What Is Environmental Economics?

Environmental economics is the study of the cost-effective allocation, use, and protection of the world's natural resources. Economics, broadly speaking, is the study of how humans produce and consume goods and services. Environmental economics focuses on how they use and manage finite resources in a manner that serves the population while meeting concerns about environmental impact.

This helps governments weigh the pros and cons of alternative measures and design appropriate environmental policies.

Understanding Environmental Economics

The basic theory underpinning environmental economics is that environmental amenities (or environmental goods) have economic value and there are costs to economic growth that are not accounted for in more traditional models.

Environmental goods include things like access to clean water, clean air, the survival of wildlife, and the general climate. Although it is hard to put a price tag on environmental goods, there may be a high cost when they are lost. Environmental goods are usually difficult to fully privatize and subject to the tragedy of the commons.

Destruction or overuse of environmental goods, like pollution and other kinds of environmental degradation, can represent a form of market failure because it imposes negative externalities. Environmental economists analyze the costs and benefits of specific economic policies that seek to correct such problems, and they may run theoretical tests or studies on the possible consequences of these policies.

Strategies in Environmental Economics

Environmental economists are concerned with identifying specific problems, but there can be many approaches to solving the same environmental issue. If a state is trying to impose a transition to clean energy, for example, they have several options. The government can impose a fixed limit on carbon emissions, or it can adopt more incentive-based solutions, like placing quantity-based taxes on emissions or offering tax credits to companies that adopt renewable power sources.

Mitigation banking is a system of credits and debits that ensure ecological loss is compensated through preservation and restoration. Primarily mitigation banking deals with wetland and stream preservation. It is simular to conservation banking which deals with endangered species.

All of these strategies rely on state intervention in the market, but some governments prefer to use a light touch and others may be more assertive. The degree of acceptable state intervention is an important political factor in determining environmental economic policy. Broadly speaking, environmental economics may produce two types of policies:

Prescriptive Regulations

In a prescriptive approach, the government dictates specific measures to reduce environmental harm. For example, they may prohibit highly-polluting industries, or require certain emissions-controlling technologies.

Market-Based Regulations

Market-based policies use economic incentives to encourage desired behaviors. For example, cap-and-trade regulations do not prohibit companies from pollution, but they place a financial burden on those who do. These incentives reward companies for reducing their emissions, without dictating the method they use to do so.

Challenges of Environmental Economics

Because the nature and economic value of environmental goods often transcend national boundaries, environmental economics frequently requires a transnational approach. For example, an environmental economist could identify overfishing as a negative externality to be addressed.

The United States could impose regulations on its own fishing industry, but the problem wouldn't be solved without similar action from many other nations. The global character of such environmental issues has led to the rise of non-governmental organizations (NGOs) like the Intergovernmental Panel on Climate Change (IPCC), which organizes annual forums for heads of state to negotiate international environmental policies.

Another challenge of environmental economics is the degree to which its findings affect other industries. More often than not, findings from environmental economists can result in controversy, and their policy prescriptions may be difficult to implement due to the complexity of the world market.

The presence of multiple marketplaces for carbon credits is an example of the chaotic transnational implementation of ideas stemming from environmental economics. Fuel economy standards set by the Environmental Protection Agency (EPA) are another example of the balancing act required by policy proposals related to environmental economics.

In the U.S., policy proposals stemming from environmental economics tend to cause contentious political debate. Leaders rarely agree about the degree of externalized environmental costs, making it difficult to craft substantive environmental policies. The EPA uses environmental economists to conduct analysis-related policy proposals.

These proposals are then vetted and evaluated by legislative bodies. The EPA oversees a National Center for Environmental Economics, which emphasizes market-based solutions like cap and trade policies for carbon emissions. Their priority policy issues are encouraging biofuel use, analyzing the costs of climate change, and addressing waste and pollution problems.

Example of Environmental Economics

A prominent contemporary example of the use of environmental economics is the cap and trade system. Companies purchase carbon offsets from developing countries or environmental organizations to make up for their carbon emissions. Another example is the use of a carbon tax to penalize industries that emit carbon.

Corporate average fuel economy (CAFE) regulations are another example of environmental economics at work. These regulations are prescriptive and specify the gallons per mile of gas for cars for car makers. They were introduced during the 1970s to promote fuel efficiency in an era of gas shortages.