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6
6.1 The Role of Economics in Environmental Regulation: The Case of Acid Rain
6.2 Global Warming
6.3 The Economics of Smoking
6.4 The Economics of Other Addictive Behaviors
6.5 Conclusion
Externalities in Action: Environmental and Health Externalities
6.1
Acid rain is a classic negative production externality.
Acid rain: Rain that is unusually acidic due to contamination by emissions of sulfur dioxide (SO2) and nitrogen oxide (NOx).
Two-thirds of SO2 emissions come from coal-fired power plants, mostly located in the Ohio River Valley.
The Role of Economics in Environmental Regulation: The Case of Acid Rain
6.1
The negative effects of acid rain include:
Environmental damage to both water and land ecosystems.
Property damage to painted surfaces (autos) and metal or stone exteriors (statuary).
Reduced visibility caused by suspended acidic chemicals (smog).
Adverse health outcomes (lung or heart diseases).
The Damage of Acid Rain
6.1
To combat acid rain, Congress passed the 1970 Clean Air Act.
1970 Clean Air Act (CAA): Landmark federal legislation that first regulated acid rain–causing emissions by setting maximum standards for atmospheric concentrations of various substances, including SO2.
Regulations only affected new plants, however, encouraging use of older, dirtier plants.
History of Acid Rain Regulation
6.1
How does acid rain (or SO2) affect health
The typical approach taken in this literature is to relate adult mortality in a geographical area to the level of particulates (such as SO2) in the air.
The results are suspect: Areas with more particulates may differ from areas with fewer particulates in many other ways, not just in the amount of particulates in the air.
Estimating the Adverse Health Effects of Particulates
Estimating the Adverse Health Effects of Particulates
6.1
Chay and Greenstone (2003) studied this question.
Used an excellent quasi-experiment by examining the infant mortality rate, using the regulatory changes induced by the Clean Air Act of 1970.
Some areas (“attainment”) did not have to reduce SO2 levels.
Others (“nonattainment”) were required to do so.
Infant mortality declined substantially in non-attainment areas, relative to attainment ones.
6.1
SO2 Levels in Attainment and Nonattainment Areas
For areas with TSPs below the mandated threshold, there was only a slight reduction in TSPs over time. For areas above the mandated threshold, there was a very large reduction in emissions after the legislation became effective in 1971.
6.1
Clean air acts reduced SO2 emissions but encouraged use of older plants.
The 1990 amendments and emissions trading attempted to rectify this.
SO2 allowance system: The feature of the 1990 amendments to the Clean Air Act that granted plants permits to emit SO2 in limited quantities and allowed them to trade those permits.
History of Acid Rain Regulation
6.1
Has the CAA Been a Success
Led to dramatic improvements in infant health and lifetime earnings, among other things.
But may have cost 600,000 jobs and $75 billion in polluting industries.
History of Acid Rain Regulation
6.2
Global warming is a serious environmental externality.
Gas emissions lead to increased global temperature because of the greenhouse effect.
Greenhouse effect: The process by which gases in the Earth’s atmosphere reflect heat from the sun back to the Earth.
Global temperatures are increasing more rapidly than any time in the last 1,000 years.
Temperatures are projected to rise even more rapidly over the next century.
Global Warming
6.2
CO2 Output: 25 Largest Contributors
China and the United States are by far the largest emitters of CO2, together accounting for over two-fifths of the world’s total.
6.2
International cooperation will be necessary to address global warming.
Montreal Protocol of 1987, which banned the use of chlorofluorocarbons (CFCs), is an early example.
As with global warming, this was a potentially enormous long-run problem.
The CFC problem was showing itself immediately and urgently: By the 1980s, a 25-million-square-kilometer hole had opened in the ozone layer over Antarctica!
APPLICATION: The Montreal Protocol
APPLICATION: The Montreal Protocol
6.2
The Montreal Protocol was adopted, aimed for complete phaseout of specified chemicals (mostly CFCs and halons) according to specified schedules.
The result is that scientists predict the hole in the ozone layer will begin to recover and return to normal around 2070.
It may take some type of exciting event to spur action on global warming, which will not be solved for centuries after emissions are greatly reduced.
If the world waits for a crisis to spur us into action, it may be too late.
6.2
In 1997, Kyoto hosted international negotiations to govern carbon emissions.
38 industrialized nations agreed to combat global warming by reducing their emissions of greenhouse gases to 5% below 1990 levels by the 2010.
Written into a treaty that has since been ratified by 35 of the 38 signatory countries, and went into effect in early 2005.
Not ratified by the United States.
The Kyoto Treaty
6.2
The Kyoto treaty allowed for international emissions trading.
International emissions trading: Under the Kyoto treaty, the industrialized signatories are allowed to trade emissions rights among themselves, as long as the total emissions goals are met.
Allows efficient countries to reduce their emissions on behalf of less-efficient ones (for a price).
Can Trading Make Environmental Agreements More Cost-Effective
Can Trading Make Environmental Agreements More Cost-Effective
6.2
Price of reduction per metric ton of carbon
Carbon reduction
(millions of metric tons)
SUS
SR
$210
440
190
20
0
In this no-trading world, the marginal cost of achieving the Kyoto target of a reduction of 440 million metric tons (as measured by the US curve) is $210 per metric ton of carbon. Other nations have much lower marginal cost reduction opportunities. For those nations to reduce by 190 million metric tons would cost them only $20 per metric ton of carbon.
Can Trading Make Environmental Agreements More Cost-Effective
6.2
Price of reduction per metric ton of carbon
Carbon reduction
(millions of metric tons)
SUS
SR
590
40
$50
0
630
ST
Any reductions that cost more than $50 per ton can be offset by purchasing permits instead. At that price, the United States would choose to reduce its own emissions by 40 million metric tons. By distributing the reduction from the high-cost United States to the low-cost other nations, we have significantly lowered the price of reductions worldwide.
6.2
By 2030, developing nations will produce more than half of the world’s emissions.
Much cheaper to use fuel efficiently as you develop an industrial base than it is to “retrofit” an existing industrial base.
By some estimates, an international trading system that included developing nations would reduce the cost of the Kyoto treaty by a factor of four.
Participation of Developing Countries
6.2
Developing nations want no part of this argument.
The problem that the world faces today is the result of environmentally insensitive growth by the set of developed nations.
Why should they be forced to be environmentally conscious and clean up the mess that the United States and other nations have left behind
Participation of Developing Countries
6.2
Developments since the Kyoto treaty of 1997 do not bode well for short-term agreements:
United States rejection of the Kyoto treaty
Difficulty of persuading developing nations to agree to reductions
However, in the fall of 2014, the United States and China announced a landmark deal to jointly slow emissions growth.
Recent evidence suggests that the nations of the world can come together to combat a global environmental threat but only when that threat is urgent.
What Does the Future Hold
6.2
In 2009, the House passed the American Clean Energy and Security Act (ACES) to help combat global warming.
Lower limits on the amount of emissions allowed, and firms could comply with the tighter targets in a number of ways:
Emissions reductions
Purchase emissions permits
Purchase pollution credits to offset their emissions
APPLICATION: Congress Takes on Global Warming
6.2
The ACES Act drew criticism from several sources.
Some feared increased costs of energy production.
Emitting firms would now either need to buy permits, buy credits, or undertake other expensive actions to reduce their emissions.
Some felt that the full value of the allowances should be rebated to consumers and not simply given back to the polluting industries.
Prospects in the Senate are unclear. There has been continued reluctance in recent years to attempt such a broad legislative approach to global warming, motivating the executive actions taken by the Obama Administration.
APPLICATION: Congress Takes on Global Warming
6.3
Not all externalities are large-scale environmental problems.
Some of the most important externalities are local and individualized.
Many of these arise in the arena of personal health, and one of the most interesting is smoking.
The Economics of Smoking
6.3
Per Capita Annual Cigarette Consumption, 1990 2013
The percentage of Americans who smoke has declined substantially over the past few decades, yet almost one-fifth of Americans still smoke.
6.3
The Externalities of Smoking
Negative health consequences do not, by themselves, mean smoking has externalities.
Externalities require that the smoker not bear all these costs.
Rational smokers—who know the health risks—may internalize these costs.
But there are several reasons that the costs might not be internalized.
6.3
The Externalities of Smoking: Increased Health Care Costs
Smoking increases health care costs. Is this an externality
Not if people pay for their health care themselves
Or if their insurance premiums are actuarially adjusted
Actuarial adjustments: Changes to insurance premiums that insurance companies make in order to compensate for expected expense differences.
Yes, if their insurance premium is not adjusted since nonsmokers pay some of the cost
6.3
Smokers have lower workplace productivity because they are more likely to get sick and to take (smoking) breaks. Externality
Yes, if smokers and nonsmokers are paid the same amount, then smokers end up taking profits from their employers or wages from nonsmokers
No, if smokers are paid according to their productivity
The Externalities of Smoking: Workplace Productivity
6.3
Smokers are much more likely to start fires than nonsmokers, mostly due to falling asleep with burning cigarettes. Externality
Yes, if smokers burn other people’s things
Yes, if smokers burn their own things and fire insurance/fire department costs aren’t actuarially adjusted
No, if smokers burn only their own things and the costs are actuarially adjusted
The Externalities of Smoking: Fires
6.3
Smokers’ early death might be a positive externality.
Social Security and Medicare pay out until death.
Early death of smokers means smokers receive less payment, leaving more money for nonsmokers.
But dying earlier also means smokers have fewer years to pay taxes.
The Externalities of Smoking: The “Death Benefit”
6.3
Secondhand smoke appears to be a classic externality.
Yet the costs of secondhand smoke are not easily added to the list of external costs:
There is considerable medical uncertainty about the damage done by secondhand smoke.
Most of the damage from secondhand smoke is delivered to the spouse and children of smokers.
What About Secondhand Smoke
6.3
Economists usually assume that smokers follow the rational addiction model:
They know the costs (which occur far into the future).
They understand the possibility of addiction.
This model may not be a good description of smoking.
Youth smoking: More than 75% of adult smokers begin smoking before their nineteenth birthday.
Should We Care Only About Externalities, or Do “Internalities” Matter Also
6.3
Many adults who smoke would like to quit but are unable to do so.
Eight in ten smokers in America express a desire to quit the habit, but many fewer than that actually do quit.
According to one study, over 80% of smokers try to quit in a typical year, and the average smoker tries to quit every eight and a half months.
54% of serious quit attempts fail within one week.
Adults Are Unable to Quit Smoking Even If They Have a Desire to Do So
6.3
Many smokers suffer from self-control problems and use commitment devices.
Self-control problem: An inability to carry out optimal strategies for consumption.
Commitment devices: Devices that help individuals who are aware of their self-control problems fight their bad tendencies.
Smokers who want to quit make public promises to do so, making it embarrassing to smoke.
Adults Are Unable to Quit Smoking Even If They Have a Desire to Do So
6.3
If smokers are not rational, then intervention may be justified because of internalities.
Negative internality: The damage done to oneself through adverse behavior that is not fully accounted for in decision makin.
Taxation of cigarettes is a plausible, effective mechanism to discourage smoking.
Implications for Government Policy
6.4
The economics of drinking are different than smoking.
Very large externalities:
Damage due to drunk driving.
Smaller internalities:
Drinking in small quantities, while it may impair one’s driving, may actually be good for long-run health.
The Economics of Other Addictive Behaviors: Drinking
6.4
Drinking is regulated as well as taxed: People younger than 21 cannot drink.
How does this regulation affect people’s health
Carpenter and Dobkin study this question using a regression discontinuity design (RDD), a very clean strategy.
The RDD compares health outcomes of people just above and just below their birthday.
These people are likely to be quite similar, so the RDD estimates the causal effect of being able to drink.
EVIDENCE: The Effects of Legal Drinking Age at 21
6.4
EVIDENCE: The Effects of Legal Drinking Age at 21
There is a discontinuous shift at age 21—a clear jump in the proportion of days drinking at the 21st birthday.
6.4
Most of the externalities associated with illicit drugs arise because of their illegality.
Legal consumption of some illicit drugs is likely to have much lower externalities than consumption of alcohol.
Milton Friedman in 1972:
“The harm to us from the addiction of others arises almost wholly from the fact that drugs are illegal…. addicts commit one-fourth to one-half of all street crime in the U.S. Legalize drugs, and street crime would drop dramatically.”
Illicit Drugs
6.4
This type of argument has been influential in the recent wave of marijuana legalization in the United States.
Marijuana has been legalized for medical purposes in 23 states and the District of Columbia.
Full legalization for recreational use is in place in four states (Colorado, Washington, Oregon, Alaska) and the District of Columbia.
The Obama Administration has stated its opposition to full legalization, arguing that legalization creates negative social costs that outweigh any reduced public criminal spending and any increased tax revenue.
Illicit Drugs
6.4
Obesity has both enormous externalities and internalities.
Addressing obesity through tax policy is hard: while every cigarette is bad for you, clearly some food consumption is good for you!
Major policy focus:
Improved information about caloric/nutrition content
Targeting of the substances most closely linked to obesity, such as “trans-fats”
APPLICATION: Public Policy Toward Obesity
6.4
Alternative policies are under consideration:
A number of states are considering taxes on sugary sodas.
Some states have moved directly to charging individuals for being obese or for not caring for their weight.
Other states and employers are providing financial incentives for employees to enroll in wellness programs that will help them manage their weight.
APPLICATION: Public Policy Toward Obesity
6.5
Public finance provides tools to help us think through the regulation of many kinds of externalities:
Regional externalities such as acid rain
Planet-wide externalities such as global warming
Even the “internalities” of smoking and other health-related decisions
Conclusion
6.5
Careful analysis of public policy options requires:
Discriminating external costs from costs that are absorbed through the market mechanism.
Understanding the benefits and costs of alternative regulatory mechanisms to address externalities.
Considering whether only externalities or also internalities should count in regulatory decisions.
Conclusion

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