Dirty technology, clean-cut solutions

New Directions in the Economic Theory of the Environment
March 6, 1998

So successful has the study of the economics of the environment become that, less than a few decades after its birth, it has spawned an inevitable "new" environmental economics. The search for newness is all part of the healthy development of the subject, although there are many false messiahs claiming revolutionary paradigm shifts and new "world views" of the environment-economy linkage. Carlo Carraro and Domenico Siniscalco have assembled contributions from true professionals to assess the groundwork for new departures in environmental economics. The resulting essays deal with theory not practice and they will prove hard going for all but fellow economics professionals. Nonetheless, this is how scientific change begins, with some seemingly unrealistic theoretical constructs ("models") being the essential precursors to empirical investigation and, ultimately, synthesis as a new body of thought. Environmental economics is fortunate in that there is a substantial "industry" now investigating real-world problems while, at the same time, some of the best mainstream economists are applying themselves to the theoretical advances in the subject. The other feature of the book is one that we would not have seen 20 years ago: a dominance of European authors, showing clearly that Europe has equalled, if not run ahead of, our North American competitors.

Space forbids a detailed overview. In an elegant essay, Andrea Beltratti addresses the new fashion in theories of economic growth that attempt to explain both why economic growth occurs and what influences the critical factors that determine growth. Much of the new focus is on technological change and the prospect for long-lived, if not perpetual economic growth. Factors affecting technology appear still to be imperfectly understood but there are signs that the best hope for future environments lies in encouraging technological change with the potential to displace dirty technology and with the capability to secure continually falling costs. The obvious example is renewable energy and the implication for policy is one of giving the new technology a helping hand with suitable financial incentives. The potential benefits from such policy are likely to be huge in environmental, social and economic terms. Yet one searches in vain for signs of a really aggressive renewable energy technology policy from the corporate sector or the government.

David Ulph looks at innovation and the firm, noting that expenditures on research and development have large strategic components - they are designed to secure competitive advantage. Yet we need to encourage R and D to get the economic and environmental benefits identified in Beltratti's essay. How then can environmental policy contribute to this process of encouragement if firms will resist measures that encroach on their strategic concerns? Ulph shows that some of the more obvious solutions - such as taxing the pollution and subsidising the R and D - fail to capture the rich set of influences at work. Firms' reticence to search for low environmental damage technology may be offset by green consumer pressures, for example. But much also depends on the nature of the markets in which these potential innovators compete. Ulph's brother, Alistair, contributes an equally authoritative chapter on the highly topical issue of international trade and the environment. As he shows, some environmentalists' objections (aided by some dubious economists) to liberalising trade confuse trade as the cause of the problem when in fact it is national economic policies that are usually at fault. Blaming trade for policy failures is counter-productive since it leaves the true causes in place. But much of the trade versus the environment discussion has tended to assume that governments do not behave strategically to favour their own industries, and that there are no "economies of scale" for companies. The former at least is a very real concern in the real world of policy. Some argue that countries demanding the highest environmental standards secure a competitive advantage (or could do if they wished). Others argue that governments have an incentive to seek lax environmental standards in order to provide their industries with a cost advantage. One can see the relevance of this to "subsidiarity" in the European Union: if environmental policy was not "uniform" across member states then there is an apparent threat to the single market. A subtle feature of strategic policy not mentioned by Ulph is the incentive that governments may have to sign up to "harmonised" policies (for example, EU directives) but then to "go slow" in implementing them, knowing that the EU has limited enforcement powers.

At a time when international environmental agreements are at the forefront of policy-makers' concerns - witness the Kyoto climate-change discussion and the new concessions to the southern African states over ivory trading - Scott Barrett's excellent essay on the economics of such agreements is required reading. He shows how insights from game theory help us to understand when such agreements are likely to success and when they are likely to fail. What often passes for a cooperative agreement may not in fact differ much from what countries would have done anyway, though some international negotiators may not find this a rewarding thought. Careful use of incentive mechanisms and "side payments" - compensation to those who have no other incentive to sign the agreement - help explain some of the more successful agreements.

Other essays in the volume include Lars Bovenberg's analysis of "double dividends" from environmental taxation - the argument that we can tax pollution, thus solving an environmental problem (the first dividend) and then use the revenues to reduce some other distortion such as labour taxation (the second dividend); Michael Rauscher's analysis of the conditions under which financial and physical capital will move from countries with strong environmental regulations to those with weak ones; Michael Hoel's investigation into the effects of harmonising international environmental taxes; and two final essays on more detailed aspects of game theory and environmental economics. None of the essays is easy reading but all testify to the prospects for several decades more of exciting research in environmental economics.

David Pearce is professor of environmental economics, University College London.

New Directions in the Economic Theory of the Environment

Editor - Carlo Carraro and Domenico Siniscalco
ISBN - 0 521 59089 2
Publisher - Cambridge University Press
Price - £40.00
Pages - 364

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