On my commute to work on the 6th October, I happened to listen to a programme on BBC radio 4, which provided some fascinating discussion on climate change, growth, capitalism and the need for co-operation. With more countries emerging as leading economic powers, pollution and emissions continue to grow. Is it time for a green revolution?
The programme considers some ‘typical’ policies and also discusses some radical solutions. There is discussion on developing and developed nations and how these countries should be looked at in terms of compensation, entitlement and aid. Carrots and sticks are analysed as means of saving the planet and how environmental damage can be reduced, without adversely affecting the growth rate of the world economy. I won’t say any more, but it’s certainly worth listening to, for an interesting discussion on one of the biggest problems that governments across the world are facing and it is not going to go away any time soon.
Naomi Klein on climate change and growth BBC Radio 4, Start the Week (6/10/14)
Questions
- What are the market failures with the environment?
- Why is global co-operation so important for tackling the problem of climate change?
- Which policies are discussed as potential solutions to the problem of climate change?
- What has been the problem with the European carbon trading scheme?
- Why may there be a trade-off between capitalism, growth and the problem of carbon emissions?
- To what extent do you think that countries such as Bangladesh should be ‘compensated’?
In market capitalism, the stock of manufactured capital provides a flow of output. The profitability of the use of that capital depends on the cost of investing in that capital and the cost of using it, and on the flow of revenues from that capital. Discounted cash flow techniques can be used to assess the profitability of a given investment in capital; the flows of costs and revenues are discounted at a market discount rate to give a net present value (NPV). If the NPV is positive (discounted revenues exceed discounted costs), the investment is profitable; if it is negative, the investment is unprofitable. (See Economics, 8th edition, section 9.3.)
There may be market imperfections in the allocation of investment, in terms of distorted prices and interest rates. These may be the result of market power, asymmetry of information, etc., but in many cases the market allows capital investment to be allocated relatively efficiently.
Natural capital
This is not the case with ‘natural capital’. Natural capital (see also) is the stock of natural resources and ecosystems that, like manufactured capital, yields a flow of goods and services into the future. 
Natural capital, whilst it can be improved or degraded by human action, is available without investment. Thus the natural capital of the oceans yields fish, the natural capital of the skies yields rain and the natural capital of forests reduces atmospheric CO2.
Even though some natural capital is owned (e.g. private land), much is a common resource. As such, it is free to use and tends to get overused. This is the Tragedy of the Commons – see, for example, the following news items: A modern tragedy of the commons and Is there something fishy going on?.
Natural capital accounting
But would it be possible to give a value to both the stock of natural capital and the goods and services provided by it? Would this environmental accounting enable governments to tax or subsidise firms and individuals for their use or enhancement of natural capital?
On 21 and 22 November 2013, the first World Forum on Natural Capital took place in Edinburgh. This brought together business leaders, politicians, economists, environmentalists and other scientists to discuss practical ways of taking natural capital into account in decision making. Central to the forum was a discussion of ways of valuing natural capital, or ‘natural capital accounting’. As the forum site states:
Natural capital accounting is a rapidly evolving new way of thinking about how we value the economic benefits we derive from our natural environment. The World Forum on Natural Capital will bring together world-class speakers, cutting edge case studies and senior decision makers from different sectors, in order to turn the debate into practical action.
But if natural capital is not owned, how is it to be priced? How will the costs and benefits of its use be valued? How will inter-generational effects be taken into account? Will firms price natural capital voluntarily if doing so reduces their profits? Will firms willingly extend corporate social responsibility to include corporate environmental responsibility? Will governments be prepared to introduce taxes and subsidies to internalise the costs of using natural capital, even if the effects extend beyond a country’s borders? Will natural capital accounting measure purely the effects on humans or will broader questions of maintaining and protecting environmental diversity for its own sake be taken into account? These are big questions and ones that various organisations are beginning to address.
Despite problems of measurement and incentives, sometimes there are clear economic benefits from careful evaluation and management of natural capital. Julia Marton-Lefèvre is Director General of the International Union for Conservation of Nature (IUCN). According to the first Guardian article below:
Her favourite example of natural capital working in practice comes from Vietnam, where “planting and protecting nearly 12,000 hectares of mangroves cost just more than $1m but saved annual expenditures on dyke maintenance of well over $7m. And that only accounts for coast maintenance: mangroves are also nurseries for fish, meaning livelihoods for fishing and source of nutrients … “
One organisation attempting to value natural capital is The Economics of Ecosystems and Biodiversity project (TEEB). It also looks at what organisational changes are likely to be necessary for the management of natural capital.
Based on data collected from 26 early adopter companies (60% of them with $10 Billion+ revenues each) across several industry sectors this provides real life evidence on the drivers and barriers for natural capital management.
Pricing the environment is a highly controversial issue. Critics claim that the process can easily be manipulated to serve the short-term interests of business and governments. What is more, where tradable permits markets have been set up, such as the EU’s Emissions Trading Scheme (ETS), prices have often been a poor reflection of social costs and have been open to manipulation. As Nick Dearden, director of the World Development Movement (WDM), says:
It is deeply ironic that the same financial markets that caused the economic crisis are now seen as the solution to our environmental crisis. It’s about time we learnt that financial markets need to be reined in, not expanded. Pricing these common resources on which people depend for their survival leaves all of us more exposed to the forces of the global economy, and decisions about whether or not to protect them become a matter of accounting.
The measurement of natural capital and setting up systems to internalise the costs and benefits of using natural capital is both complex and a political minefield – as the following articles show.
Articles
Putting a value on nature: Edinburgh conference says business is ‘part of the solution’ Blue & Green Tomorrow, Nicky Stubbs (20/11/13)
Edinburgh forum says putting value on nature could save it BBC News, Claire Marshall (20/11/13)
Natural capital must be the way forward, says IUCN director general The Guardian, Tim Smedley (11/11/13)
Is ‘natural capital’ the next generation of corporate social responsibility? The Guardian, Tim Smedley (7/11/13)
Natural capital accounting: what’s all the fuss about? The Guardian, Alan McGill (27/9/13)
Put nature at the heart of economic and social policymaking The Guardian, Aniol Esteban (1/3/13)
Campaigners warn of dangers of ‘privatised nature’ The Scotsman, Ilona Amos (21/11/13)
Edinburgh conference attempts to ‘privatise nature’ World Development Movement, Miriam Ross (18/11/13)
Valuing Nature BBC Shared Planet, Monty Don (8/7/13)
Sites concerned with natural capital
World Forum on Natural Capital
TEEB for Business Coalition
International Union for Conservation of Nature
Questions
- How would you define natural capital?
- What are ecosystem services?
- Is social efficiency the best criterion for evaluating the use of the environment? What other criteria could you use?
- How would you set about deciding what rate of discount to use when evaluating the depletion of or enhancement of natural capital?
- How can game theory provide insights into the strategies of both businesses and governments towards the environment?
- What are the arguments for and against attempting to value natural capital and to incorporate these values in decision making?
For all households, energy is considered an essential item. As electricity and gas prices rise and fall, many of us don’t think twice about turning on the lights, cooking a meal or turning on the heating. We may complain about the cost and want prices brought down, but we still pay the bills. But, is there anything that can be done about high energy prices? And if there is, should anything be done?
The worlds of politics and economics are closely linked and Ed Miliband’s announcement of his party’s plans to impose a 20-month freeze on energy prices if elected in 2015 showed this relationship to be as strong as ever. The price freeze would certainly help average households reduce their cost of living by around £120 and estimates suggest businesses would save £1800 over this 20 month period. The energy companies have come in for a lot of criticism, in particular relating to their control of the industry. The sector is dominated by six big companies – your typical oligopoly, and this makes it very difficult for new firms to enter. Thus competition is restricted. But is a price freeze a good policy?
Part of the prices we pay go towards investment in cleaner and more environmentally friendly sources of energy. Critics suggest that any price freeze would deprive the energy sector of much needed investment, meaning our energy bills will be higher in the future. Furthermore, some argue this price freeze suggests that Labour is abandoning its environmental policy. Energy shortages have been a concern, especially with the cold weather the UK experienced a few years ago. This issue may reappear with price freezes. As Angela Knight, from Energy UK, suggests:
Freezing the bill may be superficially attractive, but it will also freeze the money to build and renew power stations, freeze the jobs and livelihoods of the 600,000-plus people dependent on the energy industry and make the prospect of energy shortages a reality, pushing up the prices for everyone.
There is a further concern and that is that large energy companies will be driven from the UK. This thought was echoed by many companies, in particular the British Gas owner Centrica, commenting that:
If prices were to be controlled against a background of rising costs it would simply not be economically viable for Centrica to continue to operate and far less to meet the sizeable investment challenge that the industry is facing…The impact of such a policy would be damaging for the country’s long-term prosperity and for our customers.
Share prices naturally fluctuate with global events and a political announcement such as this was inevitably going to cause an effect. But, perhaps the effect was not expected to be as big as the one we saw. 
Share prices for Centrica and SSE fell following the announcement – perhaps no great shock – but then they continued to fall. The market value tumbled by 5% and share prices kept falling. This has led to Ed Miliband being accused of ‘economic vandalism’ by a major shareholder of Centrica, which is hardly surprising, given the estimated cost of such a price freeze would be £4.5 billion.
The economic implications of such a move are significant. The announcement itself has caused massive changes in the FTSE and if such a move were to go ahead if Labour were elected in 2015, there would be serious consequences. While families would benefit, at least in the short term, there would inevitably be serious implications for businesses, the environmental policy of the government, especially relating to investment and the overall state of the economy. The following articles consider the aftermath of Ed Miliband’s announcement.
Miliband stands firm in battle over fuel bills plan The Guardian, Patrick Wintour and Terry Macalister (25/9/13)
Michael Fallon calls Miliband’s energy prices pledge ‘dangerous’ Financial Times, Elizabeth Rigby and Jim Pickard (26/9/13)
Britain’s labour treads narrow path between populism and prudence Reuters (26/9/12)
Ed Miliband’s radical reforms will make the energy market work for the many Independent (26/9/13)
Has Labour fallen out of love with Business? BBC News (26/9/13)
Top Centrica shareholder Neil Woodford accuses Labour leader Ed Miliband of economic vandalism The Telegraph, Kamal Ahmed (25/9/13)
Centrica and SSE slide after Labour price freeze pledge The Guardian (26/9/13)
Ed Miliband’s energy price freeze pledge is a timely but risky move The Guardian, Rowena Mason (24/9/13)
Questions
- Why are energy prices such a controversial topic?
- How are energy prices currently determined? Use a diagram to illustrate your answer. By adapting this diagram, illustrate the effect of a price control being imposed. How could it create an energy shortage? What impact would this have after the 20-month price freeze
- Why would there be adverse effects on energy companies if prices were frozen and costs increased? Use a diagram to illustrate the problem and use your answer to explain why energy companies might leave the UK.
- How would frozen energy prices help households and businesses?
- Why were share prices in Centrica and SSE adversely affected?
- Is there an argument for regulating other markets with price controls?
- Why is there such little competition in the energy sector?
The UK government has just given the go-ahead for the building of two new nuclear reactors at Hinkley Point in Somerset. The contract to build and run the power station will go to EDF, the French energy company.
The power station is estimated to cost some £14 billion to build. It would produce around 7% of the UK’s electricity. Currently the 16 nuclear reactors in the UK produce around 19%. But all except for Sizewell B in Suffolk are due to close by 2023, although the lives of some could be extended. There is thus a considerable energy gap to fill in the coming years.
Several new nuclear power stations were being considered to help fill this gap, but with rising capital costs, especially following the Fukushima disaster in Japan, potential investors pulled out of other negotiations. Hinkley Point is the only proposal left. It’s not surprising that the government wants it to go ahead.
All that remains to agree is the price that EDF can charge for the electricity generated from the power station. This price, known as the ‘strike price’, is a government-guaranteed price over the long term. EDF is seeking a 40-year deal. Some low carbon power stations, such as nuclear and offshore wind and wave power stations, have high capital costs. The idea of the strike price is to reduce the risks of the investment and make it easier for energy companies to estimate the likely return on capital.
But the strike price, which will probably be agreed at around £95 per megawatt hour (MWh), is roughly double the current wholesale price of electricity. EDF want a price of around £100 per MWh, which is estimated to give a return on capital of around 10%. The government was hoping to agree on a price nearer to £80 per MWh. Either way, this will require a huge future subsidy on the electricity generated from the plant.
There are several questions being asked about the deal. Is the strike price worth paying? Are all the costs and benefits properly accounted for, including environmental costs and benefits and safety issues? Being an extremely long-term project, are uncertainties over costs, performance of the plant, future market prices for electricity and the costs of alternative forms of power generation sufficiently accounted for? Will the strike price contravene EU competition law? Is the timescale for construction realistic and what would be the consequences of delays? The articles consider these questions and raise a number of issues in planning very long-term capital projects.
Articles
Hinkley Point: Britain’s second nuclear age given green light as planning permission is approved for first of new generation atomic power stations Independent, Michael McCarthy (19/3/13)
Will they or won’t they? New nuclear hangs in the balance ITV News, Laura Kuenssberg (19/3/13)
Hinkley Point C: deal or no deal for UK nuclear? The Telegraph, Alistair Osborne (19/3/13)
New nuclear power plant at Hinkley Point C is approved BBC News (20/3/13)
Britain’s Plans for New Nuclear Plant Approach a Decisive Point, 4 Years Late New York Times, Stanley Reed and Stephen Castle (15/3/13)
Nuclear power plans threatened by European commission investigation The Guardian (14/3/13)
New Hinkley Point nuclear power plant approved by UK government Wired, Ian Steadman (19/3/13)
Renewable energy providers to help bear cost of new UK nuclear reactors The Guardian, Damian Carrington (27/3/13)
Europe backs Hinkley nuclear plant BBC News (8/10/14)
Information/Reports/Journal Articles
Environmental permitting of Hinkley Point C Environment Agency
NNB Generation Company Limited, Radioactive Substances Regulations, Environmental Permit Application for Hinkley Point C: Chapter 7, Demonstration of Environmental Optimisation EDF
Greenhouse Gas Emission of European Pressurized Reactor (EPR) Nuclear Power Plant Technology: A Life Cycle Approach Journal of Sustainable Energy & Environment 2, J. Kunakemakorn, P. Wongsuchoto, P. Pavasant, N. Laosiripojana (2011)
Questions
- Compare the relative benefits of a construction subsidy and a subsidised high strike price from the perspectives of (a) the government (b) EDF.
- What positive and negative externalities are involved in nuclear power generation?
- What difficulties are there in valuing these externalities?
- What is meant by catastrophic risk? Why is this difficult to take account of in any cost–benefit analysis?
- What is meant by a project’s return on capital? Explain how discounted cash flow techniques are used to estimate this return.
- What should be taken into account in deciding the rate of discount to use?
- How should the extra jobs during construction of the plant and then in the running of the plant be valued when making the decisions about whether to go ahead?
The environment has been a growing part of government policy for many years. With the Kyoto Protocol and Europe’s carbon trading system, effort has been made to reduce carbon emissions. Part of UK policy to meet its emission’s target requires substantial investment in infrastructure to provide efficient energy.
Details of the government’s Energy Bill sets out plans that will potentially increase average household energy bills by about £100 per annum, although estimates of this vary from about £90 to £170. This money will be used to finance much needed investment in infrastructure that will allow the UK to meet its carbon emissions target. With this extra cost on bills, energy companies will increase bring in something like £7.6bn. The benefit of this higher cost is that investment today will lead to lower energy bills tomorrow. Essentially, we’re looking at a short-term cost for a long-term gain.
The Energy Bill also delayed setting a carbon emission target until 2016. Crucially, this will come after the next election. Environmentalists have naturally criticised this omission. John Sauven of Greenpeace said:
’By failing to agree to any carbon target for the power sector until after the next election, David Cameron has allowed a militant tendency within his own ranks to derail the Energy Bill … It’s a blatant assault on the greening of the UK economy that leaves consumers vulnerable to rising gas prices, and sends billions of pounds of clean-tech investment to our economic rivals.’
One further problem that this lack of a target creates is uncertainty. The energy sector requires significant investment and in order to be encouraged to invest, firms need assurances. Without knowing the target and hence facing a degree of uncertainty, firms may be less likely to invest in building new power plants. And this investment is crucial. The Government has committed to replacing most coal-fired power stations across Britain with low carbon technology at a cost of hundreds of billions of pounds. However, the Chancellor has said “he would not allow saving the planet to come at the cost of ‘putting our country out of business.’”
When this Energy Bill is published, it is claimed that £110bn of spending on different aspects of the National Grid will occur. The suggestion is that this will generate a further 250,000 jobs by 2030 and will be a big step in the right direction towards creating an economy that is more reliant on clean energy.
The following articles consider the wide range of issues surrounding the Energy Bill.
’It’s reasonable to hike energy bills to build wind farms’ says Tim Yeo The Telegraph, Rowena Mason (23/11/12)
Energy Bill to increase prices to fund cleaner fuel BBC News (23/11/12)
Energy deal means bills will rise to pay for green power The Guardian, Juliette Jowit and Fiona Harvey (23/11/12)
Energy Bill Q&A BBC News (23/11/12)
Energy bills to rise by £170 a year to fund wind farms Independent, Andrew Woodcock and Emily Beament (23/11/12)
Energy deal – but no target to cut Britain’s carbon emissions Independent, Nigel Morris (22/11/12)
Davey defends contentious energy agreement Financial Times, Jim Pickard, Pilita Clark and Hannah Kuchler (23/11/12)
Energy bill lacks emissions target Channel 4 News (23/11/12)
Questions
- Why does the environment require so much government intervention? Think about the different ways in which the environment as a market fails.
- If household bills rise, is there likely to be an income and substitution effect between consumption of ‘energy’ and other goods? Which direction will each effect move in and which do you think would be the largest?
- Why is uncertainty such a deterrent for investment? Why does a lack of a carbon emissions target represent uncertainty?
- The higher cost of bills today may enable future bills to fall. Why is this? For a household, explain why discount factors could be important here.
- Why do some argue that the extra cost to households set out by the government are likely to under-estimate the actual increase households will face?
- Is the Chancellor right to say that he will not put our country out of business to save the planet?
On my commute to work on the 6th October, I happened to listen to a programme on BBC radio 4, which provided some fascinating discussion on climate change, growth, capitalism and the need for co-operation. With more countries emerging as leading economic powers, pollution and emissions continue to grow. Is it time for a green revolution?
