Economic Dimensions

UNIT 9 ECONOMIC DIMENSIONS

Structure
9.1 Introduction
Objectives
9.2 Environmental Economics: An Introduction
Resources
How Resources can be Used?
Internationalising the Externalities
Discount Factor
9.3 Cost Benefit Analysis
Cost Effectiveness
Market-based Incentives and Disincentives
9.4 Economic Incentives
9.5 Summary
9.6 Terminal Questions

9.1 INTRODUCTION
In the previous block you have studied about various dimensions of environmental
management approaches pertaining to four major sectors, viz. agriculture, forestry,
water resources and industrial processes outcomes. In the unit 9 of this block we will
discuss the various economic dimensions for addressing environmental concerns.
The idea of integration of economic concepts in environmental management is not
very old. Economic instruments are now considered as the best approaches to control
pollution and resource exploitation. This unit will introduce you to the basic concepts
of environmental economics and focus how these could be applied in the analysis of
environmental issues. The unit discusses: causes of environmental degradation; use of
desirable resources and minimisation of pollution; how resources could be used. The
economic dimensions of environmental management are: internalisation of
externalities, discount factor, cost benefit analysis, cost effectiveness analysis and
market based incentives and disincentives.
Objectives
After studying this unit, you should be able to:
• explain reasons for environmental degradation;
• explain as to how internalisation of external cost could prevent resource
exploitation;
• discuss the role of discount factor in limiting the growth and sustainable
development;
• describe cost benefit analysis and how it could be applied;
• describe cost effective analysis and its limitations and drawbacks ; and
• discuss market based approaches to control pollution.

9.2 ENVIRONMENTAL ECONOMICS: AN

INTRODUCTION
Not long ago, the idea of environmental economics seemed to have many a superficial
concern, something not related to the everyday world of commerce, industry or most
of people’s lives. This idea has now changed. The total costs of dealing with
environmental issues are very large. By accepting the importance of environmental
issues, we have agreed to bear these costs and therefore, we cannot ignore the issue of
the economics of environment.
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Environmental Our economic analysis involves two different kinds of environmental issues: the use
Management: Dimensions of desirable resources, such as fish in the ocean, oil in the ground, or forests on the
and Approaches land; and minimisation of undesirable pollution. Environmental decision-making often
involves analysis of both economic factors and intangibles, such as aesthetic factors.
Of the two, the intangibles are more difficult to deal with because they are hard to
measure and to value. Nonetheless, evaluation of the intangibles is becoming more
important in the local, regional and national land use planning. The purpose of
environmental economics is to develop a method of aesthetic evaluation that provides
good guidelines, and is easy to understand, and quantitatively credible.
As discussed earlier, our economic analysis of environment involves the use of
desirable resources and the minimisation of undesirable pollution.

9.2.1 Resources
Some biological resources, such as the forestland are on the publicly owned lands that
are accessible to everyone. A society that controls resources such as public lands and
waters has a number of social mechanisms to achieve its environmental goals. Laws
and regulations are the method; by which use of resources by individuals or
companies can be limited by setting quotas or by regulating use through licenses or a
society may simply rely on individual motivation, on the assumption that what people
find best for themselves will also be best for the society. This approach provides the
individual complete freedom of action.
Those who are concerned about the environment often wonder why individuals do not
choose to act in a way that leads to the protection of the environment and maintains
biological resources in a renewable state. When individuals get benefited from the
resource, it would seem to be in their best interests not to damage or destroy it. One
explanation is provided by the economic analysis, which shows that the profit motive,
by itself, will not always lead a person to act in the best interest of the environment.
When a resource is shared, an individual’s personal share of profit from exploitation
of the resource is usually greater than the individual’s share of the resulting loss. This
is called “tragedy of the commons.” There are many examples of commons, both past
and present, but the important one today is deep oceanic sea beds. The high seas have
always been considered as areas open to all and not the property of any single nation.
Another example is Antarctica. Although there are some national territorial claims on
this continent, most of the continent is common. Without some management or
control, all natural resources treated like commons will inevitably be destroyed.
Another reason the individual tends to over exploit the natural resources held in
common is low growth rate of resources. It is quite reasonable and in fact quite
practical if one considers only direct profit and harvest resources as much as s/he can.
The problem of commons makes several points clear.
1. If we want to conserve resources, we must think beyond the immediate and direct
economic advantages.
2. Policies that seem ethically good may not be the most profitable for an individual.

9.2.2 How Resource s can be Used?

Most economists look at resources as means to an end, rather than having value in
them. Resources have to be used to be of value e.g. if you bury your saving in a jar in
the ground it will last longer but may not be worth much when you dig it up. If this
saving is invested productively, it will have much more value in the future than now.
Further, a window of opportunity for investment may be open now but not later. How
do we determine the value (or price) of environmental goods and services? Some of
the most crucial environmental factors that may shape our future are not represented
by monetary values in the marketplace. Certain resource allocation decisions are
political or social. Other resources are simply ignored. Groundwater, sunlight, clean
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air, biological diversity, and other assets that we all share in common are often treated Economic Dimensions
as public goods (benefits) that anyone can use freely. Our economic system typically
has not changed for using the absorptive capacity of the environment to dispose of
wastes despite ample evidence that this capacity can be exhausted.
In theory, these resources are self-renewing, but many vital environmental assets are
threatened by human activities. If we damage basic life support systems of the
biosphere, we cannot simply substitute another material or service for the ones that
have become limited. The crux of this question is how we should manage resources in
a market system. Let us now look as to how our economic system handles the internal
and external costs and the discount factor.

9.2.3 Internalising the Externalities

Internal costs are the expenses (monetary or otherwise) that are borne by those who
use a resource. Often, internal costs are limited to the expenses involved in gaining
access to the resource and turning it into a useful product or service.
External costs are the expenses (monetary or otherwise) that are borne by someone
other than the individuals or groups who use a resource. External costs are often
related to public goods and services derived from nature. Some examples of external
costs are the environmental or human health effects of using air or water to dispose of
wastes. Since these effects usually are diffuse and difficult to quantify, they do not
show on the ledgers of the responsible parties. They are likely to be ignored in private
decisions regarding the costs and benefits of a purchase or a project. One way to use
the market system to optimise resource use is to make sure that those who reap the
benefits of resource use also bear all the external costs. This is referred to as
internalising costs.
An externality is an effect not normally accounted for in the cost revenue analysis of
producers. Air and water pollution provide good example of externalities. Consider
the production of nickel from ore at the smelters, which has serious environmental
effects. Traditionally the economic costs associated with the production of
commercially useable nickel from an ore are the direct costs borne by the producers
and passed directly on to the user or purchaser. In this case the direct cost includes the
costs of purchasing the ore, of energy to run the smelter, of building the plant and of
paying employees.
On the other hand, the costs associated with the degradation of the environment from
the emissions from the plant are traditionally considered externalities and are called
indirect costs. Some environmentalists suggest that indirect cost should be included in
the cost of production through taxes or fees. In this way, the expense would be borne
by the corporation that benefits directly from the sale or would be passed on to the
users. Others suggest that these costs should be shared by the entire society and
therefore paid for by the general taxation of citizens.

9.2.4 Discount Factor

“A bird in hand is worth two in the bush.” All of us are familiar with this saying
which suggests that it is better to have something now than in the distant future. This
economic concept, the future value compared with the present value, is another
important idea for environmental studies. Economists refer to this concept as discount
factor. The discount factor is the ratio of future worth to present worth. Economists
observe that market determines a discount factor that is often, but not always, less
than 1. A discount factor less than 1 means that something promised in the future has
less value than something given today. The market determined discount factor is the
result of the interaction of the consumer’s preferences for present instead of future
consumption.
As an example, suppose that you find yourself thirsty in a desert and meet two people;
one offers to sell you a glass of water now, and the other offers to sell you a glass of 7
Environmental water if you can be at the well tomorrow. How much is each glass worth? If you
Management: Dimensions believe you will die today without water, the glass of water today is worth all your
and Approaches money and the glass tomorrow is worth nothing. This is an extreme example of a
discount factor.
In practice, things are rarely so simple and distinct, but we all know that we are
mortal, so we tend to value personal wealth and goods more if they are available now
than in future. Modern concerns with the environment have placed a new emphasis on
the discount factor. Conservationists often argue that we have a debt to future
generations and must leave environment in at least as good condition as we have
found it. They argue that future environment is not to be valued less than the present.
Different attitudes towards the discount factor pose a dilemma for environmental
studies. Firstly, economists argue that it is difficult, if not impossible, to make a sound
economic analysis when the discount factor is greater than one. Secondly, many
people argue that humans really do place a higher value on a possession in hand today
than on one promised tomorrow. The concept of discount factors however important
as we seek the environment.

SAQ 1
Explain the following concepts:
1. Commons;
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2. Tragedy of Commons;
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3. Internalising the externalities;
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4. External cost;

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5. Discount factor;
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 Economic Dimensions
9.3 COST BENEFIT ANALYSIS
One way to evaluate the outcomes of large-scale public projects is to analyse the costs
and benefits that accrue from them in a cost benefit analysis. A cost benefit analysis
compares the estimated costs of a project with the benefits that will be achieved. Such
an analysis is often used as a means of rationally deciding whether to proceed with a
given project. All costs and benefits are given monetary values and compared by
means of what is commonly referred to as a benefit cost (or cost benefit) ratio. A
favourable ratio for a project means that the benefits outweigh the costs. Such a
project is said to be cost effective, and there is thus an economic justification for
proceeding with it. The analysis usually involves considering several options for
accomplishing the project and selecting the option with the best cost benefit ratio. If
costs are projected to outweigh the benefits, the project may be revised, dropped, or
shelved for later consideration.
This process assumes that values can be assigned to the present and future resources,
given proper criteria and procedures. It is one of the main conceptual frameworks of
resource economics. This process is controversial, however, because it deals with
vague and uncertain values and compares costs and benefits that are as different as
apples and oranges. As shown in the Fig. 9.1, several different tributary paths come
together to determine the final outcome of this process. The easiest equation is to
quantify the direct costs and benefits to the developer or investor who has proposed
the project; i.e., the out of pocket expenses and the immediate profits that will result
from this investment. These direct monetary costs and benefits are usually the most
concrete and accurate components in the analysis. It is important that they do not
outweigh the other factors which are more difficult to ascertain but are equally
important.
The other branch of the flowchart involves analysis of more diffuse, non-monetary
factors such as environmental quality, ecosystem stability, human health impacts,
historic importance of the area to be affected, scenic and recreational values, and
potential future uses. These are difficult values to quantify. It is even more difficult to
express them in monetary terms.
How much are beauty or tranquility worth? What are the benefits of ethical
behaviour? How much would you pay for good health?

Fig.9.1: A Flow-chart for a cost benefit analysis

(Source: Cunningham & Saigo, 1995) 9
Environmental Some costs and benefits simply cannot be expres sed in monetary terms. These
Management: Dimensions invaluable (in a positive sense) factors bypass the mathematical stages of comparison
and Approaches and are considered, in the final decision making process, which is more political than
mechanical. The distributional considerations include; as to who will bear the costs of
the project and who will reap the benefits? If there are two different groups of people,
as they usually are, questions of justice that arise must be resolved.
Criticisms and complications of this process include the following:
• Absence of standards: Each person assesses costs and benefits by his or her own
criteria, often leading to conflicting conclusions about the comparative values of a
project. It has been suggested that an agency or influential group set specifications
as to how factor should be evaluated.
• Inadequate attention to alternatives: To really understand the true costs of a
project, including possible loss of benefits from other uses, it is essential to
evaluate alternative uses for a resource and alternative ways to provide the same
services. These steps are often slighted.
• Assigning monetary values to intangibles and diffuse or future costs and benefits:
Some critics of this process claim that we should not even try. They believe that
attempting to express all value in monetary terms suggests that only monetary
gains and losses are important. This can lead to the “slippery slope” argument that
everything has a price and that any behaviour is acceptable as long as we can pay
for it.
• Acknowledging the degree of effectiveness and certainty of alternatives:
Sometimes speculative or even hypothetical results are given specific numerical
values and treated as if they were hard facts. We should use risk assessment
techniques to evaluate and compare uncertainties in the process.
• Justification of the status quo: Agencies may make decisions to go ahead with a
project for political reasons and then manipulate the data to correspond to the
preconceived conclusions.
Cost benefit analysis, however, intends to build efficiency into policy so that the
society does not have to pay more than it is necessary for a given level of
environmental quality. If the analysis is done properly, it will take into consideration
all the costs and benefits associated with a regulatory option. In doing so, it must
address the problems of externalities.
Cost and benefit analysis works well only if all the costs and benefits of a polluting
activity are included in the calculations. Let us assume this is possible. What would
happen if everyone had to pay the true costs of their use of environment as they used
resources or degraded the air or water? Such charges are often called green fees. The
two groups that frequently oppose each other are the economists and the
environmentalists; both agree that such a policy would go a long way towards solving
many of our environmental problems.
Economists point out that in a free-market economy, the market will guarantee that
resources will be used in the most efficient way. This means that business and people
who use, say, 100 gallons of gasoline and have to pay a levy that reflects the true costs
of that gasoline will be highly motivated to keep their use of gasoline to an absolute
minimum. They will adopt alternative modes of transportation and more efficient
vehicles. The green fee could be imposed as a tax on gasoline, and to ease its impact
on the economy, the fee could be implemented gradually until it brings the price of
gasoline to its true level. Environmentalists say that the people who do the damage
pay for their environmental impact, something which the environmental groups have
been calling for all along. They insist that some of the revenues collected should be
used to mitigate the impact of pollution and resource use, but if this were to be
10 accomplis hed, the outcome would move over society in the direction of sustainability.
Sardar Sarvar dam on the Narmada, as well as all big dams, presents classical case Economic Dimensions
which illustrates the various dimensions of cost benefit analysis. Some of the costs are
intangible and can not be easily assessed in any techno-economic appraisal, as the
construction of major dams, involve immense cost and long period of time,
profoundly change the face of nature. They tend to alter the hydrological system;
usually entailing deforestation in the submersion area and in the surroundings; the
displacement of the local people who may benefit little or not at all.
At the same time benefits also involve some intangible gains such as in semi-arid
areas canal waters are used not only for irrigation but also to wash clothes; easier
accessibility to water may enable young girls who spend long hours fetching water for
domestic chores to attend school instead. More water could also improve health by
reducing commonly prevalent skin diseases. So the project would involve financial
cost benefit analyses as well as environmental impact assessments. It is argued that
such analyses however themselves can not determine whether a big dam is worth
building or not. The society has to decide what kind of future it wants and what price
it is willing to pay and what probability of risks it is willing to bear. There has to be
some clarity regarding empirical situation which is markedly absent in the
environmentalist debate.
However, human and environmental considerations have altered the conventional cost-
benefit ratio, as greater public pressures and legal interventions are ensuring better
rehabilitation of displaced people and compensatory afforestation. There is a strong
feeling and demand for reassessment w ith regard to big dams. People are not likely to
benefit automatically if big hydroelectric dams are no longer built either because of
opposition of environmentalist or a cut in resources. Rural clarification, street lighting in
villages and urban slums and household lighting are important needs that well have to be
met.

9.3.1 Cost Effectiveness

We know that with modest degree of clean up, the benefits of a project can outweigh
the costs. In the clean up efforts, at some point, the costs of controlling pollution could
exceed the benefits. Consequently while it is argued that we should strive for 100%
control, demanding more than 90% control may involve enormous costs with little or
no added benefits. At the point when control of a particular pollutant reaches 90%, it
makes more sense to allocate funds and efforts to other projects where greater benefits
may be achieved for the money spent. Optimum cost-effectiveness that meets the
efficiency criterion for public policy is achieved at the point where benefits outweigh
the cost. Cost effective analysis provides an economic justification for proceeding
with the project or activity.
In reaching the goal of cost effective analysis, problem arises in comparing the cost
and benefits. Even after valid cost and benefits estimates are obtained, the comparison
is often complicated as during the initial stages of control, costs are high and the
observable benefits are usually few or none. As time passes, however, costs generally
level off, while benefits increase and accumulate. Consequently, whether benefits
outweigh cost or vice versa depend on whether one takes a long term or short term
view. A situation that seems cost ineffective in short term may be extremely cost
effective in the long term. This is particularly true for the problem such as acid rain or
ground-water contamination from toxic wastes. In these instances, the consequences
of delaying control may seriously affect large geographic areas and many millions of
people, and they may be irreversible.
Those who bear the cost of pollution control and those who receive most of the
benefits are frequently different groups of people. For example, industry and its
stakeholders may bear the costs of curtailing effluents into a river, while people who
enjoy sport fishing gain the benefits. Obviously, the two parties are more than likely
to reach different conclusions regarding the cost effectiveness of a particular action.
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Environmental 9.3.2 Market-based Incentives and Disincentives
Management: Dimensions
and Approaches What is the most efficient and economical way to eliminate pollution? Some people
argue that we should say to polluters, “Stop it! You can’t dump garbage into the air or
water anymore”. While this approach has a certain moral appeal, it tends to force all
businesses to adopt uniform standards and methods of pollution control regardless of
cost or effectiveness. This approach can also lead to an adversarial climate in which
resources are used in litigation rather than pollution control.
Furthermore, the “command and control” approach tends to freeze technolog y by
eliminating incentives for continued research and development. Industry is
discouraged and even prohibited from trying new technologies or alternative
production methods. These problems can be overcome, as many economists believe,
by using market mechanisms to reduce pollution rather than by rigid rules and
regulations. Since there may be a one hundred fold variation in the cost of eliminating
a specific pollutant from different sources of the equipment use, environmental factors
and other consideratio ns, like market based incentives such as pollution charges or
tradable permits can be more cost effective and flexible.
Economic incentives and disincentives are the two major categories of instruments
that can be harnessed in support of the environmental policies. Each, in turn, can
influence the environment in two ways:
• Through stimulating adjustment to the allocation of scarce economic resources
between sectors; and
• Through encouraging the adoption of improved resource management practices.

SAQ 2
1. What are the advantages and disadvantages of regulatory approach vs. a market
based approach to control pollution?
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2. Discuss cost-benefit analysis. Give illustrations.
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3. What Intangible cost and Intangible gains can accrue from big hydroelectric
dams?
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4. Discuss the impact of big Dams on environment.
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 Economic Dimensions
9.4 ECONOMIC INCENTIVES

Economic incentives can be one of the major engines for development of eco-friendly
projects. These incentives include:
Grants
These can be used to promote resource uses that are both environmentally and
economically sound. This also applies in the case of management practices . Such
incentives could be targeted either towards meeting physical requirements in pursuit
of efficiency (for the purchase of equipment) or towards making an investment in
human capital (perhaps for the training of extension workers). In the past positive
environmental results have been achieved through the use of grants and allocations for
specific projects.
Subsidies
Subsidies in support of commodities and inputs are a common form of incentive
through which the government seeks to benefit a specified, us ually private sector of
the economy. Both developed and developing countries have been extending subsidies
to various sectors of the economy. For example U.S. high subsidies to its agriculture
and steel sector. As temporary vehicle for speeding the adoption of desirable
practices, subsidies undoubtedly have a useful role to play.
On the other hand, certain subsidies have undoubtedly had an adverse impact. Price
control on agricultural commodities and the subsidised distribution of food imports
over the past few decades have contributed to poor agricultural practices, leading to
poor soil conditions especially in the developing countries. In short, the benefits
accruing from a subsidy are linked to particular resource uses and management
practices that are promoted, either directly or indirectly. In designing a subsidy
programme, particular care clearly needs to be taken so as to avoid any possible
adverse indirect effects. The governments can subsidise environment friendly
technologies.
Fiscal Relief and Concessions
Fiscal relief and concessions represent a third avenue for resource use and sustainable
development programmes. Thus, the scope for tax incentives is restricted to the formal
and organised sectors, which constitute a relatively small part of the national
economy. To encourage the demand for products, the government could provide
indirect tax exemption; a sales or excise tax could be waived, for instance, to assist
particular resource use practitioners.
Tariffs or Quotas
A fourth type incentive is the imposition of tariffs or quotas in order to protect
environmental benign producers. In an economy that is in the process of being
gradually liberalised, these instruments could pay a marginal role at best. It may
however, be worth considering whether export incentives for environmentally
recommended produce could be incorporated into current programmes for
infrastructural investments. Such an opportunity could be provided by the fruit and
vegetable sector.
Prizes
A highly visible form of incentive is the institution of much publicised prize, awarded
to those adjudged as the most successful in undertaking environmentally progressive
measures. Rules for award schemes need to be carefully drawn up. A panel of
adjudicators also needs to be established and briefed before such a high profile
incentive could become effective.

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Environmental Disincentives
Management: Dimensions
and Approaches Economic disincentives are almost opposite of the incentives, namely levies, taxes,
restricted tariffs/quotas and penalties or fines. Better resource use is sought through
negative and punitive measures. The same net effect is achieved by rescinding
subsidies that have outlived their usefulness or become subject to abuse.
Table 9.1: Categories of economic incentives and disincentives

Type of application
Types of instruments Sectoral resource Resource management
allocations practices
Incentives
Grants * *
Subsidies * *
Fiscal Relief/Concessions * *
Tariffs and quotas *
Prizes *
Disincentives
Levies * *
Taxes * *
Restrictive tariffs * *
Penalties or fines *

SAQ 3
1. Discuss the nature of incentives and disincentives which a government can give to
promote environmentally and economically sound resource use.
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Let us summarise what we have studied so far.

9.5 SUMMARY
Although scientific solution of environmental issues are part of the over-all
environmental management, however, the market based approaches and economic
analysis of environmental issues are very effective tool for managing the environment.
Economic analysis of environmental issues tell us that resources should be utilised in
an effective manner rather than conserving them. Resources may be common property
or privately owned. The kind of ownership affects the method available to achieve an
environmental goal. To avoid overexploitation of the common resources,
internalisation of external cost in product is a good strategy. Discount factor is another
method to affect our willingness to pay for an environmental quality.
If costs of all the resources used could be estimated, cost benefit analysis of a project
could tell us whether a project is feasible for environment or not. A major problem
with this approach is that some of the costs and benefits could not be expressed in
monetary terms. Moreover there are no set standards for estimating the costs and
14 benefits. If a project has more benefits than its cost, then the project is said to be cost
effective. This analysis is very complicated and complex as it involves comparison of Economic Dimensions
costs and benefits. However it is proved to be beneficial for some projects. The
market based approach of incentives and disincentives for pollution control is a very
effective tool for changing the behaviour of individual and industry to control
pollution.

9.6 TERMINAL QUESTIONS

1. Explain the various factors responsible for environmental degradation.
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2. Discuss the following in your own words:
a) Environmental management
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b) Cost benefit analysis
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c) Approaches to control pollution
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REFERENCES
1. Botkin, D. and Keller, E. (1995) Environmental Science: Earth as a Living
Planet, John Wiley and Sons, Inc.
2. Cunningham, W.P. and Saigo, B.W. (1995) Environmental Science: a Global
Concern, 3rd ed., Wm. C. Brown Publishers.
3. GoP-IUCN (1992) Pakistan National Conservation Strategy,
4. Nebel, B.J. and Wright, R.T. (1998) Environmental Science, 6th ed., Prentice
Hall, Inc.
5. Krishna Sumi (1996) Environmental Politics: People's Lives and Development
Choices, Sage Publications Pvt. Ltd.

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