degradation

Social and Private Costs in the Paper Market

Pollution as Market Failure Many forms of natural capital are not

(and cannot) be privately owned Because of this, unregulated free-

market systems will generate too much pollution by any standard, due to:The open access problemThe public goods problem

The Open Access Problem If people weigh private benefits against

private (as opposed to social) costs, they will overexploit common resources when given open access

Referred to as “The Tragedy of the Commons”

The Open Access Problem:Global Fisheries Close to half of America’s fisheries and more than

70% of global fisheries are overfished The North Atlantic is estimated to contain only

one-third of the biomass of edible fish that were present in 1950

Modern technology (bottom trawling) is damaging habitat, essentially clear-cutting, and not replanting, the ocean floor

As stocks dwindle, the incentive for any individual fisherman is to increase his or her share of the remaining stock

Vessels and Total Catch

The Open Access Problem

The Open Access Problem Private boats will go out as long as average

revenue covers costs By contrast, the profit-maximizing catch level

occurs where marginal revenue just exceeds marginal cost

Profit earned in the industry is the sum total of the difference between marginal revenue and marginal cost for each boat that goes out

When marginal revenue is less than marginal cost, a drop in industry-wide profits will occur

Resource Rents

When natural capital is used efficiently, long-run economic profits will be earned by those who retain access to the resource

These long-run profits, generated by restricted access to natural capital, are called resource rents

Resource Rents in New England Data suggest that fishing off the New

England coast would have to be reduced by about 70% to eliminate overfishing and achieve an efficient harvest

This would generate a resource rent of about $130 million

If this were collected by the government, it would be sufficient to compensate those boats put out of business due to fishing restrictions

Handling the Open Access Problem In traditional societies, informal social

pressure and tradition were relied upon to prevent overexploitation

The modern equivalent advocated by free-market environmentalists would be to internalize externalities through lawsuits against an offending company or individual

Is government regulation really needed?

The Public Goods Problem Private remedies to environmental

degradation (eg law suits) run into what economists call the public goods problem

Public goods are goods enjoyed in common (e.g. the warning service provided by a lighthouse)

One key characteristic of public goods is that they are “non-excludable”

Public Goods Problems for the Free Market

Public goods pose a problem to the free market for two reasons:Free riding: people benefit from public goods (like

law suits) regardless of whether or not they pay for them.

High Transaction Costs: public goods provision require groups of people to undertake action. In addition, information about environmental damages is costly for groups to obtain. These features add extra “transactions costs”.

Demand for Private and Public Goods, illustrates free-riding With a private good, the total demand is

the horizontal sum of the individual demand curves

With a public good, the total demand is the vertical sum of the individual demand curves

Demand for Private and Public Goods

Summary: 1 Pollution is a negative externality Negative externalities often arise due to

open access to common property When access to common property

resources is restricted to the efficient level, resource rents are earned

Resource rents can be taxed to compensate those who lose from restricted access.

Summary: 2

Negative externalities can sometimes be internalized through lawsuits, but this runs into the ..

Public Goods ProblemLaw suits are subject to free-riding and have

high transaction costs, especially with regards to obtaining information about damages.

Summary: 3

Because clean-up is a public good, government is generally expected to internalize negative externalities through: Regulation of access to common property.The promotion of clean technology

alternatives.

Appendix 3AOverfishing, ITQs and Aquaculture

In the figure on the following slide, the point at which the curve begins to bend downwards is considered the maximum sustained yield

The efficient fishing level--the one that maximizes resource rent--occurs where total revenue exceeds total cost by the greatest amount

Where total revenue equals total cost is the open access outcome

Fishing Yields: Efficient, Sustainableand Open Access

The Liquidation Strategy Profit-maximizing rule:

If the interest rate is less than the rate of growth of the fishery, maintain the harvest below the sustained yield level

If the fishery grows at a rate less than the interest rate, liquidate the fishery and invest the resource rent in activities generating a higher return

Higher interest rates thus make overexploitation of natural capital more likely

Applying the Fisheries Model

The Liquidation Strategy

Fisheries Policy The standard regulatory recommendation for

fisheries management from economists is a cap-and-trade system called an individual transferable quota (ITQ)

The advantage of an ITQ over rigid allowances is the built-in flexibility allowing for boats having good seasons to purchase quota from boats having poor seasons

Some have criticized this method as leading to the capture of large market shares by a few companies; this has not been borne out in New Zealand.

Problems Posed to Fisheries Regulation Political influence over fisheries boards

lead to excessive total allowable catch levels

Difficulty monitoring mobile sources like fishing boats

By-catch--fish accidentally caught for which boats don’t have permits--is a wasteful problem as these catches are often dumped overboard to avoid fines

Aquaculture

Aquaculture is the commercial raising and harvesting of fish in ocean environments over which fishers are granted exclusive rights

It has the potential to both significantly decrease pressure on natural fisheries and boost the productivity of the oceans

Problems With Aquaculture As currently practiced, aquaculture

generates significant negative externalities, including the immediate impact on the ocean environment fromFish wasteHeavy metalsPesticidesAntibiotics

Fish feed for carnivorous species is harvested unsustainably in the ocean

Aquaculture can destroy local habitats

Feeding 9 billion

Some mix of ITQ’s, sustainable aquaculture, and protection of breeding habitat will be required to supply fish for the world.