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Environmental Economics Seminar Series
Department of the Environment, Sport and Territories, 1996
ISBN 0 642 24878 8
Gul Izmir: We have had a range of interesting papers today. They all picked up on different aspects of consumption and the environment and how we can change people's consumption patterns. Basically it appears that there are a range of mechanisms that we can use in changing people's consumption patterns. They vary from provision of more relevant information to better education, better regulation and matters such as environmental labelling, life cycle analysis and so on.
One thing that is really striking to me is that one of the mechanisms through which we can impact on people's consumption decisions, that is pricing and the use of economic instruments, hasn't received much emphasis. This seminar was advertised as an environmental economics seminar, but we have not really touched on economics too much, apart from George, who talked a bit about market failure. But even the concepts of market failure, externalities and things like that did not really get much of an airing. So I thought it would be a good idea if I touched on those concepts and explored the potential use of economics in the service of the environment. I also thought I would look at the reasons for the reluctance I perceived to use economics to obtain environmental objectives.
Basically environmental goods or services are public goods and one of the fundamental characteristics of public goods is that one person's consumption does not decrease another person's consumption of the same thing. In economists' terms they are non-rival goods. We can all consume them. Another characteristic is that they are non -excludable. I cannot stop you from using clean air. So when you look at those sorts of characteristics you see that there is a striking difference between environmental goods and the normal type of goods.
Private goods are rival goods. If I buy myself a dinner, either I eat it or you eat it. I can exclude you from eating it.
There are a whole lot of external effects associated with environmental goods. Externalities occur when there are certain transactions between two parties which impact on a third party where that third party is not compensated.
All these things tell us that we do need a different kind of economics to deal with the environment. When it comes to the environment, the market fails; it does not work properly. So we need to develop different tools and mechanisms to deal with the environment.
What sort of things do we need to do? One of the most important tools we can use to protect the environment is pricing policy. Unless we get pricing policy right we will not really go a long way towards protecting the environment. In terms of problems relating to water, probably the price of water is the single most important determinant in dealing with water pollution. We can do all sorts of other things, but if we continue to underprice water, people will use lots of it and we will end up with a lot of toxic substances in our rivers.
So, how do we get our pricing signals right so that the consumption decisions of millions of customers are synchronised in such a way that the results are environmentally beneficial? We need to incorporate the cost of environmental damage in prices. Currently, because no value is placed on environmental goods and services, they just drop out of the picture. In setting our pricing policies, we get the costs of a whole range of inputs or factors of production, we add those up and calculate the costs and set the pricing policies accordingly.
But we ignore the fact that we are using the environment as well. So virtually the environment ends up having zero value attached to it. One of the things we can do in promoting better environmental outcomes is to make sure that we value environmental goods properly, and that we reflect that value in a whole range of pricing and investment decisions. That is one thing that we can do.
There is another thing we can do. We can work towards making the costs of using the environment transparent and avoidable to producers and consumers. If we have the appropriate mechanisms, we can make firms use all their creative energies and managerial and engineering expertise in an effort to develop solutions for reducing environmental pollution. That way we are all going to be better off.
How can we do that? How can we make the cost of environmental degradation transparent and avoidable? There are several mechanisms that environmental economists have been trying to develop. Those are discussed under the general heading of economic instruments. There are things such as tradeable permits, effluent charges, deposit -refund systems, product charges, performance bonds and so on.
What these economic instruments are really trying to do is to get the best environmental outcome at the least cost. If we can do this it means that for every environmental dollar that we spend we are getting more for the environment; we are doing more with a smaller amount of money.
We hear economists talk about Adam Smith's invisible hand. What environmental economics is trying to do is to put a green thumb on Adam Smith's invisible hand. That is not something to be frightened of or something to ignore; it is a matter of trying to use economics and the creative potential of the marketplace in the service of the environment. I put it to you that there are a whole range of tools there that can be utilised - if they are designed and implemented properly - to get better environmental outcomes.
Another thing that we need to do is get a better understanding of consumer preferences - a better understanding of how much consumers are actually willing to pay to get certain environmental services. Perhaps a lot of you have heard of the concept of willingness to pay in relation to the provision of public services. This concept has been discussed quite widely and there are trends in public policy emphasising that any investment in improving environmental standards should be done in line with the consumer's willingness to pay for them.
I have been trying to get my mind around this whole concept of willingness to pay versus another concept that could be equally valid in understanding consumers' preferences - and that is the concept of willingness to accept compensation. In standard economic theory, willingness to pay and willingness to accept compensation are supposed to be the same. But economics does not explain everything. Recent research, especially in psychology, points out that people value gains and losses differently. They weight losses from the status quo more heavily than they do gains. So the value that people put on the environment all depends on how they view it. If I view a clean environment as my right, then the right measure of my preferences is my willingness to accept compensation which could be up to an order in magnitude higher than my willingness to pay.
There are a whole range of issues of that kind on which we need to get a better handle. A lot more research needs to be done in those areas which will give us a better understanding of consumer preferences and of how to provide the appropriate environmental services that people want.
Going back to the idea of economic instruments, I know that people have certain reservations about the use of these tools. However, I want to point out that it is worthwhile to look at these tools and that the range of objections people have to their use can basically be dealt with if we design all the systems properly with the ultimate objective of better economic and environmental outcomes in mind. For example, people are often concerned that even if you cut costs, there will be no demonstrable gain for the environment. The answer is that you can design those things so that you do it at less cost and, at the same time, reduce the amount of environmental discharge. You can design them so that you get both better environmental and economic outcomes.
A whole lot more needs to be done to get public awareness and acceptance of these tools. In using concepts of economic theory and tools of economics to promote beneficial environmental outcomes, I stress the importance of not ignoring one tool that is potentially very helpful and of viewing it more positively.
Jim Donovan: As foreshadowed this morning, I have brought in some copies of an article. It is about the British Royal Commission into Environmental Pollution. It talks about very little other than transport, and among its recommendations is one that the price of petrol should double. It says that never again can the government ignore the consequences to the environment of its policy on transport. All you people will have heard this stuff before, but it is presented here in a fairly succinct way and also it is fairly current - it only happened this month. There is a lesson in it. With the question of selling a city a public transport system, there are not only the more obvious aspects such as the services taking you to where you want to go, but there is also the consideration that you get a rather different looking city. This brings in questions of town planning and that is rather harder to sell to people.
I represent Action for Public Transport, and we are flat out getting the Roads and Traffic Authority and the Minister for Transport to admit that their road building policies lead to more driving. They do this in several ways. People seem to have an innate need to live half an hour or so from their workplace. If you build a road or do something that makes it possible for them to travel faster, you cannot say they are saving time. What you are doing is making them change their habits so that they live farther away from their work. They take the benefit in the form of extra distance. When you build a road - an obvious example is the Harbour Tunnel - you find that the number of kilometres driven in the city that day increases, the city consumes more fuel and it is an environmental disaster. What I hope to get from this seminar today is some pointer from you people as to how I can tie in with the public perception the extra driving, the extra sprawl of the city, the extra pollution from exhaust fumes, the greater sales of cars and the higher number of accidents. How can I improve the public perception of what I am trying to sell?
Gul Izmir: Make them pay for use!
Scott Lyall: I really like the idea of Adam Smith's invisible hand having a green thumb, I think that is fabulous. Perhaps that should be related to Jim's problem. It is all about reflecting the true costs and maybe that dreaded term - user pays. I am sure that people heading into the city from the west, who now use the tollway, have to think more carefully about how often they will use that road and how far out they will live. If we are serious about stopping urban sprawl and perhaps consolidating the inner city for efficiency reasons, a few more tollways would not hurt. That is slightly tongue-in-cheek!
Ted Floyd: Unfortunately I tend to think that there are considerable limits to what you can do with economic theories. Everyone loves to talk about externalities, and how they should be costed into products and that sort of thing, but how do you cost an externality? What is the cost of smog? At an Industry Commission hearing I was once asked what the value of a tree was. Of course I cannot answer that; I don't think anyone can. Of course you can put up the price of something because it is environmentally damaging, but you should not pretend that you can do it scientifically and actually work out the cost of smog or the value of a tree. Also, I am not quite sure who receives the profits from costing externalities.
A few years ago there was the great debate on how we could get a 20 per cent reduction in CO2. It seemed that the participants lined up in two camps. In one camp were the economists who used tools such as carbon taxes and so forth, and who proved conclusively we could not do it because it would not work. In the other camp were the engineers and scientists who claimed it would all be so simple if we just had the will to do it and tried to do it by efficiencies. I know what efficiency means in terms of energy; but if you ask an economist what 'efficiency' means you will not get a straight answer. I do not think they have any idea. So obviously there are limitations.
Costs have a role to play. But if we are going to let the world be driven by economists, I do not know where we will be heading. I think we have to get back to a few simple facts - things that can be measured and goals that can be achieved.
Freya Marsden: I will leave it up to Ted to explain exactly how to measure the value of trees! I believe that economics can play a very definite role in these issues. While Scott admits that he made the comment about tollways tongue-in-cheek, I think it is very much an issue that we should look at. We should consider increasing the price of cars and making sure that it is more expensive to drive cars that are inefficient. We should also make sure that there is public transport and that it is efficient, very cheap and accessible. I think it is a combination of economics and going through the role of government. We must look at methods of ensuring that we do not drive as many cars and that there are alternatives. Many economic tools can be used to that effect.
Gul Izmir: I return to the point about valuing environmental goods and services. I know that the debate gets emotive when we talk about valuing a specific tree. I too would have great difficulty putting a value on a particular tree to which I might be emotionally attached. But the thing to realise is that even if you do not put a value on such things explicitly, you are doing so implicitly. As a result of a whole range of decisions that you make relating to the size of a forest or whether it should be logged or not, implicitly you are putting a value on those things. I believe that making those sorts of valuations explicit helps to further the debate. If you are going to allocate society's resources in a certain way, why not make that allocation more explicit.
Jim Falk (University of Wollongong): I wish to make a comment about the use of economic instruments. Clearly the adjustment of pricing signals one way or another has a role to play in the implementation of policy. There is no question in my mind about that. But there is a question about the primacy we give that. Firstly, it is very easy, once a pricing signal has been adjusted, to think that the problem has been basically dispensed with and that the matter is now just technical. To give you an idea of just how seductive that is, I refer to the American car manufacturer which made a decision on the basis of a cost/benefit analysis, that rather than place the petrol tank in a slightly different position, it would save itself $8 per car if it left it where it was and paid for the court cases when the victims were fried alive in rear collisions! In any ethical or moral universe one could not possibly come up with that decision. But from a pricing point of view, when you place you faith in numbers, you can.
It is equally easy to forget just how crummy our techniques are for placing values on externalities. It does not matter whether it is surveying people to see what they think about the value of something or looking at lengths of trips people are prepared to drive and so on - those are all pretty cruddy second-rate substitutes for the actual overall judgments that we would want to stand for those environmental impacts. For example, in relation to greenhouse gas emissions, what value do we put on the needs of future generations? They certainly cannot bid in today's markets. To substitute our views of what their preferences should be is an incredibly cruddy sort of substitution. There is a limit to the value we should put on those additions we make to the pricing mechanism. That is not to say we should not do it, but we should not be fooled by what we do. It seems to me absolutely central that policy be placed in command of these changes; that the changes that take place should not defeat future policy - that is, it should not create an inertia or technical barrier against a sort of lack of transparency, to ordinary people being able to change their views and shape and reshape the policy. That is the central issue.
Freya Marsden: I will try to answer that. My main point is that, yes, economics is a tool - a tool to be used warily. Up to now implicitly we have not been valuing the environment at all. By not trying to put any value on it whatsoever, we wind up by doing nothing. When we manufacture we do not take into account any of those resources - whether we use them as a sink, whether we pollute the rivers or the air. We do not have to take that into account when we manufacture. We are suggesting that we use these very rough tools to try to get some indication of the value of the environment. In that way we will be able to make manufacturers and producers have a look at what they are doing to the environment, and thus value it better. It is rough, but it is definitely a start.
Gul Izmir: I do agree that a lot of the techniques are crummy. But if you do not persevere and if you do not use them, you will never perfect them. Engineers did not start building bridges by building suspension bridges. It is all a matter of using techniques, perfecting them and polishing and refining them.
Jeanette Haycocks: Most of the taxes we have in place are there for equity reasons - income redistribution. How do you reconcile that objective of the tax system with the need for environmental protection?
Gul Izmir: That is an interesting question. I do not know whether you are aware of this, but there was some recent research by EPAC into the public expenditure preferences of the Australian people in a whole range of areas. The survey asked whether people wanted expenditure in certain areas to be increased and whether, as a result, they were prepared to pay higher taxes. It seems that in the case of the environment, people were prepared to do that. That is important to bear in mind as a background.
In dealing with environmental impacts, we find that many of them have different distributional consequences. It might be that you put in place policies that will be efficient but not perhaps equitable. The way to deal with that is to make sure that you do have additional mechanisms in place that correct those distributional inequities as and when they arise. For example, you can have higher prices for water, but in the meantime if certain groups in the community are going to be put under stress because of those higher prices, there can be safety nets, such as rebates for those people.
Jeanette Haycocks: Would that not undermine the value of that tax?
Gul Izmir: No, it does not because you are trying to achieve efficiencies at a much higher level. You are not giving rebates to every single person. You are achieving the efficient outcome but at the same time you are recognising that efficiency is not your only objective. As a government, you have equity objectives as well. Once you have arrived at an efficient solution, with savings in the economy, you can use part of those savings to correct side effects arising out of your policies that disadvantage certain groups of people.
Stephen Boyden: The mention of the value of trees reminded me that in Poland a few years ago they introduced a law to the effect that if you wanted to cut down a tree, you had to pay something. The amount you paid was calculated on the basis of some sort of formula relating to how much carbon dioxide that tree took out of the atmosphere every day. A certain value was put on that.
Something rather more basic interests me here. As I said, I am not an economist and I do not really understand the intricacies of pricing and taxing policies, but it seems to me that as far as these important environmental issues are concerned, we have three options. The first is to do nothing. The second is to use economics as a tool, as has been discussed here. The third is legislation. I am fascinated by the fact that we never use economics as a tool for protecting human beings from attacks by other human beings. For example, we do not use economic disincentives to prevent murder or other nasty crimes, we use legislation. But we do not use legislation to protect other living systems - living systems on which we depend for our very survival. I see a problem there. I wonder why we talk so much about economic incentives. Perhaps they will eventually work, but we are talking about a very urgent situation, as was reflected in the quotation I mentioned in my presentation this morning. Perhaps we have only 10 years or so. I am sceptical about introducing economic incentives or disincentives to try to persuade people to use their cars less.
Sharon Beder: I would like to give an analogy to illustrate the philosophy behind economic instruments. You could argue that the community could afford a certain amount of crime or theft, and you could deal with that by licensing a certain number of thieves. The more they stole, the more they would pay. But the community would not stand for that sort of argument, therefore it is more logical to try to catch all the thieves. For those of you who would like a more serious analysis of economic tools and instruments, I point out that I have produced a paper on this and I am happy to send it to anyone who wants it.
I wish to make a quick point about the effectiveness of economic instruments in practice. The OECD has found that pollution charges are never high enough to provide the incentive that they are supposed to provide for the same reasons that legal instruments have been ineffective in the past - there just is not the political will. There is not the political will to put in tough legislation but, by the same token, when you go to economic instruments you find that they are never enough. In terms of tradeable pollution rights, which have been used for years in the US, it is true that they have saved industry a lot of money, but the effect on air pollution levels has been nil.
The popularity of economic instruments, which have been around for decades, has come about because there is this public awareness of environmental degradation and people are pressuring governments to put in tougher legislation. But industry is saying: 'Economic instruments at least give us the choice - we can either pay or we can perform'. I don't think that industry should have the choice; I think that if there is an alternative technology that does it better, they should be forced to use it. They should not be able to say that they would rather pay the fine or buy some pollution credits from somewhere else. We are in crisis; we cannot afford to go hither and thither experimenting. Let us use the instruments that are certain, rather than handing the choice over to the polluters.
Gul Izmir: I was not suggesting for one moment that we should use economic instruments for everything. You do not use environmental labelling for everything; you do not use life cycle analysis for everything. I am just saying that there are certain appropriate cases where economic instruments can be used. Of course we would not hand out quotas for theft! Obviously, you can take everything to those sorts of extremes.
There are certain circumstances in which you can use these instruments intelligently and properly to get the results that you want. The important thing is choosing the right approach for the right problem.
Although economic instruments have been used for a while, it might seem that the effects have been negligible. But I suppose the important thing is the basis for comparison. Probably the right basis for comparison is what the level of pollution would have been if you had not used those economic instruments. It is not adequate to say that there has not been any reduction compared with previous levels.
There are many environmentalists in the US and elsewhere who find these instruments useful. My point is that if we use these tools intelligently they can be useful, so we should not have hang-ups about using them. It is all very well to say 'regulate', but prescriptive regulations kill people's innovativeness. It is all very well to say that we should find the level to which people can go and just enforce limits. In a whole range of cases the regulators do not know exactly how far they can go. Even if they do, it does not mean that that is the level that is achievable in the best of all possible worlds. If you give people incentives they will use their minds. You cannot legislate to make people think more creatively.
Chris Nobbs (Chair): I am going to give up my right to make portentous statements at the end of the day's proceedings. In the very short time remaining I would like to challenge the main speakers to say very briefly and succinctly the one thing they would like the Department of the Environment, Sport and Territories to take away from this seminar, either as a program or a challenge. If there are a few moments left at the end, I will then extend that invitation to everyone else.
Barney Foran: The problem we are having in this discussion is that we all know that something in our dominant economic system is fatally flawed. We do not know how to overcome that. Using a sporting analogy, I would say we are not trying to score tries or goals, we are more interested in the ruck and the scrum. Setting goals is a job that DEST should be about, rather than the methods of getting there.
Deni Greene: One of the things I would like to see DEST take away from this conference is a greater sense of urgency in terms of the need to come to grips with the problems of consumption, environmental damage and biodiversity. I think we are still behaving as if this were a very nice intellectual challenge, and it would be good if we solved it. I do not really get the feeling that, with greenhouse, for example, we have a really strong sense or urgency. We must do something and we must do it fast.
George Wilkenfeld: I would certainly back up everything that Deni has just said about the sense of urgency. Perhaps governments should get out of the habit of trying to communicate only the good, positive news and actually begin to start communicating realistically the risks and the bad news. One particular opportunity might be to use the instance of the current drought. Nobody with any scientific respectability to protect would claim that this is related to global warming, but it is a good example of the kind of environmental extreme effects that will become commonplace if the predictions about global warming are only half right. Perhaps DEST might like to consider using this as a rather sad, but apt case study.
Jenni Mack: I want to say something very specific rather than general. I guess the first thing would be that once the International Standards Organisation standard for environmental labelling, terms and definitions has been adopted as an Australian standard, DEST should do everything it can to make sure that Australian industry lives up to that standard. I guess that putting it into legislation has to be an option. Secondly, I would hope DEST would support moves by the Minister for Consumer Affairs, consumer groups and the Trade Practices Commission to change the Trade Practices Act to require manufacturers to have the information available to be able to back up the sorts of environmental claims they are making, which they are simply not required to do at present.
Stephen Boyden: The Department should be treating these matters as a matters of real urgency. We must try to get across this need for urgency. In addition the Department has an extremely important educational role - I am not talking about the education of the community here; I am talking about the education of other government departments. To some extent DEST recognises this already, but probably this is its most important role of all. How it should set about this I am not sure - that is another matter - but it is an extremely important role for the department to help other departments to understand why this matter is so urgent.
Gul Izmir: Basically, I have this strong belief in the use of economic theory in obtaining better environmental protection. I believe it is something that deserves careful scrutiny, and at the moment it is not getting enough emphasis.
I also wish to make the point that when you talk about tradeable permits, people think there will be a huge number of players in the market and the whole thing will be blown up out of all proportion. Okay, it may happen like that in the United States with the sulphur dioxide quota trading and the Chicago Board of Trade handling the trades and what have you, but they have a different structure to us. In Australia it would not necessarily happen like that. We can use the concepts of economics to ensure that we put in place the appropriate incentives and the appropriate flexibility to make people think a bit more creatively.
With legislation you can require people to meet certain limits, but people will only think about getting down to those limits and then they will stop worrying about it; they will not have an incentive to come up with better ways of doing things. If you really want to harness the creative energy of people and industry to try to work towards technological innovation and get better ways and means of dealing with the problems, you really need to look seriously at using economic tools.
Patrick Thompson: I want to comment on environmental economics. My view is that it is not a compromise; it is a matter of ecological outcomes. Ecological outcomes are not about using economic instruments to manage compromised outcomes. That is a personal view, and one which a lot of environmental economists would hold.
My advice to DEST is that we have major problems that will not be solved by tinkering around the edges. We have power in the hands of a small group in government, who mastermind some of those economic instruments. Those of us who examine those instruments critically know that the outcomes usually are not determined by the professional officers of organisations like the EPA, but are determined at another level of government where other political factors are the overriding concerns. There is plenty of evidence to support that.
I see only one solution, which I put to DEST - that is, to look at ways of devolving power back to the ordinary people. We have an airport in Sydney. If we asked the people who live near that airport whether they want it, we would have a clear answer. Yet those decisions are made at high levels for good economic reasons, taking account of externalities, and some decision has to be arrived at. The result is a decision which is ecologically unacceptable.
Andrew Doig (Australian Chamber of Manufacturers): My advice to DEST would be that the overall issue is extremely complex. Consumption problems will show up in some areas before they show up in others. The real problem for government will come when it needs to impose some sorts of controls over consumption. Keeping those changes fair to society will be the biggest challenge and the most difficult task facing any government. That issue needs to be considered very carefully.
Jim Falk: I find it hard to believe that regulation of market prices exactly as they stand across the entire economy should be accepted at face value and that we should assume that everything can be achieved by that regulation. That would mean throwing out a huge range of measures from increasing the cost of energy at certain levels with the introduction of a safety net, to taxing high consumption vehicles and subsidising low consumption vehicles. It would mean abandoning a vast range of quite sensible economic interventions to change consumption patterns and the way in which things are produced. The message I want to get across to DEST is that there is a tendency to believe that economic instruments can do more than they should and that the difficult political judgments can somehow be subsumed into the economic instruments. They cannot. Instruments are just what they are - at best, servants of policy, and very often present the danger of submerging the choices that have to be made. There has to be much greater sensitivity as to how and where and what economic instruments can be used in which situations. This is difficult territory, but that does not mean these instruments should not be considered.
Jeanette Haycocks: I applaud Barney's suggestion to DEST to set goals. If we are aiming for sustainability, we also need to set social goals as well as environmental ones. Then we can look at how we can work our economic and social systems to achieve those goals within the environmental goals we have set ourselves. These goals need to be set by the community so that everyone has ownership of them, but that is a very long process. In the meantime, perhaps we need a set of interim goals set by a smaller select group, which we use as a starting point to involve the rest of the community and work through a longer timeframe to get where we want to go.
Chris Nobbs (Chair): I have had a really enjoyable day, and I hope all participants have as well. I think there is a rich harvest of suggestions here from which DEST can take a lot of value. Obviously this is a very complex area and we have not managed to solve all the problems in a day's proceedings! I thank the speakers especially, and the participants and I am sure that DEST will appreciate your efforts.