My holiday reading

OK, I haven’t got around to putting in links in my site yet. I’m sure it’s all very easy and everything.

In the meantime, here is my list of recommended blogs for holiday reading:

Environmental economics

Environmental economics blog – the best envionmental eco blog on the web – regular, informative, entertaining.

Urban and environmental economics – the full text of fascinating articles with an environmental economics angle.

Law and politics

Courting disaster – Diary of an international law PhD student at Cambridge.

Envirotalk – Australian environmental forum.

Fun

Fridaysixpm – pop culture and a smattering of politics.

Lynscreens – sporadic but spot-on film reviews and discussion.


Have a great holiday!

Productivity Commission Inquiries: Waste and Water

Most people know the Productivity Commission as an Australian icon of economic rationalism. Somewhat surprisingly, its also one of the more environmentally astute and (environmentally) progressive agencies in the (conservative) Australian government.

In some ways that shouldn’t be so surprising because, despite the misperception of green ideals as ‘standing in the way of progress’, most are actually about using our scarce resources efficiently. Woodchipping old growth forests in Tasmania is as much an economic outrage as an environmental one.

The Productivity Commission has conducted a number of often influential inquiries into environmental or environmentally-related issues. Its latest is an inquiry into Waste Generation and Resource Efficiency and a copy of the Issues Paper hit my desk yesterday.

Waste used to be the big environmental issue but it’s gone a bit quiet lately, overshadowed by climate change, water and biodiversity in particular.

The Terms of Reference state the issue:

Non-optimal levels of waste represent lost value and opportunities, while imposing undesirable economic and environmental costs on society. The objective of this inquiry is to identify policies that will enable Australia to address market failures and externalities associated with the generation and disposal of waste, including opportunities for resource use efficiency and recovery throughout the product life-cycle.

Some of the environmental and market issues to be examined are:

• Institutional, regulatory and other factors which impede optimal resource efficiency, recovery and optimal waste management;
• The adequacy of current data on material flows;
• The impact of international trade and trade agreements on the level and disposal of waste in Australia;
• Strategies that could be adopted by government and industry to encourage resource efficiency and recovery;
• The effect of government and commercial procurement practices; and
• The impacts of government support to production and recovery industries.

Some of the issues identified in the issues paper are:

• Arguments for government intervention (market failure – externalities, natural monopolies, public goods and market power issues);
• Recycling markets and policies that affect them;
• Energy recovery from waste;
• Pricing measures;
• Producer responsibility for waste.

Public submissions are invited and due by 8 February 2006. The Commission will also undertake public hearings in February and release a draft report in May.

Rural Water Use and the Environment: The Role of Market Mechanisms

At the same time, the Federal Treasurer has commissioned the Productivity Commission to undertake a study to assist State governments in meeting their obligations under the National Water Initiative. The Terms of Reference were released last week. The study will assess the feasibility of establishing workable market mechanisms:

• to provide practical incentives for investment in rural water-use efficiency and water related farm management strategies; and
• for dealing with rural water-management related environmental externalities

The study will look at take into account relevant practical experiences in other areas, such as with establishing tradeable salinity and pollution credits.

The Commission will report on the study in June 2006.

Both should provide some interesting material for anyone interested in the practical application of environmental economic policy.

Economists should stick to economics

A growing trend in economics is economists extending their analysis to social issues. I’d like to look at two quite different manifestations of this trend and suggest that economists should steer clear of using economic theory to look at non-economic issues.

1. Applying economic methods

The first manifestation of this trend is applying statistical methods developed in economics to examine social trends. An example of this is examining empirically whether the death penalty might contribute to lower murder rates in an area.

This isn’t really economic analysis in any sense – it’s just taking statistical methods that happen to have been developed for economic analysis and using them in sociological analysis. And this is an area in which economists can make a positive contribution – more and reliable data always helps us make more informed decisions.

(A caveat is that you should be very wary in listening to economists discuss the moral implications of their findings. For example, in the death penalty article above, the authors reckon that each execution for a murder leads to about 18 fewer murders and therefore suggest we are morally required to execute murderers. We should think very carefully before taking that conclusion at face value, even if we could believe the data (which are suspect)).

2. Applying economic theory

Much more problematic for me is when economists start applying economic theory or models of economic behaviour to social situations.

A classic example is the economics of marriage, surprisingly well-trodden ground which tends to produce studies that are dazzling both for the sophistication of their mathematical models and the simplistic stupidity of the assumptions about human behaviour on which they’re based.

You can pick up the flavour from this one, about marriage causing the gender wage gap:

Although economic considerations are not always deciding factors when men and women fall in love, they do play an important role in the decision to marry, according to Elul and Volij, assistant professor of economics.

Men… begin saving their earnings in hopes of attracting a wife. "If the men do not save enough they will not have much to offer," said Volij.

In the model, if a woman is proposed to by a suitable man living in the same city, she will certainly accept the proposal. But if a woman is proposed to by a man living in a different city that is not as advantageous to her earning potential as the one in which she lives, she faces a dilemma: She could marry, move and earn less, or she could reject the offer. "Her choice will depend on the terms of the husband's offer (that is, his savings) as well as other factors like wages and interest rates," the authors wrote. In most cases, the model shows that women will accept the offer of marriage if the savings of the men are significant. As a result, women often sacrifice their earnings by following their husbands, leading to a gender wage gap.

In the paper, individuals are utility maximizers, choosing to marry when it is in their self-interest.

Women are assumed to control the bargaining and hence:

they are going to be able to extract more benefits of marriage for themselves. As a result, the women feel less pressure to work. In fact, they are able to work for lesser pay and yet extract better benefits since they are in control of the bargaining...

So this model brilliantly explains the gender gap – as long as you assume a myriad of things that are unproven and go against everything common sense tells you to be the case: women choose husbands according to their savings and the general level of wages and interest rates, everyone enters marriage to extract an economic benefit (economists generally and rather old-fashionedly assume this to be the man’s income for women and the woman’s labour for men).

The problem with all these sort of analyses is that they take as their starting point standard assumptions which are necessary for basic supply and demand models to work – most notably that everyone acts in their own self-interest. These assumptions are pretty reasonable when you’re looking at consumer behaviour in supermarkets or how firms price goods or choose suppliers or make investment decisions. They’re completely wrong when you’re looking at social behaviour.

Amazingly enough, most husbands don’t want to spend all their money enjoying the good life so they can leave their widows destitute. In fact, any empirical economic study shows that many wealthy older people live relatively frugally so they can leave money to their families. Husbands and wives in functional relationships don’t try to extract the maximum economic benefit from the other: their relationship is about providing love and support to the other.

Economists first assumption is that people are rational. Yet they abandon this assumption as soon as they look at social behaviour. Entering relationships solely from the point of view of what you can get out of them would leave you a miserable and lonely person. And that’s just not rational.

Sydney’s proposed desalination plant

Probably the major environmental issue in Sydney right now is the proposed desalination plant. Sydney’s catchment has been in drought for some time and Sydney’s water supply is at relatively low levels. Various solutions for a secure water supply have been proposed but the big ticket item is a desalination plant.

Some of the issues are:

• It’s a very expensive way to produce clean water;

• It’s a very energy intensive way to produce clean water and that also means lots of greenhouse gas emissions;
  

• The proposed site (and its surrounds) is environmentally sensitive and contains a number of unique and endangered ecological communities;

• The political environment is interesting as the government has been criticised for its handling of other recent large infrastructure projects, in particular effectively granting a large degree of control over public services to private entities.

I’ll look at some of the issues surrounding the desal plant over the next few weeks but, if you’re interested, the environmental impact statement and other documents are on Sydney Water’s website. You can comment on the proposal until 3 February 2006 and I’d encourage you to do so.

Unintended consequences

Economics makes a useful contribution to policy in demonstrating that when you start interfering in markets (if they’re working), you can not only get nasty side effects, you also often get the opposite of what you were intending to do. For example, putting price caps on products makes investing in producing those products unprofitable, cutting off the innovation that could bring down the prices of the products in the long run.

However, as we saw in the previous post (below), that is only the case if markets are working (and they often don’t). So – for example - economists say that we should remove the minimum wage, which would encourage firms to hire people, bringing down unemployment, boosting productivity, increasing profits and making products cheaper for everyone. Yay! In theory that might work, but because there’s so many other gremlins in the labour market, it’s unlikely to work that way in practice. One example: because of the way the tax and welfare systems are structured (essentially the working poor pay more tax than they should), if you reduce the minimum wage in Australia any further, people will earn less – after tax – than they would on the dole. So cutting the minimum wage would only make these people poorer and discourage people from working. So the real outcome is likely to be more poverty, more unemployment and more stress on the public purse.

A nasty example of this in an environmental context was reported in the last issue of New Scientist and it concerns using ‘biofuels’, renewable fuels made from such things as sugar (ethanol), palm oil or soybean (oil) that can replace diesel. According to the article:

THE drive for "green energy" in the developed world is having the perverse effect of encouraging the destruction of tropical rainforests. From the orang-utan reserves of Borneo to the Brazilian Amazon, virgin forest is being razed to grow palm oil and soybeans to fuel cars and power stations in Europe and North America. And surging prices are likely to accelerate the destruction.

The rush to make energy from vegetable oils is being driven in part by European Union laws requiring conventional fuels to be blended with biofuels, and by subsidies equivalent to 20 pence a litre. Last week, the British government announced a target for biofuels to make up 5 per cent of transport fuels by 2010. The aim is to help meet Kyoto protocol targets for reducing greenhouse-gas emissions.

Rising demand for green energy has led to a surge in the international price of palm oil, with potentially damaging consequences. "The expansion of palm oil production is one of the leading causes of rainforest destruction in south-east Asia. It is one of the most environmentally damaging commodities on the planet," says Simon Counsell, director of the UK-based Rainforest Foundation. "Once again it appears we are trying to solve our environmental problems by dumping them in developing countries, where they have devastating effects on local people."

Pretty depressing, considering the good intentions behind these laws. I guess the message is that in a world with globalised markets, you need to be even more careful when you use economic measures to help solve environmental problems. Economic measures can be powerful things.

Making things even worse

One of the most powerful concepts I’ve learnt about in environmental economics is known as “the theory of second best”. It’s one of those concepts that’s completely obvious to everyone except economists.

What it says is that in an economic system that’s pervaded by inefficiencies, fixing one source of inefficiency may actually make the system as a whole even more inefficient. In other words, in the real world - where the simplifying assumptions of economists don’t necessarily hold – taking the standard advice of Treasury boffins and other economic policy-makers and instituting microeconomic reform in one industry can actually make everything worse. I think the “second best” comes from the idea that it’s not a perfect world – and a second best world may require second best solutions.

An example is water trading. A big problem with rural water entitlements, say economists, is that traditionally they haven’t been able to be traded. Once you allow trading, the entitlements have a value, because you can sell them. This gives you an incentive to conserve as much water as you can, because you can sell any you don’t use. It also ensures that the water goes to its most highly valued use. The very profitable vineyard or, say, cotton farm that didn’t have enough water to expand can now buy that water from, say, the sheep farmer who was using it to grow grass in a very unprofitable paddock. The vineyard makes more money with its new water, the farmer makes more money because it’s more profitable to sell his water than use it for sheep, and we conserve more water overall. Hey presto, we’re all better off.

The trouble is, there’s all sorts of wacky goings on in the real world that complicate things. The most notable in this context is that there’s a whole lot of water entitlements that were given out years ago that farmers don’t use – because they don’t need them or because, for example, it’s more expensive to pump the water up from the river than it’s worth to the farm. These dormant entitlements are often called ‘sleeper licences’.

If you allow trading and there’s lots of sleeper licences around (which, in Australia, there are), what happens? Well, these licences suddenly have a value, and they’re not being used, so the farmers sell them. Others buy them and use them. Suddenly, a whole lot more water is being extracted from the rivers than before. Creeks dry up, the water doesn’t get to downstream users at all, salinity problems increase, the environment loses. Hey presto, we’re all worse off.

All pretty obvious, but just another reason why we need to be careful before we adopt economists’ magical market solutions. And this isn’t to defame economists too much either – they realise this stuff too and that’s why when water trading has been established recently in several Australian states, it’s been complicated and it’s been done slowly and carefully. It still hasn’t always worked.

Next post: A particularly horrific example of the theory of second best: European efforts to stop global warming devastate forests in developing countries.

Taxing bad things

A lot of environmental economics literature revolves around the idea that we should tax ‘bad things’ more and tax ‘good things’ less. So we should tax (or fine) things like cigarettes, speeding on the road and greenhouse gas emissions heavily and go easy on, say, payroll tax (which is a tax on giving people jobs).

It’s a pretty attractive idea. You discourage the bad activities, you make some money which hopefully can be directed to repairing some of the damage done by those activities (eg direct cigarette revenues to public health) and you get the bonus of a sort of moral satisfaction that the ‘baddies’ have to pay.

I saw a cool version of this kind of tax recently on the Freakonomics website – police in New York (where else?) handing out fines to drivers who pushed in front of a line of other drivers waiting patiently to exit a highway.

Welcome to my blog

So I've started a blog!

It's about environmental and economic issues. I've called it Oikos. Both the words ecology and economics come from the Greek word oikos, meaning “home” or “a place to live.”

Ecology literally means understanding home and economics means taking care of home. Their common roots reminds me how interconnected they are, even though they seem to have become regarded as opposites.

The aim of this blog is to discuss environmental and economic issues in a way that’s interesting and accessible to people who are not economists nor ecologists.

I'll try to post a couple of entries a week.

Let me know if you've got any comments. Are the dots annoying?