Project GCP/SYR/006/ITA

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Project GCP/SYR/006/ITA Phase II FAO-ITALIAN
GOVERNMENT COOPERATIVE PROGRAM Environmental
Economics and Sustainable Development
Donato Romano Department of Agricultural and Land
Economics University of Florence
and International Consultant to the FAO
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Objective sustainability of rural development
policies ? relevant concepts and methods
Background Basic microeconomics
Materials

• outline and reading list contents. schedule and
  references
• course notes

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• Evaluation
• homeworks
• quizzes 1 per week
• final test Wed. Nov 27th

Schedule
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Population

• Every year. more than 93 million people are being
  added to the worlds population of 6 billion
• More than 82 million of these additional people
  per year will be born in Third World countries
• Rapid population growth can have serious
  consequences for the well-being of humanity
  worldwide

5
Population historical records
6
Population historical records
7
Population historical records
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Population geographic distribution
9
Population geographic distribution
10
Population age structure
11
The hidden momentum
12
The demographic transition (in W. Europe)
13
The demographic transition (in LDCs)
14
The microeconomic theory of fertility
15
The microeconomic theory of fertility

• Policy implications
• an increase in the education of women and a
  consequent change in their role and status,
• an increase in female non-agricultural wage
  employment opportunities, which raises the price
  or cost of their traditional child-rearing
  activities,
• a rise in family income levels through the
  increased direct employment and earnings of a
  husband and wife or through the redistribution of
  income and assets from rich to poor,
• a reduction in infant mortality through expanded
  public health programs and better nutritional
  status for both parent and child,
• the development of old-age and other social
  security systems outside the extended family
  network to lessen the economic dependence of
  parents on their offspring.

16
Population-Environment-Poverty Links
17
Carrying capacity
18
Carrying capacity
19
Population pressure and technological change
20
Greenhouse effect
21
Greenhouse effect

• Why should this greenhouse effect be thought of
  as a problem?
• The additional warming is what causes concern
• many potentially damaging effects
• some beneficial ones

• The gases producing this layer around the earth
  are
• water vapor,
• carbon dioxide (CO2),
• methane (CH4),
• nitrous oxide (NO),
• some chlorofluorocarbons (CFCs), and
• ozone (O3)

22
Greenhouse effect
These gases are a mix of natural events and
anthropogenic factors ? determining the relative
contributions of these gases is complex
23
Greenhouse effect

• Two features
• uncertainty
• commitment to some degree of warming.

• Two policy responses
• prevention (to reduce trace gas emissions)
• adaptation

24
Greenhouse effect

• Projected scenarios (IPCC estimates)
• scenario A - business as usual no controls are
  exercised over current rates of emission growth ?
  global mean temperatures will increase 1C by
  2025 and 3C by 2100 compared with temperatures
  in 1990, i.e. a rise of 0.3C per decade
• scenario B deforestation is halted, natural gas
  is substituted for coal, which has a higher
  carbon content, and energy conservation measures
  are adopted ? a rise of 0.2C per decade
• scenario C increasingly strict abatement
  measures are undertaken, and energy from fossil
  fuels is aggressively replaced by renewable
  energy ? warming is held to 0.1C,

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Greenhouse effect
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Effects of global warming

• Projected scenarios (IPCC estimates)
• Rise in regional temperature mid-latitude
  regions
• summer soil moisture may be reduced, and crops
  could be affected by summer droughts
• reduction of water supplies, both of surface
  water and groundwater aquifers
• changes in hydrological regimes
• Rise in sea level melting mid- and
  high-latitude small glaciers
• and ice sheets ? mean rise in sea level of 6
  cm a decade
• loss of low-lying land to the sea
• salt intrusion to freshwater systems and
  groundwater
• storm surges that cause floods
• Frequent and severe events alteration of the
  frequency and
• variability of events related to the weather
• droughts, storms, and floods may be more frequent
  and severe

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Effects on LDCs

• LDCs more dependent than DCs on NR ? more
  sensitive to changes in climate
• the agricultural systems of many LDCs are based
  on low-lying deltaic land ? flooding and
  saltwater intrusion
• many agricultural systems rely on natural
  rainfall rather than irrigation systems ?
  problems with changes in rainfall patterns
• many small LDCs are island communities at special
  risk from severe weather events such as
  hurricanes and cyclones
• the very poverty of many LDCs will preclude them
  from undertaking the adaptive policies, such as
  sea defenses, that may be needed

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Ozone layer depletion

• Stratospheric ozone blocks ultraviolet radiation
  from the sun
• ? depletion of the ozone layer increases the
  incoming UVR
• increase of skin cancers
• suppressions of the immune system in the human
  body
• eye disorders
• reduced or distorted growth in plants

• Cause (mid 1970s) chlorofluorocarbons (CFCs)
• depletion of the ozone layer
• contribute to global warming

? 1989 Montreal Protocol
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Loss of Biodiversity
Biodiversity is the totality of genes, species,
and ecosystems. The term is helpful for
reminding us that it is not just the total stock
of living things that matters, but the range of
different living things.

• Protecting the worlds biodiversity is a
  difficult task
• 30-50 million species
• only 1.43 million species have been
  scientifically described
• most undescribed species inhabit the tropical
  forests
• rate of loss of species is not known, but
  evidence suggests that the rate of extinction has
  increased
• perhaps one-quarter of existing species are at
  risk of extinction in the next twenty to thirty
  years

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Loss of Biodiversity
31
Loss of Biodiversity

• Causes of biodiversity loss
• population growth,
• ill-defined land and resource rights,
• market, planning, and government failures

• If the above factors explain habitat loss,
• their reversal or containment will assist the
  conservation process, but
• in order to avoid to alienate people, it is
  required community involvement in protected areas

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The Mediterranean Basin

• Why the Mediterranean Sea is subject of
  environmental concern?
• land-locked
• surrounded by countries with various
  combinations of
• rapid population growth,
• industrialization,
• development,
• massive changes in land use

• Two kinds of problems (Box 3.1)
• common problems, i.e. they are shared by two or
  more countries
• problems occuring separately in several countries

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The Mediterranean Basin
Both types of problems are reciprocal
externalities that require bilateral or
collective action

• Examples
• heavily polluted rivers
• declining fisheries (because of pollution as well
  as over-fishing)
• reduced wetland areas (because of land
  reclaimation, urbanization)
• loss of forests and natural habitats
• water deficiencies and water quality problems
• soil depletion (overgrazing, overcultivation,
  salinization, water-logging)
• solid waste poorly managed

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The Mediterranean Basin

• Causes
• population growth by 2025 the 1985 population
  of 350 million persons could have increased by
  200 million
• economic policy energy and irrigation are
  subsidized
• institutional failure tenurial arrangements,
  weak controls over development, poor political
  awareness of environmental issues

• Actions
• contain population pressure on natural resources
• reduce tenurial conflicts
• getting resource prices right (i.e. reflect
  social costs)
• strengthen institutions

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Water Resources in the Middle East
Why the water resources are so important for the
Middle East? No other region of the world
embraces such a large area, with so many people
striving so hard for economic growth on the basis
of so little water

• The Mashrek lies in a transition zone. The
  dominant hydrological characteristic is the
  combination of
• aridity and
• uncertainty
• Whereas regions of higher rainfall sometimes
  suffer droughts and regions of lower rainfall
  sometimes experience floods, this region has to
  cope with both

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Water Resources in the Middle East
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Water Resources in the Middle East
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Water Resources in the Middle East

• Three water crises at the same time
• quantity demand for fresh water in the region
  exceeds the naturally occurring, renewable supply
• quality much of the regions limited water is
  being polluted from growing volumes of human,
  industrial, and agricultural wastes
• equity the same water is desired simultaneously
  by different sectors in some society or wherever
  it flows across (or under) an international border

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Water Resources in the Middle East

• Actions
• quantity much more attention should be paid to
  the low-capital-decentralized options than to the
  high-capital-centralized ones. To a large extent,
  the former are not only technically proven but
  typically more cost effective, given the marginal
  costs of new conventional water supply
• quality intervene to fix the major causes of
  pollution, i.e. overpumping of aquifers, runoff
  from agriculture, discharge of human and
  industrial wastewater, and loss of habitat
• equity develop internal as well as international
  institutions to manage conflicts

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Land Degradation and Desertification

• What is land degradation?
• soil erosion
• waterlogging
• salinization
• land use change

What is desertification? land degradation in
arid, semi-arid and dry sub-humid areas resulting
from various factors, including climatic
variations and human activities
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Land Degradation and Desertification

• Why is land degradation a problem?
• during the 1980s, the amount of per capita arable
  land declined by 1.9 per annum
• that is, every year, around 70,000 km2 of
  farmland are abandoned because the soils are too
  worn out and degraded for crop production
  another 200,000 km2 suffer from reduced
  productivity
• about 1.4 billion hectares of arable land have
  been taken out of agricultural production because
  of urban sprawl between 1980 and the turn of the
  century
• overall land degradation of various sorts is
  estimated to be causing an annual loss of 12
  million tons of grain output almost half of all
  the gains in grain output each year

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Land Degradation and Desertification

• Why is desertification a problem?
• one-third of the earths land is arid or
  semi-arid
• some 600 million people live there
• more than 20 of the earth - home to 80 million
  people - is directly threatened by
  desertification
• some 100 countries are affected.

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Land Degradation and Desertification

• Causes of land degradation/desertification
• population growth populations are increasing as
  fast in arid lands as elsewhere
• overcultivation,
• overgrazing,
• deforestation,
• poor irrigation

Traditional rainfed cropping systems break down
under pressure from growing populations and the
increased planting of cash crops
people takes too much from the soil and puts too
little back
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The Human-Environment Relationship
THE ENVIRONMENT
AIR POLLUTION
ENERGY
Firms (Production)
AIR
SOLID WASTE
THE ECONOMY
Inputs
Outputs
WASTE HEAT
Households (Consumption)
WATER
WATER POLLUTION
AMENITIES
RAW MATERIALS
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Functions of the Environment

• Source of raw materials
• depletable
• renewable
• Sink for waste
• biodegradable/short-lived/non-toxic
• toxic/persistent
• General life support
• water cycle
• carbon cycle
• ozone layer

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The First Two Laws of Thermodynamics
Closed vs. open systems exchange of energy and
matter
Earth as a closed system

• First law of termodynamics energy and matter
  cannot be created or destroyed
• the mass of materials flowing into the economic
  system has to either accumulate in the economic
  system or return to the environment as waste
• excessive wastes can depreciate the asset
  limited absorptive capacity
• Second law of termodynamics entropy increases
• no conversion from one form of energy to another
  is completely efficient and that the consumption
  of energy is an irreversible process
• over the very long run, the growth process will
  be limited by the availability of solar energy
  and our ability to put it to work

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A Classification of Natural Resources

• What is a resource?
• utility vs. altruism
• natural vs. man-made
• renewable vs. non-renewable (or exhaustible)
• - growth and reproduction
• - carrying capacity (max stock)
• - rate of extraction
• conditionally vs. uncoditionally renewable

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A Classification of Natural Resources
Natural resources
Renewable
Non-renewable

• oil
• coal
• minerals

Unconditionally renewable
Conditionally renewable
Non-biological flow resources
Non-biological cycling resources
Simple biological resources
Complex resources

• solar energy
• tidal energy
• wind energy

• water
• nitrate
• CO2
• O2

• mammals
• fish
• crops

• soil
• ecosystems

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Special Features of Agricultural Resources

• What are, if any, the special features of
  agricultural resources?
• inter-temporal or long-run nature
• ? optimal time path of use
• ? uncertainty
• close linkages between the physical system and
  biological system
• complexity of involved resources
• ? renewable exhaustible
• ? quality differentiated
• spatial nature of resources

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Ideas of Development
1950s-60s economic growth 1960s-70s growth
with redistribution 1970s-80s basic
needs 1980s-90s sustainable development

• Sustainablity is concerned with thes 3 Es
• economic dimension efficiency
• ecological dimension ecosystem functioning and
  environment maintenance
• equity and ethical dimension distributional
  consequences of policy alternatives

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Views on Sustainable Development
a) Economists
Sustainable economic development involves
maximizing the net benefits of economic
development, subject to maintaining the services
and quality of natural resources over time
(Pearce et al., 1987)
Sustainable economic development refers to the
optimal level of interaction between three
systems - the biological, the economic and the
social - through a dynamic and adaptive process
of trade-offs (Barbier, 1989)
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Views on Sustainable Development
b) Ecologists
Sustainability (is) the ability to maintain
productivity, whether as a field, farm or nation,
in the face of stress or shock (Conway and
Barbier, 1990)
Sustainable development based on prevailing
patterns of resource use is not even
theoretically conceivable ... a new definition of
sustainable development is development that
minimizes resource use and the increase in global
entropy (Rees, 1990)
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Views on Sustainable Development
c) Sociologist
Demand on the environment that are culturally
determined Are the institutions which are used
to manage the environment subject to local
control and have they evolved to meet local
needs?
The underlying global economic and political
factors which encourage environmental degradation
need to be addressed, and a global redistribution
of wealth has to occur. Only then can sustainable
development on a global scale become a realistic
possibility.
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Views on Sustainable Development
Brundtland Commission
Development that meets the needs of the present
without compromising the ability of future
generations to meet their own needs (WCED, 1987)

• Two different meanings
• the stock of natural capital in particular must
  be left intact for the next generation
• the aggregate stock of manufactured and natural
  capital must not decline between one generation
  and the next ? trade-offs

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Views on Sustainable Development
FAO
Sustainable Development is the management and
conservation of the natural resource base, and
the orientation of technological and
institutional change in such a manner as to
ensure the attainment and continued satisfaction
of human needs for present and future
generations. Such sustainable development (in the
agriculture, forestry and fisheries sectors)
conserves land, water, plant and animal genetic
resources, is environmentally non-degrading,
technically appropriate, economically viable and
socially acceptable (FAO, 1989)
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Agriculture in Economic Development

• Green revolution
• Objectives
• increasing per capita income
• rising per capita food production
• Three interrelated actions
• staple cereals that produced early maturing,
  day-length insensitive and high-yielding
  varieties (HYVs)
• packages of high payoff inputs, such as
  fertilizers, pesticides and water regulation
• implementation in the most favorable
  agro-climatic regions and for farmers with the
  best expectations of realizing the potential
  yields

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Agriculture in Economic Development

• Post green revolution problems
• equity
• widely adopted irrespective of farm size and
  tenure
• soil quality, access to irrigation water, etc.
  have been formidable barriers to adoption
• stability
• monocropping associated with increased output
  variability (pests, diseases, and weeds)
• year-to-year fluctuations in input use arising
  from shortages or price changes
• productivity
• diminishing returns to the HYVs and high pay-off
  inputs

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Agriculture in Economic Development

• A new phase in Ag Dev? Agricultural Sustainable
  Development
• World Bank successful Ag Dev
• sustainable, by insuring the conservation and
  proper use of renewable resources
• promote economic efficiency
• its benefits must be distributed equitably
• CGIAR
• technological and research priorities to make
  agricultural production in the Third World more
  sustainable
• IFAD
• strategies for implementing sustainable Ag Dev in
  resource poor environments
• strategies for spreading benefits to the rural
  poor

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Agricultural Sustainability
RESOURCES
Human
PRODUCTS Food and fiber
Man-made
AGRICULTURE
Natural
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Agricultural Sustainability

• A) The sustainability of resources
• renewable vs. exhaustible resources ? husband
  renewable resources in such a way as to provide a
  long-term sustainable base for production
• frontier and poor societies ? unsustainable
  resources use, that is intensive application of
• - capital
• - technology
• - (labor)
• LDCs cannot afford the technological investment,
  nor do they have dependent countries which they
  can exploit

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Agricultural Sustainability

• B) Mismatched technologies
• within the agricultural production system? lack
  of knowledge or appropriate skills ? low
  efficiency ? higher costs
• outside the agricultural production system ?
  agrochemicals ? human diseases, pollution, etc.

What is agricultural sustainability? The ability
to maintain productivity, whether of a field or
farm or nation, in the face of stress or shock (?
resilience). A stress may be increasing salinity,
or erosion, or debt etc.
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Agricultural Sustainability
a) Sustainability (? resilience)

• Function of
• the intrinsic characteristics of the system,
• the nature and strength of the stresses and
  shocks,
• the human inputs which may be introduced to
  counter these stresses and shocks

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Agricultural Sustainability
b) Productivity
Output of valued product per unit of resource
input land (solar energy), labor (human
energy), capital (fossil fuel energy)
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Agricultural Sustainability
c) Stability
The constancy of productivity in the face of
small disturbing forces arising from the normal
fluctuations and cycles in the surrounding
environment climate, market demand, etc.
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Agricultural Sustainability
d) Equitability
The evenness of distribution of the productivity
of the agricultural system among the human
beneficiaries
Trade-offs
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Agricultural Sustainability
e) Efficiency
Maximum economic efficiency is equivalent to
maximum profit
Maximization with sustainability constraints
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Spatial and Hierarchical Dimensions
Trade-offs
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FAO Criteria for SARD

• Meeting the basic nutritional requirements of
  present and future generations, qualitatively and
  quantitatively while providing a number of other
  agricultural products
• Providing durable employment, sufficient income,
  and decent living and working conditions for all
  those engaged in agricultural production
• Maintaining and, where possible, enhancing the
  productive capacity of the natural resource base
  as a whole, and the regenerative capacity of
  renewable resources, without disrupting the
  functioning of basic ecological cycles and
  natural balances, destroying the socio-cultural
  attributes of rural communities, or causing
  contamination of the environment
• Reducing the vulnerability of the agricultural
  sector to adverse natural and socio-economic
  factors and other risks, and strengthening
  self-reliance

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Macro Policies and the Environment
70
Macro Policies and the Environment
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Macro Policies and the Environment
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Macro Policies and the Environment
73
Macro Policies and the Environment
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Macro Policies and the Environment
Common Roots of Economic and Environmental
Problems

• Policy failures
• growth without safeguards
• lack of proper sector policies
• Market failures
• monopolies
• imperfect information
• externalities
• Governance failures
• lack of monitoring and control
• weak management
• lack of transparency
• collusion

• Financial sector problems
• excessive exposure to risk
• weak portfolio
• unsustainable business practices

• Environmental problems
• excessive pollution
• excessive NR depletion
• unsustainable industrial, agricultural, and NR
  management practices

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Macro Policies and the Environment
Conclusions

• if one traces the impacts of a macroeconomic
  policy change, one can find effects across many
  sectors, not always self-evident
• the environmental impacts of economic policies
  will depend critically on the economic
  institutions that are in place and that govern
  the use of the resource base and the
  environmental sinks of the economy
• where there are market imperfections of one kind
  or another, and where these cannot be resolved at
  source, it is desirable to use economic
  instruments specifically to address the
  environmental issues

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Some Introductory Concepts

• What is economics about?
• scarcity, allocation, and trade-offs
• values total economic value
• - market vs. non-market
• - use vs. non-use
• positive vs. normative economics
• environmental vs. natural resource economics
• neoclassical vs. ecological economics

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Some Introductory Concepts
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Some Introductory Concepts
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Neoclassical Economics

• sustainable growth
• natural resource can be substituted for capital
• technical progress will relax the limits to
  growth
• maximum sustainable yield
• recycling
• sustainability of economic development
• golden rule resource growth potential ?
  discount rate - rate of exogenous technical
  progress
• irreversibilities

80
Ecological Economics

• sustainable growth
• the substitution of capital for natural
  resources is limited
• technical progress will relax the limits to
  growth
• functions of the environment are essentially
  intertwined ? additional restriction on economic
  growth
• full recycling of energy is not possible
• sustainability of economic development
• continuous co-evolutionary feedback between
  economy and environment
• the economy has to adapt itself
• economy natural environment culture
  technology political system population
  ecological complex

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Recalling Some Basics

• Demand
• downward sloping
• willingness to pay (WTP)
• reservation price max WTP
• marginal benefits

82
Recalling Some Basics

• Consumer Surplus
• gross total benefits
• total purchasing costs
• net total benefits

83
Recalling Some Basics

• Marginal Costs
• costs of each additional Q
• MC are rising
• why?
• MC and supply curve

84
Recalling Some Basics

• Firm equilibrium
• max p ? MC MR
• competitive market ?
• MR P
• why?
• willingness to accept (WTA)

85
Recalling Some Basics

• Market supply
• horizontal sum of all firm supply curves

86
Recalling Some Basics

• Producer Surplus
• gross total benefits (revenue)
• total production costs cost of the goods sold
• net total benefits

87
Recalling Some Basics

• Market equilibrium
• market vs. individual curves
• price that clears the market
• why?
• equilibrium price
• equilibrium quantity
• decentralized mechanism

88
Recalling Some Basics

• Welfare
• why to exchange?
• benefits of exchanging
• costs of exchanging
• net social benefits
• NSB CS PS
• optimality
• economic efficiency
• at the equilibrium
• - P MC
• - WTP MC
• - MB MC

89
Recalling Some Basics

• Max NSB
• max CS PS
• a competitive equilibrium is a social optimum
• Pareto optimality
• FTWE under a set of speci-fic assumptions, any
  compe-titive equilibrium is Pareto optimal

90
Recalling Some Basics

• Market failures
• market power e.g. monopoly
• externalities uncompensated effect on a third
  party, e.g. pollution, protection from floods
• ill-defined property rights e.g. pollution,
  open access
• public goods non excludability non rivalry,
  e.g. landscape, knowledge
• imperfect information incompleteness or
  asymmetries, e.g. decisions under uncertainty,
  contract design (moral hazard, adverse selection)

91
Recalling Some Basics

• Government failures
• Government intervenes to
• - correct for market failures
• - achieve non-efficiency objectives
• trade-off between efficiency and equity e.g.
  price ceiling intervention
• two kinds of policy failure
• - underpricing natural resources e.g., timber
  or water subsidies
• - rent-seeking or directly unproductive
  profit-seeking (DUP)
• activities

92
Recalling Some Basics
Efficiency vs. equity price ceiling policy
PS CS Tot -c-b -ab -a-b
93
Environmental Economics

• Pollution
• negative externality
• social marginal costs (SMC)
• private marginal costs (PMC)
• total social marginal costs TSMC SMC PMC
• total vs. marginal costs
• internalizing a -ve externality
• social vs. private optimum
• - no 0 pollution
• - balancing market and non-
• market goals
• what if a ve externality?
• NSB C D E

94
Environmental Economics

• Env. Improvements
• marginal benefit curve
• marginal benefits of envir. improvement vs.
  marginal costs of pollution
• demand curve for envir. quality improvement
• WTP for environmental quality improvement
• trade-off between environm. improvement and
  other things we could do with income
• total benefits to the society
• total benefits vs. CS

95
Environmental Economics

• Env. Improvements
• marginal cost curve
• environmetal improvement does not come for free

96
Environmental Economics

• Optimum level of pollution/environm. improvement
• max NSB from environmental improvement NSB TB
  TC ? MB MC
• socially efficient quantity of pollution
• who should enjoy the benefits and who should
  bear the costs?

97
Environmental Economics

• Abatement vs. pollution damages
• Two ways to look at the same problem
• - max NSB ? MB(A) MC(A)
• - min TSC ? MD(Q) MC(Q)
• socially efficient quantity of pollution
• who should enjoy the benefits and who should
  bear the costs?

98
Natural Resource Economics

• Biological Model
• population growth curve Xf(t)
• logistics curve
• carrying capacity XMAX
• minimum viable population XMIN

99
Natural Resource Economics

• Biological Model
• population growth rate dX/dt f(X)
• identify A, B and XMAX
• maximum sustainable yield
• MSY ? highest possible harvest

100
Natural Resource Economics

• Economic Model
• effort
• if E ? ? X ? and viceversa
• doubling effort does not mean doubling harvest

101
Natural Resource Economics

• Economic Model
• harvest
• Hf(E)
• what about X?

102
Natural Resource Economics

• Economic Model
• total revenue TRP?H
• total costs TCW?E
• single owner equilibrium (HPROF, EPROF)
• - max p vs. MSY
• - conservation
• open access (i.e. no owner) equilibrium (HOA,
  EOA)
• - OA vs. max p vs. MSY
• - conservation

103
Natural Resource Economics

• Economic Model
• total revenue TRP?H
• total costs TCW?E
• single owner equilibrium (HPROF, EPROF)
• - max p vs. MSY
• - conservation
• open access (i.e. no owner) equilibrium (HOA,
  EOA)
• - OA vs. max p vs. MSY
• - conservation
• The Tragedy of the commons (Hardin 1968)

104
Natural Resource Economics
Introducing time discounting
Marginal product Rate of capital appreciation
Discount rate
V1
X1
P1
X0
P0
V0
?
?


105
Property Rights

• Coase Theorem
• what is a property right?
• Pareto improvement
• sufferers property right
• polluters property right
• problems
• - transaction costs
• - open access
• - information gathering costs
• - distributive impacts

106
Resource Management Regimes

• private
• - individuals have a duty to observe the rules
  of use determined by the
• controlling agency
• - the agency has the right to determine those
  rules
• state
• - individuals have the right to undertake
  socially acceptable uses and a
• duty to refrain from unacceptable uses
• - others have a duty to respect individual
  rights
• common
• - a management group has the right to exclude
  non-members
• - non-members have a duty to abide that
  exclusion
• - co-owners comprise the management group and
  have rights and duties
• related to the use of resources
• open access (no property)
• - no users or owners are defined
• - individuals have the privilege but not the
  right to use resources

107
Renewable Resources and Games

• prisoners dilemma game
• - non-cooperative game
• - isolation
• - no binding agreement
• - the resource must be privatized or be subject
  to some form of state
• regulation and control
• assurance game
• - cooperative game
• - interdependence
• - binding agrrement
• - overexploitation of renewable resources in
  open access and common
• property situations can be solved by
  cooperative agreement
• extensions
• - incentives/institutions
• - repeated over time
• - no single regime is universally best suited
  to the wise NR management

108
Economic Instruments for Envir. Policy

• Pigovian tax
• optimal tax
• need to know
• - MNPB
• - MEC
• information aymmetries?

109
Economic Instruments for Envir. Policy

• Pigovian tax
• low-cost solution to standard setting
• standard at S2 TACst OAS2 OBS2 OCS2
• tax t TACtax OXS1 OBS2 OYS3
• TACst - TACtax S1XAS2 - S2CYS3
• S1XAS2 gt S2CYS3 ? TACst gt TACtax

110
Why to Prefer Environmental Taxes?

• directly into the prices of the goods, services
  or activities polluter-pays-principle
• create incentives for producers and consumers
• more cost-effective pollution control than
  regulations
• spur to innovation
• raise revenues which can be used directly to
  improve the environment

Why Are Envir. Taxes Not Widespread?

• uncertainty about the justice of Pigovian taxes
• lack of knowledge of the damage function

111
Economic Instruments for Envir. Policy

• Envir. Standards
• command-and-control
• need to have
• - monitoring agency
• - penalties
• only by accident optimal
• for being optimal
• - standard at Q
• - penalty equal to P
• - certainty of penalty

112
Taxes vs. Standards

• taxes as least-cost solutions
• taxes are dynamically efficient
• administrative costs?
• outright prohibition

113
Economic Instruments for Envir. Policy

• Marketable Permits
• Q optimal number of permits
• P optimal price of permits
• S is the supply curve
• MAC curve demand curve

114
Economic Instruments for Envir. Policy

• Marketable Permits
• cost minimization
• low-cost polluters sell permits and high-cost
  polluters buy them

115
Economic Instruments for Envir. Policy

• Marketable Permits
• new entrants
• opportunities for non-polluters
• inflation and adjustment costs
• technological lock-in
• spatial issues
• types of permit systems
• - ambient permit system (APS)
• - emissions permit system (EPS)
• - pollution offset (PO) system

116
Agricultural Pollution

• Non-Point Source Pollution
• spatial diffusion
• high variability in space and time
• - polluters responsibility (who?)
• - pollution level at the source (how much?)
• - ecological and economic damage caused (how?)
• ? traditional instruments cannot be used

117
Agricultural Pollution

• Input-based instruments
• input taxes and subsidies
• - the regulatory agency should know the private
  production function, but
• - information asymmetries
• input proxies and empirical models
• - information asymmetries
• - other uncertainties

118
Agricultural Pollution

• Ambient-based instruments
• concentration of pollutant in the environment
• collective penalties
• - Segersons (1988) scheme, but
• - likely penalization of farms if close to the
  optimum
• - dynamic incentive disappears
• - costs of information and monitoring borne by
  farmers

119
Cost-Benefit Analysis

• What is Cost-Benefit Analysis (CBA)?
• CBA is a set of operational rules, that guides
  public choice among several project alternatives
• CBA is a method to make decisions
• decision-making involves always more than one
  alternative (at least two with and without)
• the evaluation process is made comparing
  advantages and disadvantages
• advantages and disadvantages are evaluated with
  reference to certain objectives
• CBA is applied mainly in the public sector

120
Cost-Benefit Analysis

• Two types of analysis
• private sector financial analysis
• public sector economic and social analysis
• different objective function ? different
  contents
• same evaluation phases and decision rules

121
Cost-Benefit Analysis
Financial analysis vs. economic analysis
122
Cost-Benefit Analysis

• Why Cost-Benefit Analysis?
• because the market fails to reach the social
  optimum
• to overcome the paternalistic approach at public
  policy

123
Cost-Benefit Analysis

• How CBA must be carried out?
• two fundamental principles
• - welfarism individual preferences
• - Pareto principle potential Pareto improvement
  
• two issues
• - how to compare different individual welfare
  status? Kaldor-Hicks compensation criterion
• - how to measure the impacts of different
  alternatives? Money as numeraire

124
Discounting

• Why do we need discounting?
• projects usually have a duration longer than 1
  year
• current consumption is valued higher than future
  consumption (inter-temporal preference)

• How to discount?
• cash flow stream of benefits and costs on the
  time scale
• how much a future amount of money is worth today
• VnV0(1r)n ? V0Vn(1r)-n

125
Discounting
Discounted cash flow
126
Investment Criteria
Net Present Value (NPV) sum of all items in a
discounted cash flow, i.e. it is the value
obtained summing all discounted net benefits

• decision rules
• acceptability NPVi ? ? ? i
• choice NPVi ? NPVj ? i ? j

It is a monetary value It depends on the value
of the discount rate (exogenous)
127
Investment Criteria
Benefit/Cost Ratio (B/C) ratio between the sum
of discounted benefits and the sum of discounted
costs

• decision rules
• acceptability B/Ci ? 1 ? i
• choice B/Ci ? B/Cj ? i ? j

It is a pure number It depends on the value of
the discount rate (exogenous)
128
Investment Criteria
Benefit/Cost Ratio (B/C) the discount rate that
yields NPV equal to 0 or B/C equal to 1

• decision rules
• acceptability IRRi ? r ? i
• choice IRRi ? IRRj ? i ? j

It is the average yearly return of a given
investment It does not depend on the value of
the discount rate (?)
129
Comparison
Investment Criteria
130
Comparison
Investment Criteria
131
Sensitivity Analysis

• CBA abuse can be rampant
• SA is explicit discussion of the sensitivity of
  NPV and B/C ratios to changes in
• - assumptions
• - figures
• - calculation methods
• highlight all parts of an analysis that may be
  controversial or uncertain
• provide scenarios based on range of those figures
• it should be automatic in any good CBA

132
Total Economic Value

• What does environmental valuation mean?
• Valuation means monetary valuation
• WTP or WTA ? preferences
• economic value measurements help to identify the
  social optimum
• - ex ante, i.e. before deciding on environmental
  regulation
• - ex post, i.e. after a regulation has been
  imposed
• demand curves Marshallian vs. Hicksian
• exact measures compensating vs. equivalent

133
Total Economic Value
134
Total Economic Value
A taxonomy of components
135
Total Economic Value

• TEV and Decision-Making
• Damage and benefit are obverse sides of the same
  concept
• Cost-benefit analysis
• - proceed with the development (BD - CD - BP) gt
  0
• - do not develop (BD - CD - BP) lt 0
• TEV measures BP

136
Total Economic Value

• Evaluation Techniques
• Indirect
• - change in the vector of price HPM
• - change in the vector of quantities TCM
• Direct
• - hypotetical CVM
• - experimental
• weak complementarity condition

137
Evaluation techniques

• Hedonic price method (HPM)
• look for a market in which private goods (e.g.
  real estate) or factors of production (e.g.
  labour), that are linked to the environmental
  good through a complementarity relationship, are
  bought and sold
• the good is fully described by its attributes,
  which influence the price of the good
• example real estate property

138
Evaluation techniques

• Hedonic price method
• PP f (PROP, NHOOD, ACCESS, ENV)
• implicit price for the one unit of the
  environmental characteristic ? PP/? ENV
• marginal WTP

139
Evaluation techniques

• Travel cost method (TCM)
• whenever the consumption of an environmental
  good involves some travel costs
• visitors to a given natural area enjoy an amount
  of gross benefits at least equal to the costs
  they incur
• knowing travel costs, it is possible to infer the
  use value of the natural area
• example outdoor recreation

140
Evaluation techniques

• Travel cost method
• two step procedure
• I) Kj?ixij/Aj ?ifi(TCij, wij)
• II) demand for OR
• x(P)?ijAjfi(TCijP, wij)
• use value of OR
• V?ijAj ?0?P fi(TCijP, wij)dP
• where P is the reservation
• price, i.e. fi(TCijP, wij)0

141
Evaluation techniques

• Contingent valuation method (CVM)
• use survey questions to elicit WTP for provision
  of an environmental good
• hypothetical market
• - description of the good
• - hypothetical circumstances (level of
  provision, payment
• vehicle, available substitutes, etc.)
• - questions to elicit WTP
• also respondents characteristics ? benefit
  transfer
• example any environmental good

142
Evaluation techniques

• CVM formats
• open-ended
• iterative bidding game
• payment card
• close-ended, single bounded
• close-ended, double bounded

143
Evaluation techniques

• CVM formats
• open-ended
• iterative bidding game
• payment card
• close-ended, single bounded
• close-ended, double bounded

144
Evaluation techniques

• CVM formats
• open-ended
• iterative bidding game
• payment card
• close-ended, single bounded
• close-ended, double bounded

145
Evaluation techniques

• CVM issues
• Reliability extent to which the variance of an
  estimate, such as mean WTP, is due to random
  sources ? survey design
• Validity extent to which an instrument measures
  the concept under investigation, i.e. presence of
  systematic errors (bias)
• - strategic bias ? incentive compatibility
• - hypothetical bias ? scenario
• - design bias ? ordering wording focus
  groups/pre-test

146
Evaluation techniques

• Conclusions
• Indirect only if weak complementarity ? only use
  values
• Direct all components of TEV ? CVM more
  versatile tool

How important is to estimate single TEV
components? Operationally we focus on the TEV of
a resource, not on its components