1. Life Cycle Sustainability Economics

2. Agenda  How traditional economics falls short of sustainability: Tragedy of Commons & externalities  Possible Solutions:  Triple bottom line accounting  Emissions trading systems  Life cycle cost analysis  Including environmental benefits in cost-benefit analysis

3. Objectives By the end of this unit, students should be able to: 1.Give an example of a Tragedy of the Commons and a possible solution. 2.Give an example of pollution creating an externality and a possible solution. 3.Compare advantages and disadvantages of triple bottom line accounting. 4.Perform a life-cycle cost analysis. 5.Explain how the value of environmental benefits could be determined.

4. Objectives 6.Perform a cost-benefit analysis that includes environmental benefits.

5. Where traditional economics falls short of sustainability: The Tragedy of the Commons  Dilemma first described by Garrett Hardin in Science in 1968.  Multiple individuals, acting independently, and solely and rationally consulting their own self- interest, will ultimately deplete a shared limited resource, even when it is clear that it is not in anyone's long-term interest for this to happen.

6. Tragedy of the Commons  Assume a common-property resource (exclusion is difficult and joint use involves subtractability), I.e., no property rights.  e.g. pasture open to all  Assume each herdsman tries to keep as many sheep as possible on the commons. They each try to maximize gain.

7. Add those sheep!  The rational herdsman concludes that he or she should add another sheep.  And another…  And so does each herdsman  “Ruin is the destination toward which all men rush, each pursuing his own best interest…”

8. Possible Tragic Commons?            

9. Where traditional economics falls short of sustainability: Externalities  Externalities are the effect of a decision on a third party that is not taken into account by the decision-maker.  Externalities can be either positive or negative.  Examples of environmental externalities:

10. Possible Solutions to Tragedy of the Commons/Externalities:  Macro (national or state) scale: 1. Make it cheaper to treat than discharge harmful pollutants: emission fees 2. Create emissions trading systems  Micro (project/company) scale: 1. Use triple bottom line accounting 2. Conduct life cycle cost analysis 2. Quantify environmental benefits 3. Use a lower discount rate

11. Possible Macro-Scale Solutions: Emissions Trading Systems  Also known as cap and trade – market-based  In order to pollute a specific amount (say 10 tons), companies have to hold that number of allowances, or credits (10 tons of credits).  An overall regional cap is placed on the number of allowances, to ensure good air quality. Cap can be lowered over time to improve air quality.  Companies that need to increase their emission allowances must buy credits from those who pollute less.  The transfer of allowances is referred to as a trade.

12. Possible Macro-Scale Solutions: Emissions Trading Systems  Economic incentive to reduce emissions : If polluters reduce their emissions, they can sell the excess allowances at a profit.  Economically efficient : Companies that can reduce their emissions most cost-effectively will do so (theoretically) and sell credits to companies that can’t reduce cheaply, achieving the pollution reduction at the lowest cost to society.  Technologically efficient : Companies are free to use any means to reduce emissions (technology not mandated, as it can be in other regulatory approaches).

13. Possible Macro-Scale Solutions: Emissions Trading Systems Examples:  U.S. national cap-and-trade system for sulfur dioxide, established under the Acid Rain Program of the 1990 Clean Air Act (first cap-and-trade system in the U.S.)  Texas banking & trading system for precursors that form the air pollutant ground-level ozone (nitrogen oxides and volatile organic compounds)  http://www.tceq.texas.gov/airquality/banking/banking.html http://www.tceq.texas.gov/airquality/banking/banking.html  Baseline and credit program – each company has a regulatory limit. Companies can bank and sell credits if they reduce pollution below their regulatory limit.  European Union trading scheme for greenhouse gases

14. Possible Micro-Scale Solutions: Triple Bottom Line Accounting  3 Ps of the triple bottom line:   Triple bottom line accounting : expanding the traditional reporting framework to take into account ecological and social performance in addition to financial performance  Company’s responsibility is to stakeholders, not only shareholders. Requires a corporate commitment to social responsibility.  Who would stakeholders be?

15. Possible Macro-Scale Solutions: Triple Bottom Line Accounting  Realistic?  Examples  Shell Foundation’s involvement in South Africa (helping grow local businesses to reduce poverty, reduce indoor air pollution, schools for children)  McDonald’s Corporation – Ronald McDonald House  Others

16. Possible Macro-Scale Solutions: Triple Bottom Line Accounting  Example reporting frameworks :  AccountAbility’s AA1000 standard, based on Triple Bottom Line  Global Reporting Initiative’s Sustainability Reporting Guidelines  Potential benefits?  Orlitzky, Schmidt, and Rynes found a correlation between social/environmental performance and financial performance  Aid to employee recruitment and retention, particularly grad students  Reputation risk management  Brand differentiation  Disadvantages?

17. Economic Analysis: Methods of Comparing Alternatives  Present worth, annual payments, future worth analysis  Break-even comparisons  Rate of return (ROR), incremental rate of return (IROR) analysis  Cost-benefit analysis 1. Life cycle cost analysis 2. Quantify environmental benefits 3. Use a lower discount rate

18. Possible Micro-Scale Solutions: 1. Life Cycle Cost Analysis  In choosing among engineering project/product alternatives, consider life cycle costs, or the total cost of ownership over the life of the project/product.  Also called “cradle to grave" or "womb to tomb" costs.  Useful in present worth, annual payments, and future worth analysis (methods that compare costs of alternatives), and in break-even comparisons if benefits are not included.

19. Possible Micro-Scale Solutions: 1. Life Cycle Cost Analysis  Phases of project/product life to consider :  Planning  Design  Construction/production  Operations  Maintenance, renewal/rehabilitation  Replacement or disposal

20. Possible Micro-Scale Solutions: 1. Life Cycle Cost Analysis  What phases of project/product life cycle are traditionally considered in alternatives analysis?  Why might using full life cycle cost analysis benefit the environment?

21. Possible Micro-Scale Solutions: 1. Life Cycle Cost Analysis Example problem

22. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits Methods of comparing alternatives that include benefits:  Rate of return (ROR), incremental rate of return (IROR) analysis  Cost-benefit analysis In evaluating benefits, be sure to quantify environmental benefits so they are not excluded.

23. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits  Suppose that a city is doing a cost-benefit analysis for how to use a piece of land. Two alternatives include: 1.Allowing a developer to construct a shopping mall, and 2.The “do nothing” alternative – leave the land as a forest.  How would you quantify the costs associated with each alternative?  How would you quantify the benefits associated with each alternative?

24. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits  Quantifying environmental benefits is typically difficult, so environmental benefits historically have often been left out. Ways to quantify environmental benefits:  Surrogate markets  Surveys  Willingness to pay to visit a park  Willingness to pay to use an HOV lane 

25. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits Ways to quantify environmental benefits:  Health benefits  Air pollution caused by an industry may cause people to miss work. A dollar value can be assigned to missed work using salaries. Installing an air pollution control device would have a quantifiable health benefit of fewer people missing work.  Health care costs attributable to air quality   Other

26. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits  Cost-benefit analysis : Used to choose among engineering project/product alternatives  For each project alternative, calculate the ratio of benefits to costs, with all benefits and costs adjusted for the time value of money (typically everything is adjusted to present).  Choose the option with the highest benefit-cost ratio or net benefit

27. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits  PVB (present value of benefits)  PVC (present value of costs)  BCR (benefit cost ratio) = PVB / PVC  Net benefit = PVB - PVC

28. Possible Micro-Scale Solutions: 2. Quantify Environmental Benefits Example problem – Cost-benefit analysis

29. Possible Micro-Scale Solutions: 3. Use a Lower Discount Rate  Another way to consider sustainability in all types of economic analysis: use a lower discount rate  A high discount rate implies a very low value on the welfare of future generations

30. Summary

31. References Allada, Venkat, “Introduction to Sustainable Practices in Design and Manufacturing,” PowerPoint Lecture Slides, Missouri University of Science and Technology, available at http://www.templet.org/imm/en, assessed 3/2010 http://www.templet.org/imm/en Callender, Craig. “The Tragedy of the Commons”, PowerPoint Lecture Slides, Philosophy, USCD, accessed 3/2010. “Emissions trading.” wikipedia.org/wiki/Emissions_trading, accessed 3/2010. Hardin, Garrett. ”The Tragedy of the Commons”, Science, Vol. 162, No. 3859 (December 13, 1968), pp. 1243-1248.