Lecture # 12 - Sustainability and the Future

Traditional Approach

1. Sustainability - "maintain", "support", or "endure”

• Formal definition
  • Brundtland Commission of the United Nations: - “sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.”
  • Definition is vague
    • What are the future generation's needs?
    • What are the needs of the current generation?
  • UNESCO report: “…every generation should leave water, air, and soil resources as pure and unpolluted as when it came on earth.”
    • “each generation should leave undiminished all the species of animals it found existing on earth.”
    • This definition is extreme - implies we cannot use resources
      • Is this possible?
• Population growth
  • World's population is expected to 7 billion by 2012
  • More population uses more resources
    • Most population growth is in developing countries
    • Developing countries want the Western living standard
      • Example - China and India are poised to growth
  • Thus, humans are going to hit the carrying capacity of their environment
    • Carrying capacity - the maximum population possible given current resources
• Argue for Green GDP
  • GDP does not give a complete picture of the effect of the environment on the economy
    • It ignores the value of natural resources and impact of environmental damage
    • Desired solution - adjust GDP to account for natural resources
      • “Green GDP.”
  • Theory - a country cuts down its timber to sell to the international markets
    • Traditional GDP growth rate may be high at first.
    • Once forests are gone, then GDP growth rate is low.
    • Green GDP growth rate - would not change as forests are cut down.
      • The gain for selling the timber is offset by the loss of the forests.
  • China has begun to incorporate green GDP into its decision making.
    • Local officials focus on economic growth, and ignore environmental concerns.
  • Problem
    • How do you measure this?
    • Traditional GDP
      • For the whole society in one year, multiply market prices with market quantities for finished products and services and add all markets together.
    • Environmental damage does not have market prices
      • Nobody buys environmental damage
      • People pay to clean up environmental damage or people are negatively impacted by environmental damage
        • i.e. welfare measure
    • Natural resources like timber, fish, and petroleum
      • Have market prices
      • Quantities are not precisely known.
        • Uncertain how much is there.

Economics Approach

1. Solow's definition - “an obligation to conduct ourselves so that we leave the future the option or the capacity to be as well off as we are.”

• Sustainability is defined as the problem of ensuring future generations are no worse off than today’s generation
• This is called weak sustainability.
• Weak sustainability – any loss of natural capital should be balanced out by creation of new capital of at least equal value.
  • Assumes natural capital and man-made capital are substitutes.
• Sustainability economics is an equity issue and not an efficiency issue.
• Many neoclassical economists take this approach
  • Sustainability - future generations should have at least the same utility level as humans today
    • It implies their welfare is the same or possibly better
    • Consumption approach - nondeclining consumption
      • Future generations consume the same level of products and services
  • Herman Daly (Beyond Growth 1996)
    1. Renewable resources should provide a sustainable yield
       • The rate of harvest should not exceed the rate of regeneration
       • Fisheries - harvest rate is below the net birth rate
         • Thus, fish populations increase
    2. The rate of depletion for non-renewable resources should create the same rate of development of renewable substitutes
       • Example
       • Country extracts petroleum from the ground
         • Country creates two streams of money: Income and Investment
           • Society uses income stream for current consumption
           • Society uses the investment steam to invest in alternative technologies that are substitutes
             • i.e. Electric cars, ethanol for gasoline, and biodiesel for diesel fuel
    3. Degradable pollution levels  and waste generation should be set below the assimilative capacity of the environment
       • Assimilative capacity - the environment can absorb some wastes and pollution with no ill effects
         • Some pollution and waste naturally break down
       • Ensures pollution and waste levels decrease over time
       • Examples
         • Burial of household wastes and sulfur dioxide emissions from burning coal
    4. If pollution or waste does not degrade, then the emission should be set close to zero
       • Wastes - radioactive substances
       • Pollution - greenhouse gases

2. Ecological economists - the carrying capacity of the environment determines the limit to population growth.  

• Economics is driven by scarcity.
  • Market prices reflect scarcity
• As resources become more scarce, market prices increase for products that use the resource
• High market prices
  • Law of Demand - people lower their quantity demanded
    • i.e. people conserve more
  • Firms have an incentive to increase the supply of the resource
    • Firms take recycled materials, etc.
  • Spurs technological innovation
    • Firms get around scarcity by inventing new methods, technologies, etc.
• The economic measure of the resource is different from the physical measure.
  • The value of economic reserve will change over time.
• There are alternatives of measuring scarcity.
  1. Resource lifetime measure – economic reserve of a resource is divided by its annual consumption rate.
     • Measure ignores technology and rising prices.
  2. Measuring unit costs, because the least cost resource will be extracted first.
     • Example – when growing crops, the best land is used first.
       • The costs and price would have to rise in order for people to grow agriculture on less productive land.
       • Technology reduces costs.
       • There is uncertain knowledge, which reserve is the lowest costs.
       • Discovery of a new deposit.
       • Labor and capital may be reducing production costs, but energy is an input and it has been rising.
     • Costs are based on past experiences and are not forward looking.
  3. Real prices – Using Hotellling’s rule, resource prices tend to rise at the interest rate along an optimal depletion path until the price equals the price of a backstop resource.
     • Ignores the influence of cartels on the price.
     • Empirical studies indicate a U-shaped path for price.
     • Governments interfere in the resource markets, using price controls and other measures.
     • Ignores externality costs, resulting from the pollution damage of extraction or using the resource.
     • Which price deflator should be used?
  4. Economic rent – defined as the price minus marginal extraction costs
     • Rising rents are an indication of scarcity.
     • Empirical data are scarce, however, economists tried to use exploration costs.
     • Assumes firms are following their optimal depletion paths.

3. Discounting or present value -future costs and benefits are discounted in order to determine the equivalent present dollars

• Present value biases consumption towards the present, because the future receives less weight when discounted.
  • The idea is to compare a flow of benefits and costs into a single value.
• Lower discount rate shows a greater preference for future consumption.
  • A higher discount rate shows a greater preference for the present.
• Already shown this
  • Nuclear wastes cause $50 million in damage exactly in 200 years
  • If a discount rate of 10% is chosen,, a value of damage today is $0.10
  • If a discount rate of 1% is chosen, a value of damage today is $6.8 million
  • If a discount rate of 0% is chosen, the full value is $50 million now.
• Usually discount rate equals the interest rate
  • Some economists argue for a much lower discount rate, called the social discount rate
• Problems
  • Environmental resources and pollution can exist for generations.
    • Radioactive waste, CO2 accumulation, etc.
  • Economists are uncertain which discount rate to use, especially when environmental resources can have long time spans.
  • Economists can do sensitivity analysis and determine how much influence the discount rate has on the problem.

Will Sustainable Development Occur in Market Economies?

1. Examples where markets are beginning to appreciate the values provided by ecosystems

• Panama Canal - deforestation is harming the canal.
  
  • Fresh water supply has been drying up
    
  • Most freshwater is stored upstream in Gatún Lake
    • An artificial lake created during the canal’s construction
    • Lake accumulates from rainfall
      
  • Each time a ship travels through the canal, 52 million gallons of water is released into the ocean.
    
    • Deforested slopes around the lake do not absorb rainwater. 
      
    • Thus, rain runs into the lake too quickly, causing it to overflow and run into the sea.
      
    • If the land were forested, the water would be absorbed and would flow into the lake more slowly.
  • Most deforestation occurred since the 1950s, when a highway made the land accessible to loggers.
    
    • Rain water washes sediment and nutrients into the canal
      
    • Nutrients lead to growth of weeds
      
    • Leads to expensive dredging
      
  • Leading Panamanian bankers stopped financing cattle ranchers who cut down forests for pasture.
    
    • Some reductions in deforestation since the 1990s.
  • A private insurance firm, ForestRe, has stepped in with a proposal
    
    • The plan would have shipping companies that use the canal underwrite a 25 year bond to pay for reforestation.
      
    • These companies would ask their big clients, such as WalMart and the Asian auto companies, to buy the bonds.
      
    • These companies would get discounts on insurance premiums they currently pay to insure against closure of the canal.
      • Threat??? - Pay money or we close the canal???
        
• Catskill Mountains, NY
  
  • New York City gets its water from the Catskill Mountains watershed.
    
  • In 1997, the city faced building a water filtration plant to clean water from the watershed.
    
    • This had an up-front cost of $4-6 billion, plus $250 million/year operating costs.
      
  • Instead, the city made payments to preserve the Catskill watershed
    
    • Spent $250 million to buy land to prevent development
      
    • Spends $100 million/year to farmers to minimize pollution.
  • Did New York get cleaner water???
    
• Costa Rica
  
  • Hydro-electric producers, private customers, and the government contribute $57 million/year to protect a local watershed
    
  • Services provided
    
    • For hydro-electric producers:
      
    • Stream-flow regulation
      
    • Sediment retention
      
    • Erosion control
      
    • For private consumers
      
      • Irrigation
        
      • Government
        
      • Water supply for towns
        
      • Maintain scenic beauty for recreation and ecotourism
        

2. Pollution Haven Hypothesis - the idea that firms will move from countries with strong environmental standards to those with weaker standards.

• Does free trade make protecting the environment more difficult?
  
  • Developing countries may even be able to attract industry with low standards.
    
  • Three effects of economic growth on trade:
    
    • Higher incomes => cleaner production processes.
      
    • Higher incomes => preferences for cleaner goods.
      
    • Higher incomes => increased pollution due to greater consumption.
      
  • Which effect dominates is difficult to say.
    
• Empirical evidence of the pollution haven hypothesis is weak.
  • I believe it occurs
    
  • Many problems in econometrics
    
• Not all industries are mobile
  
  • Industries are mobile if:
    
    • Low transportation costs and proximity to markets
    • Skills of workers
    • Political stability
    • Availability of materials
      
    • Industries that are mobile are more sensitive to environmental costs

3. International Agreements

• The World Trade Organization (WTO) provides a framework of rules and procedures to encourage international trade
  • The General Agreement on Tariffs and Trade (GATT) was predecessor
    
  • Aims to reduce barriers of trade.
    
  • Does allow exceptions to protect “human, animal or plant life” and to conserve natural resources.
    
    • Such import restrictions must be done in a non-discriminatory way.
      
• Examples:
  
  • GATT upheld the US tax on luxury cars and gas guzzlers because they applied equally to all autos (Europe protested the taxes).
    
  • In the 1990’s, the U.S. banned imports of tuna caught in nets that kill dolphins.
    
    • Mexico complained to GATT & won.
      
    • GATT accepted America’s aim of protecting dolphins, but objected to the use of discriminatory trade sanctions.
      
    • Suggested labeling of dolphin-friendly tuna instead.
      
  • The issue becomes cloudier when we consider pollution from production.
    
    • Consider a firm in a country such as the U.S. that has strong environmental standards, but has a competitor in a nation with weak standards.
      
    • The competitor has lower costs, so it has an advantage.
      
    • However, it isn’t clear that the U.S. can do anything legally under GATT.
      
    • GATT gives the U.S. the authority to protect the health of its citizens.
      • However, imposing stronger environmental restrictions on the second country affects the health of those citizens, not Americans.
        
• A World Trade Organization (WTO) report in the fall of 1999 admitted that trade can harm the environment.