Externalities in Action: Environmental and Health ...saez/course131/externalities2_ch06.pdf ·...

Externalities in Action: Environmental and

Health Externalities

131 Undergraduate Public Economics

Emmanuel Saez

UC Berkeley

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OUTLINE

Chapter 6

6.1 Acid Rain

6.2 Global Warming

6.3 The Economics of Smoking

6.4 The Economics of Other Addictive Behaviors

6.5 Conclusion

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THE DAMAGE OF ACID RAIN

Definition: Rain that is unusually acidic due to contamination

by emissions of sulfur dioxide (SO2) and nitrogen oxide (NOx).

Acid rain is a classic negative production externality.

Raising the acidity of lakes and other bodies of water is justone way in which acid rain affects the environment. Acid raincauses damage in a variety of other ways as well:

• Forest erosion

• Damage to property

• Reduced visibility

• Adverse health outcomes

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HISTORY OF ACID RAIN REGULATION

1970 Clean Air Act: Landmark federal legislation that first

regulated acid rain-causing emissions by setting maximum stan-

dards for atmospheric concentrations of various substances,

including SO2.

The 1990 Amendments and Emissions Trading:

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.

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© 2007 Worth Publishers Public Finance and Public Policy, 2/e, Jonathan Gruber 6 of 31

ESTIMATING THE ADVERSE HEALTH EFFECTS OF PARTICULATES

The estimates of the health costs of particulates come from a large empirical literature on pollution and health outcomes. The typical approach taken in this literature is to relate adult mortality in a geographical area to the level of particulates in the air in that area.

The results from this type of analysis are suspect due to a key empirical problem: the 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.

Chay and Greenstone (2003) addressed this problem in an excellent quasi-experimental study, using the regulatory changes induced by the Clean Air Act of 1970 and infant mortality rates.

Chay and Greenstone’s findings are striking: infant mortality declined substantially in areas with regulation-induced reductions in emissions, relative to areas where emissions were not mandated to fall.

Continued…

E M P I R I C A L E V I D E N C E

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GLOBAL WARMING

Global warming due to carbon emissions is the most seriousglobal externality

Greenhouse effect: The process by which gases in the earth’satmosphere reflect heat from the sun back to the earth. Scien-tific consensus that man-made carbon emissions are warmingthe planet

Costs of global warming: Significant uncertainty in howfast/much such warming will affect the climate (e.g. oceanrise). Great uncertainty in economic/social costs which couldpotentially be catastrophic

Big difficulty: carbon stays in atmosphere for centuries ⇒ toolate to start cutting emissions after catastrophic damage starts

Imperative to cut carbon emissions by 60-80% in coming cen-tury as an insurance device against catastrophic scenarios

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Externalities: Problems and Solutions

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Global Warming 6 . 2

ADAPTATION TO GLOBAL WARMING

Estimating costs of Global warming is daunting because soci-

ety will adapt and reduce costs (relative to a scenario with no

adaptation)

Example: heat waves and mortality analysis of Barreca-Clay-

Deschenes-Greenstone-Shapiro

1) The mortality effect of an extremely hot day (90oF+) de-

clined by about 80% between 1900-1959 and 1960-2004.

2) Adoption of residential air conditioning (AC) explains the

entire decline

3) Worldwide adoption of AC will speed up the rate of climate

change (if fossil fuel powered)

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Figure 2: Estimated Temperature-Mortality Relationship (Continued) (c) 1929-1959

(d) 1960-2004

Notes: Figure 2 plots the response function between log monthly mortality rate and average daily temperatures, obtained by fitting Equation (1). The response function is normalized with the 60°F – 69°F category set equal to zero so each estimate corresponds to the estimated impact of an additional day in bin j on the log monthly

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Estimate 95% C.I.

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THE KYOTO TREATY

International conferences to address the problem of globalwarming began in 1988. The peak of activity was a 1997meeting in Kyoto, Japan.

After intense negotiation, the 38 industrialized nations agreedto begin to combat global warming by reducing their emissionsof greenhouse gases to 5% below (depends on country) 1990levels by the year 2012

These goals were written into a treaty that has since beenratified by 35 of the 38 signatory countries, and that wentinto effect in early 2005.

A notable omission from the ratification list is the UnitedStates, which has shown no interest in signing on to this levelof emissions reduction.

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Can Trading Make Kyoto More Cost-Effective?

International emissions trading:

Under the Kyoto treaty, the industrialized signatories are al-

lowed to trade emissions rights among themselves, as long

as the total emissions goals are met.

Could reduce cost of reducing emissions by 75%

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PARTICIPATION OF DEVELOPING COUNTRIES

By the year 2030, developing nations will produce more than half of theworld’s emissions, with China and India leading the way.

It is much cheaper to use fuel efficiently as you develop an industrial basethan it is to “retrofit” an existing industrial base to use fuel efficiently. Bysome estimates, an international trading system that included developingnations would lower the cost to the developed world of complying with theKyoto treaty by another factor of four.

The developing nations did not agree: global warming is the result ofenvironmentally insensitive growth by the set of developed nations. Whyshould poor countries be forced to be environmentally conscious and cleanup the mess that the United States and other nations have left behind?

Clean Development Mechanism is a starting point on such trades withinKyoto: rich countries get credits for helping poor countries develop cleanlybut (1) hard to measure additional effect (2) forest preservation excluded.

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What Does the Future Hold?

Developments since the Kyoto treaty of 1997, in particular thedecision of the United States to reject the Kyoto treaty, donot bode well for short-term agreement on how to combat theproblem of global warming.

⇒ Will require all countries agreeing on who should pay (i.e.who gets the proceeds from the carbon tax, or how tradablepermits are distributed)

Recent evidence suggests that the nations of the world cancome together to combat a global environmental threat, butonly when that threat is urgent

Global warming raises the issue of how should we compare cur-rent costs with long-distant future benefits (Stern vs. Nord-haus debate)

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The Montreal Protocol and Ozone layer hole

� A P P L I C A T I O N

�  An excellent example of international cooperation is the Montreal Protocol of 1987, which banned the use of chlorofluorocarbons (CFCs).

�  As with global warming, this was a potentially enormous long-run problem.

�  Unlike global warming, 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!

�  This hole spurred the international community to action, and in September 1987, the Montreal Protocol was adopted, aiming 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 2050.

It may take some type of exciting, newsworthy event to spur action on global warming, but global warming will not be solved for centuries after emissions are greatly reduced. If the world waits for a crisis to take action, it may be too late.

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The Economics of Smoking 6 . 3

All externalities are not 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.

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The Externalities of Smoking

THE EXTERNALITIES OF SMOKING

1) Increased Health Costs from Smoking

actuarial adjustments: Changes to insurance premiums that

insurance companies make in order to compensate for ex-

pected expense differences.

Externalities can be financial as well as physical. My smoking

creates an externality because the social marginal benefit of

my consumption of cigarettes is below my private marginal

benefit by the extra amount that my coworkers have to pay

for insurance.

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2) Workplace Productivity

There are many reasons why smokers may be less productive

in the workplace: they may require more sick leave or more

frequent breaks (for smoking) when at work.

3) Fires

Smokers are much more likely to start fires than nonsmokers,

mostly due to falling asleep with burning cigarettes.

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4) The “Death” Benefit

An interesting twist on the measurement of smoking external-

ities is presented by the positive externalities for the taxpayer

by the early deaths of smokers.

Through the existence of the Social Security program, smokers

benefit nonsmokers by dying earlier.

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5) What About Secondhand Smoke?

secondhand smoke: Tobacco smoke inhaled by individuals inthe vicinity of smokers.

The damage done to nonsmokers by breathing in secondhandcigarette smoke is a classic externality because individuals donot hold property rights to the air. Without clearly definedproperty rights, complete Coasian solutions to this problemare not available. Yet the costs of secondhand smoke are noteasily added to the list of external costs we have noted for tworeasons:1. There is considerable medical uncertainty about the dam-age done by secondhand smoke.2. Most of the damage from secondhand smoke is deliveredto the spouses and children of smokers.

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Should We Care Only About Externalities, or Do

“Internalities” Matter Also?

Fact 1: Youth Smoking

Of all adults who smoke, more than 75% begin smoking before

their nineteenth birthday.

The traditional model of smoking presumes that the decision

to initiate this addictive behavior is made with a fully rational

trade-off in mind between current benefits and future costs.

There is some evidence that this monumental decision may

not be made in the forward-looking fashion required by rational

addiction models.

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Fact 2: Adults Are Unable to Quit Smoking Even if They

Have a Desire to Do So

Another key fact about smoking is that many adults whosmoke would like to quit but are unable to do so. Considerthe following facts:

1) Eight in ten smokers in America express a desire to quitthe habit, but many fewer than that actually do quit.

2) According to one study, over 80% of smokers try to quitin a typical year, and the average smoker tries to quit everyeight and a half months.

3) 54% of serious quit attempts fail within one week.

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Self-control problem: An inability to carry out optimal strate-

gies for consumption.

Internality: The damage one does to oneself through adverse

health (or other) behavior.

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IMPLICATIONS FOR GOVERNMENT POLICY

1) If people are fully informed and do not have self-controlproblems ⇒ no internality problem and no reason for govtto regulate smoking (rational addiction model of the Chicagoschool) ⇒ Govt regulation of smoking is bad and called “Pa-ternalism” (govt imposes its own views against the tastes ofpeople)

2) If people have self-control problems ⇒ can’t do what isin their best-interest and they are aware of it (internalities)⇒ people welcome govt regulation that helps them controladdictive behavior

3) If people are not informed about harm of smoking ⇒ theymight make suboptimal choices. Two solutions:a. Provide public information and let people chooseb. Regulate the product (better if information is complex,medical drugs)

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THE ECONOMICS OF OTHER

ADDICTIVE BEHAVIORS

While cigarette smoking is a particularly interesting applica-

tion, it is by no means the only health behavior where exter-

nalities (or internalities) potentially cause market failure.

Drinking

Externalities associated with alcohol consumption are much

larger than those associated with smoking. This is largely be-

cause the major externality associated with alcohol consump-

tion is damage due to drunk driving.

Drinking also involves internalities in the sense that it can be

addictive (alcoholism). However, not all drinking is bad for

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ADDICTIVE BEHAVIORS

Illicit Drugs

In the United States, the government regulates illicit drugactivities by prohibiting illicit drug consumption, subject tocriminal penalty.

Society wants to limit consumption of drugs because of inter-nalities (drug addiction) yet prohibition also create large costs(police and prison costs)

Drug legalization remains a radical idea in America and in mostnations

Colorado and Washington states have legalized marijuana in2012 (but still prohibited by Federal law)

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ADDICTIVE BEHAVIORS

Obesity

Recent studies have suggested that both the external costs ofobesity (in terms of government health costs) and the internalcosts of obesity (in terms of shortened lives and lower qualityyears of life) may exceed those of either cigarettes or alcohol.

Thus, under either traditional models or models that take intoaccount self-control problems, there may be a large role forthe government in addressing this problem

NYC has prohibited large sodas (quantity regulation)

Richmond city (Bay area) voters rejected a soda tax (priceregulation) in 2012 ballot

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CONCLUSION

Public finance provides tools to help us think through the reg-

ulation of regional externalities such as acid rain, global exter-

nalities such as global warming, and even the “internalities”

of smoking.

Careful analysis of public policy options requires discriminating

truly external costs from costs that are absorbed through the

market mechanism, understanding the benefits and costs of

alternative regulatory mechanisms to address externalities, and

considering whether only externalities or also “internalities”

should count in regulatory decisions.

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