Tag: environmental externalities

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Should train companies scrap peak-time fares?

In many countries, train fares at peak times are higher than at off-peak times. This is an example of third-degree price discrimination. Assuming that peak-time travellers generally have a lower price elasticity of demand, the policy allows train companies to increase revenue and profit.

If the sole purpose of ticket sales were to maximise profits, the policy would make sense. Assuming that higher peak-time fares were carefully set, although the number travelling would be somewhat reduced, this would be more than compensated for by the higher revenue per passenger.

But there are external benefits from train travel. Compared with travel by car, there are lower carbon emissions per person travelling. Also, train travel helps to reduce road congestion. To the extent that higher peak-time fares encourage people to travel by car instead, there will be resulting environmental and congestion externalities.

The Scottish experiment with abolishing higher peak-time fares

In October 2023, the Scottish government introduced a pilot scheme abolishing peak-time fares, so that tickets were the same price at any time of the day. The idea was to encourage people, especially commuters, to adopt more sustainable means of transport. Although the price elasticity of demand for commuting is very low, the hope was that the cross-price elasticity between cars and trains would be sufficiently high to encourage many people to switch from driving to taking the train.

One concern with scrapping peak-time fares is that trains would not have the capacity to cope with the extra passengers. Indeed, one of the arguments for higher peak-time fares is to smooth out the flow of passengers during the day, encouraging those with flexibility of when to travel to use the cheaper and less crowded off-peak trains.

This may well apply to certain parts of the UK, but in the case of Scotland it was felt that there would be the capacity to cope with the extra demand at peak time. Also, in a post-COVID world, with more people working flexibly, there was less need for many people to travel at peak times than previously.

Reinstatement of peak-time fares in Scotland

It was with some dismay, therefore, especially by commuters and environmentalists, when the Scottish government decided to end the pilot at the beginning of October 2024 and reinstate peak-time fares – in many cases at nearly double the off-peak rates. For example, the return fare between Glasgow and Edinburgh rose from £16.20 to £31.40 at peak times.

The Scottish government justified the decision by claiming that passenger numbers had risen by only 6.8%, when, to be self-financing, an increase of 10% would have been required. But this begs the question of whether it was necessary to be self-financing when the justification was partly environmental. Also, the 6.8% figure is based on a number of assumptions that could be challenged (see The Conversation article linked below). A longer pilot would have helped to clarify demand.

Other schemes

A number of countries have introduced schemes to encourage greater use of the railways or other forms of public transport. One of these is the flat fare for local journeys. Provided that this is lower than previously, it can encourage people to use public transport and leave their car at home. Also, its simplicity is also likely to be attractive to passengers. For example, in England bus fares are capped at £2. Currently, the scheme is set to run until 31 December 2024.

Another scheme is the subscription model, whereby people pay a flat fee per month (or week or year, or other time period) for train or bus travel or both. Germany, for example, has a flat-rate €49 per month ‘Deutschland-Ticket‘ (rising to €58 per month in January 2025). This ticket provides unlimited access to local and regional public transport in Germany, including trains, buses, trams, metros and ferries (but not long-distance trains). This zero marginal fare cost of a journey encourages passengers to use public transport. The only marginal costs they will face will be ancillary costs, such as getting to and from the train station or bus stop and having to travel at a specific time.

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Questions

  1. Identify the arguments for and against having higher rail fares at peak times than at off-peak times
  2. Why might it be a good idea to scrap higher peak-time fares in some parts of a country but not in others?
  3. Provide a critique of the Scottish government’s arguments for reintroducing higher peak-time fares.
  4. With reference to The Conversation article, why is it difficult to determine the effect on demand of the Scottish pilot of scrapping peak-time fares?
  5. What are the arguments for and against the German scheme of having a €49 per month public transport pass for local and regional transport with no further cost per journey? Should it be extended to long-distance trains and coaches?
  6. In England there is a flat £2 single fare for buses. Would it be a good idea to make bus travel completely free?
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Debt-for-nature swaps – some good news

A happy New Year for 2024. Let’s hope that the coming year brings some good news amidst all the the gloom of war, squeezed living standards, the effects of climate change and the rise of authoritarian regimes.

One piece of good news is the growth in environmental debt swaps in developing countries. These are known as debt-for-nature swaps (or debt-for-environment swaps or green debt swaps). As Case Study 26.16 in Economics (11th edition) and Case Study 15.19 in Essentials of Economics (9th edition) explain:

A debt-for-nature swap is where debts are cancelled in return for investment in environmental projects, including protecting biodiversity, reducing carbon emissions and mitigating the effect of climate change. There are two types of scheme: bilateral and commercial.

In a bilateral swap, a creditor country agrees to cancel debt in return for the debtor country investing a proportion of the amount in environmental projects. In a commercial swap, the debt owed to banks is sold to an international environmental agency at a substantial discount (or sometimes even given away); the agency then agrees to cancel this debt in return for the country funding the agency to carry out various environmental projects.

The first debt-for-nature swap was made as far back as 1987, when environmental NGO, Conservation International, arranged for Bolivia to be forgiven $650 000 of its debt in exchange for the establishment of three conservation areas bordering the Beni Reserve (see either of the above case studies). In the 1990s and 2000s, debt-for nature swaps became popular with creditors and by 2010, the total debt cancelled through debt-for-nature swaps was just over $1 billion.

However, the popularity waned in the 2010s and with COVID, many developing countries were diverting resources from long-term sustainability and mitigating the effects of climate change to emergency healthcare and relief.

More recently, debt-for-for nature swaps have become popular again.

In May 2023, Ecuador benefited from the biggest debt swap to that point. The agreement saw $1.6bn of its commercial debt refinanced at a discount in exchange for large-scale conservation in and around the Galápagos Islands. At least $12m per year of the money saved will be channelled into conservation in the archipelago, with its unique flora and fauna.

Such projects are set to increase, with potentially significant beneficial effects for biodiversity, climate and the environment generally. At the COP28 summit in December 2023, a task force was set up by a group of multilateral development banks to promote an increase in the size and number of debt-for-nature swaps.

According to the Organisation for Economic Co-operation and Development (OECD), developing economies will need an annual $2.4 trillion of investment in climate action in the coming years. So far, the market for debt-for-nature swaps is set to rise to around $800bn. If they are to make a significant contribution to tackling climate change and loss of biodiversity, they need to be scaled up massively, especially as the cost of servicing debt has risen with higher global interest rates.

Nevertheless, as part of a portfolio of measures to tackle debt, climate change, loss of biodiversity and damage to the environment more generally, they are making an important contribution – a contribution that is set to rise.

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Questions

  1. Identify other types of debt swap and discuss their importance.
  2. Why are debt-for-nature debt swaps in the interests of debtor countries, creditors and the world generally?
  3. What is ‘green washing’? How may debt-for-nature swaps be assessed to prevent such green washing?
  4. Why are many developing countries’ debt burdens skyrocketing?
  5. Why may a developing country’s solution to its growing debt be detrimental to the environment?
  6. Assess the Belize debt-swap deal in tackling both its debt and conservation.
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Global boiling – why not take urgent action now?

The global average temperature for July 2023 was the highest ever recorded and July 3rd was the world’s hottest day on record. We’ve seen scenes of wildfires raging across much of southern Europe, people suffering searing temperatures in south-west USA, southern India and western China, flash floods in South Korea, Japan and eastern USA. These are all directly related to global warming, which is causing weather systems to become more extreme. And as the planet continues to warm, so these problems will intensify.

The Secretary General of the United Nations, Antonio Guterres, in a press conference on 27 July warned that:

Climate change is here. It is terrifying. And it is just the beginning. The era of global warming has ended; the era of global boiling has arrived. The air is unbreathable. The heat is unbearable. And the level of fossil-fuel profits and climate inaction is unacceptable. Leaders must lead. No more hesitancy. No more excuses. No more waiting for others to move first. There is simply no more time for that.

The environmental, human, social and economic impact of global warming is huge, but concentrated on just part of the world’s population. For many, a more variable climate is at worst an inconvenience – at least in the short term. But it is the short term that politicians are most concerned about when seeking to win the next election.

Tackling climate change requires action to reduce carbon emissions now, even though the effects take many years. But one person’s emissions make only a minuscule contribution to global warming. So why not be selfish and carry on driving, flying off on holiday, using a gas boiler and eating large amounts of red meat? This is what many people want to do and governments know it. Many people do not like green policies as they involve sacrifice. Examples include higher fuel prices and restrictions on what you can do. So, despite the visions of fires, floods and destruction, governments are wary about raising fuel taxes, airport duties and charges to use old high-emission cars in cities; wary about raising taxes generally to provide subsidies for sustainable power generation; wary about banning new oil and gas fields that would reduce reliance on imported fuel.

Because the external costs of carbon emissions are so high and global, government action is required to change behaviour. Education can help and scenes of devastation from around the world may change the hearts and minds or some people. Also, the prospect of profits from cleaner and more fuel-efficient technology can help to spur innovation and investment. But to meet net zero targets still requires policies that are unpopular with many people who might be inconvenienced or have to pay higher petrol, energy and food prices, especially at a time when budgets are being squeezed by inflation.

Part of the problem is a distributional one. The people most affected by the cost-of-living crisis and higher interest rates are those on lower incomes and with higher debts. Politicians know that it will be hard to win the votes of such people if they are faced with higher green taxes. As elections approach, politicians are likely to backtrack on many environmental commitments to appeal to such people.

This is beginning to happen in the UK, with the government declaring that it is on the side of the motorist. Indeed, Rishi Sunak has just announced that the government will authorise more than 100 new licenses for new oil and gas wells in the North Sea. This is despite the United Nations, various other international bodies, climate scientists and charities calling for a halt to all licensing and funding of new oil and gas development from new and existing fields. The government argues that increased North Sea production would reduce the reliance on imported oil.

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Questions

  1. In what sense is the environment a ‘public good’? How is the concept of externalities relevant in analysing the private decisions made about the use of a public good?
  2. How may game theory be used to help understand the difficulties in reaching international agreement about climate change policies?
  3. What is meant by ‘net zero’? Is carbon capture and storage an acceptable alternative to cutting carbon emissions?
  4. In what ways could policies to tackle climate change be designed to reduce income inequality rather than increase it?
  5. What are the arguments for and against banning (a) petrol and diesel cars; (b) gas boilers; (c) fossil-fuel power stations? How much notice should be given if such bans are to be introduced?
  6. What is meant by ‘nudge theory’? In what ways could people be nudged into making greener decisions?
  7. What are the arguments for and against granting new licences for North Sea oil and gas drilling? Explain where you feel the balance of the arguments lies.
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Tackling climate change: ‘Everything, everywhere, all at once’

The United Nations International Panel on Climate Change (IPCC) has just published its most comprehensive report so far. It finds that ‘human activities, principally through emissions of greenhouse gases, have unequivocally caused global warming’. This has led to widespread and rapid changes in climate and biodiversity and to more extreme weather patterns, such as droughts, floods and hurricanes. What is more, the distribution of these effects is uneven, with communities who have contributed the least to current climate change being disproportionately affected.

At the 2015 COP21 climate change conference in Paris (see also), it was agreed to adopt policies to limit the increase in global temperatures to ‘well below’ 2°C above pre-industrial levels and to make an effort to limit it to 1.5°C. Global temperatures have already risen 1.1°C above 1850–1900 levels and are set to reach 1.5°C in the early 2030s. Every increment of global warming will intensify ‘multiple and concurrent hazards’.

Deep, rapid and sustained reductions in emissions would slow down the rise in global temperatures, but even with such reductions, temperatures will still exceed 1.5°C in the next few years and, even under the best-case scenario, would not fall below 1.5°C again until the end of the 21st century. Under more pessimistic scenarios, global temperatures could rise to 2.7°C above pre-industrial levels by the end of the century under an intermediate greenhouse gas emissions scenario and to 4.4°C under a very high emissions scenario. Anything above 2°C would be likely to have catastrophic effects. The longer countries wait to take action, the greater the rise in global temperatures and hence the greater the damage and the more costly it will be to rectify it.

‘For any given future warming level… projected long-term impacts are up to multiple times higher than currently observed (high confidence). Risks and projected adverse impacts and related losses and damages from climate change escalate with every increment of global warming (very high confidence). Climatic and non-climatic risks will increasingly interact, creating compound and cascading risks that are more complex and difficult to manage (high confidence).’ (Paragraph B2)

But the report is not all ‘doom and gloom’. It is possible to limit global warming to 1.5°C or only a little over by making rapid, deep and, in most cases, immediate greenhouse gas emissions reductions in all sectors and reaching net zero emissions in the early 2050s. Science and technology have the answers – answers that are now much cheaper and more available than back in 2015 when the 1.5°C target was agreed. But what it does require is doing ‘everything, everywhere, all at once’. And that requires political will and the right economic incentives.

The politics and economics of achieving net zero

In terms of the politics, there is general global agreement by governments about the likely effects of climate change. And most governments agree that action needs to be taken. However, there are three key political problems.

The first is that the costs of action will be borne now, while the benefits of action will accrue over a much longer period of time. This links to the second problem – the mismatch between the lives of governments and the long-term effects of climate change. If governments put off doing anything now and merely promise that something will be done in the future, they will not have to take unpopular actions, such as raising taxes on energy, private transport and certain goods or banning various activities. Future governments will have to sort things out, by when, although the problems will be greater, the existing politicians will no longer be in power.

The third problem concerns the distribution of the costs and benefits of action. The major emitters of carbon are the rich countries, while the major sufferers are poor people in countries subject to drought, flooding and rising sea levels. Not surprisingly, who should cut down on emissions and pay for the mitigation necessary in many of the poorer countries is a difficult political issue, which is why it’s much easier to say what needs to be achieved overall than precisely what measures should be taken by which countries.

These problems reflect the fact that many, if not most, of the environmental costs of production and consumption are external costs – costs borne, not by the direct producer or consumer, but by other people at other places and/or in the future.

Nevertheless, the relative costs of moving to greener production and consumption are falling. The costs of renewable energy, including solar power, onshore and offshore wind and hydroelectric power are falling relative to that generated from fossil fuels. At the same time, the take up of electric cars is likely to continue rising as battery technology improves. This does, of course, require an increase in charging infrastructure. Domestic heat pump technology is improving and home insulation methods are becoming more efficient.

Persuading consumers and firms to take account of environmental externalities could in part be achieved by education. It makes it much easier for politicians to take appropriate action now if their populations are on board. There has been increasing awareness over the years of the environmental impact of people’s actions. People have become more willing to take responsibility for the world that future generations will inherit. This is helped both by education in schools and colleges and by frequent items in the media.

But incentives also have a major part to play. To internalise environmental externalities, external costs could be taxed and external benefits subsidised.

The effect of a carbon tax on production

The use of taxes to reduce activities with negative environmental externalities is illustrated in the diagram (click here for a PowerPoint). It takes the case of carbon emissions from coal-fired electricity generation in a large country. To keep the analysis simple, it is assumed that all electricity in the country is generated from coal-fired power stations and that there are many such power stations, making the market perfectly competitive.

It is assumed that all the benefits from electricity production accrue solely to the consumers of electricity (i.e. there are no external benefits from consumption). Marginal private and marginal social benefits of the production of electricity are thus the same (MPB = MSB). The curve slopes downwards because, with a downward-sloping demand for electricity, higher output results in a lower marginal benefit (diminishing marginal utility).

Competitive market forces, with producers and consumers responding only to private costs and benefits, will result in a market equilibrium at point a in the diagram: i.e. where demand equals supply. The market equilibrium price is P0 while the market equilibrium quantity is Q0. However the presence of external costs in production means that MSC > MPC. In other words, MEC = b – a.

The socially optimal output would be Q* where P = MSB = MSC, achieved at the socially optimal price of P*. This is illustrated at point d and clearly shows how external costs of production in a perfectly competitive market result in overproduction: i.e. Q0 > Q*. From society’s point of view, too much electricity is being produced and consumed.

If a carbon tax of d – c is imposed on the electricity producers, it will now be in producers’ interests to produce at Q*, where their new private marginal costs (including tax) equals their marginal private benefit.

But this brings us back to the politics of measures to reduce emissions. People do not like paying higher taxes. In his latest Budget, the UK Chancellor, Jeremy Hunt, decided not to raise fuel duties by the 12p that had been previously planned, despite fuel prices having recently fallen. Meanwhile, charging prices for electric cars have risen.

Other economic measures

A simpler method for dealing with environmental externalities is ban certain activities that omit CO2. For example, in the UK there will be a ban on the sale of new petrol and diesel cars and vans from 2030 (with the exception of some low-emission hybrids until 2035). In the EU there will be a similar ban from 2035. Clearly, such measures are only suitable when there are non-emitting alternatives.

Another alternative is a cap-and-trade system, such as the European Emissions Trading Scheme. It involves setting quotas for emissions and allowing firms which manage to cut emissions to sell their surplus permits to less efficient firms. This puts a price pressure on firms to be more efficient. But the quotas (the ‘cap’) must be sufficiently tight if emissions are going to be cut to desired levels. Nevertheless, it is an efficient way of cutting emissions as it gives a competitive advantage to low-emission producers.

Conclusion

If the problem of global warming is to be limited to 1.5°C, or only very little above, multiple solutions will need to be found and there must be a combination of political will, economic incentives and the mobilisation of scientific and technical know-how. As the Secretary-General of the United Nations, António Guterres, stated in launching the new report:

This report is a clarion call to massively fast-track climate efforts by every country and every sector and on every timeframe. In short, our world needs climate action on all fronts – everything, everywhere, all at once.

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Questions

  1. Why might countries not do ‘everything, everywhere, all at once’ to avert climate change?
  2. What might an optimist conclude from the ICC report?
  3. To what extent is climate change an economic problem?
  4. On a diagram similar to the one above, show how a subsidy could be used to internalise positive externalities.
  5. How might countries reduce the consumption of fossil fuels in the most efficient way? Are they likely to want to do this? Explain.
  6. Is a ‘cap-and-trade’ (tradable permits) system (a) an effective means of reducing emissions; (b) an efficient system?
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The growth of autarky: is globalisation dead?

Over the decades, economies have become increasingly interdependent. This process of globalisation has involved a growth in international trade, the spread of technology, integrated financial markets and international migration.

When the global economy is growing, globalisation spreads the benefits around the world. However, when there are economic problems in one part of the world, this can spread like a contagion to other parts. This was clearly illustrated by the credit crunch of 2007–8. A crisis that started in the sub-prime market in the USA soon snowballed into a worldwide recession. More recently, the impact of Covid-19 on international supply chains has highlighted the dangers of relying on a highly globalised system of production and distribution. And more recently still, the war in Ukraine has shown the dangers of food and fuel dependency, with rapid rises in prices of basic essentials having a disproportionate effect on low-income countries and people on low incomes in richer countries.

Moves towards autarky

So is the answer for countries to become more self-sufficient – to adopt a policy of greater autarky? Several countries have moved in this direction. The USA under President Trump pursued a much more protectionist agenda than his predecessors. The UK, although seeking new post-Brexit trade relationships, has seen a reduction in trade as new barriers with the EU have reduced UK exports and imports as a percentage of GDP. According to the Office for Budget Responsibility’s November 2022 Economic and Fiscal Outlook, Brexit will result in the UK’s trade intensity being 15 per cent lower in the long run than if it had remained in the EU.

Many European countries are seeking to achieve greater energy self-sufficiency, both as a means of reducing reliance on Russian oil and gas, but also in pursuit of a green agenda, where a greater proportion of energy is generated from renewables. More generally, countries and companies are considering how to reduce the risks of relying on complex international supply chains.

Limits to the gains from trade

The gains from international trade stem partly from the law of comparative advantage, which states that greater levels of production can be achieved by countries specialising in and exporting those goods that can be produced at a lower opportunity cost and importing those in which they have a comparative disadvantage. Trade can also lead to the transfer of technology and a downward pressure on costs and prices through greater competition.

But trade can increase dependence on unreliable supply sources. For example, at present, some companies are seeking to reduce their reliance on Taiwanese parts, given worries about possible Chinese actions against Taiwan.

Also, governments have been increasingly willing to support domestic industries with various non-tariff barriers to imports, especially since the 2007–8 financial crisis. Such measures include subsidies, favouring domestic firms in awarding government contracts and using regulations to restrict imports. These protectionist measures are often justified in terms of achieving security of supply. The arguments apply particularly starkly in the case of food. In the light of large price increases in the wake of the Ukraine war, many countries are considering how to increase food self-sufficiency, despite it being more costly.

Also, trade in goods involves negative environmental externalities, as freight transport, whether by sea, air or land, involves emissions and can add to global warming. In 2021, shipping emitted over 830m tonnes of CO2, which represents some 3% of world total CO2 emissions. In 2019 (pre-pandemic), the figure was 800m tonnes. The closer geographically the trading partner, the lower these environmental costs are likely to be.

The problems with a globally interdependent world have led to world trade growing more slowly than world GDP in recent years after decades of trade growth considerably outstripping GDP growth. Trade (imports plus exports) as a percentage of GDP peaked at just over 60% in 2008. In 2019 and 2021 it was just over 56%. This is illustrated in the chart (click here for a PowerPoint). Although trade as a percentage of GDP rose slightly from 2020 to 2021 as economies recovered from the pandemic, it is expected to have fallen back again in 2022 and possibly further in 2023.

But despite this reduction in trade as a percentage of GDP, with de-globalisation likely to continue for some time, the world remains much more interdependent than in the more distant past (as the chart shows). Greater autarky may be seen as desirable by many countries as a response to the greater economic and political risks of the current world, but greater autarky is a long way from complete self-sufficiency. The world is likely to remain highly interdependent for the foreseeable future. Reports of the ‘death of globalisation’ are premature!

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Questions

  1. Explain the law of comparative advantage and demonstrate how trade between two countries can lead to both countries gaining.
  2. What are the main economic problems arising from globalisation?
  3. Is the answer to the problems of globalisation to move towards greater autarky?
  4. Would the expansion/further integration of trading blocs be a means of exploiting the benefits of globalisation while reducing the risks?
  5. Is the role of the US dollar likely to decline over time and, if so, why?
  6. Summarise Karl Polanyi’s arguments in The Great Transformation (see the Daniel W. Drezner article linked below). How well do they apply to the current world situation?