Social Econ Blog

I'll give an introduction to the tools of game theory and applications to environmental problems on Monday. Read pages 127-137 in Gibbons "An introduction to applicable game theory." You might skim the rest of the article if you're interested in the topic but it gets a bit more technical than we'll go in class.

Here's the link to the PSU download if the above doesn't work for you.

We'll go over the important points but try to come away with an understanding of the structure of the analysis (games, players, payoffs, strategies), what is meant by an equilibrium, and how we identify equilibria. Think about opportunities to apply the concepts for environmental problems, and what kinds of challenges likely arise to using these tools and models in the real world.

If you are looking for an additional explanation of the difference between a cap and trade scheme and a carbon tax, I think this document does a nice job:

The Basic Economics of Carbon Permits Versus Carbon Taxes

We'll continue to discuss implemented and proposed approaches to carbon mitigation at the multi-national scale on Wednesday. Read "The European Union Emissions Trading Scheme: Origins, Allocation, and Early Results". The article is on pages 66-87 of the journal issue available here.

Several other articles in the issue are directly relevant to topics we're discussing, but aren't required. Topics I discuss on Monday in class will identify the points from the article to be sure to catch.

A. Denny Ellerman, Barbara K. Buchner . The European Union Emissions Trading Scheme: Origins, Allocation, and Early Results. Review of Environmental Economics and Policy, Volume 1, Number 1 (January 2007), pp. 66-87.

You're focused on your proposals for Monday so you don't have to do much prep for Monday. We'll hold the substantial readings for Wednesday. If you have time though, read through the Wikipedia description of the European Union Emission Trading Scheme. It will be useful reference for Wednesday and after as well.

The definitive economic analysis of climate change was lead by economist Nicholas Stern, typically referred to as the Stern Review. A good place to start, and your reading for Wednesday, is Chapter 2 on the economics of climate change. If you'd like more context you can skim the overall report summaries or other chapters here (not required).

This reading provides a box identifying the key messages of the chapter. You should focus on these themes while reading the chapter.

Monday and Wednesday we'll be talking about taxes and payment/market-based approaches to pollution management and ecosystem service provision. You don't have any assigned readings for Monday so you can focus on your Policy Analysis proposal, but here are a few useful brief introductions to topics we'll discuss, and they should serve as good references later for you.

Paul Krugman has a very simple comparison of taxes vs. cap-and-trade here as a nice introduction.

Canadian economist Stephen Gordon gives you a little more detail in his comparison here.

Haab and Whitehead have a more detailed explanation from the perspective of polluting firms.

After reading these posts and our discussion in class, you should understand the basics of taxes and cap-and-trade programs and their pros and cons, from a carbon perspective. The same ideas applied to carbon can be applied to other pollutants and ecosystem services, with varied success. We'll get to more on that later.

The definitive study on the existence value of salmon in the Northwest is Layton, Brown and Plummer (1999). For an increase in salmon returning to Puget Sound, they found values ranging from $200-$550 per fish. This does not include use values such as recreation and fishing, and is based on households in the Northwest only. Adjusting for inflation the high end gets a little over $700.

A recent state audit in Washington found expenditures by the state of $768 for each blackmouth chinook salmon caught in Puget Sound.

Looks like the current price of a whole salmon at Pike Place Market right now is $72.

A fishing trip with a charter company in Puget Sound right now costs $170.

Next week we will continue to explore the value of natural capital and, in particular, how do we actually calculate dollar values for this stuff.

Please read chapter 7 from these EPA guidelines.

We also recommend this newer, draft EPA document (chapter 4 has the relevant content, but the rest of the document you might find interesting).

These figures from chapter 4 provide a nice summary:

One more from the archive. You should read the article linked below before class on Monday (we will post additional readings for next week later):

The discussion of valuing lives in the comment thread below is great. In case anyone is still struggling with the approach used by economists, Steven Landsburg (an economics professor at Rochester who also writes a column for Slate) provides more discussion and several examples in this column. He also cites some evidence that shows that lives today are more valuable than lives in the past (because we are richer):

So, how do we find out how much a life is really worth? One of the best ways is to measure how much extra you have to pay someone to take a dangerous job. If lion tamers and elephant tamers have comparable skills and comparable working conditions, but lion tamers earn $20,000 a year more than elephant tamers, it's probably because that's what it takes to compensate someone for the risk of being eaten by a lion. And if that risk amounts to, say, an extra half-percent probability of dying on the job, then you figure that the value of a life must be $20,000 per half-percent, or $40,000 per percentage point, or $4 million.

So, once you carry out that experiment, how much does a typical life turn out to be worth? Professors Dora Costa of MIT and Matthew Kahn of Tufts point out that it depends on exactly when you asked the question. As incomes have risen, so has the value of life. The increase is more than proportional: A 10 percent rise in income is generally associated with about a 15 percent rise in the value of a life. Between 1940 and 1980, according to Costa and Kahn, the value of a life increased from about $1 million 1990 dollars to between $4 million and $5 million 1990 dollars.

(Other researchers, notably Harvard's Kip Viscusi, have found higher numbers. Viscusi estimates that the value of a life in 1970 might already have been as high as $8 million 1990 dollars.)

If lives tomorrow may be worth significantly more than lives today, I think this poses some additional difficulties for figuring out what to do about long term environmental problems.

From another old blog post:

General Counsel for the Department of Defense, William Haynes II resigned yesterday. Haynes was in charge of the tribunals for Guantanamo detainees and is reported to have said:

"I said to him that if we come up short and there are some acquittals in our cases, it will at least validate the process," Davis continued. "At which point, [Haynes's] eyes got wide and he said, 'Wait a minute, we can't have acquittals. If we've been holding these guys for so long, how can we explain letting them get off? We can't have acquittals. We've got to have convictions.'"

Furthermore, he's one of the primary authors of memos supporting torture and total executive authority (essentially arguing that when the President is acting as Commander-in-Chief he get's to do whatever he wants -- regardless of the law).

But before he got around to torture and detainees Haynes offered a very interesting argument about how bombing natural capital (bird nesting sites) was good because it would increase the value of the remaining natural capital:
In this amazing brief, Haynes argued that bombing a nesting site for migratory birds would benefit birdwatchers, since “bird watchers get more enjoyment spotting a rare bird than they do spotting a common one.” Moreover, he added, the birds would benefit as well, since using their nests as a bombing range would minimize “human intrusion”. The judge’s comment on this novel line of argument: “there is absolutely no support in the law for the view that environmentalists should get enjoyment out of the destruction of natural resources because that destruction makes the remaining resources more scarce and therefore more valuable. The Court hopes that the federal government will refrain from making or adopting such frivolous arguments in the future.” (pp. 27-8)” ...

From an old blog post:

...a couple of economists published an article in Science that pointed out that over-harvesting the fisheries was (surprise) not profit-maximizing for the fishermen. They report:

A new and compelling argument for reducing fish harvests – the profit motive – could persuade world fishers to endure the short-term pain of lower catches for the long-term gain of higher returns for their labor, according to authors of a ground-breaking study on fisheries over-exploitation.

They say their findings, published in the journal Science Dec. 7, will help overcome a key cause of over-fishing – industry opposition to lower catches – by demonstrating that when stocks are allowed to recover, profits take a sharp turn upward.

“It has always been assumed that maximizing fishing profits will lead to stock depletion and possibly even extinction of some commercial species,” says co-author Quentin Grafton, research director at the Crawford School of Economics and Government at the Australian National University (ANU) and one of the co-authors of the paper “Economics of Over-exploitation Revisited.”

“But our results prove that the highest profits are made when fish numbers are allowed to rise beyond levels traditionally considered optimal. In other words, bigger stocks mean bigger bucks.”

The simple reason is “the stock effect”: when fish are more plentiful and thus easier to catch, fishers don’t have to spend as much on fuel and other costs to fill their nets – profits are higher.

Paul Krugman has a nice summary article in the NYTimes about climate change economics. You all should read it. It even includes his own quick Enviro Econ 101:

Environmental Econ 101
If there’s a single central insight in economics, it’s this: There are mutual gains from transactions between consenting adults. If the going price of widgets is $10 and I buy a widget, it must be because that widget is worth more than $10 to me. If you sell a widget at that price, it must be because it costs you less than $10 to make it. So buying and selling in the widget market works to the benefit of both buyers and sellers. More than that, some careful analysis shows that if there is effective competition in the widget market, so that the price ends up matching the number of widgets people want to buy to the number of widgets other people want to sell, the outcome is to maximize the total gains to producers and consumers. Free markets are “efficient” — which, in economics-speak as opposed to plain English, means that nobody can be made better off without making someone else worse off.

Now, efficiency isn’t everything. In particular, there is no reason to assume that free markets will deliver an outcome that we consider fair or just. So the case for market efficiency says nothing about whether we should have, say, some form of guaranteed health insurance, aid to the poor and so forth. But the logic of basic economics says that we should try to achieve social goals through “aftermarket” interventions. That is, we should let markets do their job, making efficient use of the nation’s resources, then utilize taxes and transfers to help those whom the market passes by.

But what if a deal between consenting adults imposes costs on people who are not part of the exchange? What if you manufacture a widget and I buy it, to our mutual benefit, but the process of producing that widget involves dumping toxic sludge into other people’s drinking water? When there are “negative externalities” — costs that economic actors impose on others without paying a price for their actions — any presumption that the market economy, left to its own devices, will do the right thing goes out the window. So what should we do? Environmental economics is all about answering that question.

One way to deal with negative externalities is to make rules that prohibit or at least limit behavior that imposes especially high costs on others. That’s what we did in the first major wave of environmental legislation in the early 1970s: cars were required to meet emission standards for the chemicals that cause smog, factories were required to limit the volume of effluent they dumped into waterways and so on. And this approach yielded results; America’s air and water became a lot cleaner in the decades that followed.

But while the direct regulation of activities that cause pollution makes sense in some cases, it is seriously defective in others, because it does not offer any scope for flexibility and creativity. Consider the biggest environmental issue of the 1980s — acid rain. Emissions of sulfur dioxide from power plants, it turned out, tend to combine with water downwind and produce flora- and wildlife-destroying sulfuric acid. In 1977, the government made its first stab at confronting the issue, recommending that all new coal-fired plants have scrubbers to remove sulfur dioxide from their emissions. Imposing a tough standard on all plants was problematic, because retrofitting some older plants would have been extremely expensive. By regulating only new plants, however, the government passed up the opportunity to achieve fairly cheap pollution control at plants that were, in fact, easy to retrofit. Short of a de facto federal takeover of the power industry, with federal officials issuing specific instructions to each plant, how was this conundrum to be resolved?

Enter Arthur Cecil Pigou, an early-20th-century British don, whose 1920 book, “The Economics of Welfare,” is generally regarded as the ur-text of environmental economics.

Somewhat surprisingly, given his current status as a godfather of economically sophisticated environmentalism, Pigou didn’t actually stress the problem of pollution. Rather than focusing on, say, London’s famous fog (actually acrid smog, caused by millions of coal fires), he opened his discussion with an example that must have seemed twee even in 1920, a hypothetical case in which “the game-preserving activities of one occupier involve the overrunning of a neighboring occupier’s land by rabbits.” But never mind. What Pigou enunciated was a principle: economic activities that impose unrequited costs on other people should not always be banned, but they should be discouraged. And the right way to curb an activity, in most cases, is to put a price on it. So Pigou proposed that people who generate negative externalities should have to pay a fee reflecting the costs they impose on others — what has come to be known as a Pigovian tax. The simplest version of a Pigovian tax is an effluent fee: anyone who dumps pollutants into a river, or emits them into the air, must pay a sum proportional to the amount dumped.

Pigou’s analysis lay mostly fallow for almost half a century, as economists spent their time grappling with issues that seemed more pressing, like the Great Depression. But with the rise of environmental regulation, economists dusted off Pigou and began pressing for a “market-based” approach that gives the private sector an incentive, via prices, to limit pollution, as opposed to a “command and control” fix that issues specific instructions in the form of regulations.

The initial reaction by many environmental activists to this idea was hostile, largely on moral grounds. Pollution, they felt, should be treated like a crime rather than something you have the right to do as long as you pay enough money. Moral concerns aside, there was also considerable skepticism about whether market incentives would actually be successful in reducing pollution. Even today, Pigovian taxes as originally envisaged are relatively rare. The most successful example I’ve been able to find is a Dutch tax on discharges of water containing organic materials.

What has caught on instead is a variant that most economists consider more or less equivalent: a system of tradable emissions permits, a k a cap and trade. In this model, a limited number of licenses to emit a specified pollutant, like sulfur dioxide, are issued. A business that wants to create more pollution than it is licensed for can go out and buy additional licenses from other parties; a firm that has more licenses than it intends to use can sell its surplus. This gives everyone an incentive to reduce pollution, because buyers would not have to acquire as many licenses if they can cut back on their emissions, and sellers can unload more licenses if they do the same. In fact, economically, a cap-and-trade system produces the same incentives to reduce pollution as a Pigovian tax, with the price of licenses effectively serving as a tax on pollution.

In practice there are a couple of important differences between cap and trade and a pollution tax. One is that the two systems produce different types of uncertainty. If the government imposes a pollution tax, polluters know what price they will have to pay, but the government does not know how much pollution they will generate. If the government imposes a cap, it knows the amount of pollution, but polluters do not know what the price of emissions will be. Another important difference has to do with government revenue. A pollution tax is, well, a tax, which imposes costs on the private sector while generating revenue for the government. Cap and trade is a bit more complicated. If the government simply auctions off licenses and collects the revenue, then it is just like a tax. Cap and trade, however, often involves handing out licenses to existing players, so the potential revenue goes to industry instead of the government.

Politically speaking, doling out licenses to industry isn’t entirely bad, because it offers a way to partly compensate some of the groups whose interests would suffer if a serious climate-change policy were adopted. This can make passing legislation more feasible.

These political considerations probably explain why the solution to the acid-rain predicament took the form of cap and trade and why licenses to pollute were distributed free to power companies. It’s also worth noting that the Waxman-Markey bill, a cap-and-trade setup for greenhouse gases that starts by giving out many licenses to industry but puts up a growing number for auction in later years, was actually passed by the House of Representatives last year; it’s hard to imagine a broad-based emissions tax doing the same for many years.

That’s not to say that emission taxes are a complete nonstarter. Some senators have recently floated a proposal for a sort of hybrid solution, with cap and trade for some parts of the economy and carbon taxes for others — mainly oil and gas. The political logic seems to be that the oil industry thinks consumers won’t blame it for higher gas prices if those prices reflect an explicit tax.

In any case, experience suggests that market-based emission controls work. Our recent history with acid rain shows as much. The Clean Air Act of 1990 introduced a cap-and-trade system in which power plants could buy and sell the right to emit sulfur dioxide, leaving it up to individual companies to manage their own business within the new limits. Sure enough, over time sulfur-dioxide emissions from power plants were cut almost in half, at a much lower cost than even optimists expected; electricity prices fell instead of rising. Acid rain did not disappear as a problem, but it was significantly mitigated. The results, it would seem, demonstrated that we can deal with environmental problems when we have to.

So there we have it, right? The emission of carbon dioxide and other greenhouse gases is a classic negative externality — the “biggest market failure the world has ever seen,” in the words of Nicholas Stern, the author of a report on the subject for the British government. Textbook economics and real-world experience tell us that we should have policies to discourage activities that generate negative externalities and that it is generally best to rely on a market-based approach.

Here's a link to an Excel file holding the fishery game spreadsheet (scroll down to "Download Now") I put together and tried to use in class on Monday. I had some parameter differences that confused things, but you can manipulate any cells in yellow to get a sense, and walk through a few rounds of decisions. A graph to the right of the columns plots the overall annual state. The first sheet is blank and the second is an example of the most rapid exhaustion possible. Ignore the error messages for cells below

This isn't an assignment, just something to play with if you're interested. A few questions to think about:

What happens to a company that doesn't buy boats as quickly as possible but rather waits?

Are there any signals that the fishery is being depleted? If a company knows the fishery is nearing depletion, is it better to accelerate harvest or slow down? From an individual company's perspective, is it ever better to not send a boat to fish?

From a purely profit-based motive, how would you identify the best strategy for a company? How would this strategy be dependent on the strategies of other companies?

Think about how you would design rules for a fishery to prevent depletion. We'll be looking at policies and incentives for fishery management in more detail later.

We'll discuss ecosystem services on Wednesday.

The first reading comes from the Millenium Ecosystem Assessment: Ecosystems and Human Well-Being. Read the first two paragraphs of the Foreward (p. ii), the entire Preface (p. v-ix), and the Summary for Decision-Makers (p. 1-24). If the link doesn't work, use http://www.millenniumassessment.org/en/index.aspx and of the Synthesis Reports, go to the Overall Synthesis.

The second reading by Costanza et al. (1997) addresses an attempt to assign values to global ecosystem services. It's from the journal Nature, and available with PSU's online access (and elsewhere if you google the title).

Costanza, R., R. D'arge, R. De Groot, S. Farber, M. Grasso, B. Hannon, K. Limburg, S. Naeem, R.V. O'neill, J. Paruelo, R.G. Raskin, P. Sutton and M. Van Den Belt. 1997. The value of the world's ecosystem services and natural capital. Nature 387: 253-60.

Contact me if you can't access the readings.

Sorry for the delay getting this posted. Please try and read the two articles below before class on Monday:

Garrett Hardin's original article in Science that described the tragedy of the commons.

One of Ostrom (and co-authors) follow-up articles, also in Science, but not easily linked. You should be able to find it on your own:

Ostrom, E., J. Burger, C.B. Field, R.B. Norgaard and D. Policansky. 1999.
Revisiting the commons: Local lessons, global challenges. Science 284:
278-82.

Also, don't forget, our first small quiz is on Monday. 1-2 questions based on the review material from Wednesday.

Last fall, Elinor Ostrom shared the Nobel prize for economics (here are some other links on the prize). Her work focuses on one of our topics for Monday -- the Tragedy of the Commons -- in particular how people solve this problem. Here's an excerpt from a recent interview (I recommend reading the whole thing):

Fran: Many people associate “the commons” with Garrett Hardin’s famous essay, “The Tragedy of the Commons.” He says that if, for example, you have a pasture that everyone in a village has access to, then each person will put as many cows on that land as he can to maximize his own benefit, and pretty soon the pasture will be overgrazed and become worthless. What’s the difference between your perspective and Hardin’s?

Elinor: Well, I don’t see the human as hopeless. There’s a general tendency to presume people just act for short-term profit. But anyone who knows about small-town businesses and how people in a community relate to one another realizes that many of those decisions are not just for profit and that humans do try to organize and solve problems.

If you are in a fishery or have a pasture and you know your family’s long-term benefit is that you don’t destroy it, and if you can talk with the other people who use that resource, then you may well figure out rules that fit that local setting and organize to enforce them. But if the community doesn’t have a good way of communicating with each other or the costs of self-organization are too high, then they won’t organize, and there will be failures.

Fran: So, are you saying that Hardin is sometimes right?

Elinor: Yes. People say I disproved him, and I come back and say “No, that’s not right. I’ve not disproved him. I’ve shown that his assertion that common property will always be degraded is wrong.” But he was addressing a problem of considerable significance that we need to take seriously. It’s just that he went too far. He said people could never manage the commons well.

On a sort of related topic, I recommend this post (and the original post it cites) about how comedians deal with intellectual property violations in a field without copyright law.