Reversible Environmental Catastrophes with Disconnected Generations

De Economist https://doi.org/10.1007/s10645-020-09378-7 Reversible Environmental Catastrophes with Disconnected Generations Ben J. Heijdra1,2,3 · Pim Heijnen1 Accepted: 27 October 2020 © The Author(s) 2020 Abstract We study environmental policy in a stylized economy–ecology model featuring multiple deterministic stable steady-state ecological equilibria. The economy–ecology does not settle in either of the deterministic steady states as the environmental system is hit by random shocks. Individuals live for two periods and derive utility from the (stochastic) quality of the environment. They feature warm-glow preferences and engage in private abatement in order to weakly influence the stochastic process governing environmental quality. The government may also conduct abatement activities or introduce environmental taxes. We solve for the market equilibrium abstracting from public abatement and taxes and show that the ecological process may get stuck for extended periods of time fluctuating around the heavily polluted (low quality) deterministic steady state. These epochs are called environmental catastrophes. They are not irreversible, however, as the system typically switches back to the basin of attraction associated with the good (high quality) deterministic steady state. The paper also compares the stationary distributions for environmental quality and individuals’ welfare arising under the unmanaged economy and in the first-best social optimum. Keywords Ecological thresholds · Nonlinear dynamics · Environmental policy · Abatement · Capital taxes JEL Classification D60 · E62 · H23 · H63 · Q20 · Q28 · Q50 This paper was presented at the 14th Viennese Conference on Optimal Control and Dynamic Games 2018 (3–6 July 2018) and at the CeNDEF@20 workshop (Amsterdam, 18–19 October 2018). Electronic supplementary material The online version of this article (https://doi.org/10.1007/s1064 5-020-09378-7) contains supplementary material, which is available to authorized users. * Ben J. Heijdra Extended author information available on the last page of the article 13 Vol.:(0123456789) B. J. Heijdra, P. Heijnen 1 Introduction “The window within which we may limit global temperature increases to 2 ◦ C above preindustrial times is still open, but is closing rapidly. Urgent and strong action in the next two decades [...] is necessary if the risks of dangerous climate change are to be radically reduced.” Nicholas Stern, Why Are We Waiting? (2015, p. 32) “ ...we are entering the Climate Casino. By this, I mean that economic growth is producing unintended but perilous changes in the climate and earth systems [which] will lead to unforeseeable and probably dangerous consequences. We are rolling the climatic dice, the outcome will produce surprises, and some of them are likely to be perilous. But we have just entered the Climate casino, and there is still time to turn around and walk back out.” William Nordhaus, The Climate Casino (2013, pp. 3-4) “...I am a climate lukewarmer. That means I think recent global warming is real, mostly man-made and will continue but I no longer think it is likely to be dangerous and I think its slow and erratic progress so far is what we should expect in the future.” Matt Ridley, The Times newspaper (January 19, 2015) Public commentators on climate change and, more generally, on current and future environmental issues seem to come in only two flavors. On the one hand, climate sceptics like bestselling popular science writer Matt Ridley and political scientist Bjørn Lomborg (and many others) tend to downplay the dangers and may even point at positive aspects of global warming. On the other hand, prominent environmental economists have assumed the mantle of whistle-blower and stress the immense risks current generations take with their own and future generations’ environment and welfare. One of the reasons why no consensus has emerged up to this point is, of course, due to the fact that in normal times environmental changes are only gradual and slow (compared to an individual’s life-span) and because the future is inherently stochastic and thus unknowable with certainty. In this paper we present an explorative study in which we sketch what we consider to be important elements in the long-term evolution of the intertwined economic and ecological systems. In order to bring some structure to the debate we identify what we consider to be the four most crucial principles of model-based environmental policy analysis. P1 Generations are the relevant units of analysis. Sustainability is defined in the Brundtland Report (World Commission on Environment and Development 1987, p. 43) as follows: “Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” This suggests that the evaluation of environmental policy 13 Reversible Environmental Catastrophes with Disconnected… should be conducted in the context of an overlapping generations model with disconnected generations. P2 Abrupt environmental changes are possible. In recent years ecologists have discovered that nature does not always respond smoothly to gradual changes but instead may exhibit so-called “tipping points” in which dramatic environmental disasters occur (Scheffer et al. 2001). Environmental economists have adopted the possibility of non-linearities in the response of the environmental system to economic developments. For a recent symposium on the economics of tipping points, see de Zeeuw and Li (2016). P3 Both the economy and the ecological system are inherently stochastic. Indeed, as is stressed by both Stern and Nordhaus in the quotes given above, global warming should not be seen as a deterministic process but rather should be recognized as being inherently stochastic in nature. A suitable model of environmental policy must thus explicitly recognize the fact that both private and public decision making takes place in a world hit by random shocks. P4 Individuals care for the environment but not very strongly. On the one hand, environmental quality has strong public good features so that rational individuals tend to free ride on it. On the other hand, we believe that (at least some) people do get a “warm glow” from cleaning up their local parks and beaches, even if it is merely to be seen “doing the right thing” by their neighbours and friends. A modest amount of private abatement does take place in reality and we capture this phenomenon by adopting the insights of Andreoni (1988, 1989, 1990) and Andreoni and Levinson (1990). The objective of this paper is to study environmental policy using a highly stylized conceptual model which can accommodate all principles (P1)–(P4) simultaneously. In order to capture Principle (P1) we employing an explicit general equilibrium overlapping-generations framework of the economy–ecology interaction. By adopting a closed-economy perspective we capture the notion of (...truncated)