International Dimensions of Regulation Developing countries need special attention Global pollutants particularly tough to control Green Accounting Double Dividend

Motivation Group Project: Treaty proposed to free up trade between US and Guatemala. What restrictions should we put in place to avoid environmental degradation in Guatemala?

Income effect Why are oil refineries in poor areas? Why do poor countries have weak environmental regulations? Can we expect environmental regulations to weaken or tighten over time in the US or any country? [Similar questions as when we considered environmental justice.]

Luxury, Normal and Inferior Goods Income Amount of Env. Qual. Demanded (at fixed Price) Inferior Good Luxury Good (Elast > 1) Normal Good (Elast <1)

Larry Summers Memo What was Summers suggesting? What are the arguments in support of his position? What are the arguments against his position?

GATT and the Environment GATT (General Agreement on Tariffs and Trade) says: You can place border restrictions on the quality of a product (ie, no chunks of Flipper in the can of tuna) You cannot place restrictions on how the product was produced (you cannot prohibit use of hormones in raising beef if no hormones can be detected in the imported beef) Allows environmental restrictions (eg, protecting dolphins) if the restriction allows country to choose methods that provide equal levels of environmental protection – ie, not technology standards What are the reasons for these rules? Do they work in providing environmental protection? Why did US lose the Venezuelan Refinery Case (Sanger article)?

Dynamics of Environmental Protection Environmental Quality Price Shifts with increases in income. Demand Supply

Environmental Kuznet’s Curve Income Sulfur Emissions Early phases of economic growth tend to increase pollution As income rises, clean environment is valued more, emissions decline But very difficult to estimate due to lack of time series

Reasons for failure of EKC Corruption – bribe officials to locate hazardous waste sites Nondemocratic regimes – preferences of population not represented in environmental regulations Poorly educated population Not all pollutants have same shape EKC

Back to Group Project What are some answers to our original group project problem? Do we need to put into place safeguards so that Guatemala doesn’t become dumping ground due to corrupt officials? Should we worry about differences in regs between US and Guatemala, at least in the short-run? Will increases in income in Guatemala tend to increase env quality?

Transboundary Environmental Problems Who fixes environmental problems that cross national borders? Stratospheric ozone depletion Global Warming/climate change Global species destruction (sea turtles) Need IEA’s: International Environmental Agreements

The Card Game Analogy SETUP: Each player is given two cards: one red and one black PLAY: Each player will anonymously hand in one card to Center (i.e., to Prof.) PAYOFF to each participant after play of game: 10 Environmental Currency Units (ECU) for a red card in your hand 1 ECU for each participant for each red card Center holds Maximum payoff: (N-1)+5 [where N = # participants] Ex: 51 players: the maximum payoff is 60 REWARD: Anyone scoring over 35 gets a Kiss ® ! YOUR TASK: figure out what to hand in to the Center

Choose Your Strategy Hand in your red card? It yields less to you than if you keep it It yields far more to the group than if you keep it. Society wants you to hand in your red card Keep your red card? It is worth far more to you in your hand Your payoff will be higher; society’s lower

Results This experiment has been run many times typically ⅓ -- ⅔ of people hand in their red card Refer to Scott Barrett (2003) When repeated with the same group, cooperation (handing in the red card) tends to decline Analogous to transboundary environmental problems Fundamental conflct between individual and group interests Self-interest diverges from group interest Powerful incentives to shirk your responsibility Understanding how to solve card problem gives insight into solving transboundary environmental problems

Can an Agreement Solve Problem? A typical agreement Signatories agree to hand in red card Public display of what is being handed in (red or black) Only goes into effect if x% of people agree (eg, 60%) Participants post performance bond before each play (who keeps?) Issues Should be self-enforcing (ie, no appeal to higher authority)--problem Penalties – how to enforce the agreement? Penalties for cheating (ie, not handing in red card) Penalties for free-riding (ie, not joining but benefiting from agreement) Must create an aggregate gain to participants Must be in best interest of individuals to join (both cooperators and free-riders) – what if different countries start with different # red cards Must have means to distribute gain

Back to the Real World Card game has lessons for the real world Goal: identify desirable characteristics of international environmental agreements

How to think of an IEA Global problem that affects many countries Countries have to voluntarily agree to do something about the problem Any penalties for cheating must be included in treaty There can be no overarching enforcer

Desirable Attributes of a Successful IEA Create an aggregate net benefit to participants overall gross benefits > overall gross costs Distribute the aggregate gain among participants For each participant, benefits > costs (individual rationality) Self-interest important in convincing country to agree Deter non-participation Must make it undesirable to remain outside agreement Trade sanctions most frequently used Design net benefits in > net benefits out (participation constraint) Deter cheating among participants Penalties must be credible Trade sanctions are easiest to use Deter entry of new non-participants (avoid “leakage”) Particularly appropriate for common property problems Saving a fishery increases rents and may induce non-fishing countries to enter

Montreal Protocol Designed for CFC’s leading to Ozone Depletion Quantitative emission limits for industrial, transition and developing countries Industrial countries pay for added costs to developing countries Trade sanctions for non- participants and violators Initial protocol modest; gradually tightened over 10- year period Ozone Levels Projected Source: World Met Org

UN Framework Convention on Climate Change – Kyoto Protocol Emerged from Rio Conference in 1992 US signed and ratified UNFCCC Modeled after Montreal Protocol Kyoto Protocol (1997) defines emission reductions for Annex I (developed) countries Developing countries largely exempt Penalties for noncompliance missing

Montreal vs. Kyoto A partial comparison MontrealKyoto Aggregate Net Benefit?YESYES?? Distribute Aggregate GainNO Deters nonparticipation?YESNO Deters cheating?YESNO Addresses leakage?YESNO

Environmental regulations in the developing world Often environment is low on policy priority list – urge to industrialize Policy focus: employment & income Diverse instruments used, hard to generalize. Typically market based instruments not as widely used or effective.

Environmental charges & funds Central & East Europe (planned economies): high pollution last few decades Attract limited international capital Instituted some environmental taxes But no bite until decentralized Poland: careful CBA to attract debt- for-nature, unusually successful

Planned economy emissions fees Sulfur, NOx, carbon, some particulates, lead Transportation tolls Water extraction charges, water pollution fines, waste management fees, fertilizer and pesticide fees

Regulations in China Most populous, poor ($5000 per capita GDP), one of most polluted countries 1979 law allows charging for pollution, by 1994 $2 billion collected. Fees charged when emissions above max. Fees too low to achieve standards.

Fees in Rio Negro, Colombia Colombian economy growing quickly Water/air pollution major problems 1993 law that environmental damages must be taken into account Stipulates use of economic instruments Fees implemented: 28% decline in pollution in first 6 months

Voluntary emissions control in Mexico Informal sector in Mexico: brick making Difficult to monitor, regulate (similar to non-point source pollution) 20,000 brick kilns burn nasty stuff Too difficult to enforce ban on dirty fuels Subsidize propane, voluntary switch Zoning for certain activities Involve local grassroots

Info & institutions: Indonesia Rapid economic growth – drastic exploitation of resources “Program for Pollution Control Evaluation and Rating” (PROPER) – similar to TRI Reporting, evaluating, assisting firms Grades each industry, reports in press Very successful Other countries have adopted similar (Mexico, Philippines, Papua New Guinea)…

Green national accounting Measures of national income: GNP, GDP Don’t account for environmental degradation and resource depletion Can give misleading measure of national “well-being”, may lead to wrong policy. Many adjustments have been proposed to “correct” standard measures.

“Natural capital” depreciation Natural capital: the available endowment of land and natural resources Measure depletion of natural resources (oil, timber, minerals, soils) Subtract from standard measures Result: many developing nations show substantial effect

Indonesia example: “Adjusted Net Domestic Product”

Pollution control & cleanup How should pollution control and cleanup costs be accounted for in developed nations? Should cleanup expenditures contribute to GNP? Some think not. Main issue: don’t double count. These are legitimate expenditures in order to maintain environmental values.

How are national accounts used? Primary use: assist policy makers in government. E.g. Gov’t expenditures on scientific research are linked to current economic performance and climate. United Nations has proposed a “System of Environmental and Economic Accounting”, some adjustments underway.

Paying for public goods Public goods will be under-provided, externalities will not be internalized in free market. Government intervention: tax revenues can pay for cleanup, regulation, public goods provision But many taxes “distortionary” E.g. Income tax discourages work! Costs $1.40 to raise $1 in revenue

Double dividend If we substitute distortionary taxes with pollution taxes, we may earn a “double dividend” Reduce pollution (and therefore damage from pollution) Reduce distortionary taxes on labor and thus the DWL from those taxes This is called the “revenue recycling effect”

A 3 rd effect of pollution taxes “Tax interaction effect” Polluting good and leisure are substitutes E.g. Gasoline and Leisure Tax pollution, demand for leisure shifts out If labor is still taxed, shift introduces an additional DWL attributed to decrease in pollution This DWL decreases social welfare. Overall size of tax interaction effect varies among polluting industries Estimate: pollution tax should be set at 2/3 of marginal damage. Varies considerably from industry to industry