Externalities and Public Goods

"At the center of all environmentalism lies a problem: whether to appeal to the heart or to the head-whether to urge people to make sacrifices in behalf of the planet or to accept that they will not, and instead rig the economic choices so that they find it rational to be environmentalists. To save the environment, therefore, we will have to find a way to reward individuals for good behavior and punish them for bad. Exhorting them to self- sacrifice for the sake of 'humanity' or the 'earth' will not be enough"

Overview

Make no mistake – the climate is changing and we are responsible. There are powerful forces that want us to believe this is not true, some of the same forces that would like us to believe inequality is not rising, and we will examine these in an effort to try to understand why we do so little about either problem, but first we will look briefly at some of the evidence of the change and then look at the nature of the problem. It turns out that climate change is just one example of a flaw in the market system, the same flaw that is responsible for the pollution in China that has accompanied its breakneck economic growth, or the kid down the hall in the dorm playing load music. They are examples of an externality that the market system can’t “solve,” so look more closely at externalities and some policy options to “fix” the externalities including greenhouse gas emissions that are driving climate change.

For me, the realization that climate change was BIG came in 2007 when the UN's Intergovernmental panel on climate change released its Fourth Assessment Report, a year after the British Treasury’s Stern Report was released. The two reports made climate change’s existence very clear.

Warming of the climate system is unequivocal, as is now evident from observations of increases in global average air and ocean temperatures, widespread melting of snow and ice and rising global average sea level.i

The scientific evidence is now overwhelming: climate change is a serious global threat, and it demands an urgent global response.ii

Nothing since then has questioned their conclusion, as evident in the National Research Council’s 2013 report.

Levels of carbon dioxide and other greenhouse gases in Earth’s atmosphere are exceeding levels recorded in the past millions of years, and thus climate is being forced beyond the range of the recent geological era. Lacking concerted action by the world’s nations, it is clear that the future climate will be warmer, sea levels will rise, global rainfall patterns will change, and ecosystems will be altered.iii

In fact, the speed of change has increased, prompting scientists in the 2014 National Climate Assessmentiv report, to conclude:

The effects of human-induced climate change are being felt in every corner of the United States, scientists reported Tuesday, with water growing scarcer in dry regions, torrential rains increasing in wet regions, heat waves becoming more common and more severe, wildfires growing worse, and forests dying under assault from heat-loving insects. … Climate change, once considered an issue for a distant future, has moved firmly into the present v

So, maybe the 2013 Atlantic article was not too far off the mark: “We’re screwed: 11,000 years’ worth of climate data prove it.”vi And the data summarized in the graph below is pretty remarkable. If you use the average temperature from 1961-1990 and look at how temperatures have diverged from that average, you see “temperatures increased in the last hundred years as much as they had cooled in the last six or seven thousand," he said. "In other words, the rate of change is much greater than anything we've seen in the whole Holocene," referring to the current geologic time period, which began around 11,500 years ago.”vii

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For those who are non believers, I realize the odds of getting you to rethink your position are low, but if you are interested, here are just some of the information that has come out in recent years from a virtual explosion of climate change reports and studies. And for those looking for a local spin, “Rhode Island’s coastline has lost over 250 feet of beach in just 50 years.”viii

If you are still not with me, try the “math.” We start with the evidence linking temperature and atmospheric levels of carbon dioxide, and a “meticulous new analysis of Antarctic ice suggests that the sharp warming that ended the last ice age occurred in lock step with increases of carbon dioxide in the atmosphere, the latest of many indications that the gas is a powerful influence on the earth’s climate.”ix Then look around at the rapid economic growth in some of the world’s most populous countries and consider what happens when the Chinese turn in their bicycles for cars, when India’s billion + get the TVs, refrigerators, air conditioners and array of other electricity consuming appliances that are a normal part of American life. Even nonbelievers can see x demands on the world's environment will explode, possibly by a factor of 32.

The average rates at which people consume resources like oil and metals, and produce wastes like plastics and greenhouse gases, are about 32 times higher in North America, Western Europe, Japan and Australia than they are in the developing world.xi

To see how this works, in the table below there is energy consumption, energy consumption per capita, and population data for 2009. At that time per capita energy use in the US was 16.4 times as large India’s, and total energy use was 4.4 times that of India. If, as a result of India’s economic growth, its per capita energy use reached half the US level without any increase in the population, then India’s energy use would rise eight-fold from 21.7 to 178 quadrillion Btus, which would push world energy use up by about 37%. If we made the same assumptions for China, world energy consumption would rise to 865 Quadrillion Btus – an 80% increase on 2009 levels. Primary Energy Consumption: 2009

Energy Consumption (Btus) Population Total (Quadrillion) Per Capita (Million) Million World 483.0 71.3 6776.9 North America 114.6 253.6 451.8 Central & South America 25.2 53.2 474.5 Europe 81.1 134.2 604.1 Eurasia 40.2 141.9 283.3 Middle East 27.8 133.3 208.4 Africa 16.1 16.2 992.6 Asia & Oceania 178.0 47.3 3762.2 China 90.3 68.2 1323.6 India 21.7 18.7 1156.9 United States 94.5 308.0 307.0

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If you do not like math, look at what we are seeing in China in recent years where parts of the country are running out of water and pollution levels, a by product of the rapid economic growth dependent on fossil fuel, have risen to unhealthy levels, with air pollution in Harbin in the winter of 2013 forcing the city to shut its schools and turning day into nightxii and is bringing back memories of London’s Great Smog of 1952.xiii One study links the rising pollution to 1.2 million premature deaths – bigger than all of RI, while a second finds it responsible for a 5.5 year decrease in the life expectancy of residents of north China.xiv As for daily life, you would find air filters in your home to be a necessity, and you would start each day watching not only the weather forecast, but also the air quality index.xv

But what about this cold winter? Isn’t this proof that climate change is a hoax? We certainly know there is a tendency on the part of believers and skeptics to use current weather events – cold temperature as proof that climate change is a hoax to massive floods or hurricanes as evidence that climate change is real. The reality is that on any given day we can have anomalies and these do not provide any useful evidence, so Hansen and his researchers tried to answer the question by looking at the data as follows.

[Hansen] and his colleagues took 60 years’ worth of data (the period from 1951 to 2011) from the Goddard Institute’s surface air-temperature analysis. …

They looked in particular at the three months, which constitute summer in the northern hemisphere (June, July and August). First, they created a reference value for each cell. This was its average temperature over those three months from 1951-80. Then they calculated how much the temperature in each cell deviated from the cell’s reference value in any given summer. That done, they plotted a series of curves, one for each decade that showed how frequently each deviant value occurred.xvi

What they found were two trends. The first is the rise in the average for the decade temperatures. The second is the variation tends to increase with time, so over time we are seeing an increase in the likelihood of excessive heat, and this is not been lost on the insurance industry that “is heavily dependent on scientific thought, … [and] is not as amenable to politicized scientific thought.”xvii

A second industry taking climate change seriously is the military, which since at least 1994 has realized climate change impacts national security.

It is time to understand the environment for what it is: the national-security issue of the early twenty-first century. The political and strategic impact of surging populations, spreading disease, deforestation and soil erosion, water depletion, air pollution, and, possibly, rising sea levels in critical, overcrowded regions like the Nile Delta and Bangladesh--developments that will prompt mass migrations and, in turn, incite group conflicts--will be the core foreign-policy challenge from which most others will ultimately emanate, arousing the public and uniting assorted interests left over from the Cold War. In the twenty-first century water will be in

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dangerously short supply in such diverse locales as Saudi Arabia, Central Asia, and the southwestern United States. A war could erupt between Egypt and Ethiopia over Nile River water. Even in Europe tensions have arisen between Hungary and Slovakia over the damming of the Danube, a classic case of how environmental disputes fuse with ethnic and historical ones.xviii

You can add Darfur to this list of environment related conflicts. Despite the fact the conflict was usually blamed on ethnic hatred, it is actually an early example of conflicts arising from changes in the world’s climate that has left that part of the world unable to sustain the population it once did.xix If you look at the rise and fall of China’s dynasties over thousands of years you will find climate and natural disasters behind many of those dynastic cycles, you will find temperature change associated with the number of witch burnings in Medieval Europe5, and you will find record hot temperatures in the US occurred in the 1930s during the Great Depression. In fact, try a simple experiment: ask an environmentalist to provide a list of countries with BIG environmental crises, and then compare it to a list of politically high risk countries provided by political scientists.6 This is no surprise to the Pentagon that authored the report, An abrupt climate-change scenario and its implication for United States national security. For example, imagine the future in Asia - home to 60% of the world's people. The Himalayan mountain glaciers feeding the Ganges, Indus, Brahmaputra, Mekong, Yangtze and Yellow Rivers supply water to maybe two billion people, and some estimates have the glaciers gone by 2040. If this comes to pass, then we can expect water wars in the not-so-distant future.

In the Middle East, Yemen may provide a glimpse of our future, just as Kaplan did twenty years earlier from West Africa. Population growth coupled with bad natural resource management has created a water shortage that has destabilized the country by turning workers into warriors.

One of the most threatened aquifers in Yemen is the Radaa Basin, he added, “and it is one of the strongholds of Al Qaeda.” In the north, on the border with Saudi Arabia, the Sadah region used to be one of the richest areas for growing grapes, pomegranates and oranges. “But they depleted their aquifer so badly that many farms went dry,” said Eryani, and this created the environment for the pro-Iranian Houthi sect to recruit young, unemployed farm laborers to start a separatist movement.xx

In fact, the authors of Arab Spring and Climate Change “make a compelling case that the consequences of climate change are stressors that can ignite a volatile mix of underlying causes that erupt into revolution.”xxi It is also a central theme in the work of Jared Diamond, author of Collapse and Guns, Germs and Steel.

And more recently, the Pentagon’s shift toward Asia is not the only shift – it has shifted north. The dream of a Northwest Passage may become a reality with the shrinking polar ice cap, and this has prompted the Pentagon to develop an Artic strategy.xxii

The reality is that "[t]he worlds economic geography is today organized according to a climate that has largely prevailed since the Middle Ages,"xxiii and as the world moves towards the end of cheap oil and towards a warmer future, the economic geography will be rewritten - and with it will come conflicts between the winners and losers. This is really just a math problem, which is a theme in much of the work of Thomas Friedman; author of the World is Hot, Crowded, and Flat.

The planet is getting flatter and more crowded. There will be two billion more people here by 2050, and they will all want to live and drive just like us. And when they do, there is going to be one monster traffic jam and pollution cloud, unless we learn how to get more mobility, lighting, heating and cooling xxiv from less energy and with less waste — with so many more people.

And just for the record, if you do change your mind, you would not be the first, as you can see in “The conversion of a climate-change skeptic.”

My total turnaround, in such a short time, is the result of careful and objective analysis by the Berkeley Earth Surface Temperature project .... Our results show that the average temperature of the earth’s land has risen by two and a half degrees Fahrenheit over the past 250 years, including an increase of one and a half degrees over the most recent 50 years. Moreover, it appears likely that essentially all of this increase results from the human emission of greenhouse gases.xxv

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Now, even if we are all on board, there is a long way to go from accepting the problem to doing something about it because “climate change is the most important puzzle humankind has attempted to solve,”xxvi and economics and economists will play a key role in solving the puzzle. We’ll start working on that solution with an introduction to the concept of externalities

The problem: Externalities

To understand the nature of pollution and climate change, consider the following simple example. You are fortunate to own a nice property in town and in the backyard you use for a vegetable garden and some sun tanning. You get great value out of your time spent gardening, and you save money at the grocery store and by not having to drive to the beach to get some sun. Unfortunately, your neighbor has just planted some trees on his property to provide some backyard shade that allows him to run his air conditioner less. The problem is your backyard will not get the sun it needs for your sunning or for your vegetables.

What you are experiencing first hand is an externality - when third parties are affected by the decisions of others. Normally in a market system buyers pay a price covering all of the cost of production so the value derived from the purchase of "stuff" is just equal to the cost incurred in the production of that 'stuff.' When you bought a textbook for $50, it covered the costs of the author, editors, graphic designers, photographers, producers of the paper it was printed on, cost of the inks ... And the best news was the price you paid was the lowest possible price if we were operating in a competitive environment.

In the case of the trees, though, their price does not adequately cover all costs. The costs you incur when the neighbor plants the trees are not reflected in the neighbor’s decision, and that is the externality problem. The market system has established a price for the trees that covers the costs of growing the tree - land, fertilizer, water, and labor - but not the costs of my lost sun. We have a market failure due to a negative externality, which are quite common. Here is a list of some externalities you should be able to recognize.

• Loud music: When neighbors play the loud music and their choice to listen to music imposes a cost on you. • Congestion: When you choose to drive into Providence you add to congestion on the roadways and impose a cost (lost time) on others for which you do not compensate them. • Pollution: When Midwesterners choose to turn on their lights they are using electricity generated by coal burning utilities producing sulfur dioxide that is carried by the prevailing winds eastward to New England's lakes and forests where it returns to earth in the form of acid rain, yet the people in the Northeast are not getting compensated for the environmental damage. • Gold mining: That gold ring you own did not include in its price the costs of a degraded environment imposed on those living near the gold mine.xxvii • Vacant buildings: Property owners do a quick calculation of the costs to improve a building and the rents that would be collected, and when the numbers do not justify the efforts, they leave the building vacant without taking into account the costs incurred by the neighborhood’s residents of the illegal drug business that may relocate there and the rising crime rates in the neighborhood. • Oil consumption: The dependence on foreign oil has "external" costs including the costs of providing foreign aid and military support for Middle Eastern nations.xxviii Thomas Friedman began in 2005 "pushing" the link between energy demand and the rise of authoritarian rule in many of the oil rich parts of the world - what he called "petropolitics."xxix Also, the considerable expenses of the Gulf War in the early 1990s and 2000s can be attributed to the US's reliance on foreign oil, and these expenses were not built into the price of oil. When you filled up your tank of gas, the price of that gas does not cover the hundreds of billions spent providing security in the oil producing regions of the world. • Health care: When a major corporation employs workers and does not pay for their health coverage, the taxpayers absorb many of the costs of the inadequate health care coverage. “The furious pace of oil exploration that has made North Dakota one of the healthiest economies in the country has had the opposite effect on the region’s health care providers. Swamped by uninsured laborers flocking to dangerous jobs, medical facilities in the area are sinking under skyrocketing debt, a flood of gruesome injuries and bloated business costs from the inflated economy.”xxx

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• Obesity: There is much talk about the obesity epidemic that in part can be traced back to the food we eat; too few fruits and veggies and too much junk food. When we choose to eat the junk food the price pays does not include the extra health care costs that will be incurred by taxpayers and health insurance programs. • Smoking: Inhaling the cigarette smoke of others - second-hand smoking - has a negative effect on one's health, so smokers impose costs on the nonsmokers and this is not covered in the cost of the cigarettes.

In each of these cases the externality can be traced to the fact that not all of the costs are reflected in the market price. The damages done to those breathing second-hand smoke and the lost time of those on congested highways do not show up in the price of cigarettes or gas. Certainly your neighbor never considered the costs he imposed on you with his decision to plant the trees. In fact, as pointed out in The Corporation, there is a strong incentive to ignore these externalities due to the pressure to drive down costs. A successful businessman with an insider's perspective who was interviewed for The Corporation revealed that a corporation would "externalize any cost that its unwary or uncaring public will allow it to externalize,... [that] it is no exaggeration to say that the corporations' built-in compulsion to externalize its costs is at the root of many of the world's social and environmental ills." As a result, the market prices of goods with external costs are too low and because of the low price we have too much pollution, too much congestion, and too many tress in neighbors’ yards.

This is one of the reasons my students and I see gas prices very differently. Almost all of my students think the price of gas is too high, while I believe it is too low. The reason we are so far apart was clearly laid out in a 2004 National Geographic article. In reality there are two prices for gas. The first is the private cost - what the students see as the price of oil and what we pay at the pump. This covers all of the drilling, refining, and distributing costs and taxes and was $1.57. I accept this, but I do not see it as the full price because many additional costs are not reflected in that price. When I say the price of oil is too low, I am referring to the social costs of the gas. The price at the pump does not cover a number of effects including the impact of global warming, congestion, oil wars, or macroeconomic disruptions, and if it did, the price would be $4.03.

Social Cost of Gas Cost % of cost $0.43 10.70% state & federal taxes $0.75 18.60% crude oil $0.24 6.00% refining $0.15 3.70% distribution and marketing $1.57 39% Private Cost $0.02 0.50% hidden $0.12 3.00% leaking oil $0.12 3.00% macroeconomic disruptions $0.40 9.90% global warming $0.80 19.90% local pollution (tailpipes) $1.00 24.80% Congestion (lost time) $2.46 61% Social Cost $4.03 100% Total Cost

And do not think for a minute that oil is "peculiar" because if you look at coal you find similar "math. "

Coal accounts for more than half of America's electricity because it is so cheap - and it remains cheap because no one pays the very large hidden costs of its mining and burning.xxxi

The situation is the same with congestion.

The underlying problem [of congestion] is clear enough: cheap car-travel has been based on an illusion. Only by making drivers pay for the costs they impose on society can the demand for motoring be brought into line with restricted supply. The choice for drivers is simple: que or pay.xxxii

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In the case of the trees, you would want to see the neighbor compensate you for your losses, but you cannot expect the market to produce that result. More importantly, the inefficiency of markets resulting from this divergence between social and private costs due to externalities opens the door for "solutions" we will now examine.

The Solutions: In Theory

Voluntary Agreements

Let's get back to the neighbors' trees and look at some solutions. We begin with a solution based on a theory from the 1960s for which Ronald Coase won the Nobel Prize in Economics in 1991. The problem is imperfect property rights; no one "owns" the sun so no one has to pay for using it. You lose when your neighbor plants his tree and blocks the sun, you lose when your house will be below sea level as a result of my contributions to climate change, and you lose sleep because of my loud music. Coase "proved," however, that these externalities could be avoided through voluntary agreements. The secret is the assignment of property rights. In the case of the sun-blocking trees, the problem would disappear if either you or your neighbor were given ownership rights for the sunshine.

To see how it might work, let's look at your situation: You're aggravated at the prospect of the trees because you will not be able to grow your vegetables and get that tan. After some thought, you calculate the psychic value from your gardening, the lower vegetable costs, and the extra costs associated with traveling to the park to work on that tan, to be $800 a year. Your neighbor, meanwhile, has put a price tag of $1,000 on his electricity savings and psychic value of relaxing in the summer shade. The only place the government is involved is in assigning rights to the sun.

If the law says you have the right to the sun, then you can make him take down the trees, but this would probably not happen since he could offer you $900 and you would both be happy. He saves $100 and you get $100 more than the value of the sun for your aggravation. If, however, the law gave your neighbor the right to plant the trees, then you could bribe him to take them down. This would probably not happen, though, since he values the shade more than you do. In both cases he gets the tree, the only difference is the distribution of the benefits. If you own the rights you receive $900, while if he owns it then you get nothing.xxxiii

The appeal of this solution is that we have a private solution to the externalities. In this case we could get to the preferred state - your neighbor got the trees because he valued them more than you - without the need of any government intervention. And, the result did not depend upon who was given the property rights. Before you get too excited about this, however, look at the fine print because there are three problems. First, this might work because the problem involves just two people, but many externality problems are not quite this straight forward. When there are substantial transactions costs this system does not work very well. If, for example, you need to get many neighbors together to confront a big hotel moving in that would reduce the quality of the life in the neighborhood, then it would be very expensive since you would certainly need a good lawyer - or two. Second, problems arise if information on the costs or the benefits of the project are limited, which was a theme in two movies in the 1990s - Civil Action with John Travolta and Erin Brockovich with Julia Roberts. Companies move into an area and pollute the environment, but no one really knows it is happening until after the damage is done. Third, it might not work if one of the parties is just stubborn and refuses to negotiate in good faith so that any potential benefits are more than eaten up by legal costs. It is too early to know the outcome, but in 2011 five teenagers brought suit against the federal government to increase their efforts to reduce climate change that they see as a very big tree that is casting a long shadow on their generation.xxxiv

These difficulties do not, however, mean there are no good examples. One is the Federal Trade Commission passage, on October 1, 2003, of the Telemarketing Sales Rule that established a National-Do-Not-Call Registry. With this law the FTC allowed people to make their phones off limits to telemarketers, which altered the assignment of property rights. After the Rule was passed, you were assigned property rights on your phone number, and millions took the opportunity to exercise those rights.

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So, this private "solution" to an externality is possible, but often improbable, which means we need to look elsewhere for a solution. Not surprisingly, we have turned to the government for solutions. The situation is laid out pretty clearly in the article "Can Selfishness save the environment?"

BIOLOGISTS and economists agree that cooperation cannot be taken for granted. People and animals will cooperate only if they as individuals are given reasons to do so. For economists that means economic incentives; for biologists it means the pursuit of short-term goals that were once the means to reproduction. Both think that people are generally not willing to pay for the long-term good of society or the planet. To save the environment, therefore, we will have to find a way to reward individuals for good behavior and punish them for bad. Exhorting them to self-sacrifice for the sake of "humanity" or "the earth" will not be enough.

We will now look at two generic approaches to solving externality problems – command-and-control and market-based solutions.

Command-and-control

Command and control, sometimes referred to as the direct regulation of industry, is the most obvious solution.xxxv The government simply tells someone what to do, an approach many policy makers and politicians prefer. Economists, however, generally do not favor this approach unless the externalities impose huge, or irreversible, costs. A perfect example would be the nuclear power industry; since exposure to nuclear material would be both catastrophic and virtually irreversible, the government is likely to specify certain standards. Two good examples of the catastrophic costs of a nuclear accident would be the meltdowns at Chernobyl in Ukraine in 1986 and at the Fukushima Dai-ichi plant in Japan in 2011.

Once the decision has been made to use the direct regulation approach, there are two "versions." Design standards specify the use of a specific technology such as the government's requirement of a catalytic converter on all cars by 1975, while performance standards specify performance levels such as the minimum mileage requirement on autos. In the case of your neighbor's trees, a design standard would be a specification of the maximum height of any tree or the distance the tree must be planted from the boundary line. A performance standard might be that at least 50% of the lawn had to have sun, or that the yard had to have sun for at least 3 hours a day.

In 2012 Michael Bloomberg, mayor of New York City touched off a firestorm when he proposed a design standard to tackle the obesity problem. Bloomberg, who had already imposed bans on smoking, proposed a ban on the sale of any “big gulp” beverage containers sold for individual use – the type you see at movie theaters and fast food shops. Disney, meanwhile, announced in 2012 that it would ban junk-food commercials on Disney- owned outlets during programming aimed at children.

The simplicity of a simple rule is appealing, but there is a downside to direct regulations. Once a standard has been set, there is no incentive to look for ways to improve performance. This approach fails to tap into the enormous creative power of individuals and it also ignores the power of self-interest.

[command-and-control] creates perverse incentives for polluters, because it makes pollution free up to the threshold, and so there is no encouragement to reduce pollution further. Howard Klee, the director of regulatory affairs at Amoco Corporation, gives a dramatic account of how topsy-turvy this world of "command and control" can become. "If your company does voluntary control of pollution rather than waiting for regulation, it is punished by putting itself at a comparative disadvantage. The guy who does nothing until forced to by law is rewarded." Amoco and the Environmental Protection Agency did a thorough study of one refinery in Yorktown, Virginia, to discover what pollutants came out from it and how dangerous each was. Their conclusion was startling. Some of the things that Amoco and other refiners were required to do by EPA regulations were less effective than alternatives; meanwhile, pollution from many sources that government does not regulate could have been decreased. The study group concluded that for one fourth of the amount that it currently spends on pollution control, Amoco could achieve the same effect in protection of health and the environment--just by spending money where it made a difference, rather than where government dictated.xxxvi

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Another example of where things could go wrong with direct regulation would be the seemingly well-designed policy imposed in Mexico to reduce congestion and pollution in Mexico City. To lower the use of autos for commuting, the government imposed a rule that denied all cars access to the city on a specified day depending upon the license plate. If each car was on the road one less day then congestion and pollution would be reduced - or maybe not. It turned out that Mexicans figured out how to beat the system - they bought a second car, so gas- xxxvii guzzling, pollution-spewing old clunker cars increased. An alternative approach would be market-based solutions that are favored by economists and gained popularity in the 1980s. In this section we examine two types of market-based solution - taxes and subsides, sometimes referred to as green taxes, and tradable permits, sometimes referred to as cap-and-trade.

Market-based solutions: taxes

Externalities exist because people do not pay the full-price for a product, so a tax or a subsidy could be imposed to eliminate the difference.xxxviii In the case of those trees, a tax could be imposed on all those who planted trees within the city limits, with the tax based upon the height of the trees. You could imagine setting a tax so your neighbor would decide to prune his trees annually to keep them below a certain height. This would give your neighbor shade, and you would get sun for your garden.

Taxes could also provide a simple approach to reducing US dependence on foreign oil. A tax could be imposed on each barrel of oil – the equivalent of a sales tax – or a tax could be imposed on a car’s gas mileage with higher taxes on cars with lower gas mileage. The taxes have two effects. First, in response to the higher price, businesses and individuals would reduce their demand for oil. A tax based on the car's gas mileage would raise the "full-price" of the gas-guzzling SUVs, and lower demand for them and demand for oil. In fact this was a solution proposed by Jimmy Carter in the 1970s as the US economy struggled to adjust to the dramatically higher oil prices. The same would be true with an increase in the gas tax.

Second, the higher price provides an incentive for development of alternative sources of energy. At the present time the cost of alternative energies – wind, solar – are high and thus uncompetitive with fossil fuels. This also characterizes carbon-capture technologies.xxxix

A good example was the Patriot Tax suggested by Thomas Friedman who wanted to bring the private cost of oil closer to its social cost with a 50-cents-a-gallon gasoline tax.xl The tax would lower demand for oil, which would break the OPEC cartel’s pricing power, and reduce the flow of funds to authoritarian regimes.xli This was a theme John Tierney picked up on later in the year when he wrote:

Individuals don’t always make the best choice about energy use you can make a case that we drive too much because the price of gasoline doesn’t reflect all the social costs. But if a new gas tax covered those costs, then we have all the incentives we need to conserve energy.xlii

A tax you will be hearing about in the future is the carbon tax, and if you are interested you might check out the Carbon Tax Center.xliii All fossil fuels (coal, oil, natural gas) contain carbon atoms and when the fuels are burned they release carbon dioxide (C02), one of the greenhouse gases driving climate change. To reduce the carbon footprint - a measure of the impact of an activity on the environment measured in terms of units of carbon dioxide. - the carbon tax will work by bringing the actual (private) cost of fuel into line with the total (social) cost. Once the social costs could be determined, no easy task, then a tax per ton of carbon could be established on all fuels and the price mechanism would begin to alter behavior.

One advantage of the tax is it should be very effective at altering behavior, but this is probably why it is being fought so hard. It works because it does change behavior, but people do not like change, so they will fight that change. For example, because coal is far dirtier than natural gas, the price of electricity generated by burning coal would become significantly more expensive, providing an incentive for utilities to move away from coal and for homeowners to make their homes more energy efficient. It also provides an incentive for an expansion of alternative, non fossil fuel sources of energy, but it lowers demand for dirty coal that will lead to lost jobs and lower revenues and profits for coal companies. Another advantage is that the taxes raised from the carbon tax could be used to reduce other taxes, which should make them more attractive to policy makers who face enormous pressure to reduce taxes.

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Europe has taken the lead with the carbon taxes, which has been documented by the Environmental Protection Agency (EPA).xliv Finland was the first country to impose a carbon tax in 1990, and since then Denmark, the Netherlands, Norway, and Sweden have followed with their own taxes that all have their own peculiar features. In something of a surprise move, Ireland, faced by daunting deficits and international pressure to raise additional revenue in the midst of the financial crisis, chose to raise revenues with environmental taxes.

The government imposed taxes on most of the fossil fuels used by homes, offices, vehicles and farms, based on each fuel’s carbon dioxide emissions, a move that immediately drove up prices for oil, natural gas and kerosene. Household trash is weighed at the curb, and residents are billed for anything that is not being recycledxlv

For more information on Europe you might want to check out the OECD home page where you will find an Environment link where you will find a number of publications and data including a dynamic graphic that displays the relationship between CO2 emissions and GDP over time.xlvi As of 2008 the US had not adopted a carbon tax, although Al Gore supported the idea in his book, Earth in the Balance, and in 1993 president Clinton proposed a BTU tax that was never enacted. There has been, however, some movement in this direction at the state, county, and local level.xlvii An alternative to using taxes to reduce energy consumption would be the use of government subsidies to promote alternative energy supplies of greater efficiency in energy use. These subsidies would act as a magnate for resources devoted to reducing energy use.

Congestion is another externality that has been addressed with a tax in a number of municipalities including London's 2003 tax that made international headlines.xlviii London imposed of a congestion tax of $5 per day for any car entering the center of London between 7AM and 6:30 PM in the hopes of reducing congestion by 15 percent. If you happened to be in the designated area, your car license plate would be caught on camera and you would be billed. On the one-year anniversary of the plan it was reported that traffic was down 18 percent and congestion down 30 percent.xlix

Panama Canal has also implemented congestion pricing that allows ships willing to pay a substantial fee to avoid waiting in line for up to a week for passage through the canal by receiving a specified date and time. Airports have also imposed congestion pricing, with the establishment of peak-load pricing schemes. If you want to land or takeoff during prime hours you will pay for that convenience.

And let’s not forget that obesity problem. Rather than a ban on certain products, we could impose a tax on sugar or caloric content – the “Fat Tax” that is often mentioned. Or we could subsidize the production of fruits and vegetables to reduce their costs.

Simply put: taxes would reduce consumption of unhealthful foods and generate billions of dollars annually. That money could be used to subsidize the purchase of staple foods like seasonal greens, vegetables, whole grains, dried legumes and fruit.l

Market-based solutions: tradable permits

Tradable permits, or cap-and-trade systems are a market-based approach where the government creates a market in the rights to pollute. The nature of this approach can be seen in the following simple example. Assume the government wants to reduce celphonic trioxide emissions from the current level of 25 million tons to 15 million tons. One option would be to specify that every plant emitting celphonic trioxide reduce emissions by 40%. The advantage of this command-and-control approach is that all plants are treated the same - or at least they are required to make the same reductions. The disadvantage is that we could expect substantial differences among the polluters in the cost of achieving their targets, so if we wanted to minimize the cost of meeting the targets then we would want the reductions to be made by those polluters for whom it was cheapest to cut emissions.

But how do you do this? There are three important dimensions to the plan, and as you will see, this approach works best when it is easy to identify a set of big polluters and where monitoring is relatively easy.

First, the target level of pollution - the cap - must be established, with environmentalists arguing for lower caps and business arguing for higher caps.

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Second, a mechanism for allocating the initial allowances - who gets the allowances and how much do they pay for them - must be developed. The system actually looks very much like the rationing system employed by the US in WW II when American citizens were given coupons issued by the government to purchase items such as butter. With pollution allowances, the tons of pollutants a plant is allowed to discharge would depend on the number of allowances owned by the plant. This makes the initial allocation scheme highly controversial because the initial allocation of allowances has an impact on the distribution of the program’s costs.

One option for the initial distribution would be to have the allowances auctioned off to the highest bidders, and in this case the funds raised would go to the government that could then use the funds to reduce other taxes, or to subsidize investments in additional green technology. A second option would be to give allowances away, and when this approach is taken, they tend to be allocated to existing polluters in proportion to their historic level of pollution. A disadvantage of the approach is it results in a windfall to polluters, with the windfall largest for the biggest polluters and those who might have seen the system coming and ramped up their pollution so they would get a larger allotment of allowances. It also favors existing firms and raises the cost of entry for potential competitors.li

Third, a market must be established on which the allowances can be traded.lii Each polluter must meet their cap, and they have a choice on how to meet it. They could reduce their emissions levels through a combination of new production technology, new energy sources, new emissions cleaning technology, or they could buy allowances from other polluters to allow them to exceed the cap. For example, in the celphonic trioxide example, each plant could be allocated allowances for 7.5 tons and they would seek the lowest cost method of reaching that emissions target. Since it cost plant A $200 for each ton of reductions and plant B $400 per ton, there is a deal here. Plant A would be willing to sell its allowances for any price above $200 since it would make more from selling the allowances than it would cost it to clean up the emissions, while Plant B would be willing to buy allowances for any price below $400 since it would be cheaper to buy the allowances than to clean up the emissions. If the market worked, the price for a ton of emissions would be somewhere between $200 and $400.

To see how it might work, let's assume in there are two polluters - Plant A where it costs $200 a ton to reduce emissions and Plant B where it costs $400 per ton. If the government wanted to reduce pollution by 20 tons and required both plants to lower pollution by 10 tons, the cost to society would be 10*$200 + 10* $400 = $6,000. From society's perspective this would not be the best solution. If all emission reductions were in plant A, the costs of emission reduction would be 10*$200 = $2,000 - a savings of $4,000.

This market price, like other prices, would be affected by shifts in either supply or demand. For example, if the government reduced the cap, this would decrease supply and the price of the permits would rise. If, on the other hand, there was a decrease in the price of a clean fuel – the price of natural gas falls due to expanded fracking - then plants can convert to cleaner fuels and this would decrease demand for permits. You would find a similar situation if the economy fell into a recession and demand for energy declined. In this case demand for permits would also decline. We will see how this works later when we look at Europe’s experiment with cap-and- trade.

In theory, cap-and-trade and tax systems can both achieve the same targets, but according to the Congressional Budget Office, "the most efficient policy tool for decreasing CO2 emissions is the one that can best balance the costs and benefits of the reductions [and] analysts generally conclude that a tax would be a more efficient method of reducing CO2

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liii emissions than an inflexible cap." Tradable permits, however, are an important tool that policy makers in the US seem to favor, in part because of a general aversion to taxes of any kind, and in part because of their familiarity with the approach. They have been around for years (a brief history of tradable permits) and have been used in a wide variety of situations.liv

The most notable early experiment with permits to address air pollution was the Environmental Protection Agency's (EPA) use of permits in the 1990s to reduce sulfur dioxide (SO2) emissions.lv If a cap-and-trade system would work, this would be the place. The EPA estimated that 70% of annual SO2 emissions are generated by the electric utility industry so there are a small number of polluters that could be easily monitored. The plan worked better than anyone could have imagined.lvi In its 2006 Acid Rain Program Progress Report, the EPA reports SO2 emissions in 2006 were 40% below 1990 levels and estimates the program's benefits at $122 billion annually in 2010, while the costs are $3 billion. The magnitude of the success in reducing SO2 levels is also evident in the EPA's maps of SO2 concentrations.

A cap-and-trade program is also an integral part of the world's efforts to reduce greenhouse gases (GHG) that began with the United Nations Framework Convention on Climate Change (UNFCCC), a treaty signed at the UN Conference on Environment and Development in Rio de Janeiro in 1992.lvii One of the products of this agreement was the European Union Emission Trading Scheme (or EU ETS) established in 2005,lviii and to meet the targets, the European Climate Exchange (ECX) was established to facilitate sales of emission allowances.lix In the chart below, the price of carbon allowances on the ECX rose through mid 2008. The rise in carbon prices was closely correlated with oil prices and the strength of the world economy; oil prices rose as the economy expanded, which increased demand for energy. The increase in energy demand, meanwhile, translated into a higher demand for permits. As oil prices rose, companies also shifted from oil to coal to generate power, and because coal is dirtier than oil, it generated more carbon, which increased demand for the carbon permits. Once the price of oil began to fall after the economic crisis hit it in 2008, = the price of carbon emissions also fell.lx

Closer to home, New York state got the commitments from nine Northeast governors to establish the Regional Greenhouse Gas Initiative (RGGI) – the first mandatory cap-and-trade emissions trading system to lower CO2 gases. The system was launched in January of 2009 and the initial allotments were to be auctioned off, which was unusual.lxi The initial results of the plan, described in a Congressional Research Service publication,lxii reveal the plan’s implementation in 2009 occurred just as the region fell into a recession and the region’s power plants shifted to lower carbon-content fuels because of the expansion of fracking, so the limits were non binding. And on January 1, 2013 California “became the first state in the nation to charge industries across the economy for greenhouse gases they emit.lxiii

Market-based solutions to most externality problems are preferred by economists, but there are times when they are not, or will not, be implemented so other solutions to the externality problem have been pursued – and we’ll discuss a few of them.

Alternative solutions

We have now looked at two sets of solutions to the externality problem, but there are others. One approach would be to reduce environmentally harmful subsidies imbedded in "nonenvironmental" legislation. For example, efforts to reduce air pollution and traffic congestion on the highways leading into the nation's large metropolitan areas are offset by government policies, such as the subsidization of homes in income tax laws that encourage individuals to move to the suburbs. Water pollution, meanwhile, is exacerbated by policies subsidizing pesticides and irrigation in environmentally sensitive areas. And let's not forget that in 2003-2004, when gas prices were rising, Americans were being encouraged to get out there and buy new gas guzzling trucks or SUVs to take advantage of a federal income tax break.lxiv For some additional examples check out in Sharing the wealth: If we shift the tax burden from work to waste everyone benefits.

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Another approach focuses on providing information to all of the interested parties. In Europe there is the eco- labeling program sponsored by the European Commission to encourage businesses to develop greener products by awarding the eco-label to products and services with reduced environmental impacts. In the UK a carbon label was introduced in 2007 that would show the carbon footprint embodied in a specific product, and in the US there are Energy Star ratings for appliances and EPA mileage estimates for automobiles. The expectation is that people would be able to see the carbon content or mileage and then make environmentally informed choices. In 2012 Disney announced that it would not only ban certain ads on some of its shows, but it would also develop a “Mickey check” to identify foods it considers nutritious.

In the US the availability of information on pollutants has improved as web sites appeared on which you can identify the pollutants in your area - examples being the EPA's Toxics Release Inventory and SCORECARD In fact this is part of a broader movement called environmental justice - a description of which can be found at the Environmental Justice Homepage at Clark Atlanta University. Essentially the movement is a grass roots movement focusing on the inequities in the distribution of the benefits and costs of environmental policies.

In Indonesia, a country that has suffered substantial environmental damage as a result of rapid industrialization, there is an information-based program called Proper that was begun in 1995. Indonesia's environmental agency issues a color-coded ratings scheme for facilities where the ratings are based on the facilities' compliance with existing environmental laws.

It is clear from the preceding discussion there are a variety of approaches one can take to dealing with externalities, and none of them is without flaw, although economists would tend to rank the command-and- control approach as the least desirable solution, except when dealing with irreversible externalities as would be the case with nuclear waste. The preference against direct regulation stems from the fact it does not harness the power of incentives and creativity. Now we will leave our theoretical world and look at some environmental policies.

The Solutions: In Practice

As so often happens, it takes a crisis to get people's attention, and that certainly seems to be the case with environmental policies. A short list of the key incidents behind the environmental movement would include the following.lxv 1. 1948: Donora, PA: In October a smog of pollutants rolled into this small town southeast of Pittsburgh, and before it dispersed four days later, 20 people had died and nearly 40% of the towns population had become ill. The New York Times referred to it as "one of the worst air pollution disasters in the nation's history" Hamill, Sean D. "Unveiling a Museum, a Pennsylvania Town Remembers the Smog That Killed 20", The New York Times, November 1, 2008. Accessed November 2, 2008. 2. 1952: London, England: In December, as Londoners burned more coal than usual in response to colder than usual weather, was trapped by a thermal inversion and a "killer fog" descended over London, very much as it had in Donora, and before it left 1,000s had been killed. 3. 1956: Minamata Bay, Japan: Minamata disease, a neurological syndrome caused by severe mercury poisoning, was discovered in this small town on Minamata Bay in 1956, and the cause was found to be wastewater released into the bay from the Chisso Corporations chemical factory. It was not until 1969 that the first legal action was taken against Chisso. 4. 1969: Cleveland, OH: The Cuyahoga River caught on fire. 5. 1978: Love Canal, NY: By 1978 residents of this area outside of Buffalo, NY were asking questions about the health problems in the Love Canal area, including birth defects that afflicted more than half of the children in the mid 1970s. It turned out the homes had been built on land containing 20,000+ tons of chemicals and in 1980 president Carter declared a federal state of emergency and evacuated 700 families.

In addition to these crises, the beginning of the national environmental movement in the US can also be traced back to publication of Rachel Carson's book Silent Spring in which she warned her readers of the environmental dangers of toxic chemicals and pesticides, most notably DDT, and the risks of betting on technological solutions to future environmental problems. What followed was the first Earth Day and establishment of the Environmental Protection Agency (EPA) in 1970 that marked the beginning of a busy decade of environmental lxvi legislation. In many respects the formation of the EPA was similar to the establishment of the Department of

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Homeland Security in 2002. Both were designed to bring together in one agency a collection of agencies and efforts that had been scattered across various government agencies. The four main federal laws governing air quality, water quality, solid waste, and hazardous waste are briefly described below.

Air Quality Act of 1970: This legislation authorized the development of regulations to limit emissions from both stationary and mobile sources. Two of the major programs that began here were the National Ambient Air Quality Standards (NAAQS) and the State Implementation Plans (SIPS).lxvii

Water Quality Act of 1972: This legislation created a federal program designed to achieve the goal of protecting and restoring the physical, chemical and biological integrity of our nation's waters. This was the legislation that provided the funding for the sewage treatment plants in your hometowns, and it provides a classic example of the command and control approach to pollution.lxviii

Resource Conservation and Recovery Act of 1976: This legislation set goals aimed at reducing the amount of municipal and industrial waste generated and ensuring the waste was managed in an environmentally sound manner. These goals were achieved through three distinct programs the solid waste program set guidelines for dumps, prohibited open dumping, and encouraged source reduction and recycling; the hazardous waste program that established a cradle-to-grave approach for the treatment, storage, and disposal of hazardous waste, and the underground storage tank program that regulates underground storage tanks for petroleum products and hazardous waste.

Comprehensive Environmental Response, Compensation, and Liability Act of 1980: Often referred to as Superfund, this legislation was a direct response to the Love Canal crisis and Known as Superfund and a direct response to the Love Canal Crisis, this legislation was enacted to address abandoned hazardous waste sites in the U.S through identification of those parties responsible for the toxic waste sites and establishment of a fund for removal and remedial work at sites that are on the National Priorities List. Included on that list are three local sites including the West Kingston Town Dump below campus.lxix

Have they worked? Absolutely. You cannot compare the quality of the air and water today with what it was before the EPA and the beginning of government environmental policies.

energy use in the United States has been dropping since 2007, and last year’s total was below the 1999 level, even though the economy grew by more than 25 percent from 1999 to 2012, adjusted for inflation. At the same time, the amount of oil we are using in our vehicles, homes and businesses continued to decline last year, down 14 percent from a peak in 2005. Surprisingly, oil use was lower in 2012 than in 1973 (when the nation’s economy was only about a third of its current size). The main reason is that we are demanding better mileage from our vehicles and driving them less.lxx

For those interested in observing real-time attempts to control pollution, China is the place to watch. Chinese leaders are concerned about the possibility that the dangerous levels of pollution that exist may prompt social unrest, so government officials have adopted a broad range of environmental policies. Here is just a sample of policies employed since 2011. 1. Shenzhen has adopted a carbon market to reduce air pollution.lxxi 2. Beijing announced it would reduce the number of license plates and increase the share that go to electric cars and hybrids.”lxxii 3. To combat air pollution Beijing announced a “Six Stops and One Wash” policy in which it would establish a color-coded measure of pollution and design policies for each. Included will be policies that would force vehicles off the road on alternative days depending upon their license plate, and on high pollution days factories, schools, and construction sites would be closed.lxxiii 4. China has invested in alternative energies. “In less than 10 years it has built the world’s largest wind power capacity, with plans to triple it by 2020. Its hydropower capacity, also the largest in the world, is expected to triple from 2005 to 2020, and its nuclear capacity will multiply at least six fold over that same period. And China is increasing imports and production of natural gas, the cleanest fossil fuel.”lxxiv 5. officials are ordering 180,000 older vehicles off the roads, promoting the use of “clean energy” for government vehicles and heating systems, and growing trees over 250 square miles of land in the next five years.lxxv

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There have also been some notable international efforts to control pollution. The first is the Montreal Protocol, adopted by the United Nations in 1987 that addressed depletion of stratospheric ozone, an issue that surfaced in the 1970s. By 1978 the United States had banned the nonessential use of CFCs as aerosol propellants, and in the following decade negotiations proceeded on an international agreement controlling CFC use.lxxvi

The second is the Kyoto Protocol, that president Bush rejected in 2001, a decision that has been hotly debated.lxxvii On one side are those who say it should be the industrial nations - the rich ones - that have created the problem. On the other you have those who say the future problem will be with the world's developing countries - the poor ones - that are growing rapidly and burning lots of dirty fossil fuel. The Kyoto Protocol put the burden on the world's wealthy nations where firms would need to undertake costly expenses to reduce their greenhouse gas emissions. This raised real concerns that the rising powers, China and India, would be freed of any responsibility to do so - and as a result US companies would have a difficult time competing with Chinese and Indian companies. What was also clear was a country like the US would probably be a net loser under the Protocol.lxxviii

Public Goods

The theory of public goods, like the theory of externalities, focuses on an imperfection in the market system, and as you would expect, the result is similar - the market system operating on its own will produce the wrong amount of certain goods and services because the true costs or benefits are not adequately captured in the market price. The problem of public goods can be traced to the peculiar characteristics of certain goods and services such as the lighthouses, national security, and fishing.

To understand the problem, think about your computer. If you go out and buy the computer, then it is not possible for me to buy the computer since it is no longer on the shelf. It is also true that once you own it you are not going to take the computer home and set it up on your front yard and let anyone use it. Most likely you will take it to your room or office and use it by yourself. Now think about a lighthouse. For those of you who have sailed, you know the value of lighthouses. If you are sailing and using a lighthouse to guide you around the rocks, the value of the lighthouse to other sailors is unaffected by your use of the lighthouse. Your use of the lighthouse does not limit my use. Furthermore, if you use the lighthouse it is not possible, or feasible, to restrict me from also using the lighthouse, and therefore the provider of the light will never be able to collect from all those who benefit from the service.

The features that differentiate the computer from the lighthouse are rivalry in consumption (can we both use it simultaneously) and excludability (can someone be excluded from using it). Using these two characteristics we can create the table below where we see four distinct types of goods.

Classification of Goods and Services

Rival in Consumption Nonrival in consumption Private goods Artificially scarce goods Cereal Pay-per view movies Excludable Car Computer software Common Resources Public Goods Clean water National defense Nonexcludable Clean air Lighthouse

Private Goods: If you look around your room, most of what you see there would be considered private goods where you would be the only one to receive value from the purchase price and the seller would be able to be paid by you who used the good or service.

Public Goods: Think about national security that is classified as a public good because it is nonrival in consumption and nonexcludable. In the aftermath of the events of 9/11 there were differences of opinion regarding the extent of the threat to national security in the US. Some were not concerned about future attacks on the US and did not want to fund a multi-billion dollar defense build-up, while others were terrified and willing to

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open up their checkbooks. Because your security does not reduce my security (nonrivalry) and because security could not be supplied only to those willing to pay (nonexcludability), there is a strong incentive to wait for someone else to provide the service - to wait for the paranoid to pay for defense, or the shipping magnate to pay for the lighthouse. The existence of these 'free riders' in both the lighthouse and national security examples is at the heart of the public good problem, and it is why national security is a public good and the federal government funds the military that provides national security. And do not forget those study groups that provide a good example of the free rider problem.lxxix Given the nature of public goods, the incentives are such that the market system will simply not produce adequate amounts of these goods and services.

Another area where the government has taken an active role in providing a public good is in the promotion of basic research and development (R&D). One of the marvels of the market system is its ability to provide economic growth that has resulted from innovation and technological change. Unfortunately, there are two reasons to believe a competitive system would not provide adequate levels of innovation. First is the problem of who would spend money today on research if once the product of that research came to market others could duplicate it through reverse engineering. In this situation, the competitors who duplicated the process would be able to sell the product at lower cost because they would not have to finance all of the development costs. From the short-term perspective, society would be better off since it would be getting the new good or service at lower cost. In the long-run, however, we may find there will be little incentive to innovate, which will slow down the rate of technological change. In a dynamic sense, society would be well served by the government's active promotion of innovation, which is why we saw in an earlier section how the government creates artificial barriers to entry with patents and copyrights. The government also can promote R&D by providing subsidies to research universities, including URI.lxxx

An additional feature of public goods is that there is a built in likelihood of "disgruntled buyers." When you buy a TV, the fact you paid $200 for the TV meant you believed it was worth it, but what about defense spending? You have never directly paid a certain amount for defense so you are likely to complain that too much has been spent on defense - or any of a number of other government programs.

Given the fact we can’t count on markets to generate adequate supply, what are our options. Voluntary contributions are one possibility, which we see with public broadcasting and in some small towns where we have volunteer fire departments. Public radio is not able to cover its bills with contributions, and volunteer fire departments are not scalable because they would not work in bigger towns or cities, so in general public goods are supplied by governments and supported by taxes.

Common Resources: Think about fishing where individual fishers acting in their own self-interest can be expected to over fish the seas and eventually deplete the fishing stocks. The problem is individual fishers know it is in their best interest to preserve the fishing stock by limiting today's catch and thus not reducing tomorrow's catch, but they have no incentive to do this because there is no reason to believe others will exercise restraint. Everyone will tend to overfish since they do not need to account for the impact of their decision on others. A Rhode Island fisherman described the situation as follows in a New York Times article: "Right now, my only incentive is to go out and kill as many fish as I can. I have no incentive to conserve the fishery, because any fish I leave is going to be picked up by the next guy." (Aug. 27, 2000)

This is an example of what has become known as the Tragedy of the Commons.lxxxi Resources owned by everyone are actually owned by no one and these resources will be exploited by the natural workings of competitive markets. Jay Hanson provides a simple statement of the problem as follows.

In 1944, 29 reindeer were moved to St. Matthew Island. The reindeer thrived by "exploiting" (making the best use of) their rich "commons". The island had no natural predators to keep the reindeer population in check, so the population swelled to 6,000 animals during the next 19 years. Suddenly the commons was depleted and the population crashed until only 42 animals remained alive! The reindeer could have avoided the crash by keeping the population within the carrying capacity of the island, but reindeer politics couldn't manage it, so naturally the population crashed. In his 1968 classic, "Tragedy of the Commons", Garrett Hardin illustrates why the reindeer crashed and why communities everywhere are headed for tragedies because freedom in the commons brings ruin to all:

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Visualize a pasture as a system that is open to everyone. The carrying capacity of this pasture is 10 animals. Ten herdsmen are each grazing an animal to fatten up for market. In other words, the 10 animals are now consuming all the grass that the pasture can produce. Harry (one of the herdsmen) will add one more animal to the pasture if he can make a profit. He subtracts the original cost of the new animal from the expected sales price of the fattened animal and then considers the cost of the food. Adding one more animal will mean less food for each of the present animals, but since Harry only has only 1/10 of the herd, he has to pay only 1/10 of the cost. Harry decides to exploit the commons and the other herdsmen, so he adds an animal and takes a profit. Shrinking profit margins force the other herdsmen either to go out of business or continue the exploitation by adding more animals. This process of mutual exploitation continues until overgrazing and erosion destroy the pasture system, and all the herdsmen are driven out of business. Most importantly, Hardin illustrates the critical flaw of freedom in the commons: all participants must agree to conserve the commons, but any one can force the destruction of the commons. Although Hardin describes exploitation by humans in an unregulated public pasture, his commons and "grass" principle fit our entire society.

Given the nature of the problem, we already know the solutions - the same as what we looked at earlier for externalities. The most direct approach would be to limit the catch, which is the approach that was taken in New England. Another possibility would be a tax on fishing that would be similar to the tax used to correct externalities. In fact the problem is very similar in that the fisher is not accounting for the impact of his fishing on fish stocks and the fishing experiences of others. By imposing a tax on the fish, this will raise the private cost of fishing and bring it closer to the social cost that includes the effect of the fishing on fish stocks. A third option would be to develop a tradable permit or license program where an annual catch would be established by the government, which is similar to the first approach, except here individual fishers would be given permission to harvest a set amount of fish and they could then sell the rights to this catch. Some fishers would be likely to retire from fishing and sell their rights. A fourth option would be to assign property rights to certain individuals with the expectation that the new owners would manage the resource efficiently.

Artificially scarce goods: A fourth class of good would be artificially scarce goods that are non rival in consumption and excludable. A good example of this would be network TV service because your watching a show does not affect anyone else's viewing, so the marginal cost is zero, but viewers can be excluded from viewing. What happens in this case is viewers tend to pay more for less output - precisely what we found earlier as the outcome when we had a natural monopoly.

What is the future

It may be difficult to get the environment taken seriously, but the time has come to begin to think seriously about the environment and the concept of sustainability. Climate change is not going away, and pressures on the environment will only intensify as the world's poor try to improve their standard of living. The time has come to acknowledge that market prices do not adequately reflect the scarcity of natural capital and this is leading to climate change. It is time to increase the productivity with which we use that natural capital, and to accomplish this goal we must break the link between economic growths and environmental degradation. To do this the choices made by individuals and businesses must be based on the full costs. Hurricane Sandy that ripped the Northeast coast in 2012 provides a good example of what this means. For the first time I can recall we began to hear questions about rebuilding after the storm and calls for a “retreat from the beaches.”lxxxii

It is also essential that we accept the power of incentives and recognize that self-interest drives the choices of individuals and firms and thus should provide the basis for any solutions.

We conclude that the cynicism of the economist and the biologist about man's selfish, shortsighted nature seems justified. The optimism of the environmental movement about changing that nature does not. Unless we can find a way to tip individual incentives in favor of saving the atmosphere, we will fail. Even in a pre-industrial state or with the backing of a compassionate, vegetarian religion, humanity lxxxiii proves incapable of overriding individual greed for the good of large, diverse groups.

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There is some good news. There is some bipartisan agreement that climate change exists, although the bad news it is among wealthy older American who are out of the political process. Two former treasury Secretaries under Republican presidents would like to see the US address the problem because of their belief it is real and big.lxxxiv Henry Paulson, one of those Treasury Secretaries, likens climate change to the financial crisis of 2008. In both cases the warning signs were clear, but this is not the view of the Republicans jockeying for the nomination in the 2014 presidential election who are calling it a hoax or denying man has had any responsibility. There is real money, and probably jobs, for those willing to taking the leadership role. The Economist posed the question in 2002: "Can Japan boost its economy by protecting nature?" The answer was yes then, and it was certainly true today. As the US economy continued to unravel, there was increasing talk about the upside potential of green- collar jobs and discussion of harnessing the power of government to jump-start the country's move into the post fossil-fuel era. Even Fortune, a conservative business magazine that has not been friendly to the environmental movement in the past, is now filled with stories of great green-ideas.lxxxv We can expect to see innovative proposals such as one in 2013 that suggested taking responsibility of climate change away from governments and putting it on multinational companies that tend to play one country off against the other to reduce environmental restrictions. The result is a race to the bottom, which is what we see in the US as firms seek out low tax states, but this could be reduced if simple targets were set for these corporations regardless of where they operated.lxxxvi

We have seen GE begin to move its investments towards renewable energy, and in October of 2005 Wal-Mart announced the new company directive to improve energy efficiency and reduce environmental damage. Their CEO announced Wal-Mart's intention to invest $500 million in technologies that will reduce greenhouse gases from stores and distribution centers by 20% or the next seven years; increase fuel efficiency of the truck to a 25% over the next three years and double it within 10 years, can design a new store within four years that is at least 25% more energy-efficient. There was also increasing talk of how the venture capitalists that funded the Internet boom of the 1990s have "discovered" green industry and have begun to fund innovative ways to reduce energy use and to help society adapt to the hotter world that lies ahead.

If you are looking for some ideas from people who are leading the movement you should check out Lovins' Reinventing the wheel and his Foreign Affairs article, “A Farewell to Fossil Fuels,” and William McDonough's The next industrial revolution.lxxxvii And, unless you are completely unrealistic, you realize that climate change will continue because the changes needed to stop the rise in CO2 levels will not happen soon enough, so rising CO2 levels will drive temperatures higher, and with this will come higher sea levels. We need to learn “to live with climate change,”lxxxviii and to do that we will need to “climate-proof” the world.lxxxix

And finally, it just might be the right thing to do. We are the biggest user of fossil fuels and are responsible for a disproportionately large share of the world's greenhouse gases. According to the US Energy Information Agency, in 2005 the US, which accounted for 4.5% of the world's population consumed 22% of the world's primary energy and generated 21% of the world's carbon dioxide as a result of the fact that US CO2 emissions per capita are 4.5 times the world average and 2.5 times Europe's average. This is clearly not sustainable, especially if we continue to act as the "role model" for developing countries. Now we will turn our attention to a related problem, the problem of public good.

Conclusion

Externalities and public goods are sources of market imperfections that will be at the center of much heated public debate in upcoming years. While we may find considerable agreement among economists on the existence of these market imperfections, we find considerable disagreement on where to draw the line between public and private goods, and who should provide these goods and services. President Clinton, in his first term in office, attempted to move the line when he proposed a form of national health coverage to replace the existing system. Closer to home, you are likely to see a continued debate over the privatization of education. Education has long been thought to be a public good that has been supplied by the government because everyone benefits from a more educated population, but in recent years there has been a growing concern expressed about the quality of the government's provision of education. It is a debate you can expect to hear more of as the baby boomers' kids move through the educational system. It is certainly one we will discuss in class. You will also hear much about the problems of global warming, acid rain, and sustainability, and the basic principles of externalities and public

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goods introduced in this unit should help you steer your way through the claims and counter claims on all of these issues.

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Externalities i Fourth Assessment Report, Intergovernmental Panel on Climate Change ii Stern Review on the economics of climate change iii National Research Council, Abrupt Impacts of Climate Change: Anticipating Surprises, 2013 iv http://nca2014.globalchange.gov/ v Justin Gillis, “US climate ahs already changed, study finds, citing heat and floods,” NYT May 6, 2014 vi Tim McDonnell, “We’re screwed: 11,000 years’ worth of climate data prove it,” The Atlantic, March 9, 2013 vii ibid viii Meridith Haas, “How long can we hold on to the coast?,” 41N, Spring/Summer 2014 ix Justin Gillis, “Study of Ice Age Bolsters Carbon and Warming Link,” NYT, February 28, 2013 x The table below, containing data on energy consumption for the US, China, and India, reveals the striking differences between energy usage in a developed and less developed country. Energy consumption per capita in the US is twelve times higher than in China and nearly thirty times as high as in India. Total Energy: 2000 Population (millions) Consumption. Per capita thousand BTUs) Consumption (quadrillion. Btus) China 1,261 29 36.7 India 1,014 13 12.7 US 275 351 98.8 Total 393 148.2 World 65 397.4 Given the rapid rate of growth in the two countries a reasonable question is: what happens if these two countries catch up? What happens if they succeed at growing their economies and start living like Americans and Europeans? In the table below we look at world energy demand in 2025 based on projected population growth if there is some catch up. In the second column is the projected population and in the third column is the projected energy consumption if energy per capita rates do not change. Energy demand in these three countries would increase from 148.2 to 186.3 QBTUs - about a 30 percent increase. If there is catch-up, however, energy consumption the increase will be far more significant. If per capita in these two countries rises to only one half the US average in 2000, (column 5) then projected energy consumption (column 6) would in these three countries would reach 656.5 QBTUs - nearly five times current use and approaching twice total current world energy consumption - and this is without economic and energy demand growth anywhere else. Total Energy: 2000-2025 Consumption Consumption Consumption Consumption Per Population 2025 (quadrillion Per Capita (quadrillion Btus) capita 2025 Btus) 2025 2025 2025 China 1617 29 46.9 175.5 283.8 India 1435 13 18.7 175.5 251.9 US 344 351 120.8 351 120.8 Total 186.3 656.5 Also, as you follow the news on the environmental problems in today's developing countries, keep in mind that pollution was an integral part of the development of the US, a bit of which you find in Climatic Fears - Colonialism and the History of Environmentalism. xi Jared Diamond, "What's your consumption factor?," New York Times January 2, 2008 xii Thomas Friedman, “To big to breathe,” NYT November 5, 2013 xiii Clarissa Sebag-Montefiore, “The great smog of China,” NYT December 28, 2012 xiv Edward Wong, “Pollution leads to drop in life span in Northern China,” NYT July 8, 2013 and “Air pollution linked to 1.2 million premature deaths in China,” NYT April 1, 2013 xv Yu Hua, “Jokes, lies and pollution in China,” NYT, October 29, 2013 xvi “Climate change: Bell Weather,” The Economist, Aug 11th 2012 xvii Edwrd Porter, “For insurers, no doubts on climate change,” NYT, May 14, 2013 xviii Robert Kaplan, “The Coming Anarchy,” The Atlantic Monthly, Feb 1994 xix Michael T. Klare, in "The New Geography of Conflict" (Foreign Affairs, May/June 2001) sees water scarcity as the primary driver of conflict in the future. xx Thomas Friedman, “Postcard from Yemen,” NYT, May 7, 2013 xxi Caitlin E. Werrell, Francesco Femia, and Anne-Marie Slaughter, “The Arab spring and climate change,” Center for American Progress, February 28, 2013 xxii Thom Shanker, “Pentagon releases strategy for Arctic,” NYT November 22, 2013

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xxiii Gregg Easterbrooke, “Global warming: Who wins-and who loses,” The Atlantic, April 2007 xxiv Thomas Friedman, “Take the subway,” NYT March 3, 2012 xxv Richard Muller, “The conversion of a climate-change skeptic,” NYT July 28, 2012 xxvi National Science Foundation web site, xxvii Jane Perlez & Kirk Johnson, "Behind gold glitter: torn lands and pointed questions," NYT October 24, 2005 and Jane Perlez and Raymond Bonner, "Below a mountain of wealth, a river of waste," NYT 12/27,2005 xxviii Thomas Friedman, "Shoulda, Woulda, Can," NYT 5/27/2004 and "Big oil and its subsidies," The Economist, 3/10/2001 xxix He describes the "First Law of Petropolitics" as the inverse relationship between the price of oil and the pace of freedom, and cites Putin's rise in Russia that coincided with a rising world oil price as an example of the process. xxx John Eligon, “An oil boom takes a toll on health care,” NYT January 27, 2013 xxxi Robert Cullen, "The True Cost of Coal," The Atlantic Monthly December 1993 xxxii "Jam today, road pricing tomorrow," The Economist, December 6, 1997 xxxiii There is also a potential problem with this approach if the proponents of tort reform are able to cap punitive damages. To see how this works, consider the information that appeared in The Corporation as an example of the type of calculation a firm would do when deciding on a course of action. In this case it was GM's analysis regarding the design changes in its 1979 Chevrolet Malibu and their relationship to the possibility of fuel-fed fires caused by accidents. According to court documents mentioned in the book, GM was aware of safety concerns with its vehicles and had solicited a report on fuel-fed fires. The result was "Value Analysis of Auto Fuel Fed Fire Related Fatalities" that included the following calculation. 500 fatalities x $200,000/fatality = $2.40/automobile 41,000,000 Based on available data, GM was assuming there would be 500 fatalities and that GM would end up paying $200,000 per fatality in the settlements, which if you distributed it across the 41 million of GM cars on the road, it would come to $2.40 per vehicle - less than the $8.59 per vehicle it would cost to ensure that there would be no fuel tank fires. In the Coasian world the impact of tort reform would be to reduce $200,000 which would alter GM's calculations and the calculations of all firms making similar calculations. xxxiv Ellison, “An Inconvenient Lawsuit: Teenagers Take Global Warming to the Courts,” The Atlantic Monthly, May 2012 xxxv It is not surprising the command and control approach is the first choice of many who are concerned with pollution since the simplest solution to a problem often seems to be to tell the involved parties what to do eliminate the problem. If the exhaust fumes from cars are too high, tell companies that produce the cars to put on catalytic converters. The preference for command and control can also be traced to the fact that all of the interested parties favored them - the firms, environmental groups, organized labor, and legislators. Firms like them because they can usually be manipulated to favor existing firms - an example being the imposition of tougher controls on new entrants into the market. Environmentalists disliked the market- based schemes because they believed, on philosophical grounds, these approaches were wrong because they gave firms a license to pollute and because there were real problems quantifying many of the environmental damages. They worried about difficulties with answering key questions such as, how much is an extinct species of fish worth? Environmentalists also worried about the politics of taxes - the reluctance to raise taxes would limit the ability to continually clean up the environment - and the possible existence of environmental trouble spots that could occur. Labor, meanwhile, tended to side with the United Mine Workers who did not want tougher legislation since it would decrease demand for the high-sulfur eastern coal from mines represented by the mine workers' union. Finally, there were the legislators who favored command- and-control because they were the issuers of the commands and they tended to be lawyers by training so their natural instinct was to establish new laws. They also liked the fact that the legislation tended to hide the cost of control - there was no tax per ton to report - and there was much political mileage to be gained by statements on standards, even if the statement was undone by side-deals. xxxvi Matt Ridley and Bobbi Low, "Can Selfishness Save the Environment?" The Atlantic Monthly, December 1999 xxxvii Closer to home we saw the impact of the fuel efficiency standards for cars that probably contributed to higher energy consumption in the US by creating the market for SUVs. It turns out, that SUVs aren't really cars. They are trucks that have much less restrictive efficiency standards, so Americans turned in their large cars for large trucks and the overall energy efficiency of vehicles on American roads decreased. xxxviii Let's assume the community decided to charge the university a tax of $2 for each student. The new financials of RIU are presented in the table below with the yellow columns representing the costs after the imposition of the tax. What you find is the financials look exactly like the ones earlier where we built in the social costs of the tutoring. What used to be the TSC column is now the TPC + tax column. When 8,000 students attend RIU, the tax will be equal to $16,000 (8,000*$2) so the Total Cost (TPC + tax) will be $68,000. As we saw earlier, without the tax RIU would have chosen a 10,125 student university as the maximum profit output level, but when the tax of $2 per student is imposed, the "external" costs have been internalized and you could expect RIU to choose 9,800 students as the optimal size of the university. Short-Run "Private" Financials for RIU with a Tax Students Tuition TR MR TPC APC MPC Total Profit TPC + tax APC + tax MPC + tax 6700 $11.00 $73,700 $45,000 $6.70 $28,700 $58,400 $8.72 7300 $11.00 $80,300 $11.00 $48,500 $6.60 $5.83 $31,800 $63,100 $8.64 $7.83 8000 $11.00 $88,000 $11.00 $52,000 $6.50 $5.00 $36,000 $68,000 $8.50 $7.00 8775 $11.00 $96,525 $11.00 $55,500 $6.30 $4.52 $41,025 $73,050 $8.32 $6.52 9800 $11.00 $107,800 $11.00 $59,000 $6.00 $3.41 $48,800 $78,600 $8.02 $5.41

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10125 $11.00 $111,375 $11.00 $62,500 $6.20 $10.77 $48,875 $82,750 $8.17 $12.77 10400 $11.00 $114,400 $11.00 $66,000 $6.30 $12.73 $48,400 $86,800 $8.35 $14.73 10625 $11.00 $116,875 $11.00 $69,500 $6.50 $15.56 $47,375 $90,750 $8.54 $17.56 The graphical representation of the use of taxes and subsidies to achieve the socially optimal price and hours of tutoring appears below and, not surprisingly, it looks very much like the diagram you saw earlier. The "optimal" size would be at the intersection of the firm's Marginal Revenue (MR) and Marginal Private Cost + tax curves, which is precisely the social optimum. When a tax equal to the difference between the private and social costs is imposed, then the tax would 'force' the firm to account for these costs and output would decrease. This approach is easily generalizable. For example, suppose you had reliable evidence the cost of pollution was $4,000 for each automobile produced, the cost of each additional unit of output was $6,000 (MPC), and additional revenue from selling one more unit was $9,000 (MR). In this situation the firm sees MR > MPC ($9,000 > $6,000) and it will expand production. If the firm were 'forced' to pay the additional social cost in the form of a $4,000 tax, then MR < MPC ($9,000 < $6,000 + $4,000) and the firm will not expand production. By imposing the tax we have lowered the firm's optimal choice for production. xxxixSo who could possibly be against coal gasification and carbon capture? Ratepayers, for one, mainly because carbon- capture technology is so expensive. In 2011, American Electric Power, or A.E.P., canceled a big carbon-capture project, in part because it was clear that state regulators were not going to allow the company to pass on the additional costs to its customers. Joe Nocera, “A real carbon solution,” NYT March 15, 2013 xl Increases in energy taxes such as the Patriot Act's Patriot Tax have a great ring to them, and they offer wonderful example of how the market system works. This was described quite well in a New York Times editorial. (October 24, 2005) There is also a good possibility that, over time, higher gas taxes would not hurt consumers as much as is generally feared. Oil exporters tread gas taxes because the higher gas prices go, the greater the incentive for companies and governments to invest in alternatives. For that reason, economists assume that raising the gas tax - say, by a dollar or so - would not necessarily raise the price at the pump by the same amount. Rather, a tax increase could induce exporters to allow the price of oil itself to fall, in order to keep the price at the pump below the level at which alternatives begin to look attractive. xli Thomas Friedman, “The First law of Petropolitics,” Foreign Policy, May 1, 2006 xlii John Tierney, "Instead of the soft path, try hard cash," NYT October 1, 2005 xliii At the web site they post the following advantages of a carbon tax. • A carbon tax is an “upstream” tax on the carbon content of fossil fuels (coal, oil and natural gas) and biofuels. • A carbon tax is the most efficient means to instill crucial price signals that spur carbon-reducing investment. View our spreadsheet to see how fast emissions will fall at different tax levels. • A carbon tax will raise fossil fuel prices — that’s the point. The impact on households can be softened through “dividends” (revenue distributions) and/or reducing other taxes that discourage hiring and investing (“tax-shifting or swapping”). • Carbon taxing is an antidote to rigged energy pricing that helps fossil fuels destabilize earth’s climate. Unlike cap-and- trade, carbon taxes don’t create complex and easily-gamed “carbon markets” with allowances, trading and offsets. xliv EPA carbon tax url http://yosemite.epa.gov/ee/epa/eed.nsf/6058a089548635578525766200639df3/50a39751d15c4eb785257746000aff6c!opendo cument xlv Elizabeth Rosenthal, “Carbon taxes make Ireland even greener,” NYT December 27, 2012 xlvi http://webnet.oecd.org/climatechange/#story=0 xlvii In 2006, voters in Boulder, CO passed the first municipal carbon tax on electricity consumption, and in 2008 the Bay Area Management District in San Francisco passed a carbon tax of 4.4 cents per ton. Quebec Province took a "baby step" in this direction when in 2007 it began taxing hydrocarbons the Carbon Tax Center estimated at $4.26 per pound of carbon that would add about 1.1 cents to the price of a gallon of gas. In 2008 British Columbia followed Quebec's lead with a more ambitious carbon tax. Taylor estimates that the British Columbia carbon tax will equate to an additional 2.4 cents (Canadian) on a litre of gasoline, or 9.1 cents Canadian (9.2 cents U.S.) per gallon -- triple the level of the Quebec carbon tax. Moreover, the British Columbia rate itself is set to rise by $5/tonne annual increments until it triples, to $30/tonne, by 2012. At that point the tax will equate to 7.24 cents per litre of gasoline and 8.29 cents per litre of diesel, making it roughly eight times as large as Quebec's tax. Where Carbon is Taxed, Carbon Tax Center web site, accessed 11/22/2008 xlviii In 1975 Singapore launched the first effort with its Area Licensing Scheme, which was updated in 1998 to its current Electronic Road pricing (ERP) scheme described below by the Land & Transport Authority of Singapore. Basically it is very much like Easy pass - each car has a transponder and every time the car enters the restricted area the driver is charged. The ERP system uses a dedicated short-range radio communication system to deduct ERP charges from CashCards. These are inserted in the In-vehicle Units (IUs) of vehicles before each journey. Each time vehicles pass through a gantry when the system is in operation, the ERP charges will be automatically deducted. Rome also went this route with a system similar to that in Singapore in 2001, and in 2008 Mayor Bloomberg proposed a tax for New York City that was to be modeled after xlix Stockholm, following London's lead, introduced a congestion charge in 2007 with cars "going into or out of the inner city zone pay 10, 15 or 20 kronor, depending on the time of the day," (Gwladys Fouch, "Sweden's carbon-tax solution to climate

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change puts it top of the green list," Guardian.co.uk April 29 2008) and Milan began a one-year trial in 2008. And in 2012 the Netherlands was conducting a test of a system that would directly tax people based on the miles they drove. In each car a meter is installed that tabulates a fee based on mileage, fuel efficiency, and congestion – one tax to address a number of externalities.

Hooked up to the Internet wirelessly and to GPS, the system tabulates a charge for each car trip by using a mileage- based formula that also takes account of a car’s fuel efficiency, the time of day and the route. (Driving on busier thoroughfares costs more than driving on less-traveled roads.) At the end of each month, the vehicle’s owner would receive a bill detailing times and costs of usage, not unlike a cellphone bill, although participants in the trial did not have to pay the charges. (Rosenthal, “In auto test in Europe, meter ticks off miles, and fee to driver,” NYT August 10, 2011)

In the US, the federal government has made some preliminary steps in this direction when the Urban Partnership Agreements (Congestion Initiative) were established by the U.S. Department of Transportation. Five model cities (Minneapolis, Seattle, San Francisco, Miami, and New York City) were chosen as part of a National Strategy to Reduce Congestion on America's Transportation Network, and they would be spending nearly a billion dollars on evaluating alternative methods to reduce congestion, including congestion pricing. Mayor Bloomberg’s suggestion that New York City impose such a tax, however, never gained any traction.

Shanghai, suffering from crippling congestion, took a rather different approach when it rationed the number of licenses it would issue in an effort to relieve the city's congestion. Singapore, meanwhile, has been working aggressively for years at reducing congestion with a variety of policies that include high parking fees, high gas taxes, high license fees, and in 1990 auctioning off Certificates of Entitlement that allow the holder to ride the on the streets. For more on Singapore's multi- dimensional attack on congestion you can check out the EPA web site. l Bittman, “Bad Food? Tax It, and Subsidize Vegetables,” NYT July 23, 2011 li It does, however, have one major advantage. Efforts to get firms to reduce pollution are generally fought by the affected industries, just as the auto companies fought higher mileage standards, but if you allocate the allowances to the existing big polluters then you may be able to gain their support for passage of the legislation. lii Congressional Budget Office report, Policy Options for Reducing CO2 Emissions, 2008 liii Congressional Budget Office report, Policy Options for Reducing CO2 Emissions, 2008 liv One area where there has been extensive use of tradable permits has been in fishing (case studies). Another is the Mid- Atlantic surf clam fishery that by the 1970s was experiencing the classic signs of over fishing.liv By 1990 ITQs (Individual Transferable Quotas) were in place with the state establishing an annual quota that it then divided into ITQs that were assigned to existing vessels based on the size of their prior catches. The ITQs could then be bought and sold in the marketplace, which prompted the least productive fishers to leave the industry after selling their allowances, and the over- harvesting problem was solved. lv For information on the program you should visit the EPA Acid Rain Program site. Here is how it worked. 1. SO2 allowances, each being a permission to emit one ton of SO2 in that year or in some future year, would be issued annually and each emission source was required to install Continuous Emissions Monitoring (CEM) equipment verified by EPA 2. since 1993 a small number of allowances, approximately 2.9%, are allocated via an auction 3. allowances could be bought and sold by anyone including speculators and environmentalist groups that wanted to reduce pollution levels 4. at the end of each year, each emission source would need to provide allowances for the annual emissions that would be taken from the market 5. any source that did not have adequate allowances faced fines and possible additional emission reductions For a review of the results of this experiment see the articles by Schmalensee et. al and Stavins in Journal of Economic Perspectives, Summer 1998 lvi The timeline for emissions provided by EPA appears below. In Phase I the caps were gradually lowered from 8.7 to 7 million tons, and in each of the years there were savings that could be "banked" for future use. After Phase II began in 2000 the caps were exceeded so the banked savings was depleted until 2006 when emissions dropped below the cap of 9.5 million tons.

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lvii The framework was simply a statement of purpose with no targets or enforcement provisions. These would be specified in periodic updates, known as Protocols, established at future conferences. The most notable of these agreements was the Kyoto Protocol of 1998 in which most industrialized countries agreed on binding reductions of GHGs by an average of 5% below 1990 emissions within the 2008-2012 period. The US was scheduled to lower its GHGs by 7%. President Clinton never sent the Protocol to Congress, and president Bush in 2001 rejected it. That year did, however, produce the system for achieving the goals of the Kyoto Protocol. The centerpiece was the system championed by the US that wanted to model the international system for reducing GHGs after its system for reducing SO2. The system contained three separate elements. The first two were the Joint Implementation Provision (JI) and Clean Development Mechanism (CDM) that allowed industrialized countries (Annex I countries) to fund GHG emission reductions in developing countries as an alternative to domestic emission reductions. The third was the International Emissions Trading in which Annex 1 countries can trade Assigned Amount Units (AAUs) among themselves. AAUs (one metric ton of CO2 equivalent) are allocated to Annex 1 parties at beginning of each commitment period based on each country's target. By 2012, emissions in the signature countries were to meet the allowance targets by any combination of the above methods, plus any credits generated by carbon-absorbing programs (sinks) such as forest and cropland management and re-vegetation. The World Bank, an international agency established to provide aid to the world's poor countries, has gotten in on the action with establishment of the Carbon Finance Unit (CFU) that uses money contributed by governments and companies in the industrialized countries to purchase project-based GHG emission reductions in developing countries that would include, but not be restricted to, renewable energy projects, methane reductions, energy efficiency, and reforestation project. As of 2008, the European Union and Japan have been the biggest "buyers" of these credits, while China has accounted for about 60% of the value of these projects lviii By 2012, emissions in the signature countries were to meet the allowance targets by any combination of the above methods, plus any credits generated by carbon-absorbing programs (sinks) such as forest and cropland management and re- vegetation. The World Bank, an international agency established to provide aid to the world's poor countries, has gotten in on the action with establishment of the Carbon Finance Unit (CFU) that uses money contributed by governments and companies in the industrialized countries to purchase project-based GHG emission reductions in developing countries that would include, but not be restricted to, renewable energy projects, methane reductions, energy efficiency, and reforestation project. As of 2008, the European Union and Japan have been the biggest "buyers" of these credits, while China has accounted for about 60% of the value of these projects. This is the largest trading system, and not surprisingly, its launch was quite controversial. There were disagreements over the number of allowances issued as well as the allocation scheme that gave allowances away to the biggest polluters - pretty much what we saw with the US SO2 system. Major industrial and energy producing sources of emissions, representing about 40% of GHG emissions, were identified and scheduled to reduce emissions in two phases. As with SO2 in the US, the EU ETS was phased in slowly - Phase I (2005-2007) and Phase II (2008-2012) - and in 2008 debate was already underway on Phase III (2013-) with the expectation that allocation of the allowances would be centralized and that a substantial share of the allowances will be allocated by auction. lix allowances may be traded either privately, over the counter where a broker will match buyers and sellers, or on the spot markets of one of Europe's climate exchanges - the biggest being the European Climate Exchange (ECX). lx The carbon market is described in "The Carbon Craze," Fortune magazine April 28, 2008. lxi Emissions would be capped at 150,000,000 tons of carbon dioxide a year, approximately the average omissions in the highest three years between 2000 and 2004, and emissions were to be reduced 10% below 2009 levels by 2018, with each of the nine states having its own target. For those interested in looking for more on the subject you should check out Jeff Goodell, "Capital pollution solution," New York Times July 30, 2006) and Cait Murphy, "Hog wild for pollution trading," Fortune9/2/2002 For a good overview of permits, see Tom Tietenberg, The tradable permits approach to protecting the commons: what have we learned?

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lxii http://fas.org/sgp/crs/misc/R41836.pdf lxiii Felicity Barringer, “A grand experiment to rein in climate change,” NYT October 13, 2012 lxiv For those with an interest in international issues, we have much the same problem when we look at the environmental impacts of international trade policies. According to Carl Pope, in "Race to the top: The biases of the WTO," Globally, we seek a rules-based system that allows, and ideally encourages, societies to internalize the environmental costs of economic activities. We want to avoid three kinds of subsidies: subsidizing local producers at the expense of local communities, subsidizing present generations at the expense of future generations, and subsidizing global commodity production at the expense of the global commons. What we have received, instead, is a rules-based trade system that discourages and, in some cases, effectively prohibits certain kinds of environmental protection strategies while setting the global economy against the internalization of environmental costs. lxv The situation at the end of the 1960s was described by Jack Lewis in The Birth of EPA as follows. Everywhere television programs, symposia, and "teach-ins" raised the burning question: "Can Man Survive?" In May 1969, U Thant of the United Nations gave the planet only ten years to avert environmental disaster; the following month, he blamed the bulk of planetary catastrophe on the United States. Under Secretary of the Interior Russell E. Train spoke skeptically at the April 1969 Centennial of the American Museum of Natural History: "If environmental deterioration is permitted to continue and increase at present rates, [man] wouldn't stand a snowball's chance in hell [of surviving]." In his statement to Congress in July of 1970, President Nixon described a government reorganization that created the EPA. "The Government's environmentally-related activities have grown up piecemeal over the years. The time has come to organize them rationally and systematically. As a major step in this direction, I am transmitting today two reorganization plans: one to establish an Environmental Protection Agency, and one to establish, with the Department of Commerce, a National Oceanic and Atmospheric Administration." lxvi The major landmarks in environmental legislation in the 1970s is listed in the table below. Environmental Legislation 1970 Clean Air Act 1970 Formation of EPA 1972 Water Pollution Control Act (Clean Water Act) 1972 Federal Insecticide, Fungicide and Rodenticide Act amendment 1972 Ocean Dumping Act 1974 Safe Drinking Water Act 1976 Toxic Substances Control Act 1976 Resource Conservation and Recovery Act 1977 Clean Water Act and Clean Air Act Amendment 1978 Great Lakes Water Quality Agreement 1980 Comprehensive Environmental Response Compensation and Liability Act (Superfund) For a history of the EPA you should check out the EPA History and A Look at EPA Accomplishments: 25 Years of Protecting Public Health and the Environment web sites where you will find a timeline and links to landmark policies and events in the years since the EPA in 1970. In addition to the legislation listed above, the 1970s was also the time in which we saw the introduction of the catalytic converter, the banning of DDT, the banning of aerosol fluorocarbons after linking them to a hole in the ozone, the banning of PCB manufacture, and the suit against Hooker Chemical for the Love Canal cleanup. We'll now look briefly at a timeline of air and water pollution policies. The enthusiasm for, and confidence in the ability to deliver at reasonable cost, cleaner air disappeared in the stagflation and spiraling energy costs of the 1970s and in 1977 another Clean Air Act Amendment was passed, this one basically relaxing some of the guidelines set in 1970. After more than a decade of inaction, the 1990s opened with passage of the Clean Air Act Amendments of 1990. For those interested you can check out the timeline involved in moving from the President's idea to final legislative action. Included in this legislation was the Acid rain program that introduced the tradable allowances as the approach to reducing sulfur dioxide, the source of acid rain, which may have marked a turning point in environmental legislation in the US. Prior to this there had been an overwhelming preference for command-and-control instruments and little interest in market-based solutions. For those interested, the American Meteorological Site has a timeline on clean air legislation lxvii The Clean Air Act was preceded by the following efforts at control of air pollution. 1. Chicago and Cincinnati enact clean air legislation (1881) 2. Air Pollution Control Act of 1955 put federal government in the business of funding research on air pollution. 3. Clean Air Act of 1963 that "sought to promote public health and welfare." It granted $95 million over a three year period to state and local governments and air pollution control agencies in order to conduct research and create control programs and encouraged the development of emissions standards from these sources. It also proposed establishment of standards from stationary sources, and promoted ongoing research, investigations, surveys, and experiments. 4. Motor Vehicle Air Pollution Control Act (1965) that set emissions standards from these sources to begin in 1968. The legislation was amended again in 1966 and 1967, with the latter establishing national emissions

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standards for stationary sources and dividing the nation into "Air Quality Control Regions (AQCRs) in an effort to monitor ambient air quality. Since then there have been numerous amendments and extensions including the Clean Air Act Extension (1975) that further reduced auto emission standards by 1975 and established National Ambient Air Quality Standards for six pollutants from existing pollution sources. The air quality standards were established to "protect human health" and there was no reference to costs of compliance, while the emission standards were based on crude calculations of the reduction necessary to achieve the pollutant levels that would have no adverse health effects. 62. The Clean Water Act was preceded by the following efforts at control of water pollution. 1. The Rivers and Harbors Act of 1899 was the first federal legislation designed to protect the nation's waters, although in this case the legislation was primarily designed to keep the nation's navigable waterways free of obstruction. 2. Federal Water Pollution Control Act ("Clean Water Act") of 1948, a response to a growing concern over public health and epidemic caused by waterborne bacteria. This act provided federal funding and technical assistance to promote improved water quality.45 It wasn't until 1965, however, with passage of the Water Quality Act that established the Water Pollution Control Administration within the Department of the Interior, that water quality was viewed as an environmental issue rather than a public health issue. lxviii 62. The Clean Water Act was preceded by the following efforts at control of water pollution. 1. The Rivers and Harbors Act of 1899 was the first federal legislation designed to protect the nation's waters, although in this case the legislation was primarily designed to keep the nation's navigable waterways free of obstruction. 2. Federal Water Pollution Control Act ("Clean Water Act") of 1948, a response to a growing concern over public health and epidemic caused by waterborne bacteria. This act provided federal funding and technical assistance to promote improved water quality.45 It wasn't until 1965, however, with passage of the Water Quality Act that established the Water Pollution Control Administration within the Department of the Interior, that water quality was viewed as an environmental issue rather than a public health issue. lxix The results of the legislation appear mixed. A review of studies of the water quality legislation revealed that the number of miles of river meeting the established standards did not increase more than 7 percent, and "the Clean Water Act does not appear to have achieved benefits commensurate with its costs." A Myrick Freeman III, "Environmental policy since earth day I: what has it gained?" Journal of Economic Perspectives Winter 2002 The Clean Air legislation's impact, meanwhile, was much more dramatic. According to Freeman, the "observed decreases in the national average concentrations of these pollutants can reasonably be attributed to the Clean Air Act," and the benefits appear to greatly outweigh the costs. The EPA conducted a Retrospective Analysis that evaluated the 1970-1990 period and two Prospective Analyses - one in 1999 for the 1990-2010 period and one in 2003 for the 1990-2020 period. In the retrospective, the benefits were estimated to be $22 trillion - yes I said trillion - with the majority of the benefits coming from decreased mortality - fewer people died. And the costs - less than $500 billion - so it looks like quite the deal. A summary of the work can be found in a PPT show by Robert Garbaccio Assessing the Benefits and Costs of the Clean Air Act. lxx Ralp Cavanagh, “How we learned not to guzzle,” NYT September 12, 2013 lxxi Dirk Forrister and Paul Bledsoe, “Pollution economics,” NYT, August 2013 lxxii “Beijing’s car problem,” NYT, November 15, 2013 lxxiii Didi Kirsten Tatlow, “Amid heavy pollution, Beijing issues emergency rules to protect citizens,” NYT October 17, 2013 lxxiv Chris Nielsen & Mun S. Ho, “Cleaning the air in China,” NYT, October 25, 2013 lxxv Edward Wong, “Beijing takes steps to fight pollution as problem worsens,” NYT January 30, 2013 lxxvi While it is certainly a positive step forward, in "Can Selfishness save the environment? we get an idea of how difficult it is to enact legislation and how powerful the profit motive is for the polluters. This process is described below by Peter Morrisette in The Evolution of Policy Responses to Stratospheric Ozone Depletion.", culminated in the 1987 Montreal Protocol. The evolution of stratospheric ozone depletion policy can best be understood as a two-stage process. The first stage involves the emergence of stratospheric ozone depletion as a domestic issue in the United States and several other countries in the 1970s, while the second stage focuses on its transformation to an international issue in the 1980s. In addition to the emergence of stratospheric ozone depletion as an international political issue, three other factors are important in understanding the sources of the Montreal Protocol: (1) the evolving scientific understanding of the problem, (2) increasing public concern over the problem based on the threat of skin cancer and the discovery of the Antarctic ozone hole, and (3) the availability of acceptable substitutes for CFCs." The decision by DuPont, the largest producers of the chlorofluorocarbons that were to be banned, to support the ban was originally viewed as an altruistic gesture, but it may have been for a more selfish motive of keeping out competitors. According to Peter Morrisette in The Evolution of Policy Responses to Stratospheric Ozone Depletion, Oye speculates that this explanation was incomplete, and that the company's executives may have been swayed in favor of a ban on CFCs by the realization that the CFC technology was mature and vulnerable. Du Pont was in danger of losing market share to its rivals. A ban beginning ten years hence would at least make it worth no potential rival's while to join in; Du Pont could keep its market share for longer and meanwhile stand a chance of gaining a dominant market share of the chemicals to

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replace CFCs. Again self-interest was part of the motive for environmental change. If consciousness-raising really changes corporate minds, why did the utility industry fight the Clean Air Act of 1990 every step of the way? The case of Du Pont is not, after all, an exception to the rule that self-interest is paramount. lxxvii For a sense of the "politics" of international legislation such as the Protocol you should check out Hot Air Over Kyoto. The morning after the Kyoto agreement, Republican congressional leaders held a news conference declaring the Protocol dead on arrival in the US Senate, arguing that the documents failure to set binding emissions-reduction targets for China, India, and other major developing countries would economically disadvantage the United States. In response, the Clinton administration chose not to defend the Protocols basic premise: industrialized nations, whose fossil fuel-based economic growth in the 20th century is largely responsible for todays increased level of greenhouse gas concentrations, should act first to curb their emissions growth. lxxviii Warwick McKibben & Peter Wilcoxen, "The Role of Economics in Climate Change Policy," Journal or Economic Perspective Spring 2002. You also might want to look at Gregg Easterbrook, "Global warming: Who loses-and who wins?," The Atlantic Monthly April 2007 where you get an idea of the distribution of costs and benefits of climate change. lxxix If you are like most people, you will have no difficulty describing the problems encountered in group work, the most notable being the group members who do not do their fair share - the free rider. The explanation can usually be traced to the grading scheme that assigns a group grade so an individual's grade is not directly related to the their contribution. If Mary and Jack are in the group, then Jack's receiving an A does not negatively affect Mary's chance at an A. In fact Jack's receiving an A will likely mean Mary will get the A, so the group possesses both the nonexcludability and nonrivalry characteristics of public goods. So what happens when the work needs to be done. Peter, a student with slug tendencies is considering his options. He is fairly confident that Jack, a bit of a perfectionist with a high GPA, will not let the group project fail. He also knows he cannot be excluded from the group grade and the grade he gets will not deplete the grades others get. So Peter becomes a free-rider and allows the group to do the work and is more than willing to share in the credit. lxxx In recent years there has been a movement to broaden the concept of public goods to include global public goods (GPGs). These goods traditionally were viewed as existing for goods outside a national boundary - space, the oceans, the atmosphere - but with the move toward a globally integrated world the list of public goods has been expanded. George Stiglitz, a former chief economist at the World Bank, identified five global public goods - international economic stability, international security (political stability), the international environment, international humanitarian assistance, and knowledge. A similar list has been suggested by Kofi Annan, UN Secretary General who stated in 1999, "It is not beyond the power of political volition to tip the scales towards a more secure peace, greater economic well-being, social justice and environmental sustainability. But no country can achieve these global public goods on its own, and neither can the global marketplace. Thus our efforts must now focus on global public goods." The track record on the provision of public goods, or even an agreement on what constitutes GPGs, has been less than stellar, however, but that should be expected given the history of providing national public goods and the lack of multinational institutions. In fact the UN has identified three key weaknesses in the current system that hinder the provision of public goods. 1. The jurisdictional gap: There is a significant difference between the globalized world and the national system of policy-making. 2. The participation gap: There are important new "global actors," but international cooperation is too often intergovernmental. 3. The incentive gap: International cooperation too often takes the form of handouts and too often ignores incentives. What we do know is that these goods will not be provided without government intervention and funding due to the existence of the free rider problem. lxxxi Garret Hardin, "The Tragedy of the Commons" Science, 1968

lxxxii Orrin Pilkey, “We need to retreat from the beach,” NYT November 14, 2012 lxxxiii Ridley & Low, "Can Selfishness save the environment?," The Atlantic Monthly September 1993 lxxxiv Justin Gillis, “Bipartisan report tallies high toll on economy from global warming,” NYT June 24, 2014 lxxxv Amory Lovins, "How America can free itself of oil-profitably" Fortune, September 20, 2004 lxxxvi Jerry Patchell and Roger Hayter, “How big business can save the climate,” Foreign Affairs, S/O 2012 lxxxvii One innovative effort was tried in Panama. The Panama Canal has problems that can be related to deforestation, but Panama does not have the money to finance a reforestation project. Fortunately, there might be a rather novel solution. In the case of the Panama Canal, the answer may turn out to be John Forgach, an entrepreneur, banker and chairman of ForestRe, a forestry insurance company based in London. Mr. Forgach's plan is to use the financial markets to arrange for companies dependent on the canal to pay for the reforestation. Working in collaboration with several as-yet-unnamed insurance and reinsurance companies, Mr Forgach is trying to put together a deal in which these companies would underwrite a 25-year bond that would pay for the forest to be replanted. The companies would then ask those of their big clients who use the canal to buy the bond. Firms such as Wal-Mart, and a number of Asian carmakers, which currently insure against the huge losses they would suffer if the canal were closed, would pay a reduced premium if they bought forest bonds. lxxxviii Daniel Sarewitz & Roger Pielke Jr., “Learning to live with fossil fuels,” The Atlantic, May 2013 lxxxix Eric Klinenberg, “Adaptation: How can cities be ‘climate-proofed?” The New Yorker, January 7, 2013

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