ANALYSIS
Efficiency and applicability of economic concepts dealing
with environmental risk and ignorance
Frank Wa¨tzold *
Department of Ecological Economics and En6ironmental Sociology,UFZ-Centre for En6ironmental Research Leipzig-Halle Ltd., PO Box 2,Leipzig04301, Germany
Received 12 July 1999; received in revised form 8 November 1999; accepted 8 November 1999
Abstract
The paper examines the efficiency and applicability of various economic concepts dealing with environmental uncertainty. Their applicability is analysed by classifying environmental uncertainty according to different criteria. Using such a structure, it can be shown that while the economic concepts are able to deal satisfactorily with some types of environmental uncertainty they are unable to deal with others adequately. The analysis of efficiency distinguishes between environmental risk (in which the decision-maker is aware of the distribution function of the random variables) and ignorance (in which the decision-maker does not know the relevant distribution functions). The concept of a risk premium proposed by Siebert, the policy recommendation to promote integrated technologies, and the environmental assurance bonding system developed by Costanza and Perrings are examined in terms of efficiency and applicability. The analysis reveals the following: (i) the application possibilities of the three concepts differ significantly; (ii) a concept which concentrates on the reduction of risk may lead to an increase in ignorance; (iii) while an economic concept may be efficient in the context of risk, it can be inefficient when ignorance exists; (iv) a trade-off exists between the possibility to precisely state whether an economic concept is efficient and the scope of its applicability. © 2000 Elsevier Science B.V. All rights reserved.
Keywords:Environmental ignorance; Environmental risk; Risk premium; Integrated technologies; Environmental bonds
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1. Introduction
The environmental impact of emissions arising from the consumption or production of commod-ities is often only partially known — if at all.1 In
other words, environmental uncertainty exists.2
A good example to illustrate the severity of this problem is the discovery of the damaging
proper-2I only consider the case where all actors share the same level of uncertainty. Funtowicz et al. (1998) point to the importance of reciprocal learning between public and experts when they have different levels of information and Lewis (1996) gives an overview of the literature dealing with asym-metric information between regulator and polluter.
* Tel.: +49-341-235-2670; fax:+49-341-235-2511. E-mail address:[email protected] (F. Wa¨tzold) 1For the purpose of simplification, I shall concentrate on emissions. However, the analysis can also be applied to other human activities that affect the environment.
ties of chlorofluorocarbon (CFC). At the end of the 19th century, CFC was first produced in labo-ratory experiments. Industrial production started 30 years later, and being neither flammable nor toxic, CFC was assumed to be an ideal material in environmental terms. Only in 1974, with 750 000 tons of CFC being emitted annually, was the damaging impact of CFC on the ozone layer discovered. The fact that this was a purely chance discovery reveals just how momentous environ-mental uncertainty can be.
Nowadays we can distinguish between a num-ber of economic concepts dealing with environ-mental uncertainty.3
The aim of this paper is to develop a procedure to analyse the applicability of such concepts and their ability to induce efficient abatement activities. Furthermore, this procedure is applied to some of the existing concepts. Start-ing with Weitzman (1974), the focus of most of the literature evaluating different policies under uncertainty has been a welfare analysis of price versus quantity control instruments when the de-cision-maker is uncertain about the marginal damage and the marginal abatement cost func-tion.4 Uncertainty is generally modelled such that
the decision-maker knows the distribution func-tion of the random variables (see e.g. Weitzman, 1974; Adar and Griffin, 1976; Watson and Rid-ker, 1984). This type of uncertainty can be called environmental risk. Funtowicz and Ravetz (1993) pointed out that such a way of modelling uncer-tainty is suitable for environmental problems where ‘low uncertainty exists’. They call this the domain of ‘normal applied science’. However, such modelling is inadequate for environmental problems in which the level of complexity and fundamental uncertainty is high (e.g. the green-house effect). Here, a new approach is required, which they call ‘post-normal science’.
This paper takes into account high levels of complexity and uncertainty as well as the diversity
of environmental problems in two ways: Firstly, the efficiency analysis for a world of certainty and for a world of risk is modified with respect to a situation of environmental ignorance. In such a situation, the decision-maker is unaware of the distribution function of the random variables. Secondly, the diversity of environmental problems gives rise to the question of whether all concepts dealing with environmental uncertainty are appli-cable to all environmental problems. To answer this question, a taxonomy is developed to deter-mine the applicability of the various concepts. The efficiency and applicability of three different approaches are examined.
The concept of a risk premium proposed by Siebert (1998) argues that emission targets should be lower in a world of risk compared to a similar setting in a world of certainty. This is an example of an approach which only takes into account environmental risk and ignores environmental ig-norance. By contrast, the promotion of technolo-gies that reduce a broad spectrum of emissions by changing the production process (integrated tech-nologies) is an example of a policy recommenda-tion which takes into account environmental ignorance. As the reduction of as many emissions as possible is favoured, emissions which are not known to be harmful are also reduced. The envi-ronmental assurance bonding system proposed by Perrings (1989) and Costanza and Perrings (1990) can be regarded as an example of an approach which does not directly focus on the reduction of emissions by the policy-maker, but is designed to make companies responsible for the unknown en-vironmental impact of their activities. It entails levying a bond when the environmental impact of a firm’s innovative activity is unknown. Should damage be caused, a corresponding proportion of the bond is forfeited. While these approaches are in some respects complementary (e.g. environmen-tal bonds may induce firms to use integrated technologies), each of them takes it own specific approach to enviromental uncertainty. This re-sults in a different assessment in terms of appli-cability and efficiency, and justifies their separate treatment.
The analysis reveals that the introduction of ignorance has important repercussions for the 3As explained below these economic concepts are quite
dissimilar. I use the words ‘concept’ or ‘approach’ as a generic term.
evaluation of the various approaches: A concept which concentrates on the reduction of risk may lead to an increase in ignorance, and, while an economic concept may be efficient in the context of risk, it can be inefficient when ignorance exists. In addition, it can be shown that the application possibilities of the three concepts differ signifi-cantly. Combining the results of the efficiency and applicability analysis, a trade-off can be derived between the possibility to precisely state whether an economic concept is efficient and the scope of its applicability.
The taxonomy of environmental uncertainty is developed in Section 2.1, and what efficiency means in the context of risk and ignorance is defined in Section 2.2. The following section pre-sents the three different approaches and their assessment with respect to applicability and effi-ciency. The final section summarises the main results and combines the analysis of efficiency and applicability.
2. How to evaluate applicability and efficiency?
2.1. A taxonomy of en6ironmental uncertainty
The purpose of the taxonomy developed below is to provide an assessment tool for the applicabil-ity of economic concepts that are targeted to-wards environmental uncertainty. For other purposes, a taxonomy might well appear different, such as the taxonomies in Siebert (1987), Faber and Proops (1993) and Faucheux and Froger (1995). In the taxonomy developed here, environ-mental uncertainty is classified according to three different criteria.
The first criterion is the behaviour of emissions in the natural environment (see also Siebert, 1987). Emissions may accumulate in the environ-ment before their damaging impact becomes visi-ble. Environmental uncertainty which exists in combination with the accumulation of emissions can be called ‘accumulation uncertainty’. Some emissions diffuse in the environment for a long time before they unleash their harmful conse-quences. Environmental uncertainty that is com-bined with diffusion over time can be called
‘diffusion uncertainty over time’. Environmental uncertainty can also arise in connection with the diffusion of emissions over long distances. This can be called ‘diffusion uncertainty in space’. It is also possible that none of these particularities arises, but that uncertainty still exists about the causal relationship between an emission and the damage it causes. This uncertainty can be called ‘damage uncertainty’. Even if the damage func-tion of a certain emission is known, there might be uncertainty about its effects in combination with other emissions on ecosystems, plants, ani-mals or human beings. This uncertainty can be called ‘synergy uncertainty’.
Table 1
Types of environmental uncertainty
Classification criteria Different types of environmental uncertainty
Behaviour of emissions in the Damage uncer- Synergy uncer- Accumulation Diffusion uncer- Diffusion uncer-tainty in space
tainty uncertainty tainty over time
environment tainty
Risk
Extent of knowledge Ignorance
Uncertainty caused by the emissions Uncertainty caused by the emissions of a few polluters Number of polluters
of many polluters
The third category of environmental uncer-tainty is orientated towards the number of pol-luters. In some cases, a high number of polluters contributes to an emission which has uncertain effects on the environment. This uncertainty can be called ‘uncertainty caused by many polluters’. In other cases, the emission stems only from one or a few polluters and can be termed ‘uncertainty caused by a few polluters’. Table 1 contains an overview of the various types of environmental uncertainty.
It should be noted that different forms of un-certainty can coexist. For example, a certain emis-sion has damaging effects which are not yet known; the place of the emission and the place of the damage are far apart, damage only occurs when the emission interacts with another emission and the emission stems from many polluters. Thus we have ignorance, diffusion uncertainty in space, synergy uncertainty and uncertainty caused by many polluters simultaneously.
2.2. What abatement acti6ities are efficient in the
context of en6ironmental uncertainty?
The efficiency analysis focuses on the least cost implementation of abatement activities to comply with a given emission standard (Baumol and Oates, 1971). The standard setting-process itself is therefore irrelevant in the context of this paper (for different aspects of decision-making in a world of environmental uncertainty, see Perrings, 1991; Drepper and Ma˚nsson, 1993; O’Hara, 1996; Woodward and Bishop, 1997; Faucheux et al., 1998; Froger and Munda, 1998). It is assumed that environmental uncertainty exists with respect not to the effects of the emission regulated by the
regulated emissions by other emissions is again of no importance for the efficient allocation of abatement activities. The policy-maker is in-formed about the probability distribution of dam-age from all emissions and can regulate emissions accordingly.
The situation is different in a world of igno-rance. Here, we do not know whether emissions are harmful, nor are we informed about the prob-ability distributions of damage. Therefore, envi-ronmental policy should take all emissions into account as every emission has an unknown poten-tial to cause harm. If environmental policy con-siders all potentially harmful emissions, two questions arise: What potentially harmful emis-sions should preferably be reduced to decrease the danger of environmental damage most effectively? And secondly, can the increase in one potentially harmful emission be offset by reducing another potentially harmful emission? Unfortunately, no satisfactory answer exists to the first question as there is no measurement which allows the danger of two potentially harmful emissions in a world of ignorance to be compared. This makes it impossi-ble to recommend the order in which different emissions should be reduced. The lack of mea-surement also makes it impossible to assess whether the reduction of one emission can be offset by increasing another. All we can say in a world of ignorance is that the danger of environ-mental damage decreases when at least one emis-sion is reduced and no other emisemis-sions increase.5
In a world of ignorance, the fact that every emission has an unknown potential to cause harm is important for the efficiency analysis. However, it is impossible for a policy-maker to be able to regulate all existing emissions. Therefore, by con-trast to the efficiency analysis in the world of certainty and risk, it has to be taken into account that regulating one emission might have an im-pact on the level of other emissions. More pre-cisely, it must be considered that a standard governing an emission might lead to the
substitu-tion of this emission by other potentially harmful emissions — or, more favourably, to the reduc-tion of other emissions as well.
In order to see that these effects influence the efficiency of abatement activities, let us assume for a moment that the marginal damage costs of potentially harmful emissions are known and can be expressed in monetary terms. Then, the effi-ciency analysis must not only consider the differ-ent marginal abatemdiffer-ent costs to reduce the targeted emission, but also the marginal increases or reductions in the damage costs caused by changes of other emissions. The least cost imple-mentation of abatement activities is then achieved when the marginal costs of reducing the targeted emission plus the additional marginal damage costs and the additional costs saving are equalised across all activities. However, in a world of igno-rance, the different marginal damage costs of potentially harmful emissions are unknown, and so we cannot tell whether abatement activities are efficient. Yet the above reflections make clear that abatement activities that are efficient in a world of certainty or risk might be inefficient in a world of ignorance.
3. Economic concepts dealing with environmental uncertainty
3.1. Risk premium
The concept of a risk premium is an example of an approach which takes into account only envi-ronmental risk and ignores ignorance. The main results of its evaluation are valid for all concepts that concentrate only on risk. According to the risk premium approach, the main difference be-tween environmental policy in a world of cer-tainty and risk is that uncercer-tainty should be taken into account when the policy-maker determines an emission target. In essence, the concept says that if uncertainty prevails concerning the damage of an emission, a ‘risk premium’ should be added to the expected damage to reflect this uncertainty. Originally, the risk premium literature began with Arrow (1964) and Pratt (1964). The concept pre-sented here follows Siebert (1998).
Fig. 1 shows the disutility function U of a risk-averse policy-maker with respect to environ-mental damageD. The disutility of a given emis-sion level which leads to the environmental damage D( is represented by point A. Siebert introduces uncertainty by assuming that the envi-ronmental damage is a random variable D0. Ac-cording to the expected utility theory, the risk-averse policy-maker chooses a linear combi-nation of the disutility of possible outcomes. This means that if a spreadaexists around the meanD(
and if the statesD( −aandD( +aboth occur with a probability of 0.5, the expected disutility of the policy-maker is represented by point B. Siebert models an increase in environmental uncertainty by expanding the probability distribution around
D(, i.e. a spread b instead ofawith b\a. In this case, the expected disutility of the policy-maker is represented byB%. An increase in uncertainty thus leads to a higher level of expected disutility of a given level of emissions.
Siebert concludes from these results that an increase in uncertainty can be interpreted as an upward shift of the marginal damage function. This implies that in the context of a comparison between the marginal damage and marginal abatement cost functions, the optimum level of emissions decreases. We can therefore derive the
policy implication from Sieberts’ reflections that a situation of uncertainty ought to lead to a lower level of pollution than a situation of certainty, while an increase in uncertainty ought to lead to a further decrease in pollution.
When assessing the applicability of the concept, the distinction between risk and ignorance is rele-vant. The structure of uncertainty in Siebert’s model is the structure of risk. Therefore, the policy recommendation of a risk premium can only be applied in a world of risk and not in a world of ignorance. This conclusion may be re-jected by arguing that the modelling approach does not preclude the applicability of the model in a world of ignorance. The author accepts that this argument may be given some weight. However, if we accept this argument, the next question is the level of pollution a policy-maker should aim for in a world of ignorance. It seems that this ques-tion cannot be answered within the framework of the model. For this reason and for the reason that many people certainly advocate a restriction of environmental policy on risk, it will be assumed that the concept of the risk premium can only be applied in a world of environmental risk. It is important to note that despite its limited scope of applicability, the concept may also have effects on environmental ignorance. As the policy is only targeted at emissions which are dangerous in a world of risk, but not at those which are danger-ous in a world of ignorance, polluters have an incentive to substitute the former emissions by the latter. In other words, a policy which is only targeted at environmental risk may well lead to an increase in environmental ignorance. The other subdivisions of environmental uncertainty are ir-relevant here. Apart from ignorance, the concept of the risk premium can be applied in all cases. Efficiency in a world of risk depends on the economic instrument applied to achieve the pollu-tion reducpollu-tion. The assessment is the same as in a world of certainty and extensively discussed in the literature (see e.g. Baumol and Oates, 1988). However, as there is an incentive to substitute regulated emissions by unregulated ones, the as-sessment of efficiency is different when we take ignorance into account. Abatement activities that are efficient in a world of risk may well be ineffi-Fig. 1. Disutility function of a risk-averse policy-maker.
cient if they lead to an increase in potentially harmful emissions. Although this substitution clearly bears the danger of inefficiency, as pointed out above, in a world of ignorance we cannot tell whether an abatement activity is efficient or not.
3.2. Promotion of integrated technologies
By contrast to the risk premium approach, the concept of promoting integrated technologies is targeted more towards environmental ignorance than towards environmental risk. Similar to the assessment of the risk premium, the main results of its evaluation hold for other concepts that concentrate primarily on ignorance. The concept to promote integrated technologies has been de-veloped in the context of preventive environmen-tal policy. The basic idea of preventive environmental policy is to identify environmental problems at a very early stage and to analyse the conditions for environmental goals, policies and institutions that lead to the long-term protection and regeneration of the natural environment (Si-monis, 1988). Within this framework, various pol-icy approaches have been suggested (for an overview, see Simonis, 1988), the promotion of integrated technologies being the most prominent (Walter, 1989; Zimmermann et al., 1990).
In the literature on the promotion of integrated technologies, a distinction is drawn between end-of-pipe and integrated technologies. End-end-of-pipe technologies do not change the original produc-tion process; they are added to it. In general, emissions are reduced by using a filter. Typically, an end-of-pipe technology leads to the reduction of only one emission; all other emissions increase or remain at the same level. The most important reason is that the filtering process often leads to residuals with unknown toxicity. Furthermore, energy and material are needed for the disposal of these residuals. The increase in emissions other than that filtered obviously runs the risk of an increase in environmental uncertainty.
Integrated technologies change the production process itself. An example is the recycling and reuse of acids in the pickling process of steel. This leads to the avoidance of residuals. Typically, the targeted emission is not the only one that is
reduced, with other emissions being reduced as well. Furthermore, no other emissions are in-creased. From the point of view of environmental uncertainty, integrated technologies are rated more positively. The amount of material and en-ergy needed to implement the technology is usu-ally less than that needed for an end-of-pipe technology as the production process is merely altered and not augmented. Furthermore, there is no residual which has to be disposed of. As all emissions are reduced and no emissions are in-creased, integrated technologies lead to a reduc-tion of environmental uncertainty. The aim of this strict definition of integrated technologies is to focus the concept to promote integrated technolo-gies on the reduction of environmental ignorance. In reality, probably not many existing technolo-gies are integrated technolotechnolo-gies in the sense of this strict definition. This implies that the present scope of the concept to promote integrated tech-nologies is limited. However, with future techno-logical research focusing more on overall emission reduction, the scope of the policy could well increase.
end-of-pipe technologies. By choosing an inte-grated technology, the production plant has to be wholly or at least partly renewed. Often, the old plant cannot be sold, which means that sunk costs exist. By contrast, an end-of-pipe technology does not in general require a different production plant as it is simply tacked onto the original production process.
Walter (1989) suggests that end-of-pipe tech-nologies have become the dominant technological design. Because of sunk costs, integrated tech-nologies might not be chosen even if they are cheaper than end-of-pipe technologies in a situa-tion without sunk costs. The dominance of end-of-pipe technologies leads to the question of the type of environmental policy instrument which can lead to an increase in integrated technologies. The disadvantage of an emissions standard is that it is usually oriented towards the existing abate-ment technologies. As they are mainly end-of-pipe technologies, these technologies provide ‘the model’ for environmental legislation, thus rein-forcing their dominance (Walter, 1989). An im-portant criterion for the technology choice is the time allowed to meet the target for reduced emis-sions. If a standard is very strict in this respect, firms must reduce the emissions of their old plants. However, this favours end-of-pipe tech-nologies because of sunk costs. By contrast, eco-nomic instruments allow firms a choice between emissions reduction and the payment of tax or the use of tradable permits. However, in the case of tradable permits, a temporarily high price for the permit can also force a firm to buy an abatement technology. Walter (1989) believes that none of these instruments provide sufficient incentive to induce a switch from end-of-pipe to integrated technologies. He proposes that in addition to these instruments, the government should sub-sidise the research and development of integrated technologies. UNECE (1997) argues that volun-tary agreements stimulate the development of in-tegrated technologies because of the use of proactive discussions with government and their long-term nature. However, Bizer (1999) points out that there is no empirical evidence to support this claim.
The aim of the concept of promoting integrated technologies is to reduce a broad spectrum of emissions, regardless of whether they are known to be harmful. Thus the approach is targeted primarily at environmental ignorance. However, the reduction of a broad spectrum of emissions also leads to a reduction of all other kinds of uncertainties, including risk. The concept can therefore be applied regardless of the type of environmental uncertainty which exists.
Efficiency will be examined by assuming that the policy-maker uses an economic instrument to reduce one emission where environmental risk exists. In addition, the subsidies for integrated technologies will be considered. If an economic instrument leads to the use of integrated technolo-gies by the firms in a world of risk, there is no doubt that the least-cost implementation of abate-ment activities is achieved. The case is different when only a subsidy induces firms to use an integrated technology. Here, it is not possible to tell whether efficient abatement activities are be-ing undertaken. If we believe that despite sunk costs firms will make the right technology deci-sions, the subsidy leads to inefficient behaviour. An end-of-pipe technology will be cheaper to reduce the emission; consequently, the subsidy leads to inefficient abatement activities. However, if we believe that the dominance of a technologi-cal design can lead to an inefficient choice of technology, subsidies may be efficient.
3.3. En6ironmental bonds
Perrings (1989) and Costanza and Perrings (1990) have proposed that environmental bonds should be used when the environmental impact of an innovative activity is not known.6
The basic idea is that a bond, which is equivalent to the current best estimate of the largest potential fu-ture environmental damage, is levied. The bond plus part of the interest is returned if the polluter proves that the suspected damage has not oc-curred or will not occur. If damage does occur, the bond will be forfeited to a corresponding amount. The part of the interest that is not re-turned to the polluter is used to finance the ad-ministration necessary for the environmental bonding system and research into environmental pollution control technology and management (Costanza and Perrings, 1990). The decision pro-cess on how to determine the size of the bond follows Shackle’s decision theory (see Costanza and Perrings, 1990 and Shackle, 1969). It is appli-cable in situations where the range and probabil-ity distribution of the future effects of present actions are unknown. In such circumstances, there may be a number of outcomes which will attract the decision-maker’s attention and cause no sur-prise if they do occur, but there is no basis to calculate the probability of their occurring. The decision-maker will focus on those positive or negative attention-catching outcomes to which it attaches the lowest level of disbelief. These are the focus losses and focus gains of the action. The conjectured worst case outcome recommended as the basis of the bonds is the focus loss of the activity. ‘It is not, therefore, the worst case ‘imag-inable’, but the least unbelievable of those costs of an activity to which the decision-maker’s atten-tion has been drawn for whatever reason — publicity or public sentiment included’ (Costanza and Perrings, 1990). Institutionally, the bonds are to be determined by an environmental regulatory agency with assistance from an ‘independent sci-entific advisory board consisting of independent environmental experts’ (Costanza and Perrings, 1990).
In general, the applicability of environmental bonds is impeded by several factors. One difficulty is to measure the value of environmental damage in monetary terms. While considerable advances have been made over the past few years in this area, it is still impossible to adequately measure some damage, e.g. species extinction. If it is im-possible to express the damage in monetary terms, the part of the bond which is forfeited and the damage cannot be equivalent. The application of bonds might also be restricted by the necessity to prove causation. In order to be successful in this respect, an environmental agency in charge of the system must know all the pollutants produced by an innovative activity and all the damage caused by these pollutants. Furthermore, it must be able to prove all these circumstances. Another problem arises if the actual damage is higher than the focus loss, as then the size of the bond is not sufficient to pay for the damage.
Costanza and Perrings (1990) restrict the use of environmental bonds to cases where no data exist to compute an expected value for the future envi-ronmental costs of current activities.7 In other
words, environmental bonds are not recom-mended in a world of risk. They are also not applicable in a world of ignorance. In order to influence the decision-making process in the con-text of Shackle’s theory, the attention of the deci-sion-maker must be drawn to the outcome. This is not necessarily the case in a world of ignorance. However, while not being directly applicable, en-vironmental bonds influence decisions in a world of ignorance. The reason is that they are applica-ble in the area between risk and ignorance when there is some suspicion that an emission has cer-tain damaging properties. Therefore, in a world of ignorance, a polluter must take into account for every potentially harmful emission that some sus-picion will arise that this emission is harmful and that a bond will be levied.
In the case of diffusion uncertainty over time, there is a risk that the damage is not discovered
7If an expected value can be computed, Costanza and Perrings (1990) recommend the use of liability. For an assess-ment of liability with respect to efficiency and applicability, see Wa¨tzold, 1998.
before the bond is returned. In a world of uncer-tainty, the decision-maker does not necessarily know exactly when the damage will become visi-ble. The same applies to accumulation uncer-tainty. If the decision-maker estimates that the damage will occur earlier than it actually does, it may return the bonds even though damage may arise later. Environmental bonds can only be ap-plied when the number of polluters is relatively low. The administrative costs of collecting the bonds, surveying the polluters, keeping track of them and finally returning the money or part of it may quickly rise to unacceptable levels when the number of polluters is too high.
The efficiency analysis of bonds differs from the efficiency analysis of the other two concepts as there is no standard-setting body. If bonds are applied, the level of abatement activities is chosen by the polluter himself. The question is therefore whether bonds set incentives in such a way that the polluter chooses an efficient level of abate-ment activities. An efficient level of abateabate-ment activities is that which a policy-maker acting in the interest of society would choose. Such a pol-icy-maker would try to minimise the total ex-pected costs for society, i.e. the sum of abatement costs plus expected damage costs. Ideally, under a system of environmental bonds a polluter must not only pay for its abatement costs but also for all the damage it causes. Hence, a polluter’s total expected costs are equal to the total expected costs for society; and because the polluter seeks to minimise its total expected costs, the polluter’s behaviour will lead to cost minimisation for soci-ety as well.
In a more realistic perspective, the same aspects that hamper the applicability of bonds also lead to inefficiencies as they decrease the possibility that the polluter is confronted with the complete damage. Furthermore, an efficiency analysis must examine whether the orientation of the bond to-wards the focus loss is efficient. In fact, this is not the case for two reasons. Firstly, determining the size of the bond is highly subjective and not related to efficiency considerations. Secondly, the focus loss is only one of many possible different outcomes and the neglect of other outcomes may lead to inefficiency. However, this argument has
to be qualified. The amount that the polluter has to pay in the end is calculated according to the actual damage and not the focus loss. Therefore, the neglect of outcomes other than the focus loss is only inefficient as the size of the bond deter-mines the interest and not all the interest is re-turned to the polluter.
With regard to environmental ignorance, it is important to note that the substitution of regu-lated by unreguregu-lated emissions may only occur to a limited extent. If an unregulated emission is harmful, the polluter may be held responsible for part of or even all the damage occurring once there is some suspicion that an emission has dam-aging properties and a bond has been levied. The incentive to substitute emissions whose damage is known by potentially harmful emissions is there-fore reduced compared to a situation where there is no possibility to call the polluter to account.
4. Results and conclusion
I will now summarise the main results and show that a trade-off exists between the possibility to precisely state whether an economic concept is efficient and the scope of its applicability. The overview given in Table 2 shows that the applica-tion possibilities of the three concepts differ sig-nificantly. The divisions according to the different behaviour of emissions in the natural environment and the number of polluters are important with respect to environmental bonds. In cases other than damage uncertainty, the diffusion uncer-tainty in space and the unceruncer-tainty caused by the emissions of a few polluters, their application is difficult or impossible. The distinction between risk and ignorance enables the result to be derived such that a concentration on risk leads to an increase in ignorance. This must be strongly em-phasised as it is policy-relevant. In many coun-tries, a great deal of environmental policy is targeted towards risks, neglecting the possibility that this might lead to substitution by potentially dangerous substances.
Table 2
Overview of the applicability of the different economic conceptsa
Economic concepts Environmental uncertainty
Promotion of integration
Risk premium Environmental
technologies bonds
++
++ ++
Damage uncertainty
++
Synergy uncertainty ++ +
++
++ +
Accumulation uncertainty
++
Diffusion uncertainty in space ++ ++
++
++ +
Diffusion uncertainty over time
−
Ignorance ++ +
+ 0
Risk ++
++
Uncertainty caused by the emissions of many ++ 0
polluters
Uncertainty caused by the emissions of a few ++ ++ ++
polluters
aEconomic concept: ++is applicable without problems; +is applicable with problems; 0 is not applicable or shall not be applied;−increases this sort of uncertainty.
discussed in detail by Wa¨tzold (1998). Only the main results are summarised here. With respect to the applicability of a risk premium, it is important whether a certain kind of uncertainty coexists with risk or ignorance. If it coexists with risk, the risk premium can still be applied without prob-lems as the policy-maker knows the distribution functions of the random variables. If it coexists with ignorance, it is important whether this kind of uncertainty reduces the likelihood that environ-mental research will discover the hitherto un-known damage. This might be the case with diffusion uncertainty in space and over time, syn-ergy uncertainty and accumulation uncertainty. Here, substitution by potentially dangerous sub-stances might occur to a greater extent as it is less likely that the damage of these emissions will be discovered early on. The concept of promoting integrated technologies is applicable to all combi-nations of different kinds of environmental uncer-tainty, because it is designed to reduce all emissions. Environmental bonds cannot or should not be applied when a combination exists of an environmental uncertainty where bonds cannot or should not be applied and another kind of uncer-tainty. If two uncertainties coexist where environ-mental bonds can be applied without any problems, this is also true for the combination of
these uncertainties. If an uncertainty exists where bonds can be applied without any problems in combination with an uncertainty where they can only be applied with difficulty, the application problems remain. They are aggravated when un-certainties coexist where bonds can only be ap-plied with difficulty.
The efficiency analysis of the risk premium in a world of ignorance emphasises that an incentive exists to substitute regulated emissions by non-regulated ones. This bears the risk of inefficiency. While in the context of the promotion of inte-grated technologies this substitution does not take place, it cannot always be determined whether policy measures undertaken in the context of envi-ronmental policy are efficient. Besides aspects that lower the probability that the polluter will have to pay for the damage, the efficiency of environmen-tal bonds is weakened by orientation towards the focus loss. However, bonds do not encourage the substitution of regulated by unregulated emissions.
uncertainty, as in the case of the promotion of integrated technologies, precise statements of the efficiency of a concept are not possible; whereas if it is possible to clearly state that a concept leads to efficient or inefficient abatement activities, the scope of its applicability is rather narrow. The reason for this trade-off is the impossibility to make precise statements on efficiency in a world of ignorance. If the policy aim is to broaden the scope of environmental policy and to include the reduction of ignorance, an efficiency analysis can-not deliver the precise results known from the efficiency analysis in a world of risk or certainty. The consequence of this is the possibility of ineffi-cient abatement activities. This can be interpreted as the price which has to be paid in order to reduce environmental uncertainty on a broad scale. The policy-maker is thus left with a difficult choice.
Acknowledgements
This paper owes much to the support and help of Manfred Nitsch and Dietrich Winterhager; this is gratefully acknowledged. I also wish to thank Ru¨diger Gebhard, Bernd Klauer, Bengt A. Ma˚nsson, Sabine U. O’Hara and two anonymous referees for valuable comments and suggestions on earlier versions of this paper.
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