Environmental Economics in the Central European Context Time: Mondays and Tuesday 4:30pm-6:00pm Location: at CERGE-EI, Room # 11

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1 Envirnmental Ecnmics in the Central Eurpean Cntext Time: Mndays and Tuesday 4:30pm-6:00pm Lcatin: at CERGE-EI, Rm # 11 Instructr: Jana Krajcva, PhD. krajcva.janka@gmail.cm Reading materials: What is yur backgrund? envirnmental? ecnmic (statistical/ecnmetric analysis)? envirnmental ecnmics? experimental ecnmics? What d yu expect frm this curse? OUTLINE OF THE COURSE: The aim f this curse is t intrduce students t sme basic ecnmic principles and theries explaining envirnmental issues and prblems tday and t explre existing plicies at the natinal and internatinal level. Students will learn abut basic cncepts f envirnmental ecnmics such as externalities, the tragedy f the cmmns, enfrcement as a public gd, interventinist slutins t the externality prblem, such as taxes and marketable pllutin permits, as well as nn-interventinist slutins t the externality prblem, such as the Casian slutin and self-regulatin. We will als review the debate ver the envirnmental Kuznets curve. We will discuss the field data and envirnmental plicies f the Czech Republic and place them int internatinal cntext. Finally, we will discuss current tpics such as renewable resurces and the cntrversy abut their supprt schemes. Because experimental evidence cmplements theretic insights, field data and simulating mdels nicely, we will review sme research articles that draw n the experimental methdlgy. GRADING POLICY: Class participatin and activity (10%), Quick quizzes (20%) Presentatin (30%) Final exam (40%) 1

2 Curse Outline: TOPICS: WEEK: 1 - Sep 22, Sep 29, Oct 6,7 4 - Oct 13, Oct 20, Oct 27,28 (NH) 7 - Nv 3,4 Intrductin, Market failures - externalities, tragedy f the cmmns, envirnment as public gd, An Incnvenient Truth Interventinist slutins t the Externality prblem Piguvian taxes and standards and charges Interventinist slutins t the Externality prblem Marketable pllutin permits Nn-interventinist slutins t the Externality prblem - Envirnmental labeling; Envirnmental Kuznets curve Nn-interventinist slutins t the Externality prblem The Casian slutin Presentatin tpics t be submitted Nn-interventinist slutins t the Externality prblem Vluntary prgrams and self-regulatin Nn-interventinist slutins t the Externality prblem Vluntary prgrams and self-regulatin cntd. (MIDTERM WEEK) 8 - Nv 10,11 Students Presentatins 9 - Nv 17 (NH),18 Envirnmental Plicy in the Czech Republic Histry and current issues 10 - Nv 24,25 Envirnmental Plicy in the EU Histry and Current prblems 11 - Dec 1,2 Envirnmental Plicy in the wrld cntext Histry and Current prblems, Renewable Resurces 12 - Dec 8 FINAL EXAM Sme useful links - CENIA ( website f the Czech Ministry f the Envirnment s infrmatin agency. - Envirnment Center f Charles University ( - Eurpean Envirnment Agency ( - envirnment agency f the EU web site f the EC 2

3 READINGS list might be revised as we g, always check ut the curse website fr updates the first part f the curse fllws: Schtter, Andrew (1997), Micrecnmics. A Mdern Apprach. Secnd Editin. Addisn-Wesley. Of particular imprtance: Chapter 17 in that bk [there are several editins f that bk, when I refer t page/prblem numbers it will always be cnsistent with the scanned versin which can be dwnladed frm the curse web page] Intrductin Why d we care abut the envirnment? a) life supprting functin (lcatin and the basic cnditins fr the existence f life) b) natural resurces (inputs fr cnsumptin and prductin) c) amenity values (natural beauty) Natural resurces: a) flw resurces (slar radiatin, wind r water energy the current use des nt affect the future availability) b) stck resurces (the current use affects future availability) renewable resurces (frests, stck f fish, etc ) nn-renewable (fssil fuels, mineral res) The prblem is that with increasing human activity, industrial prductin, unclean technlgies, there are adverse and ften permanent impacts n biphysical envirnment. Nature f envirnmental prblems a) nature degradatin due human activity (defrestatin, pllutin) b) cnflicting usage f the natural resurce (e.g. amenity vs. prductin) c) distributin f usage ver time (this r future generatin? cncept f sustainability) d) distributin amng agents (prblem f t many fishermen) Current issues in Eurpe and the CR a) water and air pllutin, greenhuse effect (hw t manage with grwing industrial prductin, transprtatin) b) sil pllutin (industrial fertilizers) c) energy intensity d) nise (transprtatin air/rad/railway) 3

4 e) waste management f) decrease in bilgical diversity and eclgical stability (due agricultural prductin and fragmentatin f the landscape due transprtatin and urbanizatin) Instruments f envirnmental prtectin a) regulatins, b) ecnmic and financial (standards and charges, marketable pllutin permits, taxes, fines, tax reliefs and subsidies, prperty rights), c) vluntary prgrams (envirnmental labeling), d) envirnmental educatin and public awareness Envirnmental ecnmics - a subfield f ecnmics cncerned with envirnmental issues - undertakes theretical r empirical studies (in search fr effective envirnmental measures) f the ecnmic effects f envirnmental plicies impacts f ecnmic instruments n decisin-making when envirnmental impact is a cncern - e.g. csts and benefits f alternative envirnmental plicies t deal with air pllutin, water quality, txic substances, slid waste, and glbal warming Experimental ecnmics Use f Experimental Methds is discussed in the fllwing tw academic articles (G&G) Greenstne, M., Gayer, T., (2007), Quasi-Experimental and Experimental Appraches t Envirnmental Ecnmics, RFF Discussin Paper (L&L) Levitt, S., D., List, J., A. (2009), Field experiments in ecnmics: The past, the present, and the future, Eurpean Ecnmic Review 53, we will review cuple f experimental articles thrughut this curse, why? b/c they (nt nly) prvide an imprtant insight n envirnmental measures emplyed by gvernments and NGOs Merriam-Webster Dictinary: Experiment is a tentative prcedure r plicy; an peratin r prcedure carried ut under cntrlled cnditins in rder t discver an unknwn effect r law, t test r establish a hypthesis, r t illustrate a knwn law. Benefits f emplying Experimental Methds - A new drug is tested t make sure that it has the expected effect and at the same time that it is nt utweighed by pssible side-effects t minimize ptential cst n public health 4

5 - The effect f planned plicy change can be tested at relatively lw cst (cmpared t allcatin f much larger resurces t an inefficient prgram; e.g. training prgram fr the unemplyed, new pricing scheme fr electricity, ) - Explaining r predicting nn-experimental utcmes (e.g. Barr and Serneels 2004: crrelatin f wage utcmes f emplyees with their behavir in a trust game experiment) again, relevant plicy/strategy implicatins at relatively lw cst - Testing theretical predictins at relatively lw cst (ecnmic thery, game/behaviral thery) - Help t generate the data which are difficult t be btained frm the field - Estimatin f a cst that the firm which prduces pllutin shuld internalize s that the (scially) mre efficient utcme can be achieved -> ENVIRONMENTAL ECONOMICS Externalities -> crrectin? -> Envirnmental Ecnmics -> (G&G) Imagine an example f air r water pllutin as a byprduct f the prductin f marketable gd created pllutin impses health csts n inhabitants and/r csts n the dwn-the-river cmpany nt internalized by the firm which is respnsible fr prducing the pllutin gvernment interventin might help t maximize net (scial) benefits/welfare require reliable estimates f the csts and benefits (hw t set the tax? will the market participants react in expected way?) => ENVIRONMENTAL ECONOMICS EE addresses the inefficiencies resulting frm prductin externalities > experimental and quasi-experimental methds hinge upn prper design, implementatin, apprpriate apprach t the data analysis Market failure - ne f the key cncepts - situatins when markets alne (withut any interventin) fail t allcate resurces efficiently - Hanley, Shgren, and White (2007) in their textbk Envirnmental Ecnmics: "A market failure ccurs when the market des nt allcate scarce resurces t generate the greatest scial welfare. A wedge exists between what a private persn des given market prices and what sciety might want him r her t d t prtect the envirnment. Such a wedge implies wastefulness r ecnmic inefficiency; resurces can be reallcated t make at least ne persn better ff withut making anyne else wrse ff." - market failures can be viewed as scenaris where individuals' pursuit f pure self-interest leads t results that are nt efficient that can be imprved upn frm the scietal pint-f-view. Externality ne f the cmmn causes f market failure -> anther key cncept f envirnmental ecnmics, 5

6 Externality f an ecnmic transactin is an impact n a party that is nt directly invlved in the transactin. The basic idea is that an externality exists when a persn makes a chice that affects ther peple that are nt accunted fr in the market price and thus the prices d nt reflect the full csts r benefits in prductin r cnsumptin f a prduct r service [and therefre typically results in a market failure]. Psitive externalities - an actin that impses a psitive side effect n a third party Negative externalities - an actin that impses a negative side effect n a third party; many negative externalities are related t the envirnmental cnsequences f prductin and use. Can yu think f cuple f examples n a) psitive externalities b) negative externalities Examples f psitive externalities: A beekeeper keeps bees fr their hney. A side effect r externality assciated with his activity is the pllinatin f surrunding crps by the bees. The value generated by the pllinatin may be mre imprtant than the value f the harvested hney. An individual planting an attractive garden in frnt f his r her huse may prvide benefits t thers living in the area, and even financial benefits in the frm f increased prperty values fr all prperty wners. Hme wnership creates a psitive externality in that hmewners are mre likely than renters t becme actively invlved in the lcal cmmunity. Educatin creates a psitive externality because mre educated peple are less likely t engage in vilent crime, which makes everyne in the cmmunity, even peple wh are nt well educated, better ff. Examples f Negative Externalities Transprtatin: drivers impsing cngestin cst n ther drivers, pllutin created affects health and quality f life f thse living nearby rads Industrial Prductin: prducing (as a by-prduct) greenhuse gas emissins frm burning il, gas, and cal -> climate change impsing cst n whle sciety Water pllutin by industries that adds pisns t the water, which harm plants, animals, and humans. Industrial farm animal prductin farms that were maybe mre efficient as regards the prductin csts/revenues but they cntributed t the increase in the pl f antibitic-resistant bacteria because f the veruse f antibitics + air quality prblems + the cntaminatin f rivers, streams, and castal waters with cncentrated animal waste + animal welfare prblems, mainly as a result f the extremely clse quarters in which the animals are hused. Fishing: harvesting by ne fishing cmpany in the cean depletes the stck f available fish fr the ther cmpanies and verfishing may be the result. This is an example f a cmmn prperty resurce, smetimes referred t as the Tragedy f the cmmns. 6

7 Cnsumptin f alchl in sme cases leads t drinking and driving accidents which injure r kill pedestrians and ther drivers. In these situatins (speaking f negative externalities) the marginal scial benefit f cnsumptin (i.e. benefit f cnsuming ne mre unit f a prduct) is less than the marginal private benefit f cnsumptin. This leads t the gd r service being ver-cnsumed relative t the scial ptimum -> Market failure. Withut any crrective measure, the gd r service will be under-priced as the negative externalities will nt be taken int accunt. Illustratin Paret efficiency (= Paret ptimality) - a cncept in ecnmics - named after Vilfred Paret (an Italian ecnmist wh studied ecnmic efficiency and incme distributin) - Situatins in which it is impssible t make ne persn better ff withut necessarily making smene else wrse ff. a related cncept is that f Paret imprvement - given a set f alternative allcatins f gds (r utcmes) fr a set f individuals, Paret imprvement is a change frm ne allcatin t anther that can make at least ne individual better ff withut making any ther individual wrse ff - an allcatin is defined as "Paret efficient" r "Paret ptimal" when n further Paret imprvements can be made. s if the market fails t achieve the mst efficient utcme, lking fr Paret imprvement means lking fr ways t make things wrk mre efficiently (i.e. allcate resurces mre efficiently, r make 7

8 cnsumptin decisins f individuals mre efficient) when the efficiency cannt be imprved anymre, the market is at Paret ptimal state = Paret Efficient allcatin = Allcative efficiency a) n cnsumptin side: resurces cannt be re-allcated t make ne cnsumer better ff (in terms f utility) withut making anther wrse ff; r b) n prductin side: allcatin f prductin inputs (capital and labr) is Paret-efficient if it is nt pssible t re-allcate these inputs and prduce mre f at least ne gd in the ecnmy withut decreasing the amunt f sme ther gd that is prduced A simple illustrative example: Imagine that Rbinsn Cruse has invented a machine that can make tw manges ut f ne ccnut. Cnversely, the machine can make ne ccnut ut f tw manges. Assume that Cruse s utility is U(c,m)=c*m (and thus marginal utilities are U m=c and U c=m meaning that the mre f manges he cnsumes the happier he is frm each additinal piece f ccnut and vice versa). Suppse Cruse has, initially, fur manges and fur ccnuts. Is that Paret-ptimal allcatin? If nt, what wuld Cruse have t d t get a P-O allcatin? he ll end up with Rbinsn s final utility (c*m) ding nthing 4 ccnuts + 4 manges 16 cnverting 1 ccnut int 2 manges 3 ccnuts + 6 manges 18 cnverting 2 ccnuts int 4 manges 2 ccnuts + 8 manges 16 cnverting 2 manges int 1 ccnut 5 ccnuts + 2 manges 10 cnverting 4 manges int 2 ccnuts 6 ccnuts + 0 manges 0 Yu can wrk thrugh all the alternative allcatins but it is easy t see in which case his utility functin will be the highest Rbinsn wuld bviusly end up with 3 ccnuts and 6 manges in the P-E allcatin. Nte that mre frmally, yu can slve the prblem using the cncepts f Marginal rate f transfrmatin thse interested can find the slutin in Schtter s textbk, Chapter 15, Slved Prblem 15.1 (p. 581 in the 3 rd editin) This is just a simplest case, with just ne individual, Rbinsn Cruse. What if we take int accunt als his Man Friday, whse utility ver ccnuts and manges might be different? Or even a larger ecnmy with number f cnsumers and prducers. with ptential externalities Scial efficiency efficient allcatin frm the scial pint f view when the ttal scial (including external) csts are accunted fr Typical causes f market failures: 8

9 i) externalities ii) public gds r cmmn gds ( the tragedy f the cmmn ) iii) market pwer (imperfect/n cmpetitin) i) and ii) are interesting frm the pint f view f envirnmental ecnmics (mre details t fllw), iii) is nt s imprtant fr us nw Public gd - is a gd that is nn-rivalrus and nn-excludable. - Nn-rivalrus means that cnsumptin f the gd by ne individual des nt reduce availability f the gd fr cnsumptin by thers; - Nn-excludable means that n ne can be effectively excluded frm using the gd. - Nn-rivalness and nn-excludability may cause prblems fr the prductin f such gds - markets alne might fail t prduce ptimal (r desired, fr that matter) amunt f public gds -> market failure. - envirnment in general is an example f public gd In real wrld, there may be n such thing as an abslutely nn-rivaled and nn-excludable gd; but we can get clse enugh als, sme gds might be mixed Examples f public gds (can yu think f any?): 9

10 Here cme sme. a) light huses (cannt exclude ships frm using it) b) defense and law enfrcement c) firewrks d) streetlights e) rads f) infrmatinal gds (sftware develpment, authrship, inventin) g) envirnmental gds (clean air, clean water.envirnmental prtectin in general) Sme gds are mixed in a sense that they have the prperties f bth, private and public gds a) excludable but nn-rival (like cable TV) b) nn-excludable but rival (like public park with t many visitrs it becmes less enjyable) Free rider prblem - is a central prblem and a reasn why public gds ften lead t an instance f market failure - individually-ratinal and self-interested behavir n the market might result in an inefficient utcme typically in underprductin, r n prductin at all, f public gd as individuals cannt be excluded frm cnsumptin f public gd, they can ften take advantage f public gds withut cntributing sufficiently t their creatin. If private rganizatins dn't reap all the benefits f a public gd which they have prduced, their incentives t prduce it vluntarily might be insufficient. - this is called the free rider prblem and relies n assumptin f individual ratinality and self-interest maximizatin if in unregulated market an individual cannt be excluded frm cnsumptin f public gd (breathing clean air, riding gd rads etc) and there is n mechanism t ensure his cntributin t creatin f that gd, why shuld a self interested ratinal individual pay fr smething s/he wuld get t cnsume anyway? that is why the gvernment ften has t step-in regulating, cllecting taxes, etc t crrect the market failure and ensure the prductin f public gd Example - cnsider natinal defense, a standard example f pure public gd. - suppse an individual thinks abut exerting sme extra effrt t defend the natin. - benefits t that particular individual might be very lw (especially if the defending activity is nt gegraphically clse t ur individual and he/she might nt face immediate threat f being affected by the war) - n the ther hand, there is a high pssibility that he r she culd get injured r killed during the curse f his r her military service. 10

11 - imprtantly, a free rider knws that he r she cannt be excluded frm the benefits f natinal defense, regardless f whether he r she cntributes t it (as lng as the army exists, it des nt matter t much whether there is ne mre sldier r nt). - thus a ratinal individual wuld nt vluntarily exert any extra effrt, unless there is sme inherent pleasure r material reward fr ding s (fr example, mney paid by the gvernment, as with allvlunteer army r mercenaries). Nw, t establish a natinal defense system, the gvernment needs t - determine hw much mney t spend n it small vs. huge military cmplex needs t knw the cst f each alternative and knw the maximum willingness f each member f the sciety t pay these csts -> hw t find ut? Well, the gvernment culd try t ask But that is nt s simple Suppse yu knw that everyne is reprting their true willingness t pay. Yu als knw that there are s many peple in the sciety that yur respnse, hwever small, will nt affect the level f natinal defense. In that case, yu have n incentive t reprt truthfully -> yur ecnmically ratinal respnse wuld be t say that yu are nt willing t pay fr natinal defense. But if everyne wuld d s.. Questins fr an ecnmist? (Schtter, Chapter 18) i) what is the ptimal amunt f public gd t prduce, and what cnditins must be satisfied at such ptimum? ii) Hw can ecnmy achieve that ptimum? iii) Will free markets be able t achieve that ptimum, r must the gvernment help the ecnmy t crdinate its activities? Slutins: a) Lindahl free market slutin relies n everyne truthfully revealing their preferences fr public gd; then the gvernment serves as a crdinatr (n interventin) sets everyne s share n the ttal cst if the gd is prvided peple face prices and the market will take care f the rest: peple will maximize their utility and state their demand fr the public (as well as private) gd. In the equilibrium, prices f private gds and shares n cst f public gd are set such that n ne wishes t change his/her demand fr private and fr public gds + supply f private gd equals the demand + everyne cnsumes the same amunt f public gd (due t nnexcludability). Prblem: incentives nt t be truthful in revealing ne s preferences. 11

12 Prpsed slutin: i) a demand-revealing mechanism imagine a dark street and three equally cstly plans t install streetlights (ne very bright streetlight r cmbinatins f less bright streetlights) ask inhabitants, hw much they are willing t pay fr each f the prpsed plans and implement the ne that maximizes the ttal willingness t pay) still there is n guarantee that cllected cntributins will cver the ttal cst f implementing the streetlight plan. ii) an auctin electin mechanism: peple submit their bids (bidding the mney ne is willing t pay and the quantity demanded); then if public gd is prduced, everyne pays the difference between the cst and sum f the bids made by ther peple multiplied by average quantity demanded Everyne has a right t refuse his r her cst share If all peple agree t pay their csts share the demanded quantity is prduced. If n agreement is reached, public gd is nt prduced the experimental evidence suggests that peple in general d nt seem t be truth-telling (Smith, 1977) b) Case argument: with n transactin cst and unilateral prperty rights, mst cnflicts culd be reslved by private bargaining [mre n that later] c) Gvernment prvisin (public gd financed by tax revenues) it might be difficult t ensure the gvernment has an incentive t prvide the ptimum amunt even if it were pssible fr the gvernment t determine precisely what amunt wuld be ptimum d) A gvernment may subsidize prductin f a public gd in the private sectr; unlike gvernment prvisin, subsidies may result in sme frm f cmpetitive market. Principal-agent prblems can still arise between the citizens and the gvernment r between the gvernment and the subsidized prducers. e) an exclusin mechanism (club gds) is anther slutin, which has evlved fr infrmatin gds, is t intrduce exclusin mechanisms which turn public gds int club gds. One wellknwn example is cpyright and patent laws. These laws, which in the 20th century came t be called intellectual prperty laws, attempt t remve the natural nn-excludability by prhibiting reprductin f the gd. Althugh they can address the free rider prblem, the dwnside f these laws is that they imply private mnply pwer and thus are nt Paret-ptimal. f) supprt public mindedness by traditin and scial nrms (a nn-market slutin) 12

13 Tragedy f the cmmns (Hardin, 1968) Tragedy f the cmmns (Frm Wikipedia, the free encyclpedia) "The Tragedy f the Cmmns" was an influential article written by Garrett Hardin and first published in the jurnal Science in The article describes a dilemma in which multiple individuals acting independently and slely and ratinally cnsulting their wn self-interest will ultimately destry a shared limited resurce even when it is clear that it is nt in anyne's lng term interest fr this t happen. Mre usually, the phrase des nt refer t the article per se, but t the dilemma itself, typically in applicatin t sme circumstance t which it is thught t apply. Many, perhaps mst, wh use it are nt aware f, nr have read, Hardin's essay, but are lking at cnceptually parallel situatins. Central t Hardin's article is an example, a hypthetical and simplified situatin frm medieval land tenure in Eurpe, f herders sharing a cmmn parcel f land (the cmmns), n which they are each entitled t let their cws graze. In Hardin's example, it is in each herder's interest t put the next (and succeeding) cws he acquires nt the land, even if the carrying capacity f the cmmns is exceeded and it is damaged fr all as a result. The herder receives all f the benefits frm an additinal cw, while the damage t the cmmns is shared by the entire grup. If all herders make this individually ratinal ecnmic decisin, the cmmns will be destryed t the detriment f all. - the prblem arises when prperty rights are nt well defined (hence the cmmns ) - private prperty then prvides a mechanism t avid externalities he wh wns, cares abut the prperty and cntrls its use + can exclude thers frm verusing it (see the discussin in Hardin as well) - private prperty is nt the nly available mechanism regulatins wrk as well (with legal system t enfrce them) Examples (can yu think f any?): 13

14 a) ver-herding cws (see Hardin) b) ver-fishing (each fisherman has a negligible impact n the ttal fish stck but t many fisherman might result in serius depletin) c) autmbile pllutin each autmbile lwers the air quality and it is nt likely that the free market wuld result in the ptimal amunt f pllutin emissin standards fr autmbiles Illustratin: Clean Air Act and its amendments set autmbile emissin standards fr the manufacturers f vehicles in the US and Lawrence White examined the csts and benefits f this prgram - cst f emissin cntrl equipment is estimated at $600 per car, extra maintenance cst at $180 per car, the cst f reduced gasline mileage and the necessity f unleaded gasline at abut $670 per car ttal cst at $1450 (in 1981 dllars) - White identifies fllwing prblems: everyne wh buys a car must pay extra $1450, whether they live in high pllutin area r nt mst f the respnsibility falls n the manufacturer, nly little n the user car wners have little incentives t keep the pllutin cntrl equipment in wrking rder unless they are inspected n incentive t ecnmize driving peple wh drive 2000 miles in less plluted areas pay exactly the same amunt f mney as peple wh drive 500,000 miles in heavily plluted areas it wuld make sense t encurage peple t drive less (at least in heavily plluted areas) - Alternative slutin that White ffers: effluent fees annual inspectin f all vehicles estimating the car s likely emissins during the past year different cmmunities (areas) culd levy different fees peple wuld face the true cst f generating pllutin, which wuld encurage them t generate scially ptimal amunt f pllutin (r, well, at least clser t it) Why shuld it wrk better? the system wuld encurage the wners t search fr lw-cst ways f reducing their emissins, including changing their driving habits and type f vehicle (mre ec) 14