APPENDIX 8
Memorandum from Professor David Pearce,
Economics, University College London and Environmental Science
and Technology, Imperial College London
PREAMBLE
I have worked on the links between economics
and environmental issues for nearly 40 years and have been closely
associated with past government policy on the economic valuation
of environmental impacts, the design of economic instruments,
and other issues. I acted as a Special Advisor to two Secretaries
of State for the Environment, 1989-92. Of relevance to the EAC
Inquiry, I am the co-author, with my colleague Brian Pearce (who
is lead author), of a paper on the probable size of an aviation
tax (Pearce and Pearce, 2002) which has been used within government
and which is referred to in the HM Treasury and Department for
Transport document Aviation and the Environment: Using Economic
Instruments (HM Treasury and DfT, 2003). With my colleague,
Dr Dieter Helm of New College, Oxford University, I am currently
co-authoring a comprehensive review and critical analysis of UK
government policy on market-based environmental policy, due for
publication in 2004 (Helm and Pearce, 2004). I am also a Member
of DEFRA's "Academic Panel" which airs and debates economic
aspects of UK environmental policy.
THE EAC 2002 PRE-BUDGET
REPORT
Since paras 44-62 of the EAC 2002 Budget
Report (EAC, 2002-03) are directly relevant to the issues
of controlling aviation externalities and to EAC's specific questions
noted in their Press Release of 1 April 2003, I briefly comment
on some of the issues raised there. These comments should help
to explain my answers to the questions raised by EAC.
While I share some of EAC's disappointment with
the Treasury document Tax and the Environment (HM Treasury,
2003), we should not overlook the fact that a document of this
kind exists at all. It seems to me that it is a reasonably brave
attempt to continue the stated policy of using market-based approaches
to environmental policy. I agree it is not a detailed "Strategy",
but a worked-out Strategy is hard to develop in advance of the
immense complications—political, legal and economic—that
arises when introducing market-based instruments (MBIs), and these
difficulties cannot always be foreseen in advance of detailed
appraisal of specific proposals. Many of those problems arise
from the fact that MBIs have to be superimposed on existing regulatory
policies: we do not have the textbook luxury of introducing MBIs
in a policy vacuum. The "case by case" approach may
seem frustrating, but no country has actually embarked on a major
programme of MBIs with a detailed strategy, and I suggest this
reflects the practical difficulties of doing so.
It is true that current government policy
attempts to meet too many inconsistent policy goals—liberalised
energy markets are not consistent with keeping energy prices high
to signal environmental scarcity, policy of water metering in
the interests of vulnerable customers is not consistent with treating
water as a scarce good, and so on. In short, whatever the protestations
to the contrary, we do not have "joined up" government.
Since this will be one of the running themes in the treatise by
Helm and myself, I will not dwell on these issues any further
here. However, it is worth reflecting on the fact that, in the
last ten years, the UK has done far more by way of introducing
MBIs than almost any other country. This is no mean achievement
and it is a credit to government economists that they have pursued
the issues as far as they have.
The EAC Inquiry asks if the full environmental
costs of aviation can be identified. I have taken this
to mean measured, as it seems to me that we are very clear
on the nature of the nuisances and impacts in question. I hope
the Committee will not mind too much if I suggest that Paras 56-57
of EAC's 2002 Pre-Budget Report read as if the Committee has already
made up its collective mind on the issue of measurement. If I
am wrong, all to the good. If I am right, I think that is unfortunate
that any firm view should be taken if the arguments in favour
of it are as weak as those expounded in Paras 56-57. Space forbids
a detailed rebuttal. However, one or two points can be raised.
All decisions imply monetary values of benefits (or damages).
This is because all decisions have money costs, and hence acceptance
of a policy implies that the money value of the policy benefits
exceed those costs. The reverse is true if the policy is rejected.
Saying that a policy is acceptable logically implies that society
is willing to meet the costs of that policy, which is all that
monetisation implies. It is, however, highly informative to test
the proposition, rather than simply assuming it is true. Second,
costs and benefits are obverses: a cost is a negative benefit
and a benefit is a negative cost, and these equivalences arise
because of the way costs and benefits are defined in economics,
namely as losses and gains in human wellbeing. Rejecting monetisation
of benefits whilst accepting the monetisation of costs is then
internally inconsistent. These fundamental features of monetisation
were pointed out many years ago by Harold Thomas in a classic
paper which, sadly, generations after mine seem not to have read
(Thomas, 1963). As a further example of limited argument, the
EAC Report says that monetisation involves "issues of principle"
but no explanation is offered on the meaning of this criticism,
so the remark seems to be without substance. The reference to
the goal of "preventing irreversible environmental damage"
is more than problematic. It is not, for example, government policy,
nor could it be. For example, it is not conceivable that further
biodiversity loss can be prevented in face of world population
change and the consequent land use change, which in turn is the
main reason for biodiversity loss. Nor could one prevent irreversible
loss in the UK: the government's housing policy, for example,
would automatically fail such a test, as would its transport policy,
etc etc While we may regret the losses, as I do, it is fanciful
to think that reality is otherwise. Hence any "policy"
goal of rejecting irreversible change is itself fanciful[22].
There are trade-offs and they cannot be avoided. Once trade-offs
are acknowledged, monetisation follows.
One other generic issue is relevant to the issue
of deciding on appropriate MBIs for aviation (or for anything
else). The Treasury-DfT document Aviation and the Environment
(Para 2.4) lists the criteria that Government should use when
selecting economic instruments. Absent from the list is the issue
of the baseline. If we choose not to have a MBI for aviation then
we must choose something else, or do nothing. By assumption, doing
nothing is not relevant. Hence the choice is between a MBI or
some other regulatory instrument, ie what I am calling the baseline.
It follows that the criteria with which we appraise MBIs must
be applied to the alternative instruments. But the Treasury's
Tax and the Environment document and the Treasury-DfT document
Aviation and the Environment read as if only MBIs
are to be evaluated in this way. In personal exchanges, Treasury
assure me that they wish to be even-handed in this respect, but
it seems a shame that this even-handedness is not transparent
in these documents. The issue is important. For example, MBIs
are often criticised as being potential inhibitors of "competitiveness"
(though quite what this means is never clear), or a "drag"
on economic growth. Even if there was any truth in these criticisms,
the baseline issue reminds us that the same effects, if they exist,
should be evaluated for the alternative policy. For example, if
we think resultant cost increases (which is, after all, what MBIs
are designed to achieve) are "unacceptable",
how much more or less unacceptable are they compared to the cost
increases arising from alternative forms of regulation? If we
cannot address this question, we cannot give even remotely sensible
answers to questions about the desirability of MBIs in the aviation
sector, or anywhere else.
AVIATION EXTERNALITIES
Can aviation externalities be identified? As
noted above, we are well aware of the issues—noise, local
and global pollution, disamenity. The more interesting question
is whether they can credibly be valued in money terms. The operative
word is "can". If valuations do not currently exist,
it need not follow that we cannot find them with properly conducted
research. Economists do not have a data store of unit values for
everything, so we should not be surprised if we do not have values
for some things. Indeed, valuation exercises usually respond
to policy questions, so if the question has not been asked before,
valuation studies are unlikely to exist. Additionally, we should
not be surprised if values change as research improves over time.
Some critics of valuation have adopted intellectually very curious
arguments to the effect that if different valuations exist, none
of them can be correct. (We do not argue that our lack of knowledge
of the final cost of building major infrastructure renders cost
unimportant, yet such costs are very often poorly predicted).
THE COST
OF CARBON
I thought it was somewhat disappointing that
the HM Treasury—DfT Consultation document did not offer
more comprehensive estimates of the externalities from aircraft.
Pearce and Pearce (2002), for example, provide estimates for CO2,
SO2 , low and high altitude NOX, VOCs (other than benzene), and
noise. Their analysis was unfunded so it was carried out with
very limited resources. HMT-DfT go into detail only on the costs
of carbon dioxide emissions, but even here the estimates are shown
only for a representative aircraft journey rather than per passenger.
Lack of time has prevented a detailed comparison of the estimates
in Pearce and Pearce (2002) and those suggested in the HMT-DfT
Consultation. However, it seems that the Consultation document
has used an early (2000) version of the Pearce and Pearce paper.
The figures have been revised since then. For example, in their
summary of Pearce-Pearce with respect to noise, HMT-DfT state
"The total cost of impacts for all airports has been estimated
at around £25 million for 2000" (para E.3). But the
Pearce-Pearce estimate for noise costs for Heathrow alone
are £27-66 million per annum. It would therefore be worth
encouraging Treasury and DfT to check the source of the estimates
they have quoted.
One central difference between the Pearce and
Pearce and HMT-DfT estimates of externality is the unit value
for carbon. Pearce and Pearce uses £29/tC and HMT-DfT use
£70/tC. In a subsequent review of climate damage models,
I conclude that there are two main reasons to doubt the £70/tC
figure (and, by implication, the £29 figure—Pearce,
2003). The first is that the study it is based on (Clarkson and
Deyes, 2002) is not a comprehensive review of the models and also
fails to distinguish early models and late models. The later models
include adaptation to climate change, whereas the early models
do not. It does not seem very likely that populations will simply
observe climate change without doing something to adapt to it,
so that the later models are more credible in my view. However,
there is room for disagreement. Perhaps the most telling study
is one just released by Professor Richard Tol of Hamburg University
and the Free University of Amsterdam (Tol, 2003). Whereas Pearce
(2003) offers a judgemental view that the range of credible estimates
of global warming damage is UK£2-15 tC using a conventional
discounting procedure (see below)[23],
Tol's study is a sophisticated meta-analysis and therefore more
rigorously based. It is worth stating Tol's conclusion:
". . . for all practical purposes, climate
change impacts may be very uncertain but [it] is very unlikely
that the marginal costs of carbon dioxide emissions exceed $50
tC [£31 tC], and [are] likely to be substantially smaller
than that" (Tol, 2003). (Italics added).
Work by Professor Robert Mendelsohn at Yale
University argues that the relevant values are very small and
may not differ much from zero. However, it is worth noting that
these values relate to one point in time, corresponding to 2xCO2.
All the models agree that a critical determining
factor is the discount rate. Discounting is a procedure whereby
a given unit gain or loss in the future is given a lower value
than the same unit value today. The rationale for discounting
is given in HM Treasury's Green Book (HM Treasury, 2003).
Basically, it reflects the facts that (a) people prefer the present
to the future and (b) future people are likely to be richer than
today's people, and they will therefore attach less importance
to an extra £1 compared to an extra £1 today. A related
but separate rationale derives from the existence of positive
interest rates. The choice between £1 next year and £1
now is really a choice between £1/(1+r) now and £1 now
where r is the interest rate. Hence the two £1s are not equally
valuable. In the UK, HM Treasury has a discount rate of 3.5% but,
in light of very recent research, it does hold open the possibility
that this discount rate declines with time. The relevant arguments
for "time varying" discount rates are to be found in
OXERA (2002), Groom et al. (2003) and Pearce et al. (2003). It
needs to be noted that none of the climate models surveyed
in Pearce (2003) or in Tol (2003) includes time-varying discount
rates. If the discount rate falls with time, future warming damages
will be more important than if they are discounted at a constant
rate. Precisely what happens to the damage cost of carbon depends
on the choice of trajectory of the discount rate over time. The
available literature suggests that the relevant value could rise
by a factor of about 80%. If so, and if the argument is accepted,
then the government's £70 tC figure would rise to, say, £130
tC, Pearce's £2-15 tC range would rise to £4-27 tC,
and Tol's upper limit would rise to £50 tC. It is
also worth noting that many economists regard time-declining discount
rates as being inconsistent with the design of optimal policy.
Unfortunately, the arguments are too complex to be explained here—see
Pearce et al. (2003).
A second reason for doubting high figures for
carbon damage arises from the policy implications. DEFRA has rightly
issued guidance which says that, whatever the right value of carbon,
it needs to be used consistently across decision-making. In their
case, this implies that £70 tC should be used. But Pearce
(2003) shows that this would have formidable implications. For
example, it would provide a substantial social credit to nuclear
power (at around 0.8 p kWh relative togas), would justify a virtual
doubling of the Climate Change Levy, would negate the economic
rationale for the Renewables Obligation[24],
and would justify vast programmes of afforestation. I would be
content to entertain the possibility that all of these might be
desirable, but adopting a particular figure implies that it is
adopted consistently and that its implications are acted upon.
My view is that the implications of the £70 tC figure were
not thought through.
SORTING OUT
THE CARBON
VALUE
Para 58 of the EAC 2002-03 Budget Report takes
note of the array of valuations of carbon. Oddly, it then seems
to imply that if we cannot get a consensus on the value, no value
should be used at all. As noted above, this is not a logically
tenable position. Moreover, if the implication is that we should
adopt whatever the "consensus" policy is, regardless
of what it costs, the entire purpose of policy analysis is negated
and we are reduced to a Panglossian world in which whatever is
decided by the "democratic process" is what is justified.
Policy analysis—of which cost-benefit analysis is one branch—exists
to check up on the political process, not to acquiesce in whatever
it comes up with. Neither is it very sensible to argue that because
we are uncertain about economic values, we have added to
the uncertainty of decision-making by adopting values. It is not
valuing things that creates the added uncertainty since we simply
sacrifice valuable information. That the information itself is
uncertain cannot then imply that we reduce uncertainty by not
allowing the information to be considered.
The same paragraph hints that some consensus
is needed and the EAC may already have been informed that DEFRA
is convening a high-level expert meeting on the valuation of carbon
damage on July 7. Amongst others, international experts such as
Professor Tol, who has done more research on this issue than anyone
else in the world, and Professor Mendelsohn will be attending.
CATASTROPHE
EAC asks if valuation can cope adequately with
catastrophe. As noted above, if we take certain actions because
we think there is a risk of a catastrophe at some point in the
future, then we imply a value for the catastrophe, whatever it
is. The sheer existence of a catastrophe occurring with some probability
greater than zero cannot itself be a justification for taking
action now regardless of cost. Suppose the catastrophe has a one
in a million chance of occurring and will not occur in less than
300 years time. How many people would make a financial sacrifice
now to avoid such an outcome? If, on the other hand, the chance
is 1 in one hundred and it could happen in the next 10 years,
we might take a very different view. Much also depends on what
we think the catastrophe implies: the ending of civilisation as
we know it, or some major regional event? As Richard Tol has point
in another of his papers (Tol, 2002), monetary valuation (self
evidently) assumes the variance of the estimates of damage is
bounded. If it is unbounded, then marginal damage is infinite.
But anyone wishing to argue this has some duty to show that damage
at the margin would be infinite. In addition, they would need
to persuade the rest of us that our "coefficient of concern"
extends to periods of time well beyond what we currently consider
to be the limits. No-one behaves as if people 1000 years hence
are as important as people today[25].
Nor, for that matter, do we behave as if people 1000 miles distant
from us are as important as people nearby. If we did, we would
not spend more on the National Health Service than we do on foreign
aid (if everyone is equal and it is cheaper to save lives abroad
than at home, expenditure on saving lives abroad logically must
exceed expenditure saving lives at home). It is quite possible
to think up ethical theories that would make everyone "equal"
in time and space (for example, Professor John Broome argues an
eloquent case for this: Broome, 1991. For a critique, see Freeman
and de Divita, 2001). It is quite another to suggest that we could
persuade anyone to act in accordance with that view. Once again,
it is a matter of thinking through the consequences of adopting
such views.
ON THE
CHOICE OF
MBI
I have not dwelled upon the choice of the appropriate
MBI, eg tradable permits versus taxes. I have no very strong views
on this subject. I do not know if tradable permits could be designed
efficiently. Given that we do have some reasonable estimates of
the externalities from aviation in Pearce and Pearce (2002), and
since we have a landing charge system at all airports, I think
I would be inclined to favour a tax at least approximately equal
to the marginal damage from aviation. Additionally, since the
chances of auctioning permits are probably small (although auctions
for airport slots set a precedent) it is important to have an
MBI that generates revenues. In my view these should be used to
compensate those who suffer the externalities. I am not convinced
that using revenues to reduce other taxes is the right way to
proceed, not least because it opens up further policy inconsistencies
(such as using the revenues to lower NIC and then raising the
level of NIC across the board), nor am I convinced that "trust
funds", such as those associated with the landfill tax and
the aggregates levy, are as effective environmentally as they
should be.
I am clear that some form of MBI is required.
One of the problems of embracing the "Polluter Pays Principle"
is that who pays depends on who has the property rights. This
question is not always easily answered—witness the "countryside"
debate where some people seem to think country communities "own"
the countryside, or at least have rights to use it as they see
fit. However, I do not see a case for arguing that airlines, airports
and air travellers have rights to pollute or cause nuisance and
hence I would argue that the polluter pays principle should operate.
The UK is unique, I believe, is having two environmental
taxes that were informed by estimates of marginal damage (the
landfill tax and the aggregates levy, although the former has
been "hybridised" to become a revenue raising tax that
is probably higher than would be justified on environmental grounds).
An aviation tax could be the third such tax.
ON AIRPORT
LOCATION
Finally, care has to be taken in the use to
which an MBI is put. The externalities from existing airports
differ from those for new or expanded airports.
The difference is that the latter take up additional land, which
has to be mainly greenfield land. This involves a loss of amenity,
landscape and biodiversity. None of the externality estimates
in Pearce and Pearce (2002), for example, allows for these effects.
They are likely to be very important since (a) airport expansion
options are currently focused on areas where such greenfield loss
will be significant and highly valued, and (b) the losses in wellbeing
are not confined to those who reside in or visit such areas. There
are added "non-use" values which are lost. DEFRA currently
has some consultancy work under commission which hopefully might
throw some light on non-user, non-resident valuations of such
losses as well as on local valuations. What is important is that
valuations of externalities from existing airports should not
be applied to new or expanded airport options without making an
effort to include the additional, and I suspect, substantial,
external costs arising from the development of greenfield land[26].
April 2003
References
Bohnringer, C. 2003. Will Kyoto work? Oxford
Review of Economic Policy, forthcoming.
Broome, J. 1991. Counting the Cost of Global
Warming. Cambridge: White Horse Press
Clarkson, R and Deyes, K. 2002. Estimating
the Social Cost of Carbon Emissions. GES Working Paper 140.
London: HM Treasury. Available at www.hm-treasury.gov.uk/documents/taxation
work and welfare/taxation and the environment
Environmental Audit Committee, 2002. Pre-Budget
Report 2002. HC 167 of Session 2002-03
Freeman, A.M and de Civita, P. 2001. On Discounting
Statistical Lives. Economic Issues Note: Health Canada.
Groom, B., Hepburn, C., Koundouri, P and Pearce,
D.W. 2003. Discounting—the long and short of it. Economics,
University College London. Mimeo
Helm, D and Pearce, D.W. 2004. Market-based
Environmental Policy in the United Kingdom: History and Critique.
Forthcoming.
HM Treasury and Department for Transport, 2003.
Aviation and the Environment: Using Economic Instruments. London:
HMT and DfT
Miles. D. 2000. Housebuilding in the South East
of England: Planning the way to misery, World Economics,
1, 2, 1-11.
OXERA, 2002. A Social Time Preference Rate
for Use in Long-term Discounting. London: Office of the Deputy
Prime Minister, Department for Transport, and Department for the
Environment, Food and Rural Affairs.
Pearce, D.W. 2003. The social cost of carbon
and its policy implications, forthcoming Oxford Review of Economic
Policy.
Pearce, B and Pearce, D.W. 2002. Setting environmental
taxes for aircraft: a case study of the UK. Forthcoming in D.W.Pearce
and C.Santoro (eds), Valuing the Environment: Case Studies
from Developed Economies. Cheltenham: Edward Elgar.
Pearce, D.W., Groom, B., Hepburn, C and Koundouri,
P. 2003. Valuing the future—recent advances in social discounting.
World Economics, forthcoming
Thomas, H.A. 1963. The animal farm: a mathematical
model for the discussion of social standards for control of the
environment. Quarterly Journal of Economics, 1963
Tol, R. 2002. Is the uncertainty about climate
change too large for expected cost-benefit analysis? Centre for
Marine and Climate Research, Hamburg University. Mimeo.
Tol, R. 2003. The Marginal Costs of Carbon
Dioxide Emissions: An Assessment of the Uncertainties. Centre
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22 The correct approach to irreversibility and the
so-called "precautionary principle" is to be found in
the theory of option value in the investment literature, or "quasi
option value" in the environmental economics literature.
This does not produce the infeasible result that all irreversible
losses are to be avoided. One might add that climate change will
not be prevented. The Kyoto Protocol, for example, makes virtually
no difference to rates of global warming as a number of commentators
have pointed out-see, for example, Bhringer (2003). The UK "60%"
target for greenhouse gas emissions reduction is also misleading.
It is a target conditional on other countries achieving the
same target. The reasons why countries will not agree to targets
of this kind are evident when one looks at the Kyoto Protocol,
and are brilliantly analysed in Scott Barrett's Environment
and Statecraft, Oxford University Press, 2003. Back
23
The range in Pearce (2003) is below the figure used in Pearce
and Pearce (2002), reflecting the wider literature available for
the later assessment. Back
24
Because the Renewables Obligation implies a shadow price of carbon
of around £300 tC-see Pearce (2003). Back
25
Some commentators on "sustainability" confuse maximising
the survival time of humans on Earth with sustainability. They
are not the same. The former could readily be achieved by reducing
incomes across the world to subsistence levels for all generations
save the "last" one, a result that has long been demonstrated
in the economics literature. Back
26
This is not the proper place to comment on the Government's options
for airport expansion and residential development in the South-East:
in my view, and the view of others, they are poorly thought out-see
Miles (2000). Back
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