Horst Siebert Economics of the Environment Sixth Edition Horst Siebert Economics of the Environment Theory and Policy Sixth Edition 123 Professor Dr. Dr. h.c. Horst Siebert Professor Stephen Muller President-Emeritus Johns Hopkins University Kiel Institute of World Economics Via Belmelero, 11 Düsternbrooker Weg 120 40126 Bologna D-24105 Kiel Italy Germany Cataloging-in-Publication Data applied for A catalog record for this book is available from the Library of Congress. Bibliographic information published by Die Deutsche Bibliothek Die Deutsche Bibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data available in the internet at http://dnb.ddb.de ISBN 3-540-22061-5 Springer Berlin Heidelberg NewYork ISBN 3-540-63921-7 5th Edition Springer Berlin Heidelberg NewYork This work is subject to copyright. 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Hardcover-Design: Erich Kirchner, Heidelberg Production: Helmut Petri Typesetting: Klaus Brecht Printing: betz-druck Printed on acid-free paper – 42/2202 – 5 4 3 2 1 0 Preface „The labor of nature is paid, not because she does much, but because she does little. In proportion as she becomes niggardly in her gifts, she exacts a greater price for her work. Where she is munificently benefi- cent, she always works gratis.“ David Ricardo* This book interprets nature and the environment as a scarce resource. Whereas in the past people lived in a paradise of environmental superabundance, at pre- sent environmental goods and services are no longer in ample supply. The envi- ronment fulfills many functions for the economy: it serves as a public-con- sumption good, as a provider of natural resources, and as receptacle of waste. These different functions compete with each other. Releasing more pollutants into the environment reduces environmental quality, and a better environmen- tal quality implies that the environment’s use as a receptacle of waste has to be restrained. Consequently, environmental disruption and environmental use are by nature allocation problems. This is the basic message of this book. If a resource is scarce and if a zero price is charged for its use, then misallocation will result. The environment as a receptacle of waste has been heavily overused, and consequently environmental quality declined. Scarcity requires a price. This book analyzes how this price should be set, whether a correct price can be established through the market mechanism, and what role the government should play. The book offers a theoretical study of the alloca- tion problem and describes different policy approaches to the environmental problem. The entire spectrum of the allocation issue is studied: the use of the environment in a static context, international and trade aspects of environmen- tal allocation, regional dimensions, environmental use over time and under uncertainty. The book incorporates a variety of economic approaches, in- cluding neoclassical analysis, the public-goods approach, benefit-cost analysis, property-rights ideas, economic policy and public-finance reasoning, interna- tional trade theory, regional science, optimization theory, and risk analysis. This book grew out of my research at the Kiel Institute of World Econom- ics, at the Universities of Konstanz and Mannheim, Germany, and visiting positions at the University of Aberdeen, Scotland, the Australian National University in Canberra, the Energy Laboratory of the Massachusetts Institute of Technology as well as the Sloan School of Management, the University of * D. Ricardo, Principles of Political Economy and Taxation, 1817, quoted according to Everyman’s Library, London 1911, Dent, p. 39. VI Economics of the Environment California at Riverside, the University of New Mexico at Albuquerque, New York University, and Resources for the Future. I appreciate critical comments to previous editions from Ralph d’Arge, Ferdi Dudenhöffer, Helga Gebauer, Ralf Gronych, Gernot Klepper, Allen V. Kneese, John V. Krutilla, Ngo Van Long, Peter Michaelis, Toby Page, David Pearce, Rüdiger Pethig, Michael Rauscher, Cliff Russell, Hans Werner Sinn, Walter Spofford, Frank Stähler, Sabine Toussaint, Wolfgang Vogt and Ingo Walter. For this edition, I received critical comments from Akram Esanov, David Jacobstein, Terhi Jokipii, Gernot Klepper, Michael Knoll, Rüdiger Pethig, Michael Rauscher, Joost Sneller and Bennedikt Wahler. Michael Knoll has prepared the bibliography. I am delighted that this book has been accepted by the international aca- demic community as a standard work in the economics of the environment, including an edition in Chinese. This sixth edition has been systematically revised and enlarged. Empirical references, tables and figures have been updated. The recent literature has been integrated into the text. New sections have been added on ethical aspects of environmental evaluation, the Environ- mental Kuznets Curve, pollution and endogenous growth, the Pollutee-Pays Principle, closed substance cycle and product responsibility, environmental policy in the European Union, trade aspects of environmental policy, the rela- tionship between trade and environmental degradation in models of imperfect competition, an international race to the bottom in environmental quality for the sake of competitiveness, the strategy of a unilateral first mover, the imple- mentation of the Kyoto Protocol, the experience with emission trading, inter- national and European Union emission trading and biodiversity. I hope that the analysis presented in this book contributes some insights to the emotional debate on environmental disruption, and I wish that it incor- porates nature and the environment as a scarce good into the body of econom- ic thought and that it provides an answer of economics as a discipline to a problem of great importance to our societies. Horst Siebert Contents Preface List of Figures and Tables Part I Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Chapter 1 The Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Chapter 2 Using the Environment – An Allocation Problem . . . . . 7 Externalities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Relationship between the Environment and the Economic System . . . . . . . . . . . . . . . . . . . . . 8 Material Flows between the Environment and the Economic System . . . . . . . . . . . . . . . . . . . . . 12 Competing Uses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Zero Price of Environmental Use . . . . . . . . . . . . . . . . . . . 16 Environmental Effects of Government Decisions . . . . . . . 18 How Much Environmental Quality? . . . . . . . . . . . . . . . . 19 A Taxonomy of the Environmental Problem . . . . . . . . . . 19 Appendix 2A: Input-Output Analysis and the Environment . . . . . . . . . . . . . . . . . . . . . . . . . 20 Appendix 2B: Applied General Equilibrium Models . . . . 23 Part II Static Allocation Aspect . . . . . . . . . . . . . . . . . . . . . . . . 25 Chapter 3 Production Theory and Transformation Space . . . . . . . . 27 Production Theory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 Transformation Space with Environmental Quality . . . . . . 30 Variables Affecting the Transformation Space . . . . . . . . . 33 An Alternative Approach of Production Theory . . . . . . . . 36 Appendix 3A: Properties of the Transformation Space . . . 37 Appendix 3B: Transformation Space with Negative Productivity Effect . . . . . . . . . . . . . . . . 41 Chapter 4 Optimal Environmental Use . . . . . . . . . . . . . . . . . . . . . 43 Criteria for Optimality . . . . . . . . . . . . . . . . . . . . . . . . . . 43 Optimization Problem . . . . . . . . . . . . . . . . . . . . . . . . . . 45 VIII Economics of the Environment A Shadow Price for Pollutants . . . . . . . . . . . . . . . . . . . . . 46 Implications for the Shadow-Price System of the Economy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 Optimum and Competitive Equilibrium . . . . . . . . . . . . . . 50 Requirements for an Emission-Tax Solution . . . . . . . . . . . 53 Appendix 4A: Nonlinear Optimization . . . . . . . . . . . . . . . 54 Appendix 4B: Implications of the Allocation Problem . . . 55 Appendix 4C: Implications of the Profit Maximum . . . . . 56 Chapter 5 Environmental Quality as a Public Good . . . . . . . . . . . . 59 Characteristics of a Public Good . . . . . . . . . . . . . . . . . . . 59 Allocation of Public Goods . . . . . . . . . . . . . . . . . . . . . . . 62 Social-Welfare Function . . . . . . . . . . . . . . . . . . . . . . . . . . 63 Benefit-Cost Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 Costs of Environmental Quality . . . . . . . . . . . . . . . . . . . . 66 Evaluation of Environmental Quality . . . . . . . . . . . . . . . . 70 Individual Preferences and the Pareto-Optimal Provision of Environmental Quality . . . . . . . . . . . . . . . . . . . . . . 74 Thesis of Market Failure . . . . . . . . . . . . . . . . . . . . . . . . . 77 Lindahl Solution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Mechanisms of Social Choice . . . . . . . . . . . . . . . . . . . . . 84 Ethical Aspects of Environmental Evaluation . . . . . . . . . . 91 An Example: Ambient Quality Standards . . . . . . . . . . . . . 95 Chapter 6 Property-Rights Approach to the Environmental Problem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97 Property-Rights Approach . . . . . . . . . . . . . . . . . . . . . . . 97 Property Rights and Environmental Allocation . . . . . . . . 98 Coase Theorem . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 Coase Theorem and Transaction Costs . . . . . . . . . . . . . . 101 Can Property Rights Be Specified? . . . . . . . . . . . . . . . . . 102 Part III Environmental-Policy Instruments . . . . . . . . . . . . . . . . . 105 Chapter 7 Incidence of an Emission Tax . . . . . . . . . . . . . . . . . . . . 107 Standard-Price Approach . . . . . . . . . . . . . . . . . . . . . . . . . 107 Reaction of Producers . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 Emission Taxes in Monopoly . . . . . . . . . . . . . . . . . . . . . . 110 General Equilibrium Approach . . . . . . . . . . . . . . . . . . . . 111 Allocation in a General Equilibrium Model . . . . . . . . . . . 114 Pollution Intensities, Factor Intensities, and Allocation Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 Overshooting of the Emission Tax . . . . . . . . . . . . . . . . . . 120 Is there a Double Dividend of Emission Taxes? . . . . . . . . 120 Appendix 7A: Reaction of the Individual Firm . . . . . . . . 124 Appendix 7B: General Equilibrium Model . . . . . . . . . . . . 124 Contents IX Chapter 8 Policy Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127 Transforming Quality Targets into Individual Behavior . . . 127 The Principal-Agent Problem . . . . . . . . . . . . . . . . . . . . . . 128 Available Policy Instruments . . . . . . . . . . . . . . . . . . . . . . 129 Criteria for Evaluating Instruments . . . . . . . . . . . . . . . . . 130 Moral Suasion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 Government Financing and Subsidies . . . . . . . . . . . . . . . 132 Regulatory Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . 132 Voluntary Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . 136 Emission Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136 Pollution Licenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 The Bubble Concept . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145 Success of Emission Trading . . . . . . . . . . . . . . . . . . . . . . 147 Institutional Arrangements for Cost Sharing . . . . . . . . . . . 148 Combining Standards and an Emission Tax . . . . . . . . . . . 150 Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 Chapter 9 Policy Instruments and the Casuistics of Pollution . . . . . 153 Solid Waste . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153 Optimal Waste Reduction . . . . . . . . . . . . . . . . . . . . . . . . 155 Establishing Scarcity Prices for Waste with Collection Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 Waste Management and Spatial Structure . . . . . . . . . . . . . 157 Closed Substance Cycle and Product Responsibility . . . . . 158 The German System of Waste Management . . . . . . . . . . 158 Emissions from Mobile Sources . . . . . . . . . . . . . . . . . . . 160 Accidental Emissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 Vintage Damages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 Pollutants in Consumption Goods . . . . . . . . . . . . . . . . . . 161 Pollutants in New Products . . . . . . . . . . . . . . . . . . . . . . . 162 Externalities in Land Use . . . . . . . . . . . . . . . . . . . . . . . . . 162 Chapter 10 The Political Economy of Environmental Scarcity . . . . . 163 The Opportunity Cost Principle . . . . . . . . . . . . . . . . . . . . 163 The Polluter-Pays Principle . . . . . . . . . . . . . . . . . . . . . . . 164 The Pollutee-Pays Principle . . . . . . . . . . . . . . . . . . . . . . . 166 The Precautionary Principle . . . . . . . . . . . . . . . . . . . . . . 166 The Principle of Interdependence . . . . . . . . . . . . . . . . . . . 167 Major Environmental Legislation . . . . . . . . . . . . . . . . . . . 168 Part IV Environmental Allocation in Space . . . . . . . . . . . . . . . . 171 Chapter 11 Environmental Endowment,Competitiveness and Trade 173 Environmental Systems in Space . . . . . . . . . . . . . . . . . . . 173 Environmental Endowment . . . . . . . . . . . . . . . . . . . . . . . 174 X Economics of the Environment National Environmental Policy and Comparative Advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 Environmental Policy and Trade Flows . . . . . . . . . . . . . . 177 Environmental Policy, Imperfect Competition and Trade . 179 Location Advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180 International Specialization and Environmental Quality . . 180 The Equalization of Prices for Emissions . . . . . . . . . . . . . 181 Environmental Policy and Gains from Trade . . . . . . . . . . 182 Environmental Pollution: A race to the Bottom? . . . . . . . 183 Empirical Studies of the Impact of Environmental Policy and Trade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184 Trade Policy as a Means for Environmental Protection? . . 185 Environmental Concerns – A Pretext for Protection . . . . . 186 Environmental Policy and World Trade Order . . . . . . . . . 187 Trade Policy to Solve Transfrontier and Global Pollution Problems? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190 Elements of a Multilateral Environmental Order . . . . . . . 190 Environmental Policy in the Single Market . . . . . . . . . . . . 192 Chapter 12 Transfrontier Pollution . . . . . . . . . . . . . . . . . . . . . . . . . . 195 Transfrontier Diffusion Function versus International Public Good . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 Distortions from Transfrontier Pollution . . . . . . . . . . . . . . 196 The Noncooperative Solution to Transfrontier Pollution . . 196 The Cooperative Solution to Transfrontier Pollution . . . . . 200 Side Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 The Bargaining Approach to Transfrontier Pollution . . . . . 203 Policy Instruments for Transfrontier Pollution . . . . . . . . . 204 Positive International Spillovers: The Equatorial Rain Forest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206 Biodiversity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206 Chapter 13 Global Environmental Media . . . . . . . . . . . . . . . . . . . . 209 The Noncooperative Solution to Global Media . . . . . . . . 209 The Cooperative Solution to Global Media . . . . . . . . . . . 211 Side Payments and Global Goods . . . . . . . . . . . . . . . . . . 214 Controlling the Free Rider . . . . . . . . . . . . . . . . . . . . . . . . 215 Coalitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216 The Unilateral First Mover . . . . . . . . . . . . . . . . . . . . . . . 217 Uniform Reduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 217 A Workable System of Transferable Discharge Permits . . 217 Reneging the Contract . . . . . . . . . . . . . . . . . . . . . . . . . . . 218 An International Order for the Global Environment . . . . . 219 Implementing the Kyoto Protocol . . . . . . . . . . . . . . . . . . 222 EU Emission Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . 223