Sustainable Development and the Environment in Development Economics

Sustainable Development and the Environment

une University of New England Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Sustainable Development and the Environment Week 7 Prescribed Reading: de Janvry and Sadoulet, ch. 15 ECON390/590 Economics of Developmentune University of New England

Learning Objectives for Week 7

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1 The development-resource conservation-environmental sustainability nexus 2 Negative externalities 3 Incomplete property rights 4 Public goods 5 Discounting 6 The sustainability objective 7 Dilemmas in the environmental-development relation 8 Introducing new marketsune University of New England

The Development-Resource Conservation-Environmental Sustainability Nexus

Environmental Sustainability Focus

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Environmental sustainability has been the primary focus of sustainable development in recent years. Today's industrialised countries achieved their current levels of development largely without the burden of environmental constraints and certainly of the threats of climate change. The success of development hinges on its impact on resource availability and environmental sustainability: Water and soil salinity Deforestation and desertification Air pollution Global climate change Decline in capture fisheries salinisation, desertification, and soil degradation Loss in biodiversity and biodensityune University of New England

Origins of Environmental Problems

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Poor people are the ones most negatively affected. The origins of environmental problems: 1 Market failures due to externalities 2 Incomplete property rights over common property resources 3 Under-provision of public goods 4 Private discount rates exceeding social discount rates 5 Public misunderstanding over the sustainability objective 6 Differential valuation of income and environmental amenities in poor and rich countries 7 Missing markets for environmental servicesune University of New England

Negative Externalities

Market Failures

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 A competitive equilibrium in a perfect market delivers a Pareto optimal outcome. However, markets can fail due to: Positive and negative xternalities Public goods Imperfect information Natural monopoly Noncompetitive behaviour Market failures lead to an inefficient resource allocation. To avoid this, 1 government regulation 2 private bargaining solution 3 new market creationune University of New England

Negative Production Externality

Impact of Production Decisions

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 A negative production externality when the production decision of an individual imposes costs on others. Market prices do not reflect the true marginal cost or benefit of the goods and services traded in the market, incentives are distorted, and markets fail. Production creates pollution that imposes a cost on others. Production and pollution are joint products. Price signals are inefficient and the market is failing, qc > q *. There is excess production and excess pollution relative to the social optimum.une University of New England

Marginal Social Cost Diagram

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 $ MSC = MPC + MEC A MPC B 5b ! p G 2 .5a pc C 3 6' H !F MEC Demand = MSB O q* qc q demand = MSB = marginal social benefit private supply = MPC = marginal private cost externality = MEC = marginal externality cost social supply = MSC = marginal social cost = MPC + MEC private (competitive) optimum output level: q where MSB = MPC social optimum output level: q* where MSB = MSC. 1une University of New England

Alternative Policy Instruments Making q* = qc

Policy Instruments for Desired Outcomes

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Alternative policy instruments that can help achieve the desired outcome: 1 an output or externality tax following the polluter-pays principle => Pigovian tax 2 an output-reduction subsidy if the polluter has the right to pollute => Output-reduction subsidy 3 an output or pollution quota following the command-and-control approach => Quota. 4 use of tradable pollution permits following the cap-and-trade approach => Tradable pollution permits. 5 institutional changes in the organisation of production: unitisation or cooperation => Institutional changes in the organisation. 6 private negotiations among parties in accordance with the Coase theorem ]= The Coase theorem Each policy instrument can reduce pollution to the social optimum, but has different efficiency and welfare/redistributive implications.une University of New England

Policy Responses to Negative Production Externalities

Pigovian Tax and Output-Reduction Subsidy

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Policy 1: Pigovian tax If the polluter does not have right to pollute, levying a tax. It eliminates overproduction but does not eliminate pollution. The government is the winner but producers and consumers are the losers. . It incentivises innovation. Policy 2: Output-reduction subsidy If the polluter does have the right to pollute, subsidising for each unit of output not produced. Subsidies are costly for the government but highly attractive to firms that have the right to pollute. In the long run, subsidies can attract rent-seekers to enter the industry.une University of New England

Quota Policy

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Policy 3: Quota The government can restrict output to a quota. Note that producer surplus under a quota is greater than the producer surplus under an externality tax because producers capture the rent from regulation through a higher price instead of the government through tax revenues. The government prefers a tax over a quota, but producers prefer a quota over a tax. Counter-intuitive? Producers with inelastic demand prefer regulation to extract the price rent. The government can capture this price rent by auctioning the quota to producers, cancelling out the rent.une University of New England

Tradable Pollution Permits

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Policy 4: Tradable pollution permits It's impossible for the regulator to know each firm's MPC and MEC => Allocate pollution permits to firms and let them trade these permits. This system requires strict monitoring and enforcement and entails rent seeking in permit allocation. Firms with a MB derived from pollution below (above) the permit price should sell (buy) excess permits until their MB equals the permit price. At equilibrium, all firms equalise their MB from pollution to permit price, so that the permit allocation is maximally efficient regardless of the initial permit allocation. This system encounters the following difficulties: 1 Allocating pollution rights. 2 Measuring and monitoring the emissions of each firm. 3 Ensuring that pollution by a particular firm does not exceed its permits => Enforcement mechanism.une University of New England

Optimum Trading of Pollution Permits by Firm i

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 $ Sell permits MB| < 2 Benefit from pollution for firm i Buy permits MB = λ = MSC MB | > 2; Pollution Optimum pollution for firm iune University of New England

Institutional Changes in Production Organization

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Policy 5: Institutional changes in the organisation Internalising the externality between a polluter and a pollutee suffering from the negative externality is to bring the two interests into a single decision-making process. The joint business is managed in order to achieve the (local) social optimum. The social optimum is local in the sense that it applies to the two partners but does not consider other parties that may be affected by residual pollution.une University of New England

The Coase Theorem

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Policy 6: The Coase theorem Allowing private parties to negotiate for optimum pollution. 1 Both polluter and pollutee have full information over the MB and MC of pollution. 2 Rights to pollute can be sold by the owner of the property right to the other party for a fee. The solution will be maximally (locally) efficient, irrespective of who has property rights. Who captures the net social gain is determined by who has the property rights. The Coase theorem will fail if the transaction cost in bargaining is larger than the net social gain generates by bargaining. The government should create private property rights that minimise transaction costs. Individuals can also create institutions that minimise transaction costs on behalf of their members.une University of New England

Incomplete Property Rights

Degrees of Completeness

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 Eleanor Ostrom suggests that property rights over an asset like land have different degrees of completeness: " right to access right to extract right to manage . right to exclude others right to alienate (to sell or transfer the asset to another person) Incomplete property rights may lead to mismanagement of the resource. However, the security of rights and the ability to manage if the ownership is not individual, can still result in optimum resource use.une University of New England

Types of Property Rights

Private Ownership

With complete and secure property rights, the resource is used to maximise profits, i.e. MR = MC. If no externalities, private use is socially optimum.

Open-Access Resource

Users cannot manage the resource, exclude others and sell the resource. Resource extraction continues until AR = AC, leading to the tragedy of the commons. It leads to over-extraction and total exhaustion if AC is low.

Common Property Resource (CPR)

The property right is assigned to a community with well-defined membership and boundaries. Members have rights to access, extraction and exclusion of nonmembers. Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8une University of New England

Use of A Resource According to Property Rights

Resource Use Diagram

Week 7 LO.1 LO 2 LO 3 LO 4 LO 5 LO 6 LO.7 LO 8 $ TC (Slope = MC = AC) MR = MC AC = AR, II = 0 n max TR = pF(X) Ecological relation X Private Maximum Open Total Cooperative sustainable access extinction CPR yield Non-cooperative CPR