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Environmental Economics: Basic Concepts and Debates
(Released April 2007)

 
  by Ethan Goffman  

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Economic activity that harms the environment creates present or future losses to humans in the form of damaged health, lower productivity, depleted natural resources, and reduced enjoyment of nature. Environmental economics seeks to quantify these losses and determine the most efficient way to reduce them, as well as to compare the cost of environmental damage to the cost of mitigation. To analyze the costs and benefits of reduced environmental damage, economists must compare changes in economic well being today with changes in economic well being in the future. This involves judging the extent to which future generations will have higher income and better methods for mitigating pollution affects.

smokestacks thicken the air
Environmental Economics analyzes how to protect common assets, such as air

Introduction

Of the three factors of production in classical economics, land, labor, and capital, land may be the most difficult to define. Does it refer to just the land itself? Or is land a generic term referring to all natural resources? Air, sunshine, and water, necessary to make land productive, are all part of the surrounding ecosystems. While ownership of land itself can easily be demarcated, ownership of mobile, associated resources is trickier.

diagram of land, labor, & capital leading to consumer wealth
The classical factors of production

The problem is that the way owners use their land may affect others. If they dump garbage on their neighbors' land, clearly they are infringing upon others' rights. But how about if they burn garbage and the resulting smoke blows onto nearby properties? What if they pollute a stream and it ends up affecting everyone's water source, or flush sewage away and it ends up in an ecologically stressed bay? Although the field of economics traditionally likes to deal with items that can be easily demarcated, quantified, and tagged with ownership, this becomes difficult when dealing with our shared ecosystems. Economics has dealt with this largely by labeling such items externalities, costs for which the responsible party does not pay. It then becomes up to the community, and usually the government, to decide how to deal with externalities.

Externalities are implicit in Garret Hardin's Tragedy of the Commons. In this scenario, a shared grazing area eventually suffers from overuse and ecosystem collapse. It always benefits each herdsman individually to add another cow to the pasture, and that addition by itself will cause little ecological stress. However, if each does so whenever possible, as economics dictates, over time all will be ruined. As Hardin puts it,

Each man is locked into a system that compels him to increase his herd without limit -- in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all.
Similarly, in a purely capitalist system with no government constraints, economic logic compels individual businesses to pollute the environmental commons of the air and the water. If it is possible to save money by doing so, it will happen. Any given business must rationally fear that its competitors are doing so and thereby gaining an advantage. To remain competitive and avoid being put out of business, they must do so themselves. Socialist systems face different problems, being subject to political pressures to maximize short run production that may result in equal or greater environmental damage.

There are several ways to internalize the externalities created by common ownership. One way is to create an ownership interest for the producer. In the example above, a herdsman who owns his pasture has an interest in preserving the land for his own and his family's future income. However, ownership is not always possible, particularly regarding large natural phenomenon such as air or bodies of water. When responsible ownership is impossible or impractical, other solutions must be sought to limit the external costs of production or to compensate those who bear the costs. Determining and enforcing solutions can be extremely difficult because costs are often borne by persons living in different political jurisdictions from the producer or consumer and in different time periods.

To regulate environmental common areas, local, state or national governmental interventions are often required, balancing the interests of one set of producers and consumers with the interests of another set who otherwise bear the costs of the first set. The simplest form of such intervention is to simply prohibit pollution. Unfortunately this is impossible, for all businesses, by their very nature, create some waste products. The trick is how to minimize the harmfulness and/or amount of waste products and the impact of their disposal. Finding ways to compel companies to do so efficiently, while still maintaining the robustness created by a free market system, is the task of environmental economists.

Arising out of Resource Economics, Environmental Economics evolved from work done at the research institute Resources for the Future (http://www.rff.org/) in the 1950s, which began to define the economic values of environmental resources. A more thorough and rigorous definition of the task of Environmental Economics is inherent in the National Bureau of Economic Research Environmental Economics Working Group, which, according to its website

undertakes theoretical or empirical studies of the economic effects of national or local environmental policies around the world, including effects on pollution, research and development, physical investment, labor supply, economic efficiency, and the distribution of real income. Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming. (NBER)

Go To Using Economics to Regulate the Environment

Special thanks to Sonia Conly for her support, thoughtful suggestions, and careful editing

© 2007, ProQuest CSA LLC. All rights reserved.

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