Environmental Economics

Concepts, Methods and Policies

Dodo Thampapillai, Matthias Ruth

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781351670593
• Edition: 1
• Topic: Economía
• Subtopic: Desarrollo sostenible

Environmental Economics explores the ways in which economic theory and its applications, as practised and taught today, must be modified to explicitly accommodate the goal of sustainability and the vital role played by environmental capital.

Pivoting around the first and second laws of thermodynamics, as well as the principles of ecological resilience, this book is divided into five key parts, which includes extensive coverage of environmental microeconomics and macroeconomics. It drills down into issues and challenges including consumer demand; production and supply; market organisation; renewable and non-renewable resources; environmental valuation; macroeconomic stabilisation, and international trade and globalisation. Drawing on case studies from forestry, water, soil, air quality, and mining, this book will equip readers with skills that enable the analyses of environmental and economic policy issues with a specific focus on the sustainability of the economy.

Rich in pedagogical features, including key concepts boxes and review questions at the end of each chapter, this book will be a vital resource for upperlevel undergraduate and postgraduate students studying not only environmental economics/ecological economics but also economics in general.

Part I The environment and the economy

1 The environment and economics

Environmental economics and economics

The main theme in environmental economics is that nature is capital. Sustaining a steady stock of environmental capital (KN) is a necessary condition for economic sustainability. This is because KN acts as both a source and a sink for the economy. It is a source for the basic resources the economy needs and a sink for the wastes that the economy generates. When and where the contributions of KN to the economy are disregarded, the ability to produce and enjoy the goods and services generated by the economy are undermined.

The objective of this text is to show how economic theory and its applications, as practised and taught today, can be modified to explicitly accommodate the goal of sustainability and the vital role played by KN. But it would be incorrect to presume that economics has relegated KN to irrelevance. Both classical and neoclassical economists have recognised the pivotal role of KN. However, a sense of environmental complacency pervaded economic policy during the three decades spanning 1950–1980. This was mainly due to a misplaced singular emphasis on economic growth and the spread of evidence that appeared to rationally negate the possibility of environmental limits. However, the continued proliferation of environmental problems among both rich and poor countries alike has rekindled genuine concerns for a proper balance between economic activity and the environment. The attainment and maintenance of this balance is the primary focus of environmental economics.

Many observers tend to associate the natural environment with classical economics rather than neoclassical economics. In all classical theories (Adam Smith 1776; Thomas Malthus 1798; David Ricardo 1817; John Stuart Mill 1848), economic growth was explicitly constrained by environmental limits. However, it was not only these classical economists who emphasised the role of nature to the economic enterprise. Early neoclassical economics, too, were aware that humans’ activities are shaped by natural processes and that economic production itself is the outcome of the interplay of KN with other inputs. For example, consider what Alfred Marshall (1890), who is often considered the founder of modern neoclassical economics, had to say: ‘In a sense there are only two agents of production, nature and man. . .. But on the other hand, man is himself largely formed by his surroundings, in which nature plays a great part’ (p. 116) and ‘The labour and capital of a country, acting on its natural resources, produce annually a certain net aggregate of commodities’ (p. 524).

These statements show recognition of nature and natural resources as the ultimate factors of production. The implication is that if an economy is not endowed with natural resources, it cannot produce goods and services. This same conclusion was reached nearly a hundred years after Marshall by the Brundtland Commission (1987, p. 37): ‘Environment and development are not separate challenges; they are inexorably linked’.

Yet much of recent economic theory relegated nature to the sidelines, if not entirely eliminated it from its analysis altogether. In some instances, the elimination of nature was a simple consequence of representing economic processes in mathematical form. For example, one may express the quantity Q of a finished product as a function f of the amount of labour, L_Q, capital, K_Q, and resources R (such as energy and materials) required to produce Q:

(1.1)

Similarly, the amount of resources that need to be extracted for Q may be written as

(1.2)

where L_R and K_R are the labour and capital inputs in the extraction process, respectively. Substitution of (1.2) into (1.1) yields

(1.3)

which gives the impression that Q can be produced without R. Similar arguments of irrelevance to the economic process can be made with respect to the waste assimilation services provided by nature.

In other cases, the misunderstanding of the fundamentally different role that nature plays in economic production from other inputs has shaped economic reasoning. For some economists, natural endowments are simply not essential; for example, Mankiw (2004, p. 246) states:

Although natural resources can be important, they are not necessary for an economy to be highly productive in producing goods and services. Japan, for instance, is one of the richest countries in the world, despite having few natural resources. International trade makes Japan’s success possible. Japan imports many of the natural resources it needs, such as oil, and exports its manufactured goods to economies rich in natural resources.

This is clearly a mistaken view on at least two grounds. First, natural resources are not simply extractable resources whose acquisition and use are unrelated to the performance of other parts of the natural system. Instead, natural resources, such as oil or natural gas, are a collection of linked endowments within a broader ecosystem. Scientists now believe that it would be unwise to isolate ecosystems to local contexts, given their global connectivity. For one thing, when oil or gas deposits are extracted in one location, after-effects (such as earthquakes) can be felt elsewhere. For another, the combustion of these resources in one location will result in emissions that cause climate change, with effects that are felt globally and for centuries to come. Second, the fact that natural resources can be traded does not mean they are infinite. Japan’s riches have enabled it to draw on, and draw down, KN in other countries. To the extent that Japan and a large number of other nations have neglected to preserve KN globally, they have impacted their and everyone else’s ability to grow their economies in the future.

Although environmental economics became established as a discipline within economics only in the 1960s, several economists had written extensively from as early as the mid-1800s on environmental issues and problems within the framework of neoclassical economics. Important developments in economics owe their origins to theoretical and empirical work on environmental issues. For example, the theory of externalities, which was introduced by Marshall in 1890 and subsequently formalised in welfare economics by Pigou in 1920, arose primarily from the recognition of events such as pollution, which traditionally fall outside the market. Irving Fisher, writing in 1904 on the various definitions of capital, considered natural endowments such as lakes and rivers as capital assets and used them to illustrate the difference between stocks and flows of resources. The concept of user costs was developed by Hotelling (1931) to account for the requirements of future generations. This was taken up by Keynes (1936) to explain the concept of permanent income, more popularly known in contemporary times as sustainable income (see Box 1.1).

Box 1.1 The concept of sustainable income

Hicks (1946) reviews the meaning of income in Chapter 14 of his Value and Capital. He suggests that the practical role for income calculations is to indicate the amount individuals can consume without impoverishing themselves. He therefore argues (p. 174) that income should be defined as ‘the maximum amount of money which the individual can spend this week and still be able to spend the sa...