What is Environmental Economics?
Environmental economics is a sub-area of economics that is concerned with the relationship between the economy and the environment. Its main thrust is on the efficient allocation of natural resources. Environmental economists observed that there is an interdependent relationship between the environment and the economy, as the two influence each other.
- Environmental economics is an evolving discipline that developed as a result of environmental damage caused by economic activities and the pursuit of sustainable development.
- It is concerned with the design of environmental policies and its implementation.
- Environmental economics was premised on the neoclassical approach dealing with a number of issues, such as inefficient natural resource allocation, market failure, negative externalities, and management of public goods.
Origins of Environmental Economics
The origins of environmental economics date back to the 1960s when industrialization was experiencing a boom, particularly in the western world, and pollution from industrial activity became an increasing concern. Environmental activism also started to increase due to the perceived negative consequences of environmental degradation. The world became aware of rapid economic growth and its consequences to the environment.
Environmental economists see the environment as a form of natural capital that provides amenities and life support functions to the earth’s inhabitants. Environmental economics was premised on the neoclassical approach dealing with issues, such as inefficient natural resource allocation, market failure, negative externalities, and management of public goods.
As the movement developed over time, other intricate details on the relationship between the environment and the economy became apparent. The study brought about powerful environmental arguments and propositions, which gave rise to contemporary environmental policies and regulations around the world. It led to the establishment of new environmental bodies – chief among them, the United Nations Environmental Programme (UNEP) in 1972.
Scope of Environmental Economics
Environmental economics encompasses the following concepts:
1. Sustainable Development
Sustainable development is defined by UNEP as “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” The concept analyzes the role of economic development in supporting sustainable development.
The four basic components of sustainable development are economic growth, environmental protection, social equity, and institutional capacity.
2. Market Failure
Market failure occurs if the functioning of a perfect market is compromised; hence, it is unable to efficiently allocate scarce resources at a given price as conditions for laws of demand and supply are not met.
An example can be an environmental good such as clean oceans. It is difficult to price the value of clean seas and oceans, and there exist no markets for clean water bodies where it is traded depending on the degree of cleanliness. It is a standard case of market failure.
Externalities are inadvertent consequences of economic activity that affect people over and above those directly involved in it. Externalities are also another form of market failure. They can either be negative or positive.
A negative externality creates unplanned outcomes that are harmful to the environment or directly to the general public. An example can be pollution through industrial production, which results in unclean air and water and other health risks. The polluting entities may not incur any costs to address the pollution, even though their activities harm the environment and negatively affects the surrounding community.
A positive externality is a benefit to other people not directly involved in its generation. A community nature park can benefit people outside the community who visit family and friends in the area and would not have contributed to its development. People who benefit from an economic resource without contributing to its establishment are called “free riders.”
Valuation is an important aspect of environmental economics, as it helps to evaluate a variety of options in managing challenges with the use of environmental and natural resources. The valuation of ecological resources is a complex process, as it is difficult to assign value to intangible benefits, such as clean air and unpolluted environment.
Resources that offer multiple benefits are difficult to value – for example, mountains may prevent flooding, provide scenic beauty, direct river flow patterns, and provide fertile soils for agriculture.
Environmental resources can be assigned values depending on use and non-use methods. Its easier to assign value to a product in use through observing what consumers are willing to pay.
Opportunity cost pricing, replacement cost, and hedonic pricing techniques can be employed in the “use” method. The contingent valuation technique is used for the “non-use” method by measuring what consumers are willing to pay for a product they do not use or enjoy.
5. Cost-Benefit Analysis
Cost-benefit analysis (CBA) involves weighing the benefits arising from a policy against the perceived benefits. Hence, the best policy is one in which there is the greatest surplus of benefits over costs.
CBA starts with a base policy where no changes are made to the status quo. A time horizon is selected where the perceived costs and benefits are expected to be realized. Benefits are instances where human well-being is improved, and costs decrease human well-being.
Costs and benefits to be realized in the future are discounted using a discount factor to cater for the time value of money. Benefits include extra income, improved quality of life, clean water and beaches, and costs include opportunity costs, internal and external costs, and externalities.
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