Most Americans believe that protecting the environment is a valuable goal for our society. The way that government and environmentalists have gone about achieving this goal has for the most part ignored the realities of economics. The Endangered Species Act, the Clean Air Act, and the Clean Water Act all have laudable goals. Critics of the legislation are not pro-extinction, pro-smog, and pro–dirty water. For most, the criticism is in how these goals are achieved and not the goals themselves. Economists offer a unique perspective on the environment, and inclusion of economic principles can be used to bring about the goal of environmental protection more efficiently and with greater utility.
One of the costs of an ever-growing economy is the strain that it places on the environment. As the population expands more and more, resources are required to sustain the population. This growth need not necessarily lead to environmental collapse. Instead, markets can be used to alter the incentives of individuals and firms as they face trade-offs in their use of resources.
Demand for resources tends to increase the price of those resources. As the price increases, individuals and firms that use these resources face an incentive to use less in the case of nonrenewables. In the case of renewable resources, entrepreneurs gain an incentive to increase the production of the renewable resource. These incentives are powerful and efficient.
Consider the case of lumber, a renewable resource. Increased demand for lumber has led to an increase in the price of lumber. This price increase leads tree farmers to expand their output to meet the demand. The net effect of increased demand for lumber is increased demand for forests. Increased demand for forests makes the land more desirable and leads to more land being placed into forest production. Some would argue that if you cut down the trees, eventually there will be none left. However, this statement ignores economic incentives. Would there be more corn or less corn if people stopped eating it? If you answered less, you would be correct. If people stop eating corn, farmers have no incentive to grow corn. Likewise, if people eat more corn, then farmers grow more corn. The same is true with trees. Trees take longer to grow, though, and as a result they’re priced much higher than corn.
In the case of nonrenewables like coal, oil, and natural gas, markets provide incentives to both producers and consumers. As demand increases for these factors of production, the price increases. This leads to higher prices and higher costs of production for firms that use the resources. These higher costs provide firms with an incentive to become more efficient in the use of the resource. For example, if a firm uses natural gas in production and gas prices rise, the firm has a strong incentive to use its natural gas in the most efficient way possible. Firms that are wasteful and inefficient will find it difficult to compete against firms that use resources more efficiently. They’ll eventually go out of business.
Economic efficiency occurs as resources are used with less waste. Efficiency should be a goal of not only economists, but anyone who cares about the planet. Less waste means that fewer resources are required in production.
Protecting endangered species is important to many people. There is considerable political pressure for governments to enact legislation to protect species. One way to protect endangered species that is promoted by economists is to kill them for food.
Why did the American bison population almost go extinct while the cow population increased exponentially? Is it because the cows ate the bison? No, the reason bison faced extinction while cows thrived is because cows were private property while bison were not. The population of bison fell from the millions to just over 1,000 by 1889. Today, fortunately, the American bison is back from the brink of extinction because they became private property. Today there are more than 500,000 bison, and their numbers are growing as a market has developed for bison meat.
Pollution is an economic bad. All production processes create some form of pollution, so zero pollution is not a reasonable goal. What is the right amount of pollution? The right amount, or socially optimal amount, of pollution occurs when the marginal social benefit equals the marginal social cost of production. That means that firms should produce to the point where the extra benefit of production to society equals the extra cost, inclusive of the cost of pollution to society. Because of tragedy of the commons, firms often do not have an incentive to produce the amount of output that is socially optimal. Firms do not pay the cost of pollution, and so they produce too much output and thus too much pollution. In order to get firms to produce the appropriate amount of pollution, the cost of pollution must enter into their production decision. Governments can tax or sell pollution permits. Another option is for affected individuals who bear the cost of the pollution to negotiate a payment from the polluter.
A per-unit tax on the production of a good or service could be used to reduce the amount of pollution that the firm produces. The tax on the producer increases the cost of production, which reduces their willingness and ability to produce their product. The market outcome is for the price of the good or service to increase and for the quantity to decrease. The result is less production, and therefore, less pollution. The problem with a per-unit tax is that it would most likely be levied on all producers in an industry, which means that cleaner, more efficient producers are taxed at the same rate as the heavier polluters. The tax reduces pollution in the industry, but does not increase the incentive for individual producers to clean up their act. Also, if demand for the good or service increases, then the quantity of pollution would still increase. The ultimate goal is to reduce pollution and not just punish producers.
Another option is to create a market for pollution permits. Under a permit scheme, the government establishes a cap on how much of a certain pollutant will be allowed in the atmosphere that year. For example, assume that last year 7 million tons of nitrogen oxide gas was released into the atmosphere and government wants to reduce it to 6 million tons. Government would allocate to industry the number of permits required to achieve this goal. If each permit allowed one ton of emissions, then government would allocate 6 million permits to firms. The firms would be required to surrender one permit for each ton of pollutant they produced. Under the system, firms and even individuals could buy and sell the permits in an exchange. Firms that are relatively clean could sell their unused permits to firms that are heavier polluters. Individuals could also buy permits and effectively keep a certain amount of pollution out of the atmosphere. This scheme encourages firms to become more efficient and reduce pollution simultaneously. Unlike pollution taxes, this solution rewards firms for reducing pollution instead of punishing all firms equally.
Climate exchanges exist worldwide for trading permits in various industrial pollutants. Climate exchanges act much like stock exchanges, allowing firms to buy and sell permits. In the future, students interested in the environment and economics may become climate brokers.
A final option for firms that pollute or harm the environment is to directly pay those who are harmed by the pollution. This option is referred to as the Coase theorem. Ronald Coase, a British economist, suggested that an efficient outcome could be achieved if polluters and those who bear the cost directly negotiated a payment that was acceptable to both parties. Some assumptions of the Coase theorem are that there are no bargaining costs for either party, property rights are clearly defined, and the number of people involved is small.
The Nature Conservancy and Sierra Club use this strategy to preserve environmentally sensitive areas. Many concerned with the environment have applied this strategy in preserving the rainforest. It is much easier to save a forest that you own than to save a forest that everyone owns. In the end, economic principles can be used to effectively and efficiently achieve environmental goals.