Modern Economics on Resources and Environment

One typical example of environmental economics as an established field can be seen in a standard textbook written by Baumol and Oates (1988), a result of the orthodox eco­nomics which analyses systematically allocation of environmental resources almost in the same way as that of other ordinary resources, generalizing Pigou’s idea.

Mainstream environmental economics extended and advanced the basic framework of environmental analysis to the extent that more realistic and substantial environmen­tal issues became subjects of analyses. As applicability of those analyses was greatly enhanced, many important policy implications were deduced.

One good example is an analysis of trade of emission permits or entitlements. The idea of this policy scheme became popular among economists after Dales (1968), being regarded as an alternative policy to Pigouvian taxation. The idea was given a rigorous theoretical base by Montgomery (1972), and the workings of an economy under the scheme have been explored rigorously by means of a general equilibrium analysis since then.

It is easy to show that trade of emission permits has the same effect on the allocation of resources as a Pigouvian taxation in the purely hypothetical case in which the environ­mental authority is omnipotent and omniscient, that is, it has complete information on marginal damages (MD) and marginal abatement costs (MAC).

Weitzman (1974) showed that two schemes have different effects on reduction of tar­geted pollutants if there is uncertainty. Suppose that the environmental authority does not know how a MAC curve is located, but knows that of a MD curve. If the absolute value of the slope of a MD curve is larger than that of a MAC curve in the neighbour­hood of an equilibrium point, trade of emission permits is preferred to Pigouvian taxa­tion, since the former scheme hits at a point nearer to the optimal one than the latter, and vice versa.

The same analytical method as Baumol and Oates’s has been applied to a policy analysis of waste management and recycling as well as utilization of secondary resources, which is one of the most fundamental issues in recent environmental policy. Fullerton and Kinnaman’s seminal paper (1995) demonstrates, by means of a matchbox general equilibrium model, how alternative policies for waste management and recycling work. Many studies on waste management and recycling follow them (Calcott and Walls 2000; Eichner and Pethig 2001). One of the most important contributions of those researches is that an upstream policy such as the extended producer responsibility (EPR), which was proposed as a policy concept by the Organisation for Economic Co-operation and Development (OECD) for reduction of waste and promotion of recycling, is theorized and justified by rigorous economic analysis.

Sustainable development is another important issue related closely to real envi­ronmental policies. The concept of “sustainable development” first appeared in Our Common Future written by the United Nations World Commission on Environment and Development (1987), better known as the Brundtland Report. As global environ­mental problems such as climate change (global warming), depletion of the ozone layer, desertification, destruction of rainforests, acid rain and so on came to be recognized as impending crises for human beings, sustainability became the key concept for environ­mental policies.

Related to this, it is worth pointing out that maximization of the discounted sum of future streams of net benefits does not necessarily guarantee sustainability. According to the conventional optimization theory, it is quite possible that the present generations will not leave resources in a narrow sense for future generations, giving less weight to their descendant’s welfare than to their own. That is, the optimal path determined at present is different from the sustainable path.

Then, the question is how to find and implement the sustainable path.

On the path implemented by the rule, the following equation holds:

Here p_s and p_M are prices of natural resources (natural capital) and man-made capital, respectively. If the left-hand side of (11) is positive, an economy can possibly leave more resources to future generations, satisfying sustainability. Actually, the left-hand side is called genuine savings, which are used as an index to measure sustainability by the World Bank.

An interesting result related to the sustainability argument, which is about Green Net National Product (NNP), is the following. Denoting the consumption of non-renewable resources (natural capital) as R, Green NNP is defined as:

Based upon Weitzman’s idea of NNP (Weitzman 1976), it is shown that Green NNP is “the stationary equivalent of future consumption”. Notice that Green NNP defined above may not be feasible. Onuma (1999) shows that increasing Green NNP is a necessary condition for maximum sustainable consumption, which satisfies feasibility.

For the Hartwick rule to hold, and for the concept of Green NNP to be justified, an important assumption must be satisfied: natural resources (natural capital) can be substi­tuted by man-made capital or human capital. Otherwise, sustainable development cannot be realized. Sustainability based upon substitutability is called weak sustainability.

This notion of sustainability is, however, criticized by non-mainstream economists such as ecological economists, who argue that some natural resources can be substituted neither by man-made capital nor by human capital. The notion of strong sustainability is based upon the presupposition of restricted substitutability among different types of capital. Yet, strong sustainability can be considered to be fulfilled in a steady-state economy, where reproducible resources must be used within the regenerative capacity and non-reproducible resources be used as far as they are substituted by reproducible resources at least in the same amount (Daily 1991). The steady state, which ecological economists have in their minds, may be quite akin to the idea of the classical economists represented by Mill. In this context, it is worth pointing out that some ecological econo­mists are sceptical about economic development or growth, since neither of them is com­patible with the second law of thermodynamics (see Martinez-Alier 1987).

This is too short a discussion in my view. Another similarity to the classical econo­mists’ viewpoint is found in the works of researchers in the tradition of Sraffa (1960). As already shown, the classical economists focused their analysis on the reproducibility of a capitalist economy, where natural prices or production prices prevail. Modern clas­sical economists analyse the reproducible nature of an economy from the viewpoints of income distribution and inter-industrial relationships, using Sraffa’s analytical framework.

Beginning in the early 1980s they have developed their basic models by explicitly intro­ducing environmental resources. Giving up the free-disposal assumption, and consider­ing uses of environmental resources as joint products, they demonstrate how natural prices of discommodities (bads) as well as of commodities (goods) are formed (Schefold 1988, 2006; Lager 2001b; Parrinello 2001; Hosoda 2010b). Although those models are abstract, an interesting application to a real issue of waste management and recycling is made based upon them. Extended producer responsibility (EPR) can be justified in a case where waste treatment service has the same nature as a non-basic commodity in Sraffa’s sense. Hence, EPR is justified for household waste only, not for industrial waste (Hosoda 2010a).