economic valuation Archives - Page 3 of 4 - An Economic View of the Environment

Good News from the Regulatory Front

As each day passes, the upcoming November 2012 general elections produce new stories about potential Republican candidates for President, as well as stories about President Obama’s anticipated re-election campaign. At the same time, the 2012 elections are already affecting Congressional debates, where each side seems increasingly interested in taking symbolic actions and scoring political points that can play to its constituencies among the electorate, rather than working earnestly on the country’s business.

The new Tea Party Republicans in the House of Representatives decry the “fact” that the U.S. Environmental Protection Agency (EPA) continues to promulgate “job-killing regulations” for made-up non-problems. And Democrats in the Congress – not to mention the Administration – are eager to talk about “win-win” policies that will produce “clean energy jobs” and protect Americans from the evils of imported oil and gas.

Neither side seems willing to admit that environmental regulations bring both good news – a cleaner environment – and bad news – costs of compliance that affect not only businesses but consumers as well. Sometimes the cost-side of proposed regulations dominates. Those regulatory moves are – from an economic perspective – fundamentally unwise, since they make society worse off. In other cases, the benefits of a proposed regulation more than justify the costs that will be incurred. Such regulations are – to use a word now favored by President Obama – a wise investment. They make society better off. Failure to take action on such opportunities is imprudent, if not irresponsible. Just such an opportunity now presents itself with EPA’s Clean Air Transport Rule.

In an op-ed that appeared on April 25, 2011, in The Huffington Post (click here for link to the original op-ed), Richard Schmalensee and I assess this opportunity. Rather than summarize (or expand on) our op-ed, I simply re-produce it below as it was published by The Huffington Post, with some hyperlinks added for interested readers.

For anyone who is not familiar with my co-author, Richard Schmalensee, please note that he is the Howard W. Johnson Professor of Economics and Management at MIT, where he served as the Dean of the Sloan School of Management from 1998 to 2007. Also, he served as a Member of the President’s Council of Economic Advisers in the George H. W. Bush administration from 1989 to 1991. By the way, in previous blog posts, I’ve featured other op-eds that Dick and I have written in The Huffington Post (“Renewable Irony”) and The Boston Globe (“Beware of Scorched-Earth Strategies in Climate Debates”).

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An Opportunity for Timely Action: EPA’s Transport Rule Passes the Test

by Richard Schmalensee and Robert Stavins

The Huffington Post, April 25, 2011

At a time when EPA regulations are under harsh attack, one new environmental regulation – at least – stands out as an impressive winner for the country. Studies of the soon-to-be-finalized Clean Air Transport Rule have consistently found that the benefits created by the rule would far outweigh its costs. By reducing sulfur dioxide and nitrogen oxide emissions from power plants in 31 states in the East and Midwest, the Transport Rule will create substantial benefits through lower incidence of respiratory and heart disease, improved visibility, enhanced agricultural and forestry yields, improved ecosystem services, and other environmental amenities. According to EPA, these benefits will be 25 to 130 times greater than the associated costs. We document this in our new report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation.

Despite the benefits offered by the Transport Rule, some argue that it – and other EPA regulations – will stifle economic growth and threaten the reliability of our electric power system. However, a careful look at the evidence reveals that the Transport Rule is unlikely to create such risks. Analyses of the Transport Rule have found that it need not lead to significant plant retirements. Robust regulatory and market mechanisms ensure that the nation can meet emission targets while reliably meeting customer demand.

While compliance with the Transport Rule would – in some cases – require installation of new pollution control equipment, the capital expenditures required would comprise a small fraction of aggregate capital spending by the power industry. In fact, because of the Transport Rule’s unique legal circumstances, in which the Courts have mandated that EPA replace a stringent predecessor, utilities have already begun to make pollution control investments needed to comply with the Transport Rule.

The Rule’s timing can also contribute to lowering its cost and supporting other policy goals. Installation of the pollution control technologies needed to comply with the Rule could increase short-term employment. Although the longer term job impacts are less clear, these short-term employment effects would complement other policy initiatives aimed at supporting the nation’s economic recovery.

EPA analysis estimates modest impacts on regional electricity rates, but reductions in health care expenditures could partially or fully offset these effects. Expanded supplies of low-cost natural gas can also help lower the Transport Rule’s cost by providing a less costly substitute for power generated from coal.

Most importantly, actions taken to reduce emissions would create substantial health benefits. Tens of thousands of premature deaths would be eliminated annually, as would millions of non-fatal respiratory and cardiovascular illnesses. A diverse set of studies find that these health improvements will create $20 to over $300 billion in benefits annually. And, while the Transport Rule is designed to reduce the impact of upwind emissions on downwind states, upwind states would also receive substantial health benefits from the cleaner air brought about by the Rule. These upwind states have much to gain, because states with the highest emissions from coal-fired power plants are also among those with the greatest premature mortality rates from these emissions.

Along with these health benefits, the largest shares of short-term improvements in employment and regional economies are likely to accrue to the regions that are most dependent on coal-fired power, as they invest in new pollution control equipment. Thus, while designed to help regions downwind of coal-fired power plants, the Transport Rule also offers substantial benefits to upwind states.

As the U.S. economy emerges from its worst recession since the Great Depression of the 1930s and faces an increasingly competitive global marketplace, regulation such as the Transport Rule that creates positive net benefits and allows industry flexibility in creating public goods can complement strategies intended to foster economic growth. Such regulations are best identified by careful analyses to ensure that benefits truly exceed costs and avoid unfair impacts on particular groups or sectors. The Transport Rule has undergone a series of such thorough assessments, and the results consistently indicate that it would create benefits that far exceed its costs. Failure to take timely action on this opportunity would seem to be imprudent, if not irresponsible.

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*Richard Schmalensee is the Howard W. Johnson Professor of Economics and Management at the Massachusetts Institute of Technology, a research associate of the National Bureau of Economic Research, and a fellow of the Econometric Society and the American Academy of Arts and Sciences. He served as a member of the Council of Economic Advisers with primary responsibility for environmental and energy policy from 1989 through 1991. Robert N. Stavins is the Albert Pratt Professor of Business and Government at the Harvard Kennedy School, a university fellow of Resources for the Future, a research associate of the National Bureau of Economic Research, and a fellow of the Association of Environmental and Resource Economists. He served as chairman of the EPA’s Environmental Economics Advisory Committee from 1997 through 2002. Their report, “A Guide to Economic and Policy Analysis of EPA’s Transport Rule,” which was commissioned by the Exelon Corporation, can be downloaded at: http://www.analysisgroup.com/uploadedFiles/Publishing/Articles/2011_StavinsSchmalansee_TransportRuleReport.pdf

Reflecting on a Century of Progress and Problems

As the first decade of the twenty-first century comes to a close, the problem of the commons is more important to our lives – and more central to economics – than a century ago when the first issue of the American Economic Review appeared, with an examination by Professor Katharine Coman of Wellesley College of “Some Unsettled Problems of Irrigation” (1911). Since that time, 100 years of remarkable economic progress have accompanied 100 years of increasingly challenging problems.

As the U.S. and other economies have grown, the carrying-capacity of the planet – in regard to natural resources and environmental quality – has become a greater concern, particularly for common-property and open-access resources. In an article that appears in the 100^th anniversary issue of the American Economic Review (AER) – “The Problem of the Commons: Still Unsettled After 100 Years” – I focus on some important, unsettled problems of the commons.

100 Years of Economic Progress and More Challenging Environmental Problems

Within the realm of natural resources, there are special challenges associated with renewable resources, which are frequently characterized by open-access. An important example is the degradation of open-access fisheries. Critical commons problems are also associated with environmental quality, including the ultimate commons problem of the twenty-first century – global climate change.

Small communities frequently provide modes of oversight and methods for policing their citizens, a topic about which Professor Elinor Ostrom of Indiana University has written extensively. But as the scale of society has grown, commons problems have spread across communities and even across nations. In some of these cases, no over-arching authority can offer complete control, rendering commons problems more severe.

Although the type of water allocation problems of concern to Coman have frequently been addressed by common-property regimes of collective management, less easily governed problems of open-access are associated with growing concerns about air and water quality, hazardous waste, species extinction, maintenance of stratospheric ozone, and – most recently – the stability of the global climate in the face of the steady accumulation of greenhouse gases.

Whereas common property resources are held as private property by some group, open-access resources are non-excludable. My article in the AER focuses exclusively on the latter, and thereby reflects on some important, unsettled problems of the commons. It identifies both the contributions made by economic analysis and the challenges facing public policy.

The article begins with natural resources, highlighting the difference between most non-renewable natural resources, pure private goods that are both excludable and rival in consumption, and renewable natural resources, many of which are non-excludable.

Some of these are rival in consumption but characterized by open-access. An example is the degradation of ocean fisheries. An economic perspective on these resources helps identify the problems they present for management, and provides guidance for sensible solutions.

The article then turns to a major set of commons problems that were not addressed until the last three decades of the twentieth century – environmental quality. Although frequently characterized as textbook examples of externalities, these problems can also be viewed as a particular category of commons problems: pure public goods, that are both non-excludable and non-rival in consumption.

A key contribution of economics has been the development of market-based approaches to environmental protection, including emission taxes and tradable rights. These have potential to address the ultimate commons problem of the twenty-first century, global climate change.

Themes That Emerge

First, economic theory – by focusing on market failures linked with incomplete systems of property rights – has made major contributions to our understanding of commons problems and the development of prudent public policies.

Second, as our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated, enabling policy makers to address problems that are characterized by uncertainty, spatial and temporal heterogeneity, and long duration.

Third, government policies that have not accounted for economic responses have been excessively costly, often ineffective, and sometimes counter-productive.

Fourth, commons problems have not diminished. While some have been addressed successfully, others have emerged that are more important and more difficult.

Fifth, environmental economics is well positioned to offer better understanding and better policies to address these ongoing challenges.

Conclusions

Although I hope you will read the full article – which is very accessible — I will summarize its conclusions here.

Problems of the commons are both more widespread and more important today than when Coman wrote about unsettled problems in the first issue of the American Economic Review 100 years ago. A century of economic growth and globalization have brought unparalleled improvements in societal well-being, but also unprecedented challenges to the carrying-capacity of the planet. What would have been in 1911 inconceivable increases in income and population have come about and have greatly heightened pressures on the commons, particularly where there has been open access to it.

The stocks of a variety of renewable natural resources – including water, forests, fisheries, and numerous other species of plant and animal – have been depleted below socially efficient levels, principally because of poorly-defined property-right regimes. Likewise, the same market failures of open-access – whether characterized as externalities, following A. C. Pigou (1920), or public goods, following Ronald Coase (1960) – have led to the degradation of air and water quality, inappropriate disposal of hazardous waste, depletion of stratospheric ozone, and the atmospheric accumulation of greenhouse gases linked with global climate change.

Over this same century, economics – as a discipline – has gradually come to focus more and more attention on these commons problems, first with regard to natural resources, and more recently with regard to environmental quality. Economic research within academia and think tanks has improved our understanding of the causes and consequences of excessive resource depletion and inefficient environmental degradation, and thereby has helped identify sensible policy solutions.

Conventional regulatory policies, which have not accounted for economic responses, have been excessively costly, ineffective, or even counter-productive. The problems behind what Garrett Hardin (1968) characterized as the “tragedy of the commons” might better be described as the “failure of commons regulation.” As our understanding of the commons has become more complex, the design of economic policy instruments has become more sophisticated.

Problems of the commons have not diminished, and the lag between understanding and action can be long. While some commons problems have been addressed successfully, others continue to emerge. Some – such as the threat of global climate change – are both more important and more difficult than problems of the past.

Fortunately, economics is well positioned to offer better understanding and better policies to address these ongoing challenges. As the first decade of the twenty-first century comes to a close, natural resource and environmental economics has emerged as a productive field of our discipline and one that shows even greater promise for the future.

Unintended Consequences of Government Policies: The Depletion of America’s Wetlands

Private land-use decisions can be affected dramatically by public investments in highways, waterways, flood control, or other infrastructure. The large movement of jobs from central cities to suburbs in the postwar United States and the ongoing destruction of Amazon rain forests have occurred with major public investment in supporting infrastructure. As these examples suggest, private land-use decisions can generate major environmental and social externalities – or, in common language, unintended consequences.

In an analysis that appeared in 1990 in the American Economic Review, Adam Jaffe of Brandeis University and I demonstrated that the depletion of forested wetlands in the Mississippi Valley – an important environmental problem and a North American precursor to the loss of South American rain forests – was exacerbated by Federal water-project investments, despite explicit Federal policy to protect wetlands.

Wetland Losses

Forested wetlands are among the world’s most productive ecosystems, providing improved water quality, erosion control, floodwater storage, timber, wildlife habitat, and recreational opportunities. Their depletion globally is a serious problem; and preservation and protection of wetlands have been major Federal environmental policy goals for forty years.

From the 1950s through the mid-1970s, over one-half million acres of U.S. wetlands were lost each year. This rate slowed greatly in subsequent years, averaging approximately 60 thousand acres lost per year in the lower 48 states from 1986 through 1997. And by 2006, the Bush administration’s Secretary of the Interior, Gale Norton, was able to announce a net gain in wetland acreage in the United Sates, due to restoration and creation activities surpassing wetland losses.

What Caused the Observed Losses?

What were the causes of the huge annual losses of wetlands in the earlier years? That question and our analysis are as germane today as in 1990, because of lessons that have emerged about the unintended consequences of public investments.

The largest remaining wetland habitat in the continental United States is the bottomland hardwood forest of the Lower Mississippi Alluvial Plain. Originally covering 26 million acres in seven states, this resource was reduced to about 12 million acres by 1937. By 1990, another 7 million acres had been cleared, primarily for conversion to cropland.

The owner of a wetland parcel faces an economic decision involving revenues from the parcel in its natural state (primarily from timber), costs of conversion (the cost of clearing the land minus the resulting forestry windfall), and expected revenues from agriculture. Agricultural revenues depend on prices, yields, and, significantly, the drainage and flooding frequency of the land. Needless to say, landowners typically do not consider the positive environmental externalities generated by wetlands; thus conversion may occur more often than is socially optimal.

Such externalities are the motivation for Federal policy aimed at protecting wetlands, as embodied in the Clean Water Act. Nevertheless, the Federal government engaged in major public investment activities, in the form of U.S. Army Corps of Engineers and U.S. Soil Conservation Service flood-control and drainage projects, which appeared to make agriculture more attractive and thereby encourage wetland depletion. The significance of this effect had long been disputed by the agencies which construct and maintain these projects; they attributed the extensive conversion exclusively to rising agricultural prices.

In an econometric (statistical) analysis of data from Arkansas, Mississippi, and Louisiana, from 1935 to 1984, Jaffe and I sought to sort out the effects of Federal projects and other economic forces. We discovered that these public investments were a very substantial factor causing conversion of wetlands to agriculture, with between 30 and 50 percent of the total wetland depletion over those five decades due to the Federal projects.

More broadly, four conclusions emerged from our analysis. First, landowners had responded to economic incentives in their land-use decisions. Second, construction of Federal flood-control and drainage projects caused a higher rate of conversion of forested wetlands to croplands than would have occurred in the absence of projects, leading to the depletion of an additional 1.25 million acres of wetlands. Third, Federal projects had this impact because they made agriculture feasible on land where it had previously been infeasible, and because, on average, they improved the quality of feasible land. Fourth, adjustment of land use to economic conditions was gradual.

Government Working at Cross-Purposes

The analysis highlighted a striking inconsistency in the Federal government’s approach to wetlands. In articulated policies, laws, and regulations, the government recognized the positive externalities associated with some wetlands, with the George H.W. Bush administration first enunciating a “no net loss of wetlands” policy. But public investments in wetlands – in the form of flood-control and drainage projects – had created major incentives to convert these areas to alternative uses. The government had been working at cross-purposes.

The conclusion that major public infrastructure investments affect private land-use decisions (thereby often generating negative externalities) may not be a surprise to some readers, but it was the 1990 analysis described here that first provided rigorous evidence which contrasted sharply with the accepted wisdom among policy makers.

The Ongoing Importance of Induced Land-Use Changes

As wetlands, tropical rain forests, barrier islands, and other sensitive environmental areas become more scarce, their marginal social value rises. In general, if induced land-use changes are not considered, the country will engage in more public investment programs whose net social benefits are negative.