The Political Economy of Environmental Policy

This research project develops a theory of environmental policy formation to address the problems of commitment, implementability and sustainability that the long time scale of natural resource dynamics implies. The theory is then applied to two important domains of economic policy and environmental research: international trade and climate change. Particular emphasis is placed on (i) capital asset markets which transfer future gains and losses to the presence and (ii) general equilibrium effects between the resource-based and manufacturing sectors. A two-sector OLG model is used to identify the intergenerational effects of environmental policy that protects an environmental stock. A traded asset capitalizes the economic returns to future policy- induced environmental changes, potentially benefiting the asset owners, the old generation. Policy comes at a cost which has the potential to lower welfare of both the young and the old generation. If asset price changes are sufficiently large, the current generation can benefit from the implementation of policy. Future generations benefit from the tax-induced improvement in environmental stock. Future generations also have the ability to change policy, introducing questions of commitment and time-consistency. However, the principal intergenerational conflict arising from policy is between generations alive at the time society imposes the policy, not between generations alive at different times. Various political economy settings are introduced to determined equilibrium environmental policy. Most importantly, the laissez-faire scenario is compared to the Markov-perfect equilibrium policy and first-best policy. The proposed research project applies this methodological framework to the important policy domains of international trade and climate change. The research project proposes a combination of environmental economics, modern macroeconomics, political economy, and international and climate change economics. Host institutions are Columbia University and University of California, Berkeley, abroad and the International Institute for Applied Systems Analysis in Austria.

Everybody wants to preserve natural resources for future generations a comforting assumption, often used in theory. In practice, however, not every participant in society is concerned with the well-being of others, let along willing to limit himself/herself for them. This is a serious problem, particularly when it comes to environmental policy: in order to avoid potential damage in the distant future, expenditures must be incurred immediately. The goal of this project was to better understand and develop solutions to master this challenge by studying the connection between environmental policy and asset creation. By accounting for future prosperity and the translation of this future well-being into todays financial wealth, we study how todays generations, who are the ones shouldering the costs, can already benefit from futures wealth. Consider the following scenario: To lower resource use, a policy measure is adopted that incurs economic costs upon implementation. At the same time, however, it also reduces future environmental degradation and, in particular, climate damage, and thus the costs of economic production in the future. There are many ways in which this relative increase in future prosperity can manifest itself: higher economic growth, faster job creation, and better incomes. The key observation of our project is that the capital market can serve to translate such future positive economic developments into higher assets today. This can occur through investments in the form of government bonds, securities or stocks. This increase in asset wealth can be used to finance, at least in part, the costs of the policy measure. A further aspect that is incorporated in the model is the possible revision of current measures. For instance, the decisions made today by generation X could be eliminated again by the subsequent generation Y, leaving generation Z empty-handed. To account for this commitment problem, different voter models and their relevance to intergenerational prosperity are analyzed.