ECON 4925 Resource Economics Autumn 2006

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1 ECON 4925 Resource Economics Autumn 2006 Lecturer: Finn R. Førsund ECON

2 Perman et al. Chapter 1. An introduction to natural resource and environmental economics Three themes: efficiency, optimality, sustainability Efficiency eliminating waste technical inefficiency (physical) allocative inefficiency Concern: how economics might avoid inefficiencies in the allocation and use of natural resources. ECON

3 Perman et al. Chapter 1.1 Optimality A group called society Some overall objective that this society has; can then measure desirability of resource use decisions Optimality: maximising the objective under relevant constraints. Resource allocation: cannot be optimal without being efficient. Necessary, but not sufficient. ECON

4 Perman et al. Chapter 1.1 Sustainability Taking care of posterity. Given optimality, is sustainability redundant? Pursuit of optimality will not necessarily take care of posterity Taking care of posterity as a moral obligation: then sustainability constraints have to be included in the optimality problem ECON

5 Perman et al. Chapter Classical economists: century Economic growth: importance of natural resources (land) Living standards in the long run subject to constraints (land) Diminishing returns, inevitability of a stationary state ECON

6 Perman et al. Chapter Adam Smith: markets and allocation of resources, invisible hand Malthus: population growth geometric and food output growth arithmetic Ricardo: subsistence wage level in steady state, land in varying quality John Stuart Mill: diminishing returns, but also growth of knowledge and technical progress. Amenity values, first environmental economist? ECON

7 Perman et al. Chapter Neoclassical economics: marginal theory and value in exchange 1870+, Jevons, Menger, Marshall (consumer surplus), Walras (general equilibrium) Production- and utility functions Keynes: short-run use of resources Neoclassical growth theory: absence of natural resources, introduced from ECON

8 Perman et al. Chapter Welfare economics Rankings of allocation must be based on ethical criterions Utilitarian moral philosophy, Hume, Bentham, Mill. Weighted average of the total utility levels enjoyed by all individuals in the society Pareto optimality (1897) ECON

9 Perman et al. Chapter Ecological economics Economic system part of the larger system, interdependence of economic and natural systems, sustainability at the forefront. Boulding: spaceship earth ECON

10 Perman et al. Chapter 1.3 Economic approaches to resource issues: Property rights, efficiency and government intervention Role of markets and property rights as the basis for markets Exhaustability, sustainability and irreversibility Stock and flow resources Renewable and non-renewable resources Time dimension of economic decisions Resources as stocks, must study pattern of use over time, optimality an intertemporal problem Substitutability between resources, between man-made capital and resources Irreversibility: asymmetry implies stronger preferences for non-development ECON

11 Perman et al. Chapter 2 Can the global economic system continue to grow without undermining the natural systems, which are its ultimate foundation? Can poverty be alleviated in such ways that do not affect the natural environment in such a way that future economic prospects suffer Interrelationship between poverty, economic development and the state of the natural environment World Commission on Environment and Development 1987 Our Common Future ECON

12 Perman et al. Chapter 2 A general production function y = f(, l K, R, M( R), A( M)) l=labour, K=capital, M=waste, A=ambient concentration Waste creation has a resource base, M > 0 Limits to growth Resources, environment, population, food ECON

13 Perman et al. Chapter 2.1. Biodiversity Biodiversity: variety and variability of all living organisms in terrestrial, marine and other aquatic ecosystems and the ecological complexes of which they are parts. Diverse gene pools, evolutionary potential, insurance against ecological collapse Source of medicine, resources. Measures of biodiversity Population and genetic diversity Number of species within an area Ecosystem-diversity Surrogate measure: magnitude of undisturbed ecosystems Biodiversity a multidimensional concept, cannot be reduced to a single measure ECON

14 Perman et al. Chapter 3. Ethical foundations for economics Naturalist moral philosophies Humanist and naturalist moral philosophies Libertarian: (John Locke) Fundamental inviolability of individual rights Utilitarian school: (David Hume, Bentham) Well being comparable over persons and time Individuals and generations, intertemporal welfare function ECON

15 Perman et al. Chapter 3. Utilitarism Discounting ethical indefensible? T t= t t ρ t= 0 t= 0 ρt W = U (1 + ) ( = Ute dt ) Positive time preference and consumer sovereignty Individual preferences and social preferences Role of population growth ECON

16 Perman et al. Chapter 3. Utilitarism Utility discount rate and consumption discount rate, r. T ρt W = U( Ct ) e dt t= 0 Discounting discriminating against future generations? Rising consumption over time may be consistent with positive discounting r C& U''( Ct ) C = ρ+ η, η = C U'( C ) t ECON

17 Perman et al. Chapter 3 (11). Derivation d ρt ρt UC ( t) e U'( Ct) e dc = t d ρt dc ρt ρt U'( Ct) e U''( Ct) e U'( Ct) e dt ρ dt U''( Ct ) C& ρ ρt = ρt = U'( C ) e U'( C ) e U'( C ) t t t d dc t rt Ce t = e rt d e rt rt re dt = = r rt rt e e U''( Ct ) C& C& ρ = r r = ρ+ η U'( C ) C t ECON

18 Two reasons for discounting future consumption Care less about consumption tomorrow than today, ρ > 0, pure rate of time preference, defective telescopic faculty (Pigou) One believes tomorrow s consumer will be better off than today s, C& / C > 0 ECON

19 Perman et al. Chapter 3. Rawls Theory of justice { A B} W = min U, U Rawlsian social welfare indifference curves U 2 U 1 ECON

20 Perman et al. Chapter 4. Sustainability If a man takes no thought about what is distant, he will find sorrow near at hand Confucius Sustainability in the past: Historic and archaeological evidence of nonsustainable developments Easter Islands: non-sustainable culture; building of large stone monuments, had to be transported on timber rollers, lead to deforestation and climate change destroying the culture, could not escape on rafts because the trees had gone ECON

21 Setting the new agenda for sustainability issues World Commission on Environment and Development (WCED): Our Common Future (1987) A sustainable development is a development which meets the needs of the present without compromising the ability of the future generations to meet their needs. ECON

22 Sustainable income Person living off wealth: sustainable consumption is how much that can be consumed without reducing the wealth (John Hicks, Erik Lindahl, Irving Fisher) Calculate the present value of predicted future incomes, find a constant amount per year that has the same present value.this is sustainable consumption ECON

23 Think globally, act locally World Commission on Environment and Development Sustainability from the macro level to the micro level: can all micro levels be sustainable? Sustainable transport, sustainable agriculture, sustainable tourism, sustainable cities? Must make a decision on level of aggregation and geographical dimension ECON

24 Sustainability problems How to compare the present and really distant future How to find sustainable developments How to know when we have sustainable development How to deal with scientific uncertainties about eco-system responses reduce the use of environment as an insurance ECON

25 Sustainability definitions Ends-based definitions: Non-declining per capita consumption Non-declining per capita welfare Survivable development, C*>C SURV Means-based definitions: non-declining stock of aggregate capital; manmade physical capital, knowledge/ cultural capital, resource/environmental capital ECON

26 Natural capital stock approaches Non-declining natural capital approach: keystone processes, photosynthesis, nutrient cycles Safe minimum standards approach: biodiversity, critical loads, assimilative capacity Research challenges: define natural capital, safe minimum standards, measure critical loads ECON

27 Substitution between man-made and natural capital Man-made and natural capital: substitutes or complements? Can natural resources be substituted? Weak and Strong sustainability Is it meaningful? Substitution natural birdsong experienced outdoors and a CD with birdsong played indoors? Swimming pools and lakes? ECON

28 Sustainability definitions The basic issue: whether future generations will be at least as well off as the present generation Long tradition in economics considering unfavourable treatment of future generations as ethically unacceptable Sustainability implies that environmental and natural resources have to be shared with future generations Sustainability: future generations can obtain a utility level at least as high as ours ECON

29 Sustainability, equity and efficiency Sustainability requirement Equity Genuinely ethical as it is based on a desire to be fair toward future generations Every generation should be treated equally in intergenerational social preferences, which is the same as saying discrimination towards future generations is excluded. Efficiency The strong Pareto axiom of efficiency Only sustainable paths are ethically acceptable when efficiency and equity are used as ethical axioms ECON

30 Defining sustainability A generation t Inherits capital k t, chooses a utility level u t and feasible capital stocks k t+1 bequeathed to the next generation t+1 u ut Ft( kt, k t + 1) Sustainability Future generations can obtain a utility level at least as high as ours; constant utility path is feasible from t+1 given k t+1 ECON

31 Defining sustainability, cont. It may be the case that it is not desirable to follow any sustainable path But any good path may be sustainable: If we have a non-decreasing utility path that is feasible given k 1, then this path is sustainable Justification of sustainability Whenever equity and efficiency are fulfilled utility paths are non-decreasing ECON

32 Technology assumptions Immediate productivity of the technology: Consumption can costlessly be postponed to later periods by transforming consumption sacrifices into stocks of man-made capital or by not depleting natural capital. But efficient sustainable paths need not exist Eventual productivity of the technology: For any t and k t there exists a feasible and efficient path with constant utility. This utility level is the maximal sustainable utility if capital k t is inherited ECON

33 Discounted utilitarism Equity rules out social preferences based on discounted utilitarism But paths that are maximal under discounted utilitarism are not necessarily ruled out Optimal paths that impoverish generations in the distant future, although sustainable paths are feasible, do not seem ethical Sustainability may be justified as a side constraint ECON

34 Sustainability and the Hartwick rule Constant population, each generation lives for one instance Any intertemporal issue is of an intergenerational nature Multiple capital goods Human economic activity leads to depletion of natural capital Is our accumulation of man-made capital sufficient to make up for the decreased availability of natural capital? ECON

35 The setting, cont. Assumption: existence of intertemporal competitive equilibrium that leads to efficiency and that provides market prices for all capital goods Dynamic efficiency is equivalent to Pareto efficiency when each generation is only living an instant ECON

36 Can sustainability be measured? Extension of national accounts: Concern has been expressed for the long-term effects of natural resource depletion and environmental deterioration National accounts constructed to measure current economic activity: Providing information on unemployment, savings, growth, balance of payments, etc. necessary for conducting economic policy ECON

37 Green national accounting Can national accounting be greened by taking into account the changes in the stocks of natural and environmental resources? Would Green NNP be able to indicate whether the actual development is sustainable? ECON

38 Rules within resource economics Two intertemporal allocation rules have attracted particular attention: the Hotelling rule and the Hartwick rule The Hotelling rule: No-arbitrage possibility condition that every efficient resource utilisation path has to meet. The net price of an exhaustible resource must grow at a rate that equal the interest rate ECON

39 The Hartwick rule: prescription or description? The Hartwick investment rule Invest proceeds from resource extraction such that total capital is constant The Hartwick result The investment rule rule is necessary but not sufficient for constant sustainable consumption The relevance of the Hartwick rule for sustainability is related to the question of whether a constant utility path exists ECON

40 Using the Hartwick rule The Hartwick investment rule cannot serve as a prescription for sustainability Neither necessary nor sufficient for sustainability If the Hartwick rule is followed it describes how the path would look like, egalitarian constant utility path, descriptive result characterising an efficient and egalitarian utility path ECON

41 Problems with the Hartwick rule Competitiveness conditions require all externalities internalised. How can we now know that competitiveness conditions will be followed in the future? Constant present value of net investments Not sufficient to have current price information, must have information for all future points in time Feasibility: constant positive consumption sustained indefinitely How can we know that now? No exogenous technical progress How do we know that future technical progress can be attributed to accumulated stock of knowledge? ECON

DISCOUNTING AND SUSTAINABILITY JOHN QUIGGIN DEPARTMENT OF ECONOMICS, RESEARCH SCHOOL OF SOCIAL SCIENCES AUSTRALIAN NATIONAL UNIVERSITY

DISCOUNTING AND SUSTAINABILITY JOHN QUIGGIN DEPARTMENT OF ECONOMICS, RESEARCH SCHOOL OF SOCIAL SCIENCES AUSTRALIAN NATIONAL UNIVERSITY DISCOUNTING AND SUSTAINABILITY JOHN QUIGGIN DEPARTMENT OF ECONOMICS, RESEARCH SCHOOL OF SOCIAL SCIENCES AUSTRALIAN NATIONAL UNIVERSITY 1993, Review of Marketing and Agricultural Economics 6(1), 161 64.

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