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Economics of the Environment

The Sixth Edition of Economics of the Environment: Selected Readings has just been published by W. W. Norton & Company of New York and London. Through five previous editions, Economics of the Environment has served as a valuable supplement to environmental economics texts and as a stand-alone book of original readings in the field of environmental economics. Nearly seven years have passed since the previous edition of this volume was published, and it is now more than three decades since the first edition appeared, edited by Robert and Nancy Dorfman. The Sixth Edition continues this tradition.

Motivation and Audience

Environmental economics continues to evolve from its origins as an obscure application of welfare economics to a prominent field in its own right, which combines elements from public finance, industrial organization, microeconomic theory, and many other areas of economics. The number of articles on the environment appearing in mainstream economics periodicals continues to increase, and more and more economics journals are dedicated exclusively to environmental and resource topics.

There has also been a proliferation of environmental economics textbooks for college courses. Many are excellent, but none can be expected to provide direct access to timely and original contributions by the field’s leading scholars. As most teachers of economics recognize, it is valuable to supplement the structure and rigor of a text with original readings from the literature.

Scope and Style

With that in mind, this new edition of Economics of the Environment consists of thirty-four chapters that instructors will find to be of great value as a complement to their chosen text and their lectures. The scope is comprehensive, and the list of authors is a veritable “who’s who” of environmental economics, including: Joseph Aldy, Kenneth Arrow, Trudy Cameron, Ronald Coase, Maureen Cropper, Peter Diamond, George Eads, Jeffrey Frankel, Rick Freeman, Don Fullerton, Lawrence Goulder, John Graham, Robert Hahn, Michael Hanemann, Jerry Hausman, Steven Kelman, Nathaniel Keohane, Alan Krupnick, Lester Lave, John Livernois, Eric Maskin, Leonardo Maugeri, Gilbert Metcalf, Richard Newell, Roger Noll, William Nordhaus, Wallace Oates, Sheila Olmstead, Elinor Ostrom, Karen Palmer, Ian Parry, Carl Pasurka, Robert Pindyck, William Pizer, Michael Porter, Paul Portney, Forest Reinhardt, Richard Revesz, Milton Russell, Michael Sandel, Richard Schmalensee, Steven Shavell, Jason Shogren, Kerry Smith, Robert Solow, Nicholas Stern, Laura Taylor, Richard Vietor, and myself.

The articles are timely, with more than 90 percent published since 1990, and half since 2005. There are two completely new sections of the book, “Economics of Natural Resources” and “Corporate Social Responsibility,” and all of the chapters in the section on global climate change are new to the sixth edition.

In order to make the readings in Economics of the Environment accessible to students at all levels, one criterion I use in the selection process is that articles should not only be original and well written — and meet the highest standards of economic scholarship — but also be non-technical in their presentations. Hence, readers will find virtually no formal mathematics in any of the book’s 34 chapters throughout its 733 pages.

The Path Ahead

Environmental economics is a rapidly evolving field. Not only do new theoretical models and improved empirical methods appear on a regular basis, but entirely new areas of investigation open up when the natural sciences indicate new concerns or the policy world turns to new issues. Therefore, this book remains a work in progress. I owe a great debt to the teachers and students of previous editions who have sent their comments and suggestions for revisions. Looking to future editions, I invite all readers — whether teachers, students, or practitioners — to send me any thoughts or suggestions for improvement.

In the meantime, if you’re interested finding out more about the book, immediately below is a chapter-by-chapter summary of the book. Alternatively, you can check out the W. W. Norton or Amazon web sites.

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Appendix: A Summary of Economics of the Environment, Sixth Edition

Part I of the volume provides an overview of the field and a review of its foundations. Don Fullerton and I start things off with a brief essay about how economists think about the environment (Nature 1998). This is followed by the classic treatment of social costs and bargaining by Ronald Coase (Journal of Law and Economics 1960), and a new article by Jason Shogren and Laura Taylor on the important, emerging field of behavioral environmental economics (Review of Environmental Economics and Policy 2008).

The Costs of Environmental Protection

Part II examines the costs of environmental protection, which might seem to be without controversy or current analytical interest. This is not, however, the case. This section begins with a survey article by Carl Pasurka that reviews the theory and empirical evidence on the relationship between environmental regulation and so-called “competitiveness” (Review of Environmental Economics and Policy 2008).

A somewhat revisionist view is provided by Michael Porter and Class van der Linde, who suggest that the conventional approach to thinking about the costs of environmental protection is fundamentally flawed (Journal of Economic Perspectives 1995). Karen Palmer, Wallace Oates, and Paul Portney provide a careful response (Journal of Economic Perspectives 1995).

The Benefits of Environmental Protection

In Part III, the focus turns to the other side of the analytic ledger — the benefits of environmental protection. This is an area that has been even more contentious — both in the policy world and among scholars. Here the core question is whether and how environmental amenities can be valued in economic terms for analytical purposes.

The book features a provocative debate on the stated-preference method known as “contingent valuation.” Paul Portney outlines the structure and importance of the debate, Michael Hanemann makes the affirmative case, and Peter Diamond and Jerry Hausman provide the critique (all three articles are from the Journal of Economic Perspectives 1994).

In the final article in Part III, the book turns to a concept that is both very important in assessments of the benefits of environmental regulations and is also very widely misunderstood — the value of a statistical life. In an insightful essay, Trudy Cameron seeks to set the record straight (Review of Environmental Economics and Policy 2010).

There are two principal policy questions that need to be addressed in the environmental realm: how much environmental protection is desirable; and how should that degree of environmental protection be achieved. The first of these questions is addressed in Part IV and the second in Part V.

The Goals of Environmental Policy: Economic Efficiency and Benefit-Cost Analysis

In an introductory essay, Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and I ask whether there is a role for benefit-cost analysis to play in environmental, health, and safety regulation (Science 1996).

Then, Lawrence Goulder and I focus on an ingredient of benefit-cost analysis that non-economists seem to find particularly confusing, or even troubling — intertemporal discounting (Nature 2002). Next, Robert Pindyck examines a subject of fundamental importance — the role of uncertainty in environmental economics (Review of Environmental Economics and Policy 2007). Steven Kelman provides an ethically-based critique of benefit-cost analysis, which is followed by a set of responses (Regulation 1981).

Part IV concludes with an up-to-date essay by John Graham on the critical role of the U.S. Office of Management and Budget in federal regulatory impact analysis (Review of Environmental Economics and Policy 2008).

The Means of Environmental Policy: Cost Effectiveness and Market-Based Instruments

Part V examines the policy instruments — the means — that can be employed to achieve environmental targets or goals. This is an area where economists have made their greatest inroads of influence in the policy world, with tremendous changes having taken place over the past twenty years in the reception given by politicians and policy makers to so-called market-based or economic-incentive instruments for environmental protection.

Lawrence Goulder and Ian Parry start things off with a broad-ranging essay on instrument choice in environmental policy (Review of Environmental Economics and Policy 2008). Following this, I examine lessons that can be learned from the innovative sulfur dioxide allowance trading program, set up by the Clean Air Act Amendments of 1990 (Journal of Economic Perspectives 1998). Finally, Michael Sandel provides a critique of market-based instruments, with responses offered by Eric Maskin, Steven Shavell, and others (New York Times 1997).

Economics of Natural Resources

Part VI consists of three essays on a new topic for this book — the economics of natural resources. First, John Livernois examines the empirical significance of a central tenet in natural resource economics, namely the Hotelling Rule — the proposition that under conditions of efficiency, the scarcity rent (price minus marginal extraction cost) of natural resources will rise over time at the rate of interest (Review of Environmental Economics and Policy 2009).

Essays by Leonardo Maugeri (Review of Environmental Economics and Policy 2009) and Sheila Olmstead (Review of Environmental Economics and Policy 2010), respectively, examine two particularly important resources: petroleum and water.

The next four sections of the book treat some timely and important topics and problems.

Corporate Social Responsibility and the Environment

Part VII examines corporate social responsibility and the environment, discussion of which has too often been characterized by more heat than light. Forest Reinhardt, Richard Vietor, and I provide an overview of this realm from the perspective of economics, examining the notion of firms voluntarily sacrificing profits in the social interest. In a second essay, Paul Portney provides a valuable empirical perspective (both are from the Review of Environmental Economics and Policy 2008).

Global Climate Change

Part VIII is dedicated to investigations of economic dimensions of global climate change, which may in the long term prove to be the most significant environmental problem that has arisen, both in terms of its potential damages and in terms of the costs of addressing it. First, a broad overview of the topic is provided in a survey article by Joseph Aldy, Alan Krupnick, Richard Newell, Ian Parry, and William Pizer (Journal of Economic Literature 2010).

Next, William Nordhaus critiques the well-known Stern Review on the Economics of Climate Change, and Nicholas Stern and Chris Taylor respond (both are from Science 2007). In the final essay in this section, Gilbert Metcalf examines market-based policy instruments that can be used to address greenhouse gas emissions (Journal of Economic Perspectives 2009).

Sustainability, the Commons, and Globalization

Part IX begins with Robert Solow’s economic perspective on the concept of sustainability. This is followed by Elinor Ostrom’s development of a general framework for analyzing sustainability (Science 2009), and my own historical view of economic analysis of problems associated with open-access resources (American Economic Review 2011). Then, Jeffrey Frankel draws on diverse sources of empirical evidence to examine whether globalization is good or bad for the environment (Council on Foreign Relations 2004).

Economics and Environmental Policy Making

The final section of the book, Part X, departs from the normative concerns of much of the volume to examine some interesting and important questions of political economy. It turns out that an economic perspective can provide useful insights into questions that might at first seem to be fundamentally political.

Nathaniel Keohane, Richard Revesz, and I utilize an economic framework to ask why our political system has produced the particular set of environmental policy instruments it has (Harvard Environmental Law Review 1998). Myrick Freeman reflects on the benefits that U.S. environmental policies have brought about since the first Earth Day in 1970 (Journal of Economic Perspectives 2002). Lastly, Robert Hahn addresses the question that many of the articles in this volume raise: what impact has economics actually had on environmental policy (Journal of Environmental Economics and Management 2000)?

The Platform Opens a Window: An Unambiguous Consequence of the Durban Climate Talks

In my previous essay – following the 17^th Conference of the Parties (COP-17) of the United Nations Framework Convention on Climate Change (UNFCCC), which adjourned on December 11, 2011 – I offered my assessment of the Durban climate negotiations, addressing the frequently-posed question of whether the talks had “succeeded.” I took note of three major outcomes from the negotiations: (1) elaboration on several components of the Cancun Agreements; (2) a second five-year commitment period for the Kyoto Protocol; and (3) a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020. My conclusion was that this package – in total – represented something of a “half-full glass of water,” that is, an outcome that could be judged successful or not, depending upon one’s perspective.

However, something I did not discuss last month is that this third provision – the “Durban Platform for Enhanced Action” – has opened an important window. To explain what I mean requires a brief review of some key points from twenty years of history of international climate negotiations.

The Rio Earth Summit (1992)

The U.N. Framework Convention on Climate Change, adopted at the U.N. Conference on Environment and Development (the first “Earth Summit”) in Rio de Janeiro, Brazil, in 1992, contains what was to become a crucial passage. The first “principle” in Article 3 of the Convention reads as follows: “The Parties should protect the climate system for the benefit of present and future generations of humankind, on the basis of equity and in accordance with their common but differentiated responsibilities and respective capabilities. Accordingly, the developed country Parties should take the lead in combating climate change and the adverse effects thereof.” [emphasis added] The countries considered to be “developed country Parties” were listed in an appendix to the 1992 Convention – Annex I.

The phrase – common but differentiated responsibilities – has been repeated countless numbers of times since 1992, but what does it really mean? The official answer was provided three years after the Earth Summit by the first decision adopted by the first Conference of the Parties (COP-1) of the U.N. Framework Convention, in Berlin, Germany, April 7, 1995 – the Berlin Mandate.

The Berlin Mandate (1995)

The Berlin Mandate interpreted the principle of “common but differentiated responsibilities” as:

(1) launching a process to commit (by 1997) the Annex I countries to quantified greenhouse gas emissions reductions within specified time periods (targets and timetables); and

(2) stating unambiguously that the process should “not introduce any new commitments for Parties not included in Annex I.”

Thus, the Berlin Mandate established the dichotomous distinction whereby the Annex I countries are to take on emissions-reductions responsibilities, and the non-Annex I countries are to have no such responsibilities whatsoever.

The Kyoto Protocol (1997)

It was in direct response to this Mandate that the U.S. Senate subsequently passed unanimously (95-0) the Byrd-Hagel Resolution in August of 1997 (Senate Resolution 98, 105^th Congress, 1^st Session) stating that:

“It is the sense of the Senate that the United States should not be a signatory to any protocol to, or other agreement regarding, the United Nations Framework Convention on Climate Change of 1992, at negotiations in Kyoto in December 1997, or thereafter, which would mandate new commitments to limit or reduce greenhouse gas emissions for the Annex I Parties, unless the protocol or other agreement also mandates new specific scheduled commitments to limit or reduce greenhouse gas emissions for Developing Country Parties within the same compliance period.”

So, in a very real sense, the Berlin Mandate brought about sustained bi-partisan opposition in the United States to the international climate regime and the Kyoto Protocol. This sealed the Protocol’s fate in terms of ever being ratified by the U.S. Senate. President Clinton did not submit the Protocol to the Senate for ratification, nor would Al Gore have done so had he been elected to succeed Clinton. Likewise, Senator John Kerry was explicit about his opposition to Kyoto when he ran for President against George W. Bush, and President Bush was subsequently more than explicit about his lack of support for the Protocol and, for that matter, the UNFCCC process. When Barack Obama ran against John McCain for President in 2008, one thing on which they agreed was their opposition to the Kyoto Protocol.

Beyond those decisive impacts on U.S. climate politics, the Berlin Mandate had wide-ranging and worldwide normative consequences, because it became the anchor that prevented and has – until very recently – continued to prevent real progress in international climate negotiations. With 50 non-Annex I countries having greater per capita income than the poorest of the Annex I countries, the distinction is clearly out of whack. But, more important than that, this dichotomous distinction means that:

(a) half of global emissions soon will be from nations without constraints;

(b) the world’s largest emitter – China – is unconstrained;

(c) aggregate compliance costs are driven up to be four times their cost-effective level, because many opportunities for low-cost emissions abatement in emerging economies are taken off the table; and

(d) an institutional structure is perpetuated that makes change and progress virtually impossible.

Fast Forward to Copenhagen (2009) and Cancun (2010)

The dichotomous Annex I/non-Annex I distinction remained a central – indeed, the central – feature of international climate negotiations ever since COP-1 in Berlin in 1995. Then, at COP-15 in 2009, there were hints of possible change.

The Copenhagen Accord (2009) and the Cancun Agreements (2010) began a process of blurring the Annex I/non-Annex I distinction. However, this blurring was only in the context of the interim pledge-and-review system established at COP-15 in Copenhagen and certified at COP-16 in Cancun, not in the context of an eventual successor to the Kyoto Protocol. Thus, the Berlin Mandate retained its centrality.

Finally, We Arrive in Durban (2011)

The third of the three outcomes of the December 2011 talks in Durban, South Africa, which I mentioned at the beginning of this essay – the Durban Platform for Enhanced Action – completely eliminates the Annex I/non-Annex I (or industrialized/developing country) distinction. In the Durban Platform, the delegates reached a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020. That’s a strange and confusing sentence, but it’s what happened, and it’s potentially important.

Rather than adopting the Annex I/non-Annex I (or industrialized/developing country) distinction, the Durban Platform focuses instead on the (admittedly non-binding) pledge to create a system of greenhouse gas reductions including all Parties (that is, all key countries) by 2015 that will come into force (after ratification) by 2020. Nowhere in the text of the decision will one find phrases such as “Annex I,” “common but differentiated responsibilities,” “distributional equity,” “historical responsibility,” all of which had long since become code words for targets for the richest countries and blank checks for all others.

A Dramatic Departure

Thus, in a dramatic departure from some seventeen years of U.N. hosted international negotiations on climate change, the 17^th Conference of the Parties in Durban turned away from the Annex I/non-Annex I distinction, which had been the centerpiece of international climate policy and negotiations since it was adopted at the 1^st Conference of the Parties in Berlin in 1995.

Because of this, the international law scholar, Daniel Bodansky, has labeled “the Durban Platform a complete departure from the Berlin Mandate.” Likewise, Indian professor of international law, Lavanya Rajamani says that Durban delivered a “new process and with it, a clean slate on differentiation.” And Elliot Diringer of the Center for Climate and Energy Solutions, finds the overall Durban deal to be “delicately poised between two eras – the fading age of Kyoto, and a new phase … with developed and developing countries presumably on a more equal footing.”

This is of vast potential importance, but – of course – only “potential” importance, because just as it was the Kyoto Protocol’s numerical targets and timetables that fulfilled the Berlin Mandate’s promise, it remains for the delegates to the UNFCCC to meet this Durban mandate with a new post-Kyoto agreement by 2015 (to come into force by 2020). Only time will tell whether the Durban Platform delivers on its promise, or turns out to be another “Bali Roadmap,” leading nowhere.

So, with such uncertainty, what’s the “unambiguous consequence” of Durban that I refer to in the title of this essay?

An Unambiguous Outcome: The Platform Opens a Window

The Durban Platform – by replacing the Berlin Mandate – has opened an important window. It is this. The national delegations from around the world now have a challenging task before them: to identify a new international climate policy architecture that is consistent with the process, pathway, and principles laid out in the Durban Platform, namely to find a way to include all key countries (such as the 20 largest national and regional economies that together account for upwards of 80% of global carbon dioxide emissions) in a structure that brings about meaningful emissions reductions on an appropriate timetable at acceptable cost.

Having broken the old mold, a new one must be forged. There is a mandate for change. Governments around the world now need fresh, outside-of-the-box ideas from the best thinkers, and they need those ideas over the next few years. This is a time for new proposals for future international climate policy architecture, not for incremental adjustments to the old pathway. I trust that this call will be heard by a diverse set of universities, think tanks, and – for that matter – advocacy and interest groups around the world. With 48 research initiatives in Australia, China, Europe, India, Japan, and the United States, the Harvard Project on Climate Agreements is prepared to contribute to this effort. Please stay tuned.

Assessing the Climate Talks — Did Durban Succeed?

The 17^th Conference of the Parties (COP-17) of the United Nations Framework Convention on Climate Change (UNFCCC) adjourned on Sunday, a day and a half after its scheduled close, and in the process once again pulled a rabbit out of the hat by saving the talks from complete collapse (which appeared possible just a few days earlier). But was this a success?

The Durban Outcome in a Nutshell

The outcome of COP-17 includes three major elements: some potentially important elaborations on various components of the Cancun Agreements; a second five-year commitment period for the Kyoto Protocol; and (read this carefully) a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020.

Is This a Success?

If by “success” in Durban, one means solving the climate problem, the answer is obviously “not close.”

Indeed, if by “success” one meant just putting the world on a path to solve the climate problem, the answer would still have to be “no.”

But, I’ve argued previously – including in my pre-Durban essay last month – that such definitions of success are fundamentally inappropriate for judging the international negotiations on the exceptionally challenging, long-term problem of global climate change.

The key question, at this point, is whether the Durban outcome has put the world in a place and on a trajectory whereby it is more likely than it was previously to establish a sound foundation for meaningful long-term action.

I don’t think the answer to that question is at all obvious, but having read carefully the agreements that were reached in Durban, and having reflected on their collective implications for meaningful long-term action, I am inclined to focus on “the half-full glass of water.” My conclusion is that the talks – as a result of last-minute negotiations – advanced international discussions in a positive direction and have increased the likelihood of meaningful long-term action. Why do I say this?

The Significance of Durban

Let’s look at the three major elements of the Durban outcome.

1. Putting More Flesh on the Bones of the Cancun Agreements

First, the delegates agreed to a set of potentially important details on various components of the Cancun Agreements. This progress may turn out to be very important indeed, and helps advance – at least for the interim – a workable bottom-up, pledge-and-review approach to international climate cooperation. The progress on this front includes work done on the Green Climate Fund to help mobilize public and private funding of climate change mitigation and adaptation in developing countries; more specifics on technology transfer mechanisms; mechanisms to enhance the transparency of national commitments under the Cancun Agreements; and an international scheme to reduce deforestation, which – importantly – includes market mechanisms.

2. A Second Commitment Period for the Kyoto Protocol

Second, the delegates agreed to a second five-year commitment period for the Kyoto Protocol. Without this element, the talks would have collapsed, because the key emerging economies of China, India, Brazil, South Africa, Korea, and Mexico (not to mention the much larger number of truly poor, developing countries) would have walked out. Would this have been so bad?

I have long argued that the Kyoto Protocol – with its structure of relatively ambitious targets for a small set of industrialized countries (the Annex I countries) and no targets whatsoever for the much larger set of other nations in the world (the non-Annex I countries) – is fundamentally flawed as a basis for addressing the climate change problem in a meaningful way, that is, in a way that can eventually limit global temperature increases to no more than 2 or 3 degrees Centigrade above pre-industrial levels. In the past, some observers have gone so far as to argue that such a collapse of the talks would be necessary to free the world to consider alternative and ultimately more productive routes going forward. Eventually, that may turn out to be true, but extending the Kyoto Protocol at this time for another period does little mischief.

The major effect – in addition to keeping the emerging economies (and developing countries) from walking out of the room – was to place the European Union in a position of accepting a target (for a second five-year period) that is no more stringent than what it has already committed to do under the European Union Emission Trading Scheme (EU ETS). The United States is not a party to the Kyoto Protocol, and Canada, Japan, and Russia have indicated that they will not take up targets in a second commitment period. Europe (and New Zealand, and possibly Australia) will be doing what they would have done anyway. In exchange for this, the major emerging economies agreed to the third key element.

3. The Durban Platform for Enhanced Action

Third and finally, the delegates reached a non-binding agreement to reach an agreement by 2015 that will bring all countries under the same legal regime by 2020. That’s a strange and confusing sentence, but it’s what happened, and – in my opinion – it’s potentially important, although it’s much too soon to say for sure.

The anchor that has been preventing real progress in the international climate negotiations for the past fifteen years has been the Kyoto Protocol’s dichotomous distinction between Annex I and non-Annex I countries. With 50 non-Annex I countries now having greater per capita income than the poorest of the Annex I countries, it is clearly out of whack. But, much more than that, this dichotomous distinction means that the world’s largest emitter – China – is unconstrained, that half of global emissions soon will be from nations without constraints, it drives up costs to four times their cost-effective level, and it creates a structure that makes change and progress virtually impossible.

Fortunately, the Copenhagen Accord and the Cancun Agreements began the process of blurring the Annex I/non-Annex I distinction, which was an important accomplishment, although it was only in the context of the interim pledge-and-review system, not in the context of an eventual successor to Kyoto. Now, the COP-17 decision for “Enhanced Action” completely eliminates the Annex I/non-Annex I (or industrialized/developing country) distinction. It focuses instead on the (admittedly non-binding) pledge to create a system of greenhouse gas reductions including all Parties (that is, all key countries) by 2015 that will come into force (after ratification) by 2020. Nowhere in the text of the decision will one find phrases such as “Annex I,” “common but differentiated responsibilities,” or “distributional equity,” which have – in recent years – become code words for targets for the richest countries and a blank check for all others.

We should not over-estimate the importance of a “non-binding agreement to reach a future agreement,” but this is a real departure from the past, and marks a significant advance along the treacherous, uphill path of climate negotiations.

The Path Ahead

In my previous essay at this blog, I expressed the fear that contentious debates over a possible second commitment period for the Kyoto Protocol might disrupt the Durban talks, divert them from making sound progress on the Cancun structure, and keep the delegates from moving toward a sound foundation for meaningful long-term action. I worried, in essence, that Durban – despite the weather – might resemble Copenhagen more than Cancun.

My conclusion is that this did not happen. Not only did Durban not undo the progress made in Cancun, it built upon it, and moved forward. This won’t satisfy the 350.org crowd, and it must greatly annoy the opponents of sensible climate policy, but in the real world of international negotiations on this exceptionally difficult global commons problem, this is what success looks like.

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For an interesting and helpful assessment of “The Legal Aspects of the Durban Platform Text,” I recommend an insightful Q&A by Jacob Werksman of the World Resources Institute.