ECONOMICS AND THE

ENVIRONMENT
 How much is clean air worth?
 Can you charge somebody for
damaging your air?
 How much are you willing to pay for
clean air?
 Should you have to pay for clean air?
 Have you ever caught a fish off the UST
pier?
 Is cutting down the rainforests efficient?
 What market incentives are there for
research on the environment?
 How can the environment be priced and
sold?
 Does Hong Kong have any mechanisms for
valuing its environment?
 Lecture Objectives:
 ReviewAdvantages and Limitations of
Market Economics

 Understand how economics is creating

new principles and guidelines for
business activity.
Comparing:
 Neo-classical Economics
 Environmental Economics
 Ecological Economics

 To reveal policy implications

 What is an economy supposed to
do?

 Whatis the Neo-classical

approach?
 What is a market?

A system of exchange
 What is exchanged?
 Resources: land, labor, capital
(ie. goods or services in some
form)
 How does the market work?

 Matching of supply and

demand
Why is the market such a good system?
 Optimal use of resources: buyers force
competition on suppliers; greatest return for the
efforts of suppliers
 Pareto efficiency: “a situation where it is
impossible to make one person better off without
making anyone else worse off”
– Meaning: allocation of resources to the uses
that will bring the greatest overall increase in
production and monetary value by matching
producers with the highest bidders
What enables the
market to work?
 Price or Value setting
 Profit motive
 Private property
 Government and other
regulating institutions
 Does the market operate
perfectly?
1. General Market Failures:
 Monopoly;
 information asymmetry;
 missing markets;
 transaction costs.
 Market Failures
 What company did you buy your air from?
 How much did you pay for your air? How was that
price set?
 How clean was the air you bought? How do you
know?
 How can a company stop other companies from
dirtying its air? What can you do if someone
makes your air dirty after you bought it?
 What rate of return should a company expect to
get from investing in air quality?
2. Environmental Market Failures:
 Failure to value the environment:
unpriced use values; option values; existence
values; bequest values
 Lack of information
 Externalities
 Common Access Resources/Sinks
 Discounting the future
 Missing Markets
 Externalities
 “An unintended cost or benefit of
production or consumption that is not
reflected in the price of the related
transactions. Externalities are often
borne by people who are not parties to
the transactions that create them.”
 Externalities
 Define the externalities of your
company: who are the parties to the
monetary transaction and who or what
pays for the impacts of the transaction
 Discounting the Future with
Net Present Value (NPV)
NPV = x/(1+.10)nyrs
X + your present money value
.10 = the discount rate
nyrs = the power of how many years down the future
you are looking at
NPV of 100 dollars in five years with a discount rate
of 10% is 100/(1+.10)5 or $62.09
Environmental & Ecological Economics
1. Why should CLP pay for pollution controls in
Guangdong rather than in Hong Kong?
2. Are there any economic tools we can use to value
Hong Kong’s environment?
3. Are air-conditioned shopping malls reasonable
substitutes for clean air and clean beaches?
4. What impact would the use of the Mai Po
conservation area for building houses have on
Hong Kong’s net worth?
 Cleaner air on horizon by year's end: Liao
Improvements to Guangdong power plants will cut
pollution, says minister

 Guangdong's biggest cluster of power plants, at Humen in

Dongguan - which are blamed for much of Hong Kong's air
pollution - are being equipped with desulphurisation devices to
cut emissions.

 In the longer term, Dr Liao hopes a cross-border emission

trading scheme can be set up to assist other power plants in
Guangdong to cut emissions in a more cost-effective manner.

In the meantime, the government has started talks with CLP

Power and Hongkong Electric on emission reduction and an
emission trading scheme.
 Hong Kong administration states preference for
system to be used in cross-border emissions
trading
…the government says a "cap and trade" method is best for Hong
Kong.

Under this system, the government would set an emissions cap

as well as a timetable for this to be lowered. The capped quantity
of emissions would then be distributed to sources of air pollution,
including power plants and large factories, in the form of emission
allowances or permits.

Polluters who fail to meet the requirements of the cap would have
to buy emissions reduction credits from others who could
successfully lower their emissions below the capped level
 Environmental Economics: From
Market Failure to Government Failure
 Limited information of how to deal with
specific environmental problems (of area or
industry) and of firms’ capability to deal with
or hide environmental impact
 Limited resources to regulate, monitor and
enforce

 Command and Control regulations:

uniform standards and technologies
Policy Guidelines from Environmental Economics:
I. Benefits of Using the Market (as
opposed to CAC)
 1. Cost effectiveness: example, emission
trading credits
 2. Substitution and technological advance:
example, green taxes
 3. Other institution/market based schemes:
deposit refund schemes, environmental
bonds, transferable quotas, transfer of
development rights.
 Policy Guidelines from Environmental Economics
II. Better Valuation of Non-
market Valued Assets
 1. Financial Costs
 2. Averting Behavior For: Better
 3. Travel Cost Method Cost-Benefit
 4. Hedonic Pricing
Analysis,
 5. Contingent Evaluation
regulations,
fines
Environmental Economics and
Ecological Economics

Weak vs. Strong

Sustainability
Environmental Economics and Ecological
Economics: Weak vs. Strong Sustainability
 Efficiency standard vs. ecological
standard
 Discount rate (growth) driven vs. discount
rate (growth) limiting
 Resources as inputs & outputs of
unlimited economic system vs. economic
system as limited subsystem of
ecosystem
 Substitutability vs. complementarity
The Environmental Economics Trade-off
 Neo-classical Environmental
Empty World Economics World
S
Recycle? Recycle

M M M M
S Economy H Economy
E E E E
Ecosystem Ecosystem
Ecosystem H

S = solar energy H = heat M = matter E = energy

natural capital man-made capital
Figure 1: The Economy as an Open Subsystem of the Ecosystem
(Daly 1996:49).
 Environmental Ecological Economics
Economics World Full World
S S
Recycle Recycle

M M M
M
Economy
Economy E E
E E
Ecosystem
H Ecosystem H
S = solar energy H = heat M = matter E = energy
natural capital man-made capital

Figure 1: The Economy as an Open Subsystem of the Ecosystem

(Daly 1996:49).
 Substitutability vs. Complementarity
 Manufactured and
knowledge capital for
natural capital
 Land, labor and capital
substitutability
 Same service by
different product
 Technological fixes
 Ecosystem resilience
 Manufactured capital
depends on natural capital
 Uniqueness, uncertainty
and irreversibility
 Ecosystem services
 Growth outpaces
substitution
 Ecosystem fragility
 Policy Influences from
Ecological Economics
Strict demands for environmental protection
reflected in:
 Environmental impact assessment
 Natural preservation areas (parks, reserves)
 Absolute limitations on chemicals
 Policy Guidelines from
Ecological Economics
 1. Daly Rule
 2. Index of Sustainable Economic
Welfare (ISEW)
 3. Ecological tariffs on free trade
 4. Community based sustainability
through self-sufficiency and
diversification
 Policy Guidelines from
Ecological Economics
 1. Daly Rule: "Never reduce the stock
of natural capital below a level that
generates a sustained yield unless good
substitutes are available for the
services generated."
Index of Sustainable Economic Welfare
ISEW=
total output
+ unpaid work
- environmental destruction and
degradation
- environmental improvement
measures
- depreciation of human-made
capital
+/- welfare distribution effect
 Free Trade Limitations
 Regional specialization obscures view
of resource exploitation, depresses
ecological and social laws, weakens
terms of trade and impoverishes
landholders
 Externalities from the shipping of goods
around the world
 Therefore, tariffs to compensate or
reduce free trade
Community Based Development
 Community rather than corporations or
government creates social conditions
(wants and needs) that limit impacts
 Greater self-sufficiency through
decentralized control
 Local synergies for recycling and
energy reduction
 Ethical bonds amongst business
community
 Summing up:
 Market success in exchange efficiency
 Market failures in: valuation, common access,
externalities, and discount rate
 Environmental economics guidelines: cost
effectiveness and market-based incentives
 Ecological economics guidelines: limiting
growth to within global and local ecosystems
*therefore reducing throughput of
economy within ecological carrying capacity