Since its inception, the environmental movement has had an uneasy relationship with economics. The environmentalism that arose in the 1970s relied almost exclusively on “command and control” regulations that mandated certain actions by polluters, with little attention paid to issues of economic efficiency, business incentives, or how markets are likely to evolve over time. The movement was populated largely by scientists, lawyers, and activists, many of whom believed that our capitalist system was the main driver of environmental degradation—and that economics was little more than capitalism’s enabler.
This skepticism, and sometimes outright hostility, towards economics stemmed from many firmly held beliefs: that the quest for economic growth by definition resulted in the exploitation of the natural world; that private entities with their focus on profit will always degrade the environment; that assigning dollar values to nature was counter-productive, and one of the main drivers of the unhealthy relationship between humans and the environment. The overarching position of the environmental community for much of its first 20 years (roughly1970 to1990) was that markets could not be harnessed to benefit the environment, but instead needed to be suppressed and reined in to promote environmental values.
This position still prevails in some environmental circles, but the profound distrust of economics has largely given way to a more balanced and realistic assessment. Environmentalists have discovered that the theory of market failure (the foundation of much of microeconomics) contains a powerful environmental message: private markets alone will not fully account for the costs they impose on the environment and human health, nor under many routine circumstances will they promote the sustainable use of natural resources. Environmentalists can now point to classical economic theory for one of their strongest arguments in favor of government action to protect the environment.
This theory not only provides diagnostic criteria to determine when markets work effectively and when they don’t; it also offers prescriptive action on how to make markets function better. For example, the rationale for greenhouse gas taxes comes directly from the economic theory of Pigouvian taxation, which posits that polluters should be charged on a per unit basis for the damages they impose on society. Microeconomics can also provide insight into the best stage of the production process to levy the taxes (in order to maximize their efficacy), as well as methods to redistribute the tax revenue to reduce any regressive impact and help transition to cleaner modes of production.
The primary alternative to direct emissions taxation is “cap and trade,” which allows the government to set an overall cap on total pollution while allowing firms to achieve emissions reduction by buying and selling pollution permits. Cap and trade was successfully implemented in the U.S. in 1990 for sulfur dioxide emissions (and was adopted by the EU in 2005 for greenhouse gas emissions), with cost savings to the industry in the hundreds of millions a year, without compromising the target reductions. Environmentalists used to fret about the moral implications of giving polluters a “right to pollute;” now that cap and trade has a demonstrated record of success, there is growing acceptance that the method can be a powerful environmental policy mechanism.
There is also growing recognition that, where property rights are nonexistent and natural resources are being exploited unsustainably, assigning property rights and limiting access can help reverse the damage. The principle has been applied with significant success in many ocean fisheries; it’s also being put into practice to help reverse deforestation in areas where ownership is currently contested.
Sometimes markets fail in subtle ways that have major environmental implications. For example, private entities have little incentive to provide the public with information about their toxic emissions. Consumers, therefore, make purchasing decisions with limited information about what types of production processes their purchases support. Policies that force firms to provide complete information on their toxic emissions can empower users to make better-informed purchases, and more knowingly express their preferences for greater environmental quality.
The above examples are only a few of the ways in which environmental goals have been advanced by addressing market failures. Assigning dollar values to ecosystems has also been accepted by many environmental organizations, who now view this as an essential ingredient in making sure policymakers and businesses don’t overlook, and underestimate, the benefits that nature provides.
New York City decided to purchase its upland watershed because forests could provide water filtration cheaper than a sanitation plant. Costa Rica elected to pay private landowners for the forest ecosystem services their properties provide to the general public. These are just two real-world examples of how placing a dollar value on ecosystems led directly to increased preservation.
The ability of economic theory to advance environmental goals has helped the economics profession win over many once-skeptical environmentalists. The environmental community has come to recognize that market failures are to blame for much of our environmental degradation, along with market distortions—e.g., subsidies, tax breaks, and the right to pollute without accountability. These market failures and distortions are the antithesis of healthy capitalism, and are opposed by most economists.
Summing up, over the decades environmentalists have become far more sophisticated in their understanding of economics. Economic theory provides many important tools to analyze when markets work and when they don’t, and how to use that knowledge to benefit the environment. Most important, there’s a growing recognition that well-functioning markets aren’t the enemy of the environment, but in fact may be one of its greatest allies.