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CHAPTER OUTLINE
I. Chapter 20 examines the economics of managing natural resources, including
environmental quality. Few developing countries have been able to convert
resource wealth into rapid economic growth. Too often, resources are degraded
or depleted without producing sustainable development. The inef ciencies
stem partly from market failures. For example, open access to a common
resource— including forests, shing stocks, wildlife, aquifers, soils, rangeland,
and the air we breathe— leads to excessive depletion. More broadly, the exploi-
tation of natural resources creates external diseconomies, including conges-
tion, erosion, and pollution. With such externalities, competitive markets
exploit the resources beyond the point that maximizes net bene ts to society.
II. Economic analysis provides rules for the sustainable harvest of renewable
resources and for the optimal rate of depletion of nonrenewable resources.
The general rule is to maximize the discounted present value of resource rents
(net revenues). One implication is that the present generation, with reinvest–
ments, can exploit nonrenewable resources without sacri cing the welfare of
future generations. The higher the real return is on alternative investments
(and thus the discount rate), the greater the warranted rate of exploitation. In
order to mea sure sustainable development, adjusted net savings (ANS) has
been de ned to include depreciation of natural resources to the traditional
net savings model. The rate of ANS is just as vital as the ANS itself in deter–
mining whether there will be wealth to compensate for the future population
growth.
III. The fact that externalities cause markets to overexploit resources suggests
that government controls are needed for an ef cient outcome. Most countries
respond with arbitrary regulations, but it is dif cult for any government to
Sustainable Development
CHAPTER 20
144 | Chapter 20
regulate ef ciently. A better solution is to internalize external costs so market
participants will take the costs into account. One way to do this is to confer
long- term, transferable property rights. A second device is to impose taxes
that approximate the external costs. A more ef cient technique is to introduce
marketable permits that entitle the holders to use the resource. The permit is
a property right with a market value; use of the permit therefore entails an
opportunity cost that internalizes the externality. Furthermore, using the
concept of marginal externalities, one can mea sure the optimal level of pollu-
tion (which is not equal to zero). All three of these are ways to correct the
market rather than regulate it.
IV. Minimizing government intrusion is desirable because policy failures are
another major cause of resource mismanagement. Through protectionist trade
mea sures, tax breaks, energy subsidies, and poorly appraised infrastructure
investments, government interventions often accentuate the wasteful use of
scarce resources. However, informal regulation is an alternative to govern–
ment regulation. It often involves public disclosure of information pertaining
to environmental rec ords. This form of regulation is especially attractive to
developing nations.
V. With any form of intervention, including government regulation, adverse effects
are a possibility. It is dif cult to nd the right balance of how much intervention
and which form of intervention are needed to reach optimal levels and avoid
policy failures. The previous sections draw attention to resource degradation,
wastefulness, and external costs as potential results from inef cient resource
management. There are clear links between poverty and the environment. It is
always important to remember the three primary goals for development: eco-
nomic growth, poverty alleviation, and environmental sustainability.
VI. A nal issue is sustainable development. Many uncertainties remain concern-
ing the long– term effects of pollution, but history consistently has disproved
simple Malthusian views that the world is running out of resources. One
reason is that technology has more than kept pace with population. More to
the point, neoclassical economics shows that markets respond to scarcity by
inducing substitutions, conservation, exploration for new reserves, and devel-
opment of alternative materials. Hence, a sound strategy for sustainable devel-
opment is to promote ef cient markets, effective property rights, and a
minimum of distortionary interventions. Because poverty is a powerful imped-
iment to conservation and prudent management of resources, economic devel-
opment is itself part of the solution. In this regard, the rich nations have a great
stake in promoting development of the poor nations.
Sustainable Development | 145
Boxed Examples
Box 20– 1: The Malthusian Effect of Population Growth on Adjusted Net
Savings in Ghana
Box 20–2: Taxing Water Pollution in Colombia
Box 20– 3: Policy Failures and Deforestation in Indonesia
Three new box studies are contained in this chapter. The rst box study examines
through Malthusian lenses how comprehensive wealth grew in Ghana, but fell,
per capita. The rate of ANS did not keep up with the population. The second box
study discusses how a new regulation in Colombia charged a tax to facilities caus-
ing pollution. There were many barriers to this policy, but wastewater discharges
have been signi cantly reduced. The nal box study discusses how government
intervention in Indonesia restricted the export of raw material, causing overcapac-
ity. Deforestation continued to occur, primarily to make room for other industry.
In the New Edition
Chapter 20 is essentially a new treatment of the subject, retaining from the previ-
ous edition only the discussion of market and policy failures. New topics
addressed in this edition include: the environmental Kuznets curve hypothesis,
an expanded and more analytical treatment of the concept and mea sure ment of
sustainable development, institutional perspectives on externalities (drawing on
the work of Elinor Ostrom), payments for environmental ser vices as a response to
externalities, a substantially expanded treatment of poverty- environment link–
ages, and a new section on the economics of climate change. All three boxes
discussed above are new in this edition.
Class Notes
This chapter presents a minicourse on the economics of natural resources and
pollution, with a steady eye on applications to developing countries (which are
fascinating in their own right). The chapter’s basic theme is that market– oriented
solutions may be the best way to correct market failures and encourage sustain-
able development. Students nd many of the topics to be quite thought
provoking— how a market pro cess can lead to extinction of shery stocks, the
concept of optimal pollution, the use of marketable permits, the advantages of
higher energy prices, and the idea that real resource prices do not indicate that we
are running out of resources. These issues are topical and highly relevant to
industrial countries as well as developing countries.
The text contains some formal analysis. You will need to cover discounting
brie y in order to explain the valuation of natural capital and the rules for opti–
mal extraction over time. Figure 20– 3, showing harvest options for slow– growth
146 | Chapter 20
forests, is a good lecture subject. It combines discounting, optimal depletion, and
valuation of natural capital, and it is dif cult enough to require an explanation.
The basic question of sustainability of worldwide development— including the
respective interests of rich and poor countries— is a ne topic for discussion.
Some of the issues that may be raised include eco- colonialism and global warm-
ing. For students who are more technically prepared, you can provide problems
on the Coase theorem and marketable permits.
QUESTION BANK
Concept Map
Sustainable Development
Will Economic Growth Save or Destroy the Environment?
Concept and Mea sure ment of Sustainable Development
Saving for a Sustainable Future
Externalities and the Commons
Property Rights
Informal Regulation
Policy Failures
Poverty- Environment Linkages
Global Climate Change
Multiple- Choice Questions
1. Which British economist predicted that continued population growth would
bring the world to disaster?
a. John Stuart Mill
b. David Ricardo
c. Adam Smith
d. Thomas Malthus
2. Statistical estimations suggest that pollution peaks at what level of income
per capita?
a. $5,000 to $8,000
b. $13,000 to $16,000
c. $21,000 to $24,000
d. $29,000 to $32,000
3. The relationship between levels of pollution and levels of income generally
follows an inverted- U shape and is commonly called the:
a. pollution- level Laffer curve.
b. environmental Kuznets curve.
c. sustainability Lorenz curve.
d. atmospheric Engel curve.
4. Which or ga ni za tion declared the requirement that consumption by today’s
generation must be accompanied by suf cient conservation of resources to
protect the future generation’s ability to consume as well?
a. Brundtland Commission
b. The Club of Rome
c. Millennium Project
d. The Earth Institute
5. The combination of produced capital, natural capital, and intangible capital
make up which of the following terms?
a. complete wealth
b. total assets
c. comprehensive wealth
d. comprehensive resources
6. The ________ suggests that a sustainable development path for countries that
depend on nonrenewable resources requires the rents from those resources to
be continually invested rather than consumed.
a. Hartwick rule
b. Solow growth model
c. Malthus theory
d. Ricardo rule
7. Adjusted net saving is equal to gross saving minus both the depreciation of
made capital and the depreciation of:
a. resource surpluses.
b. natural capital.
c. trade assets.
d. reserve capital.
8. Which of the following are characteristics of common- pool resources
(CPRs)?
a. It is dif cult to exclude anyone from using them.
b. Use by one person reduces the availability of that resource for use by
others.
c. CPRs cannot be governed or regulated.
d. Both a and b.
9. The socially optimal outcome is achieved when the own er of property rights
is a(n) ________ and sells output in a competitive market.
a. experienced manager
b. pro t- maximizer
c. skilled land own er
d. wealthy investor
10. Public disclosure of information about a factory’s environmental per for–
mance to local stake holders is an example of:
a. informal regulation.
b. formal regulation.
c. unof cial guidelines.
d. transparency pa ram e ters.
11. Fragile environments of the world are largely populated by the world’s:
a. rich.
b. poor.
c. industrialized population.
d. developed economies.
12. Which of the following is a function of forest income in rural livelihoods?
a. safety nets to help compensate production shortfalls
b. support for current consumption
c. a source of income growth
d. all of the above
13. As of 2006, which country overtook the United States as the world’s leading
source of carbon dioxide emissions?
a. India
b. China
c. Rus sia
d. Japan
14. Response to the potential threats from global climate change requires simul-
taneous action on which two fronts?
a. interception and adjustment
b. mitigation and adaptation
c. alleviation and treatment
d. easing and restoration
15. The incremental cost of achieving a lower target in the amount of change in
global temperature is a form of:
a. climate insurance.
b. atmosphere protection.
c. weather price.
d. global cooling fee.
IDs and Paired- Concept Questions
These terms can be used individually as short- answer identi cation questions, or
they can be used in pairs. In the latter case, ask students to explain (1) the meaning
and signi cance of each of the two terms and (2) the relationship between them.
1. Pollution, green house gases
3. Present value, optimal target
5. Common- pool resources, nonrenewable resource
7. Malthusian trap, neoclassical theory
9. Pollution, rich countries