How can we better manage environmental risks using economic tools? Illustrate using examples.
The failure to adequately manage and prepare for environmental risks is perhaps the greatest risk humanity has ever faced. No other danger, including that of global warfare, has the ability to terminate life on earth as efficiently, or as thoroughly. According to the World Economic Forum’s Global Risk Report 2016, the main environmental threats to the continued existence of mankind are: extreme weather events, failure of climate-change mitigation and adaption, major biodiversity and ecosystem collapse, major natural disasters, and man-made environmental catastrophes (Global Risks Perception Survey 2015). In order to attenuate the danger of these potential disasters, government intervention is needed.
Environmental dangers could be interpreted as an externality, and as such, it can be argued that governmental regulation is economically and socially desirable. The various methods of governmental interference have, like with all economic actions, some degree of diminishing returns, and as such, it is probably most efficient to tackle environmental risks using a variety of different economic tools.
In order to better describe how different policies affect the impact of humanity on the environment, the IPAT identity is useful. The IPAT identity stipulates that mankind’s influence on the environment is proportional to the product of the population, the per capita affluence, and a technology coefficient. Since IPAT is a general formula, the units of A and T change depending on what policy is to be evaluated (i.e. CO2 emissions per unit of GDP).
I=P*A*T=P*GDPP*Resource UseGDP
Generally speaking, the probability and danger of all the manmade or man-caused environmental disasters can be reduced through a decrease in the total population of mankind. In the 1970s, China was facing a rapidly growing population which posed a great threat to the stability and future of the country. In order to relieve some of the pressure of the expanding population, china implemented the one-child policy, which reportedly caused “China’s total fertility rate [to fall] from close to six around 1970 to only 2.7–2.8 at the end of the decade” (Whyte, Feng, Cai, 2015). In order to better manage environmental risks such as climate-change, pollution, and a collapse in biodiversity, governments could, like China, subsidise things such as education and housing for one-child households until the human population is brought down to a more sustainable level. Furthermore, the government could subsidise sexual education and birth control to reduce births through unintended pregnancies, and provide social security for elders so that people do not see childbearing as a necessary provider of care for them when they retire. Dramatic policies aimed at reducing fertility rates might not be necessary, however, as there has been shown to be “a significant negative correlation between the components of HDI with … total fertility rate” (Almasi-Hashiani , Sepidarkish , Vesali , Omani-Samani, 2016) implying that governments might be better of attempting to raise the HDI of their country rather than to incentivise a lower fertility.
In order to maintain or reduce the impact of humanity on environmental risks in the likely scenario of an increasing population, the magnitudes of affluence and/or technology must change. Seeing as the trend for GDP per capita, if not for a global deep financial crash, is not likely to be negative, the ratio of resources to GDP must decrease if the total level of impact is to remain level assuming an increase in population. Essentially, this can be done through limiting the use of inefficient production methods and through the adoption of more efficient production processes. For the purpose of this essay, the efficiency of a production method is seen as its ratio of produced value to environmental damage. In order to sponsor such efficiency, the government could change economic policies such as: taxes, subsidies, and quotas.
Taxes are a tool with which governments can disincentivize activities and actions they deem socially undesirable. On july 1st 2012 the Australian government imposed a tax on carbon emissions, the tax was intended to reduce to reduce the emission levels of the greenhouse gas carbon dioxide in order to slow the progression of global warming. Because of the regular and reliable data on emissions in Australia, and because of the repealment of the tax on the 17th of July 2014, it is possible to plot the amount of greenhouse gas emitted during and after the tax to see the degree to which the tax had an impact.
Figure 1: Graph of annualised tonnes of carbon emissions in Australia over time. The red line represents the date at which the carbon tax was repealed. Source: The Guardian (2014) using figures from the Australian Energy Market Operator
The above graph clearly shows a drastic change of rate of carbon emissions around the time during which the tax was repealed. Due to there not being any other significant changes in Australia around the time pertaining to carbon emissions, it can be assumed that a large portion of the change was resultant from the tax being repealed, implying the tax worked. The marginal abatement cost curve (or MACC) is a curve that attempts to represent the different ways by which emissions can be emitted, and their respective costs. Although they are not perfect, detailed MAC curves can be used to estimate how much abatement will occur given any carbon tax using the assumption that in the long run, the economy will drive companies to abate to the point where marginal abatement costs equal the carbon tax in order to maximise profits.
Figure 2: Graph of the global abatement costs of Gigatons of carbon dioxide emissions per year with respect to the year 2030. Source: Global GHG Abatement Cost Curve v2.0 by McKinsey & Company 2010
Figure 2 represents the world’s marginal abatement cost curve as estimated by McKinsey & Company. It implies that, given the lack of both carbon taxes and ‘dirty subsidies’, the approximate annualised abatement of carbon dioxide emissions by 2030 will be 11 gigatons. The general trend of the curve following the 0 cost intercept appears to be curving upwards, which implies that additional marginal carbon tax increases will eventually face diminishing returns.
Another form of taxation that governments make use of is tariffs. Tariffs are a tax on a certain imports; tariffs can be based on the country of origin, the type of good, or a combination thereof. In order to affect climate change governments can impose tariffs on products made in different countries based on the amount of environmental risk resulting from the creation of the specific good, or on all products from a certain country depending on the country’s general emission levels. Agreements such as the Kyoto Protocol and the Paris Agreement attempt to deal with climate change through giving the members of the respective treaties certain greenhouse gas emission targets to stay within. Although they have both, to some degree, helped reduce emissions in the participating countries, several countries have avoided ratifying one or both of them. In order to disincentivize not partaking in the agreements, several entities, notably the EU, have argued for the need for carbon taxes on countries not attempting to meet their respective emission goals. As the abatement of greenhouse gasses past a certain point results in a downwards pressure on national GDP, countries are, as per game theory, incentivised to cheat on their pollution targets. Therefore, in lieu of self enforcement, carbon tariffs may be a more realistic policy.
There are essentially three ways that the government can use subsidies to affect environmental risks. The government can use subsidies to help companies pay for more environmentally friendly ways of production that are more expensive than the more polluting ways, they can be used to encourage research into technological advancements that can decrease the environmental cost of production, and they can be used to reimburse companies for damages they receive as a result of environmental causes. The former two reasons for subsidies are preventative, whereas the latter subsidy is used to mitigate the impact of environmental problems. To best manage the potential costs of environmental disasters, governments should both attempt to prevent it happening, and prepare to deal with the damages if it necessary.
Through subsidisation, the government can help entities within its nation overcome the high upfront costs often associated with adapting cleaner energy production methods. Through the subsidisation of solar power, Germany has enough photovoltaic cells to cover approximately 7.5 percent of its net electricity consumption (Fraunhofer ISE, 2016). It must be noted, however, that the support provided by the German government is not technically speaking a subsidy, but rather a surcharge. This surcharge, however, provides both commercial and self-use producers of electricity with a guaranteed monetary boost based on “the difference between costs paid and revenues received … [and that] the cumulative costs paid out for PV power … up to and including 2015 amounted to around 62 billion euros” (Fraunhofer ISE, 2016). Furthermore, Germany is also subsidising electric vehicles through a plan that will give consumers a per unit reward of 4,000 euros for purely electric vehicles provided it costs less than 60,000 euros (Guardian, 2016). The subsidy is part of a government effort to bring the number of electric cars in germany up to 1 million. It should be noted, however, that an increase in the number of electric cars, will not necessarily decrease the emission of greenhouse gasses if the energy used to power the vehicle comes from fossil fuel. The increase in electric cars should, therefore, go hand in hand with an increase in the clean energy network. If, through further monetary support, the use of renewable energy can overtake the use of fossil fuels, the danger posed by environmental catastrophes resulting from global warming will be significantly diminished.
The existence of dirty subsidies undermines the ability of the green subsidies to protect the environment. For example, according to ODI (2015) “G20 country governments are providing $444 billion a year in subsidies for the production of fossil fuels”, which, according to the International Energy Agency (2014) is more than four times the amount given to renewable energy. If the renewable energy subsidies are to have any significant effect, a sizable amount of the subsidies going to industries like petroleum and coal mining must be diverted to renewables like wind and hydroelectric power.
Through quotas and permits, the government can dynamically reward and punish efficient and inefficient producers respectively. Emissions trading (or cap and trade) is the application of quotas and permits to regulating the emissions of pollutants; it works through the government releasing a certain amount of pollution allowances. All companies must possess allowances equal to or greater than their specific emission levels. Furthermore since producers are able to buy and sell these allowances, producers that pollute less will be rewarded through money earned from these sales, thus incentivising further technological research intended to make the environmental production costs lower. When the allocation of pollution permits is left to the free market, the producers who can most cheaply abate their pollution levels should, in the long run, end up being the ones who do so, ensuring that the emission reduction inflicts the least possible amount of social cost (Montgomery, 1972). One example of the use of quotas to reduce emissions is the EU Emissions Trading System (ETS), which aims to reduce carbon dioxide emissions in the EU.