Is the Environment a Luxury?

Silvia Tiezzi, Chiara Martini, Silvia Tiezzi, Chiara Martini

• Publisher: Routledge
• Year: 2014
• ISBN:
  9781317820338
• Edition: 1
• Topic: Negocios y empresa
• Subtopic: Negocios en general

The purpose of this collection of essays is to shed some light on the complex relationship between environmental quality and the distribution of income. Are the preferences of the poor towards a cleaner environment really different from those of the rich?

Environmental economists have traditionally focused on efficiency issues. In their analyses the quality of the environment is usually related to aggregate or average variables, like per capita income; policy recommendations are usually formulated considering efficiency with no regard for equity and also the predicted effects of policies are evaluated in aggregate terms.

The essays collected in this volume go into the problem of the relationship between environmental quality and income distribution. The book's opening essay shows how different theories of economic growth and environmental quality seem to suggest that the higher the level of income the higher is the value of environmental protection. The essays that follow, a mix of already published papers and of papers solicited for this book, analyse the relationship between environmental quality and income distribution from different perspectives (both micro and macro) and on the basis of more than one methodology.

This book highlights that the preferences of the poor towards a cleaner environment may differ from those of the rich, but income is also very likely to represent only one factor affecting them. The essays consider other relevant factors affecting preferences for environmental quality. What clearly emerges is that the distribution of costs and benefits of environmental policies is the key for their successful implementation, and that further research is needed to both address the distributional effects themselves and the strategies to mitigate them.

1 Introduction

Chiara Martini and Silvia Tiezzi

What this book is about

The relationship between environmental quality and income is at the very foundation of the environmental sustainability versus economic growth divide. An inverted “U” finding linking pollution and economic growth seems to offer evidence that the net benefits of environmental regulation increase at higher income levels, implying that they are progressively distributed. In fact such a pattern is consistent with different theories linking economic growth and environmental quality and each of them has different implications for the pattern of people’s Marginal Willingness to Pay (MWTP) for improvements in environmental quality. Moreover, the empirical relationship between income and MWTP may differ in different countries and may not conform to the predictions of the theory (Israel and Levinson, 2004). In particular, it is not clear whether in low-income countries MWTP is initially low and then increases until a switch point is reached. This is crucial because the MWTP for improvements in environmental quality identifies the reservation value people attach to environmental improvements, i.e. it is a money measure of the benefits people experience from environmental policies. What these different theories seem to have in common is the idea that the poor and the wealthy assign different priority to environmental protection: the proposed construction of new buildings on the Sardinian coasts could produce cries from middle- and upper-income inhabitants, who might perceive the associated loss of natural resources as a welfare loss, and yet it could be welcomed as a source of new jobs at a time of high unemployment rates by individuals in lower-income brackets. This is a controversial and important issue which calls for further investigation and suggests that any Cost-Benefit Analysis (CBA) should carefully consider not only the absolute level of the costs and benefits of environmental protection, but also the distribution of both the costs and the benefits of environmental policies (Johansson-Stenman, 2005). While the distributional impact of costs is fairly straightforward to assess using standard economic analysis, because market policies often translate into higher prices for households and firms, assessing the distributional impact of benefits poses additional challenges, as they are usually not traded in markets. This is probably the reason why the literature on benefits distribution is much less developed than that on the distribution of costs (Kristrom, 2006). Yet, any sound CBA of environmental policies should take both aspects into account.

Even though CBA constitutes a direct link from economic analysis to recommendations for political decision makers, one of the most important problems with it is the practice of focusing solely on efficiency, by simply comparing aggregate maximum willingness to pay (WTP) figures with costs. In fact, for the political debate, distributional issues, especially concerning environmental issues, are often extremely important. Distributional issues are at the core of debates over reforms that will affect other countries or generations where identifying potential winners or losers, and in particular how environmental policies’ net benefits and costs will be distributed by income levels, is important (Tol, 2001; Narita et al., 2010). By ignoring the redistributive effects of an environmental policy, we may either unintentionally harm certain groups in society or, alternatively, undermine the program politically (Johansson-Stenman and Konow, 2010).

Distributional issues are also crucial in the context of international climate negotiations: Tol (2001) shows how the adoption of different criteria when defining emission reduction commitments implies different results, in terms of both efficiency and equity (respectively, total emissions and inequity level). Narita et al. (2010) highlight that burden sharing in international climate treaties does not account for international equity: the EU proposal for a post-Kyoto treaty appears generous in monetary terms, but not so in utility terms. More generally, fairness perceptions by individuals about alternative environmental policy instruments may be particularly important to reach a consensus on environmental policy and in international negotiations (Johansson-Stenman and Konow, 2010).

The purpose of this collection of essays is to shed some light on the complex relationship between environmental quality and the distribution of income. Are the preferences of the poor towards a cleaner environment really different from those of the rich?

The main aim of any environmental policy measure is to reduce environmental damages caused by production and consumption activities or, stated differently, to increase social welfare. Depending upon the distribution of benefits, environmental policies may favor the rich, in the sense that net benefits are larger for individuals with high incomes than for those with lower incomes. Environmental benefits, expressed as a fraction of income, are progressively distributed when they rise with income. In this case they are considered pro-rich. They are, instead, regressively distributed, and considered pro-poor, when they fall with income. The opposite is true for environmental costs, which are pro-rich when they are regressively distributed and pro-poor when their distribution is progressive.

The degree of progressiveness of environmental benefits may limit a policy’s political appeal, because further implementation of environmental policies may result in a redistribution against lower-income groups. In contrast, the case for government intervention is strengthened in situations where net benefits are positive and large across income groups. Correctly measuring the incidence of environmental benefits, besides costs, is therefore crucial for policy purposes.

Since the quantity demanded of most environmental goods is rationed, the relevant parameter is not the income elasticity of demand but the income elasticity of willingness to pay (WTP) for a fixed quantity of the public good. When the income elasticity of WTP is considered, the literature has produced evidence of a value consistently smaller than one (Kristrom and Riera, 1996), which argues against the idea that the environment is a luxury and that the growing concern with environmental protection is an “upper-class” movement (Harry, Gale and Hendee, 1969).

Finding an income elasticity of WTP for environmental benefits less than one has striking policy implications. First, growth in income and in environmental quality could be decoupled, as higher-income groups would not show a higher willingness to pay for environmental quality than lower-income groups do (Martini and Tiezzi, 2013). Second, CBA of environmental projects would also be affected, because ignoring the real incidence of social projects may produce decisions that are “biased” against the poor. Therefore, finding that environmental benefits are regressively distributed suggests using appropriate weights that take into account the distribution of costs and benefits (Johansson-Stenman, 2005). Third, the income elasticity of environmental benefits is important for shaping efficient environmental policies. In international agreements for curbing carbon dioxide emissions, poorer countries should be allocated larger shares of the total number of emissions’ rights at an efficient allocation, if the income elasticity of WTP is between zero and one (Chichilnisky and Heal, 1994). Finally, recent research (Cai, Cameron and Gerdes, 2010) empirically demonstrates that the distributional consequences of alternative environmental policies can have strongly significant effects on individuals’ WTP, meaning that it may not be possible to adequately design an efficient policy measure without taking its distributional consequences into account.

One issue that clearly emerges from this book is that information on the distributional effects of costs is much larger and more detailed than information on the distributional effects of benefits of environmental policies. This makes the evaluation of the distribution of the net benefits of environmental policies more difficult. The book’s opening essay shows how different theories of economic growth and environmental quality do not offer precise predictions on the distribution of the benefits of environmental protection, but they seem only to suggest that the higher the level of income, the higher is the value of environmental protection. The chapters that follow, a mix of already published papers and of papers solicited for this book, analyze the complex issue of benefits and costs distribution in more details.

The distributional incidence of the costs of environmental policies can be analyzed with partial equilibrium analysis focusing on households or firms, or with general equilibrium analysis considering the entire economy. This book considers carbon/energy taxes as one prominent example of environmental policy and discusses their distributional effects from a variety of methodological standpoints. Carbon/energy taxes can increase firms’ net output prices in carbon-supplying industries and raise costs in industries that intensively employ fossil fuels as inputs. They can also produce two types of disparities in households’ welfare: the first is due to a change in environmental quality, the second is linked to the distribution of financial effects, such as direct or indirect compliance costs (Tiezzi, 2005; Verde and Tol, 2009; Martini, 2010). The overall distributive incidence of environmental policies also includes more indirect effects on public finance, labor markets and international trade, which can be best analyzed adopting a general equilibrium approach.

Our answer to the opening question is that the preferences of the poor towards a cleaner environment may differ from those of the rich, but income is also very likely to represent only one factor affecting them. Other relevant factors affecting preferences for environmental quality could be the age and education of households’ members, the production structure and competitiveness profile of firms, and the vulnerability of countries to specific environmental damages. What clearly emerges is that the distribution of costs and benefits is key to the successful implementation of environmental policies, and that further research is needed to address both the distributional effects themselves and the strategies to mitigate them.

What the chapters are about

The book is divided into four parts. The first part considers the environmental quality/income distribution nexus from a macroeconomic viewpoint. Chapter 1 by Debra Israel and Arik Levinson, “Willingness to pay for environmental quality: testable empirical implications of the growth and environment literature,” is a streamlined version of a paper published in 2004 on the Contributions Tier of the BEJEAP. This contribution shows very clearly how the macroeconomic theories linking economic growth and environmental quality are connected to the microeconomic theories on individual preferences and then to WTP. The empirical analysis performed by the authors represents a very valuable example of this connection. The different theories examined all imply an inverse “U” relationship between per capita income and pollution, but offer a different explanation for it and imply a different pattern of individual MWTP. The “technological constraint” hypothesis implies that poor countries will always trade worse environmental quality for more income. In the alternative “institutional constraints” explanation, poor countries cannot afford the fixed costs of developing environmental protection agencies until their economies grow. Finally, in the “returns to scale” explanation, as countries become richer abatement becomes cheaper. The authors then empirically explore the relationship between national income and MWTP using the World Values Surveys. A strong relationship is found between MWTP and individual characteristics, such as age, income, and education, but little evidence that MWTP varies systematically with economic growth. We are left with no clue as to which theory is consistent with the observed patterns of MWTP and economic growth. This suggests that more empirical research is needed to explore the link between MWTP and national income.

Chapter 3, by David Anthoff and Richard Tol, uses the integrated assessment model FUND to compute the income elasticity of climate change total impact for different world regions over time. This macroeconomic approach allows us to consider a wide range of both beneficial and harmful impacts, in developed and developing countries. Limited support is found for the Schelling Conjecture that development might be the best defense against climate change impacts, and for the Sterner Conjecture that the impacts from climate change might be akin to a “luxury good.” By contrast, no support is obtained for the Weitzman Conjecture that impacts are independent of development. Impacts are highly heterogeneous across time and space. A very important factor is considering the country-specific relevance of environmental damages. For very poor societies, a strong confirmation of the Schelling Conjecture is obtained, since harmful health impacts initially prevail and then rapidly disappear as societies get richer. This seems to be an area for future research: if some regions stay poor throughout the century, it is highly likely that even small increases in wealth might be the best way to lower the harmful impacts from climate change. For wealthier regions, climate impacts show characteristics of a “luxury good” in the medium term, consistently with the Sterner Conjecture. This effect disappears in the long run as the composition of damages changes.

The second part deals with the distributional incidence of the benefits of environmental improvements, with specific emphasis on the role of the income elasticity of demand for environmental quality and of demand drivers different from income. This part includes chapters by Udo Ebert, “Environmental goods and the distribution of income,” and Chiara Martini and Silvia Tiezzi, “How much do we care about air quality improvements? Evidence from Italian households.” Chapter 4 by Udo Ebert, reprinted in this book, is a milestone in this literature and aims at presenting a thorough theoretical investigation of the benefits from environmental commodities and of their effect on the income distribution. This chapter also clarifies the theoretical linkages between demand theory, as used in Chapter 5, and incidence parameters such as the income elasticity of demand and the income elasticity of the WTP for environmental quality. The magnitude of the income elasticity of MWTP for an environmental good turns out to be the crucial variable determining progressivity of benefits. The author points out that even normality of an environmental good does not necessarily imply that the income elasticity of MWTP is positive. For this reason, benefits incidence should be examined empirically. Furthermore, if the assumption of equal preferences is dropped, individual characteristics other than income influence consumers’ choices. Consistently with other empirical studies included in this volume (Israel and Levinson, Chapter 1; Martini, Chapter 6), Chapter 5 by Chiara Martini and Silvia Tiezzi empirically confirms the relevance of demand drivers different from income.

In Chapter 5, WTP for air quality improvements is estimated using a novel approach (Ebert, 2007) and a unique dataset, obtained by merging data on Italian households’ monthly current expenditure and unique information on a bundle of air pollutants’ concentrations. WTP is found to vary by geographical location, the level of air quality, and over time, maybe signaling a change of preferences. Higher WTP values are observed for the Northwest and the Centre, the macro-regions where the big metropolitan areas are located; WTP for air quality is declining as the level of air quality improves, and also shows a negative time trend, confirming results obtained from other studies (Noonan, 2011).

The environmental benefits associated with environmental policies may be counteracted by the adverse consequences of such policies on specific income groups. Such consequences may be the main obstacle to implementing environmental reforms, complicating their political acceptability. Part III of the book deals with the distributional incidence of the costs of environmental policies, with particular reference to the case of carbon/energy taxes. It includes three chapters reviewing the literature on the distributional incidence of carbon taxes on households (Chapter 6, by Martini), on firms (Chapter 7, by Bardazzi and Pazienza), and on the whole economy in a specific country (Chapter 8, by Stefano Verde). The first and second chapters provide a useful methodological synthesis of the different approaches available for investigating costs distribution at household and firm level respectively. Chiara Martini’s chapter is focused the distributional implications of Environmental Tax Reforms (ETR), especially for low- and middle-income households which may be disproportionately...