Economics and the Environment

The livelihood of more than half of the economically active population in the
developing world directly depends in whole or part on the environment
through agriculture, as well as animal husbandry, hunting, fishing, forestry,
and foraging. This alone underscores the importance of the seventh Millennium
Development Goal: to ensure environmental sustainability. Environmental quality affects,
and is affected by, economic development.
In recent years, economists have increasingly focused on the important implications of
environmental issues for the success of development efforts. It is clear that classic market
failures lead to too much environmental degradation.
We now also understand that the interaction between poverty and environmental
degradation can lead to a self-perpetuating process in which, as a result of ignorance or
economic necessity, communities may inadvertently destroy or exhaust the resources on
which they depend for survival. Rising pressures on
environmental resources in developing countries can have severe consequences for selfsufficiency, income distribution, and future growth potential.

Land, Natural Resources, and Environmental Resources

Land and natural resources are considered nonproducible, because, unlike
capital, they cannot be replenished through production. In practice, however, the
line between these resources and capital is blurred. Thus, we say land is
nonproducible, but in some major port cities, such as Singapore, Mumbai (Bombay),
and Boston, where land was scarce, landfills extended overall area. Although only
about 11 percent of the earths land area is cultivated, new arable land is
continually created through drainage, irrigation, and the use of fertilizer, new seeds,
and new machinery. New techniques and cheap transport have made economical
the exploitation of resources that were previously unused. Land and natural
resources, although often lumped together, have highly distinguishable properties.
Land is immobile and potentially renewable. Natural resources, by contrast, are
mobile, but most are nonrenewable they cannot be replenished at a rate fast
enough to be meaningful in terms of the human life span. Nonrenewable energy
sources include petroleum, coal, lignite, peat, natural gas liquids, terrestrial heat
flows, oil shale, tar sands, uranium, and thorium.
Resource flows. Renewable energy sources consist of photochemical energy
stored in plants and animals (for example, food, wood, animal excrement, and
vegetable fuel), and sun, water (including tidal energy), wind, and animal power
(Cook 1976:17, 51). Some economists do not like calling them renewable resources,
preferring the term resource flows, for even if they cannot be exhausted, they lack
regenerative capacity (i.e., humans cannot regenerate these flows). Solar energy
may be stored by trees, fossil fuels, or algae, and may be artificially stored by
batteries or hot water tanks, but the stock of solar energy is the sun itself; our
consumption of solar energy has no effect on the stock or our future consumption.
Environmental resources are resources provided by nature that are indivisible.
An ecosystem, an ozone layer, or the lower atmosphere cannot be allocated unit by
unit (as you would allocate oil or copper) or consumed directly, but people consume
the services these resources provide (Kahn 1995:5).

Poverty and Environmental Stress

Grinding poverty and impatience may spur people to strive for immediate gain,
forgetting long-term sustainability, especially when property or use rights are
unclear. To survive, impoverished people degrade and destroy their immediate
environment, cutting down forests for fuelwood and export earnings, overusing
marginal agricultural land, migrating to shrinking areas of vacant land, and
destroying habitat for biological species essential for pharmaceuticals and seed
varieties (Norgaard 1992:3840; U.N. World Commission on Environment and
Development 1987:28). Additionally, they forego maintenance of vegetation,
forests, and the biosphere. At subsistence levels of living, when peoples survival is
at stake, hand-to-mouth economics prevail in which the future is infinitely
discounted; people overexploit natural resources and underinvest in conservation
and regeneration, leading to resource depletion and species loss. In this economic
climate, people make irreversible decisions, foreclosing options by logging and
mining of rain forests and other economic options that reduce species (Panayotou
1993:4654; Flavin 1989). More than 100 million people in LDCs experience acute
firewood shortages.

Market Imperfections and Policy Failures as Determinants of

Environmental Degradation
Theodore Panayotou (1993) argues that environmental degradation originates from
market distortions, defective economic policies, and inadequate property rights definitions, that is, that environmental problems are, at heart, economic problems.
Market and policy failures mean a disassociation of scarcity and prices, benefits and
costs, rights and responsibilities, and actions and consequences. People maximize
profits by shifting costs onto others and appropriate common and public property
resources without compensation. Market failures are institutional failures partly
attributable to the nature of certain resources and partly to the failure of the
government to establish fundamental conditions for efficient markets and use
instruments (taxes, regulations, public investment, and macroeconomic policies) to
bring costs and benefits that institutions fail to internalize into the domain of the
market. Policy failures are cases of misguided government intervention in fairly well
functioning markets or unsuccessful attempts to mitigate market failure which
results in worse outcomes. However, societys goals cannot be eliminating
environmental deterioration altogether but, rather, accounting for all costs from
diminished quantity and quality and lost diversity of natural resources, considering
the productivity and sustainability of alternative resource uses, and insisting that
environmental costs are borne by those who generate them. Growth must be
derived from increased efficiency and innovation rather than by shifting
environmental costs onto others.
Following are six market imperfections that contribute to environmental
degradation.

(1)Externalities. Externalities refer to economic activities conveying direct and

unintended costs and benefits to other individuals and firms. The concept of
external economies, discussed in Chapters 5 and 11, also includes negative
externalities or external diseconomies. These diseconomies include air pollution
(from steel plants and automobile exhausts), water pollution, and depletion of
fisheries by over- fishing. You can trace almost all resource problems to
discrepancies between the private and social valuation of resources. In general,
overexploitation, inefficient use, inadequate conservation, and the lack of
investment in the regeneration of natural resources arise from the failure of
either the market or government to price resources according to social scarcity.
Government should identify spillovers (externalities) ignored in calculating
private benefitcost or user costs over time (where current resource use affects
the future resource available), and internalize these costs or charge them to the
current consumers and producers through taxation or modifying prices (rather
than future generations or innocent bystanders from the present generation).
Examples include the state levying taxes on polluters or charging a surcharge
for pesticide use (Panayotou 1993:3945). Government here has a more active
role than when operating under Coases theorem (Box 13-1).
(2)Common property resources. The biologist Garrett Hardins (1968:1244
1245) tragedy of the commons implies that just as the herders cattle
eventually overgraze a pasture open to all, so do businesses and individuals
over pollute atmosphere and overuse biosphere free for all to use. Individuals
exploit an unpaid or open access resource as if they were facing an infinite
discount rate. Indeed, having large families, although harmful to society, is
optimal for a couple exploiting the commons. Families, factories, fishers, and
herders that generate environmental costs should bear the costs they convey to
others through the degradation of air, water, and pastures.
(3) Public goods. Many environmental resources are public goods, which are
characterized by nonrivalry and nonexclusion in consumption. Nonrivalry means
that one individuals consumption of the good (lighthouses, biodiversity of species,
oceans) does not diminish the amount of good available for others to consume.
Nonexclusion means that if one person is able to consume the good (the
atmosphere, flood protection, national defense, and police fire protection), then
others cannot be excluded from consuming it (Kahn 1995:18).
(4) Irreversibility. Many environmental and natural resource goods cannot be
reproduced in the future if we fail to preserve them now. The market makes
inadequate provision for the future of a rare phenomena of nature (the Grand
Canyon), a threatened species (the elephant), or an ecosystem (the tropical rain
forest) essential for the survival of a species. We should place a high value on
retaining options to use goods or services that would be difficult or impossible to
replace and for which there are no close substitutes (Krutilla 1993:188198).
Logging or mining of the tropical rain forest, the habitat for about half of the worlds
biological species, destroys the species that are essential for the pharmaceuticals
and seed varieties that humankind needs in the future.

(5) Undefined user rights. People will not pay for or conserve a resource without
the assurance of secure and exclusive rights over it. The overuse of common
property resources ensues from legally unclear ownership and user rights to an
asset. In Thailand, subsistence farmers, without long-term tenure rights, mined
the soil because they lacked incentives for more sustainable practices. In Pakistans
Indus River basin (Chapter 7) and Californias valleys, the delivery of water from
large public irrigation projects to farmers at low, subsidized costs results in its
wasteful use. Pakistans large, influential farmers get access to water at the
expense of the rights of small farmers because user (or ownership) rights to water
are not explicitly defined in terms of prices, quantities to be used, and rights of
upstream and downstream users.
(6) High transactions costs. Transactions costs are the costs of information,
coordination, bargaining, monitoring, and enforcement of contracts. If setup costs
are high, markets based on voluntary agreement and exchange fail to emerge. The
costs of parceling out the sea to individual fishers and enforcing property rights over
a mobile resource, such as water, may be prohibitively high. Moreover, when
millions of people burn carbon-based fuels whose pollution, which migrates across
borders, affect millions of victims, the costs of negotiations among the many parties
involved are going to be significant (Panayotou 1993:34, 4344; Kahn 1995:46).
Pollution
As argued earlier, pollution problems result from divergences between social and
commercial costs, divergences arising under both capitalism and socialism. In the
late 1980s, more than half the rivers of socialist Poland were too polluted even for
industrial use. Stalinism and subsequent state management in the Soviet Union
meant cheaply priced resources and ruthless treatment of land, air, and water.
Indeed, the former Soviet Union best illustrates the tragedy of the commons, in
which everybodys property is nobodys property. Worldwatch researchers Lester R.
Brown, Christopher Flavin, and Sandra Postel (1991:2627) contend that the worlds
worst water quality is in the former Soviet Unions Aral Sea basin. The accumulation
of agricultural pesticides in local water supplies has caused birth defects,
miscarriages, kidney damage, and cancer. According to Murray Feshbach and Alfred
Friendly, in Ecocide in the USSR (1991:x, 125), these pesticides and defoliants have
so contaminated the rivers feeding the Aral Sea that mothers in the region who
breast-feed their babies run the risk of poisoning them. Global Public Goods:
Climate and Biodiversity
Many environmental resources are public goods, which are characterized by
nonrivalry and nonexclusion in consumption. Globalization breaks down national
boundaries for many economic activities, including their goods and bads. Although
carbon emissions and rain forest and specie destruction are internal public bads
within an individual tropical country, these forms of environmental degradation also
have adverse impact on climate change and biological diversity for other countries,
both within the region and throughout the globe. The atmosphere and biosphere are
global public goods, as nations cannot exclude other nations from the benefits of
their conservation or from the costs of their degradation.

BIOLOGICAL DIVERSITY
The earths four biological systems forests, grasslands, fisheries, and
croplands supply all of our food and much of the raw materials for industry (with
the notable exceptions of fossil fuels and minerals). Each of these systems is fueled
by photosynthesis, in which plants use solar energy to combine water and carbon
dioxide to form carbohydrates, a process that supports all life on earth. Brown,
Flavin, and Postel (1991:7374) argue that unless we manage the basic biological
system of converting solar energy into biochemical energy more intelligently, the
earth will never meet the basic needs of 6.5 billion people. Sustainability requires a
multitude of species and genetic stock with which to experiment. Biodiversity
includes genetic diversity, the variation between individuals and populations within
a species (for example, the thousands of traditional rice varieties in India); species
diversity, differing types of plants, animals, and other life forms within a region;
ecosystem diversity, a variety of habitats within a grassland, marsh, woodland, or
other area; and functional diversity, the varying roles of organisms within an
ecosystem (World Resources Institute, U.N. Environment Program, and the U.N.
Development Program 1994:147148). Diversity is important for two reasons. First,
the diversity of species bestows stability in ecosystems. Species are entwined like a
woven fabric; they cannot be seen in isolation from their ecosystem. Examples of
this interdependence are the food chain, plant dependence on birds and insects for
pollination, the habitat dependency of animals and insects, and the protection of
species from natural enemies. Greater genetic diversity means a species is more
likely to survive threats such as droughts and floods. Species diversity, the worlds
available gene pool, is one of the planets irreplaceable resources.
GLOBAL WARMING (GLOBAL CLIMATE CHANGE)
Human activities affect the earths climate. Although most environmental risks are
local or regional, some risks, such as the costs from greenhouse gases, are global in
scope. Indeed, William D. Nordhaus (1993:1125) contends that humankind,
through injecting greenhouse gases into the atmosphere, is playing dice with the
universe. Air pollutants that originate from human activity and volcanic eruptions
change the temperature and climate, which spur shifts in ocean circulation, which
feeds back to affect climate variables (World Resources Institute, U.N. Environment
Program, and U.N. Development Program 1994:197).
The greenhouse effect.
The earth reflects some sunlight and absorbs other. When absorption is not
matched by radiation back into space, the earth gets warmer until the radiation
matches the absorbed incoming sunlight. Some atmospheric gases transparent to
sunlight absorb radiation in the infrared spectrum, blocking outward radiation and
warming the atmosphere. The greenhouse effect is the phenomenon by which the
earths atmosphere traps infrared radiation or heat. As a metaphor, the smudgepot
effect is preferable to the greenhouse, according to Thomas C. Schelling (1993:465).
On a clear day in January in Orange County, California, the earth and adjacent
atmosphere warm nicely, but warmth radiates rapidly away during the clear nights
and frost may threaten the orange trees. Smudgepots, burning cheap oil on

windless nights, produce carbon dioxide and other substances that absorb the
radiation and protect the trees with a blanket of warm air. Greenhouses trap the air
warmed by the earths surface and keep it from rising to be replaced by cooler air.
Greenhouse gases include carbon dioxide (CO2), methane, nitrous oxide, and
water vapor, which keep the earth habitable, and chlorofluorocarbons (CFCs); the
problem is the excessive concentration of these gases. In 1990, carbon dioxide
(from coal, oil, natural gas, and deforestation) added 57 percent of the greenhouse
effect. CFCs, from foams, aerosols, refrigerants, and solvents, which progressively
deplete the stratospheric ozone layer, contributed 25 percent. Methane, from
wetlands, rice, fossil fuels, livestock, and landfills, added 12 percent, and nitrous
oxide, from fossil fuels, fertilizers, and deforestation, 6 percent. CO2 absorbs
infrared or heat radiation, so that increasing concentrations of CO2 change the
temperature of the earths surface, reducing temperature differentials between the
equator and the poles and decreasing atmospheric cycling, providing the potential
for dramatic climatic and ecological effects. The facts of the greenhouse effect,
temperature changes, and that human activity is a major contributor are not in
dispute, but the magnitude of climate change on the natural environment and
human welfare is in dispute.