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10/03/2017 Slide 2.1 Slide 2.2 Introduction Natural resources and environmental services Definition and classification Environmental Economics Economy-environment interdependence Spring 2017 Economic analysis Artti Juutinen Efficiency Lecture 1: Introduction and Sustainability Optimality Lecture notes modified from Perman et al. Natural Resource and Environmental Economics (4th Ed.), Pearson Education Limited 2011 Sustainability Interdisciplinary approach: there is not a single methodology used by all economist Time dimension Slide 2.3 Slide 2.4 The origins of the sustainability problem CHAPTER 2 The origins of the sustainability problem 2.1 Economy–environment interdependence 2.2 The drivers of environmental impact 2.3 Poverty and inequality 2.4 Limits to growth? 2.5 The pursuit of sustainable development 1 10/03/2017 Slide 2.5 Slide 2.6 The economy in the environment Economy–environment interdependence The environment is a thermodynamically closed system, exchanging energy (but not matter) with its environment. Economic activity takes place within, and is part of, the system which is the earth and its atmosphere. This system we call ‘the natural environment’, or more briefly ‘the environment’. This system itself has an environment, which is the rest of the universe. The economy is located within the environment. The environment provides four functions to the economy 1. source of resource inputs 2. source of amenity services Economy 3. receptacle for wastes 4. provides life support services. These environmental functions interact with one another in various ways, and may be mutually exclusive. Environment There exist possibilities to substitute reproducible capital for ‘natural capital’. Solid lines represent flows between the environment and economy. Dashed lines represent possibilities of substitution for environmental services. Figure 2.1 Slide 2.7 Economic activity in the natural environment Slide 2.8 The economy in the environment The environment is a thermodynamically closed system, exchanging energy (but not matter) with its environment. Classification of natural resources Natural resources The economy is located within the environment. The environment provides four functions to the economy Stock resources Flow resources 1. source of resource inputs 2. source of amenity services Economy 3. receptacle for wastes 4. provides life support services. Environment Solid lines represent flows between the environment and economy. Dashed lines represent possibilities of substitution for environmental services. Figure 2.1 These environmental functions interact with one another in various ways, and may be mutually exclusive. There exist possibilities to substitute reproducible capital for ‘natural capital’. Renewable resources Nonrenewable resources Energy Mineral resources resources Economic activity in the natural environment 2 10/03/2017 Slide 2.9 Slide 2.10 Productive resource services Stock resources Natural resources used in production are of several types. One characteristic: does the resource exist as a stock or a flow? The difference lies in whether the level of current use affects future availability. Stock resources: a second standard distinction concerns the nature of the link between current use and future availability. Renewable resources are biotic populations – flora and fauna: have potential to grow by natural reproduction. Non-renewable resources are minerals, including the fossil fuels: no natural reproduction, except on geological timescales. Why it is important to distinct between renewable and non-renewable resources? Flow resources: no link between current use and future availability (e.g. solar radiation, wave and wind power). Stock resources: level of current use does affect future availability. Slide 2.11 Slide 2.12 Distinction between fossil fuels and the other minerals is important 1. The use of fossil fuels is pervasive in industrial economies, and is one of their essential distinguishing characteristics. 2. Fossil fuel combustion is an irreversible process in that there is no way in which the input fuel can be even partially recovered after combustion. – In so far as coal, oil and gas are used to produce heat, rather than as inputs to chemical processes, they cannot be recycled. – Minerals used as inputs to production can be recycled. This means that whereas in the case of minerals there exists the possibility of delaying, for a given use rate, the date of exhaustion of a given initial stock, in the case of fossil fuels there does not. Amenity services In Figure 2.1 amenity services flow directly from the environment to individuals. The biosphere provides humans with recreational facilities and other sources of pleasure and stimulation. In many cases the flow to individuals of amenity services does not directly involve any consumptive material flow. However, the flows of amenity services may sometimes impact physically on the natural environment (e.g. erosion). Amenity services are often non-marked goods 3. Third, fossil fuel combustion is a major source of a number of waste emissions, especially into the atmosphere, e.g. CO2. 3 10/03/2017 Slide 2.13 Slide 2.14 Basic life-support functions Waste sink Wastes = ‘pollution’ Residuals to be discharged into the natural environment (e.g. solid wastes, air and water pollution) Pollution problems can be conceptualizes as Pollution as a stock of material resident (negative value) in the natural environment A flow which affects negatively the natural environment Assimilative/absorptive capacity of the environment Cleaning/treatment technology (i.e. pollution control) Slide 2.15 The fourth environmental function, shown in Figure 2.1 as the heavy box, is difficult to represent in a simple and concise way. The biosphere currently provides the basic life-support functions for humans. While the range of environmental conditions that humans are biologically equipped to cope with is greater than for most other species, there are limits to the tolerable. We have, for example, quite specific requirements in terms of breathable air. The range of temperatures that we can exist in is wide in relation to conditions on earth, but narrow in relation to the range on other planets in the solar system. Humans have minimum requirements for water input. Slide 2.16 Interaction The interdependencies between economic activity and the environment are pervasive and complex. The complexity is increased by the existence of processes in the environment that mean that the four classes of environmental services each interact one with another. In Figure 2.1 this is indicated by having the three boxes intersect one with another, and jointly with the heavy black line representing the life-support function. Complex interaction Market mechanisms is used to allocate recourses. What about in this case? Function of ecosystem Natural variation Uncertainty Time lags Irreversibility Threshold level Waste 4 10/03/2017 Slide 2.17 Slide 2.18 Substituting for environmental services (Continued) Substituting for environmental services In Figure 2.1 there are also some dashed lines. These represent possibilities of substitutions for environmental services. Consider first recycling. Recycling substitutes for environmental functions in two ways. First, it reduces the demands made upon the waste sink function. Second, it reduces the demands made upon the resource base function, in so far as recycled materials are substituted for extractions from the environment. Slide 2.19 Also shown in Figure 2.1 are four dashed lines from the box for capital running to the three boxes and the heavy black line representing environmental functions. These lines are to represent possibilities for substituting the services of reproducible capital for environmental services. Some economists think of the environment in terms of assets that provide flows of services, and call the collectivity of environmental assets ‘natural capital’. In that terminology, the dashed lines refer to possibilities for substituting reproducible capital services for natural capital services. Slide 2.20 Other kinds of substitution possibilities The waste sink function consider again treatment of discharge of sewage into a river estuary – affects the demand made upon the assimilative capacity of the estuary is reduced for a given level of sewage. Capital in the form of a sewage treatment plant substitutes for the natural environmental function of waste sink to an extent dependent on the level of treatment that the plant provides. Energy conservation: substitution of capital for resource base functions. Amenity services: provision by physical capital may yield close substitutes in some dimensions (e.g. a swimming pool). It is often thought that in the context of the life support function substitution possibilities are most limited. From a purely technical point of view, it is not clear that this is the case. However, the quantity of human life that could be sustained in the absence of natural life-support functions would appear to be quite small. Other kinds of substitution possibilities • The waste sink function consider again – treatment of discharge of sewage into a river estuary – affects the demand made upon the assimilative capacity of the estuary is reduced for a given level of sewage. – Capital in the form of a sewage treatment plant substitutes for the natural environmental function of waste sink to an extent dependent on the level of treatment that the plant Manyprovides. scientist regard the possibilities of substitution for for resource base • Energy conservation: substitution of capital life supporting services as most functions. limited! • Amenity services: provision by physical capital may yield close substitutes in some dimensions (e.g. a swimming pool). • It is often thought that in the context of the life support function substitution possibilities are most limited. – From a purely technical point of view, it is not clear that this is the case. – However, the quantity of human life that could be sustained in the absence of natural life-support functions would appear to be quite small. 5 10/03/2017 Slide 2.21 Slide 2.22 Human capital Substitution between sub-components The possibilities for substituting for the services of natural capital have been discussed in terms of capital equipment. ‘Human capital’ may also be relevant; this forms the basis for technical change. However, while the accumulation of human capital is clearly of great importance in regard to environmental problems, in order for technical change to impact on economic activity, it generally requires embodiment in new equipment. Knowledge that could reduce the demands made upon environmental functions does not actually do so until it is incorporated into equipment that substitutes for environmental functions. In Figure 2.1, flows between the economy and the environment are shown as single lines. Each single line represents what is, in fact, a whole range of different flows. With respect to each of the aggregate flows shown in Figure 2.1, substitutions as between components of the flow are possible and affect the demands made upon environmental services. The implications of any given substitution may extend beyond the environmental function directly affected. Slide 2.23 For example, a switch from fossil fuel use to hydroelectric power reduces fossil fuel depletion and waste generation in fossil fuel combustion, and also impacts on the amenity service flow in so far as a natural recreation area is flooded. Slide 2.24 The materials balance principle Thermodynamics Open system exchanges energy and matter with its environment – an organism The materials balance principle is the term that economists often use to refer to the Law of Conservation of Mass, and its implications. This law says that matter can be neither created nor destroyed, just transformed from one state to another. Closed system exchanges only energy with its environment – planet earth Isolated system exchanges neither with its environment – the universe First Law – energy can be neither created nor destroyed. It can only be converted from one form (chemical as in coal, e.g.) to another (electricity). The environment Second Law – all energy conversions are in terms of available energy less than Environmental firms 100% efficient (not all of the energy in the coal becomes available as electricity). Implies that all energy conversions are irreversible. Non-environmental firms B+R+E ≡ R+A1+F Also known as the Entropy Law , which says that the entropy of an isolated system cannot decrease. Entropy is a measure of unavailable energy. Living systems are not subject to the second law as they are open systems. But it does apply to dead organisms. Given enough available energy, all transformations of matter are possible, at least in principle. As a practical matter, complete recycling is impossible however much energy is available. Households A materials balance model of economy–environment interactions A ≡ B+C+D A ≡A1+A2+C A2+E ≡ D+F Figure 2.2 Source: Adapted from Herfindahl & Kneese (1974) Economic activity essentially involves transforming matter extracted from the environment. Economic activity cannot, in a material sense, create anything. It involves transforming material extracted from the environment so that it is more valuable to humans. All material extracted from the environment must, eventually, be returned to it, albeit in a transformed state. 6 10/03/2017 Slide 2.25 Slide 2.26 Optimal growth with nonrenewable resource input Production function specification Qi = fi (Li , Ki ) Microeconomics Qi = fi (Li,Ki,Ri ) Resource economics Qi = fi (Li , Ki , Mi ) L= labour, K=capital Maximise t =∞ W = ∫ U(C )e dt R=some natural resource extracted from the environment − ρt t =0 Environmental economics Subject to & = Q(K , R ) − C K M=flow of waste arising from the ith firm’s activity t Qi = fi Li , Ki ,Mi , A∑Mi i with ambient pollution A S& = − R Concentration level depends on total of waste emission across all firms Qi = fi Li , Ki , Ri ,Mi [ Ri ] , A∑Mi i (3.21) t t t (3.22a) (3.22b) t t=∞ S = ∫ R dt emissions linked to resource use t=0 (3.22c) t Production must have a material base Slide 2.27 Slide 2.28 Sustainable development Sustainable development was put on political agendas in 1987 by Our Common Future, often referred to as The Brundtland Report after the chair of the World Commission on Environment and Development (WCED) which wrote it. ‘Environment and development are not separate challenges: they are inexorably linked. Development cannot subsist on a deteriorating environmental base; the environment cannot be protected when growth leaves out of account the costs of environmental protection.’ (p. 37) The report defines sustainable development as development that: seeks to meet the needs and aspirations of the present without compromising the ability to meet those of the future. (p. 43) Sustainability Sustainable use of non-renewable resources? Does not mean that we should conserve non-renewable resources for future generations Refers to generalized productive capacity or to certain standards of consumption/living Feasibility depends on the form of production function, that is, the associated possibilities for substituting human-made capital services for natural capital services Three pillars and the report states that: Ecological sustainability ‘Far from requiring the cessation of economic growth, it [sustainable development] recognizes that the problems of poverty and underdevelopment cannot be solved unless we have a new era of growth in which developing countries play a large role and reap large benefits.’ (p. 40) Economic sustainability Social sustainability 7 10/03/2017 Slide 2.29 Slide 2.30 Weak and strong sustainability Sustainability Sustainability is a constant level of consumption/utility indefinitely Are not different kinds of sustainability – both refer to constant consumption/utility. Is sustainability feasible when production uses a non-renewable resource input? The distinction is between assumptions about substitution possibilities. Q = αK + βR t t t For weak sustainability the assumption is that these possibilities are as for the Cobb Douglas production function so that sustainability is feasible via the substitution of K for R. YES, perfect substitutability For strong sustainability the assumption is that these possibilities are as for the Leontief production function. Q =K R More generally t α β t t with α + β = 1 Q = Q(L, KN, KH) For α>β, YES (Cobb Douglas CRS) Qt = min(αKt, βRt) where KN is natural capital, and KH is human-made, or reproducible, capital and the weak/strong sustainability distinction is in terms of the substitution possibilities between KN and KH. Proponents of strong sustainability argue that KN must be non-declining, while for proponents of weak sustainability it is KH + KN that must be non-declining. NO, non-substitutability (Leontief) Slide 2.31 Slide 2.32 Ecology Stability and resilience Ecology is the study of the distribution and abundance of plants and animals. Holling (1973, 1986; see also other definitions) Stability: a property attaching to the populations comprised by an ecosystem A fundamental concept – the ecosystem, an interacting set of plant and animal populations, together with their abiotic (non-living) environment. An ecosystem can be defined at various scales from the small and local – a pond or field – through to the large and global – the biosphere as a whole. Stability is the propensity of a population to return to some kind of equilibrium following a disturbance. Resilience: a property of the ecosystem Resilience is the propensity of an ecosystem to retain its functional and organisational structure following a disturbance. The fact that an ecosystem is resilient does not necessarily imply that all of its component populations are stable. It is possible for a disturbance to result in a population disappearing from an ecosystem, while the ecosystem as a whole continues to function in broadly the same way, so exhibiting resilience. 8 10/03/2017 Slide 2.33 Slide 2.34 Ecological footprints Wackernagel et al. (2002) Humanity's ecological footprint: the ecological impact of the human species. An ideal definition (Wackernagel and Rees, 1997) of a particular human economy's ecological footprint is: Report estimates of the size of the footprint for each of the years from 1961 to 1999, for the whole global economy. Consider the demands for land and water on account of “the aggregate area of land and water in various ecological categories that is claimed by participants in the economy to produce all the resources they consume, and to absorb all the wastes they generate on a continuing basis, using prevailing technology.” growing crops grazing domesticated animals harvesting timber fishing space for locating human artefacts such as houses, factories, roads, etc. sequestering the CO2 released in fossil-fuel combustion An ‘ideal’ definition because, to date, estimates of the size of ecological footprints have been based on just subsets of consumed resources and generated wastes, and are in that sense conservative estimates. The footprint size will vary with technology as well as with levels and patterns of production and consumption. Slide 2.35 Wackernagel et al. (2002) (Continued) In relation to the available amounts in the biosphere, they find that for all of humanity the ratio of the former demand to the latter supply increased from approximately 0.7 in 1961 to approximately 1.2 in 1999. They conclude that as presently constituted the global economy is not sustainable in that it would ‘require 1.2 earths, or one earth for 1.2 years, to regenerate what humanity used in 1999’. Slide 2.36 Other footprint statistics For 2003 the global human ecological footprint was 1.25 (from http://www.footprintnetwork.org/ May 2008). On a per capita basis the global average demand for biologically productive space in 2003 was 2.3 hectares. Other studies have estimated per capita footprints of 9.7 hectares for the USA, 5.4 for the UK and 4.7 for Germany. The implication is that if the developing world were to attain the consumption levels of the developed world, using current technology, the total footprint for the world would be the size of several earths. 9 10/03/2017 Slide 2.37 Slide 2.38 The Millennium Ecosystem Assessment (MEA) MEA conducted over 2001 to 2005, coordinated by the UNEP. Intended to assess the implications for human well-being of ecosystem change, and to establish the scientific basis for actions to enhance the conservation and sustainable use of ecosystems and their contribution to human well-being. Synthesised existing information, rather than seeking to generate new data. Available as books and for downloading from the MEA website: http://www.millenniumassessment.org/en/index.aspx. See also TEEB (The economics of ecosystem services and biodiversity) Slide 2.39 Four main findings of the MEA: 1. Over the past 50 years, humans have changed ecosystems more rapidly and more extensively than in any comparable period of human history, largely to meet rapidly growing demands for food, fresh water, timber, fibre and fuel. This has resulted in a substantial and largely irreversible loss in the diversity of life on earth. 2. The changes that have been made to ecosystems have contributed to substantial net gains in human well-being and economic development, but these gains have been achieved at growing cost in the form of the degradation of many ecosystem services, increased risk of non-linear changes, and the exacerbation of poverty for some groups of people. These problems, unless addressed, will substantially diminish the benefits that future generations obtain from ecosystems. 3. The degradation of ecosystem services could grow significantly worse during the first half of this century and is a barrier to achieving the Millennium Development Goals. 4. The challenge of reversing the degradation of ecosystems while meeting increasing demands for their services can be partially met under some scenarios that the MA has considered, but these involve significant changes in policies, institutions and practices that are not currently under way. Many options exist to conserve or enhance specific ecosystem services in ways that reduce negative trade-offs or that provide positive synergies with other ecosystem services. Slide 2.40 The drivers of environmental impact The environmental impact of economic activity can be looked at in terms of: extractions from the environment insertions into the environment. In either case, the immediate determinants of the total level of impact are: the size of the human population and the per capita impact. The per capita impact depends on: how much each individual consumes and the technology of production. The IPAT identity A simple but useful way to start thinking about what drives the sizes of the economy’s impacts on the environment. It can be formalised as the IPAT identity: I = P×A×T (2.6) I: impact, measured as mass or volume P: population size A: per capita affluence, in currency units T: technology, amount of the resource used or waste generated per unit production 10 10/03/2017 Slide 2.41 Slide 2.42 Affluence and technology: the Environmental Kuznets Curve (EKC) The IPAT identity (Continued) Measure impact in terms of mass Use GDP for national income. Then T is resource or waste per unit GDP. Then for the resource extraction case, we have: I ≡ P× GDP Resource Use × P GDP (2.6) World Development Report 1992, subtitled ‘Development and the environment’, noted that: ‘The view that greater economic activity inevitably hurts the environment is based on static assumptions about technology, tastes and environmental investments’. Label the per capita emissions of some pollutant into the environment as e , and per capita income as y. Then the view that is being referred to can be represented as e =α y A T (2.7) so that e increases linearly with y, as shown in Figure 2.8(a). Slide 2.43 Slide 2.44 The EKC hypothesis The EKC e =α y It has been hypothesised that a relationship like that shown in Figure 2.8(b) holds for many forms of environmental degradation. plus α = β 0 − β1 y gives e = β 0 y − β1 y 2 Figure 2.8 Environmental impact and income Source: Adapted from Common (1996) Such a relationship is called an ‘environmental Kuznets curve’ (EKC). If the EKC hypothesis held generally, it would imply that instead of being a threat to the environment as is often argued, economic growth is the means to environmental improvement. That is, as countries develop economically, moving from lower to higher levels of per capita income, overall levels of environmental degradation will eventually fall. EKC – Environmental Kuznets Curve 11 10/03/2017 Slide 2.45 Slide 2.46 Empirical status of the EKC hypothesis If economic growth is generally good for the environment, then it would seem that there is no need to curtail growth in the world economy in order to protect the global environment. In recent years, there have been a number of studies using econometric techniques to test the EKC hypothesis. Two key questions: 1. Are the data generally consistent with the EKC hypothesis? 2. If the EKC hypothesis holds, does the implication that growth is good for the global environment follow? Evidence: Summary There is now an extensive literature investigating the empirical status of the EKC hypothesis. Some economists take the results in the literature as supporting the EKC for local and regional impacts, such as sulphur for example, but not for global impacts, such as carbon dioxide for example. However, Stern and Common (2001) present results that are not consistent with the existence of an EKC for sulphur. The EKC hypothesis may hold for some environmental impacts, but it does not hold for all. Slide 2.47 Slide 2.48 Implications of the EKC Confirming an inverted U in per capita terms does not necessarily imply that future growth means lower environmental impact. Figure 2.10 An EKC for SO2 Source: Adapted from Panayotou (1993) Some evidence from the EKC. Estimates are based on cross-country regression analysis of data from the 1980s Figure 2.9 Later econometric work has cast doubt on the existence of an EKC for sulphur. Stern et al. (1996) projected economic growth and population growth for every country with a population in excess of 1 million. They then used the relationship in Figure 2.10 to compute each country’s SO2 emissions from 1990 to 2025, and added across countries – global emissions grew from 383 million tonnes in 1990 to 1181 million tonnes in 2025. Arrow et al. (1995) concluded that: ‘Economic growth is not a panacea for environmental quality.....policies that promote gross national product growth are not substitutes for environmental policy’. Source: Adapted from World Bank (1992) 12