Key Themes 2: Pollution and Policy

Introduction:
The environmental impact of economic activity has become a key issue of public policy in the last 30 years.  Every decision to produce and consume creates private cost and benefits which allow the price mechanism to determine price and output levels taking account of changing market conditions. 

However there are information failures in the sense that not all costs (in the case of pollution) are included.  A missing market exists for external costs of our actions.  It is only when these are considered that we generate an efficient allocation of resources.

Private Cost + External Cost = Social Cost

A false equilibrium is generated by the market leading to over production and consumption of certain goods, a misallocation of resources, market failure and a justification for government intervention.

Analysis:

Policy Options:

• Green (Piguvian) Tax - the tax will shift the existing supply curve (MPC) to the left; the tax will be specific (per unit) and reflect the MEC caused at the efficient output level. The tax revenue will be protected (ringfenced / hypothecated) and used to deal with the pollution impacts
• Evaluate
• measuring external cost is difficult, especially when it is global and long term
• does the "polluter pays principle" apply ie is the person causing the problem paying the tax - contribution is dependent on elasticity of demand

• Carbon Trading - this is where an agency such as the government or EU sets a limit on a certain emission in a certain time period (eg tonnes of CO2 per year) for a certain industry (Commerical Air Travel - introduced in 2011).  The "CAP" (limit) is shared out among existing producers in the industry (auction will generate income?).  Firms have an incentive to clean up production as any surplus on their allocation may be sold to dirty producers.  Over time the cap is reduced to keep the price of carbon high and thus a market based solution to pollution is generated.

• Evaluate
• Where to put the cap? what is an acceptable level of pollution?? EMTS phase 1 created too many pollution permits and the price of a tonne of carbon plumeted to 50 cents - too low to incentivise firms to clean up their acts
• what emissions should be included? carbon yes but what about nitrous oxide??
• what industries and activities? surely all economic activity must be dealt with .....is trading a practical solution for this?

Conclusion

The tax v trade debate goes on.  A combination of policies will ultimately lead to progress on climate change and pollution, but only if there is multilateral action ( all nations working together).  EU has acted whilst other nations such as US and China have been slow to act.  This may actually make the present pollution levels worse as firms relocate to low regulation centres and emissions rise (carbon leakage). This could be said to be a form of Governement Failure.

The environment is a global public good with associated free rider problems leading to inertia with regards to effective policy, but something must be done to guarentee a sustainable future,

Remember inability to agree on policy is a failure of government in a political sense rather than government failure in an economic sense.

Other policy Issues:

• Clean Development Mechanism:  Allowing firms to offset carbon emissions by investing in developing countries clean production
• Subsidies for clean energy and technology - picking winners?? acting as a catalyst in the switch from non-renewable to renewable energy.