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Economics of Pollution

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Economics of Pollution Powered By Docstoc
					IBS HYDERABAD

ECONOMICS OF POLLUTION
HarSimran Kaur 08BSHYD0291

Contents
1. ECONOMICS OF POLLUTION ............................................................................................ 3 Four Market System Goals............................................................................................... 3 The Economist’s Perspective on pollution ....................................................................... 5 2. POLICIES, INSTRUMENTS AND THE ENVIRONMENT ................................................. 6 Property Rights ................................................................................................................. 6 Command and Control Regulation ................................................................................... 6 Pollution Charges ............................................................................................................. 7 Tradable Permits .............................................................................................................. 7 Other Charge Systems ...................................................................................................... 7 3. INVERTED ‘U’ HYPOTHESIS ............................................................................................. 9 U-shaped hypothesis ........................................................................................................ 9 4. 5. OTHER ECONOMIC THEORIES ON POLLUTION ......................................................... 10 POLLUTION ABATEMENT ............................................................................................... 12 Carbon Taxes.................................................................................................................. 12 Setting the optimal carbon tax level ............................................................................... 12 Carbon Taxes Vs. Emissions Trading: What's the difference, and which is better? ...... 13 Emissions Trading ............................................................................................ 14 Carbon Taxes .................................................................................................... 14 Which is better? ................................................................................................ 14 The Case for Emissions Trading .................................................................................... 14 The Case for Carbon Taxes ............................................................................................ 15 The Politics: Who likes which policy, and why? ........................................................... 15 6. THE TECHNIQUE OF DECOMPOSITION ANALYSIS ................................................... 16 Projection ....................................................................................................................... 23 Conclusions .................................................................................................................... 23 Recommendations .......................................................................................................... 24 7. REFERENCES………………………………………………………………………………..23

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1.

ECONOMICS OF POLLUTION

The study of the economics of pollution as it relates to the environment must begin with an understanding of the nature of the economic system. This starting point is essential to any analysis of pollution economics because the basic cause of environmental problems is a specific type of market (economic) system failure. Four Market System Goals All economic systems that are formulated by various economists consider four central objectives:

MicroEconomics • Efficiency • Equity
Efficiency

MacroEconomics • Stability • Growth

The concept of efficiency is defined as the maximum consumption of goods and services given the available amount of resources. Perfect efficiency occurs when the market resolves fficiency all production and consumption decisions so that the market allocation of resources is such that all goods are being produced at the lowest possible cost. No government intervention is necessary in this scenario. One of the critical conditions for the analysis of pollution economics ne is that all costs and benefits be registered (or known) in the marketplace. With regard to pollution, environmental damage has resulted when all costs have not been recorded in the marketplace, either because they were ignored or, more recently, due to the fact that these costs tplace, cannot be properly defined. For example, the price of a gasoline-powered vehicle does not powered include the indirect costs that result from its production and use, such as air pollution and resultant health care. When such environmental damage is defined, then the government must intervene by regulating pollution, funding sewage treatment plants, and other s such unmeasured production costs.

Equity
The concept of equity refers to the just (or equitable) distribution of total goods and fers services among all consumers. People own resources (such as their expertise and talents, consumers. along with property and land) that can be used in the production process. The more resources an individual owns, the more income that individual usually generates. This equitable ual Economics of Pollution Page 3

distribution of income does not always hold in the real world. Economists, so far, have not developed a good theory of "equitable income distribution." As a result, equity considerations are generated on a need-by-need basis, usually by government actions such as minimum wage laws, social security benefits, and unemployment insurance. The correction of existing pollution problems involves equity issues. What is fair to all those involved? The value of human and physical resources will be affected by changes in environmental regulations. For example, if a coal mine is forced to close because of environmental abuses, its workers will suffer. However, other local employees who work at the hydroelectric power plant will benefit directly with better wages and indirectly with cleaner air, water, and land. The coal mine workers will not consider this new arrangement very "equitable" in the redistribution of income, nor will the fishing business sector when fish cannot travel up the river past the dams to reproduce.

Stability
The concept of stability is defined as a system's ability to maintain a balance. A real-life economic system, such as in the United States, tends to be unstable. Adjustments in monetary and fiscal policies at the federal, state, and local levels are constantly being made. These policies are essential in order to strive for full employment and price stability. Improvements in pollution control and prevention have far-reaching implications in economic stability. Large capital expenditures may be required for companies to install new pollution abatement equipment as ordered by the government. This action forces new capital and operating costs on such firms and if large enough can subject the macroeconomic system to instabilities.

Growth
The concept of growth refers to a system's ability to increase in size or intensity. The ability to regularly achieve economic growth must be present in economic systems. Standards of living will increase as long as the rate of output growth exceeds the rate of population growth. Again, a government acts within an economic system to provide ways (such as tax laws to promote the creation of capital goods) to provide stability. Growth is the one goal that has been viewed critically by environmentalists. The more growth an economy generates, the more pollution it also generates. In theory, the more restraint that the government places on industry with respect to pollution controls, the more likely it is that those companies will decrease their growth rate. Society is then faced with a choice: more goods or less pollution.

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Perspective The Economist’s Perspective on pollution

Economists view pollutants as by-products of economic activity. Above figure shows how pollution relates to the ordinary economic activities of energy production, industrial production, and household consumption. The process begins with inputs of natural resources, such as oil and coal. These natural resources are converted to useful energy, such as electricity and gasoline, or used in industrial production. Some of the useful energy is used, in turn, in industrial production; some of it goes directly to households. Industrial production is sold to energy producers and to households. Energy production, industrial production, household production and household consumption are all generate wastes, the amount of which grows as the economy grows. Waste, however, is not necessarily pollution. Some waste is assimilated without harm by the natural environment, and some of it is recycled. The waste that is neither assimilated nor recycled constitutes pollution. Pollution is inevitable in a market economy. The amount produced, however, is likely to be excessive if polluters are not required to pay for damages inflicted by the pollution they produce. Economics of Pollution Page 5

2.

POLICIES, INSTRUMENTS AND THE ENVIRONMENT

Having set the macro and sectoral policies, the next task is to identify the externality problem and to design policies to address them.

Property Rights
In a classic article, Ronald Coase (1960) showed that in the absence of transactions cost the social optimum would be reached (for example, the optimal level of pollution, the optimal level of trees cut of a protected level and so on) whether property rights are initially allocated to polluters or to those suffering from the pollution. This result has become known as the Coase Theorem. The Coase theorem tells us that the optimum is reached whoever is allocated the property right. But for this result to be obtained, important assumptions must be satisfied. First, it must be possible to precisely define the property right. Second, this property right must be enforceable and transferable. Third, the parties to the transactions must be well defined. Third, the parties to the transactions must be well defined. This may be particularly difficult when today’s actions affect future generations; by definition, these cannot be part of current negotiation. Fourth, those owing the property rights must be able to capture all values associated with the environmental asset they own. In the forestry sector for example, this is generally a problem since the property right is typically defined solely over the wood value of the forest. Finally, the transaction costs must be small.

Command and Control Regulation
The traditional approach to environmental protection has often relied on command and control instruments. The regulator commands a desired behavior, typically by imposing a limit on the amount of emissions that a polluter can produce. These limits are generally called emission standards. The regulator then controls and enforces compliance with the chosen standard. Under this regime, the incentive for pollution control takes the form of penalties or sanctions that the polluter is faced with if they do not comply with the command. The granting or withholding of permits, licenses, or other authorizations is another important tool for controlling pollution. The permits or licenses are tied to an air or water quality standard and may be subject to the fulfillment of specific conditions such as compliance with a code of practice, minimization of environmental and economic impacts, installation of treatment plants.. The biggest advantage of this methodology is that it provides the regulator a reasonable degree of predictability about how much pollution levels will be reduced. The problem with this methodology is that this approach is ineffective and insufficient in addressing many of the Economics of Pollution Page 6

recent pollution control and waste management problems confronting environment managers, like solid waste disposal, global environmental problems like ozone depletion and climate change.

Pollution Charges
The principle supporting the use of this is that a charge per unit of pollution is relatively simple. Consumers and producers base their decisions on private costs and benefits as opposed to social costs and benefits. The principle behind pollution charges and tradable emissions permits is to create a price equivalent to these external costs. The level of charge, which equates the marginal abatement cost and the marginal damage functions, is referred as Pigouvian tax. In reality, however the regulator does not know the firm specific marginal abatement cost and marginal damage functions. As a result, the pollution chares tend to be uniform

Tradable Permits
This is a scenario where the actors can buy ‘rights’ for producing pollution or they can sell these ‘rights’ to other actors. Under a marketable/tradable permit system, the responsible authority determines a target level of environmental quality defined as an allowable level of emissions or an ambient environmental quality standard. This is then translated into a total number of allowable emissions that can be discharged. Discharge rights are then allocated to firms in form of permits and the owner is allowed to discharge a specific amount of pollution. This may also be transferred from one source to another. One major problem with this approach is that knowing the nature of the process into which the regulator is engaged, firms are going to adjust their emissions in a strategic manner.

Other Charge Systems
User Charges are direct payments for the costs of collective or public treatment of pollution. They are used most often in the collection and treatment of municipal solid waste and for the discharge of wastewaters. Product Charges are fees added to the price of the products or product inputs that cause pollution in either the manufacturing or consumption phase or for which a special disposal system has been established. They are similar to effluent and emission charges. Administrative Charges are fees paid to authorities for services like chemical registration or the implementation and enforcement of environmental regulations. They are a component of direct regulation and are intended primarily to finance the licensing and control activities of pollution authorities. Tax Differentiation is used to promote consumption of products that are environmentally safe. This instrument involves a positive charge on a polluting product and a negative charge, or Economics of Pollution Page 7

subsidy on a cleaner alternative. It is used mainly in the context of transport to discourage consumer purchases of polluting vehicles or fuels.

A comparison of Costs for typical and Eco-friendly “GREEN FIRMS”

b) Long Run Average Cost (LRAC)

A “GREEN FIRM” has higher costs in both short and long run. A “TYPICAL FIRM” considers only private costs as shown by MPC (Marginal Private Cost) and APC (Long Run Average Private Cost). The “GREEN FIRM” includes both private and external costs shown by MSC (Marginal Social Cost) and ASC (Average Social Cost). In the short run price in a competitive industry equals MPC. The “GREEN FIRM” produces a smaller quantity than the competitive firm. In the long run, price equals minimum long run average private cost (LRAPC) in a competitive industry. Minimum cost for the “GREEN FIRM” is above price so the “GREEN FIRM” loses money and eventually leaves the industry. A typical competitive industry operates at a price PC, below the Comparison Of Equilibrium in A Competitive Firm socially efficient price PS, that would And a Green Firm be charged by “GREEN FIRMS” including all social costs. The competitive industry produces too large quantity QC as compared to socially efficient quantity QS and charges too low a price PC as compared to the socially efficient green industry price PS

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3.

INVERTED ‘U’ HYPOTHESIS

Inverted U-Shaped hypothesis.

U-shaped hypothesis

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A widely held view by environmental economists is that economic growth does inevitably lead to the increasing pollution of air, water, and land. However, a diversion of resources to pollution control and general environmental objectives will eventually follow. That is, as prosperity increases (based on rising gross domestic product per capita), a more closely watched environmental program slowly replaces the former lack of concern with the environment. Evidence of this inverted U-shaped graph is already clear in many developed countries, such as the United States and England. In phase 1 a country begins to develop, and growth (increasing at a rapid pace) exceeds pollution. Greenhouse gases, radioactive wastes, and pollution in small bodies of water start to increase. In phase 2 a country begins to mature, and pollution equals growth (although growth continues to increase). Pollution and wastes have accumulated and pollution becomes noticeable in larger bodies of water, such as oceans and seas. In phase 3 a country recognizes its pollution problems, and pollution is allowed to decrease along with increasing growth. Measures to counteract pollution are instituted, such as sanitation, treatment, regulations, and zoning.

4.

OTHER ECONOMIC THEORIES ON POLLUTION

Many environmental health indicators, such as water and air pollution, show the inverted Ushaped curve. The argument for the Environmental Kuznets’s Curve(EKC) is based on the following argument. In a developing industrial economy, little weight is given to environmental concerns, raising environmental pollution byproducts. After attaining a certain standard of living from the industrial production system and when environmental pollution is at its greatest, the focus changes from self-interest to social interest. The interests give greater weight to a clean environment by reducing and reversing the environmental pollution trend from industrialization. 1) McConnell (1997) examines the role of the income elasticity of demand for environmental quality in EKC models by adapting a static model of an infinitely lived household in which pollution is generated by consumption and reduced by abatement. He finds that the higher the income elasticity of demand for environmental quality, the slower the growth of pollution when positive, and the faster the decline when negative, but there is no special role assigned to income elasticity equal or greater to one. In fact, pollution can decline even with zero or negative income elasticity of demand, when pollution reduces output (e.g. reduced labor productivity due to health damages, material damage due to acid rain deposition or loss of crop output due to Economics of Pollution Page 10

agricultural externalities). He concludes that preferences consistent with a positive income elasticity of demand for environmental quality, while helpful, are neither necessary nor sufficient conditions for an inverted-U shaped relationship between pollution and income 2) Kriström (1998, 2000) interpreting the EKC as an equilibrium relationship inwhich technology and preference parameters determine its exact shape, proposed a simple model consisting of:(a) a utility function of a representative consumer increasing in consumption and decreasing in pollution. (b) a production function with pollution and technology parameters as inputs. Technological progress is assumed to be exogenous. He interprets the EKC as an expansion path resulting from maximizing welfare subject to a technology constraint at each point in time; along the optimal path the marginal willingness to pay (MWTP) for environmental quality equals its marginal supply costs (in terms of forgone output). Along the expansion path the marginal utility of consumption, which is initially high, declines and the marginal disutility of pollution (MWTP for environmental quality) is initially low and rises. Technological progress makes possible more production at each level of environmental quality, which creates both substitution and income effects. The substitution effect is positive for both consumption and pollution, while the income effect is positive for consumption and negative for pollution. The substitution effect dominates at low-income levels and the income effect dominates at high-income levels producing an inverted-U shaped relationship between pollution and income. 3) Andreoni and Levinson (1998) derived inverted-U shaped pollution-income curves from a simple model with two commodities, one good and one bad, which are bundled together. Income increases result in increased consumption of the good which generates more of the bad. This presents consumers with a trade-off: by sacrificing some consumption of the good they can spend some of their income on abatement to reduce the ill effects of the bad. When increasing returns characterize the abatement technology, high income individuals (or countries) can more easily achieve more consumption and less pollution than low income individuals (or countries), giving rise to an optimal pollution-income path that is inverted-U shaped. The abatement technology is characterized by increasing returns when it requires lumpy investment or when the lower marginal cost technology requires large fixed costs (e.g. scrubbers or treatment plants); poor economies are not large enough or polluted enough to obtain a worthwhile return on such investments and end up using low fixed cost,

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high marginal-cost technologies, while rich economies are large enough and polluted enough to make effective use of high fixed cost, low marginal-cost technologies.

5.

POLLUTION ABATEMENT

carbon taxes A carbon tax is a tax on the carbon content of fuels (principally coal, oil, and natural gas) that generate CO2 emissions when burned. The tax would apply at a specific rate per ton of coal, per barrel of oil, or per million cubic feet of gas, with the amounts adjusted to equalize implied taxes on carbon content. Effect of a carbon tax (or a similar energy input tax) on competitiveness. A carbon tax would affect competitiveness by increasing the costs of polluting inputs (e.g., coal, oil, natural gas, and electricity).Hence, a carbon tax may significantly increase production costs, leading to lower profits, either through lower margins or through a reduction in sales (or both). A tax may not necessarily lead to a one-for-one reduction of profit margins. Part of the tax may be borne by input suppliers and part by the final consumers. The impact of a carbon tax would also differ across the sectors of the economy because of different input combinations and emission profile setting the optimal carbon tax level This graph represents the economic effect of a carbon tax and shows how the tax level might best be set. A carbon tax changes each emitter's marginal cost and marginal benefit of reducing emissions. The tax raises the cost of using traditional carbon-based surces of energy like coal and petroleum, stimulating users to turn to alternative energy like solar cells or wind power. The graph promotes the idea that the tax would be most efficient if set at a level that would reflect the marginal cost of abatement as well as the marginal damage costs of pollution. But in a vastly complex economy, a tax rate could not be calculated in this way, nor would it actually be set with such elegant simplicity. Instead, the rate would probably reflect different costs in different economic sectors, as well as political battles, interest group pressures, and other factors. Further, if high carbon emissions lead towards an uninhabitable planet due to global warming, can we responsibly place abatement into a simple cost-benefit calculus of the type this graph proposes?

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Graph developed by Professor Elizabeth Bogan at the Princeton Department of Economics

When a carbon tax is introduced, emissions are reduced to the level at which the cost of abating emissions and the cost of paying the levy on emissions are at an equilibrium. This equilibrium simplifies the factors that affect marginal costs which vary between country, region, sector and access to information for the sake of modeling the effects of a carbon tax. This equilibrium point represents the amount of carbon that would be emitted according to the cost of abating emissions for each emitter. To the right of this point, along the x axis, the fee for the levy on carbon emissions is more than the cost of abating emissions. This would cause a firm to reduce emissions, moving left along the x axis. To the left of the equilibrium point, however, the marginal cost of reducing emissions is greater than paying the levy on the carbon tax. This causes an emitter to move right along the x axis until the equilibrium between paying the levy on carbon and the marginal cost of emissions reductions is reached. taxes carbon taxes vs. emissions trading: what's the difference, and which is better? There is a growing debate between two competing climate change policy instruments - carbon taxes and emissions trading. Although an international emissions trading system does not necessarily preclude the use of carbon taxes (domestically or internationally), the two are commonly seen as competing policy instruments to reduce greenhouse gases (GHG). This analysis attempts to clarify the two policy approaches and the respective advantages of each. Carbon taxes, and all environmental taxes, are "priced-based" policy instruments. Taxes increase the prices of certain goods and services, thereby decreasing the quantity demanded. This is called the "price effect." Tradable permits, or emissions trading, is considered a "quantity-based" environmental policy instrument. Although both policy approaches are "market-based," they operate differently - carbon taxes fix the marginal cost for carbon emissions and allow quantities emitted to adjust, while tradable permits fix the total amount of carbon emitted and allow price levels to fluctuate according to market forces. Economics of Pollution Page 13

Emissions Trading Under an emissions trading system, the quantity of emissions is fixed
(often called a "cap") and the right to emit becomes a tradable commodity. The cap (say 10,000 tons of carbon) is divided into transferable units (10,000 permits of 1 ton of carbon each). Permits are often referred to as "GHG units," "quotas" or "allowances." To be in compliance, actors participating in the system must hold a number of permits greater or equal to their actual emissions level. Once permits are allocated (by auction, sale or free allocation) to the actors participating in the system, they are then tradable. This enables emissions reductions to take place where least costly.

Carbon Taxes Carbon taxes are simply direct payments to government (collection body), based on the carbon content of the fuel being consumed. Given that the primary objective of the abatement policy is to lower carbon dioxide emissions, carbon taxes make sense economically and environmentally because they tax the externality (carbon) directly. Coal generates the greatest amount of carbon emissions and is therefore taxed in greater proportion than oil and natural gas, which have lower carbon concentrations. Which is better? There is no simple yes or no answer, and the policies are not necessarily mutually exclusive. Several important advantages and drawbacks of the respective policies are outlined below. The Case for Emissions Trading
• A well functioning emissions trading system allows emissions reductions to take place wherever abatement costs are lowest, regardless of international borders. Since costs associated with climate change (e.g. coastal flooding, increasing incidence of violent storms, crop loss, etc.) have no correlation with the origin of carbon emissions, the rationale for this policy approach is clear. If emissions reductions are cheaper to make in Poland than in France, emissions should be reduced first in the former where costs are lower. • Emissions trading has the advantage of fixing a certain environmental outcome - the aggregate emissions levels are fixed, and companies/countries pay the market rate for the rights to pollute. This also makes emissions trading more conducive to international environmental agreements, such as the Kyoto Protocol, because specific emissions reduction levels can be agreed upon more easily than tax rates or policy instruments, which may vary in appropriateness and applicability between states. • Emissions trading is more appealing to private industry. By decreasing emissions, firms can actually profit by selling their excess greenhouse gas allowances. Creating such a market for pollution could potentially drive emissions reductions below targets. In general, transferring resources between private entities is more appealing than transfers to government. • Emissions trading is better equipped than taxes to deal with all six GHGs included in the Kyoto Protocol and sinks (e.g. trees which absorb and store carbon) in one comprehensive strategy. • Permits adjust automatically for inflation and external price shocks, while taxes do not. For example, the US has already experienced an extended period of stable greenhouse gas emissions Economics of Pollution Page 14

levels from 1972 to 1985 because of high oil prices. Taxes would need to be designed to adjust for such external shocks.

The Case for Carbon Taxes
• A carbon tax would offer a broader scope for emissions reductions. Trading systems can only be implemented among private firms or countries - not individual consumers (transaction costs would be prohibitively high if commuters needed permits to fill up their car with gas). Carbon taxes extend to all carbon-based fuel consumption, including gasoline, home heating oil and aviation fuels. Trading systems may not be able to reach parts of the transportation and service sectors which could account for 30-50% of emissions. • A system of tradable permits entails significant transaction costs, which include: search costs, such as fees paid to brokers or exchange institutions to find trading partners; negotiating costs; approval costs, such as delays or fees incurred during the approval process; and insurance costs. Conversely, taxes involve little transaction cost, over all stages of their lifetime. • Carbon taxes have dynamic efficiency advantages that trading lacks because taxes offer a permanent incentive to reduce emissions. Technological and procedural changes, and subsequent technology diffusion, will lead to reductions in permit price (i.e. since emissions goals will be easier to meet, there will be a decrease in permit demand, and hence, a decrease in permit price). Trading systems may not be able self-adjust in response to rapid change, and thus provide the permanent incentive of a tax system to reduce emissions • Taxes are not susceptible to strategic behavior by firms or non-governmental organizations which may harm the contractual environment of the market. Non-governmental organizations or even private individuals that object to the concept of purchasing the "right to pollute" may purchase large numbers of permits to drive up costs of CO2 abatement. • Emissions trading proposals are highly complicated and technical, unlike taxes which are an extremely familiar instrument to policymakers. Many technical issues would need to be resolved before trading could begin, including treatment of sinks, different GHGs, monitoring, enforcement, etc. Ongoing costs are also low for tax systems because of the lack of monitoring and enforcement requirements. • Emissions trading may prevent meaningful domestic reductions from taking place. If the global climate system is to be stabilized, emissions reductions should take place sooner, rather than later, in the countries most responsible for the problem. This concern relates to profound equity issues among developed, developing and transitional economies. • Carbon taxes earn revenue, which can be "recycled" back into the economy by reducing taxes on income, labor and/or capital investment. This is often referred to as a "revenue neutral" tax and may be part of a broader program of "environmental tax reform" (ETR) which attempts to shift the tax burden from "goods" like labor, to "bads" like pollution. Evidence indicates that there can be profound employment, distributional and political benefits to such an approach. Permit systems have the potential to earn revenue, but only if permits are auctioned.

The Politics: Who likes which policy, and why? United States is the strongest
proponent of emissions trading and fought hard to include trading in the Kyoto Protocol. The reasons are straightforward. Relative to other industrialized countries, the US is energy inefficient and has high per capita carbon dioxide emissions levels. Thus carbon taxes would Economics of Pollution Page 15

penalize the US relative to other, less fossil fuel dependent nations. US industry is also strongly against any taxation measures to achieve GHG reductions. Trading would allow US firms to purchase emissions allowances from other countries, and avoid domestic reductions. The European Union has traditionally been in favor of strong coordinated policies and measures, such as energy/carbon taxes, among countries. Because the EU is already relatively energy efficient (improvements have been made steadily since the late 1980s, through energy deregulation, taxes and agreements with industrial sectors), carbon taxes would be less of a burden than in the US. In Kyoto, the EU was against emissions trading, but was unable to overcome US support for trading. Therefore, EU efforts have been channeled into developing effective rules and guidelines for a trading system. For example, the EU has recently announced that at least 50% of countries' reduction targets should be achieved domestically. The Russian Federation and the Ukraine are major supporters of emissions trading, and would stand to gain financially. Their emissions reduction targets are 0% reductions by 2008-2012 based on 1990 levels (i.e. to remain at 1990 levels through 2012). However, because of the economic collapse of the former Soviet bloc, and the closure of inefficient power plants, these countries are already 30% below 1990 levels. If they were allocated trading permits (based on their emissions target), they would be able to immediately flood the market and receive major cash inflows. Developing countries are extremely cautious of emissions trading, and view it primarily as a "loophole" that the US and Japan can use to avoid their domestic responsibility. They are in favor of rules and guidelines that ensure equitable allocation of allowances and monitoring provisions. Currently, trading is being discussed only as a means industrialized and transitional country, since developing countries do not have binding emissions reduction targets. However, if the system were to be extended globally in the future, developing countries would demand that permit allocations be based on population, rather than historic national emissions levels. This position is indicative of the strong equity concerns held by developing countries. Developing countries favor the principle of carbon taxes - as long as they are levied on rich countries and not poor ones.

6.

The Technique of Decomposition Analysis

The decomposition of fossil fuel CO2 emissions into related factors dates back to a series of studies undertaken in the 1980s, mainly at the industry level for a single industrialized country. Kaya (1990) was influential in proposing an identity around which a decomposition of emissions related to four factors could be based: CO2 emissions from energy ≡ CO2 emissions per unit of energy consumed × energy consumed per unit of GDP × GDP per capita × population Economics of Pollution Page 16

This has subsequently been expanded: CO2 emissions from energy ≡ CO2 emissions per unit of fossil fuel consumed × fossil fuel consumed per unit of energy consumed × energy consumed per unit of GDP × GDP per capita × population -(2) These identities focus on CO2 emissions from the combustion of fossil fuels (oil, gas, and coal). Although these are identities that must always be satisfied by the data, and are not based on an estimated model of causal links between the variables, the movements of the components provide an important guide to changes in factors influencing CO2 emissions from energy use. Because the variable of interest—emissions from the consumption of energy—is related to the product of several factors, the change in emissions cannot simply be expressed as the sum of absolute changes in the five factors. According to Lee and Oh (2006), equation (2) can be rewritten as follows:E = the amount of CO2 emissions from the consumption of fossil fuel FEC = the amount of fossil fuel consumption TEC = the total primary energy consumption GDP = gross domestic product POP = population. Hence, emissions in country i can be expressed as Ei ≡ (Ei / FECi) × (FECi /TECi) × (TECi / GDPi) × (GDPi / POPi) × (POPi) ≡ Ci Si Ii Gi Pi The change in a country’s emissions (∆Ei) between a base year 0 and an end year T can be decomposed into the effects of:(a) The change in C (the emissions per unit of fossil fuel, termed the coefficient effect, C eff) (b) The change in S (the share of fossil fuels in total energy, termed the substitution effect, S eff) (c) The change in E (the energy intensity effect, I eff) (d) The change in GDP per capita (G eff) and (e) The change in Population (P eff). ∆Ei ≡ Ei(T) – Ei(0) ≡ C eff + S eff + I eff + G eff + P eff The energy intensity of the economy will fall if the use of energy increases more slowly than the level of GDP. This can happen, when the sector structure of GDP changes toward sectors that are less energy intensive, without any other changes, the average use of energy in total GDP would fall.

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There is a tendency for CO2 emissions per capita to increase as GDP per capita increases

Table 3 provides the information based on GDP measured at purchasing power parity (PPP). The values of GDP per capita are also provided, and the list of countries is ranked by emissions per unit of GDP at PPP. Although the correlation between the two measures of GDP per capita is extremely high (R2 = 0.92), most countries have rather different values on the two measures. Accordingly, emissions per unit of GDP are generally very much lower when measured at PPP. The data in table 3 indicate that the ranking of countries according to emissions per unit of GDP at PPP is different from that for total emissions—with some low population countries appearing at the top of the ranking. Oil producers are again well represented in the top group. Among large developing economies, China, and especially India, Brazil, and Mexico, move well down the list. Among high-income countries, the two largest contributors to global CO2 emissions, the United States and Japan, also move down the list when ranked by emissions per unit of GDP. Higher Economics of Pollution Page 18

and lower income countries are scattered throughout the table, suggesting that there is little evidence of a systematic relationship between emissions per unit of GDP and the level of GDP.

Table 4 shows emissions per capita for each country in the list and GDP per capita, with countries ranked by emissions per capita. The relationship between these two variables for individual countries over time is explored in the Environmental Kuznets Curve literature where some authors have found an inverted U shape between them, suggesting that initially as income per capita increases, emissions per capita rise, but then as income per capita increases further the level of emissions per capita declines. On a per capita basis, a group of low population countries heads the ranking, but the United States also has a high value. China, and especially India and Indonesia, all with very large populations, move toward the bottom of the list. Higher income countries are found predominantly in the top half of the rankings, and lower income countries in the bottom half.

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\

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In the majority of countries, the substitution effect (the change in the share of fossil fuels in total energy consumption), whether positive or negative, was small. Norway and Canada experienced increases in the share of fossil fuels in total energy consumed, which made a large contribution to the overall increase of emissions, while Germany and Ukraine experienced declines in the share of fossil fuel that were substantial in relation to the total change in emissions.

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At the global level, increases in GDP per capita (G eff) were the largest single factor associated with growth of emissions. Population increases (P eff) were associated with an effect almost half as large as GDP per capita. A large decrease in energy intensity (I eff) offset 40 percent of the combined effects of these two factors. The effect of the fossil fuel mix (C eff) was associated with a small decline in aggregate emissions, and the share of fossil fuels in total energy (S eff) with a small increase in total emissions.

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PROJECTION While the largest share of historical and current global emissions of greenhouse gases has originated in developed countries, developing countries will soon account for a greater share of world CO2 emissions from fossil fuel combustion than developed countries.

Conclusions Economic growth and poverty reduction require that trading opportunities be rooted in the development agenda of developing countries. As developing countries increasingly fuel global economic growth, countries like India and China—with their increasing share of carbonintensive development—will be called on to respond to emissions reductions. Various pollution abatement processes have led to a decrease in pollution levels in various countries but a lot more needs to be done. The key findings of this study are as follows:1) The top 20 contributors to global CO2 emissions from were mainly drawn from higher income developed countries, but they also included several large developing economies. The intercountry distribution of emissions per unit of GDP (emissions intensity) was measured using GDP at purchasing power parity. 2) Emissions per capita were positively but only moderately correlated with GDP per capita and showed no evidence of an eventual decline in emissions per capita at higher per capita income (the Environmental Kuznets Curve phenomenon). 3) The decomposition analysis related the change in emissions during the decade to changes in five factors (emissions per unit of fossil fuel, fossil fuel consumption relative to total energy consumption, energy intensity of GDP, GDP per capita, and population). Economics of Pollution Page 23

For the group of countries as a whole, GDP per capita was the dominant variable linked to the growth in total emissions, with population being only one-half as important. However, several countries did experience improved performance of emissions relative to GDP, suggesting that there need not be a negative trade-off between slowing the growth of emissions and maintaining high growth rates of the economy. However, the experience of several countries also makes it clear that, without active policies to curb the emissions intensity of the economy, emissions can actually increase faster than GDP, even when GDP has reached a high level.

4) The two major pollution abatement measures are Carbon Taxes and Emission Trading. There is no clear evidence to prove which is more effective. Different countries use different measures based on their convenience and benefits. For example, the US is a strong supporter of Emission Trading and the EU is traditional supporter of Carbon Taxes. The abatement measures have been successful to some extent, but not the full extent. Government policies have a major role in controlling pollution associated with production and economic development.

POLLUTION LEVEL IN A COUNTRY IS POSITIVELY RELATED (Moderately) TO THE LEVEL OF ECONOMIC DEVELOPMENT OF THE COUNTRY. HIGH INCOME COUNTRIES ARE MAJOR POLLUTERS FOLLOWED BY DEVELOPING COUNTRIES AND MIDDLE INCOME COUNTRIES.

Recommendations 1) The magnitude of the decline in CO2 in many countries suggests that further work to understand why this has happened would be important. In particular, a further decomposition into changes in sector structure (the shares of agriculture, manufacturing, and services) and changes in energy intensity at sector levels would provide information on the extent to which changes in the sector mix that are related to economic growth and development have been responsible for changes in overall emissions.

Economics of Pollution

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REFERENCES

Economics of Pollution

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Description: A project explaining the economics of pollution.