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Block

4VALUATIONAND PRICING OF NATURALRESOURCES

UNIT 1Ecosystem Services and its Valuation 5

UNIT 2Policy Instruments for Pollution Control,Conservation and Clean Energy 24

UNIT 3Kyoto Protocol and Carbon Trading 33

UNIT 4Green National Income Accounting 50

MSD-014ECOLOGICAL ECONOMICS

Indira GandhiNational Open UniversitySchool of Interdisciplinary andTrans-disciplinary Studies

Unit 1 Ecosystem Services and its Valuation Dr. Naresh Chandra SahuUnit 2 Policy Instruments for Pollution Control,

Conservation and Clean Energy Dr. Naresh Chandra SahuUnit 3 Kyoto Protocol and Carbon Trading Dr. Swarna S. VepaUnit 4 Green National Income Accounting Dr. Naresh Chandra Sahu

ADVISORSProf. V. N. Rajasekharan PillaiFormer Vice-Chancellor,IGNOU, New Delhi

COURSE EDITOR COURSE COORDINATOR BLOCK COORDINATOR

PROGRAMME DESIGN COMMITTEEProf. M.S. SwaminathanHonorary Chair, Chair forSustainable DevelopmentIGNOU, New Delhi

Dr. (Mrs.) Latha PillaiFormer Pro-Vice Chancellor andExecutive Director, CSD,IGNOU, New Delhi

EXPERT COMMITTEE

Prof. P.C. KesavanEmeritus ProfessorCSD, IGNOU, New Delhi

Prof. P.S. Ramakrishnan,JNU, New Delhi

Dr. P. A. AzeezSálim Ali Center for Ornithology and Natu-ral History (SACON), Coimbatore

Dr. Tanushree BhattacharayaInstitute of Science and Technology forAdvance Studies and Research (ISTAR),Gujarat

Dr. Jagdamba PrasadARD, Regional Service DivisionIGNOU

Dr. Naresh Chandra SahuDepartment of Humanities, SocialSciences, and ManagementIndian Institute of TechnologyBhubaneswar (IITBBS), Odisha

Dr. A.K. Shiva KumarAdvisor, UNICEF, New Delhi

Dr. Swarna S. VepaMadras School of Economics, Chennai

Dr. Nehal A. FarooqueSOEDS, IGNOU

Dr. Bibhu Prasad Nayak,The Energy and Research Institute (TERI),New Delhi

Dr. Oinam HemlataSchool of Human EcologyAmbedkar University, New Delhi

Dr. Y. S. Chandra KhumanSOITS, IGNOU, New Delhi

Prof. M.K. SaloojaCSD & SOA, IGNOU, NewDelhi

Prof. K.S. RaoDept. of Botany,University of Delhi

Dr. Subhakanta MohapatraSOS, IGNOU

Dr. Anjan PrustySálim Ali Center for Ornithol-ogy and Natural History(SACON), Coimbatore

Dr. Narendra Kumar Sahoo,Civil Engineering Department,Maharishi MarkandeshwarUniversity, Ambala

PROGRAMME COORDINATORDr. Y. S. Chandra KhumanSOITS, IGNOU, New Delhi

Prof. D.K. MarothiaFounder professor and Head,Department of Agricultural andNatural Resource EconomicsIndira Gandhi AgriculturalUniversity, Raipur, Chhatisgarh



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INTRODUCTION TO BLOCK-4

The major objective of Block-4 is to explain the ecosystem services and itsvaluation; describe the policy instruments for pollution control, conservation andclean energy; define Kyoto protocol and carbon trading; and explain Green NationalIncome Accounting. The Block-4 on “Valuation and Pricing of Natural Resources”comprises of four units. The Unit- 1 is on “Ecosystem services and its valuation”.This unit introduces you to the need and significance of valuing ecosystem services.This unit familiarizes you with the basic concepts of Valuation of EcosystemServices and also Valuation Methods and Techniques involved in Valuing EcosystemServices. The Unit-2 is on “Policy Instruments for Pollution Control, Conservationand Clean Energy”. This unit introduces you to the need for policy instruments toreduce pollution and familiarize you with various types of Environmental PolicyInstruments. We will also discuss the relevance of market based instruments indeveloping countries. The Unit-3 is on “Kyoto Protocol and Carbon Trading”. Inthis unit, we will discuss the evolution of Kyoto Protocol, different types of KyotoMechanisms and features like Carbon Trading, Tradable Permits and CarbonMarkets. The Unit-4 is on “Green National Income Accounting”. This unitintroduces you to the concept of Conventional GNP and Green GNP. We willdiscuss the flaws in the Conventional System of National Accounting. You will beintroduced to the Methodological Approaches to Green Accounting and Issuesand Challenges related to Green Accounting.

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UNIT 1 ECOSYSTEM SERVICESAND ITS VALUATION

Structure

1.0 Introduction

1.1 Objectives

1.2 The Need and Significance of Valuing Ecosystem Services

1.3 Conceptual Issues in Valuation of Ecosystem Services

1.4 Economic Values of Ecosystem Services

1.5 Methods and Techniques for Valuation of Ecosystem Services

1.5.1 Market Price Method

1.5.2 Damage Cost Avoided, Replacement and Substitute Cost Method

1.5.3 Hedonic Pricing Method

1.5.4 Travel Cost Method

1.5.5 Contingent Valuation Method

1.5.6 Contingent Choice

1.6 Steps in Ecosystem Service Valuation

1.7 Let Us Sum Up

1.8 Key Words

1.9 References and Suggested Further Readings

1.10 Key to Check Your Progress

1.0 INTRODUCTION

Ecosystem is a biological environment consisting of all the living and non-livingorganisms in a particular area. It consists of plants, animals, and microorganismsthat live, feed, reproduce and interact in the physical and chemical environment.The structure and functioning of an ecosystem is strengthened by synergeticfeedbacks between organisms and their environment. For instance, the physicalenvironment puts constraints on the growth and development of biologicalsubsystems which in turn could potentially modify the physical environment overthe time.

These physical, chemical and biological interactions constitute ecosystem functionsand provide critical life support systems as well as a range of ecosystem goodsand services for the survival of human and other living species. Ecosystem functionsinclude carbon cycling, nutrient trapping, soil formation, water cycles and so on.Ecosystem services constitutes goods, services and cultural benefits from thoseecosystem functions that are perceived to support, help and protect human andother living beings. These ecosystem services include the maintenance of thecomposition of the atmospheric environment, amelioration and stability of climate,waste assimilation, scenic beauty, provision of food, water, air and so on. Henceecosystem provides a variety of goods and services that forms the core of anyeconomic activity and contributes significantly for the human welfare.

However, the values of these ecosystem services are ignored or given little weightin ecosystem resource use and management decision making as these services arenot assigned with any monetary value like other commodities in market andperceived to be free and unlimited. The discourses of environmental conservation

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Valuation and Pricing ofNatural Resources

in recent years have emphasized on the valuation of ecosystem services so thatvalue of these services will be reflected in decision making. Though there havebeen debates around the methodological and ethical issues in valuation, severalvaluation techniques have emerged in recent years and are widely used all overthe world.

Valuation of ecosystem services is the process of assigning monetary value onecosystem services that are not conventionally priced or valued. It is not necessaryfor ecosystem services to be bought and sold in markets in order to measure theirvalue in monetary terms. What is required is a measure of how much people arewilling to pay to get the services of the ecosystem, or how much people wouldneed to be paid in order to give up, if they were asked to make a choice similarto one they would make in a market. The detailed discussion related to thevaluation of ecosystem services has been made in the following sections.

1.1 OBJECTIVES

After reading this unit, you will be able to:

l underline the need and significance of valuing ecosystem services;

l define the basic concepts of valuation of ecosystem services; and

l explain the valuation methods and techniques involved in the valuingecosystem services.

1.2 THE NEED AND SIGNIFICANCE OFVALUING ECOSYSTEM SERVICES

Though ecosystem provides a range of services for the welfare of human beings,the values of these ecosystem services are given little weight in ecosystem resourceuse and management decision making or in business and policy decision relatedto concerned ecosystem services. In our daily life, we care for every othercommodities or services for which we pay in our daily life even if it’s a small USBdrive or a big car, but we tend to ignore the damage we cause to environmentby bursting fire-crackers, throwing waste into rivers as air, water and other suchresources that nature provides us are perceived to be free. This could be due tothe fact that most of the ecosystem services are not quantifiable or given amonetary value like other commodities in commercial markets as well as otherfactors like different kinds of market failure associated with ecosystem services.For example, the price of steel does not reflect cost in terms of pollution by thesteel plants during its production or loss of forest and biodiversity during themining of iron ore. The storm protection service of mangrove forest was hardlyreflected in policy dialogues before thousands of people were killed in 1999 supercyclone in coastal Odisha or in 2004 Tsunami that hit Tamil Nadu coast.

The increased understanding about the complexities involved in environmentalconservation and resource use tradeoffs have emphasized on the valuation of thebenefits that accrues to society in terms of goods, services and cultural benefitsfrom the nature. The emergence of the notion of considering natural environmentas a capital asset i.e., natural capital in economics also contributed to theenvironmental valuation discourses. The natural capital not only refers to specificnatural resources like minerals, trees, air and water but also all the servicesecosystem provides. So the environmental valuation or valuation of ecosystemservices is the process of assigning monetary value on ecosystem services whichare not conventionally priced or valued.

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The issue of valuation cannot be separated from the choices / preferences anddecisions that human make about ecosystems. Some scholars are of the opinionthat valuation of ecosystems is either impossible or inappropriate. It is argued thatwe cannot put a value on some intangibles such as human life, environmentalaesthetics, and long-term ecological benefits. In addition to this some even arguethat ecosystem should be protected from moral or aesthetic point of view andvaluation of ecosystem is not required for this purpose. It is also argued that ifindividual preferences undergo change due to various factors such as education,advertising, peer pressure, etc, then value that we assign to the ecosystem servicealso changes though the intrinsic value of the said service remain same. On thecontrary, some scholars argue in favour of valuation of ecosystem services andviewed that valuation can help policymakers to deal with market failures associatedwith ecosystem services, by measuring their costs to society, in terms of losteconomic benefits. The costs to society can then be imposed, in different ways,on those who are responsible for the damage, or can be used to determine thevalue of actions to minimize or eliminate environmental impacts. So with valuation,the society can make better choices on management of ecosystem services.

The objective of the valuation is not to put a price tag on ecosystem services andmarket them but to make their values reflected in decision making concerning useand management of the ecosystem. The agencies involved in decision making forthe protection and management of natural resources must often make difficultdecisions that involve tradeoffs in allocating resources. These types of decisionsare economic decisions, and thus are based, either explicitly or implicitly, onsociety’s perception towards the values of the ecosystem resources. Therefore,economic valuation can be useful by providing a way to justify and set prioritiesfor programs, policies, or actions that protect or restore ecosystems and theirservices. In order to understand how economists approach ecosystem valuation,it is useful to discuss some important definitions and concepts.

1.3 CONCEPTUAL ISSUES IN VALUATION OFECOSYSTEM SERVICES

Before we discuss the economic values of the ecosystem services and the valuationtechnique, it is very useful to briefly analyze some conceptual issues related tovaluation of ecosystem services. The major conceptual issues in analyzing valuationof ecosystem services are the understanding of the notions of ecosystem functionsand services and the concept of market failure associated with the ecosystemservices.

The notion of ecosystem functions and services are drawn from the biologicalsciences and widely used across other disciplines. Ecosystem, as defined byWikipedia, is a biological environment consisting of all the organisms living in aparticular area, as well as all the non-living (abiotic), physical components of theenvironment with which the organisms interact, such as air, soil, water and sunlight.Ecosystem functions can be physical, chemical, and biological processes or attributesthat contribute to the self-maintenance of an ecosystem. Some examples ofecosystem functions are carbon cycling, nutrient trapping, soil formation, watercycles and so on. In other words, ecosystem function is what the ecosystem does.Thus, ecosystems, such as wetlands, forests, or estuaries, streams, wastelands,etc. can be characterized by the processes, or functions, that occur within them.

The concept of ecosystem services has multiple definitions given the vastness ofthe term and the complexities associated with the ecosystems and its functions.Ecosystem services, as defined by the IPCC, are ecological processes or functions

Ecosystem Services andIts Valuation

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that have value to individuals or society. Hence ecosystem services are the beneficialoutcomes of the ecosystem functions that help sustain and fulfill human life. Someexamples of ecosystem services are amelioration and stability of climate, provisionof food, water and air, carbon sequestration and assimilation of other materialwaste, habitat for diverse living species, pollination of native and agriculturalplants, scenic beauty, and so on. In order for an ecosystem to provide servicesto humans, some interaction with or at least some appreciation by humans isrequired. The ecosystem functions are value-neutral, whereas the ecosystem serviceshave value to the society.

So ecosystem provides a range of valuable services that are critical for humansurvival and also key to any economic activity. However, these services areperceived as free and the values of ecosystem services are never reflected in theecosystem resource use and management decision making leaving these valuableresources vulnerable for over-exploitation and degradation. The primary reasonfor the ignorance of the ecosystem services values in decision making is the failureof the market mechanism in capturing the values of such services that natureprovides. The goods, services and cultural benefits that the ecosystem providesare associated with various types of market failures. Market failure is defined asthe inability of market forces such as demand and supply to reflect the full socialcosts or benefits of a good, service, or state of the world. For example, the priceof petrol does not fully reflect the costs, in terms of pollution, that are imposedon society by burning petrol. The ecosystem services are subject to market failurefor three reasons i.e., (i) many ecosystems provide services that are public goods;(ii) many ecosystem services are affected by externalities; and (iii) property rightsrelated to ecosystems and their services are often not clearly defined.

Ecosystem services are often public goods, which mean that they may be enjoyedby any number of people without affecting other peoples’ enjoyment. For example,an aesthetic view is a pure public good. No matter how many people enjoy theview, others can also enjoy it. Other services may be quasi-public goods, whereat a certain level of use, others’ enjoyment may be diminished. For example, apublic recreation area may be open to everyone. However, crowding can decreasepeoples’ enjoyment of the area. The problem with public goods is that, althoughpeople value them, no one person has an incentive to pay to maintain the good.Thus, collective action is required in order to produce the most beneficial quantity.

Ecosystem services are subject to externalities, or uncompensated side effects ofhuman actions. Externalities are the costs or benefits that one individual incur orderives due to the action of another individual and this cost or benefit is notreflected in price of the good or service in transaction. The externalities could bepositive or negative. For example, if a stream is polluted by runoff from agriculturalland, the people downstream experience a negative externality. The problem withnegative externalities is that the people (or ecosystems) they are imposed uponare generally not compensated for the damages they suffer. Similarly, if my neighborinvests in a beautiful garden which is visible from my house too, I get positiveexternality without paying anything. Many of the ecosystem services like carbonsequestration, watershed function of forests, natural cleaning mechanism of flowingwater in the river helps in dealing with the negative externalities of the severalhuman actions and these services are not reflected in its prices in the absence ofa market to do so.

Another factor which contributes to the market failure for ecosystem services islack of clearly defined property rights or ownership structure. Whom should wepay for the ecosystem services like carbon sequestration or watershed function?How the prices to be determined? When property rights for natural resources

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are not clearly defined, they may be overused, because there is no incentive toconserve them. For example, unregulated fisheries are an open-access resource– anyone who wants to harvest fish can do so. Because no one person or group“owns” the resource, open access can lead to severe over-harvesting and resultsin significant declines in fish abundance over time.

Ecosystem valuation can help resource manager’s deal with the effects of marketfailures, by measuring their costs to society, in terms of lost economic benefits. Thecosts to society can then be imposed, in various ways, on those who are responsible,or can be used to determine the value of actions to reduce or eliminateenvironmental impacts. In the case of a stream polluted by agricultural runoff, thebenefits from eliminating the pollution can be compared to costs of actions toreduce the runoff, or can be used to determine the appropriate fines or taxes tobe levied on those who are responsible. In the case of open-access fisheries, thebenefits from reducing overfishing can be compared to regulatory costs or coststo the commercial fishing industry, if access is restricted.

1.4 ECONOMIC VALUES OF ECOSYSTEMSERVICES

Total economic value (TEV) of ecosystem services constitutes the values that weobtain from its uses for various purposes (use values) as well as from its veryexistence (non-use values). The use values are based on the actual use of ecosystemservices and include direct use values, indirect use values and future use valuesor option value. The non-use values are the values obtained from the very existenceof the ecosystem as well as the option for the future generation to use theecosystem services.

Total Economic Value (TEV) = Use Value (UV) + Non Use Value (NUV)

The economic values of ecosystem services are presented in the following figureand discussed in subsequent paragraphs.

Fig. 1: The Economic Value of Ecosystem Services


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Use Value:

Use value is defined as the value derived from the actual use (both direct andindirect) of ecosystem services such as timber from forests, non-timber forestproducts (NTFPs), minerals from earth, water from rivers, hunting, fishing, birdwatching, or hiking as well as non-perceived value and option value of ecosystemservices.

Use Value (UV) =Direct use value + Indirect use value+ Option value

Let’s discuss the each of these components of the use value for furtherunderstanding.

Direct use value: Direct use value can be either be consumptive or non-consumptive and refer to the current use of goods and services provided byecosystem. For example, food, water, firewood from forest, fodder, medicinalplants, fruits, poles, etc., that the forest provides to the people and thereby createdirect consumptive use values. The examples of recreational services provided bynature such as tourism to wildlife sanctuaries or Himalayan glaciers fall underdirect non-consumptive use values. Hunting wildlife for meat or their body partsis a consumptive use value whereas viewing wildlife in sanctuaries and nationalpark or even in zoo is an example of non-consumptive use values. Given theextensive dependence of people on ecosystem for a range of their needs in ourcountry, the direct consumptive use value is substantial in case of ecologicalresources such as land, forest and water resources. In many parts of the world,wild foods constitute still over 40 percent of the people’s consumption and itspercentage is very high in low income countries. Around 80 percent of medicinesused by common people across the world come from plants, forest and animal.An alternative to consumptive use value is the productive use value. It constitutesvalues of products that are harvested and sold in commercial markets at both theinternational and national levels. They include timber, fuel wood, fish and othermarine products, medicinal plants, fibers, honey, natural dyes, forest potatoes, salseeds, flowers, resins, and many others.

Indirect Use Value: Indirect use value refer to the values of services thatecosystem provides without harvesting or depletion and that are not directly used-consumptive or non-consumptive. Some of such ecosystem services includes thewatershed function of nature like flood control, regulation of stream flows, rechargingof ground water, and other critical services like fixing of nitrogen, assimilation ofwaste, carbon sequestration, gene pool and so on. Among several other indirectecosystem services, natural environments and beautiful landscapes have been thesources of inspiration of many great work of art, literature and culture and hencehave immense indirect use value. Some of these indirect use values are also non-perceived values as they not readily perceived when individuals are asked toevaluate a natural resource.

Option Value: Option value is the value that people place on ecosystems forhaving the option to enjoy the services in the future, although they may notcurrently use it. In other words, it refers to the benefits received by retaining theoption of using a resource in the future by protecting and preserving it today. Sooption value is the additional value placed on natural resource by those peoplewho want to have the possibility of using the goods and services in future. Thevalue of biodiversity conservation or the conservation of flagship species like tigerand elephant is for the option value that the society place for these species. Theoption value constitutes the value for future use option by any individual, valuesin use by other individuals in society and the value in use by future. The decisionof the countries not to maintain the petroleum reserves or other mineral resourcesfor future use is also an option value.

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Option value = value for future use option by the individual + value in use byothers (vicarious value) + value in use by future individuals (descendant and futuregenerations)

Non-Use Value

Non-use values, also referred to as “passive use” values, are values that are notassociated with actual use, or even the option to use a good or service. Theseare entirely different from use values and are generated without any direct relationwith the use of natural resources in question. Essentially, evolutionary processvalues, cultural and other societal values from the very existence of the ecosystemconstitute the non-use values of ecosystem services. Non-use values includeexistence value and bequest value.

Non-Use Value (NUV) = Existence Value (EV) + Bequest Value (BV)

Existence value: Existence value is the non-use value that people place onsimply knowing that something exists, even if they will never see it or use it. Forexample, a person from Gujarat might be willing to pay to protect Tigers inSimilipal in Odisha or Bandipur in Karnataka, even though he or she neverexpects or even wants to go there, but simply because he or she values the factthat it exists. In fact, these values are often revealed through people’s perceptionsand concerns towards conservation, culture, and aesthetics and so on. Peopleswilling to pay to protect and preserve of endangered species is an example ofexistence value.

Bequest value: Bequest value is the value that society places on ecosystem topreserve environmental assets for the enjoyment of other people of both presentgeneration and the future generation. Bequest values involve altruisms and aresimilar to option value discussed under use values. The bequest value generateswhen people are willing to pay to conserve and protect an ecological resourcefor the use and welfare of the future generations. In this process, people who paydo not have any intention to use the benefits of that resources during their ownlife span, but they are bequesting those benefits for the future generations.

The above discussion shows that a single person may benefit in more than oneway from the same ecosystem. Thus, total economic value of ecosystem resourcesis the sum of all the relevant use and non-use values for a good or service.

Check Your Progress 1

Note: a) Use the space below for your answer.

b) Compare your answers with those given at the end of the unit.

1) What is the need for valuation of ecological services?

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2) What do you mean by Total Economic Values of ecosystem services?

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Valuation and Pricing ofNatural Resources 1.5 METHODS AND TECHNIQUES FOR

VALUATION OF ECOSYSTEM SERVICES

The valuation of ecosystem services is complex and need multiple methods tomeasure different ecosystem services or the services in different ecosystems.There are three broad approaches for valuation of ecological resources. Theseare as follows.

l Market Approaches

l Revealed Preference Approaches

l Stated Preference Approaches

Each of these approaches has different methods of measuring ecosystem servicesand we will discuss these methods in detail in the following paragraphs of thissection.

The market approach includes methods like Market Price Method, ProductivityMethod, Replacement Cost Method, Substitute Cost Methods, Human capital/Cost of illness. The market approach also imputes the value of ecosystemservices by quantifying the Aversive Behaviors or damage cost avoidance andmeasuring the Defense Expenditure. The valuation methods in revealed preferenceapproach include travel cost method and hedonic price method, and the methodsin stated preference approach include contingent valuation methods and choicemodeling. Some of the widely used and popular valuation methods coveringdifferent approaches are discussed below in detail. The discussion focuses onsignificance and application of the methods and the advantages and limitations ofeach method.

1.5.1 Market Price Method

The market price method estimates the economic value of ecosystem products orservices that are bought and sold in commercial markets. The market price methodcan be used to value changes in either the quantity or quality of a good orservice. It uses standard economic techniques for measuring the economic benefitsfrom marketed goods, based on the quantity people purchase at different prices,and the quantity supplied at different prices. For example, water pollution hascaused the closure of a commercial fishing area, and agency staff wants to evaluatethe benefits of cleanup. The market price method can be adopted in this case,because the primary resource affected here is fishing whose value can be imputedbased on the available market price of fish.

There are several advantages of market price method. First, the market pricemethod reflects the actual costs and benefits of goods that are bought and soldin markets, such as fish, timber, or fuel wood. Thus, people’s values are likelyto be well-defined in such cases. Price, quantity and cost data are relatively easyto obtain for established markets. The method uses observed data of actualconsumer preferences. However, market price method has some limitations. Marketdata may only be available for a limited number of goods and services providedby ecosystem and may not reflect the value of all productive uses of a resource.The true economic value of goods or services may not be fully reflected in markettransactions due to existence of market imperfections and/or policy failures.Seasonal and species variations and other effects on price must be considered.

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1.5.2 Damage Cost Avoided, Replacement andSubstitute Cost Method

The damage cost avoided, replacement cost, and substitute cost methods arerelated methods that estimate values of ecosystem services based on either thecosts of avoiding damages due to lost services, the cost of replacing ecosystemservices, or the cost of providing substitute services. These methods do notprovide strict measures of economic values, which are based on peoples’ willingnessto pay for a product or service. Instead, they assume that the costs of avoidingdamages or replacing ecosystems or their services provide useful estimates of thevalue of these ecosystems or services. This is based on the assumption that, ifpeople incur costs to avoid damages caused by lost ecosystem services, or toreplace the services of ecosystems, then those services must be worth at leastwhat people paid to replace them. Thus, the methods are most appropriatelyapplied in cases where damage avoidance or replacement expenditures haveactually been, or will actually be made.

Some examples of cases where these methods might be applied include: Valuingimproved water quality by measuring the cost of controlling effluent emissions;Valuing erosion protection services of a forest or wetland by measuring the costof removing eroded sediment from downstream areas; valuing storm protectionservices of mangroves by measuring the cost of building retaining walls.

The Damage Cost Avoided method might be applied using two differentapproaches. One approach is to use the information on flood protection obtainedin the first step to estimate potential damages to property, if flooding were tooccur. A second approach would be to determine whether nearby propertyowners have spent money to protect their property from the possibility of flooddamage, for example by purchasing additional insurance or by reinforcing theirbasements. These avoidance expenditures would be summed over all affectedproperties to provide an estimate of the benefits from increased flood protection.However, one would not expect the two approaches to produce the same estimate.One might expect that, if avoidance costs are expected to be less than thepossible damages, people would pay to avoid those damages.

The replacement cost method is applied by estimating the costs of replacing theaffected ecosystem services. In this case, flood protection services cannot bedirectly replaced, so this method would not be useful. The substitute cost methodis applied by estimating the costs of providing a substitute for the affected services.For example, in this case a retaining wall or a levee might be built to protectnearby properties from flooding. The researcher would thus estimate the cost ofbuilding and maintaining such a wall or levee. The researcher must also determinewhether people would be willing to accept the wall or levee in place of a restoredwetland.

The monetary values of the property damages avoided, or of providing substituteflood protection services provide an estimate of the flood protection benefits ofrestoring the wetlands, and can be compared to the restoration costs to determinewhether it is worthwhile to restore the flood protection services of the wetlands.

Advantages: The method may provide a rough indicator of economic value,subject to data constraints and the degree of similarity or substitutability betweenrelated goods.


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l It is easier to measure the costs of producing benefits than the benefitsthemselves, when goods, services, and benefits are non-marketed. Thus,these approaches are less data and resource-intensive.

l The methods provide surrogate measures of value that are as consistent aspossible with the economic concept of use value, for services which may bedifficult to value by other means.

Limitations:

l These approaches assume that expenditures to repair damages or to replaceecosystem services are valid measures of the benefits provided. However,costs are usually not an accurate measure of benefits.

l These methods do not consider social preferences for ecosystem services,or individuals’ behavior in the absence of those services. Thus, they shouldbe used as a last resort to value ecosystem services.

l The replacement cost method requires information on the degree of substitutionbetween the market good and the natural resource. Few environmentalresources have such direct or indirect substitutes. Substitute goods are unlikelyto provide the same types of benefits as the natural resource, e.g., stockedsalmon may not be valued as highly by anglers as wild salmon.

l The goods or services being replaced probably represent only a portion ofthe full range of services provided by the natural resource. Thus, the benefitsof an action to protect or restore the ecological resource would be understated.

l Just because an ecosystem service is eliminated is no guarantee that thepublic would be willing to pay for the identified least cost alternative merelybecause it would supply the same benefit level as that service. Withoutevidence that the public would demand the alternative, this methodology isnot an economically appropriate estimator of ecosystem service value.

1.5.3 Hedonic Pricing Method

The hedonic pricing method is used to estimate economic values for ecosystemservices that directly affect market prices. It is most commonly applied to variationsin housing prices that reflect the value of local environmental attributes. It can beused to estimate economic benefits or costs associated with:

l environmental quality, including air pollution, water pollution, or noise

l environmental amenities, such as aesthetic views or proximity to recreationalsites

The basic premise of the hedonic pricing method is that the price of a marketedgood is related to its characteristics, or a range of services it provides. Forexample, the price of a car reflects the characteristics of that car namely comfort,style, fuel economy, etc. Therefore, we can value the individual characteristics ofa car or other good by looking at how the price people are willing to pay for itchanges when the characteristics change. The hedonic pricing method is mostoften used to value environmental amenities that affect the price of residentialproperties.

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The hedonic pricing method is used to estimate the value of environmental amenitiesthat affect prices of marketed goods. Most applications use residential housingprices to estimate the value of environmental amenities. The method is based onthe assumption that people value the characteristics of a good, or the services itprovides, rather than the good itself. Thus, prices will reflect the value of a setof characteristics, including environmental characteristics that people considerimportant when purchasing the good.

The hedonic pricing method is relatively straightforward and uncontroversial toapply, because it is based on actual market prices and fairly easily measureddata. If data are readily available, it can be relatively inexpensive to apply. If datamust be gathered and compiled, the cost of an application can increase substantially.

Advantages:

l The method’s main strength is that it can be used to estimate values basedon actual choices.

l Property markets are relatively efficient in responding to information, so canbe good indications of value and property records are typically very reliable.

Limitations:

l The method only captures people’s willingness to pay for perceived differencesin environmental attributes, and their direct consequences. Thus, if peoplearen’t aware of the linkages between the environmental attribute and benefitsto them or their property, the value will not be reflected in home prices.

1.5.4 Travel Cost Method

The travel cost method is used to estimate economic use values associated withecosystems or sites that are used for recreation. The method can be used toestimate the economic benefits or costs resulting from changes in access costs fora recreational site; elimination of an existing recreational site; addition of a newrecreational site; changes in environmental quality at a recreational site. The basicpremise of the travel cost method is that the time and travel cost expenses thatpeople incur to visit a site represent the “price” of access to the site. Thus,peoples’ willingness to pay to visit the site can be estimated based on the numberof trips that they make at different travel costs. The major advantage of thismethod is that it is based on actual behavior i.e. what people actually do ratherthan stated willingness to pay and what people say they would do in a hypotheticalsituation. The method is relatively inexpensive to apply. There are some limitationsof this method. First of all, this method assumes that people perceive and respondto changes in travel costs the same way that they would respond to changes inadmission price. Secondly, the interviewing visitors on site can introduce samplingbiases to the analysis. Thirdly measuring recreational quality and relating recreationalquality to environmental quality can be difficult. This method is limited in its scopeof application because it requires user participation. It cannot be used to assignvalues to on-site environmental features and functions that users of the site do notfind valuable. It cannot be used to value off-site values supported by the site.Most importantly, it cannot be used to measure non-use values. Thus, sites thathave unique qualities that are valued by non-users will be undervalued.


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Valuation and Pricing ofNatural Resources Box 1: Case Study for the Travel Cost Method

Valuation of a Day Use Recreation Site- Lake Vivekananda in RaipurCity

Marothia (2001) have used travel cost method to value the ecosystemservices of Lake Vivekananda in Raipur City in the state of Chhattisgarh.The Lake Vivekananda (LV), popularly known as Budha Talab is locatedin southern part of the city. This lake, one of the many water bodies in thecity was constructed almost 200 years ago by the Gondwana Kings. Thesize of the lake is around 34 ha and the depth of the lake is about 8 meters.The lake is used for several purposes by different users. i.e., fisheries,boating, washing, cattle tending, bathing and swimming, dumping of sewerage,immersion of idols, site seeing and so on. However, due to unregulated usethere has been deterioration of water quality as well as spread of waterhyacinth in recent years resulting in reduced recreation services. The studyintended to value the recreation services of LV and have used travel costmethod (TCM) to estimate the same. The demand function and both zonaltravel cost method (ZTCM) and individual travel cost method (ITCM)were used to estimate the recreation value. Contingent Valuation Methodwas used to estimate the willingness to pay (WTP) and non-use value ofthe lake accruing from lake has been discussed based on the perception ofthe local population living in the periphery, scientists and environmentallyconscious citizens.

1.5.5 Contingent Valuation Method

The contingent valuation method (CVM) is used to estimate economic values forall kinds of ecosystem and environmental services. It can be used to estimateboth use and non-use values, and it is the most widely used method for estimatingnon-use values. It is also the most controversial of the non-market valuationmethods. The contingent valuation method involves directly asking people, in asurvey, how much they would be willing to pay for specific environmental services.In some cases, people are asked for the amount of compensation they would bewilling to accept to give up specific environmental services. It is called “contingent”valuation, because people are asked to state their willingness to pay, contingenton a specific hypothetical scenario and description of the environmental service.

The contingent valuation method is referred to as a “stated preference” method,because it asks people to directly state their values, rather than inferring valuesfrom actual choices, as the “revealed preference” methods do. The fact thatCVM is based on what people say they would do, as opposed to what peopleare observed to do, is the source of its greatest strengths and its greatestweaknesses. For example, a national park in India provides important habitat forseveral species of wildlife. The management agency in charge of the area mustdecide whether to issue a mining lease within the national park. Thus, they mustweigh the value of the mining lease against the wildlife habitat benefits that maybe lost if the site is leased for mining. Because the area is remote, few peopleactually visit it, or view the animals that rely on it for habitat. Therefore, non-usevalues are the largest component of the value for preserving the site.

The contingent valuation method was selected in this case because of the importanceof non-use values, and their potentially significant levels. Since non-use values aresignificant, and few people actually visit the site, other methods, such as the travel

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cost method, will underestimate the benefits of preserving the site. In this case,contingent choice methods might also be used, depending on the questions thatmust be answered, and whether contingent choice question formats are moreeffective than standard contingent valuation questions.

Advantages

l Contingent valuation is enormously flexible and can be used to estimate theeconomic value of virtually anything. However, it is best able to estimatevalues for goods and services that are easily identified and understood byusers and that are consumed in discrete units (e.g., user days of recreation),even if there is no observable behavior available to deduce values throughother means. CVM is the most widely accepted method for estimating totaleconomic value, including all types of non-use, or ‘passive use’ values.CVM can estimate use values as well as existence values, option values andbequest values.

l CVM has been widely used, and a great deal of research is being conductedto improve the methodology, make results more valid and reliable, and betterunderstand its strengths and limitations.

Limitations

l Although the contingent valuation method has been widely used for the pasttwo decades, there is considerable controversy over whether it adequatelymeasures people’s willingness to pay for environmental quality.

l The payment question can either be phrased as the conventional ‘What areyou willing to pay (WTP) to receive this environmental asset?’, or in the lessusual form, ‘what are you willing to accept (WTA) in compensation forgiving up this environmental asset?’Theoretically, the results should be veryclose. However, when the two formats have been compared, WTA verysignificantly exceeds WTP. Critics have claimed that this result invalidatesthe CVM approach, showing responses to be expressions of what individualswould like to have happen rather than true valuations.

l If people are first asked for their willingness to pay for one part of anenvironmental asset (e.g. one lake in an entire system of lakes) and thenasked to value the whole asset (e.g. the whole lake system), the amountsstated may be similar.

l Strategic bias arises when the respondent provides a biased answer in orderto influence a particular outcome.

l Information bias may arise whenever respondents are forced to value attributeswith which they have little or no experience. In such cases, the amount andtype of information presented to respondents may affect their answers

l Non-response bias is a concern when sampling respondents, since individualswho do not respond are likely to have, on average, different values thanindividuals who do respond.

Box 2: Case Study for the Contingent Valuation Method

The State of California Water Resources Control Board was faced with adecision about how much water to allocate to Los Angeles from sourcesflowing into Mono Lake. The reduced water flows to the lake were affecting


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Valuation and Pricing ofNatural Resources food supplies for nesting and migratory birds. One of the first contingent

valuation studies to measure the use and non-use values that citizens havefor public trust resources was a survey of California households regardingwillingness to pay for increased water flows into Mono Lake.

The average willingness to pay per household was estimated to be $13 permonth, or $156 per year. When multiplied by the number of households inCalifornia, the total benefits exceeded the $26 million cost of replacing thewater supply by a factor of 50. One impact of the survey results was tochange the nature of the debate over Mono Lake from “fish or people” toone that recognized that people care about fish and birds, as well as aboutinexpensive water supplies for Los Angeles.

The State of California determined that information about the general public’swillingness to pay for increased water in Mono Lake could be an importantpart of the economic analysis of the water allocation decision.

1.5.6 Contingent Choice

The contingent choice method is similar to contingent valuation, in that it can beused to estimate economic values for virtually any ecosystem or environmentalservice, and can be used to estimate non-use as well as use values. Like contingentvaluation, it is a hypothetical method as it asks people to make choices based ona hypothetical scenario. However, it differs from contingent valuation because itdoes not directly ask people to state their values in rupees/dollars. Instead, valuesare inferred from the hypothetical choices or tradeoffs that people make.

The contingent choice method asks the respondent to state a preference betweenone group of environmental services or characteristics, at a given price or cost tothe individual, and another group of environmental characteristics at a differentprice or cost. Because it focuses on tradeoffs among scenarios with differentcharacteristics, contingent choice is especially suited to policy decisions where aset of possible actions might result in different impacts on natural resources orenvironmental services. For example, improved water quality in a lake will improvethe quality of several services provided by the lake, such as drinking water supply,fishing, swimming, and biodiversity. In addition, while contingent choice can beused to estimate monetary values, the results may also be used to simply rankoptions, without focusing on monetary values.

Advantages:

l Contingent choice method can be used to value the outcomes of an actionas a whole, as well as the various attributes or effects of the action.

l Survey methods may be better at estimating relative values than absolutevalues. Thus, even if the absolute dollar values estimated are not precise, therelative values or priorities elicited by a contingent choice survey are likelyto be valid and useful for policy decisions.

l The method minimizes many of the biases that can arise in open-endedcontingent valuation studies where respondents are presented with theunfamiliar and often unrealistic task of putting prices on non-market amenities.

Limitations:

l Respondents may find some tradeoffs difficult to evaluate, because they areunfamiliar.

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l Contingent choice may extract preferences in the form of attitudes instead ofbehavior intentions.

l Contingent ranking requires more sophisticated statistical techniques to estimatewillingness to pay.

l Although contingent choice has been widely used in the field of marketresearch, its validity and reliability for valuing non-market commodities islargely untested

1.6 STEPS IN ECOSYSTEM SERVICE VALUATION

After discussing various methods of valuation of ecosystem services, it is importantto discuss the practical issues involved in choosing the appropriate method forevaluation and the steps to move ahead. It’s important that the appropriate stepsare followed for the valuation of ecosystem services and these have to have soundeconomic rationality and theory. One can make three cases for three differentsituations for ecosystem valuation.

l When a market for ecosystem resources exists?

l When market for a substitute or surrogate exists?

l When no market and no substitute or surrogate exists?

Whenever market exists for any environmental resources, the prices as revealedfrom the market forces can be an indicator of the value or benefit from thoseresources. The fundamental logic behind the market determined values is thewillingness to pay by the demanders who reveal their preferences based on theirincome level, socio economic characteristics and other considerations. Examplesare timber, Honey, mineral water (wherever water price exists), or willing to paycess to locate a public park. An alternative to enjoy ecological benefits can alsobe one of forgoing the benefit and receive something else in exchange. It may beincome or compensation to the party who is forgoing the ecological benefits. Forexample, monetary compensation paid to the farmers by industrialist who haspolluted their agricultural land by industrial waste water.Suppose if there is no market for a particular use of the resource under questionthen how price will be determined? It is found that resource may have alternativeand multiple uses with revealed market prices or may have alternative resourcesto substitute for. Examples are market for fuel wood may not exist for householdconsumption, but it exists for industrial uses. Or there are substitutes such askerosene for fuel wood in household uses. Then other methods are possible.Valuation methods such as opportunity or replacement costs basically draw uponmarket data and information on prices and values for such alternative, replacementand substitute. Surrogate prices are hypothetical market price taken from suchgoods and services which are close substitutes for those resources. For example,value of herbal medicinal plants can be the prices of non-herbal chemical basedproducts such as synthetic creams or perfumes.

How one can value a resource for which there are no markets and no surrogateeither? In this case, alternative or non-user based methods in stated preferenceapproach need to be devised. The fact of the matter is that users do value them,give some clues on developing an indirect method of arriving at those values. Theuser or non-user of such resources may have to be brought to a psychologicalsituation in which he or she may agree to pay for the use or existence of theresource. If an individual is made to state her or his preference, it only reflects


20


a statement of value, not actual value. In spite of all these methods, it is still noteasy to assign monetary values to natural resources.

The discussions on methodology and approaches are part of the ongoing discourseon valuation literature. There are several unresolved issues. The recent years haveseen several valuation studies in India using different valuation methods as discussedabove. These studies assessed economic value of the different components ofnatural resources or different ecosystem services (box 3).

Box 3: Economic Value of the Components of Natural Resources inIndia

Goods Annual Location Methodology Sourceand Services ValueValues

Recreation/ Rs. 16197per Keoladeo Travel Cost ChopraEcotourism ha (Rs.427.04 National Method (1998)

per Indian Park,visitor and BharatpurRs. 432.04per foreignvisitor)

Recreation/ Rs. 20944 Keoladeo Contingent Murty andEcotourism per ha National Valuation Menakhaus

(Rs. 519 per Park, Method (1994)Indian visitor Bharatpurand Rs. 419per foreignvisitor)

Recreation/ Rs. 23300 per Borivili Contingent HadkarEcotourism ha National Valuation et al, (1997)

Park, MethodMumbai

Wetland Additional Bhoj Lake Hedonic Vermavalue of Pricing (2000)propertyaround thelake is Rs.186per sq ft.

Soil Cost of soil Doon Replacement KumarConservation ersion: Valley Cost (2000)

Rs. 21583 Approachper ha

Urban Water Average cost New Delhi Production DasguptaPollution of illness per function (2001)

household peryear: Rs.1094

Carbon Store Rs. 1.2 All India Biomass Kadekodi andlakh per ha Forest estimation Ravindranath

(1997)

Iron Ore User cost per Goa User Cost TWGEVA,tonne Method 2001

Source: Kadekodi, G. K. (2001).

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1) What are the different approaches in valuation of ecosystem services?

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2) Briefly state the various methods in revealed preference approaches invaluation of ecosystem services?

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1.7 LET US SUM UP

l Ecosystem is a biological environment consisting of all the living and non-living organisms in a particular area. The structure and functioning of anecosystem is strengthened by synergetic feedbacks between organisms andtheir environment.

l The physical, chemical and biological interactions taking place within theecosystem constitute ecosystem functions and provide critical life supportsystems as well as a range of ecosystem goods and services for the survivalof human and other living species. Ecosystem functions include carbon cycling,nutrient trapping, soil formation, water cycles, etc.

l Ecosystem services constitutes goods, services and cultural benefits fromthose ecosystem functions that are perceived to support, help and protecthuman and other living beings. These ecosystem services include themaintenance of the composition of the atmospheric environment, ameliorationand stability of climate, waste assimilation, scenic beauty, provision of food,water, air, etc.

l Valuation techniques are very useful in developing policy instruments pertainingto the up gradation of environmental quality in both developed and developingcountries.

l Valuation techniques are very important in formulating national developmentstrategies in the wake of deteriorating natural resources. The estimation ofnational environmental damage by various valuation techniques plays verymajor role in assessing developmental priorities.

l Valuation techniques are essential for modifications of national accounts.National accounts are now widely regarded as an indicator of development.But national account is deficient in respect of its treatment of environment.Any measure of well-being which ignores the resource and energy flows willfail to measure sustainable wellbeing.


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l Valuation of ecological resources is helpful in implementing the polluter paysprinciple (PPP). Environmental standards are set by regulatory agencies onbehalf of the population. Regulatory agencies should set standards such thatthe cost borne by the emitter and the consumer can therefore be thought ofas a form of valuation. Valuation therefore becomes important in giving guidanceto setting environmental prices in the form of taxes, charges, or tradablepermits.

1.8 KEY WORDS

Contingent Valuation Method (CVM): In CVM, people are asked directly tostate their willingness to pay for specific environmental services, based on ahypothetical scenario.

Ecosystem Function: Ecosystem functions are the physical, chemical, andbiological processes or attributes that contribute to the self-maintenance of anecosystem.

Ecosystem Services: Ecosystem services are goods, services and cultural benefitsaccrue from ecological processes or functions that have value to individuals orsociety.

Hedonic Price Method (HPM): HPM estimates economic values for ecosystemor environmental services that directly affect market prices of some other good.

Total Economic Value: Total economic value (TEV) of ecosystem servicesconstitutes the values that we obtain from its different uses (use values) as wellas from its very existence (non-use values).

Travel Cost Method (TCM): TCM measures economic values associated withecosystems or sites that are used for recreation with the basic assumption that thevalue of a site is reflected in how much people are willing to pay to travel to visitthe site.

1.9 REFERENCES AND SUGGESTED FURTHERREADINGS

l Common, M. and Stagl, S. 2005. Ecological Economics: An Introduction.Cambridge University Press, pp 560.

l Costanza, R., Cumberland, J., Daly, H., Goodland, R. and Norgaard, R.1997. An Introduction to Ecological Economics. St. Lucie Press and ISEE,Florida. Pp.274.

l Daly, H.E. and Farley, J. 2004. Ecological Economics: Principles andApplications. Island Press, Washington. pp. 454.

l Kadekodi, G. K. 2001. Valuation of Natural Resources: What Have weLearnt from Indian Experience? Indian Journal of Agricultural Economics.Vol. 56 (3): 285- 312.

l Kolstad, C.D. 2011. Intermediate Environmental Economics. OxfordUniversity Press, 198, Madison Avenue, New York-10016. pp.470.

l Marothia, D.K. 2001. Valuation of a day-use recreation site: Application ofalternative estimation techniques. Indian Journal of Agricultural Economics.

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Vol. 56 (3): 313- 324.

l Pearce D. 1998. Economics and Environment: Essays on EcologicalEconomics and Sustainable Development, Edward Elgar Publishing Limited,UK. pp.363.

l Pearce, D. and Barbier, E.B. 2000. Blueprint for a sustainable economy.Earthscan Publications Ltd., London. pp. 273.

l Reddy, V.R. 2001. User Valuation of Renewable Natural Resources: TheUser Perspective. Nova Science publisher, Inc. New York

1.10 KEY TO CHECK YOUR PROGRESS


1. Your answer must include the following points

l For making suitable policy for ecological sustainability

l Ecosystem services and market failure

l Environmental Conservation


l Economic value of ecosystem services

l Use and non-use value of ecosystem services



l market approach, revealed preference and stated preference approaches


l hedonic pricing method and travel cost method

l Advantages and limitation of these methods


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Valuation and Pricing ofNatural Resources UNIT 2 POLICY INSTRUMENTS

FOR POLLUTIONCONTROL, CONSERVATIONAND CLEAN ENERGY

Structure

2.0 Introduction

2.1 Objectives

2.2 Types of Environmental Policy Instruments2.2.1 Decentralized Policy Instruments

2.2.2 Command and Control Regulations

2.2.3 Market Based Instruments (MBI’s)

2.3 Market Based Instruments and Developing Countries

2.4 Let Us Sum Up

2.5 Key Words


2.7 Key to Check You Progress

2.0 INTRODUCTION

Pollution is the introduction of various contaminants into an ecosystem that causesdamage, instability, disorder, harm or discomfort to the ecosystem componentsi.e. physical systems or living organisms and acts as impediments to achievesustainable development. There are different forms of pollution and these couldbe water pollution, air pollution, noise pollution, oil contamination and so on.Pollutants, the elements of pollution, can be foreign substances or naturallyoccurring. When pollutants are naturally occurring, they are considered ascontaminants as they exceed natural levels. The increasing size of different formof pollution adversely affect the human health and hence the economic activity andhuman welfare. The higher level of pollution can reduce the ability of the environmentto provide life support services. The increasing accumulation of toxic and nonrecyclable or slowly recyclable waste represents high entropy and leads to gradualincrease in intergenerational inequity. In fact, the poor in the present generationsuffer the worst in terms of diseases like TB, hepatitis, cancer, other physicaldeformities, etc., on account of direct exposures to contaminated waste. Withoutpollution control, the waste products from consumption, heating, agriculture, mining,manufacturing, transportation and other human activities, whether they accumulateor disperse, degrade the environment and hamper economic development process.Therefore, it is important to develop and implement some policy instruments toreduce pollution and environmental damage based on “polluter pay principle” andother pollution control measures to achieve the goals of sustainable development.Several instruments have been devised by the policy makers in different parts ofthe world over time to deal with pollution and these instruments range from moralsuasion to imprisonments. Under polluter pay principle, polluters are made to payin the form of taxes to compensate the negative externalities from their activities.The broad policy instruments to control and regulate pollution are decentralizedpolicy instruments; market based instruments and command and control instruments.Some of the popular and widely used pollution control instruments includesregulation of emissions by designing standards, taxing emissions, taxing products

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which add pollutants before and after use, issue of pollution permits, incentivizingpolluters to abate, labeling products, creating awareness among the users, imposingdeposit refund systems on polluting products and so on.

2.1 OBJECTIVESAfter reading this unit, you will be able to:

l state the need for policy instruments to reduce pollution;

l explain the types of environmental policy instruments; and

l indicate the relevance of market based instruments in Developing Countries

2.2 TYPES OF ENVIRONMENTAL POLICYINSTRUMENTS

The beginning of modern environmental policy making started taking shape inearly 1970s in the USA. The first National Environmental Policy Act (NEPA)was signed by the then USA President Richard Nixon on January 1, 1970. At thattime, environmental policy was a bipartisan issue and the efforts of the UnitedStates of America helped countries around the world to make proper environmentalpolicies and programmes to reduce environmental pollution. During this period,legislation was passed to regulate pollutants that go into the air, water tables, andsolid waste disposal in USA. Since 1970, the government of various countriesstarted adopting different legislations to reduce environmental pollution anddegradation.

All the policy instruments for protecting and sustaining ecological resources havethe common goal to achieve ecological improvements (e.g. a certain reduction inCO

2emissions and other green house gases) and avoid negative, and create

positive impacts in the other areas of society. Policy instruments attaining sustainablemanagement of ecological resources can be classified into three groups:(1) decentralized such as moral suasion; (2) command and control (directregulation), such as ambient, effluent or technology standards combined withenforcement; and (3) market based instruments such as emissions tax, subsidies,and tradable permits.

2.2.1 Decentralized Policy InstrumentsMoral suasion is persuasion exerted or acting through and upon the moral natureor sense. This is considered as one of the important means adopted by variousenvironmental regulatory authorities of different countries of the world to reduceenvironmental degradation and depletion. Environmental protection authority (e.g.,Ministry of Environment and Forest, Government of India) often exert pressureby issuing orders without resorting to legal actions in an attempt to get firms andindividuals to behave in ways that serve the policy of regulating pollution. Moralsuasion aims to manipulate the cultural environment. It involves attempts to changethe preferences of economic agents without adopting command and controlmeasures and without directly changing price incentive structures. The mostimportant objective of moral suasion is providing information about the ecologicalconsequences of anthropogenic activities. Examples of moral suasion as anenvironmental policy instruments are: (1) financing the campaigns to raise publicawareness; (2) product labeling requirements; (3) voluntary agreements by thepolluters on emissions targets; (4) subsidization of research and development foralternative or eco-friendly technologies; and (5) finance of basic research. Theseare some of the moral suasion that has been used in practice in different countriesof world. However, neoclassical economists are generally dismissive of moralsuasion approaches which are probably a reflection of the assumptions of givenpreferences and consumer sovereignty. According to neoclassical economists, the

Policy Instruments forPollution Control,

Conservation and CleanEnergy

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changing price that firms and individuals face so as to reflect better environmentalcosts and conveys information and aims to change behavior of the people. However,the ability of prices to communicate relevant information about the environment –economy relationship is limited and prices influence rich and poor people in verydifferent ways. Therefore the moral suasion approach to change preference of theconsumer, firms and government pertaining to environmental sustainability assumesa significant place in a democratic society.

Check Your Progress 1Note: a) Use the space below for your answer.


1) State the need for environmental policy instruments?

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2) Elaborate briefly the various types of environmental policy instruments?

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2.2.2 Command and Control RegulationsCommand and control instruments are also known as direct regulation. Theseinstruments have been the dominant method of environmental regulation in themajority of the countries. While framing the early environmental policies of the1970’s to reduce pollution and environmental degradation, policy makers institutedstandard-based systems keeping in mind the prevailing legal traditions of dealingwith activities deemed excessive by society. Command and control pattern ofregulations set uniform targets for how much firms should emit by dictating theproduction processes that should be carried out in their facilities. Broadly thereare two types of command and control regulations: technology based andperformance based. The former specify the methods, strategy, and equipmentsthat firms must use to meet the target. Performance standards, on the other handset an overall target for each firm, or plant, and give firms some discretion in howto meet the standard. These regulations set standards which can be emissionbased, product based, ambient based, and technology based. They are mostlyused for pollution control and the sustainable management of common propertyresources. These instruments which are currently in use operate at various stagesof the production and pollution generation process: input used, productiontechnique, emission output, location of emissions and ambient pollution levels. Anemission based standard puts up a regulation in the form of not emitting morethan X units of pollutant (e.g. CO

2, SOx) per unit of fuel or per unit of time

(e.g. weight of SOx

in a given 24 hour period), or per unit of output. In general,these measures are not cost efficient because they tend to be applied uniformlyacross the polluters. Making emission reduction targets the same across polluterswould lead to inefficient outcomes. Therefore, command and control regulationshould state that emissions should be as low as reasonably achievable. Directingthe controls at points closest to what is the target, namely ambient pollution levels,gives polluters most flexibility in how a pollution reduction is achieved. Examplesof direct regulation in India include control and abatement of air pollution (Air Act,1982, 87), prevention and control of water pollution (The Water Act), standardsfor hazardous waste disposal (Hazardous waste Rules, 1989), and restrictions onthe dangerous substances (The Manufacture, Storage and import of hazardouschemical rules, 1989). Under direct regulation, a Government can ban substancesor production techniques if there are deemed to be dangerous for human being

27

and ecological resources. Otherwise, the quantity of a pollutant that can be producedor the share of a resource stock that can be used will be limited or the technologyor location restricted.

Ambient based standards stipulate a given maximum concentration of pollution inthe receiving environment. It is up to the polluters to ensure that they do notexceed the stipulated standard. Since no one polluter will know what has to bedone to achieve the standard, ambient standards are best thought of as overalltargets. The actual control regulation to achieve that target will have to be allocatedbetween polluters and may consist of emissions limits or technology standards forexample.

Technology based standards basically tell the polluter what technology they arepermitted to adopt usually the best available eco-friendly technology or cleanestone. In fact, the cleanest technology may be very expensive so that best availabletechnology regulations are very often attenuated by clauses such as not entailingexcessive cost. This is an attempt not to reduce competitive advantage. Howevertechnology based standards leave no room for flexibility of response i.e. a giventechnology has to be used. Hence they will also tend to be inefficient.

Some environmental economists consider command and control approach aseconomically inefficient (overall compliance costs are not minimized) and dynamicallyinefficient (once the standard is achieved the polluter has no incentive to gofurther). But in case of zero emission option or ambient concentration, this commandand control instruments are most preferred. Then the best policy is to put acomplete ban on pollutant as has happened in case of certain pesticides which arevery dangerous for sustainable development.

2.2.3 Market Based Instruments (MBI’s)Ecological resources are public goods which are not exchanged in the conventionalmarkets. Therefore no price emerges to indicate relative scarcity of these resourcessuch as air, water and forests. Economic activities generate pollution that leads tocosts to others that is called externalities. In order to understand the logic ofadoption of economic instruments to reduce pollution, one has to understand whypollution arises. Economists consider pollution as a market failure which arisesbecause of polluters. For instance, a manufacturer releases contaminated effluentsinto the nearby river, with adverse effects on fish populations and quality of waterresources. In the downstream area of the river, commercial fishermen find theirlivelihoods under severe threat; recreational anglers start to find their weekendpastime less enjoyable, while others may simply be distressed by the loss ofwildlife and the damage to ecosystems. Because the use of the river as an effluentdepository is perceived as free, the manufacturer has no incentive to controlcontaminated effluents. In contrast to the permanent incentive, he has to reducehis labor size, materials, machinery, equipments and energy inputs, all of whichhave costs attached to them. In economic terminology, the downstream adverseimpacts are ‘externalities’ that lie outside of the manufacturer’s decision-makingframe work and cost of manufacturing. The underlying premise for market basedinstruments is to correct this market failure by placing a cost on the release ofpollutants and contaminated items. These instruments are designed to internalizethe ‘externalities’ into the decision making process. Putting a charge, fee, or taxon every unit of effluent and contaminated pollutants released into the river,influences the manufacturer’s decisions regarding how much he will produce, andhow he will produce it. Now, the manufacturer must minimize total productioncosts that consist not only of labor, material, machinery and energy inputs, butalso of the effluent output. It is sometimes evident that due to higher pollutioncharges or tax the manufacturer decides to modify and alter the core productionprocess by installing latest technologies, or working with new materials which



28


result in less waste and pollutants. By adjusting the charge level or the costattached to effluent release, the regulators can ask for a different degree ofresponse from manufacturers, and hence control the overall level of pollution. Atthe end polluter has to pay or compensate the damage inflicted upon environment.Through the market instruments, any unaccounted social costs (and benefits) ofenvironment can be internalized which will ensure environmental improvement andsustainable development. For the purposes of our discussion, common types ofMBI’s are:

l Taxes (Charges), fees or other additional prices to be paid by the pollutersfor the social cost arising from environmental damage, degradation anddepletion. Examples are: effluents charges on sulphur dioxide emissions, taxdifferentiation between leaded and unleaded petrol, user charges for publicwaste disposal, depletion taxes on mineral exploitation and stumpage fees fortimber extraction.

l Subsidies are provided to induce the individuals to alter or comply with theenvironmental standards stipulated by the regulatory authority. Example ofenvironmental subsidies includes development and adoption of cleantechnologies, clean energy and clean tax allowances.

l Deposit/refund/rebate systems where a surcharge is put on the price ofa product leading to environmental resource depletion or pollution which isthen refunded, if the product is recycled or depleted resources is restoredor regenerated. Examples are: deposit or refund schemes for plastic bottles,glass bottles, aluminum cans and other containers, reforestation and plantationactivities.

l Tradable permits/Emission Trading are used where rights to dischargepollution or exploit resources can be exchanged either through a fee orcontrol permit market by creating enabling institutions such as green banks,water banks, etc. Encouraging environmentally responsible investments andprudent lending should be one of the responsibilities of the banking sector.Those industries which have already become green and those, which aremaking serious attempts to grow green, should be given high priority tolending by the banks. This method of finance can be called as “GreenBanking”. Banks should play very vital role in making industries adopt greentechnology and grow green. Banks which facilitate environmentally responsiblelending and investment are called green bank. A water bank is a mechanismdesigned to facilitate the transfer of water use entitlements from one locationor use to another. A water bank functions like an intermediary, or broker,similar in some ways to a financial bank that acts as a broker or clearinghouse between savers and borrowers. In the case of water banks and unlikesome brokers, there is some kind of public sanction for its activities. A validwater use entitlement can be “deposited” with the water bank, making itavailable for withdrawal by others for a fee. The overexploitation of wateris a costly affair and the user has to pay a price for overexploitation comparedto his entitled amount. On the other hand, the user who is using less amountof water than stipulated will get monetary incentives by selling its water rightsto the bank. The water bank serves an important role, determining whichwater rights can be banked, and the amount of water corresponding to agiven water right entitlement.

Example of these permits include carbon trading through tradable permits forgreen house gas emissions, marketable quotas for fish harvesting, tradable depletionrights to mineral and water use and marketable discharge permits for waterborneeffluents and pollutants. These instruments offer a dynamic incentive and can helpensure that a given target is met, if combined with appropriate allocation of

29

emission allowances. The price of allowances is, however, uncertain and determinedby the market. ET can lead to significant additional administrative tasks andburdens and greater needs for monitoring, verification and enforcement, the costsof which need to be taken into account in any consideration of whether ETschemes are the sensible solution.

l Compensatory incentives for conservation of environmental resources:These are very much similar to subsidies in the market or financial inducementswhich are created for certain individuals who bear the cost of environmentalimprovement or who possess unique environmental resources. Examples ofcompensatory incentives are providing financial aid for transferring environmentfriendly technology to developing countries for compliance with internationalenvironmental agreements and increasing allowances for the poor and agedto compensate for energy or carbon taxes.

Box. 1: Environmental Instruments Adopted by Countries forPollution Control

Source: Sawhney, A. (1997).



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Valuation and Pricing ofNatural Resources 2.3 MARKET BASED INSTRUMENTS AND

DEVELOPING COUNTRIES

The market based instruments as discussed above have been widely used in manydeveloped countries and found to be effective in reducing pollution and improvingthe quality of the environment. Then the question is how relevant are theseinstruments for developing countries? The experience of developing countries inimplementing market based instruments is very poor and proved not to be veryeffective in reducing pollution and enhancing the quality of environment. Thereasons could be lack of adequate enforcement mechanism. However the popularityof implementing MBIs is gaining strength among the fast growing economies likeSouth Korea, Malaysia and Chile. The reason of the slow progress of MBIsimplementation in developing countries like Pakistan, India, Bangladesh, andIndonesia can be attributed to the problem of asymmetric and improper informationand corruption. The regulators know less about the magnitude of pollution and thepolluters. In spite of all, there are some good examples of MBIs in practice in thedeveloping countries and the economies which are undergoing transition phaseover the last couple of years. It is evident that there are charges for exceedingemission limits in Korea and China, but the incentives are generally very weak dueto the charge level being too low and with no incentive for the polluter to adjusttechnologies or output. There are effluent charges in the palm-oil industry inMalaysia. The deposit-refund schemes in Korea and Taiwan are the examples ofthe MBIs in reducing pollution and enhancing the programme environmentalconservation. Tradable water rights are very popular in Chile and the market forwater is growing at faster rate. The water bank concept is also gaining momentin the United States of America to reduce water pollution and conservation waterresources.


Note: a) Use the space below for your answer.b) Compare your answers with those given at the end of the unit.

1) Explain the command and control approach of controlling environmentalpollution?

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2) What are the various instruments of market based instruments?

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2.4 LET US SUM UP

l It is essential to develop and implement some policy instruments to reducepollution and environmental damage based on “polluter pay principle” andother pollution control measures to achieve the goals of sustainable

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development. Under polluter pay principle, polluters are made to pay in theform of taxes to compensate the negative externalities from their activities.

l The broad policy instruments to control and regulate pollution are decentralizedpolicy instruments; market based instruments and command and controlinstruments. The popular pollution control instruments includes regulation ofemissions by designing standards, taxing emissions, taxing products whichadd pollutants before and after use, issue of pollution permits, incentivizingpolluters to abate, labeling products, creating awareness among the users,imposing deposit refund systems on polluting products, etc.

l Moral suasion is persuasion exerted through and upon the moral nature orsense. This is considered as one of the important means adopted by variousenvironmental regulatory authorities of different countries of the world toreduce environmental degradation and depletion.

l Command and control measures, through the use of emission limit values andenvironmental quality standards, are a key aspect of environmental legislationand help ensure that emissions fall and that the quality of the environment isrespected.

l Common types of MBI’s are Taxes (Charges), fees or other additionalprices to be paid by the polluters for the social cost arising from environmentaldamage; Subsidies provided to induce the individuals to alter or comply withthe environmental standards stipulated by the regulatory authority; Deposit/refund/rebate systems where a surcharge is put on the price of a productleading to environmental resource depletion or pollution which is then refunded,if the product is recycled or depleted resources is restored or regenerated;Tradable permits /Emission Trading are used where rights to discharge pollutionor exploit resources can be exchanged either through a fee or control permitmarket by creating enabling institutions such as green banks, water banks,etc.; Compensatory incentives for conservation of environmental resources.

l Voluntary schemes like environmental management systems or voluntaryagreements can be useful optional routes to capacity building and progressin selected areas, contributing to a move towards shared responsibility.

2.5 KEY WORDS

Command and Control Instruments: Command and control regulations setstandards which can be emission based, product based, ambient based, andtechnology based.

Decentralized policy instruments: include moral suasions, suggestions, andadvice to the polluters not to pollute and damage the environment. It is an indirectinstrument to control environmental pollution.

Market based instruments: By the help of market based instruments, anyunaccounted social costs (and benefits) of environment can be internalized whichwill ensure environmental improvement and sustainable development. MBIs includetax, subsidies, tradable permits, compensatory measures, etc.

Polluter Pays Principle: This principle implies that the polluter who destroysenvironmental resources should pay for the damage.



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Valuation and Pricing ofNatural Resources 2.6 REFERENCES AND SUGGESTED FURTHER

READINGS

l Beder, S. 2006. Environmental Principles and Policies: An InterdisciplinaryApproach. University of New South Wales press Ltd., Australia. pp.336.



l Daly, H.E. and Farley, J. (2004). Ecological Economics: Principles andApplications. Island Press, Washington. pp. 454.

l Kolstad, C.D. 2011. Intermediate Environmental Economics. OxfordUniversity Press, 198, Madison Avenue, New York-10016. pp.470.

l Sawhney, A. 1997. A Review of Market Based Instruments for PollutionControl: Implications for India. NIPFP, New Delhi. Pp57.




l Need of environmental policy instruments

l To reduce pollution and environmental damage

l To achieve sustainable development


l Decentralized policy instruments

l Command and control instruments

l Market based policy instruments



l Concept of command and control instruments

l Types of command and control instruments


l Basic concept of Market based instruments

l Types of market based instruments

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UNIT 3 KYOTO PROTOCOL ANDCARBON TRADING

Structure

3.0 Introduction

3.1 Objectives

3.2 Climate Change and Need to Reduce Emissions

3.2.1 Free Rider Problems of Climate Change Mitigation

3.3 Evolution of Kyoto Protocol

3.3.1 Ratification and Enforcement : Post-kyoto Commitments

3.4 The Kyoto Mechanisms

3.4.1 Flexibility Provisions of Kyoto Protocol

3.4.2 Joint Implementation

3.4.3 The Clean Development Mechanism

3.4.4 International Emission Reduction and Emission Trading

3.4.5 India’s Position on Kyoto Protocol

3.5 Carbon Trading and Tradable Permits

3.5.1 Use of Tradable Permits within a Country

3.5.2 International Carbon Trading Advantages

3.5.3 Carbon Markets

3.5.4 Carbon Offsets

3.6 Kyoto Protocol and Impact Assessment

3.6.1 Equity Issues

3.6.2 Impact of Kyoto Protocol and the Problem of Emission Cuts

3.6.3 Cost of Mitigation Under Kyoto

3.6.4 Problems of Emission Cuts

3.6.5 Kyoto Protocol : A Weak Instrument to Achieve Sustainable Development

3.7 Let Us Sum Up

3.8 Key Words



3.0 INTRODUCTION

The main objective of this unit is to give a descriptive and analytical account ofthe Kyoto protocol and its relevance in mitigating the climate change impact in theworld. Kyoto Protocol is important as it is the only policy instrument that promoteseconomic incentive based global emission reduction and energy saving throughmutual co-operation at the international level. The focus is on two issues; theeffectiveness of international negotiations of the nations with self interest and themechanisms used under Kyoto protocol to reduce green house gas emissions.Joint implementation, clean development mechanisms and emission trading are a

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part of Kyoto Protocol. The emission reducing mechanisms such as taxation,command and control and subsidies are already dealt with in other units. Hencethis unit deals with carbon trading, its effectiveness and equity, and the need toevolve a global system of climate certification and induced economic incentivebased voluntary compliance beyond Kyoto Protocol that comes to an end in2012.

3.1 OBJECTIVES

After reading this unit, you will be able to:

l state the evolution of Kyoto Protocol;

l explain the different types of Kyoto Mechanisms; and

l discuss the features of carbon trading, tradable permits and carbon markets.

3.2 CLIMATE CHANGE AND NEED TOREDUCE EMISSIONS

International concern over the environmental impacts of the world’s uncontrolleduse of coal, oil and gas has grown in the second half of the twentieth century. Thedamage caused to plants, animals and buildings by acid rain and the effects onhuman health of poor air quality and smog have become more apparent. In themid-1980’s, awareness began to increase of yet another problem caused by fossilfuels i.e. climate change.

The concentration of Green House Gases released when fossil fuels are burnt isincreasing in the atmosphere, leading to rise in global temperature. The mostimportant greenhouse gas is carbon dioxide (CO

2). Carbon dioxide, methane,

nitrous oxide and man made chlorofluorocarbons (CFCs) have long atmosphericlifetimes – the time between the emission of a molecule into the atmosphere andits removal from the atmosphere.

Among the adverse effect of prospective climate change are

1. Reduced crop yields,

2. Decreased water availability in water scarce regions

3. Increase in human exposure to vector borne diseases such as Malaria andwater borne diseases.

4. Increase in heat induced stress mortality in humans, livestock and wild life

5. Flood, landslides, avalanche and mudslide damage

6. Increased run off and increased soil erosion

7. Melting of snow caps and glaciers and sea level rise and possible partialsubmergence of coastal areas and total submergence of Island nations

In general, developing world and the poor people are expected to bear the bruntdue to two reasons. First less developed and developing countries depend uponthe sectors which are more sensitive to climate change such asAgriculture. Second,developing countries cannot afford better protection from the consequences of

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climate change due to lack of financial resource, and limited institutional andtechnological capability.

Given the wide range of impacts, it is difficult to get some sense of how bad thesituation is. Estimates of aggregate impacts are controversial, because the gainsfor some, is treated as cancelling the losses for others. The second assessmentreport has put some money value to the damage. The third Assessment report didnot summarize the aggregate impact to get an idea of the bottom line impact.IPCC does not recommend about what is to be done but it only spells out theimpacts and the costs of alternative courses of action.

There are responses to green house gas effect. They are adaptation, offsetting andMitigation. Adaptation involves breeding new types of crops to cope with highertemperatures, limiting development in coastal zones likely to be submerged, buildingdefenses against frequent droughts and floods, etc. Off setting efforts consists ofincreasing the chances of reflecting the solar radiation back into space. So farthere was no guaranteed way of scientifically achieving this. The concentration ofGreen House Gases is rather an irreversible process as of now. Mitigation involvestrying to reduce the climate impacts by reducing the rate of discharge of GreenHouse Gases into the atmosphere.

Mitigation is given more attention. It is found that at the present conservativeestimates of population growth and the increase in economic activity given amodest aspiration of the people for higher economic growth, it takes 50% emissionreduction to keep the CO

2concentration alone at the present level. Given the

gravity of the situation, mitigation of by way of reducing emissions of CO2

hasreceived priority. Reducing emissions per US dollar of GDP is called de-carbonization of the economy. Mitigation options that carry negative costs arereferred to as no-regret options. It is because they would make sense to do soindependent of climate change problems. Third Assessment report of IPCC lookedat barriers to the adoption of feasible mitigation possibilities.

3.2.1 Free Rider Problems of Climate Change Mitigation

Free rider problem is a situation, where selfish individuals/nations conceal theirwillingness to pay for public good provision. If a public good which is non-excludable and non-rival is supplied, they cannot be prevented from consumingit. The selfish lot will not pay hoping that others will not conceal their willingnessto pay and that others will pay for provision which non-payers can enjoy fornothing. People will try to ‘free ride’, on others who pay. The major Green HouseGases mix uniformly in the atmosphere, and it is the global concentration thataffects the earth’s heat balance, and hence the global climate. The climatic effectof a given molecule of a greenhouse gas in no way depends on where it originated.The pollution due to increasing greenhouse gas concentrations in the atmosphereis a global public bad. The associated damage is non-rival and non-excludableand dealing with it involves the free-rider problem. The agents involved are nationstates rather than individuals. The free-rider problem can be analyzed using gametheory. This is a way of analyzing situations where the outcome of a decision byone agent, or player, depends on the decisions made by the other agents. At thetime that decisions have to be made, no decision maker knows what the decisionsof the others will be.

To bring out the nature of the free rider problem here as clearly as possible, wewill assume that there are just two nations, called North and South. We will also

Kyoto Protocol andCarbon Trading

36


assume that the two nations have the same population sizes, the same GDP percapita, the same technologies, and are affected in the same way by climatechange. In respect to the climate-change problem, each nation has two possiblecourses of action: it can do nothing (BAU for Business As Usual) or it can reduceits greenhouse gas emissions by a fixed amount by mitigation. To make thingssimple, we fix the numbers for the status quo where neither country abates at 1for each country. Now suppose that, if a country mitigates the cost to it is 0.3,and that the amount of mitigation involved is such that climate change damageavoided can be valued at 0.2, which benefit applies to both countries. Supposethat South mitigates but North does not. South incurs 0.3 cost and gets 0.2benefit, and hence the net benefit is 0.1 less compared BAU i.e. 0.9. While Northincurs 0 costs and gets 0.2 benefit hence a gain of 0.2 over BAU, so that the pay-offs are 0.9/1.2. If North mitigates but South does not, then these outcomes arereversed as shown in the top-right cell in table 3.1. If both the countries mitigateboth incur 0.3 costs but now there is twice as much mitigation. The benefit to bothcountries is 0.4, so that both gain by 0.1 compared to BAU/BAU. Thus it is clearthat if every one mitigates the benefit is at a maximum. If only one countrymitigates and incurs the cost, others benefit without incurring any cost but thecountry that mitigates does not get all the benefit. Hence for a problem for whichbenefits are common but costs are individual, there must be a mutual agreementwith punishment for non-compliance of the agreement.

Table 3.1

If each country is going to pursue its own interest in isolation, then neither willmitigate. Acting alone would make a country worse off. The best thing would beto free ride on the mitigation of the other country. Business as usual is clearly thedominant strategy for South as well as North. Neither country will mitigate. Nowsuppose that North and South acted cooperatively, rather than in isolation. Supposethat a credible and binding agreement could be negotiated according to whichNorth would mitigate if South did, and vice versa. With such an agreement inplace, things look very different. Now Mitigation is the preferred strategy for bothcountries. It is business as usual for both, or Mitigate for both. For both thecountries the latter is better than the former. Note that this requires that thenegotiated agreement is credible and binding. It would be in either country’sinterest to negotiate such an agreement and subsequently defect while the othercomplied. This implies that, in order to be credible and lasting, the agreementwould have to involve penalties for non-compliance. Hence an effective negotiationshould have binding commitments and penalties for non compliance.

3.3 EVOLUTION OF KYOTO PROTOCOL

In late 1988, two United Nations agencies, the UN Environment Programme andthe World Meteorological Organization (WMO) set up the Intergovernmental

Free- Rider Problem

N orth

BAU Mitigate

S BAU 1.0/ 1.0 1.2/0.9

O

U Miti gate 0.9/1.2 1.1/1.1

T

H

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Panel on Climate Change (IPCC). IPCC membership is open to members of theUN and WMO. This brought together scientific experts from all over the worldto assess the climate change, its impacts and the strategies needed to respond toit. The main tools that climate scientists use are models of climate change systems.They also use data on a large number of inputs including sulfur and particulatematter in the atmosphere. Climate models are large and complicated. The IPCChas made a series of reports related to climate change. The first AssessmentReport was released in 1990, the Second Assessment Report was released in1995, the Third Assessment Report (TAR) was brought out in 2001 and thefourth in 2007 in two parts.

The first assessment report was released in August 1990, despite heavy pressureto block its publication from oil producing countries and industry. It is becausethe oil companies loose revenues if they produce less oil and export less oil.

“We predict ... a rate of increase of global mean temperature during thenext century... greater than that seen over the past 10,000 years.”

In November, 1990, the United Nations General Assembly agreed to establish aprocess aimed at negotiating and adopting an international climate convention tobe ready for countries to sign at the Earth Summit in Rio de Janeiro in June 1992.The UNFCCC was opened for signature on May 9, 1992, after anIntergovernmental Negotiating Committee produced the text of the FrameworkConvention as a report following its meeting in New York from April 30 to May9, 1992. It entered into force on March 21, 1994. As of December 2009,UNFCCC had 192 parties (Countries).

The negotiating process involved nearly all the world’s nations, as well as observersfrom business and industry and environmental organizations such as Greenpeace.While many countries wished to see legally binding limits on greenhouse gasemissions included in the convention, the USA refused to agree to this, claimingthat there were still scientific uncertainties over the need to take action, and citingunacceptable economic consequences of cutting energy consumption. The moreprogressive countries were forced to compromise their positions in order to getthe USA on board, and as a result, the final treaty, known as the United NationsFramework Convention on Climate Change (UNFCCC), includes only a legallyweak and ambiguously worded ‘aim’ requiring the industrialized countries (listedin Annex I of the Convention) to return their greenhouse gas emissions to 1990levels by the year 2000.

The Convention required the first meeting of the Parties to the Convention (thefirst Conference of the Parties, known as COP1) to review the adequacy of thecommitment to return emissions to1990 levels by 2000. Projections of futureemissions provided by the industrialized countries in fact showed that carbondioxide emissions in most of the OECD countries were continuing to rise sharplyas a result of increasing fossil fuel use. Parties at COP1, held in Berlin in March/April 1995, came up with a document known as ‘the Berlin Mandate’, merely toset up a new negotiating process.

Although, the Berlin Mandate specifically stated that there should be no newcommitments for the non-Annex I developing countries, some OECD countries,particularly the USA, as well as the US fossil fuel lobby, argued that action bythe developed countries would be overwhelmed by projected increases in emissionsin the developing countries, and that the Protocol must therefore introduce, at a


38


minimum, a timeframe for the introduction of emission commitments for developingcountries. The logic behind the non commitment by developing countries is thatthey did not emit any green house gases in the past when developing countrieswere emitting green house gases profusely during the industrial revolution. Thepresent carbon concentration in the atmosphere that caused the temperature riseis due to the gas emitted and trapped in the atmosphere since the time of industrialrevolution.

However, International Energy Agency figures show that in the 1990s two thirdsof global emissions of carbon dioxide came from the developed countries, andproject that these countries will still be the source of over half the world’s emissionsunless they take action to reduce their emissions. It is the developed countrieswhose emissions since the Industrial Revolution have caused the climate changeproblem we are currently facing. It is therefore the responsibility of the developedcountries to take action first.

The negotiations on the Berlin Mandate was carried out by a committee whichincluded most of the world’s nations, including hundreds of observers from businessand industry and the environmental and development movements. It was thiscommittee which negotiated what became at COP3 what is known as the KyotoProtocol to the UNFCCC. The third COP took place in Kyoto in Japan on 11December, 1997 and involved many more negotiations and finally adopted theprotocol. The Kyoto Protocol, part of the UNFCCC, has come into force in2005 and countries that ratified are now bound by Protocol requirements. Foursummits, called Conference of the Parties, have taken place since the Protocolentered into force. The first commitment period expires 31, December, 2012 andno binding framework has been established post-2012.

The Kyoto Protocol is significant because it introduces, for the first time, legallybinding greenhouse gas emission commitments for the developed countries (thisincludes most of the developed countries listed in Annex I of the UNFCCC). Thecommitments agreed upon according to the Protocol, lead to an overall globalreduction of at least five per cent of 1990 levels of greenhouse gases by 2008-2012. An association of the Parties that have ratified the Kyoto Protocol, knownas the Conference of the Parties serving as the Meeting of the Parties to theKyoto Protocol (COP/MOP), meets around the same time as the UNFCCCCOP and is the highest decision-making body of the Kyoto Protocol. The mostrecent meeting of Kyoto Protocol Parties took place at the United Nations ClimateChange Conference in Copenhagen Denmark in 2009. COP 16 is scheduled forNovember 2010 at Cancun in Mexico. The aim is to put in place a bettercompliance structure in place of Kyoto that expires in 2012.

As compared with the UNFCCC, the Kyoto Protocol did not involve any newcommitments for the developing countries. A number of industrialized countries,listed in Annex B to the Kyoto Protocol and known as the Annex B Parties, didtake on a new commitment. The membership list for Annex B is effectively thesame as that for Annex I to the UNFCCC. These countries undertook to ensurethat their greenhouse gas emissions did not exceed their ‘assigned amounts’ by the‘commitment period 2008 to 2012’ (Article 3). The ‘assigned amount’ for eachcountry is stated, in Annex B, in terms of a reduction on the country’s 1990 levelof emissions. The reductions vary from 8 per cent (several countries) to ?10 percent, i.e. an increase of 10 per cent (Iceland).

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The Conference of Parties (COP-15) held in December 7-18, 2009 inCopenhagen, Denmark was unable to accomplish the objective of establishing anew agreement that would follow the Kyoto Protocol. Independent of the officialprocess, on the last day the U.S., Brazil, South Africa, India, and China (BASICcountries) drafted “The Copenhagen Accord”, a non-binding voluntary agreementon Green House Gas emissions reductions.

At COP15, no binding framework was created; the 2°C target temperatureprevailed due to the high cost associated with the 5°C decrease (trillions ofdollars per industrialized nation). The goal of reducing global CO

2emissions by

50% (80% for industrialized nations) was dropped. No mechanisms put in placeto mobilize $100 billion by 2020 to aid developing countries. No decisions weremade as to which developed countries would provide funding. No bindingframework was created; no obligations on developing countries to make cuts.The Copenhagen Accord was created separately from COP15.

Between November 29 and Dec 10, 2010, signatories to the Kyoto Protocolgathered in Cancun, Mexico for COP16. The agreement called on rich countriesto reduce their greenhouse gas emissions as pledged in the Copenhagen Accordand for developing countries to plan to reduce their emissions. The agreementincludes a “Green Climate Fund,” proposed to be worth $100 billion a year by2020, to assist poorer countries in financing emission reductions and adaptation.There was no agreement on how to extend the Kyoto Protocol, or how the $100billion a year for the Green Climate Fund will be raised, or whether developingcountries should have binding emissions reductions or whether rich countrieswould have to reduce emissions first.

3.3.1 Ratification and Enforcement: Post-kyotoCommitments

The Kyoto Protocol becomes binding under international law (or ‘enters intoforce’) ninety days after 55 countries which are Parties to the UNFCCC andthose that join UNFCCC have ratified it. It is then binding on these countries, andon any others which subsequently ratify it. The Kyoto Protocol was ratified andcame into force since 2005. These 55 countries include Annex I Parties whichtogether account for 55 per cent of the carbon dioxide emitted by the Annex Icountries in 1990. This means that no single country can block entry into force(the USA, for example, accounted for 36 per cent of Annex I carbon dioxideemissions in 1990). As of 2009, the Protocol was signed by 84 countries andratified by nearly all who signed, although the US did not ratify it. COP17 failedto produce a binding post-Kyoto commitment referred to as “The Kyoto Gap”.Alternatively the components of the Kyoto Protocol could be carved into smallerpieces of action in a stepped or parceled approach that may offer a more palatable,politically viable menu. However in June, 2011 meeting held at Bonn, Germany,Canada confirmed that it would not support an extended Kyoto Protocol after2012, joining Japan and Russia in rejecting a new round of the climate emissionspact. The current Kyoto Protocol binds only the emissions of industrialized countriesfrom 2008-2012. Poor and emerging economies want to extend the pact, creatinga deadlock at U.N. climate talks at Bonn, Germany. The world financial recessionis what making the countries go-back on their commitment to emission cutsfearing that it could lead to a fall in their national GDP.


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Valuation and Pricing ofNatural Resources 3.4 THE KYOTO MECHANISMS

The Kyoto Protocol allows countries to come together as a group which is theentity which has an emissions reduction commitment and it is then for the groupto decide individual commitments for its members so as to meet the groupcommitment. To date, the European Community is the only such group. It agreedMember State emissions-reduction targets in 1998. Mainly, the richer countriesare to reduce emissions, while the poorer can increase them. The range is froma 28 per cent reduction for Luxembourg to a 27 per cent increase for Portugal.The adoption of quantified emissions-reduction targets by the Annex B countries,but not by any others, is the key feature of the Kyoto Protocol.

3.4.1 Flexibility Provisions of Kyoto Protocol

Kyoto Protocol also included so-called ‘flexibility’ provisions relating to howthese commitments could be met. They can be classified as internal and external.Internal flexibility had two dimensions. First, the targets referred to the total ofseveral greenhouse gases to be added together in terms of their CO

2equivalency.

Thus, for example, if methane were twice as effective as carbon dioxide in itswarming effect, a unit of CH

4is equivalent to two units of CO

2for the purposes

of the Kyoto Protocol emissions reductions. The Kyoto Protocol did not say byhow much emissions of each greenhouse gas should be cut and this was left toeach Annex I Party to decide for itself. The point here is that the costs of cuttingdiffer across the gases in different ways in different countries, so that this flexibilityleft the option open, to each party to choose a mix that minimized its costs.Second, the effects of land-use changes could be taken into account. This relatesto carbon sequestration, where sink enhancement through, for example, re-forestation could be counted against the emissions-reduction target. Again, thiswas about the costs of meeting the target —for some countries re-forestationcould be cheaper than reductions in, say, CO

2emissions from fossil-fuel burning.

Under Article 3.3 of the Kyoto Protocol, Parties decided that net changes inGreen House Gases (GHG) emissions by sources and removals by sinks throughdirect human-induced Land Use and Land Use Change and forestry activities,limited to afforestation, reforestation and deforestation that occurred since 1990can be used to meet Parties’ emission reduction commitments.

External flexibility took three forms: Emissions Trading, Joint Implementation andthe Clean Development Mechanisms. In each case, the basic point is again aboutcost reduction.

3.4.2 Joint Implementation

Article 6 of the Kyoto Protocol, relates only to Annex 1 countries. Where a firmor government entity from country X finances an investment project in country Ythat has the effect of reducing emissions or enhancing sinks in Y, country X mayclaim this result for itself. Country Y cannot then claim it against its commitment.In some circumstances, this may be cheaper for country X than doing the equivalentamount of emissions reduction at home. Emission reductions derived from projectsare described in Article 6 as “emission reduction units” (ERUs).

3.4.3 The Clean Development Mechanism

Article 12 of the Kyoto Protocol, relates to Annex I and non-Annex I countries.Apart from that, it is very much like joint implementation. Annex I countries canfund development projects in non-Annex I countries and claim any emissions

41

reductions entailed for themselves. Again, the point here is about costs to AnnexI countries — financing a project that would benefit a developing country couldbe a cheaper way of meeting some of the Kyoto Protocol commitment thanaction at home. Time was spent in COP 15 in improving the clean developmentmechanism and drafting decisions on adaptation, technology, and capacity building.

3.4.4 International Emission Reduction and EmissionTrading

Emission trading was in existence even before, but Kyoto made it a part of themechanisms to cut emissions. Notwithstanding that the Kyoto Protocol was notin force prior to 2005, there was already emission trading, and some jointimplementation projects, as projects falling under the Clean DevelopmentMechanism umbrella. Some countries have stated that they will meet theircommitments even before Kyoto protocol came into force.

Under Kyoto protocol, the participants can buy and sell permits from and to oneanother. As with all environmental policy instruments, monitoring emissions (ornatural resource use) and implementing a system of penalties for non-permittedemissions (use) is crucial. The control authority devises the total quantity of permitsissued and the initial allocation. The initial allocation to firms and/or individuals canbe either by auction, which generates revenue for the government, or it can bewithout charge. Adequate safeguards need to be put in place to ensure thatpermits can be freely traded between participating firms and/or individuals atwhichever price they have agreed for that trade.

Emission trading is one of the mechanisms used to reduce emissions. Emissionstrading relates to only the Annex B Parties. Covered byArticle 17, the idea is thatrather than reduce emissions within its borders, Party X may claim against itsreduction target a reduction in emissions taking place in Party Y. Party X wouldpay Party Y for the right to do this. Party Y would lose the right to claim thereduction for itself in meeting its commitment. Article 17 of the Protocol statesthat the industrialized country Parties listed in Annex B may achieve theircommitments using emissions trading. Emissions trading works by setting a legallybinding limit on each Party’s emissions (the assigned amount) and then permittingParties to trade part of this. After all trading is finished the total sum of emissions(assigned amounts) should equal the total sum before any trading began - in otherwords trading re-distributes the allowed emissions from one Party to another butkeeps the total emissions within the originally agreed limit.

This means that developed countries whose emissions are less than their assignedamounts can sell the unused portion to countries whose emissions exceed theirassigned amounts. The net result is the same as if both countries achieved theircommitments, since emissions are deducted from the assigned amount of theselling country and added to the assigned amount of the buying country. Thoughthe Kyoto Protocol will come to an end and none is proposed to have bidingemissions thereafter, the carbon trading will go on between the developed anddeveloping nations as it is mutually beneficial to abide by the national restrictionson emissions.

3.4.5 India’s Position on Kyoto Protocol

India endorsed Kyoto protocol soon after it was adopted in 1997 and reiteratedits initial stand which is based on “polluter pays” principle for emission reductiontargets in post 2012 when the Kyoto Protocol expire. India along with other


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developing countries have been advocating for an agreement on a secondcommitment period for the Kyoto Protocol and with discussions on a “legallybinding agreement” which includes all countries. India has been consistent in itsposition that any decision on the legal form can’t be taken till the contents of theoutcome have been agreed to. India has stressed the importance of a ‘step-by-step approach’ and cautioned against ‘rushing into a straight-jacketed internationallylegally-binding agreement’. The Government of India highlighting its concern aboutthe adverse impact of climate change on millions of its poor and rural citizens whodepend on climate sensitive livelihood activities, strongly argues for effective emissionreduction mechanism by developed countries and urge them to support sustainabledevelopment in developing countries. Though India initially is not committal of anyemission reduction targets, developed an elaborate National Climate ChangeActionPlan to initiate steps in mitigating climate change.




1) What is Clean Development Mechanism?

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2) What is Joint Implementation?

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3.5 CARBON TRADING AND TRADABLEPERMITS

Tradable permits are another type of market-based policy instrument, under whichrights to discharge pollution or exploit resources can be exchanged through eithera free or controlled permit-market. Like taxes, they generate economic incentivesto economic agents to move towards less environmentally harmful behaviour. Asused to date, they have mainly impacted directly on firms. The tradable permitscheme as applied under the US Clean Air Act led to reductions of smog and acidrain emissions at lower economic cost than would have been the case with acommand and control instrument used in Germany. Thus they are proveninstruments. They can be applied to any sector. Currently researchers are workingon options for more systematic use of tradable permits in the transport sector.

3.5.1 Use of Tradable Permits within a Country

Tradable permits differ from taxes in a fundamental way. Consider the control ofpollution. With taxes, the monetary incentive facing the agent is the fixed price tobe paid for each unit of emissions. With permits the agent faces a quantitativeemissions target which is fixed by the amount of permits held, and the agent can

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vary her holding by buying or selling permits at a variable price. From the pointof view of the regulatory authority, taxes fix the price at which agents can emitbut not the amount that they emit individually or collectively, whereas permits fixthe amount that agents can collectively emit but not the price at which they do itor the amount they emit individually.

So, how do tradable permits work? A tradable permit is an environmental policyinstrument which organizes the exchange of rights to discharge a particular kindof waste into some environment, or to use a particular natural resource. In theformer case, instead of being charged for releases, one needs to hold a permitto discharge the amount that one actually does discharge. The regulatory authoritysets a limit (expressed in biophysical units) on the total amount of emissionspermits in existence.

By controlling the total number of permits, the regulating authority can control theaggregate pollution quantity. While the regulating authority sets the total amountpermissible, they do not attempt to determine how that total allowed quantity isallocated among individual sources of emissions. Tradable permits are based onthe principle that any increase in emissions from one source must be offset by anequivalent decrease elsewhere. Sources can vary the amount of permits that theyhold, and hence their emissions levels, by buying and selling from and to othersources.

The main advantage of the scheme is that it is cost-effective and generates dynamicincentives for cost reduction. The regulatory authority could issue a total amountof permits equivalent to the allocative efficiency target, if it knew what it was oran amount equivalent to an ‘arbitrary standard’. The basic principle are the samein the case of permits to use a natural resource — a regulatory authority determineswhat the level of use is to be and issues a corresponding total amount of permits,denominated in terms of tonnes or number of individuals for a fish stock, forexample. Once issued by the authority, permits can be bought and sold amongthe resource-harvesting firms and individuals. Examples include individual transferable

quotas in fisheries, tradable depletion rights to mineral concessions and marketabledischarge permits for water-borne effluents.

3.5.2 International Carbon Trading Advantages

Most developed countries have so far failed to implement widespread energyefficiency measures, and so use energy very wastefully. There are huge opportunitiesin such countries to reduce domestic emissions very cost effectively by bringingin energy efficiency measures. In an emissions trading regime, there may well bean incentive for these countries to reduce their domestic emissions below theircommitment. This is because the price they could receive for selling these “excess”reductions (technically, excess assigned amount units) may well be higher than thecost to them of reducing the emissions in the first place. In the absence of anemissions trading regime, these countries would have aimed to achieve theircommitment but probably nothing more. Other countries, however, would be ableto purchase these excess assigned amount units and thereby legally increase theiremissions above their original commitment.

Many economists believe this system to be an economically effective means ofachieving global emission reductions at least cost. If the trading system works well


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and no one sells too many permits, then the total emissions from the Annex BParties should be kept within the limit set originally for all Parties together. Atrading regime could therefore, in theory, bring about a more cost-effective reductionin global emissions than would otherwise be the case and produce some otheroverall economic benefits. This would be the ideal situation, but there are manyways in which a global emissions trading regime could go badly wrong.

There are two broad types of tradable permit system namely the ‘cap-and-trade’scheme and the ‘emission reduction credit’ scheme. For the latter, a baseline isagreed for every participant source before the start of the operation of the system.A participant is credited with any over achievement, and is allowed to sell thecredits arising. The ‘cap-and-trade’ scheme involves a decision by the regulatoryauthority about the total quantity of emissions (or natural-resource use) that is tobe allowed — the ‘cap’ and shares the total among the participating agents. Thisscheme establishes a quantified ceiling assigned to each participant for a givenperiod. No one is allowed to emit (or use) more than the amount for which itpossesses emission (or natural-resource use) permits.

3.5.3 Carbon Markets

Carbon Market is a market based mechanism for helping mitigate the increase ofCO

2in the atmosphere. Carbon trading markets are developing that bring buyers

and sellers of carbon credits together with standardized rules of trade. The carbonmarket approach is that of a cap-and-trade system. The government or bodyrunning the carbon market will set an annual cap on the amount of emissions thatparticipants such as industry and governmental bodies can cause. If their emissionsfall under the limit, then they are given credits that can be sold. Organizations thatemit more than the cap are required to buy the credits in the market. This systemallows emission levels to be monitored, and incentivizes participants to reducetheir emission levels.

Critics, however, point out that there is no proof that carbon markets havereduced emissions levels. In particular they say there has been a glut of theavailable carbon credits. With low prices, it is easier for polluters to buy creditsthan to change their ways.

The PointCarbon.com estimated that the world carbon market was worth $60billion, and will grow a further 50 to 80 per cent in 2008. Traded carbon creditshave grown 64 per cent from 1.6 Giga tons to 2.7 Giga tons. Consensus forecastsare for carbon prices to reach $37 per ton by 2010 and $54 by 2020, withoptimism that this will lead to a reduction in EU emissions during that period. TheEU carbon market, the European Union Emissions Trading Scheme (EU ETS) isexpected to witness carbon credit shortages by 2010, and this will lead toimprovements in efficiency and increased usage of renewable energy sources.Indeed, carbon prices will be the key to the success of the trading. Europeansare increasingly expecting a global market to be formally created after the KyotoProtocol lapses in 2012.

There are many Global Carbon Exchanges set up. In India Carbon credits canbe traded in the Multi Commodity Exchange since 2010. The European ClimateExchange (ECX) Chicago Climate Exchange (CCX) and International CarbonBank & Exchange (ICBE) are other carbon exchanges.

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3.5.4 Carbon Offsets

A carbon offset is a reduction in emissions of carbon or greenhouse gases madein order to compensate for or to offset an emission made elsewhere. Carbonoffsets are measured in metric tons of carbon dioxide-equivalent (CO

2e) and may

represent six primary categories of greenhouse gases. One carbon offset representsthe reduction of one metric ton of carbon dioxide or its equivalent in othergreenhouse gases. There are two markets for carbon offsets. In the larger,compliance market, companies, governments, or other entities buy carbon offsetsin order to comply with caps on the total amount of carbon dioxide they areallowed to emit. In 2006, about $5.5 billion of carbon offsets were purchased inthe compliance market, representing about 1.6 billion metric tons of CO

2e

reductions.

3.6 KYOTO PROTOCOL AND IMPACTASSESSMENT

To begin with, we need to recognize that the time dimensions involved in changingthe concentrations of atmospheric green house gases are very long. Any impactof mitigation cannot be felt in the short run. It has issues of poor and rich nationsand issues of inter generational equity costs to be borne now.

3.6.1 Equity Issues

In the past 200 years, most of the increase in global CO2

concentrations in theatmosphere is due to emissions from Developed countries. Part of the reason thatthese countries are now rich is that they have burned lots of fossil fuels since theIndustrial Revolution. Because they are rich, they are more able to afford thecosts of mitigation. Developing countries are poor, and need to grow economically,and mitigating their emissions could damage their growth prospects. It could beargued that for the sake of equity, developed countries do the mitigating, whiledeveloping countries continue to increase their emissions. On the other hand,developed countries argue that by 2025 about 43% of the emissions come fromdeveloped countries and by the turn of the century at 2100, 90% of the emissionscome from developing countries, even if we assume de-carbonization at the rateof 2% by all nations. Hence developing countries should also mitigate as theircontribution (total CO

2concentrations) would rise in future.

Costly action to reduce emissions now would be to secure benefits far into thefuture. The current generation would be bearing costs to reduce the harm to futuregenerations. If the decision were for no mitigation now, the current generationwould be avoiding costs at the expense of future generations.

3.6.2 Impact of Kyoto Protocol and the Problem ofEmission Cuts

The following simple model shows the implications.

St= St 1 + Et (d × St 1)

Where S refers to the stock size, E to emissions and where d is the parameter

that gives the rate at which the existing stock decays. Even an over simplified


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model such as the one given above clearly gives the dynamics of the atmosphericcarbon stock. If the initial value of S is 750 Giga tons (Gt) and emissions startat the actual current level of 6.3 Gt per year and grow at 1.4 per cent per yearout to fifty years from now, and then stabilize, then per year emission would be12.85 Gt nearly double of what they are now. The atmospheric stock is stillgrowing even after 500 years. It eventually stabilizes at 2,570 Giga tonsconcentration. This is, in general terms the story that models considered to bebetter descriptions of the carbon cycle tell.

Emission cuts take a long time to show up in concentrations, and major cuts oncurrent levels would be necessary to get back to pre-industrial levels. The Kyotoemission cuts are too small compared to the rate of accumulation. Kyoto cutswould just postpone the concentration that is expected in 2100 just by 11 years.A 5% emission reduction by developed countries each year would reduce theCO

2concentration from 436,528 rather than the 466,222 million tonnes by 2100.

The temperature reduction would be no more than 0.03 to 0.3 0C.

3.6.3 Cost of Mitigation Under Kyoto

One set of estimates of costs of Kyoto mitigation is given in Nordhaus and Boyer(2000). Their modeling results show that by 2105, the global costs of the KyotoProtocol commitments would be $59 billion with the flexibility mechanisms workingand $884 billion without them working at all. This is the present value. The futurevalue of the present value goes with a constant annual cost of $42.6 billion peryear for an interest rate of 5 per cent. The total global cost does not appear tobe high.

Achieving the commitments in the industrialized countries would presumably beaccompanied by the development of new infrastructure, technologies and industriesthat would set their energy economies on a different course over subsequent yearsand decades. These changes may also tend to spread globally. In such a situation,the benefits would be more.

3.6.4 Problems of Emission Cuts

There are reasonably straightforward ways, in a technical sense, for enhancingsinks: by growing and harvesting more trees. While enhancing terrestrial carbonsinks in this way is reasonably straightforward in the technical sense, it is attended

by lots of economic and political problems. Further in reality, the Clean DevelopmentMechanism (CDM) contains a number of serious weaknesses which mean itcould not only fail to deliver “clean development”, but could actually allow globalemissions to increase rather than decrease. The structural shortcomings and lowemission cuts committed under Kyoto lead to a net increase in global emission,despite Kyoto being ratified in 2005.

3.6.5 Kyoto Protocol: A Weak Instrument to AchieveSustainable Development

Given conservative assumptions about the growth of the human population out to2050, and modest aspirations in terms of economic growth to that date, holdingCO2 emissions at their current global level would require that emissions per $ ofGDP would have to fall by more than 50 per cent. Reducing CO2 emissions per$ of GDP is known as de-carbonization of the economy. Most experts consider

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this amount of de-carbonization to be technically achievable, but unlikely in theabsence of strong policy measures in pursuit of it globally. Given the magnitudeof the problem and the expensive mitigation mechanisms, Kyoto protocol appearsto be an extremely weak instrumental scheme of voluntary national self commitment.Global climate certification system is suggested as an alternative to Kyoto.




1) What are Carbon Markets?

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2) What is Carbon Offset?

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3.7 LET US SUM UP

l Climate Change is a global public bad which is non excludable and non rival.The self interest of the nations not to reduce emissions, problems of noncompliance and the intention to free ride on the back of mitigating nationsmake reduction of Green House Gases emissions an uphill task.

l Kyoto Protocol was put in place in 1997 at the conference of the partiesheld in Kyoto, Japan. After a long process of negotiations on the level ofemission cuts and a series of discussions on the rules of compliance it couldbe ratified only in 2005 by 85 developed countries baring United States ofAmerica and came into force.

l Kyoto Protocol included flexibility provisions relating to how the commitmentson GHG emission reduction could be met. They can be classified as internaland external. Internal flexibility had two dimensions. First, the targets referredto the total of several greenhouse gases to be added together in terms oftheir CO

2equivalency. Second, the effects of land-use changes could be

taken into account. External flexibility includes Emissions Trading, JointImplementation and the Clean Development Mechanisms.

l Tradable permits are another type of market-based policy instrument, underwhich rights to discharge pollution or exploit resources can be exchangedthrough either a free or controlled permit-market. Like taxes, they generateeconomic incentives to economic agents to move towards less environmentallyharmful behaviour.

l Carbon Market is a market based mechanism for helping mitigate the increaseof CO

2in the atmosphere. Carbon trading markets are developing that bring

buyers and sellers of carbon credits together with standardized rules oftrade. The carbon market approach is that of a cap-and-trade system.

l Though Kyoto Protocol has shown the way to international cooperationbased on economic incentive system, it remained a weak instrument as thelevel of emission cuts remained very small compared to the threat of fastincreasing carbon concentration in the atmosphere.


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l Given the enormous scope for the developed countries to cut emissionsfurther and the need of the developing countries to develop using moreenergy, a reasonable system of cap and trade scheme and an evolution ofthe global climate certificate system for sustainable development are on theagenda beyond Kyoto protocol.

3.8 KEY WORDS

Certified Emission Reduction Unit (CER): Equal to one metric tonne of CO2-

equivalent emissions reduced or of carbon dioxide (CO2) removed from the

atmosphere through the Clean Development Mechanism (CDM) project, calculatedusing Global Warming Potentials (GWP).

Decarbonization: The process by which countries or other entities aim to achievea low-carbon economy, or by which individuals aim to reduce their carbonconsumption.

Kyoto Mechanisms (Flexibility Mechanisms): Market-based mechanisms thatParties to the Kyoto Protocol can use in an attempt to lessen the potentialeconomic impacts of their commitment to limit or reduce greenhouse gas (GHG)emissions. They include Joint Implementation (JI) (Article 6), Clean DevelopmentMechanism (CDM) (Article 12), and Emissions trading (Article 17).

Kyoto Protocol: The Kyoto Protocol to the United Nations FrameworkConvention on Climate Change (UNFCCC) was adopted in 1997 in Kyoto,Japan, at the Third Session of the Conference of the Parties (COP) to theUNFCCC. It contains legally binding commitments, in addition to those includedin the UNFCCC. Countries included inAnnex B of the Protocol (most Organizationfor Economic Cooperation and Development countries and countries witheconomies in transition) agreed to reduce their anthropogenic greenhouse gas(GHG) emissions.

Offset (in climate policy): A unit of CO2-equivalent emissions that is reduced,

avoided, or sequestered to compensate for emissions occurring elsewhere.

United Nations Framework Convention on Climate Change (UNFCCC):The Convention was adopted on 9 May 1992 in New York and signed at the1992 Earth Summit in Rio de Janeiro by more than 150 countries and the EuropeanCommunity. Its ultimate objective is the ‘stabilisation of greenhouse gasconcentrations in the atmosphere at a level that would prevent dangerousanthropogenic interference with the climate system’.


l Allwood J. M., Bosetti, V., Dubash, N.K., Echeverri, L.G. and von Stechow,C. 2014. Glossary. In: Climate Change 2014: Mitigation of Climate Change.Contribution of Working Group III to the Fifth Assessment Report of theIntergovernmental Panel on Climate Change. Cambridge University Press,Cambridge, United Kingdom and New York, NY, USA.



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l Daly, H.E. and Farley, J. 2004. Ecological Economics: Principles andApplications. Island Press, Washington. Pp. 454.

l Kolstad, C.D. 2011. Intermediate Environmental Economics. OxfordUniversity Press, 198, Madison Avenue, New York-10016. p.470.

l Nordhaus, W.D. and Boyer, J. 2000. Warming the World: Economic Modelsof Global Warming. The MIT Press, Cambridge. Pp 245.

Website

http://unfccc.int.




Clean Development Mechanism:

l Annex I countries can fund development projects in non-Annex Icountries and claim any emissions reductions entailed for themselves.

l The costs to Annex I countries — financing a project that would benefita developing country could be a cheaper way of meeting some of theKyoto Protocol commitment than action at home.


Joint implementation:

l Where a firm or government entity from country X finances an investmentproject in countryY that has the effect of reducing emissions or enhancingsinks in Y, country X may claim this result for itself.

l Country Y cannot then claim it against its commitment. In somecircumstances, this may be cheaper for country X than doing the equivalentamount of emissions reduction at home.



l Carbon Market is a market based mechanism for helping mitigate theincrease of CO2 in the atmosphere.

l Carbon trading markets are developing that bring buyers and sellers ofcarbon credits together with standardized rules of trade.

l The carbon market approach is that of a cap-and-trade system.

l This system allows emission levels to be monitored, and incentivizesparticipants to reduce their emission levels.


l A carbon offset is a reduction in emissions of carbon or greenhousegases made in order to compensate for or to offset an emission madeelsewhere.

l Carbon offsets are measured in metric tons of carbon dioxide-equivalent(CO2e) and may represent six primary categories of greenhouse gases.

l One carbon offset represents the reduction of one metric ton of carbondioxide or its equivalent in other greenhouse gases.


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Valuation and Pricing ofNatural Resources UNIT 4 GREEN NATIONAL INCOME

ACCOUNTINGStructure

4.0 Introduction

4.1 Objectives

4.2 Conventional GNP and Green GNP

4.3 Integrated Environmental and Economic Accounting

4.4 Flaws in the Conventional System of National Accounting

4.5 Methodological Approaches to Green Accounting4.5.1 Pollution Expenditure Accounting

4.5.2 Physical Accounting

4.5.3 Extension of the SNA Type Systems

4.6 Green Accounting in India

4.7 Issues and Challenges of Green Accounting4.7.1 Environmental Protection and Economic Growth

4.7.2 Distributional Impacts and Natural Resource Policies

4.7.3 Links between Trade and Natural Resource Policies

4.8 Green Accounting and Sustainable Development

4.9 Let Us Sum Up

4.10 Key Words



4.0 INTRODUCTION

Green accounting is a popular term for environmental and natural resourceaccounting and aims at incorporating environmental assets and their source, andsinks functions into national and corporate accounts. Corporate environmentalaccounting is yet to be adopted widely, though the concepts and methods aresimilar to those of national green accounting and hence not further discussed here.This unit discusses green national accounting in detail. The conventional nationalaccounts largely ignore the observed scarcities of natural resources, which threatento undermine the sustainability of economic performance and growth, and considerenvironmental degradation as an ‘external’ (social) cost of economic activity.

Further critique refers to a possible distortion from counting environmental protectionexpenditures as an increase in national income, despite the fact that such ‘defensiveexpenditure’ tends to maintain, rather than increase, the welfare of society. Inresponse, the United Nations issued in 1993 and revised in 2003 a handbook ona System for integrated Environmental and Economic Accounting. Since then,number of countries is trying to build an integrated environmental and economicaccounting by modifying the traditional system of national accounts to address theissue of sustainable development.

4.1 OBJECTIVESAfter reading this unit, you will be able to:

l explain the concepts of conventional GNP and Green GNP;

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l underline the flaws in the conventional system of national accounting;

l describe the methodological approaches to Green Accounting; and

l state the issues and challenges of Green Accounting.

4.2 CONVENTIONAL GNP AND GREEN GNP

Before discussing various issues related to green accounting system, let’s discussthe basic concept of Gross Domestic Product (GDP), Gross National Product(GNP) and green GNP. The GDP is one of the primary indicators used to measurethe economic health of a country. It represents the total monetary value of all finalgoods and services produced in an accounting year of a country by using existingfactors of production such as land, labour, capital and organization. GDP is nota tool of economic projections, which would make it subjective; it is just ameasurement of economic activity. That is why it does not reflect the sustainabilityaspects of the economic growth. A country may achieve a temporarily high GDPby over-exploiting ecological resources such as forest, air, water, land, etc .or bymisallocating investment. For instance, the large deposits of phosphates gave thepeople of Nauru located in Micronesia in the South Pacific, one of the highest percapita incomes on earth, but since 1989 their standard of living has declinedsharply as the supply has run out. Oil-rich states like Iraq, Iran, Kuwait and othercan sustain high GDP without industrializing, but this high level would no longerbe sustainable, if the oil runs out. Aspiring for higher economic growth at theexpense of environmental degradation can end up costing dearly to clean up andwill put the country on unsustainable growth trajectory.

Gross National product (GNP) is the monetary value of final goods and servicesproduced in the current period by domestically owned factors of production athome or abroad. Moreover, it is considered as one of the indicators of economiccondition of a country. The difference with GDP arises because some productionwithin the domestic economy is done by factors of production owned by foreigners.For example, the salary of an American consultant in General motors office inBangalore or the profit repatriated from India by the same company belongs tothe GNP of America. In the same way, the earning of an Indian national workingin a bank in China contributes to China’s GDP and India’s GNP.

GNP = GDP + income earned by domestically owned factors abroad- incomeearned at home by foreign owned factors

In general, the GNP measures everything that has a market value. It doesn’tinclude household activities, neighborhood help, leisure time, natural resourcedegradation, natural sink capacity, depletion or income distribution. Therefore,GNP in its present form doesn’t include the contributions of ecological resourcesand reflect degradations or declining stock of ecological resources. However,green GNP includes the degradation and contributions of natural resources whichis required for achieving sustainable development in the world.

Net Domestic Product (NDP) can be defined as Gross Domestic product (GDP)minus depreciation of man-made capital only. It doesn’t take into accountdepreciation of natural capital such as air, water, land, forests, etc. Higher NDPof a country by exporting timbers to other countries does not ensure sustainableor higher green growth. Whereas green NDP is defined as GDP minus depreciationof both man made capital and natural capital. If green NDP rises, then we cansay that country growth is a sustainable one.

Green National IncomeAccounting

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Net National Product (NNP) is traditionally defined as GNP minus depreciationof man-made capital/asset (Km). NNP does not take into account the depreciationof natural capital such as degradation air, land, water, and forests. This is theincome left over after we put money to one side for the depreciation of assets.Depreciation of man-made capital is nothing but wear and tear of man-madecapital like machines when they are put into use for production. This can bewritten as follows:

NNP = GNP- dKm (2)

Where, dKm is depreciation on man-made capital. Putting the two equationstogether we have

NNP = C+S-dKm

But this equation and concept is incomplete because it doesn’t take into accountthe depreciation of natural capital / assets of economy (e.g., land, water, air,forests, etc.). By taking into account the depreciation of natural capital (Kn), wecan have a modified NNP.

NNP* = NNP = C+S-dKm-dKn (3)

Where, dKn is now the loss or depreciation in value of natural resources/assets.The * on NNP reminds that we are now measuring a modified version of NNPwhich takes into account of loss and value addition of natural resources.

Let’s now shed some light on dKn. Suppose Kn consists of two kinds of assets:non-renewable ones like oil, minerals, metals, and renewable ones, like fisheriesor timber. For non-renewable resources, each year there are discoveries D ofnew resources and there is an extraction rate Q, the net loss of these resourceseach year is given by:

Loss of non-renewables = Q-D

For renewable, the same considerations hold but the discovery rate is replacedby the natural rate at which such resources grow (the biological growth rate, B)and the extraction rate is replaced by the harvesting rate H

Loss of renewable = H-B

In case of each asset, we need to put a value on these losses. The losses couldbe gains, if for example harvests are less than natural growth. Therefore it isrequired to multiply each of the net changes by the profit.As we know in economicsthat the rental is a measure of resource scarcity. Hence it is used as an indicatorof depreciation which is the price minus the cost of extraction (harvesting). Let’scall it Rn for non-renewable resources, and Rr for renewable resources. Thedepreciation of natural resources is given by the following equation.

dKn = Rn(Q-D) + Rr (H-B) (4)

In the above equation, the impact of pollution on the environment and economyis not considered here. Pollution due to emission ‘E’ does severely affectenvironment. At the same time, some part of pollution gets assimilated ‘A’ by thecarrying capacity of the environment. Then the net change in the environment canbe expressed by E-A. The net change has to be valued. The valuation is in factthe willingness of the population to pay to avoid that pollution willingness to pay(WTP). So the overall depreciation on natural resources and the environment isgiven as follows:

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dKn* = Rn(Q-D) + Rr (H-B) + WTP (E-A) (5)

So the final equation is:

NNP* = C+(S–dKm-dKn*)

Or

NNP* = C+S–dKm- Rn(Q-D)-Rr(H-B)- WTP (E-A) (6)

Equation 6 can be expressed as follows:

NNP* = GNP – depreciation on man-made capital - depreciation of naturalresources and environment.

The above definition of NNP* shows that environmental resources areincorporated while calculating GNP. This also implies what kind of informationwe need to collect in order to estimate green net national product (NNP*). Thedifference between green NNP* and traditional NNP is explained with the helpof an example. A calculation of green national product is briefly illustrated in theBox 1.

Box 1: Green State Domestic Product for Goa

A study carried out by Parikh et al., (2008) to estimate the Green StateDomestic Product (SDP) for the state of Goa in India. Green SDP for year2003-04 was calculated by considering the State Gross Domestic Product,depreciation value, loss of income due to environmental degradation fromvarious sectors viz., solid waste, air pollution, water pollution anddeforestation (or afforestation) activities in the state. The environmentallyadjusted or green SDP was estimated as the differential between actualstate domestic product and the loss of income due to environmentaldegradation. The study also considered the Avoidance cost while estimatingthe Green SDP. The loss of income due to environmental degradation wasestimated by taking into account following five kinds of losses:

a) Uncollected urban municipal solid wastes causing loss to environmentand that are Rs.1.4 Crores.

b) The environmental degradation due landfill sites that is unaccounted inthe national Accounts is Rs.11 Crores.

c) Avoidance cost for the solid waste management is 0.4 Crores

d) Environmental degradation causing loss of income due to industrial airpollution is Rs.517 Crores.

e) Afforestation activities are going in Goa state and that has led toincrease in environmental capital and therefore the contribution dueforest is Rs.550 Crores.

The study estimated the green SDP for the year 2003-04 at Rs. 7929.2crores against the SDP of Rs. 9657 crores for the same period. With allthe limitation of data concerning loss of income due to environmentaldegradation and avoidance cost the differential is the SDP was reduced byaround 18 percent when adjusted to the loss due to environmentaldegradation.

Source: Parikh, et.al. (2008).


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It is evident in the above findings that depreciation of natural capital is larger thanthe depreciation of man - made capital. The end outcome is the green net nationalproduct (NNP). In fact, green national product is less than conventional NNP.The green net domestic product shows the real growth of the country unliketraditional NDP which overestimates and overstates the growth of a country. Thisis very much apparent from the above calculation in such a small state like Goa.Similar studies for other states in India reveal even a large gap between SDP andenvironmentally adjusted SDP.

4.3 INTEGRATED ENVIRONMENTALANDECONOMIC ACCOUNTING

The integration of the environmental accounting into the system of national account(SNA) dates back to the 1970s. In fact, this issue got immense significanceamong the experts and economists how to integrate the natural resources as acomponent of SNA after publication of the Bruntland Commission Report, ourCommon Future in 1987, which popularized the notion of sustainable development.Furthermore, it was recommended in Rio Summit in 1992 that integratedenvironmental and economic accounting be undertaken by the governments of thesignatory countries. The endeavors on this issue got started by individual countriesor practitioners and each has been developing their own framework andmethodologies depending upon their concerns on the environment. But the concertedand comprehensive efforts have been underway since 1990s by multilateralinstitutions of the world to standardize the framework and methodologies. Recently,the search for a consensus on the framework and methodologies for the integrationof environmental resources into the system of national accounts (SNAs) has beenfully underway by these international organizations. The most important primarybenefit of the environmental accounting is to obtain more accurate overall picturesof country’s income and wealth as far as produced and natural capital is concerned.Moreover, the role and importance of natural capital in the individual sector maybe better reflected while estimating its performance within a framework ofsustainable development path. The valuation of environmental degradation anddepletion in terms of magnitude of natural capital in the various sectors may helpin identifying the sectors which are to be prioritizing while formulating environmentalpolicies and programmes to achieve a sustainable development. Though, theincorporation of integrated environmental and economic accounting into system ofnational account (SNA) is useful for the policy making of a nation, but the variouschallenges, issues and practical problems pertaining to the environmental accounting,are yet to be figured out .

The major objective of the national income accounting is to provide a properinformation framework which would be suitable for analyzing the overallperformance of economic institutions and system. However, the current system ofnational accounts reflects only the Keynesian macroeconomic model that wasdominant when the system was developed, largely through the work of Kuznets(Repetto, 1989). The Keynesian aggregates such as consumption; saving,investment, and government expenditures are carefully defined and measured. ButKeynes and his team were very much preoccupied with the Great Depression(1936) and business cycle and specifically busy in explaining how an economycould remain for long periods of time at less than full employment. They evendidn’t talk about the scarcity of the natural resources and their vital productiverole in the economy. Unfortunately, after couple of decades the same system of

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national accounts based on Keynesian notion doesn’t consider the productive roleof natural resources in the light of alarming degradation and depletion ofenvironmental and natural resources which have very significant bearing on theoverall performance of economy of a country. Some scholars like Herman Daly(1990) and his collaborators acknowledge the defects of GDP measures thatexclude resource depletion and addition of natural resources. However, they havedevoted little attention to this particular problem because they challenge the useof the national accounts in general. Group of analysts comprising Robert Repetto,Henry Peskin, Salah EI Serafy, David Pearce and many others accept the inherentusefulness of the ongoing system of national accounts, but they recommend specificways of embodying natural resources in the accounts through arguments and casestudies.

National income accounting is one of the most important policymaking tools toappear in the last 50 years in the hands of the policymakers. Its measures likeGross Domestic Product (GDP) and Net Domestic Product (NDP) have beenused as measures of the economic progress and standard of living of all most allcountries. Decision makers and researchers use these measures for new policyinitiatives and to analyze policy alternatives respectively. The traditional Systemsof National Accounting (SNA) are now recognized as inadequate as they cannotaccurately measure the contribution of environment and the impact of economicactivities on it due to the exclusion of the non-marketed services provided bynatural assets; inconsistent treatment of depreciation on man-made and naturalassets; and inadequate representation of the degradation of environment. Thisgives a false impression of increase in income while natural wealth is reducing, tothe decision makers and researchers. Hence, green accounting can be useful forsustainable national income accounting in removing the current biases. Greenaccounting system has the capability to include environmental goals in theconventional economic development. The environmental management theoriesdeveloped in the last three decades states that environment is a means of economicwealth. If these environmental services were sold in conventional markets, theywould provide a positive price. Moreover, these services are scares in nature.Keeping the economic values and scarcity nature of environment in mind, if welink it with the conventional economic accounts, then environment will be anadditional economic sector, i.e., “Nature”. We have to treat the non-marketedgoods and services generated by environment like the marketed goods and servicesgenerated in the conventional sectors. Since Earth Day 1970, environmentalistshave challenged economists’ definitions of progress, wealth, and development –pointing out that economic theories and models shortchange nature as well asfuture generations. They highlight absurdities of Gross National Product (GNP)accounting such as in Alaska, which posted gains after the Exxon Valdez oil spillbecause the additional costs of the clean-up are added to GNP instead of beingsubtracted (as environmentalists advocate). The Exxon Valdez oil spill occurredin Prince William Sound, Alaska, on March 24, 1989, when the Exxon Valdez,an oil tanker bound for Long Beach, California, struck Prince William Sound’sBligh Reef and spilled 260,000 to 750,000 barrels (41,000 to 119,000 m3) ofcrude oil. Till today, it is considered to be one of the most devastating human-caused environmental disasters. The Valdez spill was the largest ever in U.S.waters until the 2010 Deepwater Horizon oil spill, in terms of volume released.

GNP ignores the value of clear water, fish and pristine, scenic environments, etc.In this connection, green accounting/environmental accounting is an attempt to


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measure sustainable development by correcting the national income accounts forthe depletion of natural capital. In other words, the notion of incorporating the useof natural resources and the environment into the national accounts has beencalled “green accounting”. Green accounting, one of the methods, takes intoaccount environmental resources and services, and changes therein. It measurestheir effects on System of National Account (SNA) to reveal true maximumincome which a nation can consume while maintaining a sustainable developmentwithout jeopardizing the interests of the present and future generations.Environmentally adjusted net domestic product (EDP) or environmentally adjustednet income (ENI) is obtained by deducting environmental cost from net capital.




1) Explain the concepts of traditional and green national income accounting?

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2) Elaborate the need for green accounting?

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4.4 FLAWS IN THE CONVENTIONAL SYSTEMOF NATIONALACCOUNTING

In the early 1970s, the increased importance of environmental conservationhighlighted the deficiencies in the conventional system of national accounting (SNA)and emphasized the need for integrating environmental indicators to nationalaccounting to make it more reflective of the true wealth of a country. Measuresof economic activity in the national accounts can be misleading when importantinformation about natural resources and the environment is either missing ormislabeled. The desire to improve measurement of the effects of economic policiesis responsible for much of the interest in adding more information to the accountsabout natural resources and the environment. The growing interest in policies thatpromote “sustainable development,” for example, has led to suggestions thatnatural resources and the environment be treated as capital assets providingservices to the economy so called natural assets / capitals.

Firstly, the conventional SNA takes into account only goods and services tradedin markets and does not include the non-marketed goods and services providedby the ecosystem like forests helps in flood control, prevent soil erosion, providestimber and fuel wood; many other services. The SNA only consider the economiccontribution of forests and ignore the environmental services. Similarly, the wastedisposal services of the environment are not recorded in the national accounts.

Secondly, natural capital contributes to production just as physical capital does.The absorptive capacity of the environment or the wood from harvested timber

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can contribute to production just as machines contribute to the manufacture ofgoods. Similarly, the environment or natural resources can depreciate just asmachines do from wear and tear. Also, as with physical capital, investment canbe made in some forms of natural capital as a means of maintaining or increasingits stock; for example, expenditures to maintain levels of environmental quality orto expand the stock of timber. Investment in either physical or natural capitalrequires that current consumption be sacrificed in expectation of a flow of incomein the future. In short, SNA neglect the stock of natural resources as well asenvironment, and their depletion coupled with the degradation in environmentalquality.

Thirdly, SNA do not adequately represent the degradation of environment. Theaccounts ignore the capability of the environment to dispose of wastes, eventhough its ability to absorb pollutants is a valuable service to both producers andconsumers. Money spent on avoiding damages caused by pollution or so calleddefensive expenditures on such items as pollution abatement equipment and someprescription medicines is included in national income but is not differentiated fromother forms of investment or consumption in the national accounts.

4.5 METHODOLOGICAL APPROACHES TOGREEN ACCOUNTING

The above flaws in the traditional SNA have given birth to various green accountingapproaches. Different green accounting approaches have been developed dependingon existing methodologies and its weakness in the traditional SNA. There are fourapproaches to green accounting namely Pollution expenditure accounting; Physicalaccounting; Development of green indicators and Extension of the SNA typesystems.

4.5.1 Pollution Expenditure Accounting

One of the important weaknesses in the conventional economic accounts is todevelop data series on pollution abatement and other environmental expenditures.This involved developing data series on pollution abatement and other environmentalexpenditures. Such data series has been maintained by USA since 1972 and arealso available for other OECD countries. However, there are some limitations ofusing this approach (1) these data refer to expenditure already incurred, eitherdue to policy or standard business and household practice. Hence they should notbe considered as additions to conventional economic accounts as they are a re-specification of the information already accounted for. (2) The abatement expendituredata can tend to overestimate the true opportunity costs, as they contain outlayson materials, which are already included in the value-added expression of thesector producing these materials, thus there may be the risk of double counting.(3) The practice of comparing pollution abatement expenditures with GDP ismisleading since the GDP covers primary costs and is free from double counting.This can be addressed by using input-output techniques. The use of pollutionexpenditure data has limited scope for policy. They can only give an indication ofhow various environmental policies may affect the productivity.

4.5.2 Physical Accounting

The second approach to improve the conventional economic accounts is tosupplement these accounts with physical information about the natural environmentand its status. This approach, especially followed by France, Germany, Norway,


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and several other industrialized countries to measure physical changes in the stockof environmental assets over time. Physical accounting refers to the natural resourceand environmental accounting of stocks and changes in stocks in physical (non—monetary) units, for example, weight, area or number. Qualitative measures,expressed in terms of quality classes, types of uses or ecosystem characteristics,may supplement quantitative measures. The combined changes in asset qualityand quantity are called volume changes. For example, the area under denseforests, open forests, volume of stock of timber, area disturbed by fire; or givethe quality of air in terms of CO

2emissions, suspended particulate matter, nitrogen

oxide emissions etc. or water using physical indicators like dissolved oxygen,Biological Oxygen Demand (BOD), and Chemical Oxygen Demand (COD).Such type of information can also be arranged in conventional input-output typeof matrices. For example Netherlands has used such a complete input-outputmatrix system in their NationalAccounting Matrix including EnvironmentalAccounts(NAMEA). The system fully integrates economic and physical environmentalinformation. Development of such physical accounts is important as the accountscan provide the inputs for the construction of various environmental indicators andthus be used for scorekeeping purposes. However, it is very difficult to use thesephysical accounts for policy purposes. Some of the reasons include: (1) thechoice of appropriate physical units of measure is not obvious; (2) there isincomparability of units; (3) difficulty in getting condensed description as the unitsare not similar; (4) involve development of huge data sets due to different qualityindicators for forests, air, land and water without reaching general conclusions ontheir (economic and non-economic) significance; (5) the potential severity of theenvironmental problem not reflected and hence the decision-makers will not beable to set relative environmental priorities while taking various investment decisions.

However, physical accounting framework has been acknowledged as a majortool to address society’s environmental problems by the professional societies likeInternational Society for Industrial Ecology and the International Society forEcological Economics. The basic philosophy behind this physical accountingframework is that the economy has to be seen as a sub-system of the environment,being embedded into natural processes. The main argument is that any economicactivity has to rely on a certain exchange of material and energy between natureand the economy or within the economy.

4.5.3 Extension of the SNA Type Systems

This approach modifies the existing conventional SNA by introducing environmental–economic interaction to all its accounts and ambitiously also covers all theinformation required for the above three approaches. To make the environmentalpolicies more effective in the line of overall economic objective, this approachgenerates and systematically assembles environmental resources data. This systemis a combination of the UN Satellite System for Integrated Environmental andEconomic Accounting approach (SEEA) and the Environmental and NaturalResource Accounting Framework (ENRAP) which has been adopted in thePhilippines. The principal difference between these two lies in the extent of theiradherence to SNA concepts. SEEA appears much more concerned with adherenceto the principle of SNA than to economic theory. The ENRAP framework, on theother hand, stresses more on the consistency with economic theory than with theSNA. The main objectives of SEEA are:

l Division of environment-related flows and stocks: According to thisobjective, the environmental protection expenditures may be treated separately.

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These expenditures have been treated as defensive expenditures to compensatefor the negative impacts of economic growth.

l Linking physical accounts with monetary environmental accounts: Thisobjective creates a corresponding link between the natural environmentaland economy in physical terms. In other words, for every monetary stockand flow accounts of the SEEA, there will be a corresponding physicalcounterpart account.

l Valuation of costs and benefits of the environmental goods andservices: The SEEA expands and complements the scope of traditionalSNA by calculating the cost of the utilization of environmental resources inproduction process and final demand; and the cost of environmentaldegradation by the process of pollution.

l Inclusion and measurement of natural capital: The SEEA expands themeaning of capital to include not only the man-made but also the naturalcapital. Natural capital comprises of scarce renewable resources, non-renewable resources and cyclical resources like water.

l Assessment of indicators of environmentally adjusted product andincome: The SEEA explains and measures the costs of environmentaldegradation and changes in its quality. After these adjustments, it is knownas environmentally adjusted net domestic product (EDP). The SEEA is asatellite system of the SNA that comprises four categories of accounts. Thefirst account consists of purely physical data relating to flows of materials andenergy; and this account is accommodated in the accounting structure(monetary flows) of the traditional SNA. A hybrid account is produced bycombining both physical and monetary data flows. For example, emissionsaccounts for greenhouse gases. There is also a second category of account.These accounts include the principles of existing traditional SNA which arerelated to management of the environment. Environmental protectionexpenditures are actual expenses incurred by industries, households, thegovernment and nongovernmental organizations to avoid environmentaldegradation or eliminate the effects after degradation has taken place. Theyare included in the SNA, but are usually not identified separately in theconventional production and final use accounts.

In SEEA, the environmental resources are measured in both physically andmonetarily and put in to separate accounts which are known as the third categoryof accounts. For example, timber stock accounts have both opening and closingbalances and the changes therein over the period of time. The final category ofSEEA accounts are related to the impact of economy on environment. Thiscategory of accounts is basically adjustment accounts. The traditional SNA adjuststhe positive and negative impacts of economy on environment in three ways:depletion, defensive expenditures and degradation.

4.6 GREEN ACCOUNTING IN INDIA

It is evident that available indices of development including the current system ofnational account with its primary focus on Gross Domestic Product (GDP) growthrates don’t capture many vital aspects of national wealth in India such as changein quality of health, extent of education, and quality and magnitude of environmentalresources. All these have significant impact on the well being of India’s citizensand most of them are critical to poverty alleviation, providing income generation


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opportunities and livelihood security for the poor. Therefore, GDP accounts andGross State Domestic product accounts are inadequate for properly evaluatingthe trade-offs encountered by India’s policy makers.

In this context, GAISP (Green Accounting for Indian States and Union TerritoriesProject) was launched in July 2004 by largely in recognition of the fact that GDPgrowth percentages are substantially misleading about the economic growth inIndia. GAISP is being undertaken by GIST (The Green Indian States Trust), anIndian NGO which was created in July 2004 to promote sustainable developmentin India. GAISP proposes to build a framework of adjusted national accounts thatrepresents genuine net addition to the national wealth and economic development.These are referred as green accounts in the literature. Such a system ofenvironmentally – adjusted national income accounts will not only reflect in economicterms of the depletion of natural resources and the health costs of pollution, butalso reward additions to the stock of human capital through education. GreenAccounts for India and its states will provide a much better measure of developmentcompared to GDP (National income) growth percentages and gross state domesticproduct (State income) growth measures. This project will encourage theemergence of sustainable development as a focus of economic policy at bothnational and state level. Moreover, the Central Statistical Organization (CSO) inIndia is working on a methodology to systematically incorporate natural resourcesinto national accounts in different states for land, water, air, & sub-soil assets.However, the CSO approach develops accounts for some states & for somesectors, and their studies are still in progress.

4.7 ISSUES AND CHALLENGES OF GREENACCOUNTING

An important benefit of green accounting would be to increase the informationavailable for analyzing policy issues. Among the key issues are the effect ofenvironmental protection on economic growth, the distributional impacts ofenvironmental and natural resource policies, and the link between trade andenvironmental and resource policies.

4.7.1 Environmental Protection and Economic Growth

The impact of environmental protection on the economy and employment is amatter of much debate. Researchers disagree about the effect of environmentalpolicies on the economy. Since the extensive environmental legislation of the1970s, interest has arisen in evaluating the economic and employment effects ofenvironmental regulations. Many of the studies of the effects of environmentalprotection conclude that statutory limits on pollution reduce economic growth.Given current models, it is not clear what the net impact of such programs mightbe and whether significant differences in growth rates exist in the relative impactof one program over another. It is clear, however, that more detailed informationis needed about the relationship between policy, expenditures on final andintermediate products, and environmental and natural resources. Informationgenerated by an expanded set of accounts could provide important pieces of thepuzzle.

4.7.2 Distributional Impacts and Natural Resource Policies

The benefits and costs of environmental and resources policies fall more heavilyon some industries or income groups than on others. Improved water qualityespecially seems to favor higher income groups since most of the improvement is

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in urban areas. Employment in industries that pollute more, such as chemical andpaper manufacturing, could be most affected by tighter air quality standards. Sucha perception whether correct or not can cause political resistance to new initiativesthat might result in policy improvements. The input-output accounts can beespecially useful for analyzing the impact of legislation on different industries.Detailed models of the payments sector in input - output tables have also beendeveloped to predict the effect of policies on income distribution.

4.7.3 Links between Trade and Natural Resource Policies

Policymakers have come to appreciate the notion that nations cannot make policywithout considering what is happening in other countries. Concern about theeffects of the North American Free Trade Agreement on the environment, forexample, was an important consideration during negotiations and required workingout a separate side agreement on environmental issues before the Administrationwas willing to submit the final agreement to the Congress. National accountingsystems that include environmental and natural resources could provide usefulinformation during negotiations over the nation’s commitments to restore or maintainnatural capital. Trade restrictions have not been used when a country’s productionand processing methods result in excessive discharges of pollutants such as carbon,sulfur or nitrogen oxides, or chlorofluorocarbons across national boundaries. Onereason is the difficulty of determining the effect of trans-boundary pollutants onindustry costs. Expanding the input-output tables to include the use of wastedisposal services and identify abatement costs could help in identifying primaryand secondary costs of trans-boundary pollutants. There are at least two moregood reasons for incorporating environmental and natural resources into the nationalaccounts. First, incorporating such information would result in a more comprehensivesource of data for identifying the causes of economic problems related to theenvironment and natural resource management. Second, the process of compilinginformation for a single integrated data set could yield new and important insights.




1) Briefly elaborate the various issues related to Green accounting?

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4.8 GREEN ACCOUNTING AND SUSTAINABLEDEVELOPMENT

It is most important on the part of the policy makers and planning agencies of acountry whether the economy has performed sustainably during one or moreaccounting periods, green accounting indicators can be employed in policyformulation and evaluation.


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At the macro-level, the increase of productive wealth is the key determinant ofthe economic growth potential of an economy. Especially in resource-richdeveloping countries, natural resource rents, determined in natural resourceaccounts, could be absorbed in a development fund. Rather than using the earningsfor short-term private and public consumption, these funds should be invested inlong-term development projects.

A particular strength of green accounting is the measurement of environmentalcost caused by economic agents of households and enterprises. The well-knownpolluter/user pays principle hold the responsible agents accountable for theirenvironmental impacts. Economists deem market instruments of environmentalcost internalization more efficient in bringing about sustainable production andconsumption patterns than top-down environmental regulation. In the absence ofgreen accounting information, political exigencies rather than rational cost estimatesappear to determine in most cases the setting of market instruments.

The SEEA accounts explicitly for actual environmental expenditures by differentagencies and organizations. Sharing the burden of environmental protection withemerging groups of civil society and private corporations is one of the keyrecommendations of the 2002 Johannesburg Summit of the United Nations. Greenaccounting and accounting analysis can assess the economic and ecological efficiencyof different environmental protection measures by governmental and non-governmental organizations which would be instrumental in achieving sustainabledevelopment.

4.9 LET US SUM UP

l The conventional national accounts largely ignore the observed scarcities ofnatural resources, which threaten to undermine the sustainability of economicperformance and growth, and consider environmental degradation as an‘external’ (social) cost of economic activity.

l Green accounting is a popular term for environmental and natural resourceaccounting and aims at incorporating environmental assets and their source,and sinks functions into national and corporate accounts.

l It is found that much of the use and application of green accounting has beenin developed countries especially Europe, Australia, and Canada. The assetsaccounts are compiled by most of the countries but not used very much inassessing sustainability. In addition, although some countries are using thegreen accounting quite actively, the accounting is still underutilized especiallyin low income countries like India.

4.10 KEY WORDS

GDP: It is defined as “the sum of all the incomes in the economy generated inan accounting year within the domestic territory of a country by using existingfactors of production such as land, labor, capital and organization. It doesn’tinclude external sector contribution.

GNP: It is defined as “the sum of all the incomes in the economy generated inan accounting year by using existing factors of production such as land, labour,capital and organization

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Green NDP: GDP– depreciation on man-made capital - depreciation of naturalresources and environment.

Green NNP: GNP – depreciation on man-made capital - depreciation of naturalresources and environment.

NDP: Net Domestic Product (NDP) is traditionally defined as GDP minusdepreciation of man-made capital/asset (Km).

NNP: Net national Product (NNP) is traditionally defined as GNP minusdepreciation of man-made capital/asset (Km)



l Daly, H. E. 1990. Toward Some Operational Principles of SustainableDevelopment. Ecological Economics. Vol. 2(1):1-6.

l Daly, H.E. and Farley, J. 2004. Ecological Economics: Principles andApplications. Island Press, Washington. pp. 454.

l Kolstad, C.D. 2011. Intermediate Environmental Economics. OxfordUniversity Press, 198, Madison Avenue, New York-10016. p.470.

l Parikh, J., Singh, V., Sharma, S. and Buragohain, C. 2008. Natural ResourceAccounting for Goa. Integrated Research and Action for Development(IRADE), New Delhi. Pp.139.

l Pearce D. 1998, Economics and Environment: Essays on EcologicalEconomics and Sustainable Development, Edward Elgar Publishing Limited,UK. Pp.363.

l Pearce, D. and Barbier, E.B. 2000. Blueprint for a sustainable economy.Earthscan Publications Ltd., London. Pp 273.

l Repetto, R., Magrath, W., Wells, M., Beer, C. and Rossini, F. 1989. WastingAssets: Natural Resources in the National Income Accounts. World ResourcesInstitute, Washington, D.C. pp.68.

l Soumyen, S. 2006. Principles of Macroeconomics. Oxford University Press,New Delhi. Pp.181.




l Definition of conventional GDP ,GNP, and NDP

l Calculation of green NDP


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l Need of green accounting

l Significance of green accounting from sustainable development point ofview



l Environmental Protection and Economic Growth

l Links between Trade and Natural Resource Policies

l Distributional Impacts and Natural Resource Policies

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