Environmental sustainable development goals

environmentally sustainable economic development and sustainable development environmental issues
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Univerzita Jana Evangelisty Purkyně Fakulta životního prostředí Sustainable environmental and natural resource economics Josef Seják Ústí nad Labem 2014 Název: Sustainable environmental and natural resource economics Autor: doc. Ing. Josef Seják, CSc. Vědecký redaktor: doc. RNDr. Jan Pokorný, CSc. Recenzenti: Ing. Václav Vacek, CSc. Ing. Jakub Vosátka, Ph.D. © Nakladatel: Univerzita J. E. Purkyně v Ústí n. Labem, Fakulta životního prostředí Tato publikace vznikla v rámci projektu OPVK EnviMod – Modernizace výuky technických a přírodovědných oborů na UJEP se zaměřením na problematiku ochrany životního prostředí. Reg. č.: CZ.1.07/2.2.00/28.0205 Neprodejný výtisk ISBN 978-80-7414-877-4 (brož.) ISBN 978-80-7414-878-1 (online: pdf) CONTENT INTRODUCTION.................................................................................................................................................. 4 CHAPTER 1. BRIEF HISTORY OF ECONOMICS AND NATURE PRICING ............................................ 6 1.1. Economics, natural and environmental resources .................................................................................. 6 1.2. Brief history of economics and nature pricing ......................................................................................... 8 1.3. Welfare economics and the environment ................................................................................................ 16 1.4. Environment, ethics and discounting the future .................................................................................... 20 References ......................................................................................................................................................... 25 CHAPTER 2. NATURAL RESOURCE ECONOMICS ................................................................................. 26 2.1. Time Factor (discounting) ........................................................................................................................ 26 2.2. Cost-benefit Analysis ................................................................................................................................ 32 2.3. Basic methods of natural resource pricing ............................................................................................. 34 2.4. Some elementary concepts from the field of valuation ......................................................................... 37 References ......................................................................................................................................................... 39 CHAPTER 3 ENVIRONMENTAL (≈POLLUTION PREVENTION) ECONOMICS ................................. 40 3.1 Relations between economy and environment ......................................................................................... 43 3.2 Economic growth and environment.......................................................................................................... 44 3.3. Economically optimal quality of environment ........................................................................................ 44 3.4. Pollution control policies .......................................................................................................................... 49 References ......................................................................................................................................................... 57 CHAPTER 4 NON-MARKET ENVIRONMENTAL RESOURCE ECONOMICS ..................................... 60 4.1. Concepts of valuing non-market parts of nature ................................................................................... 60 4.2. The concepts of economic valuation and economic value ...................................................................... 65 4.3. Economic valuation and sustainable development ................................................................................. 68 4.4. The basic methods of imputing values for non-market environmental goods and services ................ 70 4.4.1. Methods of surrogate, related markets (indirect methods) ................................................................... 73 The method of hedonic pricing .................................................................................................................. 73 4.4.2. Contingent valuation method (CVM) .................................................................................................. 76 4.4.3. Methods of valuing environmental goods and services through non-demand curve approaches (through costs and damages) .......................................................................................................................... 81 4.5. Valuation of biotopes through benefit-cost approach ............................................................................ 85 4.5.1. Methodology of monetary valuations of ecological functions of the territory ..................................... 85 4.5.2.Identifying ecological quality of environmental resource ..................................................................... 86 4.5.3. Biotope restoration costs ...................................................................................................................... 88 4.5.4. Linking biotope values with CLC (Corine land-cover) (satellite images) ............................................ 88 4.5.5. Utilizing environmental values as economic instruments..................................................................... 92 4.5.6 Values of biotope types in the CR ........................................................................................................ 95 4.6 Energy-water-vegetation-based method for valuation of ecosystem services ....................................... 99 4.6.1. Results ................................................................................................................................................ 105 4.6.2 Conclusions ......................................................................................................................................... 106 References ....................................................................................................................................................... 107 Enclosure 1 Valuing damages and losses from construction of Klanovice golf resort ............................. 110 Enclosure 2 Examples of thermocamera images from different biotopes ................................................. 113 Introduction Sustainable development strategies are gradually becoming the core of economic policies of nations and international organisations, although in many cases only in declarations. The quality of environment and the integrity of natural wealth of our planet are decisive for the quality of life. Man is an integral part of the biosphere which constitutes our only life-support system in an otherwise hostile cosmic environment. By threatening its integrity and functioning, we are not only seriously affecting the quality of human and other life, but we may even be threatening the very existence of life on Earth. Even though more than forty years have passed since the Stockholm Conference on the Environment (1972) and despite the Brundtland Commission’s explicit warning that human activity was disrupting the ecological life-support systems to the extent of approaching the “thresholds of human survival” (WCED, 1987), policy-makers have not even begun to address the issue in its extreme gravity. The systems of production and consumption in market economies, based largely on the paradigm of neoclassical mainstream economics, combined with the negative environmental impacts of former centrally planned economies and the impacts of poverty in non-industrialized countries have resulted in a variety of patently unsustainable and threatening effects, including global climate changes, depletion of the stratospheric ozone layer, acid rains, deforestation, soil erosion, species extinction and toxic pollution. As the foremost thinkers of our current world show, humans are facing a wide range of global problems, which are systemic problems, mutually tied and interrelated. The quantum physicist and philosopher Fritjof Capra notes that “The extinction of animal and plant species on a massive scale will continue as long as the Southern Hemisphere is burdened by massive debts...There are solutions to the major problems of our time; some of them even simple. But they require a radical shift in our perceptions, our thinking, our values.” (Capra, 1996, p. 3-4). Similarly, Hawken, Lovins and Lovins, the authors of an important book on the shortages of current market economies write: “Capitalism, as practised, is a financially profitable, nonsustainable aberration in human development...It liquidates its capital and calls it income. It neglects to assign any value to the largest stock of capital it employs - the natural resources and living systems, as well as the social and cultural systems that are the basis of human capital.” (Hawken, Lovins, Lovins, 1999, p. 5) The aim of this textbook is to describe and explain the methods for valuing the environment and the complex relations between the economy and the environment. The unifying theme of this study is the explicit recognition that economic system is a subset of the physical world. Any economic decision-making or any decisions about the environment must respect the constraints that exist among natural environment and economic systems. Around the world you can find dozens of textbooks on economics and on the environment. However, few of them address the problem of integrating the economy and environment from the viewpoint of practical decision-making processes. Economy, society and the environment are linked together in an evolutionary network. A real integration of economic systems with the environment can only be based on the real market and non-market valuations of natural and environmental resources. This 4 textbook intends to contribute to broader knowledge of the market and non-market valuation methods. th Natural resource economics (established already in the first half of the 19 century) and th much newer environmental economics (developed in the second half of the 20 century) have tended to be treated as separate and autonomous disciplines of neoclassical mainstream economics. The practical needs of the current globalized world and a growing scientific knowledge argue that these two disciplines should be treated as a unified discipline. Natural resource economics that was formed gradually over the last two centuries deals with the utilitarian question how to use a natural resource in order to obtain a maximal net benefit. Traditionally, it includes agricultural and forest economics, the theory of optimal resource extraction for non-renewable (exhaustible) resources, and economics of urban land. Overall, natural resource economics systematically describes a rational and economically optimal use of a natural resource viewed from the standpoint of the user (owner). The past several decades witnessed the proof that the environment and its resources are important not only for economic welfare, but that they are much more important as life- supporting ecosystems (the terms environment and nature are treated in this study as synonymous). The biosphere of the Earth is not only a source of natural resources for production and consumption, but also an environment which enabled the birth of human species and the birth of millions of other plant and animal species. The growing scarcity of such life-supporting services of ecosystems must become an organic part of natural resource and environmental economics and, more generally, a part of economics. The reason for this is that only by incorporating the environmental services into economics and economic decision-making processes people can find the equilibrium among the economic and ecological functions of the environment and implement one of the important principles of sustainable development. Environmental economics is focused on identifying the optimum level of environmental pollution and it treats the economic efficiency of environmental protection. The majority of the existing approaches to environmental economics treat pollution as only a flow of polluting matters. This substantially limits the economic analysis, as almost all forms of pollution have a stock dimension too. Damages to the environment are related to the stock level of the pollutant in the environmental medium. Similarly, economic theory is often understood as the analysis of economic behaviour of people when assuring their material needs. In other words, economics is explained as a study of an effective allocation of production factors in maximizing production results. The production factors are labour, capital and mainly the natural resources that come from the environment. At the same time, it is known that in standard economics the factor of land has been marginalized for decades. For example, even during the 1970s in many models of economic growth the input of environment was completely omitted and production results were analyzed as dependent on only labour and capital. However, among the production factors all forms of environmental use must be included together with all the externalities caused by such economic activity. The production factors must incorporate also the use and destruction of environmental services produced by ecosystems. The overall aim of this textbook is to show that only by integrating the approaches of all these three scientific disciplines we can contribute to a sustainable economic theory and to sustainable economic systems. 5 Chapter 1. Brief history of economics and nature pricing 1.1. Economics, natural and environmental resources If economics is generally understood as the study of the allocation of limited resources to satisfy human wants and desires, then it is first of all necessary to define the term resources. In many standard economics textbooks the term resources is used synonymously with the factors of production (inputs without which the production could not take place). Economic analysis typically adopts the premise ceteris paribus, which means other things being equal. Similarly, for any given state of technology, the relation between some quantity of production and some quantities of economic resources can be expressed by a production function as a mathematical relationship between these two entities Q = f (X , X , ... X ) (1.1) 1 2 n where Q = maximised quantity of output flow for given values of the arguments of production function and given quantities of n productive inputs or factors X. Since the times of classical English political economy, it is common to identify three distinct classes of production factors, namely L, C, and M, denoting respectively quantities of labor, capital and land. In applied empirical analyses sometimes a fourth factor energy E is applied. These production factors enter into production function either as flows of services over some period of time, or as stocks employed at some point in time. Production function can then be formalised as Q = f (L, C, M, E) (1.2) Is the above mentioned classification of production factors sufficient from the viewpoint of economics and economic decision-making? The answer to this question depends on the level of complexity these production factors are debated at. Under the notion of land sometimes only a space or territory is understood, sometimes soil fertility from the viewpoint of agricultural or forest production. Nevertheless, neither the former, nor the latter notion is sufficient, because land, i.e. the nature and its resources, serve not only as a source of natural resources for human economic activities, but due to their growing scarcity increasingly also as a life-supporting environment. These life-supporting functions or services of the environment and its ecosystems (clean air, water etc.) were and often as yet are used by people as free, zero priced services. In general, environment services comprise: 1. direct provision of economic services with direct use value (production of food, fibres, extraction of fossil fuels etc.) 2. human and industrial waste assimilation by natural ecosystems 3. direct provision of environmental inputs (such as clean air and water, landscape amenities, aesthetical values) 4. environmental system maintenance processes, i.e. the processes of conserving and regulating the ecosystems that sustain and clean the air and water, maintain climatic conditions, regulate chemical composition of the atmosphere and oceans, regulate soil fertility, fixate solar energy and converse into raw materials, store and recycle nutrients and food cycles, maintain and support the stock of renewable resources (fish, biomass, regulate water flows in river systems etc.) and provide the life- supporting environment. 6 The main problem is that people are over-using the first two economic functions of environment at the expense of the other two ecological functions, which are decisive for sustaining life. One of the main axioms or principles of economic theory says that resources are scarce (in other words, resources are limited). The scarcity of resources means that the resource demand outstrips supply (insufficient availability of a resource to satisfy human needs or wants). The scarcity of resources implies that their use is costly, they have a positive price. The use of a scarce resource has an opportunity cost in the form of an alternative foregone benefit. In those cases where a resource user directly incurs this opportunity cost, the cost is known as private cost. However, in many cases opportunity cost is borne by other persons (for example in the case of polluting emissions). These costs are known as external costs (externalities, see Pigou, 1920). The full cost of the resource use is composed of private and external costs. Many resources can be used as private resources (can be possessed and owned by an individual) under well-defined property rights. From the viewpoint of environment, in market economies these were traditionally natural resources that were privately owned (agricultural land, forests, mineral deposits etc.). At the same time, there have been many environment services that are not priced and used as free public goods (clean air for breathing, climatic conditions with favourable temperature, constant composition of air etc.). These resources, often described as environmental services, are useful and irreplaceable as the existence condition for all living forms. However, as free public goods they do not enter into production functions as production factors. As an example of environmental resources, natural ecosystems can be mentioned as well as all their plant and animal species. Around the world, there are approximately 1.5 million of plant and animal species identified. By incorporating insects, this figure increases from 5 to 30 million species. Only a negligible fraction of percentage is directly used by humans and more than 99.9 % remain beside direct use. Their contribution for human society and contribution in ecosystems is so unclear but so deeply tied in living networks that it is hard to estimate their individual values. There are many classification schemes of environmental resources. One fundamental property concerns the reproducibility of a resource stock (rates of regeneration). Resources with high rate of regeneration are renewable, otherwise the resource is non- renewable (exhaustible). This distinction is useful but limited, because renewable resources are also exhaustible in case that the rates of using the resource are relatively high (higher than the rate of reproducibility). Such classification scheme, as shown on page 15, has the advantage that it enables us to view pollution and over-using of environment as a form of environmental resource depletion, in so far as pollutant flows result in reductions in the quantity and quality of one or more environmental resources. Natural resource economics has a history of about two hundred years, while environmental economics started only in the second part of the twentieth century. An important characteristic of both these scientific disciplines is their eclecticism. They draw their techniques largely from the field of pure and applied economic theory and they had incorporated only some elements from natural sciences, system analysis and ethics. But both disciplines are far from having achieved a synthesis of these components. That is why it will be useful to say something about the history of economic theory alone. 7 1.2. Brief history of economics and nature pricing The interest in economics, i.e. the interest in how people are ensuring their basic human needs, is as old as the human civilisation itself. It is possible to say that since a long time ago people have been mainly pricing those natural resources that had brought them some direct economic benefit. Primarily it was the space alone, the territory and its parts – grounds for construction, agricultural lands, forests, water resources and deposits of mineral resources. Economics started to be formed systematically at the beginning of the industrial revolution two or three hundred years ago under the influence of the depletion of traditional natural resources. The advent of the industrial revolution (which put an end to the several hundred year history of the feudal system), tied with enforcing the freedom of a human individual, brought a change to the ethical-institutional system of values, which meant a radical turn in the moral rules for economic activities. The medieval value system of European nations originated in the idea of the holiness of natural world, in the moral barriers against lending money for interest, and in the conviction that personal profit and accumulation should be hampered, that work is devoted to the benefit of a group (collective, community), that trade is substantiated only for the renewal of abundance for society and that the real rewards are awaiting in the other world. In all early societies, the principle of household economy, from the Greek oikonomia, played a substantial role. Private property was substantiated only to the extent that served the welfare of all. The word “private” comes from the Latin privare (deprive sb of sth), which shows an enlarged medieval opinion that property should be first and foremost common (F. Capra, 1983). th Up to the 17 century, people did not meet the economic phenomena alone, separated th from life. Only in the 17 century the nation-wide markets spreaded (production for an anonymous consumer) to all over the world. As soon as individual nations (national communities) started to leave the shared ownership (common property, municipal ownership) and started to hold more individualistic opinions, people ceased to perceive private ownership as a damage (detriment) to community and a contrary approach started to be preferred, stemming from the position that private property should create the basis and the individual should not be deprived of his/her property by society without proper legal process (F. Capra, 1983). A breakthrough turning point in the moral codex for economic activities, consisting of the abandonment of the moral duty of an individual toward his/her community and toward common property and founding the new, self-interested orientation of individuals was expressed in the work of Adam Smith (l723-l790), who is considered the father of modern economics and the founder of classical political economy. Adam Smith introduced the ideas of self-interest and of an invisible hand, i.e. the ideas that an economic system that relies on a free market and on free self-interested individuals tends to a natural state of ultimate welfare. In his major work “An Inquiry into the Nature and Causes of the Wealth of Nations” (1776), Smith expressed and confirmed the belief in the predestined harmony of interests in the conditions of a free competition and the belief in the efficacy of invisible 8 hand (i.e. the belief in the efficacy of the market mechanism) that regulates economic activities in a way leading to a state general equilibrium among demand and supply: “As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it…he is, in this as in many other cases, led by an invisible hand to promote an end which was no part of his intention…By pursuing his own interest he frequently promotes that of society more effectively than when he really intends to promote it” (Smith, 1776, Book IV, Chapter 2, p. 477). However, Smith’s confidence in the “laissez-faire” liberal system was not boundless, because he was conscious of the possibilities of unfair distribution of resources and incomes even in the conditions of relative economic freedom. Let us note that also many later thinkers proved that the “laissez-faire” principle does not secure the protection of human freedom. For example, the Frenchman Lacordair wrote in 1848: “In a system which produces an unevenness of power and wealth, freedom mutes (restrains) and law liberates”; similarly e.g. Riviere, 1932: “Economic freedom, according to the conception of liberals, is a freedom for strong individuals, so that they could repress weak ones” (see E. James, pp. 142, 143). Generally it can be said that the doctrine of invisible hand (the doctrine of free market) th has been since the 19 century accused of being a bad guidance for solving social problems, and it concerns in the first place the relations among society and nature. The classical English political economy differentiated the concept of land as one of the three basic production factors (beside labour and capital, to which presently sometimes energy is also added). Land is understood not only as space alone, but also as all other natural resources (woods, mineral deposits, water resources, e.g. water head etc.). Because land and other natural resources were understood as the factors of production, it was natural to appreciate their economic utility stemming from the services which these factors could bring in production and consumption. The evaluation of natural resouces according to the flow of their future services (benefits) was the original and the most natural pricing method. It was not a natural resource itself which has been valued, but the sum of its economic effects (services) from its exploitation. According to the original Judeo-Christian teaching, God intrusted people with nature to their usage. According to some other cultures, man does not stand above nature, but is a part of nature. Early classical economists took land as fixed and, due to the diminishing returns, they saw bad prospects for future generations. This thesis was most strongly argued by Thomas Malthus (l766-l834). Given a fixed land quantity and an assumed continual positive population growth, the diminishing returns in agriculture imply a tendency for the output per capita to fall over time. That is why Malthus was sceptical in a long-run tendency for living standards. At the same time this English priest and thinker supposed that before the exhaustion, the limit of natural resources does not enter into economic decision-making processes. The modern views on scarcity of natural resources have their roots in the work of David th Ricardo from the first half of the 19 century. David Ricardo (l772-l823) approached 9 the problem of scarce sources differently from Malthus, because he started from the assumption that the highest quality sources are exploited first and gradually the interest passes to the less high quality sources. Such gradation entails that from the beginning, scarce resources enter in his considerations. At the same time he presumed that economic development proceeds in such a way that the economic surplus is appropriated increasingly in the form of rent as return to land (i.e. will accrue to land owners). That is why, analogous to Malthus, he regarded the possibilities of a long-term economic development sceptically (the development converges toward the Malthusian stationary state). Ricardo’s theory of rent creates probably the most important part of his main economic work, “Principles of Political Economy and Taxation” (1817). The statement that the problem of land use (use of natural resources) was central for Ricardo is proved in the text of his main work, which starts by the following (Ricardo, 1956, p. 7): “The produce of the earth – all that is derived from its surface by the united application of labour, machinery, and capital, is divided among three classes of the community; namely, the proprietor of the land, the owner of the stock or capital necessary for its cultivation, and the labourers by whose industry it is cultivated. But in different stages of the society, the proportions of the whole produce of the earth which will be allotted to each of these classes, under the name of rent, profit and wages will be essentially different; depending mainly on the actual fertility of the soil, on the accumulation of the capital and population, and on the skill, ingenuity, and instruments employed in the agriculture. To determine the laws that regulate this distribution, is the principal problem in Political Economy.” In Ricardo’s theory, there are two reasons for rent: unequal fertility and scarcity of land. Differences in fertility were the inspiration for his differential rent (“If all land were equally fertile there would be no rent. Rent is not the result of the generosity of nature but of her niggardliness.”). The second reason for rent was the scarcity of land. If land was homogenous in quality, the limitations of supply would create only scarcity rents (Hubacek, K., van der Bergh, J.C.J.M., Ecol. Econ. 56 (2006), p. 9). In his work Ricardo adds (Ricardo, 2001, p. 54 and 56): “Rent is those part of soil produce that is paid to the proprietor of the land for the use of original and indestructible forces of the land… Rent is paid for the use of land because it is scarce and of unequal fertility and because in the progress of population, land of aninferior quality, or less advantageously situated, is called into cultivation. It is only, then, because land is not unlimited in quantity and uniform in quality, and because in the progress of population, land of an inferior quality, or less advantageously situated, is called into cultivation, that rent is ever paid for the use of it... When in the progress of society, land of the second degree of fertility is taken into cultivation, rent immediately commences on that of the first quality, and the amount of that rent will depend on the difference in the quality of these two portions of land“. The above mentioned principles of rent generation are respected by economic theory up to the present days as fundamentals of natural resource economics. John Stuart Mill (1806-1873) is also included among classical economists. His greatest economic treatise “Principles of Political Economy and Taxation” was for the first time made public in 1848. This work is considered by contemporary specialists on history of economic teaching as “a final synthesis of Ricardian doctrine” (Blaug, 1985). While 10 classical economists overestimated the role of diminishing returns, Mill judged its role more realistically. He appraised economic progress as a competition among the technical progress and the diminishing returns in agriculture. Nevertheless, he also assumed that economic growth must in the end, from the long-term standpoint, enter in a stagnation stage. Mill also realized that land is not exploited only for agricultural production and mining of natural resources, but that it is also used as living environment and offers esthetical values to man. Some of Mill’s ideas are surprisingly topical today: “I confess that I am not charmed with the ideal of life held out by those who think that the normal state of human beings is that of struggling to get on; that the trampling, crushing, elbowing and treading on each other’s heels which form the existing type of social life, are the most desirable lot of human kind, or anything but the disagreeable symptoms of one of the phases of industrial progress…Those who do not accept the present very early stage of human improvement as its ultimate type may be excused for being comparatively indifferent to the kind of economic progress which excites the congratulations of ordinary politicians: the mere increase of production…It is only in the backward countries of the world that increased production is still an important object; in those most advanced, what is needed is a better distribution…If the earth must lose great portion of its pleasantness which it owes to things that the unlimited increase of wealth and population would extirpate from it, for the mere purpose of enabling it to support a larger, but not a happier or better population, I sincerely hope, for the sake of posterity, that they will be content to be stationary long before necessity compels them to it.” (Mill, 1857, Book IV) Classical economists, who stayed relatively pessimistic in the question of the possibility of a long-term growth, did not treat only the impact of land scarcity on the long-term development. Another problem for them was the fixation of prices or setting the values of different reproducable commodities. Emanated at the same time from labour theory of value, according to which price and value are determined by the quantity of work necessary to create specific commodities (value and price are determined by the production costs). The modes and efficiency of nature use in former centrally planned economies were under a heavy influence of Marx’s economic theory. Karl Marx (1818-1883) developed the labour theory of value of classical economists with the ideological goal to prove that the only one source of economic value is the “productive work of labour”. Contrary to Ricardo (who respected price formation according to labour with only reproducable goods), Marx ascribed to labour theory of value general validity (which, logically under his doctrine, he had to do because normally land prices are formed on the basis of their useful services and not under labour input). He called the rent from land “the false social value”, derived as a difference among market price (regulated by the production costs in the worst natural conditions) and the real average social production costs. Marx supposed that after removing private ownership, the future society can produce the products of nature with only the real production costs, i.e. he supposed that the rent as a price of land can be removed from the production costs. It means that he supposed natural resources can be used as free goods. In centrally planned economies, Marx’s doctrine about the possibility of a free usage of nature was made real. At the beginning, the realization of this doctrine seemed to be an advantage of the socialist system (because it was possible to use the products of nature with prices that were lower compared to prices that included rent). But after a relatively 11 short period it was proved that it had negative impacts. The elimination of rent from the price system led to wasteful use of natural resources and very often to enormous devastation of nature and environment. The ideological reasons for such unfortunate relation to nature were obvious. They were grounded in the refusal of rent as something which is false and antisocial. But in reality, the concept of rent fulfils not only the function of income distribution (which was treated by Marx as decisive) but also the function of balancing the supply and demand of natural resources. If the rent part is expelled from price creation and prices are created only according to the average costs of production, as it was in centrally planned economies, an economic system is facing a permanent overuse of natural resources. While classical political economy saw value as arising from the labour power embodied (directly or indirectly) in output (i.e. it was concentrated on the supply side only), neoclassical economics (that creates the economic substance of Western civilization) envisaged value as being determined in exchange by the utility or scarcity of resources (looked at price from the demand side). Neoclassical economics that was formed since the 1870s S. Jevons (1835-1882), K. Menger (1840-1921), L. Walras (1834-1910), A. Marshall (1842-1924) introduced a new concept of value as an expression of marginal utility. This paved the way for the development of welfare economics, in which values could be measured in terms of consumer preferences. This school assessed the problem of using natural resources as a part of a general system of using scarce resources. The classical problem of absolute scarcity was replaced by a relative concept of scarcity. Exhaustion of natural resources was not treated for a long period as a serious economic problem (and many economists in market economis still hold a similar approach even now), because, according to its principles, with the growing resource scarcity the price is growing as well, which stimulates looking for cheaper substitutes. Many neoclassical growth models are characterized by the absence of land or any wider category of natural resources from the production function underlying growth models. Neoclassical economics approached nature from the utilitarian positions (utilitarianism evaluates natural resources from the viewpoint of their benefits for human individual or for society as a set of individuals), i.e. it approached nature as only a base of natural resources exchanged on markets and it was not concerned with non-market functions of nature. The original investigation of optimal depletion of exhaustible resources dates back to L. Gray (1914) and especially H. Hotelling (1931): “Disappearance of world’s reserves of mineral sources, woods and other exhaustible sources led to requirement of regulation of their exploitation. Conviction, that these products are now too cheap for welfare of future generations, that are selfishly exploited in instant rate and that in consequence of their excess cheapness are wasted in production and consumption, put origin of protectionist movement.” Gray and Hotelling provided a foundation upon which a more general and extended structure was built later by P. Dasgupta, G. Heal, R. Solow and Hartwick, who developed models of efficient and optimal use of exhaustible and non-exhaustible natural resources (Nedoma, Seják, 1992). The basic principles of natural resource valuation and pricing are outlined in the next parts of this chapter and in more details in Seják et al., 1999. 12 The paradigm of neoclassical system (especially welfare economics) upon which the current natural resource economics is based is individual utilitarianism and libertarianism, i.e. an approach to human individual as a free and rationally acting individual (with his/her individual rights and liberties undisturbed) who maximizes his/her own self-interest. The basic neoclassical libertarian approaches come from the axiom of minimal state, i.e. they want the state to intervene on free markets only in the cases of a market failure, i.e. when a market does not ensure an optimal allocation of resources. Neoclassical theory came from the conception of A. Smith who understood economics as a study of demand and supply that governs the distribution of scarce resources by free markets without any regulating interventions. While English classical political economy was understood by the representatives as a historical science (economic laws are changing with changes of economic system), neoclassicists ceased to respect the historical basis and started to explain neoclassical principles as universally valid timeless concepts. Due to this approach, neoclassical economics became only a formal framework (e.g. Walras theory of general equilibrium) that was unable to reflect real problems of real economy. th Only during the 20 century economists revealed that markets can assure optimal (efficient) allocation of resources just in the very specific conditions of perfect competition that are characterized by the following institutional arrangements: 1) markets exist for all goods and services, 2) all markets are perfectly competitive, 3) no externalities exist, 4) all goods and services are private goods, there are no public goods, 5) property rights are fully assigned, 6) all transactions have perfect information, 7) all firms are profit maximisers and all individuals utility maximisers, 8) long-run average costs are non-decreasing, 9) transactions costs are zero, 10) all relevant functions satisfy convexity conditions (Perman, Ma, McGilvray, 1996, p. 93). On the basis of the above quoted institutional arrangements (that originally were implicit) and on the basis of marginal utility theory, neoclassical economics resolved the paradox of price and value which puzzled classical economists. This paradox can be expressed by the following question: Why should the price of diamonds exceed the price of water, if water is more valuable? Should it not therefore command a higher price? Adam Smith for this reason differentiated between use value and exchange value. Neoclassicists resolved the hundred year dilemma by the concepts of total and marginal utility. In standard neoclassical textbooks we can obtain the following explanation: “The key to the puzzle is scarcity and how it affects marginal utility. Water is cheap because it is so abundant. Another gallon provides little additional utility. Therefore, consumers are willing to pay very little for the extra water. In contrast to water, the supply of diamonds is extremely limited. Because the value or utility of an additional diamond is high, consumers are prepared to pay a high price for it. Of course, the degree of scarcity may change over time and, as it does, so will marginal utility of an additional unit. Other things equal, a scarcer a good becomes, the higher its marginal utility and therefore its market price.” (Ragan, Thomas, 1993, p. 589) The paradox of value and price was resolved in such a way that total value was given by total utility (total use value) while the exchange value and price depend on marginal utility, not on total utility. Neoclassical economics comes from the assumption that any individual maximizes his/her utility and that this utility can be measured. Total utility is given by the cummulative satisfaction obtained from all consumed units of the goods 13 (the sum of marginal utilities from all consumed units of the goods) while marginal utility (and price) is measured by the satisfaction flowing from the last unit consumed. While total utility grows with the growing number of goods consumed, marginal utility from any other unit of goods consumed is lower. The key to the resolution of classical problem, i.e. what the basis of price is, was found by neoclassical theory in scarcity. Because water is plentiful, people are willing to pay little for it (low price). The scarcer the goods becomes, the higher is the willingness of people to pay for it. Although water is essential to life and has high total value or total utility, its price is not determined by average utility, but by the utility of the last water unit consumed. Fig.1.1 Relation between marginal utility and quantity of water and diamonds consumed The above text implies that according to neoclassical theory the price of goods is determined by the ratio of demand and supply. If the goods is abundant relative to the demand, then it is supplied either freely (free goods with zero production costs) or with a price reflecting the production costs (if the goods has to be produced or accommodated for consumption). If a demand for goods is higher than the supply, then its price starts to reflect scarcity. The scarcer the goods become, the higher is the share of scarcity in its price. From the mode of price setting it is clear that neoclassical theory introduced a new methodology into economics – marginal analysis, i.e. the study of relations among small (incremental) changes. The original interest of classical political economy in a long-term development and the historically conditional view on reality were abandoned while the schematic problems of static equilibrium were put in the forefront – a market equilibrium among the demand and supply of resources and products. Without the use of the utilitarian social welfare function, W. Pareto (1897) developed the criterion of economic efficiency as a state in which it is not possible to make anyone better off without making at least one other person worse off. The Pareto criterion of efficiency carries no ethical content, because it does not take into account the 14 distribution of income and wealth. That is why an efficient allocation need not be necessarily an optimal one (see 1.3 for more details). On the basis of the libertarian individualism paradigm – individuals that follow their own self-interest by means of unregulated free markets – neoclassical economics became the theory of belief in free markets as the best system for the organisation of social production. According to neoclassical theory, the majority of prices and allocative decisions is to be generated on individual markets among producers and consumers. On these markets, it is determined what will be produced, how and for whom it will be produced. The answers to these three basic economic questions is given by the market mechanism via final consumers’ monetary options – via the willingness and ability of consumers to pay for selected goods and services. From consumer markets, i.e. the markets with final production, markets of production factors are derived – land market, labour market and capital market. On these markets, production factors are given prices – rents, wages and interests - that depend on the marginal products of these production factors. In the economic theory of market economies, rent (net price or royalty) has its robust place and, having a dimension of flow (dependent on time), it expresses the price of land services (in the concept of land meaning, all other natural resources that are fixed in supply as well). For example, an annual rent or annual rent effect reflects the net effect (as the difference between the benefits and costs necessary for the realization of a service) that a land brings during one year. The concept of rent includes also the payment for the use of a natural resource (or for the use of various property). In connection with natural resource pricing, it is more convenient to talk about rent effect that is the basis for such pricing. In this respect it can be useful to emphasize the difference between the markets of final products and the markets of production factors. When we buy final products, we buy them to satisfy our needs and the needs of our family. On the other hand, when we buy production factors, we buy them for their useful services that they can give us in the production process. For example, if we hire a piece of agricultural land for one year, we hire the services that this plot can bring us during the year. For this plot lease we pay a rent that is derived from the services of the land. It is similar to hiring labour or any other production factor. At the same time, it is necessary to differentiate the lease of production factors – for their finite services we pay rent, wage or interest – from the purchase of production factors. We can buy a piece of land into our personal possession; in this case we buy its infinite future services. Labour forces can be hired, they only existed as an object of purchase in slavery states. If we take into account the difference between land and other production factors, we must stress that land is fixed in supply. This scarcity flows from the fact that land is the earth surface which is clearly limited. The linkage of the notion land with earth surface is explicit in juridical dictionary in the words „immovable“ or „dead stock“ (alternative notions: estate, real estate, real property, realty). According to economic theory, land and other natural resources are the nonextensive production factors. They cannot be enlarged according to the needs, wants and wishes of humans. In many current textbooks, natural resources are divided into renewable natural resources (agricultural land, forests, water resources) and non-renewable natural 15 resources (mineral deposits). Another structuring is into exhaustible and non- exhaustible natural resources. One such classification is in the following chart: A classification of natural and environmental resources At the end of this theoretical part devoted to neoclassical economics it must be stressed that it would not be true to say that neoclassicists fully ignored ecological questions. The problem of externalities was introduced by A. Marshall in 1890 and at the beginning of the 20th century the idea was elaborated by A. Pigou (1920). Nevertheless, it is proper to say that up to the mid-20th century, neoclassical economists treated externalities and environmental pollution as an exceptional economic problem. 1.3. Welfare economics and the environment In the link with utilitarian philosophy in neoclassical economics during the 20th century, a new direction was developed, called the theory of welfare. It attempts to provide the framework for efficient and optimal allocations of resources, including natural resources. One of the basic axioms of today’s environmental economics is the assertion that natural resources are scarce. Scarcity means that resources are limited in the sense that the demand is higher than their supply and that it is necessary to decide on their rational, i.e. effective use. Resources should be used effectively and in an optimal way. Thus, the main interest of welfare theory is the effective and optimal use of resources. Let us start with the simplest case of a static allocation of production factors. We can use the Pareto efficiency principle (named after the Italian economist W. Pareto) which states that an allocation is efficient in cases where the welfare of any person cannot be increased without making at least one other person worse off. Contrary, an allocation is inefficient if it is possible to increase the welfare of an individual without reducing the welfare of another (Perman, Ma, McGilvray, 1996). To illustrate the static economic efficiency (abstracted from time), let us consider a simple economy of two persons A and B, two products X and Y and two production 16 factors K and L. These productive inputs are available in fixed quantities. We also suppose that there are no externalities and both goods are private goods (there are no public goods). The utility of a society can be put as the utility of both persons A and B U = U (X , Y ) A A A A U = U (X , Y ) (1) B B B B Where utility enjoyed by person A depends upon the quantities he or she consumes of goods X and goods Y and similarly for person B. Production function for goods X and goods Y can be written as X = X (K , L ) X X Y = Y (K , L ) (2) Y Y If the marginal utility that A derives from the consumption of goods X is denoted as A A A U = ∂U /∂X and the marginal product of the input L in the production of goods Y is X Y Y MP = ∂Y / ∂L and if equivalent notations apply for the three other marginal utilities L and the three other marginal products, we can then introduce three conditions that must be met if resources are to be allocated efficiently. Consumption efficiency requires that the ratios of the marginal utilities of goods X and Y are the same for each consumer. That is  U U X X    (3) U U  Y Y A B If this condition is not met, then the two consumers can exchange commodities at the margin in such a way that both gain and neither suffers. For example, suppose that the ratios of marginal utilities were as follows, 6 2    (4) 3 4  A B i.e., if consumer A values X twice as highly as Y, while consumer B values X at only half the value of Y, then if A exchanged one unit of Y for one unit of X from consumer B, both would gain. Production is effective when the ratio of the marginal product of each input is identical in the production of both goods, i.e. when it is not possible to increase efficiency by exchanging production factors among producers.  MP MP L L    (5) MP MP  K K X Y The final condition which is necessary for economic efficiency is the “product-mix efficiency” which requires that 17 Y  MP U K X    X  (6) U MP Y K Equation (5) can be rearranged to yield the following relation that shows that ratios of marginal products of capital and labour are equal Y Y  MP MP K L   X X (7) MP MP  K L This equation implies that the ratio of marginal utilities of both products must be equal to the ratio of marginal products of labour and capital. Y Y  U MP MP X K L   X X (8) U MP MP  Y K L A simultaneous satisfaction of the conditions (3), (5) and (8) is an assumption for a fully efficient static allocation of resources. These results generalise to economies with many inputs, goods and individuals with the condition that the three efficiency equations have to hold for each possible pairwise comparison that one could make. The non-uniqueness of efficient allocations The above mentioned conditions of effective allocation of resources are primarily determined by one particular initial distribution of property rights. If the initial distribution of property rights is different, a different efficient allocation will result. In other words, efficiency carries no ethical content and gives no criterion to say which allocation is best from the social point of view. If we restrict our attention to the two person special case again, we can represent this idea using the concept of Grand Utility Possibility Frontier, illustrated in the next figure. Each point on this frontier is an efficient allocation of resources satisfying the three necessary conditions, the position an economy takes on this frontier depends upon the intitial distribution of property rights. There is clearly an infinite number of efficient allocations. 18 U A Grand utility possibility frontier U B To discuss the well-being or welfare of a society requires that some ethical criterion be adopted, for example in the form of a social welfare function (SWF) that can in general form be written as: W = W (U , U ) (9) A B SWF gives a criterion that enables interpersonal comparisons to be made. If we have SWF (that is non-declining), we can logically suppose that under optimal allocation of resources, the SWF is at its highest level. If the convex curves are social welfare indifference curves (each one is contructed to represent combinations of individual utilities that yield a costant level of social welfare), then the SWF maximum is attained at the level of welfare B in point of contact of indifference curve with utility possibility 2 frontier (point is marked by circle). In the tangent point, the slopes of both curves are the same (it is the only one optimal point, because in all other points the slopes are not identical). It means that a static efficiency of resource allocation is achieved if the conditions (3), (5) and (8) are simultaneously met and the maximised welfare implies an additional necessary condition B  W U U A X   (10) A   U W  Y U B  The left-hand side of this equation is the slope of the utility possibility frontier; the righ- hand side term is the slope of the social welfare indifference curve (B2). At the social welfare maximum (circle), these slopes must be equal. 19 U A B 2 U B An allocation of resources over time is intertemporally efficient if for some given level of utility at the present time, utility at all future points in time is as high as is economically feasible. In other words, utility can only be increased at the expense of current utility. An effective allocation of resources can be achieved in different institutional conditions, like in dictatorship, centrally planned economy or free markets. Each of them can, but will not necessarily, achieve an effective allocation of resources. The institutional arrangements necessary for an efficient static allocation of resources in free market economy include the following (Perman, Ma, McGilvray, 1996, p. 90): 1) markets exist for all goods and services exchanged, 2) all markets are perfectly competitive, 3) all transactions have perfect information, 4) property rights are fully assigned, 5) no externalities exist, 6) all goods and services are private goods, there are no public goods and no common property resources, 7) long-run average costs are non-decreasing (if production were characterised by economies of scale, then natural monopolies would exist, and a competitive conditions could not be sustained). An efficient static and intertemporal allocation would be sustained if these seven institutional circumstances, in all points in time now and in future, were satisfied. 1.4. Environment, ethics and discounting the future Environmental and natural resource economics deal with allocation, distribution and use of natural and environmental resources. These problems can be seen from the viewpoint of positive economics, which does not require the adoption of any particular ethical viewpoint. It treats only the causes and consequences under given assumptions. Many economists take this approach as insufficient, because economics as a social science on the relations among people in the processes of production, exchange and consumption, and environmental economics as a science on the relations among economic systems 20

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