Cost Benefit Analysis

                                                         Comments due Oct. 7, 2018

The notion that a zero pollution objective is not necessarily ideal policy is one of the more difficult concepts for environmental economists to convey.  After all, if pollution is bad shouldn’t we design policy to completely eliminate it?  Many of us are drawn to the field based on a genuine concern for the environment and the belief that economics provides a powerful tool for helping solve environmental problems.  Yet we are often in the position of recommending policies that appear on the surface to be anti-environmental.  How can these observations be reconciled?  The answer lies in understanding scarcity:  we have unlimited wants, but live in a world with limited means.  Economists in general study how people make decisions when faced with scarcity.  Scarcity implies that resources devoted to one end are not available to meet another; hence there is an opportunity cost of any action.  This includes environmental policy.  For example, funds used by a municipality to retrofit its water treatment plant to remove trace amounts of arsenic (a carcinogen) cannot also be used to improve local primary education. Environmental economists are tasked with recommending policies that reflect scarcity of this type at the society level.  For both individuals and societies scarcity necessitates tradeoffs, and the reality of tradeoffs can make the complete elimination of pollution undesirable.  Once this is acknowledged the pertinent question becomes how much pollution should be eliminated.  How should we decide?  Who gets to decide?  To help provide answers economists use an analytical tool called cost-benefit analysis. 

Cost-benefit analysis provides an organizational framework for identifying, quantifying, and comparing the costs and benefits (measured in dollars) of a proposed policy action.  The final decision is informed (though not necessarily determined) by a comparison of the total costs and benefits.  While this sounds logical enough, cost-benefit analysis has been cause for substantial debate when used in the environmental arena (see the online debate between Lisa Heinzerling, Frank Ackerman, and Kerry Smith).  The benefits of environmental regulations can include, for example, reduced human and wildlife mortality, improved water quality, species preservation, and better recreation opportunities.  The costs are usually reflected in higher prices for consumer goods and/or higher taxes.  The latter are market effects readily measured in dollars, while the former are nonmarket effects for which dollar values are not available.  In addition to complicating the practice of cost-benefit analysis (dollar values for the nonmarket effects must be inferred rather than directly observed) this raises ethical issues.  Should we assign dollar values to undisturbed natural places?  To human lives saved?  To the existence of blue whales and grey wolves?  If we decide such things are too ‘priceless’ to assign dollar values we lose the ability to use cost-benefit analysis to inform the decision.  What then is the alternative?  How do we decide?  Who gets to decide?

Environmental economists tend to favor cost-benefit analysis in the policy arena because of the discipline and transparency it provides in evaluating policy options.  It is easy to evaluate absolutes.  Most would agree that reducing nitrogen contamination of groundwater wells, limiting the occurrence of code red ozone alerts, and preserving habitat for grizzly bears are worthy goals.  Determining the relative merits of any one of these compared to the others, or compared to non-environmental goals such as improving public education, is much more daunting.  Because policy making is ultimately about evaluating the relative merits of different actions some mechanism is needed to rank the alternatives.  Without the discipline of cost-benefit analysis it is not clear how the interests, claims, and opinions of parties affected by a proposed regulation can be examined and compared.  Criterion such as ‘moral’ or ‘fair’ do not lend themselves well to comparison and are subject to wide ranging interpretation.  Who gets to decide what is moral or fair?  Cost-benefit analysis is far from perfect, but it demands a level of objectivity and specificity that are necessary components of good decision making.

To begin this post I described an apparent contradiction:  environmental economists who consider themselves ‘environmentalists’ will on occasion recommend environmental regulations that do not seek to completely eliminate pollution.  Hopefully it is now clear that this is really not a contradiction.  Environmentalists come in many forms, including activists, lobbyists, spokesmen, natural scientists, and even economists.  Economics provides a structured framework for evaluating outcomes absent hype and advocacy.  Cost-benefit analysis is a part of this.  By using the tools of their field environmental economists can contribute unbiased information that can lead to better policy decisions, and ultimately better environmental outcomes. (The Cromulent)

Paradigm Shifts are very difficult to Achieve

Comments due Sept. 30, 2018

(The following is an essential read if one is to understand the difficulties encountered by those who believe in sustainability, ecologism and "ecological economics") 

Do you see a duck or a rabbit?  

Modern economics starts by making assumptions which are dramatically in conflict with everything we know about human behavior (and firm behavior) and applies mathematical reasoning to situations where it cannot be applied, quantifying the unquantifiable and coming to completely absurd and ridiculous conclusions. Nonetheless the brainwashing is powerful and effective. It is a slow and painful process to undo.

Despite widespread dis-satisfaction, the vast majority of dissidents argue that no paradigm shift is required. Instead of a complete overhaul, we just need to patch-up the problem areas. In contrast to this reformation, I would like to argue for a revolution. We need to re-think the whole project of economics from scratch. Just like modern astronomy was created by rejecting the concept of the heavenly spheres on which the stars rotated around the earth, so creating a viable economics for the 21st century requires rejecting the entire edifice of modern economics.

In “The Structure of Scientific Revolutions”, historical studies by Kuhn show that there are two distinct phases in the progress of scientific knowledge. In the phase he calls “normal science”, a fixed paradigm is applied to solve problems of explaining phenomena and manipulating the world via experiments. However, sometimes progress in knowledge occurs through a second type of event called “scientific revolution”, when an existing paradigm is overthrown, and replaced by a new and different paradigm. Paradigms represent ways of looking at the world, with frameworks, concepts, axioms, and methods. Different paradigms are incommensurable – terms in one paradigm are meaningless in another. One cannot achieve paradigm shifts by arguments, since concepts and terms of a new paradigm make no sense in terms of the old paradigm. Instead, what is required is to put aside one way of looking at the world, and attempt to understand another way of looking at the same world. It is this putting aside – unlearning the old ways – which creates the greater part of the difficulty in achieving paradigm shifts. As Keynes put it, “The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.” It is only by laying aside one coherent way of looking at the world that it becomes possible to visualize alternatives.

This discussion can be summarized metaphorically by saying that we all use glasses to see the world. The direct world out there is a jumble of sensations – a matrix of points – which makes no sense by itself, and must be interpreted using our own frameworks, represented by the glasses. This means that ALL observations are tinged with subjectivity, and interpreted within the frameworks created by our past experiences, successes and failures, in viewing the world. A paradigm shift occurs if we remove the glasses we use to view the world, and instead put on a different pair of glasses. A famous experiment conducted by Professor Theodor Erismann, of the University of Innsbruck put reversing glasses on his student and assistant Ivo Kohler. It caused extreme disorientation and discomfort at first, but after about a week of stumbling around, he adapted to this new way of seeing the world. His subjective interpretative equipment learned to interpret the reversed image by performing an additional reversal within the brain to arrive at a correct image of the world. Now, when the glasses were removed, the world appeared to be upside down to Ivo. On a much larger scale, this is what happened in Europe due to the Great Transformation which transformed traditional society to a market society, where everything is viewed a commodity for sale. Later, these ways of thinking were spread throughout the world by colonization and Western education. We learned to value everything according to its market price, and forgot that the most precious things cannot be purchased.

We can now understand the extreme difficulty of creating a paradigm shift. For those who have spent lifetimes learning to see the world with a specific pair of glasses, these glasses become melded into the flesh, and are impossible to remove. After failing to convince his contemporaries about his Quantum theory, Max Planck disappointedly realized that science progresses one funeral at a time. Thomas Kuhn also noted that paradigm shifts do not occur by converting those faithful to the old paradigm, but by inducting the young into the new worldview. Unlike the older generation, for younger and more flexible minds, it is possible to take off glasses manufactured in the Euclidean factory, and put on non-Euclidean glasses. Nonetheless, it is still a disconcerting and uncomfortable experience, which will not be undertaken unless there is some expectation of a great reward for this struggle and sacrifice. The costs of paradigm shift must be paid upfront – one loses the ability to talk to the mainstream when one describes the world using an alien framework. The rewards are in the future, and highly speculative and uncertain. Nonetheless, for reasons explained elsewhere, 8 it seems essential to make the effort – the survival of humanity is at stake.

Externalities: A Primer

                                                Comments due by September 23, 2018

Externalities are unintentional side effects of an activity affecting people other than those directly involved in the activity. A negative externality is one that creates side effects that could be harmful to either the general public directly or through the environment. An example would be a factory that pollutes as a result of its production process. This pollution may pose health risks for nearby residents or degrade the quality of the air or water. Either way, the owner of the factory does not directly pay the additional cost to address any health issues or to help maintain the cleanliness of the air or water. In some cases, however, the harmed parties can use legal measures to receive compensation for damages.

A positive externality, on the other hand, is an unpaid benefit that extends beyond those directly initiating the activity. One example would be a neighborhood resident who creates a private garden, the aesthetic beauty of which benefits other people in the community. Also, when a group voluntarily chooses to create a benefit, such as a community park, others may benefit without contributing to the project. Any individuals or groups that gain additional benefits without contributing are known as “free riders“.

Traditionally, both negative and positive externalities are considered to be forms of market failure – when a free market does not allocate resources efficiently. Arthur Pigou, a British economist best known for his work in welfare economics, argued that the existence of externalities justified government intervention through legislation or regulation. Pigou supported taxes to discourage activities that created harmful effects and subsidies for those creating benefits to further encourage those activities. These are now known as Pigovian taxes and subsidies.

Many economists believe that placing Pigovian taxes on pollution is a much more efficient way of dealing with pollution as an externality than government-imposed regulatory standards. Taxes leave the decision of how to deal with pollution to individual sources by assessing a fee or “tax” on the amount of pollution that is generated. Therefore, in theory, a source that is looking to maximize its profit will reduce, or control, their pollution emissions whenever it is cheaper to do so.

Other economists believe that the most efficient solution to externalities is to include them in the cost for those engaged in the activity. Thus, the externality is “internalized.” Under this framework, externalities are not necessarily market failures, which weakens the case for government intervention. Many externalities (pollution, free rider benefits) can be internalized through the creation of well-defined property rights. Through much of his work, economist Ronald Coase showed that taxes and subsidies were typically not necessary as long as the parties involved could strike a voluntary bargain. According to Coase’s theorem, it does not matter who has ownership, so long as property rights exist and free trade is possible.

Two methods of controlling negative externalities loosely related to property rights include cap and trade and individual transferable quotas (ITQs). The cap and trade approach sets a maximum amount of emissions for a group of sources over a specific time period. The various sources are then given emissions allowances which can be traded, bought or sold, or banked for future use, but – over the course of the specified period of time – overall emissions will not exceed the amount of the cap and may even decline. Therefore, individual sources, or facilities, can determine their level of production and/or the application of pollution reduction technologies or the purchase of additional allowances.

Individual transferable quotas (ITQs) are a market-based solution often associated with fisheries management. Regulators first determine a total annual catch that will preserve the health of the ecosystem, and then it is divided into individual quotas to prevent overfishing. Each ITQ allows for a certain amount of fish to be caught in any given year and they are transferable, which allows fishing vessel owners to buy and sell their quotas depending on how much they want to catch. The goal is to create a commercial fishing industry that is both more stable and profitable.

The options for dealing with externalities – positive or negative – are numerous, and often depend on the type of externality. The key is to identify the particular tool or policy alternative that will best move the market toward the most efficient allocation of resource

Earth Overshoot Day

                                         Comments due by Sept 15, 2018

Experts widely agree that human activities are harming the global environment. Since the Industrial Revolution, the world economy has grown dramatically. Overall this is a success story, since rising incomes have lifted millions of people out of poverty. But it has been fueled by population growth and increasing consumption of natural resources.

Rising demand to meet the needs of more than 7 billion people has transformed land use and generated unprecedented levels of pollution, affecting biodiversity, forests, wetlands, water bodies, soils and air quality.

On Aug. 1, humans will have consumed more natural resources in 2018 than the Earth can regenerate this year, according to the California-based Global Footprint Network. This environmental nonprofit calculates the annual arrival of Earth Overshoot Day – the date when humanity’s demands on nature exceed what the network’s analysts estimate the Earth can regenerate over the entire year. Aug. 1 is the earliest date since ecological overshoot began in the early 1970s.

Aug. 1 is the earliest arrival of Earth Overshoot Day since humans started overusing the planet’s resources in the 1970s.Global Footprint Network, CC BY-SA

As an ecological economist and scholar of sustainability, I am particularly interested in metrics and indicators that can help us understand human uses of Earth’s ecosystems. Better measurements of the impacts of human activities can help identify ways to sustain both human well-being and natural resources.

Earth Overshoot Day is a compelling concept and has raised awareness of the growing impact of human activities on the planet. Unfortunately, the methodology used to calculate it and the ecological footprint on which it is based is conceptually flawed and practically unusable in any science or policy context. In my view, the ecological footprint ultimately does not measure overuse of natural resources – and it may very well underestimate it.

Rising demands, finite resources

The Global Footprint Network estimates when Earth Overshoot Day will arrive based on its National Footprint Accounts. These include extensive data sets that the organization uses to calculate two overarching indicators:

• The ecological footprint, perhaps the most commonly used metric of the environmental impacts of human resource use. Each country’s ecological footprint is an estimate of the biological resources required to meet its population’s consumption demands and absorb its carbon emissions.
• National biocapacity, which is an estimate of how well each country’s ecosystems can produce the natural resources consumed by humans and absorb the waste and pollution that humans generate.

The Global Footprint Network’s National Footprint Accounts compare countries’ annual demand for goods and services to the resources they produce.

Both of these measures are expressed in global hectares. One hectare is equal to 10,000 square meters, or about 2.47 acres.

Going into overshoot

To estimate when Earth Overshoot Day will arrive, the Global Footprint Network calculates the number of days in a given year for which Earth has enough biocapacity to provide for humans’ total ecological footprint. The rest of the year represents “global overshoot.”

When the footprint of consumption worldwide exceeds biocapacity, the authors assert that humans are exceeding the regenerative capacity of Earth’s ecosystems. This year, they estimate that humans are using natural resources 1.7 times faster than ecosystems can regenerate – or, put another way, consuming 1.7 Earths.

As an example, the ecological footprint for France is 4.7 global hectares per person, and global biocapacity is 1.7 hectares per person. Therefore, it would take (4.7/ 1.7 =) 2.8 Earths if everyone lived like the French.

France’s Overshoot Day would be estimated as (365 x (1.7/ 4.7)) = 130, or the 130th day of the year, which is May 5 based on 2014 data. The United States reached overshoot even earlier, on March 15.

What to count?

However, there are some fundamental and misleading shortcomings in these calculations. In a 2013 paper, six authors from academia, The Nature Conservancy and the California-based Breakthrough Instituteanalyzed how the Ecological Footprint falls short. In their view, it primarily measures humans’ carbon footprint but does not address other key impacts.

To calculate ecological footprints, the Global Footprint Network estimates the supply and demand of renewable biological resources across six land use types: forests, fishing grounds, croplands, grazing lands, developed lands and the area of forest required to offset human carbon emissions – that is, the carbon footprint. According to the network’s own analysis, each of these land use types is nearly in balance or in surplus, except for the carbon footprint.

Conventional tillage leaves fields in South Dakota vulnerable to erosion. Impacts like this are not captured in footprint calculations that focus on quantifying resources. USDA NRCS South Dakota, CC BY-SA

The two key categories for producing food – cropland and grazing land – are defined in such a way that they can never be in deficit. And the analysis does not reflect environmental consequences of human use of these lands, such as soil erosion, nutrient runoff or overuse of water. It measures only land area.

For example, the ecological footprint for Indonesia is 1.61 global hectares per person, which is among the lowest 30 percent of all countries. But according to a 2014 study, Indonesia has the highest deforestation rate in the world.

Furthermore, the footprint calculation does not consider whether stocks of natural resources are decreasing or increasing as a result of human consumption. This question is critical for understanding ecological impacts.

These national ecological footprint calculations also conflate sustainability with self-sufficiency. They assume that every nation should produce all of the resources it consumes, even though it might be less expensive for countries to import some goods than to produce them at home.

As an example, the network lists Canada as an “ecological creditor” whose biocapacity exceeds its population’s ecological footprint. However, Canada is among the top 10 oil-producing countries in the world, and exports much of that oil for foreign consumption. Most of it goes to the United States, an “ecological debtor” that consumes more resources than it produces.

Thinking purely in terms of generic “resources,” everyone is better off when debtor countries can import resources from nations with supplies to spare. There are real and important environmental impacts associated with producing and consuming oil, but the network’s calculations do not address them. Nor do they reflect the decline in natural capital from extracting a nonrenewable resource.

Measuring sustainability

The Global Footprint Network asserts that “You can’t manage what you can’t measure,” but it may be impossible to create a single metric that can capture all human impacts on the environment. Earth Overshoot Day highlights unsustainable uses of natural resources, but we need scientifically robust ecological indicators to inform environmental policy, and a broader understanding of ecological risks.

Better measurements of sustainability should reflect changes in our supplies of natural capital, include estimates of uncertainty and incorporate multiple pathways to reducing carbon footprints. The best tool for measuring human impacts on the planet may be a dashboard of environmental indicators, not a footprint.