Economics of the Environment

The Sixth Edition of Economics of the Environment: Selected Readings has just been published by W. W. Norton & Company of New York and London.  Through five previous editions, Economics of the Environment has served as a valuable supplement to environmental economics texts and as a stand-alone book of original readings in the field of environmental economics.  Nearly seven years have passed since the previous edition of this volume was published, and it is now more than three decades since the first edition appeared, edited by Robert and Nancy Dorfman.  The Sixth Edition continues this tradition.

Motivation and Audience

Environmental economics continues to evolve from its origins as an obscure application of welfare economics to a prominent field in its own right, which combines elements from public finance, industrial organization, microeconomic theory, and many other areas of economics.  The number of articles on the environment appearing in mainstream economics periodicals continues to increase, and more and more economics journals are dedicated exclusively to environmental and resource topics.

There has also been a proliferation of environmental economics textbooks for college courses.  Many are excellent, but none can be expected to provide direct access to timely and original contributions by the field’s leading scholars.  As most teachers of economics recognize, it is valuable to supplement the structure and rigor of a text with original readings from the literature.

Scope and Style

With that in mind, this new edition of Economics of the Environment consists of thirty-four chapters that instructors will find to be of great value as a complement to their chosen text and their lectures.  The scope is comprehensive, and the list of authors is a veritable “who’s who” of environmental economics, including:  Joseph Aldy, Kenneth Arrow, Trudy Cameron, Ronald Coase, Maureen Cropper, Peter Diamond, George Eads, Jeffrey Frankel, Rick Freeman, Don Fullerton, Lawrence Goulder, John Graham, Robert Hahn, Michael Hanemann, Jerry Hausman, Steven Kelman, Nathaniel Keohane, Alan Krupnick, Lester Lave, John Livernois, Eric Maskin, Leonardo Maugeri, Gilbert Metcalf, Richard Newell, Roger Noll, William Nordhaus, Wallace Oates, Sheila Olmstead, Elinor Ostrom, Karen Palmer, Ian Parry, Carl Pasurka, Robert Pindyck, William Pizer, Michael Porter, Paul Portney, Forest Reinhardt, Richard Revesz, Milton Russell, Michael Sandel, Richard Schmalensee, Steven Shavell, Jason Shogren, Kerry Smith, Robert Solow, Nicholas Stern, Laura Taylor, Richard Vietor, and myself.

The articles are timely, with more than 90 percent published since 1990, and half since 2005.  There are two completely new sections of the book, “Economics of Natural Resources” and “Corporate Social Responsibility,” and all of the chapters in the section on global climate change are new to the sixth edition.

In order to make the readings in Economics of the Environment accessible to students at all levels, one criterion I use in the selection process is that articles should not only be original and well written — and meet the highest standards of economic scholarship — but also be non-technical in their presentations.  Hence, readers will find virtually no formal mathematics in any of the book’s 34 chapters throughout its 733 pages.

The Path Ahead

Environmental economics is a rapidly evolving field.  Not only do new theoretical models and improved empirical methods appear on a regular basis, but entirely new areas of investigation open up when the natural sciences indicate new concerns or the policy world turns to new issues.  Therefore, this book remains a work in progress.  I owe a great debt to the teachers and students of previous editions who have sent their comments and suggestions for revisions.  Looking to future editions, I invite all readers — whether teachers, students, or practitioners — to send me any thoughts or suggestions for improvement.

In the meantime, if you’re interested finding out more about the book, immediately below is a chapter-by-chapter summary of the book.  Alternatively, you can check out the W. W. Norton or Amazon web sites.

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Appendix:  A Summary of Economics of the Environment, Sixth Edition

Part I of the volume provides an overview of the field and a review of its foundations.  Don Fullerton and I start things off with a brief essay about how economists think about the environment (Nature 1998).  This is followed by the classic treatment of social costs and bargaining by Ronald Coase (Journal of Law and Economics 1960), and a new article by Jason Shogren and Laura Taylor on the important, emerging field of behavioral environmental economics (Review of Environmental Economics and Policy 2008).

The Costs of Environmental Protection

Part II examines the costs of environmental protection, which might seem to be without controversy or current analytical interest.  This is not, however, the case.  This section begins with a survey article by Carl Pasurka that reviews the theory and empirical evidence on the relationship between environmental regulation and so-called “competitiveness” (Review of Environmental Economics and Policy 2008).

A somewhat revisionist view is provided by Michael Porter and Class van der Linde, who suggest that the conventional approach to thinking about the costs of environmental protection is fundamentally flawed (Journal of Economic Perspectives 1995).  Karen Palmer, Wallace Oates, and Paul Portney provide a careful response (Journal of Economic Perspectives 1995).

The Benefits of Environmental Protection

In Part III, the focus turns to the other side of the analytic ledger — the benefits of environmental protection.  This is an area that has been even more contentious — both in the policy world and among scholars.  Here the core question is whether and how environmental amenities can be valued in economic terms for analytical purposes.

The book features a provocative debate on the stated-preference method known as “contingent valuation.”  Paul Portney outlines the structure and importance of the debate, Michael Hanemann makes the affirmative case, and Peter Diamond and Jerry Hausman provide the critique (all three articles are from the Journal of Economic Perspectives 1994).

In the final article in Part III, the book turns to a concept that is both very important in assessments of the benefits of environmental regulations and is also very widely misunderstood — the value of a statistical life.  In an insightful essay, Trudy Cameron seeks to set the record straight (Review of Environmental Economics and Policy 2010).

There are two principal policy questions that need to be addressed in the environmental realm:  how much environmental protection is desirable; and how should that degree of environmental protection be achieved.  The first of these questions is addressed in Part IV and the second in Part V.

The Goals of Environmental Policy:  Economic Efficiency and Benefit-Cost Analysis

In an introductory essay, Kenneth Arrow, Maureen Cropper, George Eads, Robert Hahn, Lester Lave, Roger Noll, Paul Portney, Milton Russell, Richard Schmalensee, Kerry Smith, and I ask whether there is a role for benefit-cost analysis to play in environmental, health, and safety regulation (Science 1996).

Then, Lawrence Goulder and I focus on an ingredient of benefit-cost analysis that non-economists seem to find particularly confusing, or even troubling — intertemporal discounting (Nature 2002).  Next, Robert Pindyck examines a subject of fundamental importance — the role of uncertainty in environmental economics (Review of Environmental Economics and Policy 2007).  Steven Kelman provides an ethically-based critique of benefit-cost analysis, which is followed by a set of responses (Regulation 1981).

Part IV concludes with an up-to-date essay by John Graham on the critical role of the U.S. Office of Management and Budget in federal regulatory impact analysis (Review of Environmental Economics and Policy 2008).

The Means of Environmental Policy:  Cost Effectiveness and Market-Based Instruments

Part V examines the policy instruments — the means — that can be employed to achieve environmental targets or goals.  This is an area where economists have made their greatest inroads of influence in the policy world, with tremendous changes having taken place over the past twenty  years in the reception given by politicians and policy makers to so-called market-based or economic-incentive instruments for environmental protection.

Lawrence Goulder and Ian Parry start things off with a broad-ranging essay on instrument choice in environmental policy (Review of Environmental Economics and Policy 2008).  Following this, I examine lessons that can be learned from the innovative sulfur dioxide allowance trading program, set up by the Clean Air Act Amendments of 1990 (Journal of Economic Perspectives 1998).  Finally, Michael Sandel provides a critique of market-based instruments, with responses offered by Eric Maskin, Steven Shavell, and others (New York Times 1997).

Economics of Natural Resources

Part VI consists of three essays on a new topic for this book — the economics of natural resources.  First, John Livernois examines the empirical significance of a central tenet in natural resource economics, namely the Hotelling Rule — the proposition that under conditions of efficiency, the scarcity rent (price minus marginal extraction cost) of natural resources will rise over time at the rate of interest (Review of Environmental Economics and Policy 2009).

Essays by Leonardo Maugeri (Review of Environmental Economics and Policy 2009) and Sheila Olmstead (Review of Environmental Economics and Policy 2010), respectively, examine two particularly important resources:  petroleum and water.

The next four sections of the book treat some timely and important topics and problems.

Corporate Social Responsibility and the Environment

Part VII examines corporate social responsibility and the environment, discussion of which has too often been characterized by more heat than light.  Forest Reinhardt, Richard Vietor, and I provide an overview of this realm from the perspective of economics, examining the notion of firms voluntarily sacrificing profits in the social interest.  In a second essay, Paul Portney provides a valuable empirical perspective (both are from the Review of Environmental Economics and Policy 2008).

Global Climate Change

Part VIII is dedicated to investigations of economic dimensions of global climate change, which may in the long term prove to be the most significant environmental problem that has arisen, both in terms of its potential damages and in terms of the costs of addressing it.  First, a broad overview of the topic is provided in a survey article by Joseph Aldy, Alan Krupnick, Richard Newell, Ian Parry, and William Pizer (Journal of Economic Literature 2010).

Next, William Nordhaus critiques the well-known Stern Review on the Economics of Climate Change, and Nicholas Stern and Chris Taylor respond (both are from Science 2007).  In the final essay in this section, Gilbert Metcalf examines market-based policy instruments that can be used to address greenhouse gas emissions (Journal of Economic Perspectives 2009).

Sustainability, the Commons, and Globalization

Part IX begins with Robert Solow’s economic perspective on the concept of sustainability.  This is followed by Elinor Ostrom’s development of a general framework for analyzing sustainability (Science 2009), and my own historical view of economic analysis of problems associated with open-access resources (American Economic Review 2011).  Then, Jeffrey Frankel draws on diverse sources of empirical evidence to examine whether globalization is good or bad for the environment (Council on Foreign Relations 2004).

Economics and Environmental Policy Making

The final section of the book, Part X, departs from the normative concerns of much of the volume to examine some interesting and important questions of political economy.  It turns out that an economic perspective can provide useful insights into questions that might at first seem to be fundamentally political.

Nathaniel Keohane, Richard Revesz, and I utilize an economic framework to ask why our political system has produced the particular set of environmental policy instruments it has (Harvard Environmental Law Review 1998).  Myrick Freeman reflects on the benefits that U.S. environmental policies have brought about since the first Earth Day in 1970 (Journal of Economic Perspectives 2002).  Lastly, Robert Hahn addresses the question that many of the articles in this volume raise:  what impact has economics actually had on environmental policy (Journal of Environmental Economics and Management 2000)?

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What’s Good for the Goose is Good for the Gander: Rahm’s Doctrine and Mercutio’s Complaint

In a January 2009 article – “The Big Fix” – in the New York Times Magazine, David Leonhardt introduced a frequently-employed political strategy into popular political culture by identifying it with the new President’s Chief of Staff, Rahm Emanuel:

Two weeks after the election, Rahm Emanuel, Obama’s chief of staff, appeared before an audience of business executives and laid out an idea that Lawrence H. Summers, Obama’s top economic adviser, later described to me as Rahm’s Doctrine. “You never want a serious crisis to go to waste,” Emanuel said. “What I mean by that is that it’s an opportunity to do things you could not do before.” … That’s the crux of the doctrine.

Exploiting a Crisis

Stated less sympathetically, perhaps, the argument seems to be that sensible political strategy calls for exploiting the existence of a crisis by using it as an opportunity (excuse) to pursue policies you want, whether or not they are the best responses to the specific crisis. The crisis in this case was the worst recession since the Great Depression, and the “opportunities” on the new President’s mind were ambitious policies for health care costs and coverage, energy and climate change, and taxes.

Killing Two Birds with One Stone: Fixing the Economy and the Environment

At about the same time that Leonhardt’s article appeared in the New York Times Magazine, Elizabeth Kolbert’s profile of green jobs activist Van Jones, “Greening the Ghetto: Can a Remedy Serve for Both Global Warming and Poverty,” was published in The New Yorker. Kolbert included the following passage:

When I presented Jones’s arguments to Robert Stavins, a professor of business and government at Harvard who studies the economics of environmental regulation, he offered the following analogy: “Let’s say I want to have a dinner party. It’s important that I cook dinner, and I’d also like to take a shower before the guests arrive. You might think, Well, it would be really efficient for me to cook dinner in the shower. But it turns out that if I try that I’m not going to get very clean and it’s not going to be a very good dinner. And that is an illustration of the fact that it is not always best to try to address two challenges with what in the policy world we call a single policy instrument.”

I elaborated on that analogy and explained my concerns about the “greening of the economic stimulus package” (one element of the White House attempt “not to let a serious crisis go to waste”) in my essay on “Green Jobs” at this blog in March, 2009.

Two activities — each with a sensible purpose — can be very effective if done separately, but sometimes combining them means that one does a poor job with one, the other, or even both. In the policy world, such dual-purpose policy instruments are sometimes a good, even great idea, but other times, they are not. Whether trying to kill two birds with one stone makes sense depends upon the proximity of the birds, the weapon being used, and the accuracy of the stoner. In the real world of important policy challenges — such as environmental degradation and economic recession — these are empirical questions and need to be examined case by case.

In this case, it was (and is) important to separate the two issues: (1) environmental degradation (which in economic terms calls for pricing the externality, i.e. getting relative prices right); and (2) the economic downturn (which calls for increasing and maintaining aggregate demand in the economy). Environmental regulations address the first issue, while broad-based fiscal and/or monetary policies address the second. So, in economic terms, the imperative is to get relative prices right (internalize externalities), and avoid tilting an economic stimulus package toward any particular type of activity (such as “green jobs”).

I argued in my March, 2009 essay (and argue now) that addressing the worst economic recession in generations called for the most effective economic stimulus package that could be devised, not a stimulus package that was diminished in effectiveness through excessive bells and whistles meant to address a myriad of other (legitimate) social concerns. (And, likewise, getting serious about global climate change would require the enactment and implementation of meaningful, dedicated climate policies.)

By the way, I do not wish to add any fuel to the current political fire raging over the bankruptcy of Solyndra, the solar power manufacturer supported by a $500 million Federal loan guarantee under the stimulus package. The failure of Solyndra was largely due to the collapse of silicon prices and the consequent increased competitiveness of conventional solar cell technologies. I will leave it to others to debate whether the government should have seen this coming.

My point rather is that there is a strong counterargument to Rahm’s Doctrine, and that counterargument is – in the words again of David Leonhardt – “hardly trivial — namely, that the financial crisis is so serious that the administration shouldn’t distract itself with other matters. That is a risk, as is the additional piling on of debt for investments that might not bear fruit for a long while.”

That’s the Goose – What About the Gander?

Do not think for a moment that only Democrats are quick to subscribe to and employ Rahm’s Doctrine. On the contrary, Republicans – particularly the ultra-conservative ones that are coming to dominate the Party – have recently embraced it with breathtaking enthusiasm by exploiting national concerns about the sluggish economy and stubbornly high levels of unemployment in order to pursue their anti-regulatory agenda and focused attack on the U.S. Environmental Protection Agency.

As I have also written at this blog (“Good News from the Regulatory Front,” April 25, 2011), the blanket characterization of environmental regulations as “job killers” is simply inconsistent with decades of economic research. In the short term, new environmental regulations can have either positive or negative effects on employment in particular sectors, but in the long term, their employment impacts are trivial when compared with those of the overall set of factors that affect national employment levels. Attacking EPA “to save jobs” is a shameful attempt to exploit economic fears in pursuit of an ideological agenda (whether or not that agenda has social merit).

Enter Mercutio

So, as is so often the case, this economist (like many – maybe most – others) disagrees with the economic arguments put forward by both sides in the political world. Talking about “job-killing environmental regulations” is dishonest, and no more than another cynical application of Rahm’s Doctrine. But the same must be said about the “greening of the stimulus,” and the ongoing, bloated claims about “clean energy jobs.” As usual, those of us in the moderate middle are left to echo Mercutio’s censure: “A plague o’ both your houses!”

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The Credit Downgrade and the Congress: Why Polarized Politics Paralyze Public Policy

There’s room for debate about whether U.S. government deficits justify Standard & Poor’s downgrading last week of long-term U.S. debt, but the more important factor cited in S&P’s report is that “the effectiveness, stability, and predictability of American policymaking and political institutions have weakened…” The S&P team emphasizes that “the difficulties in bridging the gulf between the political parties … makes us pessimistic about the capacity of Congress and the Administration” to address the crucial problems the country faces.

Although these S&P judgments were intended to refer exclusively to fiscal policy, they really apply to a much broader set of issues, ranging from economic to health to environmental policies. The key reality is this: there is a widening gulf between the two political parties that is paralyzing sensible policy action.

Political Polarization

This increasing polarization between the political parties has shown up in a number of studies by political scientists employing a diverse set of measures that place roll-call votes by members of Congress on an ideological spectrum from extreme right to extreme left. This polarization – the disappearance of moderates – has been taking place for four decades. The rise of the Tea Party movement within the Republican Party is only the most recent vehicle that has continued a 40-year trend.

Why has this collapse of the middle taken place; why has party polarization increased so dramatically in the Congress over the past 40 years? In my view, three structural factors stand out.

Three Structural Factors

First, there has been the increasing importance of the primary system, a consequence of the “democratization” of the nomination process that took flight in the 1970s. A small share of the electorate vote in primaries, namely those with the strongest political preferences – the most conservative Republicans and the most liberal Democrats. This self-selection greatly favors candidates from the extremes.

Second, decades of redistricting – a state prerogative guaranteed by the Constitution – has produced more and more districts that are dominated by either Republican or Democratic voters. This increases the importance of primary elections, which is where the key choices among candidates are now made in many Congressional districts. Because of this, polarization has proceeded at a much more rapid pace in the House than in the Senate.

Third, the increasing cost of electoral campaigns greatly favors incumbents (with the ratio of average incumbent-to-challenger financing now exceeding 10-to-1). This tends to make districts relatively safe for the party that controls the seat, thereby increasing the importance of primaries.

These three factors operate mainly through the replacement of members of Congress (whether due to death, retirement, or challenges from within the party) – that is, the ideological shifts that cause increasing polarization largely occur when new members are elected (from either party, although a disproportionate share of polarization has been due to the rightward shift of new Republicans).

To a lesser degree, polarization has also taken place through the adaptation of sitting members of Congress as they behave more ideologically once in office. Such political conversions are due to the same pressures noted above: in order to discourage or survive primary challenges, Republican members shift rightward and Democratic members shift leftward.

A recent case in point is Senator John McCain, Republican of Arizona, who evolved from being a moderate at the time of his 2008 Presidential run to being a solid conservative in 2010, in response to a primary challenge from a Tea Party candidate.

Long-Term Implications

If the increasing polarization of the Congress is due to these factors, then it is difficult to be very optimistic about the prognosis in the near term for American politics. This is because it is unlikely that any of these factors will soon reverse course.

The two parties are not about to abandon the primary system to return to smoke‑filled back rooms. Likewise, no state legislature is willing to abandon its power to redistrict. And public financing of campaigns and other measures that would reduce the advantages of incumbency remain generally unpopular (among incumbents, who would – after all – need to vote for such reforms).

Other Factors?

True enough, in addition to these long-term structural factors that have driven political polarization, shorter-term economic and social fluctuations have also had pronounced effects. In particular, significant economic downturns – whether the Great Depression of the 1930s or the Great Recession of the past several years – increase political polarization.

The 1930s saw not only the rise of American socialists and communists, but also the rise of American right-wing extremism. It took World War II to bring an end both to the economic upheaval of the 1930s and the destructive political polarization that had accompanied it.

U.S. participation in the war brought a degree of political unity at home, largely because U.S. action was precipitated by the attack on Pearl Harbor. Under conditions of less clear motivation for U.S. military action abroad – such as the war in Vietnam – the result has not been political unity, but divisiveness and polarization. The ultimate impacts on domestic politics of the wars in Afghanistan and Iraq may hinge on whether they are perceived to be patriotic responses to a foreign attack (9/11) or the latest manifestations of U.S. military adventurism.

The Future

So, it’s reasonable to anticipate – or at least to hope – that better economic times will reduce the pace of ongoing political polarization. However, in the face of the three long-term structural factors I’ve identified above – the increasing importance of primaries, continuing redistricting, and the increasing costs of electoral campaigns – it is difficult to be optimistic about the long-term prognosis for American politics.

No matter how one feels about the wisdom of Standard & Poor’s downgrading of long-term U.S. debt, the issue of greater concern should be their assessment of the state of the U.S. body politic.

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