Economics and the Environment

A Materials Balance Approach

Allen V. Kneese, Robert U. Ayres, Ralph C. d'Arge

• Publisher: Routledge
• Year: 2015
• Print ISBN:
  9781138927988
• eBook ISBN:
  9781317402251
• Topic: Economics
• Subtopic: Environmental Economics
• Index: Economics

This monograph length report, first published in 1970, originated from a program of research at Resources for the Future that dealt with the management of residuals and of environmental quality. It presents some of the broad concepts that the program was based on and represents the effort to break out of the traditional approach in pollution and policy research, which had treated air, water, and solid waste problems as separate categories. This book will be of interest to students of economics and environmental studies.

Chapter I
PERSPECTIVE

We are now in the middle of a long process of transition in the nature of the image which man has of himself and his environment. Primitive men, and to a large extent also men of the early civilizations, imagined themselves to be living on a virtually illimitable plain. There was almost always, somewhere beyond the known limits of human habitation, and over a very large part of the time that man has been on earth, something like a frontier. That is, there was always some place else to go when things got too difficult, either by reason of the deterioration of the natural environment or a deterioration of the social structure in places where people happened to live. The image of the frontier is probably one of the oldest images of mankind, and it is not surprising that we find it hard to get rid of.¹

Prelude—Economic Theory and Material Things

The hunter is camped on a great plain with a small fire providing a flickering light and intermittent warmth. Tiny wisps of smoke ascend into a vast, clear night sky. Tomorrow the hunter will move, leaving behind ashes, food scraps, and his own excreta. After ten steps these are lost from sight and smell, probably forever. With them he leaves too his brief speculation about sky and earth, brought on by the loneliness of night, and he peers toward the horizon in search of prey.

The Administrator of the World Environment Control Authority sits at his desk. Along one wall of the huge room are real-time displays, processed by computer from satellite data, of developing atmospheric and ocean patterns, as well as the flow and quality conditions of the world's great river systems. In an instant, the Administrator can shift from real-time mode to simulation to test the larger effects of changes in emissions of material residuals and heat to water and atmosphere at control points generally corresponding to the locations of the world's great cities and the transport movements among them. In a few seconds the computer displays information in color code for various time periods—hourly, daily, or yearly phases at the Administrator's option. It automatically does this for current steady state and simulated future conditions of emissions, water flow regulation, and atmospheric conditions. Observing a dangerous reddish glow in the eastern Mediterranean, the Administrator dials sub-control station Athens and orders a step-up of removal by the liquid residuals handling plants there. Over northern Europe, the brown smudge of a projected air quality standards violation appears and sub-control point Essen is ordered to take the Ruhr area off sludge incineration for 24 hours but is advised that temporary storage followed by accelerated incineration—but with muffling—after 24 hours will be admissible. The CO₂ simulator now warns the Administrator that another upweller must be brought on line in the Murray Fracture Zone within two years if the internationally agreed balance of CO₂ and oxygen is to be maintained in the atmosphere.

These are extremes of interactions of man with his natural environment. But surely everyone would agree that actuality is much closer to the latter than to the former end of this spectrum. It appears, however, that our concepts of law and economics are somewhere in the middle. These are rooted in the idea that property and private two-party exchange can satisfactorily solve almost all resources allocation problems. Instances of air and water pollution have been regarded as somewhat unusual aberrations which can be satisfactorily treated in an ad hoc and specific way—not as problems of resources allocation on a massive scale.

Externalities and Economic Theory

Economic theory has long recognized in a limited way the existence of "common property" problems and resource misallocations associated with them. It was early appreciated that when property rights to a valuable resource could not be parceled out in such a way that one participant's activities in the use of that resource would leave the others unaffected, except through market exchange, unregulated private exchange would lead to inefficiencies. These inefficiencies were of two types: those associated with "externalities" and those associated with "user costs." The former term refers to certain broader costs (or benefits) of individual action which are not taken into account in deciding to take that action. For instance, the individual crude petroleum producer, pumping from a common pool, has no market incentive to take account of the increased cost imposed on others because of reduced gas pressure resulting from his own pumping. Also, because he cannot be sure that a unit of petroleum he does not exploit now will be available for his later use, acting individually he has no reason to conserve petroleum for later and possibly higher value use. Thus he has no incentive to take account of his user cost. The only limit to his current exploitation is current cost—not the opportunity cost of future returns. Consequently the resource will be exploited at an excessively rapid rate in the absence of some sort of collective action. While these problems were recognized with respect to such resources as petroleum, fisheries, and groundwater, and there was rather sophisticated theorizing with respect to them, still private property and exchange have been regarded as the keystones of an efficient allocation of resources.

To quote the famous welfare economist Pigou:

When it was urged above, that in certain industries a wrong amount of resources is being invested because the value of the marginal social net product there differs from the value of the marginal private net product, it was tacitly assumed that in the main body of industries these two values are equal.²

And Scitovsky, another important student of externalities, after having described his cases two and four, which deal with externalities affecting consumers and producers respectively, says:

The second case seems exceptional, because most instances of it can be and usually are eliminated by zoning ordinances and industrial regulations concerned with public health and safety.

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The fourth case seems unimportant, simply because examples of it seem to be few and exceptional.³

It is the main thesis of this book that at least one class of externalities—those associated with the disposal of residuals resulting from modern consumption and production activities-—must be viewed quite differently.⁴ In reality they are a normal, indeed inevitable, part of these processes. Their economic significance tends to increase as economic development proceeds, and the ability of the natural environment to receive and assimilate them is an important natural resource of rapidly increasing value.⁵ We suggest below that the common failure to recognize these facts in economic theory may result from viewing the production and consumption processes in a manner which is somewhat at variance with the fundamental physical law of conservation of mass.

Modern welfare economics concludes that if (1) preference orderings of consumers and production functions of producers are independent and their shapes appropriately constrained, (2) consumers maximize utility subject to given income and price parameters, and (3) producers maximize profits subject to these price parameters, then a set of prices exists such that no individual can become better off without making some other individual worse off. For a given distribution of income this is an efficient state. Given certain further assumptions concerning the structure of markets, this "Pareto optimum" can be achieved via a pricing mechanism and voluntary decentralized exchange.

If the capacity of the environment to assimilate residuals is scarce, the decentralized voluntary exchange process cannot be free of uncompensated technological external diseconomies unless (1) all inputs are fully converted into outputs, with no unwanted material and energy residuals along the way,⁶ and all final outputs are utterly destroyed in the process of consumption, or (2) property rights are so arranged that all relevant environmental attributes are in private ownership and these rights are exchanged in competitive markets. Neither of these conditions can be expected to hold in an actual economy, and they do not.

Nature does not permit the destruction of matter except by annihilation with antimatter, and the means of disposal of unwanted residuals which maximizes the internal return of decentralized decision units is by discharge to the environment, principally watercourses and the atmosphere. Water and air are traditionally examples of free goods in economics. But in reality in developed economies they are common property resources of great and increasing value, which present society with important and difficult allocation problems that exchange in private markets cannot solve. These problems loom larger as increased population and industrial production put more pressure on the environment's ability to dilute, chemically degrade, and simply accumulate residuals from production and consumption processes. Only the crudest estimates of present external costs associated with residuals discharge exist, but it would not be surprising if these costs were already in the tens of billions of dollars annually.⁷ Moreover, as we shall emphasize again, technological means for processing or purifying one or another type of residuals do not destroy the residuals but only alter their form. Thus, given the level, patterns, and technology of production and consumption, recycle of materials into productive uses or discharge into an alternative medium are the only general operations for protecting a particular environmental medium such as water. Residual problems must be seen in a broad regional or economy-wide context rather than as separate and isolated problems of disposal of gaseous, liquid, solid, and energy waste products.

Frank Knight perhaps provides a key to why these elementary facts have played so small a role in economic theorizing and empirical research.

The next heading to be mentioned ties up with the question of dimensions from another angle, and relates to the second main error mentioned earlier as connected with taking food and eating as the type of economic activity. The basic economic magnitude (value or utility) is service, not good. It is inherently a stream or flow in time... .⁸

Standard economic allocation theory is in truth concerned with services. Material objects are merely the vehicles which carry some of these services, and they are exchanged because of consumer preferences for the services associated with their use or because they can help to add value in the manufacturing process. Yet we persist in referring to the "final consumption" of goods as though material objects such as fuels, materials, and finished goods somehow disappear into a void—a practice which was comparatively harmless only so long as air and water were almost literally "free goods."⁹ Of course, residuals from both the production and consumption processes remain, and they usually render disservices (like killing fish, increasing the difficulty of water treatment, reducing public health, soiling and deteriorating buildings, etc.) rather than services. These disservices flow to consumers and producers whether they want them or not, and except in unusual cases they cannot control them by engaging in individual exchanges.¹⁰

The Flow of Materials

To elaborate on these points, we find it useful to view environmental pollution and its control from the perspective of a materials balance problem for the entire economy.¹¹ The inputs of the system are fuels, foods, and raw materials which are partly converted into final goods and partly become residuals. Except for increases in inventory, final goods also ultimately enter the residuals stream. Thus, goods which are "consumed" really only render certain services. Their material substance re...

Table of contents

• Cover
• Title
• Copyright
• Original Title
• Original Copyright
• PREFACE AND ACKNOWLEDGMENTS
• Contents
• CHAPTER I. PERSPECTIVE
• CHAPTER II. MATERIAL RESIDUALS FROM PRODUCTION AND CONSUMPTION
• CHAPTER III. RESIDUALS, GENERAL EQUILIBRIUM, AND WELFARE ECONOMICS
• CHAPTER IV. CONCLUSIONS, POLICY, RESEARCH
• SOURCES FOR CHARTS