Introduction

This book is a primer on the economics of the environment and natural resources. The title, Markets and the Environment, suggests one of our central themes. An understanding of markets—why they work, when they fail, and what lessons they offer for the design of environmental policies and the management of natural resources—is central to an understanding of environmental issues. But even before we start thinking about how markets work, it is useful to begin with a more basic question:What is environmental economics?

Economics and the Environment

"Environmental economics" may seem like a contradiction in terms. Some people think that economics is "just about money," that it is preoccupied with profits and economic growth and has nothing to do with the effects of human activity on the planet. Others view environmentalists as being naïve about economic realities, or "more concerned about animals than jobs."

Of course neither stereotype is true. Indeed, not only is "the environment" not separate from "the economy," but environmental problems cannot be fully understood without understanding basic economic concepts. Economics helps explain why firms and individuals make the decisions they do—why coal (dirty, polluting, high-in-carbon coal) is still the dominant fuel for electric power plants in the United States, or why individuals drive Hummers instead of Priuses. Economics also helps predict how those same firms and individuals will respond to a new set of incentives—for example, what investments electric utilities will make in a carbon-constrained world, and how high gas prices would have to rise before people stopped buying sport utility vehicles.

At its core, economics is the study of the allocation of scarce resources. This central focus, as much as anything else, makes it eminently suited to analyzing environmental problems. Let's take a concrete example. The Columbia and Snake rivers drain much of the U.S. Pacific Northwest, providing water for drinking, irrigation, transportation, and electricity generation—as well as for the support of endangered salmon populations. All of these activities—including salmon preservation—provide economic benefits to the extent that people value them.

If there is not enough water to meet all those needs, then we must trade off one good thing for another: less irrigation for more fish habitat, for example. How should we as a society balance these competing claims against each other? To what lengths should we go to protect the salmon? What other valued uses should we give up? We might reduce withdrawals of water for agricultural irrigation, remove one or more hydroelectric dams, or implement water conservation programs in urban areas. How do we assess these various options?

Economics provides a framework for answering these questions. The basic approach is simple enough: Measure the costs and benefits of each possible policy, including a policy of doing nothing at all, and then choose the policy that generates the maximum net benefit to society as a whole (that is, benefits minus costs). This is easier to say than to carry out, but economics also provides tools for measuring costs and benefits. Finally, economic theory suggests how to design policies that harness market forces to work for rather than against environmental protection.

To illustrate how economic reasoning can help us understand and address environmental problems, let's take a look at perhaps the most pressing environmental issue today, and one that is increasingly in the news: global climate change.

Global Climate Change

There is overwhelming scientific consensus that human activity—primarily the burning of fossil fuels and deforestation due to agriculture and urbanization—is responsible for a sharp and continuing rise in the concentration of carbon dioxide (CO2) and other heat-trapping gases in the earth's atmosphere. The most direct consequence is a rise in average global surface temperatures, which is why the phenomenon is known widely as "global warming." (Surface temperatures have already increased worldwide by 0.6 degrees Celsius, or about 1 degree Fahrenheit, since the start of the twentieth century.) But the consequences are much broader than warming, which is why the broader term "climate change" is more apt. Expected impacts (many of which are already measurable) include sea level rise from the melting of polar ice caps; regional changes in precipitation; the disappearance of glaciers from high mountain ranges; the deterioration of coastal reefs; increased frequency of extreme weather events like droughts, floods, and major storms; species migration and extinction; and spatial shifts in the prevalence of disease. The worst-case scenarios include a reversal of the North Atlantic thermohaline circulation—better known as the Gulf Stream—which brings warm water northward from the tropics and makes England and the rest of northern Europe habitable. While there has been much international discussion regarding the potential costs and benefits of taking steps to slow or reverse this process, little progress has been achieved.

What are the causes of climate change? A natural scientist might point to the complex dynamics of the earth's atmosphere—how CO2 accumulating in the atmosphere traps heat (the famous "greenhouse effect"), or how CO2 gets absorbed by ocean and forest "sinks." From an economic point of view, the roots lie in the incentives facing individuals, firms, and governments. Each time we drive a car, turn on a light, or use a computer, we are indirectly increasing carbon emissions and thereby contributing to global climate change. In doing so, we impose a small cost on the earth's population. These costs, however, are invisible to the individuals responsible. You do not pay for the carbon you emit. Nor, indeed, does the company that provides your electricity (at least if you live in the United States), or the company that made your car. The result is that we all put CO2 into the atmosphere, because we have no reason not to. It costs us nothing, and we receive significant individual benefits from the energy services that generate carbon emissions.

Economics stresses the importance of incentives in shaping peoples' behavior. Without incentives to pay for the true costs of their actions, few people (or firms) will voluntarily do so. You might think at first that...