2 Environmental Economics

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1 1. Introduction Within the past three decades, the world has witnessed a period of unprecedented economic growth. Total global output of goods and services increased from US$9.4 trillion to over US$25 tillion between 1960 and 1990 (UNDP, 1996). The benefits of this growth have not been evenly distributed. In 1993, the developed counties accounted for US$22.5 trillion of the total global gross domestic product (GDP) of US27.7 trillion. Although some developing countries, especially those in South-East Asia, have shared in this growth spurt, others have missed out on the bonanza. Large parts of the developing world have been bypassed by the past three decades of economic growth. Since 1980, about 100 developing counties have experienced economic decline or stagnation; in 70 of these counties, average incomes in the late 1990s were below the 1980s (UNDP, 1 997). The impressive performance of the world economy has come about mainly as a result of globalisation. 'Globalisation' is a term that was coined in the 1990s to refer to the integration of the global economy brought about by the rapid developments in information technology and the reduction of international trade barriers. Globalisation has created a near 'borderless' world and has facilitated free trade and flows of private capital between counties. Global trade increased from US$4,345 billion to US$6,255 billion between 1990 and Transfers of net private capital into low-income and middle-income countries amounted to US$l8O billion in 1995, compared to official development assistance of US$64 billion (World Bank, 1999). The growth of the global economy has brought with it several benefits such as improvement in health and living conditions in many developing countries. For example, in many developing counties, infant mortality rates have declined, life expectancy has increased and illiteracy rates have declined over the past three decades. However, disparities in poverty and income distribution persist between regions and within countries. Absolute poverty in parts of Afnca, Latin America and the Caribbean has increased, and the gap between the developed and developing counties has widened. Economic growth is required to meet the needs of a growing population. However, rapid growth has serious implications for our physical environment. Expansion of agricultural land is essential to produce more

2 2 Environmental Economics food.' Activities such as land clearing and the use of pesticides have potential adverse environmental impacts. Industrial production is required to house, clothe and feed the population. However, some industrial processes result in the production of air and water pollution, as well as the generation of toxic waste products. Energy is a vital input to transportation, industrial production and agricultural production. It also provides other important domestic services such as heating, cooling and lighting. At the present time, the developed countries account for about 70 percent of carbon dioxide (COz) emissions even though they account for less than 20 percent of global population (UN, 1997). Energy demand is projected to increase rapidly in the developing countries. It is estimated that developing country share of world energy demand will increase by almost 40 percent by This demand on world energy resources will come about as a result of rapid economic expansion, especially in the South-East Asian region (IEA, 1996). The unrestrained use of fossil fuels poses a serious threat to the environment. There is the potential to increase greenhouse gas emissions and global warming. Although the precise impacts of climatic change are not quite clear, some possible outcomes have been identified. If current trends of energy use continue, the average global temperature is expected to increase by 1.O C to 3S C over the next century (WO, 1996). There will be rise in the sea level of about 30cm; there will be accurnmulation of ice and snow in polar ice caps; and there will be severe storms, drought and flooding due to the climatic changes. There could also be an increase in insect-borne diseases such as malaria, and some animal and plant species could become extinct. 1.1 The Role of Environmental Economics This book is concerned with the application of economics to the solution of global and local environmental problems. 'Economics' may be defined as a study of choice given limited financial and natural resources. In a world of unlimited resources, the choice an individual or society makes has no implications whatsoever. However, in view of the finiteness of resources, ' Of course, with improved technology more food could be produced without necessarily expanding agricultural land. However, the fact of the matter is that most developing countries do not utilise high technology in agriculture.

3 Introduction 3 every possible choice has an associated cost. We refer to this in economics as opportunity cost. This term is defined later. Consider a situation in which the government wants to construct, say, an airport on pristine land. In this case, given limited funds and natural resources, a decision to go ahead with the project precludes the use of the land for other purposes. As will be explained in the next chapter, the economy is a complex system and when modelling such a system simplifying assumptions need to be made. Due to the wide range of issues relating to economic systems, various specializations have arisen within the economics profession. Microeconomics is the study of the economy at the individual or firm level, whereas macroeconomics is the study of the economy at the aggregate level. Examples of the former include the behaviour of economic agents (consumers and producers) and effects on demand conditions and prices, whereas examples of the latter include issues such as changes in employment (or unemployment), inflation, savings, investment, and so on. The subdiscipline of econometrics uses economic concepts and statistical methods to carry out quantitative analyses of economic issues. Traditionally, the study of natural resource economics was concerned with the application of economic theory and quantitative methods to determine the optimum allocation and distribution of natural resources. However, with the rise of environmental concerns in the 1960s, environmental economics has evolved as a subdicipline of economics which not only includes aspects of natural resource economics (e.g., allocation and distribution of resources) but also broader issues such as the interactions between the economy and the environment. Environmental economics also deals with institutional and ethical issues associated with the conservation and use of natural resources. Tisdell (1993:3) defines environmental economics as the 'study of the impact of economic activity on the environment as well as the influence of the environment on economic activity and human welfare'. This broad definition includes man-made environments such as built (urban) environments, historical and cultural environments. Within the last decade or so, ecological economics has emerged as a new subdiscipline of environmental economics. Ecological economics emphasises the constraints that the natural ecosystem places on the economic system. The subject of ecological economics is discussed at length in Chapter 2.

4 4 Environmental Economics 1.2 Defining the Natural Environment In view of the fact that the environment is a major focus of this book, it would be useful to define the natural environment in order to set the discussion in an appropriate context. Broadly spealung, the natural environment comprises two types of resources: renewable resources and non-renewable resources. As the name suggests, renewable natural resources are biological resources that have a capacity for regeneration. Examples are forests, animals and micro-organisms. In theory, renewable resources have the capacity to provide infinite services. However, we demonstrate in the next chapter that there are some ecological constraints to this possibility. Non-renewable resources are finite in terms of supply. There are three major types of non-renewable resources: exhaustible resources, recyclable resources and non-renewable resources with renewable service flows. Examples of exhaustible resources include coal, crude oil and bauxite. Examples of recyclable resources include most metals such as tin, copper, aluminium and gold. Examples of non-renewable resources with renewable service flows include land, seas and rivers. It is important to emphasise that the above classification is not static. A renewable resource can become non-renewable if poorly managed. For example, indiscriminate fishing could reduce the population to a level where the species cannot reproduce. A piece of land is a finite non-renewable resource that could be used to provide a renewable service such as cultivation of crops. The approach adopted in this book is to consider resources not in isolation but as a system-the ecosystem. In this regard, interactions within the system are important. For example, although a stand of forest timber would be valued for its timber in the traditional economic approach, the approach taken here would be to also consider the contribution of the biological functions of the forest cover, the wildlife, the biodiversity functions, and so on. 1.3 Overview of this Book The material is presented in three parts. Part I presents conceptual issues that are required to analyse how the economic activities impact on the

5 Introduction 5 environment. Part I leads off, in Chapter 2, with an introduction to the relatively new subdiscipline of ecological economics. The adjective 'new' is used here because even though some of the ideas have been around since the the 18" Century, they are only now being applied in the area of environmental economics. Many people would agree that the concept of free markets does not work well for environmental resources. In Chapter 3, we demonstrate how markets are supposed to work under traditional (neoclassical) economic theory. We then go on to explain, in Chapter 4, why markets fail to work the way they should in the case of environmental resources. Part I1 of the book presents various tools for environmental policy analysis. It begins with techniques for valuing environmental damage and benefits. In recent years, as environmental issues have grown in importance, governments have been forced to legislate laws protecting the environment. Measures of environmental damage are now sought to assess penalties and to determine compensation levels in litigation cases. In many countries, the law requires project developers to conduct an environmental impact assessment and part of this process requires an estimate of the amount and value of any potential damage. Chapter 5 discusses recently introduced techniques that could be used to estimate the value of environmental damage and benefits. A consistent framework is required in development planning and policy analysis. Chapter 6 introduces the methodology of cost-benefit analysis (CBA), with particular emphasis on public projects. Cost-benefit analysis is not always adequate, or even appropriate, in certain situations. Therefore, Chapter 7 introduces additional methods4ost-effectiveness analysis (CEA), impact analysis (IA) and stakeholder analysis (SA)-that could be used to complement a CBA. Techniques such as CBA and CEA are designed for decisions with single objectives. To complement these approaches, Chapter 8 introduces Multi-Criteria Analysis (MCA) which is applicable to decisions involving multiple objectives that may be conflicting or competing. All forms of environmental degradation, whether local or regional, have global implications in the long term. Part I11 of the book examines global environmental issues. Chapter 9 discusses the effects of population growth and resource use on the environment and the policy implications. Chapter 10 reviews the debate on the relationship between economic growth and the environment. This chapter also includes the effects of economic growth on biodiversity. Chapter 11 adresses the issue of sustainable development.

6 6 Environmental Economics 'Sustainable development' is, perhaps, the most widely used term in both governmental and non-governmental organisations. However, it could be among the least understood terms in use today. In this chapter, definitions from various perspectives are presented. Practical issues such as measurement of sustainable development and implementation constraints are discussed. Chapter 12 delves deeper into practical tools that could be used to assess progress towards sustainable development. Finally, Chapter 13 concludes with an assessment of current global environmental trends and their policy implications. References International Energy Agency, IEA, (1996). World Energy Outlook Organisation for Economic Co-operation and Development, Paris. Tisdell, C. (1993). Environmental Economics: Policies for Environmental Management and Sustainable Development. Edward Elgar, Aldershot, UK. United Nations, UN (1997). Critical Trends: Global Change and Sustainable Development. United Nations, New York. United Nations Development Programme, UNDP (1997). Human Development Report. Oxford University Press, New York and Oxford. United Nations Development Programme, UNDP (1996). Human Development Report. Oxford University Press, New York and Oxford. World Bank (1999) World Development Indicators 1999CD-ROM. World Bank, Washington, D.C. World Health Organization, WHO, (1996). Climate Change and Human Health. World Health Organization, Geneva.