6: Externalities October 26, 2014 1 ``Pittsburgh from the Salt Works at Saw Mill,'' by William T. Russell (1843)

6: Externalities

October 26, 2014

1

``Pittsburgh from the Salt Works at Saw Mill,'' by William T. Russell (1843)

``Pittsburgh from the Salt Works at Saw Mill,'' by William T. Russell (1843)

2

Pollution Externalities and Licenses

3

Licensing vs. Regulation4

A Pollution Tax5

A Pollution Tax with Rising Supply

6

Optimal Pollution7

US Emissions8

Marginal Damage of Emissions: Where To Put the

Factories

9

Toxic Waste Dump Cleaning Cost and Benefit

10

Two Firms and Cap and Trade11

Cap and Trade vs. Pollution Taxes

If it is very important to avoid letting total pollution crosssome particular threshold where its marginal cost risessharply, regulating quantity this way is better than puttinga price on it.

If it may be very beneficial to let output (and pollution)rise above a particular level, a pollution tax is better.If companies must buy their initial pollution permits, thequantity policy can, like the tax policy, raise revenue.

12

EPA and EEX Auctions

The test U.S. auctions are at “Clean Air Markets,” http://www.epa.gov/airmarkets/trading/2011/index.html .Note the environmentalists.

Europe: http://petrolog.typepad.com/climate_change/2009/07/spot-price-of-eu-emission-allowances.html

13

Selling Allowances Can Pay Better than Steelmaking

The Kyoto Protocol of 1997 required signing countries toreduce their carbon emissions. The European Union in2005 launched its own cap-and-trade system.

Corus, Europe’s second-largest steel producer, closed itsU.K. steelmaking plant at Redcar, cutting 1,700 jobs. It has 7.5 million carbon dioxide allowances. At e15/tonne,that’s worth 112.5 million euros,

Is the plant closing good, or bad?

14

The Summers World Bank Memo

DATE: December 12, 1991TO: DistributionFR: Lawrence H. SummersSubject: GEP ’Dirty’ Industries: Just between you and me, shouldn’tthe World Bank be encouraging MORE migration of thedirty industries to the LDCs [Less Developed Countries]?

I can think of three reasons:

15

Summers Memo pp 1, 5

http://ban.org/whistle/summers.html

16

Summers Memo, first part17

1) The measurements of the costs of health impairingpollution depends on the foregone earnings from increased morbidity and mortality.

From this point of view a given amount of health impairing pollution should be done in the country with the lowest cost, which will be the country with the lowest wages.

I think the economic logic behind dumping a load of toxic waste in the lowest wage country is impeccable and we should face up to that.

Summers Memo, second part 18

2) The costs of pollution are likely to be non-linear as theinitial increments of pollution probably have very low cost.I’ve always thought that under-populated countries in Africaare vastly UNDER-polluted, their air quality is probablyvastly inefficiently low compared to Los Angeles or MexicoCity.

Only the lamentable facts that so much pollution is generatedby non-tradable industries (transport, electrical generation)and that the unit transport costs of solid waste areso high prevent world welfare enhancing trade in air pollutionand waste.

Summers Memo, third part

3) The demand for a clean environment for aesthetic andhealth reasons is likely to have very high income elasticity.The concern over an agent that causes a one in a millionchange in the odds of prostrate cancer is obviously going to be much higher in a country where people survive to get prostrate cancer than in a country where under 5 mortality is 200 per thousand.

Also, much of the concern over industrial atmosphere discharge is about visibility impairing particulates. These discharges may have very little direct health impact. Clearly trade in goods that embody aesthetic pollutionconcerns could be welfare enhancing. While production ismobile the consumption of pretty air is a non-tradable

19

THE COASE THEOREM:

But why do we need the government to establish licenses?If information is symmetric, negotiation is costless, andcontracts are costlessly enforceable,

then people will choose surplus-maximizing actions regardlessof whether there are externalities and regardless ofwho has the property rights.

20

A Coase Theorem Example

21

A paper mill is polluting a river. The farmer downstreamhad been selling trout fishing rights to rich tourists for$20,000.Now the trout have fled, and he gets zero.

The factory could install filtering machinery that wouldeliminate the pollution, at a cost of $4,000.

1.Suppose the farmer has the right to a clean river.

2. Suppose the factory has the right to dump its wastewater into the river.

What if Pollution Is Efficient in the Trout Example?

Let the trout fishing income be $2,500, not $20,000. Letmitigation cost stay at $4,000.

If the farmer has the right to clean water, what happens?

If the factory has the right to dispose of waste in the river,what happens?

22

How the Coase Theorem Assumptions Break Down

Farmer benefit from trout: $20,000.Factory filtering machinery cost: $4,000.

If information is symmetric (that is, the players don’tdiffer too much in their information) . . .If negotiation is costless (that is, not too costly) . . .If contracts are costlessly enforceable, (that is, nottoo costly) . . .

23

The Town of Cheshire Buyout

American Electric Power had a polluting coal plant in Cheshire,southeast Ohio, that locally produced bothersome air pollution.

The company bought most of the town for $20 million,supposedly for plant expansion.

Most of the 221 residents of Cheshire left. 90 homeownerswere paid three times the value of their houses. Theysigned away their suing rights.

24

Applications of the Coase Theorem

1. Bees and crops that need pollination. http://pollinationconnection.com/beekeepers2. Inefficient contract law is not so harmful as inefficient tort law. If the standard contract rule is not value-maximizing, the two parties can write in a special clause. Binding arbitration, for example. 3. Coase’s example of two adjacent radio frequencies interferingwith each other. Clear property rights are enough.4. Buying out bad employees (IU presidents, coaches)

25

Extortion: SaveToby.com 26

http://www.rasmusen.org/g406/save-toby-com.pdf

http://www.theregister.co.uk/2005/04/13/rabbit_extortion/

“Toby Has Finally Been Saved!!!!!” http://www.savetoby.com/.

The Science of Global Warming

Carbon dioxide is generated when people burn coal, oil,or wood, or make cement from calcium carbonate.Carbon dioxide is absorbed when plants grow.

If the earth has high carbon dioxide and water vapor levels, that keeps heat from leaving, a “greenhouse” effect. (Greenhouses keep heat from leaving an enclosed space.) We do not really know what causes Ice Ages.

27

Reasons for Concern

Carbon dioxide emissions have quadrupled since 1950. The preindustrial amount of atmospheric CO2 was 280ppm(parts per million). Since 1960 it’s increased steadily from 315 to 390 ppm.

Average global temperature rose 1 degree Farenheit from1980 to 2000.

The sea level rose 80mm from 1970 to 2000.

28

Human Sources of Carbon Dioxide

29

Global Temperatures 1880-2012

30

Look at the vertical axis: it is anomalies, not average temperature. Source: http://data.giss.nasa.gov/gistemp/graphs_v3/

World Temperatures 1996-2012

31

http://data.giss.nasa.gov/gistemp/graphs_v3

U.S. Temperatures 1880-201032

http://data.giss.nasa.gov/gistemp/graphs_v3

Bloomington Temperatures33

NASA’s map for world weather station time series is athttp://data.giss.nasa.gov/gistemp/station_data/.

Cambridge Temperatures34

NASA’s map for world weather station time series is athttp://data.giss.nasa.gov/gistemp/station_data/.

A Badly Located Weather Station

35

http://www.surfacestations.org/

Satellite-Measured Temperature

36

Source: Roy Spencer, http://www.drroyspencer.com/latest-global-temperatures/.

Sea Level37

What’s Happened, Summary

The preindustrial amount of atmospheric CO2 was 280ppmv. Since 1960 it’s increased from 315 to 380 ppmv, to 0.038% of the atmosphere. Average global temperature rose about 1 degree Farenheitfrom 1980 to 2000. It also rose .5 degrees from 1910 to 1940, which can’t have been because of C02.The temperature has levelled off since 2000. The sea level rose 100mm from 1970 to 2000. It also rose 100mm from 1880 to 1970, which can’t have been because of CO2.

38

Costs of Global Warming

Decreased water except at high latitudes and moist tropical areas. Loss of coastland and coastal swamps. Less food production at low latitudes. Coral death from more acidic oceans.The biggest question is how temperature affects water patterns. Humidity will rise, but be unevenly spread. http://www.ipcc.ch/publications_and_data/ar4/syr/ en/mains3-3-1.html

Global Warming Costs and the Discount Ratehttp://rasmusen.org/g406/older/discounting.xls

39

The Nordhaus Plan

Reduce carbon dioxide 15 percent 2015-2050 relative to what it would be without regulation. Reduce by 25 percent after 2050-2100 and 45 percent after 2100. Since without regulation emissions would grow, they would still rise under this plan, but more slowly. He suggests a carbon tax of $28 per ton ($8/ton of CO2). Americans emit 5 tons per year on average now. That means 9 cents per gallon on gasoline, and a 10% tax on coal-generated electricity. At current levels, this would raise $50 billion per year of revenue. http://nordhaus.econ.yale.edu/dice_mss_072407_all. pdf

40

Costs– in Numbers

The IPCC, a U.N. organization, says that if carbon dioxide isn’t stabilized till the late 21st century, the temperature will increase about 7.2 degrees Farenheit .(http://www.ipcc.ch/publications_and_data/ar4/syr/en/spms3.html, “A1F1 scenario,” worst-case, Table SPM-1.)

Yale economist William Nordhaus says that we should spend a present value of $2.2 trillion on abatement, saving $5.2 trillion in warming costs. http://nordhaus.econ.yale.edu/dice_mss_072407_all.pdf That’s equivalent at a 5% discount rate to spending $110 billion per year on abatement.

41

EPA vs. Massachusetts

In 1999, 19 private organizations filed suit demanding that the EPA regulate greenhouse gas emissions. Fifteen months later, the EPA requested public comment.It received more than 50,000 comments. The EPA concluded that carbon dioxide was not an “airpollutant,” so it had no authority to regulate it. The EPA’s denial was challenged in court, and the EPA lostin the Supreme Court. In 2009 it issued an endangermentfinding, and it has started regulating mileage of cars. Itcan only use command-and-control.

42

Can the EPA Regulate Carbon Dioxide?

US Code 42. §7521. “Emission standards for new motorvehicles or new motor vehicle engines” says:(1) The Administrator shall by regulation prescribe (andfrom time to time revise) in accordance with the provisionsof this section, standards applicable to the emission of anyair pollutant from any class or classes of new motor vehicles or new motor vehicle engines, which in his judgmentcause, or contribute to, air pollution which may reasonablybe anticipated to endanger public health or welfare.”

43

The Garden Hose to the

Skyhttp://freakonomics.com/2011/09/02/finally-a-garden-hose-to-the-sky/ http://www.intellectualventures.com/about/leadership/nathan-myhrvold/

44

Solutions to Global Warming

1. Reduce carbon emissions: Taxes, tradable permits,command and control. Cost: $2.2 trillion (Nordhaus)2. Subsidize nuclear energy, wind, solar. 3. Carbon sequestration: Plant trees.4. Carbon sequestration: Lock carbon up under the ground.5. Geoengineering: Fertilize the ocean with iron. Cost= $300-500 billon. (5% discount rate)6. Geoengineering: Put light-blocking substances intothe atmosphere. Cost: $20-160 billion. (Barrett 2008)7. Amelioration: air conditioning, shifting to differentcrops, higher sea walls, and so forth.

45

Helping Poor Countries

Costs and benefits of warming are unevenly distributed.Russia, Canada, and the United States could actually benefitfrom having less cold winters. Tropical countries– which are poorer– would lose more.

But for 1 trillion dollars per year, what else could be done tohelp poor countries? Should we reduce economic growth now to help people inBangladesh in 2100? Or should we help people in Bangladeshin 2011?

46

Future Carbon Dioxide47

48

Emissions by Region

Lots of Countries Produce Carbon Dioxide (2007)

China produced 22%, the US 20%, the European Union14%, India 6%, Russia 5%, and Japan 4%.

Other countries producing more than 1% were Canada,South Korea, Iran, Mexico, South Africa, Saudi Arabia, Indonesia, Australia, Brazil, and Ukraine.

http://en.wikipedia.org/wiki/List_of_countries_by_carbon_dioxide_emissions from http://mdgs.un.org/unsd/mdg/SeriesDetail.aspx?srid=749&crid=

49

Summary

The main economic costs of global warming would be from water changes— drought and flood. Europe uses cap-and-trade. The EPA is starting to imposecommand-and-control. Carbon taxes are another solution. These can all include sequestration and offsets.

All solutions except adaptation face the problem that countries can free-ride. Geoengineering solutions are potentially the cheapest.

The big growth in carbon is in developing countries because of their big population and income catch-up to developed countries.

50

The following slides are old and probably won’t be used

51

52

An Idea from Last Time

Ways of dealing with externalities include licenses (for free or auctioned) and taxes.

53

An Idea from Last Time

Even if a situation starts out as inefficient, if those affected can make a deal easily, the deal will solve the problem.