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Equity and the Environment

Environmental Economics Seminar Series
Department of the Environment, Sport and Territories, 1996
ISBN 0 642 24878 8

Background paper

Mick Common
Centre for Resource and Environmental Studies
Australian National University

Equity (fairness, justice) means different things to different people. Some conceive it in terms of outcomes, others in terms of opportunities, and others in terms of procedures. Here equity is interpreted as fairness in outcome, following the dominant usage in the economics literature. In environmental economics the concern is mainly with efficiency rather than equity criteria (see, for example Cropper and Oates 1992). Equity considerations have been more to the fore in natural resource economics, and some would argue that they are central to ecological economics as the economics of sustainable development/sustainability.

The first section of the paper considers the connection between equity and poverty, and notes that the real bite of the argument that there are environmental limits to growth is that it returns the solution to the poverty problem to the distributional context. Section 2 is essentially a very brief overview of the intertemporal equity aspects of the natural resource economics literature. Section 3 looks at the question of the distributional incidence of the damage costs arising from environmental degradation, while section 4 considers the incidence of abatement costs. Questions about intratemporal equity and the environment have domestic and international dimensions: the latter have recently received a lot of attention particularly in the context of prospective global climate change. Some very brief concluding remarks are offered in section 5.

1. Sustainable development

It is often stated that equity issues are at the core of the idea of sustainable development (see, for example, Pezzey 1989). It is claimed, that is, that the basic objective is equality across generations - we are enjoined not to degrade the environment such that our successors are less well off than ourselves. Actually, the basic Brundtland definition does not mention equity. It says:

Sustainable development seeks to meet the needs and aspirations of the present without compromising the ability to meet those of the future (World Commission on Environment and Development, 1987)

What Brundtland appears actually to be about is addressing current poverty without creating future poverty.

In the period after the second World War, economic growth was promoted by economists and accepted by politicians as the holy grail of economic policy, largely because it was accepted that it could solve the poverty problem (Arndt 1978). In the absence of growth, improving the lot of the poor involved redistribution from the better-off which inevitably involves social tension of some degree. Economic growth was seen as the means to address poverty without creating excessive social tensions. Given it, the lot of the poor could be improved from incremental output, rather than by reducing the living standards of the better-off The reaction, particularly that of economists, to the publication of The Limits to Growth (Meadows et al 1972) has to be understood against this background. The point here was well put by the editor in the first issue of Ecological Economics:

Issues of sustainability are ultimately issues about limits...We do not have to worry so much about how an expanding pie is divided, but a constant or shrinking pie presents real problems (Costanza 1989).

The Brundtland Report received a much less hostile reception than The Limits to Growth. One reason for this was, no doubt, that it did not call for the abandonment of the growth objective, as did The Limits to Growth. On the contrary, it explicitly called for the continuation of growth in the developing and the developed economies as the means to address the global poverty problem. It did call for a different kind of growth from that of the past. Growth that avoids running into environmental constraints is what sustainable development is according to Brundtland.

The concept of poverty that can be addressed by growth is one that sees it as the failure to reach some living standard defined in absolute terms. Given this conceptualisation of poverty, there is no necessary connection between inequality and poverty. One could imagine a society where all are well above some poverty line defined in terms of an absolute living standard as the income required to buy the physiological necessities of life, yet there is massive inequality. This is essentially the vision of the future entertained by those who argue, for example, against progressive taxation on the grounds that it inhibits the wealth creation which is necessary if poverty is to be eliminated.

In fact, the experience of growth in the industrial economies has, in regard to reducing the perceived extent of poverty, been rather disappointing. This is explicable if the concept of poverty as relative deprivation is accepted. Poverty thus conceived is directly linked to inequality. According to, for example Townsend (1979, and see also Common 1995) an individual is poor if she lacks the means for the lifestyle considered normal by her culture, or lacks the means to participate fully in what the culture defines as normal social intercourse. On this conception of poverty, cultural subsistence moves with economic growth, and so long as there are major inequalities in the distribution of income and wealth, poverty will persist notwithstanding economic growth. On this conception of poverty, the pursuit of greater equity is not simply motivated by a concern for justice and fairness, but also by a desire to eliminate poverty.

Of course, conceiving of poverty as relative deprivation does not involve denying the existence of absolute deprivation. There is no question that the poor in Australia are absolutely better off than the poor in Bangladesh. There is no question that the latter require improvements in absolute standards irrespective of what happens to equity in that country. Addressing the problem of poverty in Bangladesh requires there what may, for want of a better term, be called economic growth. Addressing the problem of poverty in Australia is much more a problem of equity and redistribution. From a global perspective, if we project constant relativity of absolute consumption levels as between Bangladesh and Australia as the former grows out of absolute deprivation, given modern communications, we can expect the continuing perception of poverty in the former on the basis of relative deprivation.

If it is accepted that economic growth is not effective in dealing with poverty in developed economies, then its importance as a policy objective there is much reduced. This is important for the environment to the extent that arguments against policies to protect it are frequently couched, at least in part, in terms of the adverse effect of such policies on economic growth. If it were generally accepted that poverty alleviation in developed economies requires greater equality in the distribution of current output, rather than more output, arguments against 'costly' environmental policies would surely have less political leverage. On the other hand, if it is accepted that the global economy is currently at the limits of its prudent expansion, then the global poverty problem is back to being a redistributive problem, addressing which would enhance equity between nations.

2. Intergenerational equity and natural resource depletion

In economics the end purpose of economic activity is the generation of individual utility, and intergenerational equity is considered in terms of the distribution of utility over time. The standard sort of model assumes a planner whose objective is the maximisation of the discounted sum of the future utilities of the representative individual alive at each point in time. Such models are useful for making some important and fundamental points (see, for an introductory treatment, Common 1988 chapter 7).(see note 1 below)

1 See Norgaard and Howarth (1991) for a treatment which looks at intergenerational equity in terms of intergenerational transfers with the interest rate as then endogenous and thereby emphasises the distinction between equity and efficiency considerations as noted below.

The simplest model assumes a single commodity which can be either consumed or added to the capital stock. Capital accumulation is productive in the sense that a unit of consumption foregone today makes available something in excess of one unit of consumption available tomorrow. The productivity of capital falls as capital is accumulated. The key parameters in this model are those capturing the behaviour of capital productivity as capital is accumulated and the planner's preferences as between consumption utility at different dates. In regard to the latter, it is usually assumed that the planner adds future utilities using weights that decline exponentially with futurity, and the relevant parameter is the social discount rate. It is widely believed that discounting at a positive rate is unfair to the future. In fact, in a model like this planning with zero discounting may mean that poor early generations save and invest large proportions of their production for the benefit of richer later generations, and that positive saving goes on forever. It might well be seen as unfair to the present. Generally, the outcome depends on the relative sizes of the two key parameters. In some ways this is the most important lesson - intertemporal equity cannot be considered simply in terms of the social discount rate alone. The implications of a given discount rate depend upon the productivity of saving and investment. Figure 1 illustrates for the two period case, assuming that 0(C) C so that consumption utility is non-declining. AB shows how saving and investment shift consumption over time. The II are the planner's indifference curves for consumption at different dates. For the social discount rate in use, the distribution of consumption over time favours the future. Clearly, the distribution would change with a change in AB - reflecting different opportunities for shifting consumption over time - and/or a change in the slopes of the II - reflecting a different social discount rate.

Consumption distribution: possibilities and preferences

FIGURE 1
Consumption distribution: possibilities and preferences

Figure 1 can also be used to make the important distinction in economics between intertemporal equity and efficiency considerations. Suppose that there is more than one commodity which can be produced and consumed or invested and that C in Figure 1 refers to aggregate consumption. AB then represents the way in which aggregate consumption can be shifted over time, assuming that intertemporal efficiency holds. Intertemporal efficiency holds when it is impossible to increase consumption at one date other than by decreasing it at another (for more detail see Common 1988 chapter 5). C1C2 combinations inside AB do not correspond to intertemporal efficiency as movement in a northwesterly direction toward AB is possible. Once on AB, C 1/C2 can only be increased at the cost of a decrease in C 2/C1. Intertemporal efficiency requires that the rates of return on investment in the production of all commodities are equalised. This will be the case if in all lines of production, investment is carried out up to the point where the rate of return equals the interest rate. An equivalent rule is to undertake all investment projects where the Net Present Value is equal to or greater than the interest rate. The project appraisal/cost benefit analysis rule, invest if the NPV is non-negative, is a rule concerned with the attainment of intertemporal efficiency.

Equity considerations are irrelevant to the use of this rule. Arguments that discounting in project appraisal/cost benefit analysis with long lived adverse environmental effects are 'unfair' to future generations are misplaced. Such analysis is not concerned with fairness or equity, but with efficiency. The real point about arguments concerning long lived environmental impacts must be either that they are of such magnitude as to affect AS, or that the environmental impacts involved are such that they should not be treated as commensurable with produced commodities. In either case, cost benefit analysis is simply inappropriate. A somewhat different argument that sometimes comes up is that in doing cost benefit analysis, the environmental effects should be discounted at a lower, often zero, rate than other inputs and outputs. This often turns out to be really an argument that the relative price attached to the environmental impacts should be increasing over time.

Going back to the distribution of consumption over time, the starkest problem arising from the use of environmental inputs in production arises where these are non-renewable natural resources, such as minerals and the fossil fuels. The first model run in The Limits to Growth had the world system collapsing on account of the depletion of such resources. Economists responded to this by considering planning models of the type described above, but where production of the consumption/capital good used inputs of a non-renewable resource as well as capital. This was really the origin of the neoclassical economics analysis of the sustainability question. The problem is: if production requires inputs from a finite stock of a non-renewable resource, is constant consumption forever possible? The answer to this question is 'yes' if the substitution possibilities in production as between capital and the resource are of the right kind, and if a particular saving/investment rule is followed. Hartwick (1977) showed that for a constant returns to scale Cobb Douglas production function, saving and investing the resource rent arising along the efficient depletion path would permit constant consumption forever, notwithstanding the finite nature of the resource base. The saving/investment rule here has become known as the Hartwick Rule. It has been shown that an essentially similar rule applies where renewable resources are at issue: Hartwick's original production function specification has been somewhat generalised. The Hartwick rule focuses attention on the substitution possibilities in production. As a necessary rule for sustainability as constant consumption it has immediate intuitive appeal. However, it is clearly a sufficient rule only if capital can in fact be substituted for resources as required to maintain constant consumption. Otherwise, a finite resource base necessarily implies that consumption falls and goes to zero eventually. Equity hinges on substitution possibilities that are necessarily highly uncertain.

In the case of a renewable resource, it is plausible that the size of the stock should be treated as an argument in the instantaneous utility function of the representative household. Whereas it seems unreasonable to suppose that people get utility from knowing that there is oil in the ground, it might be reasonable to suppose that the size of the stock of whales is an argument in utility functions. Planning models of the type considered above have been constructed along such lines, and have generated interesting results. Consider first such a model where the representative individual consumes, with costless harvesting, a renewable resource which grows logistically (Common 1988 chapter 6). Then, the planner's programme will involve the convergence of consumption and stock size on stationary levels - eventually it will involve sustainable yield harvesting. The stationary stock size will depend on the logistic growth parameter and the social discount rate, and for a given level of the former decreases as the social discount rate increases. In this case, setting the social discount rate to zero gives maximum sustainable yield harvesting in the stationary state.

Now, consider this model modified such that the stock size is an argument in the utility function along with the level of consumption. In this case the stationary state outcome depends on preferences over consumption and stock size, as well as on the growth rate and social discount rate. In this model setting the social discount rate to zero gives a stationary state stock size greater than that corresponding to maximum sustainable yield. Conservationists often argue that maximum sustainable yield harvesting is self-evidently the right and proper thing to do, that we should plan as if utility was increasing in renewable resource stock size, and that the future should not be discounted. The simple model considered here shows that conservationist preferences and zero discounting do not produce maximum sustainable yield harvesting - the outcome is a larger stock size and a lower level of consumption. These kinds of simple models are useful for checking the implications of simple ethical rules such as zero discounting. The point is that such a simple rule itself does not uniquely determine the equity outcome. The circumstances in which the rule is applied also have to be considered.

3. Intragenerational equity: damage costs/abatement benefits

It is widely believed that, according to standard economic criteria, environmental protection/improvement programmes generally benefit the rich more than the poor - that they are regressive in terms of their net impact (see, for examples, Baumol and Oates 1988 chapter 15, Baumol and Oates 1979 chapter 12). This presumption arises mainly in the context of the consideration of programmes to abate environmental pollution, and it is generally this context that will be assumed in the remainder of this paper. In that context, the distribution of net benefits will depend on the interaction between:

(i) the distribution of the benefits flowing from the programme, which is the distribution of the damages avoided as a result of the programme

(ii) the distribution of the costs of the programme.

This section of the paper deals with the first of these. The distribution of environmental improvement costs is considered in the next section.

If pollution is a pure public bad then a programme to reduce it will reduce it equally for rich and poor. This does not, of course, mean according to economic criteria that rich and poor are to seen as suffering equally from the existing level of pollution, or that the benefits of reduction will be the same for rich and poor. If environmental quality is a normal, or a luxury, good, the demand for it increases with income. The rich will be willing, and able, to pay more for the given improvement than the poor, and in the standard cost benefit analysis calculus, will be recorded as benefiting more from it. To the extent that the rich have stronger preferences for environmental quality, this effect will be reinforced.

Except over limited spatial domains, pollution is very rarely a pure public bad. For many pollutants the individual's consumption level is endogenous, either by locational choice, occupational choice, recreational choice, or on account of the possibility of defensive expenditures.(see note 2 below) Given this, on the assumption that environmental quality is at least a normal good, one would expect the rich to consume less pollution than the poor. The implications of such endogenity for the relative benefits, in terms of willingness to pay for uniform environmental improvement do not appear to have been thoroughly analysed in the literature. However, given that pollution is not a pure public bad, a programme for its reduction does not have to involve uniform reductions across individuals, and endogenity may operate through the political process to shape the nature of the programmes actually put in place.

The presumption that willingness to pay for environmental quality increases with income is strong. In contingent valuation studies, it is routine to regress willingness to pay on income and to take a negative coefficient as indicating that there is something wrong with the survey. In the published literature anyway, a positive relationship between income and stated willingness to pay is what is usually reported. Similarly, in applications of the travel cost method one would have a prior that the coefficient on income in the trip generating function would be positive, and finding a negative coefficient would give rise to concerns about the conduct of the survey.

2 In regard to locational choice this endogenity is the basis for the 'hedonic pricing' approach to the valuation of environmental quality.

In recent years a number of cross-country studies have looked at the relationship between per capita income and a variety of pollution/environmental impact indicators. The data is generally taken to be consistent with the hypothesis that pollution initially increases with income, then levels off and declines, giving rise to an inverted U shaped curve: for a critical review of this literature see Stern et al (1994). According to such a relationship, beyond the turning point environmental quality improves with income. Some commentators argue that this evidence supports the view that rather than economic growth being a threat to the environment, it is necessary, and perhaps sufficient, for environmental protection:

Furthermore there is clear evidence that, although economic growth usually leads to environmental deterioration in the early stages of the process, in the end the best - and probably the only - way to attain a decent environment in most countries is to become rich (Beckerman 1992).

Others draw a different conclusion from the same evidence:

economic liberalisation and other policies that promote gross national product growth are not substitutes for environmental policy. On the contrary, it may be desirable that they are accompanied by stricter policy reforms...Economic growth is not a panacea for environmental quality; indeed, it is not even the main issue. (Arrow et al 1995)

The point here is that the evidence which supports these disparate conclusions indicates that for many pollutants, environmental quality is higher in the developed than in the developing economies. Internationally, that is, the incidence of damage is, generally, regressive in terms of physical measures, though not necessarily in terms of the willingness to pay measure of damage. On cost benefit analysis criteria, this is consistent with high levels of abatement spending on relatively minor human health problems in the industrial economies and low levels of abatement spending on major human health problems in the developing economies.

Consider the case of global climate change, where physical damage estimates are highly uncertain. According to the draft chapter on 'The social costs of climate change: greenhouse damage and the benefits of control' for the IPCC Working Group III Second Assessment Report, the 'best guess' damage assessments for CO2 x 2 are:

World Impact: 1.5-2.5 per cent of world GNP
Developed Country Impact: 1-2 per cent of GNP
Developing Country Impact: 2-9 per cent of GNP

These figures are drawn from a range of sources. This draft chapter gave rise to some controversy, as it was alleged that it endorses valuing damages such as loss of human life less if they occur in a developing country than if they occur in a developed country. Actually, it is not clear that it does endorse, or follow, this practice. The draft chapter advances the following qualitative considerations regarding the size of developing country impact relative to developed country impact:

4. Intragenerational equity: abatement costs

The real cost of environmental measures is, ultimately, the additional resources needed to run the economy in a less polluting way. Smoke suppression devices and recycling processes use up raw materials, fuel and labour. The individual consumer will bear these costs in two forms: in higher taxes to pay for the operations of environmental agencies, and in increased prices when private industry passes on some (or all) of the increase in its costs. Whether industry is required to pay a pollution tax or is simply ordered to install pollution control equipment, its costs will increase, and this puts an upward pressure on the prices of its products...The issue, then, is: 'Who purchases the goods whose prices are increased?'...If the items take up a larger portion of the budgets of the poor, then the price rises will be 'regressive', and will effectively increase income inequality (Baumol and Oates 1979).

There is a widespread presumption that pollution abatement costs are, in fact, generally regressive. This could reflect an understanding that pollution arises mainly in manufacturing rather than the service sector, and that the proportion of expenditure going on services increases with income. Baumol and Oates cite a study that found the US National Environment Protection Program to have a regressive impact.

The case of CO2 abatement is instructive, especially since the dominant source of emissions is fossil fuel combustion. Increasing energy prices have long been considered to be regressive, since the poor spend larger proportions of their budget on fuels purchases. In the UK this is largely on account of heating, and in the 1975 there were proposals to subsidise the fuels purchases of the worst-off to prevent winter hardship. However, many of the studies cited in support of such proposals overstated the regressivity of higher energy prices, as they considered only fuels purchases by households. Since energy is used directly and indirectly in the production of all of the goods and services that households consume, this is to ignore much of the impact of higher energy prices on households. For the UK anyway, when the impact of higher energy prices on the prices of all of the commodities consumed by households is considered, the extent of regressivity falls (Common 1988). While the poor spend more on fuels, the rich spend more on air travel for example. One would expect this to carry over to the impact of CO2 emissions abatement, however that might be attained. Table 1 shows that for Australia the impact of carbon taxation is regressive, but that simulated regressivity is lower when all of the resulting commodity price increases are allowed to impact on households than when only the prices of oil, gas and electricity are accounted for.

The results in Table 1 assume that all of the carbon tax is passed through to the consumers of final demand, and that there are no substitution responses in production or consumption. It is difficult to see how allowing for such substitution responses could increase regressivity. Generally, models of the applied general equilibrium type which capture substitution possibilities do not distinguish households at different income levels, and so cannot produce results on regressivity within a nation.(see note 3 below) In the case of substitution in production, there are grounds for thinking that it could actually work to reduce regressivity. Energy and labour are substitutes in production, so higher energy input prices would work to increase the demand for labour, other things equal. Increasing the demand for labour would reduce unemployment, which is now a major source of relative deprivation in industrial economies. Of course, other things are not equal, and the effect on the demand for labour of the introduction of an effective programme for carbon emissions abatement would also include an output effect, the size and sign of which would depend on, especially, the actions on carbon abatement of other economies and the trade pattern of the economy introducing the programme.

Australian CPI increases by decile for tax

TABLE 1 - Australian CPI increases by decile for tax of $20 per tonne CO2

3 Body and Uri (1991) used an applied general equilibrium model of the US which did distinguish households at different income levels and found no regressive impact from energy taxation.

In Australia, there have been lots of modelling studies which have looked at the effects of carbon emission abatement programme outcomes under a variety of scenarios in terms of who else does what, etc. None of the models are such that the implications for regressivity can be derived, though the net effect on aggregate employment is usually computed. For unilateral action by Australia, it is usually found to be negative. The abatement instrument modelled is usually the taxation at a uniform rate of the carbon content of fossil fuels. This generates government revenue, and the way that this is used affects the impact of the abatement programme. Clearly, the revenue arising could be used to reduce the regressive impact of carbon taxation. As noted above, existing applied general equilibrium models of national economies typically are, and for Australia all are, such that this question cannot be properly addressed using them. A variety of alternative approaches to the question can be adopted. One is to use a model to simulate the pattern of commodity price increases and the revenue arising, then to input the price increases and the modified tax/welfare system to models of household income and expenditure at different points in the income distribution. I am not aware that this has been done in Australia. Table 2 gives some results from a UK study of this kind, showing that it is possible to design packages which have substantial leverage on emissions, are approximately revenue neutral, and which reduce inequality: see also Smith (1993). Common and Hamilton (1994) report results for Australia, using the ORANI model, where the carbon tax revenue is used to reduce payroll taxation, and where aggregate employment is increased.

UK household welfare changes by decile

TABLE 2 - UK household welfare changes by decile for alternative tax/transfer packages

The incidence across nations of the abatement costs of securing a given reduction in global CO2 emissions has been the subject of much debate and analysis. This is not solely a question of equity in burden sharing. The outcome would depend upon the abatement instrument adopted, and upon the way it was implemented, and has implications for incentives to participate in an international programme of abatement. Broadly, the alternatives in terms of instrument are:

  1. National Emissions Targets
  2. Uniform Emissions Taxation
  3. Tradeable Emissions Permits

For 1 and 3, the first question is how to initially allocate the global emissions reduction between nations. For l, that determines national abatement targets. For 3, a nation's abatement target depends upon its calculation as to where its interest lies in striking a balance between abating and permit trading, given its initial allocation of permits. In both of these cases, the distribution of the costs of global abatement across nations depends upon the initial distribution of quotas and how abatement costs vary across nations, though the outcomes would be expected to differ, for any given initial quota allocation, between the two cases. It would also depend upon the choices of instruments by nations for achieving their abatement targets. A number of rules for the allocation of quotas/permits have been suggested and their implications analysed with varying degrees of sophistication (see Janssen and Rotmans 1995, for example). A rule which would appear to have considerable appeal on equity grounds would involve the global emissions target being divided by world population to give a per capita share, with each country given an allocation of quotas/permits based on its population size.

However, some might worry that this would generate perverse incentives in regard to population growth policies, given that allocations would likely be periodically adjusted.

In the case of 2, the distribution of the global cost of abatement would depend upon whether the tax was administered by an international agency, and then upon what it did with the revenues arising, or by nation states, and by the distribution of abatement costs. If the tax were collected by an international agency, it could use the revenues arising so as to promote international equity, for example, by returning the money to nations according to their population size adjusted for per capita income level, though again some might worry about the population growth incentives arising.

Table 3 gives some results from an applied general equilibrium model to illustrate some of these issues. For Options 1 and 2 all of the economies listed cut back by 50 per cent - National Emissions Targets are set on the basis of equal percentage cutbacks. Each economy uses the taxation of fossil fuel as an instrument for the attainment of its target. The two options differ according to whether the tax base is production or consumption. Option 3 involves an international agency taxing fossil fuel carbon content at a uniform rate across economies, and returning the revenue to economies according to population size. The figures shown for the economies under Option 3 refer to the situation after the disbursement of the tax revenue. For this option, the Rest of the World, roughly the developing economies, is actually better off in the post tax than in the pre tax situation. Note that this is also the least cost option for the world as a whole.

Cost associated with alternative instruments for emissions reduction

TABLE 3 Cost associated with alternative instruments for emissions reduction (percentage reductions in GDP)

Concluding remarks

Clearly, the issues arising from the intersection of environmental and equity considerations are complex and wide-ranging. The economic analysis that is generally seen as policy relevant is dominantly about the attainment of efficiency. Where it addresses equity, it employs the same ethical basis, ie, the particular version of utilitarianism which is consumer sovereignty. The standard assumption is that the consumption services that the natural environment provides can and should be brought within this ambit. There is generally a further, implicit, assumption that produced commodities can substitute for such services in production and consumption to the extent necessary to maintain the level of aggregate consumption over time, given appropriate savings and investment behaviour. One might speculate that to the extent that this is true, adaptation over time to the increasing scarcity of natural environment services could actually increase the potential for intratemporal inequality. It is often remarked that there was generally less scope for inequality in hunter gatherer societies than in agricultural and industrial societies on account of the simpler technology. Whether future technological adaptation will increase the potential for inequality will depend upon the extent to which the substitutions involved are matters of private or public provision. To some extent private or public provision is itself a technological matter, but will also in many cases involve social choice.

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