Environment and

Sustainable BLOCK INTRODUCTION

Development

Now we arrive at the penultimate block—the fifth—of the course. This block is titled
Environment and Sustainable Development This block, too, has two units. The block
discusses the crucial topic of sustainable development. The concept is discussed and the link
between environment and economic development is explained. The block also describes the
concept of externality.

The first unit of this block, unit 11, titled Sustainable Development discusses how economic
development impacts the environment. The unit defines and discusses sustainability and
also explains and discusses the role of renewable resources in development. The unit
provides a brief history of environmental change. The unit also explains and discusses
common-pool resources.

The final unit of the present block, unit 12, is titled Theories of Regulation. This unit
combines elements of public economics, environmental economics and development
economics. The unit explores the relation between economic activity and climate. The
concept of externalities, is explained and discussed in the unit. The unit also discusses very
important topics in economics, like the Coase Theorem, correcting for externalities, Pigovian
taxes and the pros and cons of emission taxes.

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UNIT 11 SUSTAINABLE DEVELOPMENT
Sustainable
Development

Structure
11.0 Objectives
11.1 Introduction
11.2 Sustainable Development
11.3 Renewable Resources
11.3.1 Types of Renewable Resources
11.4 A Brief History of Environmental Change
11.4.1 India’s Environmental Problems
11.4.2 Globalisation and Environmental change
11.5 Common Pool Resources
11.5.1 Tragedy of Commons
11.6 Let Us Sum Up
11.7 Hints to Check Your Progress Exercises

11.0 OBJECTIVES
After going through this unit, you will be able to:
 Explain the concept of Sustainable Development
 Define the renewable resources and explain its types
 Discuss the environmental changes over time
 Describe the common pool resources
 Present the issues related to common pool resources.

11.1 INTRODUCTION
Environment is of a great importance for the mankind. There are different types
of resources which humans use in day-to-day life. The way we use them impacts
the environment. The wastage of resources leads to depletion of such resources.
We begin this unit by understanding the concept of Sustainable development and
renewable resources. The changes in global environment and climate change is
something we all keep hearing in the news now and then. So, in one of the
sections, we will learn about the environment and the changes in environment
over the years. Environmental degradation also takes place due to the property of


Dr. Nidhi Tewathia, Assistant Professor, School of Social Sciences, IGNOU
211
Environment and common ownership of certain resources. Such resources fall in the category of
Sustainable
Development common pool resources and we humans take advantage of the existence of such
resources. The last section of this unit is dedicated to such resources.

11.2 SUSTAINABLE DEVELOPMENT

Natural resources are considered as basic requirements for development of an
economy. But they are limited and available on specific location only. The limit
leads to the scarcity and the basic three central problems of an economy. The
extraction of resources and moving them at the required location involves cost
which gets added to the cost of production. Hence, it becomes necessary to
allocate these resources in a judicious manner. This helps us achieve the most
efficient cost combination. So, we can say that resource allocation is an important
area of study for efficient allocation of factors of production including natural
resources.
Many countries have achieved rapid growth due to the existence of natural
reserves like minerals, oil and other metals. But, the social cost of this type of
growth is environmental degradation. Degradation of natural resources leads to
loss of livelihood as many people are dependent on these resources on everyday
basis. This degradation is also a threat to the health and wellbeing of people. It is
of common knowledge that the air and water pollution have become a major
health hazard over the decades. This also indicates that the resources are not used
at their efficient level. Realisation of such effects led to the concept of
sustainable development. Sustainable development is the idea that human
societies must live and meet their needs without compromising the ability of
future generations to meet their own needs. The “official” definition of
sustainable development was developed for the first time in the Brundtland
Report in 19871. In other words, sustainable development is a way to organize the
society so that it can exist in the long term. This means we take into account the
present and the future requirement of resources with a clear objective of efficient
use of those resources, social and economic equality.
In its report, the World Commission on Environment and Development, 1987,
puts stress on achieving international as well as inter-generational equity for
achieving a level of growth which can be sustained over time. This way the
available resource base would help to improve the average quality of life of
present and future generations. To create the non-declining consumption of
resources in the context of inter-generational efficiency, economists suggested
that we need to reinvest. The reinvestment should be into the creation,

1
In 1987, the World Commission on Environment and Development (WCED), which had been set
up in 1983, published a report entitled ‘Our common future’. The document came to be known
as the Brundtland Report after the Commission's chairwoman, Gro Harlem Brundtland. It
developed guiding principles for sustainable development as it is generally understood today.
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 Sustainable
exploration and search of the renewable and non-renewable resources. The Development
problem with this approach is that all the resources are not substitutable. Also,
they cannot be created at the same speed at which they are being consumed.
There is a lot of discussion based on the concept of ecological sustainability. To
keep the welfare of the future generations in mind, the resources should be
allocated in a stable manner which can help us to sustain the levels of
development over time. That means we need to question the levels of
consumerism that the developed world and the rich class of the developing
countries are manifesting. This was the context of The Earth Summit, Rio de
Janeiro, 1992. The Agenda 21 of the Earth Summit accepted that human beings
are entitled to a healthy and productive life in harmony with nature. The
Sustainable Development Goals (SDGs), also known as the Global Goals, were
adopted by all United Nations Member States in 2015 as a universal call to action
to end poverty, protect the planet and ensure that all people enjoy peace and
prosperity by 2030. The 17 SDGs are integrated—that is, they recognize that
action in one area will affect outcomes in others, and that development must
balance social, economic and environmental sustainability.
But we must admit that uncertainty is a vital consideration in the economics of
sustainability. Over time it is expected that changes will occur in technology,
income and people’s preferences. Technology may change enormously as an
answer to changing relative scarcities and knowledge. Income will also not be
constant and preferences will differ across generations. The problem is not the
changes but we do not know for sure how and when these changes will occur and
we do not know what the implications of these changes will be for future
resource availability.

11.3 RENEWABLE RESOURCES

Renewable energy is often referred to as clean energy. The natural resources
which are classified as renewable are capable of self-production. Anything that is
a part of the atmosphere comes under the category of renewable natural
resources. For example, sunlight or wind keep shining and blowing, even if their
availability depends on time and weather. While renewable energy is often
thought of as a new technology, harnessing nature’s power has long been
used for heating, transportation, lighting, and more. Wind has powered boats to
sail the seas and windmills to grind grain. The sun has provided warmth during
the day and helped kindle fires to last into the evening. Resources like fish and
forest are renewable resources and can also be replaced.
Over the past 500 years or so, humans increasingly turned to cheaper, dirtier
energy sources such as coal and fracked gas. Searching for the right method of
using renewable resources is a task that is growing ever more important as the
Earth’s supply of non-renewable resources continues to dwindle. But, in recent
years, renewable power has become more popular as innovation is bringing down 213
Environment and costs. It seems that the promise of a clean energy future can become a reality.
Sustainable
Development The renewables are increasingly displacing “dirty” fossil fuels in the power
sector which offers the benefit of lower emissions of carbon and other types of
pollution.
But the use of natural resources is becoming increasingly intense, several
varieties of renewable resources cannot be replaced at the speed they are being
consumed, hence the fear of destruction/extinction of these resources. In recent
years, depletion of several species of fish and extinction of several flora and
fauna thus reducing biodiversity has become a major concern. Several action
plans with a global reach have been devised to protect the endangered species. In
this context, forestry and wildlife protection have assumed significance to retain
diversity in nature and to stabilize the survival of various species of plants and
animals. Further, not all sources of energy marketed as “renewable” are
beneficial to the environment. Biomass and large hydroelectric dams create
difficult trade-offs when considering the impact on wildlife, climate change, and
other issues. Another challenge associated with using renewable resources is that
the renewable energy can be less reliable than non-renewable energy. There are
seasonal and even daily changes in the amount of such energy produced.
However, scientists are continually working to improve feasibility and reliability
of renewable resources. Converting to renewable energy will not only better
sustain the world’s rapidly growing population, but it will also provide a cleaner,
healthier environment for the generations to come.

11.3.1 Types of Renewable Resources

Biomass refers to organic material from plants or animals. This includes wood,
sewage, and ethanol (which comes from corn or other plants). Biomass can be
used as a source of energy because this organic material has absorbed energy
from the Sun. This energy is, in turn, released as heat energy when burned.
Excluding residential use, Brazil, the U.S. and India are the top countries
utilizing all sources of biomass for energy.
Hydropower is one of the oldest renewable resources and has been used for
thousands of years. Today, every U.S. state uses some amount of
hydroelectricity. With hydropower, the mechanical energy from flowing water is
used to generate electricity. Hydroelectric power plants use the flow of rivers and
streams to turn a turbine to power a generator, releasing electricity. China
produces the most electricity from hydropower.
Geothermal energy comes from the heat generated deep within the Earth’s core.
Geothermal reservoirs can be found at tectonic plate boundaries near volcanic
activity or deep underground. Geothermal energy can be harnessed by drilling
wells to pump hot water or steam to a power plant. This energy is then used for
heating and electricity. Iceland has many such reservoirs.

214
 Sustainable
Wind energy generates electricity by turning wind turbines. The wind pushes the Development
turbine’s blades, and a generator converts this mechanical energy into electricity.
This electricity can supply power to homes and other buildings, and it can even
be stored in the power grid. China has the world's largest onshore wind farm in
Gansu Province.
Radiation from the Sun can be used as a power source as well. Photovoltaic cells
can be used to convert this solar energy into electricity. Individually, these cells
only generate enough energy to power a calculator, but when combined to create
solar panels or even larger arrays, they provide much more electricity. China,
U.S, Germany, Japan and India are top 5 countries producing solar energy.

Check Your Progress 1

Note: i) Use the space given below for your answers.
ii) Check your progress with those answers given at the end of the unit.
1) Why the concept of sustainability important?
………………………………………………………………………………….
………………………………………………………………………………….
2) Explain the challenges which are thrown in by uncertainty to maintain
sustainability.
………………………………………………………………………………….
…………………………………………………………………………………
3) List few renewable resources.
………………………………………………………………………………….
………………………………………………………………………………….
………………………………………………………………………………….
4) Explain how the renewable energy works. Are there any challenges in order
to use renewable energy?
………………………………………………………………………………….
………………………………………………………………………………….

11.4 A BRIEF HISTORY OF ENVIRONMENTAL

CHANGE
Broadly speaking environment is essential for continuation of life on earth. It
performs several functions which can be divided into four categories. These are,
i) production functions, ii) regulation functions, iii) habitat functions, and iv)
information functions. As you are aware, environmental degradation restricts the
flow of environmental services. Dumping of pollutants in excess of its
assimilative capacity into air, water and soil results in deterioration of the quality
of these crucial resources.
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Environment and 11.4.1 India’s Environmental Problems
Sustainable
Development
The nature of environmental problem depends upon the level of economic
development and the geographical condition of the area under consideration.
India being a developing economy with a low per capita income, high population
density, agriculture-dependent labour force, and high percentage of rural areas,
the problems here are different from those in developed countries. The tropical
climate with scanty rainfall in many areas also brings in a specific set of
environmental problems. Poverty, illiteracy and lack of awareness have
aggravated environmental problems in many cases. Poverty in rural areas, largely
due to unavailability of gainful employment, compels people to go to the nearby
forests to collect fuelwood and minor forest products to supplement their
household income. Agriculture being the backbone of the country and draught
animal being the major source of power, animals are reared in large numbers and
sent to forests for grazing. Cooking by using fuelwood not only aggravates
destruction of forest but also releases harmful gases into the air. Lack of proper
sanitation both in rural areas and urban slums vitiates the local environment.
High population density in urban areas without adequate infrastructure such as
water and electricity supply, public transport and waste disposal has brought in
many environmental problems. For example, lack of public transport and rise in
per capita income have led urban households to go for private vehicles which has
increased fuel consumption, traffic congestion, and increased emission from
vehicles. Technological progress has also contributed to environmental problems
in India. Disposal of effluents without treatment have increased pollution of air,
water and soil. Technological progress in agriculture has led to increased use of
fertilizer on land which has increased pollution of land. The cultivation of water-
intensive crops by using ground water has depleted ground water table. In order
to attract investment several governments offer concessions to industries
overlooking environmental concerns. In the process industries come up in the
area but convert the state into a pollution haven. A particular problem of North
India around the months of October and November is stubble burning. With the
onset of winter, farm fires become rampant in northern India, particularly in the
states of Punjab, Haryana and western Uttar Pradesh. Stubble burning is
intentionally setting fire to the straw stubble that remains after grains, like paddy,
wheat, etc., have been harvested. This activity emits fine particulate matter
(PM 2.5), an air pollutant that is a concern for people's health. The environmental
management will have to be more serious and of growing dimensions in the
coming years.

11.4.2 Globalisation and Environmental Change

In a globalised world, the boundaries between states are less visible and political,
economic, cultural and social events are more interconnected with far- reaching
impact. We all experience diverse effects of globalisation. The damage caused to
216 ecosystem from the oil that spilled from one of the leaking containers of British
 Sustainable
Petroleum in 2010 is just one of the examples of the threat globalization poses to Development
the environment. Climate change, deforestation, pollution are now, few of the
many, widely used expressions in international relations as we have achieved the
era of the resource wars.
The process of globalization has further intensified the use of untapped natural
resources of the poor countries with minor benefits for the traditional users of
these resources. The multinational companies - particularly those engaged in
trading agricultural products or processed agricultural produce - have destroyed
the sustainable agriculture of several poor nations through exports of their cheap
and subsidised food products. The control over the production and distribution of
seeds by multinationals has led to destruction of biodiversity. In other words,
while the United Nations and other agencies talk about achieving the goal of
sustainable development, the process of globalization and increasing
concentration of wealth has negated these measures. 'The lop-sided distribution
of wealth has led to manifold increase in consumption levels of the rich few
while the poor are displaced from their traditional habitat.
The literature on environmental effects of globalisation mainly talks about two
types of effects i.e., direct and indirect effects. The direct effects include
emissions and environmental damage which is related to the physical movement
of goods from exporters to importers. This largely includes emissions from fossil
fuel use. Simultaneously there are numerous indirect effects that are caused due
to the growth in trade and foreign direct investment. These indirect effects are
classified in three categories: composition, scale and technique effects. The scale
effect indicates that the global production possibilities frontier shifts due to the
more efficient allocation of resources within countries. This increases the size of
the industrial pollution base which means there will be greater global emissions
other things being equal. The composition effect measures changes in emissions
which arise as a result of trade liberalisation as the country’s industrial
composition changes. For example, if liberalization expands the service sector of
a country while the heavy industry contracts, then the country’s total emissions
will most probably fall as the sector which is expanding is less emission
intensive. Finally, the technique effect refers to the glut of channels through
which globalisation impacts the rate at which the pollution increases by the
industry and the households. These channels include changes in the
environmental regulations and their stringency. Such changes are in response to
income growth or the political climate surrounding such regulations. The
technique effect also includes the technology transfer which is facilitated by trade
or we can say by globalisation.
The international agencies which have been created for protecting the
environment shall once revisit their concerns and are required to show a strong
will to implement the decisions in this direction.

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Environment and
Sustainable
11.5 COMMON POOL RESOURCES
Development
Common Pool Resources (CPRs) are the resources which may be owned by
national, regional, or local governments, by communal groups, by private
individuals or corporations. They may be used as open access resources by
anyone who can access it. CPRs share two attributes of importance for economic
activities: (1) it is costly to exclude individuals from using the resource either
through physical barriers or legal instruments, and (2) the benefits derived by one
individual reduce the benefits available to others.
These resources may not have a formal owner but some kind of ownership
control is exercised collectively and the resources are often managed as common
property. The goods produced from these resources are consumed individually
(as private goods). For example, forests and grazing lands are CPRs and they
provide goods such as firewood and fodder.
CPRs play an important role in the users’ life. They supplement rural livelihood
and act as the safety nets for the poor in some seasons or at the time of bad
harvest or any other kind of crisis. CPRs are public goods with
limited/subtractive benefits; if individual A uses more, less will be left for others.
Many a times, CPR users resort to the practices which reflect their selfishness
and short sightedness. To avoid such deliberate acts, some sanction rules also are
applied to people or to whole communities in order to make them do what they
may not want to do. CPRs are therefore likely to face problems related to
congestion, depletion or degradation.
CPRs exhibit free or restricted access. Situations where there are no restrictions
on the access to a resource or its use, are called free or open access CPR. When a
resource is in abundant supply, it does not make sense to restrict its access or
limit its use. However, if the demand for the resource increases due to factors like
population pressure, industrialization, economic growth, etc. and the resource
becomes scarce, a common property free access regime is no longer appropriate.
Different models of CPRs’ governance are suggested by different people. There
are two dominant conceptual models of common property resource management:
a capitalist model and a socialist model. The capitalist model argues that
resources that are held commonly are subject to degradation. Hence, privatization
of public resources is the only viable solution to the problem. The socialist model
explains that economic poverty caused by inequitable distribution of resources
among rural agrarian population is the delivering force of resource destruction.
Therefore, collectivization or nationalization of public resources serves as an
equitable strategy of resource management.

11.5.1 Tragedy of Commons

Due to open access and lack of proper management, CPRs are being degraded
overtime due to overuse. To see this, consider an agricultural village in which the
218 villagers graze their cows on a common field. An individual villager would use
 Sustainable
the grazing land to the point where his private marginal cost equals his private Development
marginal revenue. But in doing so, each villager generates an external cost borne
by all other villagers in terms of reduced fodder available for their cows that
would reduce the productivity of cows. Since each villager ignores the social cost
of grazing an additional cow, too many cows will be grazed on the common land.
Thus, the social cost of exploiting the resource exceeds the individual private
cost. In this sense, open-access common property resources are closely linked to
congestible public goods. This is explained by Garret Hardin in an essay of 1968,
entitled the tragedy of the commons. He argued that if individuals act
independently, rationally and focused on pursuing their individual interests, they
would end up going against the common interests of their communities and
exhaust the planet’s natural resources. This overuse of public resources is termed
as the "Tragedy of the Commons". Overfishing in international waters,
deforestation, and several species of animals being on the verge of extinction due
to overhunting, are some of the examples of this phenomenon. Of course,
assigning private rights to the resource can ensure its efficient use. In situations
where there is some difficulty in assigning such rights, the overuse can be
prevented by social institutions that are strong enough to limit the use of the
resource by individuals. These are called restricted access CPRs.
Though we have discussed about few CPRs already but we can list a large
number of CPRs, which can be brought under the broad headings like land
resources, forest resources, water resources, and fishery resources.
Land Resources
Common property land resource refers to lands identified with a specific type of
property rights. The common lands covered in the National Sample Survey
(NSS) enquiry are panchayat lands, government revenue lands, village common
lands, village thrashing lands, unclassified forest lands, woodlands and
wastelands, river banks, and lands belonging to other households used as
commons.
Forest Resources
Another category of land for which common property rights may exist is land
under forests. Unclassified forests, with very low productivity, are always open
to use by local communities. Accordingly, both protected and unclassified forests
are treated as forming a part of common property forest resources. It is, therefore,
the subset of total forest area minus reserve forests to which common property
rights are assumed to exist.
Water Resources
There are a variety of resources of water, which are in the public domain, and a
significant part of these are included in the category of commons. Examples are
flows of rivers, tanks and natural lakes, groundwater, wetland and mangrove
areas, and such other water bodies. Man-made water resources such as dams and 219
Environment and canals, tube wells, other wells, and supply of all types of potable water also fall
Sustainable
Development in the category of CPRs depending upon their property rights. Unfortunately,
even after many debates about property rights (such as traditional rights,
community rights, and basic need human rights), water has not yet been declared
as CPR in India, though references are made in the water policy document
indirectly. By and large, water resources in India are in common property
regimes only. Irrigation canals are managed jointly by the government and
communities. Traditionally, tanks, village ponds, and lakes - all of which are
treated as CPRs - are sources of water for drinking, livestock rearing, washing,
fishing and bathing, and several sanitary-related activities.
Overall, we can say that human free access and unlimited consumption of finite
resource would extinguish such common resources. Hardin believed that since
man is compelled to procreated unlimitedly the Earth resources would eventually
get overexploited. To his eyes, mankind needed to radically change its way of
using common resources to avoid a disaster in the future. And this would also be
the way to keep on a sustainable development track.

Check Your Progress 2

Note: i) Use the space given below for your answers.
ii) Check your progress with those answers given at the end of the unit.
1) How are India’s environmental problems different than developed world.
………………………………………………………………………………….
………………………………………………………………………………….
………………………………………………………………………………….

2) How is globalisation adding up to the environmental problems?

………………………………………………………………………………….
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3) What are the characteristics of common pool resources? Explain?

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4) Define Tragedy of Commons.

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 Sustainable
11.6 LET US SUM UP Development

In this unit we began by the understanding of concept of sustainability. The

future generations need the resources which we are over using today and the
orientation of many countries towards conserving the natural resources further
needs to be serious. The capacity of earth to assimilate waste is limited and the
present consumption patterns indicate that we are moving in a direction which
holds danger for the future. There are many resources which are renewable in
nature which are gaining popularity but still need to be cost-effective. The
environmental problems discussed in this Unit are of diverse and grave nature.
The efforts towards pollution abatement and cleaner environment need to be
more targeted and effective at both national and international level. A key reason
for many kinds of environmental problems is common pool resources. These
resources do not have clearly defined property rights due to which the people
around such resources usually land up over using them. We discussed how
dangerous this over-use can be. Overall, we learnt about the environmental issues
we presently face and which the future generations will also face if we do not
give the required importance to the concept of sustainable development.

11.7 HINTS TO CHECK YOUR PROGRESS

EXERCISES
Check Your Progress 1
1) (Refer section 11.2) Natural resources are considered as basic requirements
for development of an economy. But they are limited and available on
specific location only.
2) (Refer section 11.2) Over time it is expected that changes will occur in
technology, income and people’s preferences. Technology may change
enormously as an answer to changing relative scarcities and knowledge.
Income will also not be constant and preferences will differ across
generations
3) (Refer section 11.3) Hydropower, geothermal, wind energy, solar energy etc
4) (Refer section 11.3) But the use of natural resources is becoming increasingly
intense, several varieties of renewable resources cannot be replaced at the
speed they are being consumed, hence the fear of destruction/extinction of
these resources.

Check Your Progress 2

1) (Refer sub-section 11.4.1) India being a developing economy with a low per
capita income, high population density, agriculture-dependent labour force,
and high percentage of rural areas

221
Environment and 2) (Refer sub-section 11.4.2) The damage caused to ecosystem from the oil that
Sustainable
Development spilled from one of the leaking containers of British Petroleum in 2010 is just
one of the examples of the threat globalization poses to the environment.
3) (Refer section 11.5) Common Pool Resources share two attributes of
importance for economic activities: (1) it is costly to exclude individuals from
using the resource either through physical barriers or legal instruments, and
(2) the benefits derived by one individual reduce the benefits available to
others.
4) (Refer sub section 11.5.1) Garret Hardin argued that if individuals act
independently, rationally and focused on pursuing their individual interests,
they would end up going against the common interests of their communities
and exhaust the planet’s natural resources. This overuse of public resources is
termed as the "Tragedy of the Commons".

222
 Theories of
 Regulation
UNIT 12 THEORIES OF REGULATION
Structure
12.0 Objectives
12.1 Introduction
12.2 Externalities and its Types
12.2.1 Positive Externality
12.2.2 Negative Externality
12.3 Coase Theorem
12.4 Economic Activity and Climate
12.5 State Regulation of the Environment
12.5.1 Pigouvian taxes
12.5.2 Emission taxes
12.6 Let Us Sum Up
12.7 Hints to Check Your Progress Exercises

12.0 OBJECTIVES
After going through this unit, you will be able to:

 Define the negative and positive externality with the help of an example

 Discuss the economic consequences of externalities

 Describe the Relationship between the economic activity and climate change

 Explain the role of state as the regulator of environment

 Discuss the pigouvian taxes and their rationale.

12.1 INTRODUCTION
In this unit, we will start with understanding the concept of Externality and its
types. The economic consequences of externalities will also be discussed in order
to understand how the basic activity of production and consumption impacts the
climate. The role of state is very important in order to mitigate the environmental
damage due to economic activity. Hence the unit also covers the role of state in
this regard. The specific mechanisms like Pigouvian tax or emission tax are also
explained in detail.


Dr. Nidhi Tewathia, Assistant Professor, School of Social Sciences, IGNOU
223
Environment and
Sustainable 12.2 EXTERNALITIES AND ITS TYPES
Development
We noted in the previous unit that market mechanism will not be successful if the
resource ownership is not clearly defined. The property being the common
resource, individuals could neither take account of the full benefits nor they could
completely understand the costs of their actions. This happens because the costs
and benefits are treated as incidental or external by such individuals. Similarly,
there is another situation wherein the individuals do not take a complete account
of their transaction/activity. A technical term used to describe this situation is
externality. Externalities are the conditions which arise when the actions of some
individuals have direct effects on the welfare or utility of other individuals. The
effects mentioned can be positive or negative. Also, an externality is a spillover
effect associated with production or consumption that extends to a third party
outside the market. Externalities can also be distinguished as depletable and non-
depletable. The flowers falling from a tree are depletable externality because if
one person takes it another cannot. The fragrance of flowers, however, is a non-
depletable externality because one person's enjoying it does not reduce the
fragrance for others. In many instances, the problem of externality creeps into
many government policies having spill over effects. For example, free electricity
offered to farmers for irrigation purposes results in over-extraction of ground
water, which depletes the water table that reduces the availability of water to
others.

12.2.1 Positive Externality

When the effect of the actions of an individual on another individual is positive,
we call it a positive externality. For example, I may get pleasure from observing
my neighbour’s flower garden—this is an example of a positive consumption
externality. The activity of gardening in my neighbour’s house has provided a
benefit to me. I have not spent any amount of money of time in maintaining that
flower garden but yet I am drawing a positive utility out of it. Similarly, when a
firm’s production positively affects the production possibilities of the other firm,
a positive production externality is generated. A simple example is that if an
apple orchard is located next to a beekeeper (Many varieties of fruit and nut trees
need bees to pollinate their blossoms, thereby allowing the trees to produce
crops). The bees will help the apple orchard to produce large number of apples.
In a situation where a positive externality is present:
Social benefits = Private benefits + External benefits
And External benefits > 0
Therefore, Social benefits > Private benefits
In the Fig. 12.1, the curve D shows private benefits or the demand for the product
which involves positive externality. MSB curve represents marginal social
benefit, which is derived after adding the external benefits to the private benefits.
224
 Theories of
This means that the difference between the D curve and MSB curve is external Regulation
benefits.
Given a constant marginal cost (MC), the private equilibrium leads to the
quantity Q1 but the social optimum will be achieved with the intersection of MC
and MSB. This intersection gives us the quantity Q*. So, we can say that if the
positive externality is not considered, less quantity of the product is produced and
exchanged in the market as Q1< Q*. We now understand that in the presence of a
positive externality, we expect to observe a clear divergence between social and
private benefits which leads to less than social optimal level of production.

Fig. 12.1: Positive Externality

12.2.2 Negative Externality

Negative externality is an external effect that imposes costs on a third party. For
example, I don’t drive but the pollution produced by local automobiles affects my
health or my neighbour loves to play loud music in the early morning hours when
I prefer to sleep. These are all examples of negative consumption externalities.
Similarly, a negative production externality arises when the production
possibilities of one firm impacts the choices of another firm in a harmful manner.
For example, a fishery downstream cares about the amount of pollutants dumped
into the river upstream by a steel manufacturer. This will be harmful for the fish
and will affect the revenue of the fishery. In a case where negative externality
prevails:
Social costs = Private costs + External costs
And External costs > 0
Therefore, Social costs > Private costs.

225
Environment and In the Fig. 12.2, the curve MC shows private costs of the product which involves
Sustainable
Development negative externality. MSC curve represents marginal social cost, which is derived
after adding the external costs to the private costs. This means that the difference
between the MC curve and MSC curve is external costs. Given a horizontal
demand curve (P1), the private equilibrium leads to the quantity Q1 but the social
optimum will be achieved with the intersection of MSC and demand curve. This
intersection gives us the quantity Q*. So, we can say that if the negative
externality is not considered, more quantity of the product is produced and
exchanged in the market as Q1> Q*.

Fig. 12.2: Negative Externality

We now understand that in the presence of a negative externality, we expect to
observe a clear divergence between social and private costs which leads to more
than social optimal level of production.

12.3 COASE THEOREM

Externalities generally arise due to two reasons. First, the resource or product in
question by its very nature may be nonrival in consumption. Such a product will
be subject to joint consumption. Second, for either natural or technical reasons,
the transaction cost of internalizing the externality may be excessively high. In
the example of steel manufacturer and fishery, the river is viewed as a common
pool resource and hence, no one can be excluded from using it. Thus, the
nonexclusive use of the river is what causes an externality to persist. The non-
exclusiveness resulted from the fact that the resource under consideration is non-
rival, and thus is subject to joint consumption. Further, the non-exclusiveness
resulted from the fact that the ownership of the resource (the river) was not
clearly defined – that is why it is treated as a common property. Hence, we can
generalize that lack of excludability (non-exclusiveness) is the root cause of
externality.
If the garden of a neighbour generates positive consumption externality for you,
it makes no economic sense to exclude you from the use (consumption) of such
an activity. Of course, it is possible to exclude the you and other neighbours by
226 building a tall concrete wall around the house. However, this will involve an
 Theories of
additional cost. The most commonly used economic jargon to describe the costs Regulation
associated with internalizing (remedying) externalities is transaction costs. In
broad terms, transaction costs include any outlay expended for the purpose of
specifying property ownership, excluding nonusers and enforcing property rights.
This would be the intended effect if, in fact, the neighbour in our example
decided to erect a concrete wall around her or his clearly identified property line.
By now we know that the problem arises if the property rights over the
product/service, which generates externality, are not well defined. If A believes
that he has the right to smoke and B believes that he has the right to clean air, we
will have issues. So, we can say that the practical problems with externalities
generally arise because of poorly defined property rights. My neighbour feels he
has the right to play loud music in the early hours of the morning while I prefer to
think that I have the right to sleep undisturbed at that time. The steel factory feels
it has the right to dump all its pollutants in the river whereas the fishery believes
they have the right to breed fish in the same river.
Ronald Coase developed the property rights approach in 1960. The approach
suggests that an efficient solution to the problem of externality may be arrived at
if property rights are well-defined and this solution is known as Coase theorem.
The theorem states that efficient allocation of resources and solution to Pareto
relevant externality is possible but with the following assumptions:
i) Zero transaction costs – the cost involved in the bargaining process between
the two parties does not exist,
ii) Well-defined property rights - either of the party or both the parties possess
well-defined property rights,
iii) Perfect competition prevails in the market,
iv) No income or wealth effects are imposed with the Coasean solution,
v) No free rider effects -- since the parties have well-defined property rights.
If property rights are well defined (regardless of which party has the right over
the property), and mechanisms are in place to allow for negotiation between
people, then people can trade their rights to produce externalities in the same way
that they trade rights to produce and consume ordinary goods. Let us understand
with the help of an example. Suppose the steel factory’s effluents dumped in the
river upstream reduce the profit of the fishery which is located downstream. The
problem between the steel factory and the fishery arises because their economic
activities involve the joint use of a river.
To demonstrate how this problem can be solved using a property rights approach
(Coase Theorem), let us start by assuming that the legal rights to the use of the
river belong to the fishery. So, if the fishery wants, it could completely deny the
river access to the steel factory. Then the steel factory would not be permitted to
use the river to discharge its waste.
227
Environment and In Fig. 12.3, this situation is represented by the origin O, where the amount of
Sustainable
Development waste emitted into the river from the steel factory is zero. This means that the
steel factory has to find an alternative way of disposing the waste (a total of 200
units) from its current operation. But, will that be a stable solution? Given the
MDC (Marginal damage cost) and MCC (Marginal control cost) curves presented
in Fig. 12.3, the answer to the question would be a no.
Let us look at the reason. When the waste discharged by the steel factory is less
than EO (110 units), we observe that the MCC is greater than the MDC. For
example, for the 70th unit of the waste that is emitted into the river, the MDC to
the fishery is Rs. 20. However, to achieve this same result, the cost to the steel
factory is Rs. 50. Note that this Rs. 50 is the MCC of treating (cleaning) the 130 th
unit of waste (200 - 70). Thus, given this situation, the steel factory will clearly
have an incentive to offer a financial bribe to the fishery for the right to use the
river for discharging its industrial waste. For example, to discharge the 70th unit
of waste the steel factory will be willing to pay the fishery a fee of between
Rs. 20 and Rs. 50. This should be acceptable to both parties.
For the fishery, a payment exceeding Rs. 20 more than compensates for the
damage caused to its fish operation from the dumping of the 70th unit of waste
into the river. Similarly, this situation should also be advantageous to the steel
factory because the cost of using an alternative technology to dispose of the 70th
unit (i.e. to clean up the 130th unit) of waste to this firm is at least Rs. 50.
In general, then, these two firms will be in a position to engage in a mutually
beneficial transaction provided that, at the point where the negotiation is taking
place, MCC > MDC. Furthermore, the negotiation between these two parties
ceases when, for the last unit of waste discharged by the steel factory,
MCC = MDC. This takes place at EO, or 110 units of emission. We can call
MCC = MDC the condition for the optimal level of pollution.

Fig. 12.3: Coase Theorem

228
 Theories of
The Coase theorem goes beyond the recognition of optimality. It also states that Regulation
this optimal outcome is completely independent of the two parties who have
rights to the river. So, let us now consider the case where the steel factory has
exclusive legal rights to the use of the river. The steel factory, if wishes, can
dispose of all its waste into the river. If this strategy is followed, then as shown in
Fig. 12.3, the steel factory will discharge a total of 200 units of waste into the
river. However, this is not the only option for the steel factory. For each unit
between 110 and 200 units of waste discharged, the MDC is greater than the
MCC. This situation will allow the fishery and the steel factory to engage in a
mutually beneficial transaction.
Let us see what happens when the emission is at 140 units. When this unit of
waste is discharged, the MDC to the fishery is Rs. 45, but the cost to the steel
factory of treating this same unit is Rs. 15. Note that the Rs. 15 is the marginal
cost to the steel factory for controlling the 60th unit of emission (200 - 140).
Thus, when the emission level is at 140 units the MDC is greater than the MCC.
Given this, the fishery will have an incentive to offer a financial bribe to the steel
factory of anywhere between Rs. 15 and Rs. 45 to withhold this unit of waste.
It is easy to see that the steel factory will most likely take this offer seriously
since the cost of controlling the 60th unit of waste (200 - 140) is only Rs. 15.
Thus, to the extent that the offer of the fishery exceeds Rs. 15, the steel factory
will abide by the wishes of the fishery.
A similar situation prevails for all the units where the MDC exceeds the MCC,
i.e., between 200 and 110 units. Thus, the optimal level of pollution is again
reached at EO or 110 units, where MDC = MCC. This result verifies the validity
of the Coase theorem.
In general, the amount of the externality that will be generated in the efficient
solution will depend on the assignment of property rights. The reflective
implication of this theorem has been that pollution problems can be resolved by
an arbitrary assignment of property rights. The optimal level of pollution is
attained through voluntary negotiation of private parties – just like it happens in a
private market.
The Coasian approach has certain weaknesses. However, in many real-world
situations, the sources of the pollution are likely to be multifaceted and their
impacts quite diffuse. In addition, environmental disputes normally involve
several parties. In a typical real-world situation, then, the cost of negotiation and
enforcement – the transaction cost (the monetary outlays for specifying, defining
and enforcing property rights) – could be quite high. A high transaction cost
could distort the final outcome of an environmental dispute in a rather significant
manner. In such a situation, a resolution reached using the property rights
approach might be far removed from what is considered to be socially optimal.

229
Environment and
Sustainable
Check Your Progress 1
Development
Note: i) Use the space given below for your answers.
ii) Check your progress with those answers given at the end of the unit.
1) Define Positive externality and Negative externality.
………………………………………………………………………………….
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2) Why does the social optimal level of production is higher in case of positive
externality? Explain with the help of a diagram.
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3) Why do the externalities arise?
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4) Define Coase Theorem. Under which assumptions the theorem works?
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12.4 ECONOMIC ACTIVITY AND CLIMATE

Resource allocation through market mechanism – i.e., one that is based solely on
consideration of private costs and benefits – would be inefficient when viewed
from the perspective of society at large (refer to sub-section 12.2.1 & 12.2.2).
This constitutes a clear case of market failure because the market, if left alone,
lacks any mechanism by which to account for external costs and/or benefits. So
we can say that the high consumption levels have led the Earth to struggle in
order to keep up with the regeneration of resources which is required for us to
maintain those high consumption levels.
Our lifestyles have been altered over the years. We are globally consuming more
products, discarding more clothes and piling more electronic waste. This all has
impacted the ecological cycle as increased consumerism leads to high levels of
production which requires more transportation of raw materials and that in turn
leads to high carbon footprints. Stress on transportation has led to the added
strain on the non-renewable sources of energy. The waste generated from
production gets dumped in the oceans which adversely affects the sea life. The
incidents where sea animals are found dead on the shores are not rare now.
230 Foreign foods are preferred more than the locally- grown food. The genetic
 Theories of
makeup of the plants is also getting affected due to toxic waste disposal. Plastic is Regulation
very useful for packaging and preserving the products. While many studies have
found that plastic is non-biodegradable and one of the major toxic pollutants, we
still continue to use it in various ways. There are innumerable examples and
incidents which clearly suggest that the consumption patterns have made
irreversible changes to our lives and has also led to some major concerns,
environment in particular.
Climate change is a cause of concern for the mankind as it has serious and
various catastrophic economic, ecological and environmental implications. It is a
common knowledge that due to climate change we experience many disasters.
The frequency and the severity of climate related disasters is on an increase.
Hurricanes like Katrina in USA, Tsunamis in South Asia, Earthquakes in
Afghanistan and India, and Tokage Typhoon in Japan are a few examples of the
disasters from the recent past. India is also one of the highly vulnerable countries
to global warming because the Indian economy highly depends on climate
sensitive sectors like agriculture, water, forest and hydro-power. Further addition
to the magnitude of vulnerability is provided by India’s densely populated low-
lying coastline. The coastline remains under constant threat from climate related
disasters including rise in level of sea water.
Environmental economists are interested in externalities that damage the
atmosphere, water supply, natural resources, and overall quality of life. To model
these environmental externalities, the relevant market must be defined as the
good whose production or consumption generates environmental damage outside
the market transaction.

12.5 STATE REGULATION OF THE ENVIRONMENT

The classic examples of externalities (like the garden of the neighbour or
beekeeper near apple orchard) suggest as if they are a trivial concept without any
grave consequences. Externalities, however, have serious consequences in the
context of environment. Contaminated drinking water, smog in cities,
deforestation, threat to coastal areas, depletion of ozone layer, acid rain, global
warming, etc. are important examples of externality that pose a threat to
sustainability of mankind. There is a clear urgency to tackle them.
Government regulation in an economy has been quite varied depending upon the
nature of commodity or activity in question and prevailing business environment.
Basically, there are two types of policies that the government follows: i)
command and control measures (CAC), and ii) market-based incentives (MBI).
In order to control production of goods with negative externalities the
government in traditional approach imposes restrictions of firms. On the other
hand, government tries to enter into production of goods which generate positive
externalities. Pollution abatement is usually by means of regulatory approach also
231
Environment and known as CAC measures, which are in the form of imposing bans, specifying
Sustainable
Development quotas or emission standards. Under the CAC approach certain economic
activities, considered to be polluting, are prohibited as well. In other cases, a
quota for many polluting activities are determined and allocated among firms
through licensing.
According to the CAC approach, either the government or its designated body
fixes the standards for various pollutants (liquid, gas and noise) emerging out of
various pollution sources. The emission standards are fixed by keeping in view
the assimilative capacity of the ambient environment as well as the health
impacts on human beings living in the area, and existing natural resources. In
order to regulate the environmental pollution, there could be two types of
standards:
a) ambient environment standards,
b) industry specific standards.
Ambient environment standards refer to the limits set for various pollutants that
is considered to be safe for living beings and property. These standards have been
prescribed for ingredients of the environment such as air, water and noise. The
National Ambient Air Quality Standards are prescribed by the Central Pollution
Control Board (CPCB). These standards have been determined keeping in view
the air quality necessary to protect public health, vegetation and property.
Different standards are laid down for industrial, residential and sensitive areas.
The CAC measures are found to be inefficient as it imposes higher cost on
society for realizing a target. As the CAC approach does not distinguish between
polluting agents and puts a universal ban on certain activities, it does not leave
any scope for innovation in clean technology. Studies have shown that similar
objectives can be achieved at a much lower cost through MBIs.
The main aim of the MBIs is creation of a market mechanism where the social
cost of pollution will be borne by the polluters. Thus, the divergence between
private cost and social cost will be avoided and polluting goods will be produced
at their socially optimum level. The MBIs are developed on the basis of the
principles of the market structure, and attempt to remove the distortions emerging
out of inefficient use of resources by removal of subsidies and introduction of
environmental charges on emission, input and output.
Let us consider the case of environmental pollution. Producers of a polluting
good would dump the effluents to the river or the sea. As a result, the water
downstream or on the seacoast would get polluted. The adverse effect of the
polluting activities often prompted the government to impose restriction on
production of polluting goods or shifting of polluting activities away from
residential areas. Dumping the effluents anywhere free of cost reduces the cost of
production for the producer. This encourages the producer to produce at a level
232
 Theories of
higher than the social optimum. In recent years, there is a shift in policy from Regulation
CAC measures to MBIs. Thus, instead of imposing a blanket ban on polluting
activities, the government collects certain amount of pollution charge (Emission
tax) from the polluting units. The objective is to increase the cost of production
so that polluting goods are produced at socially optimum level. In the process,
however, the government generates revenue which can be used for pollution
abatement or for other productive activities.

12.5.1 Pigouvian Taxes

An economic solution to the problem of externalities was evolved in the 1920s by
the well-known British economist Arthur Pigou in the form of pollution tax. This
tax is popularly known as Pigouvian tax. According to Pigou, the social damage
or the social cost imposed by a firm by its pollution activity on society may be
neutralised by imposing a pollution tax on the firm. According to Pigou, the rate
of the tax is equal to the marginal environmental cost or marginal social damage
by the polluting firm on society. This is the same external cost which we
discussed in the sub-section 12.2.2.
Let us take the example of the steel firm located on the upstream river and the
fishery located at the downstream river. In the absence of any fine or tax, the
steel firm faces the wrong price for pollution. As far as the steel firm is
concerned, its production of pollution costs it nothing. But that neglects the costs
that the pollution imposes on the fishery. According to this view, the situation
can be rectified by making sure that the polluter faces the correct social cost of its
actions. One way to do this is to place a tax on the pollution generated by the
steel firm.
We explain the situation in Fig. 12.4 where MCS is the social marginal cost while
MCP is the private marginal cost of production of a good. As more output is
produced, MC, increases with the level of pollution. The demand for the
pollution good is given by the demand curve D' (representing marginal revenue
curve, MR). As per market mechanism, the equilibrium is at point b indicating
the equilibrium output to be q1, and equilibrium price to be P1. Here, MCP = MR
or D'. Socially optimum level of output, however, is Q* and price P*, where
MCS = MR or D'. If the producer were made to pay for the social costs also,
equilibrium output would have been at the level Q1.
We observe from Fig. 12.4 that the difference between MCS and MCP, at the
socially optimum level output is 'ac'. In order to internalize the externalities
Pigou suggests imposition of a tax t per unit of output where t = ac. It is
necessary to note the assumption that pollution emitted per unit of output remains
unchanged as level of output changes.

233
Environment and
Sustainable
Development

Fig. 12.4: Pigouvian Tax

12.5.2 Emission Taxes

With respect to environmental regulations, we shall examine cases where the
legal system is used only indirectly, and primarily to correct price distortions.
One major approach which is used to address these issues is effluent charges or
emission tax. An emission tax is a tax or financial penalty imposed on polluters
by government authorities. The charge is specified on the basis of rupees per unit
of emission into the ambient environment. For example, a firm may be required
to pay an emission tax of Rs. 100 per unit of waste material it discharges into a
lake.
Figure 12.5 shows a Marginal cost of abatement (MCA) curve and the specific
emission tax (T1) by a horizontal curve. MCA is low at high emissions level and
vice-versa. The emission tax equals the MCA at L1 levels of emissions. If the
firm wants to reduce the emissions and wish to be on the left side of L1 level then
the MCA is greater than the emission tax T1 so the firm will not bear the higher
cost of abatement and would like to pay the emission tax and stay at the L1 level
of emissions.
Similarly, if the firm wants to be at the emission level which is on the right side
of L1 then the MCA is smaller than the emission tax T1. The firm would like to
bear the MCA instead of paying the emission tax for all the levels of emissions
till L1 level of emissions.

234 Fig. 12.5: Emission Tax

 Theories of
As public policy instruments, effluent charges have a long history and have been Regulation
used to resolve a wide variety of environmental problems. There are three major
attractions of an emission tax. First, it is less interventionist than emission
standards and operates purely on the premise of financial incentive or
disincentive, not on a CAC principle. Second, it can be relatively easy to
administer. Third, it provides firms with incentives to reduce their pollution
through improved technological means.

Check Your Progress 2

Note: i) Use the space given below for your answers.
ii) Check your progress with those answers given at the end of the unit.
1) How does the rising consumption levels affect the climate?
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2) How does state regulate the environmental issues related to externalities?
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3) Explain the Pigouvian Tax with the help of a diagram.
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4) What is Emission Tax? What are its advantages?
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12.6 LET US SUM UP

In this unit we began by the understanding of concept of externality and its types.
There are two - positive and negative - externalities. It was necessary to
understand how the over production or under production takes place in case of a
product generating externality. The environmental negative externalities affect
the environment drastically and hence the government needs to look in to the
matter of externalities generating activities and firms. Globally the issue of
environmental externalities has taken an important place and so in India. There
are ways to curb the over production of such products by the way of regulation:
Control and Command Approach and the Market Based Incentives. We also
discussed the Pigouvian tax and the emission tax as two major ways to regulate
the environmental pollution. 235
Environment and
Sustainable 12.7 HINTS TO CHECK YOUR PROGRESS
Development EXERCISES
Check Your Progress 1
1) (Refer sub section 12.2.1. and 12.2.2) When the effect of the actions of an
individual on another individual is positive, we call it a positive externality.
Negative externality is an external effect that imposes costs on a third party.
2) (Refer sub section 12.2.1) In the presence of a positive externality, we expect
to observe a clear divergence between social and private benefits which leads
to less than social optimal level of production.
3) (Refer Section 12.3) Externalities generally arise due to two reasons. First,
the resource or product in question by its very nature may be non-rival in
consumption. Such a product will be subject to joint consumption. Second,
for either natural or technical reasons, the transaction cost of internalizing the
externality may be excessively high.
4) (Refer Section 12.3) The approach suggests that an efficient solution to the
problem of externality may be arrived at if property rights are well-defined
and this solution is known as Coase theorem. It works under these
assumptions: Zero transaction costs, Well-defined property rights, Perfect
competition prevails in the market, No income or wealth effects are imposed
with the Coasean solution, No free rider effects -- since the parties have well-
defined property rights.

Check Your Progress 2

1) (Refer Section 12.4) We are globally consuming more products, discarding
more clothes and piling more electronic waste. This all has impacted the
ecological cycle as increased consumerism leads to high levels of production
which requires more transportation of raw materials and that in turn leads to
high carbon footprints.
2) (Refer Section 12.5) Basically, there are two types of policies that the
government follows: i) command and control measures (CAC), and ii)
market-based incentives (MBI).
3) (Refer sub section 12.5.1) The social damage or the social cost imposed by a
firm by its pollution activity on society may be neutralised by imposing a
pollution tax on the firm called Pigouvian tax.
4) (Refer sub section 12.5.2) An emission tax is a tax or financial penalty
imposed on polluters by government authorities. The charge is specified on
the basis of rupees per unit of emission into the ambient environment. There
are three major advantages of this tax. First, it is less interventionist than
emission standards and operates purely on the premise of financial incentive
or disincentive, not on a CAC principle. Second, it can be relatively easy to
administer. Third, it provides firms with incentives to reduce their pollution
236 through improved technological means.