Environmental Economics

I visited the Banking and Finance Academy in the week of Earth Day to give a lecture about what the British Government is doing to make the UK economy greener – that is, more environmentally sustainable. Environmental economics is a fascinating subject. At the centre of it is the idea of “internalising externalities”. Market systems are very efficient at allocating resources to the most profitable uses, and thus to providing consumers what they want at the best price. But problems arise when, for example, a factory has impacts on third parties that are not captured in its own balance book: for instance if it emits pollution that damages agriculture or people’s health downwind or downstream; or the impact of deforestation on water flow or weather patterns. The challenge is to find a system that puts a monetary value on these things and then brings them into the economic and financial decision making process, either so that the polluter pays for the damage done or, better, so that is in his financial interest to reduce pollution.

There are different ways of doing that, used with greater or lesser success in different contexts, for example by creating markets for carbon or sulphur dioxide emissions (treating the right to emit as a limited good that can be traded), by levying taxes on certain types of activity that have an impact on the environment, or by offering incentives for the introduction of clean or energy-efficient technology. But there are not always straightforward answers, especially when there is a perceived tension between environmental and development imperatives. I say perceived, because in my experience working in previous jobs on the interface between environment and development, it’s often the case that it isn’t a direct choice between the two – indeed sometimes it’s a choice between an approach that provides both and an approach that provides neither.

There were some interesting questions from the students, mostly about climate change – which is the biggest externality of all – and the future of the international agreements on reduction of carbon emissions. On that issue, the next few months are a crucial time that should see agreement on the shape of a post-2020 legally binding global agreement on emissions reductions. The UK will be pushing hard for a strong and effective agreement.