The Economic Approach to Environmental and Natural Resources, 3e

1. The Economic Approach to Environmental and Natural Resources, 3e By James R. Kahn © 2005 South-Western, part of the Thomson Corporation

2. Exhaustible Resources, Pollution and the Environment Part II

3. Material Policy: Minerals, Materials, and Solid Waste Chapter 10 © 2004 Thomson Learning/South-Western

4. Introduction • This chapter focuses on the question of whether we have a socially efficient level of waste and whether our production, consumption, and waste treatment policies are efficient. • The circular nature of our use of materials provides a powerful argument for simultaneously examining both the input and the output side to the question of how to efficiently utilize our material resource. • If the mass of the good that is produced is less than the mass of the inputs used in production, then the differential has been converted into waste. • After a good is consumed, all of the mass of the good becomes waste.

6. Introduction • Resources such as minerals are present in the environment, but must be extracted from whatever form and structure they take in the environment. • The extraction of copper from copper-containing ore creates waste. • Since both mechanical and chemical processes are used in refining the ore, the waste can be hazardous to plants and animals and can contaminate ground and surface water • The conversion of minerals into materials from which products can be made generates two major categories of waste: air pollutants from production process and waste from the production process. • The consumption of goods and services also generates wastes.

7. The Economics of Mineral Extraction • The fashion in which the invisible hand of the market allocates mineral resources is virtually identical to the way in which it allocates fossil fuels. • The market price of an exhaustible resource must be equal to the sum of the marginal extraction cost and marginal user cost in order for the market to allocate the resource in a socially efficient fashion, in the absence of market failure. • The greater the future value of the mineral, the greater the current opportunity cost, marginal user cost, and market price.

8. The Economics of Mineral Extraction • Recycling cannot eliminate the scarcity problem. • The entropy law, one of the laws of thermodynamics, states that matter is continually moving towards a less well-ordered state. • As a mineral is used, the quantity and quality of the mineral in recycling is reduced. • Eventually the mineral will be exhausted.

9. Market Failures in the Extraction of Mineral Resources • Environmental externalities are the result of the waste that is generated and the disruption of the landscape that occurs as a result of mining and refining activities. • Water quality problems result from the refining activity as water is exposed to impurities and these are carried to surface and ground waters through runoff. • The smelting process, where intensely hot furnaces are used to melt the ore and separate the mineral from the waste material, is associated with the release of energy related pollutants and impurities from the ore itself. • This generates acid rain problems.

10. Market Failures in the Extraction of Mineral Resources • Since most of the convenient opportunities for mining have already been exhausted, many potential new mines are located in wilderness areas or other areas that have unique environment properties. • The benefits of preserving the environmental resource are primarily public good benefits and are often not considered in the land use decisions. • John Krutilla, in his landmark article "Conservation Reconsidered," was the first to argue that the focus of conservation should be less concentrated on the resources that are extracted and more directed to the unique environmental resources that mining (and other developmental activities) destroys.

11. Market Failures in the Extraction of Mineral Resources • The benefits of preservation include preserving the area for recreation, habitat, biodiversity, scientific inquiry, water-shed protection, and the non-use benefits that people derive from the existence of the area. • The existence of potential irreversible damage as a consequence of mining suggests a need to be cautious in embarking on economic development. • The benefits associated with preservation may increase over time as demand for recreation increases and the number of substitutes for natural environments is reduced. • Depending on the disparity between future benefits of preservation and future benefits of development, the present value of preservation may be greater than the present value of development, even if current benefits have a different relationship.

12. Market Failures in the Extraction of Mineral Resources • Since development is an " either / or" decision and not a marginal decision, marketable permits and the like are not appropriate tools. • A benefit-cost analysis of societal benefits and societal costs should be conducted. • Other decision-making criteria which consider equity, sustainability, environmental justice and ecological risk should also be examined. • Mines require federal permitting and as such, they are subject to the National Environmental Policy Act (NEPA) requirements for an environmental impact statement (EIS).

13. Market Failures in the Extraction of Mineral Resources • An additional source of market failure within the mining industry is inappropriate government intervention. • A depletion allowance, which allows the firms to depreciate their mineral deposits in the same way a manufacturing firm is allowed to depreciate capital items, results in a lower marginal private cost associated with production and a higher level of mining activity than would occur otherwise. • This increases the disparity between private and social costs associated with mining.

14. Market Failures in the Extraction of Mineral Resources • Monopolistic or oligopolistic market structure in mining industries can lead to a loss in social welfare, as the monopoly or oligopoly restricts output below the optimal level in order to generate monopoly profits. • National Security issues result in monopoly power in the mining of strategic minerals. • Strategic minerals are minerals important to aerospace and military applications that are relatively rare and generally found in countries which are of unpredictable political stability or are potential hostile towards the U.S. and its military allies.

16. Market Failures in the Extraction of Mineral Resources • One approach used to mitigate the problems associated with strategic minerals is for the government to subsidize the production of these ores, even though the extraction cost is much higher than world market price. • An alternative approach is to stockpile these minerals in anticipation of an interruption in availability in the future. • Both of these actions result in a greater quantity of mining of these minerals than is socially optimal.

17. Market Failures in the Extraction of Mineral Resources • One of the environmental legacies of mining is the fact that many old mines create serious ongoing environmental problems such as contamination of surface and ground waters, underground fires and exposure to toxic substances. • Policy makers seeking to deal with mine closings and resulting environmental legacies face two problems. • The first is that the owners of the mines may have disappeared or gone out of business and there is no one to hold responsible for future damages. • The second is the difficulty in creating a policy which gives current owners an incentive to properly close their mine.

18. Market Failures in the Extraction of Mineral Resources • The “temporal separation” between current operations and distant future shut down makes it difficult to design an appropriate incentive system. • One option is to design a performance bonding system which requires a mine owner to put money in an account before the beginning of operation which is only returned upon successful closure of the mine. • Other alternatives include a maintenance fund which would be paid into by mine owner or requiring mine owners to purchase insurance against future environmental damage.

19. Solid Waste and Waste Disposal • Although the problem of waste disposal receives the most public discussion, the real solid waste problem is that we are generating an inefficiently high level of waste. • Why do we generate too much waste? • The simple answer is that people do not pay the full social costs of waste disposal at every level of the production process and in the consumption of the good.

20. Solid Waste and Waste Disposal • The market for carbonated beverages illustrated in Figure 10.3 shows a divergence between the marginal social cost function and the marginal private cost function. • The difference is the social cost associated with waste disposal. • If the analysis is extended to include the amount of waste as a variable input, then the analysis must look at the demand and marginal cost of the material input. • The marginal private cost of a material input (such as the packaging of a product) does not include the full cost of disposal, or the costs of the externalities associated with the disposal. • Not only must the socially optimal level of waste be determined, but also the socially efficient disposition of the waste.

21. Solid Waste and Waste Disposal

22. Solid Waste and Waste Disposal • Figure 10.4 illustrates two options associated with the disposal of 25 units of waste. • One option is proper disposal and is represented by marginal private and social costs (MPCp and MSCp). • The other option is improper disposal and is also represented by marginal private and social costs (MPCi and MSCi). • The optimal allocation, which considers marginal social costs associated with waste disposal, would be 17 units properly disposed and 8 units improperly disposed. • In actuality, the determination of the optimal quality of waste and the determination of the allocation of wastes across disposal options are made concurrently. • There may also be many more options for disposal.

23. Solid Waste and Waste Disposal

24. Why do the social costs of solid waste diverge from the private costs? • Even waste that is stored in a landfill generates external costs. • The landfill itself reduces the aesthetic value of the surrounding land, as odors, vermin, and unsightliness reduce the benefits that people can derive from using the surrounding land. • Even if the landfill is lined with impermeable clay or plastic, which keeps water from moving downwards through the waste into the groundwater, water that has been contaminated by the waste can still move back upward through the garbage (leachate) and be carried by rainwater runoff into surface or groundwater.

25. Why do the social costs of solid waste diverge from the private costs? • Trash disposal is often a government provided or government regulated activity. • However, the price associated with this service seldom reflects the marginal cost associated with its provision. • The environmental costs associated with waste disposal are not incorporated. • The scarcity of landfill space is not incorporated into market price. • The price is often based on average and not marginal cost.

26. Why do the social costs of solid waste diverge from the private costs? • Municipalities that operate landfill services have been slow to include the opportunity cost or scarcity value associated with filling up landfill sites. • The result is that the tipping fee (price per ton dumped) is $5-$10 per ton rather than $40-$50 per ton which would reflect scarce dumping area. • It would be very difficult to get voter approval for such a rise in price. • Also, the practice of billing as an average price across all customers means there is not a link between the price for waste disposal and the amount of waste generated.

27. Waste and Recycling • An increase in recycling would mean we would reduce our use of minerals, have less mining to disturb the environment, use less energy, and have less waste to dispose of in landfills. • The failure to include the social cost of waste in either the price of a product or in the price of disposal means that it is less profitable to recycle. • There is inertia built into our economic system that makes it difficult for recycling to become established.

28. Waste and Recycling • The effect of failure to incorporate social costs of materials and waste disposal into market price is shown in Figure 10.5. • The aggregate marginal private cost curve is the sum the marginal private costs of recycled materials and virgin materials (made from extracted resources) when the consumer views these two materials as identical. • By summing the marginal social costs of both recycled materials and virgin materials it is possible to generate an aggregate marginal social cost curve. • This figure assumes a disparity between the marginal social and marginal private costs of virgin materials. • Marginal private costs associated with recycled materials are assumed to be identical to the marginal social costs.

29. Waste and Recycling

30. Waste and Recycling • The inverse demand curve for materials is represented as a downward sloping curve. • The aggregate private cost curve intersects the inverse demand curve at q1 units of materials, with r1 representing the amount of recycled material used in the production process. • The optimal allocation of recycled and virgin materials is represented by the intersection of the aggregate social cost curve and the inverse demand curve. • The result is an allocation of recycled (r2) and virgin material (v2) that is different from the private allocation. • The disparity between private and social costs results in too great a reliance on virgin materials.

31. Waste and Recycling • In order for the cost of recycling to be relatively low, an extensive amount of recycling must take place to achieve economies of scale. • However, an extensive amount of recycling will not take place without a lowering of the cost of recycling. • In much the same way that new industries receive government protection until they can achieve economies of scale, an argument can be made that the government should require a certain percentage of recycling in order to generate the quantities that will allow economies of scale.

32. A Comprehensive Materials Policy • At the federal level, the government can adopt direct controls or economic incentives to help reduce the environmental externalities associated with mining. • The implementation of a federal level packaging tax, in order to reduce the quantity of waste generated in the packaging of goods, would provide manufacturers with an incentive to reduce materials used. • A local or state level tax would probably result in firms choosing to locate in areas without the tax. • In addition, a differential tax system could be developed based on the ability to recycle the packaging material. • This type of tax is a second best alternative to reflecting the marginal social cost in resource allocation decisions.

33. A Comprehensive Materials Policy • A deposit-refund system on heavy metals would allow for the removal of these materials from the waste stream for separate handling to meet special requirements for recycling or disposal. • At the state and local level the single most important action would be to develop a system for financing the collection and disposal of solid waste that incorporates the full social cost of waste into the price of collection and disposal. • While voters may resist higher disposal fees, a policy of education and gradual rises in fees may make the rise in price more palatable.

34. A Comprehensive Materials Policy • The difficulty of reflecting the full social cost in waste disposal can be dealt with in a variety of ways. • The purchase of “official bags" for trash disposal will effectively charge households differential rates based on quantity of trash. • Because sorting recyclables at the household level is more cost efficient, many communities have designed their recycling programs to take advantage of this fact. • By separating yard waste and generating mulch material, many communities have turned a waste item into an economic product.

35. A Comprehensive Materials Policy • There is a potential problem with both increasing the cost of legal waste disposal and with moving to marginal cost pricing of waste. • Incentives develop for illegal dumping. • In order to counter this, policies must be developed to increase the expected penalty for illegal dumping by increasing the both the fine for illegal dumping and the probability of being caught.

36. Summary • Market failures associated with materials occur throughout the cycle of use, from the mining of minerals to the disposal of economic products when useful life is over. • Market failures in materials policy arise from environmental externalities, imperfect competition and inappropriate government intervention. • A variety of policies are necessary to reduce the economic inefficiency associated with these market failures.