Essays on Long-Term Cost-Benefit Analysis and the Environment

Abstract

This thesis consists of four essays related to topics characteristic of the economic analysis of environmental issues with long-term consequences. The first two analyze intergenerational equity when benefits and costs of a project fall unevenly upon generations. The last two examine the effect of uncertainty and learning on optimal environmental policy, with specific application to mitigating eutrophication in the Baltic Sea in Northern Europe. The first essay examines the situation where the social time preferences differ from those revealed in agents' market behavior. I show that the reaction of the market prevents implementation of the government's first-best allocation. This implies a Ricardian-equivalence result for social discounting: The government cannot do better than to evaluate public investments using the time preferences revealed in the market. This equivalence-result breaks down and the government can use a social discount rate if public investment is either risky or large, or has returns that are imperfect substitutes for private consumption. The second essay analyzes the possibility of implementing intertemporal social welfare functions to promote intergenerational equity. As each generation chooses independently whether it will follow the proposed welfare function or not, it is ultimately only policy rules leading to subgame-perfect equilibria of the intergenerational game that will be followed. I propose a particular social welfare function satisfying this requirement: a backward-looking function that includes preferences of deceased generations in future decision making. The third essay studies the effect of an uncertain baseline development of emissions on optimal environmental policy. This uncertainty precludes implementation of the first-best policy and induces adjustment costs for society. In order to quantify this effect, we construct a model for the Baltic Sea, where nutrient emissions are subject to uncertain climate impacts. The optimal policy is a strong and immediate abatement of both nitrogen and phosphorus. Adjustment costs are found to be less than one percent of the total cost of climate change for the sea. The fourth essay analyzes geoengineering measures whose true effectiveness are unknown but can be ascertained through experimentation. The relevant question for cost-benefit analysis in this context is determining the conditions under which experimenting should be started. We analyze this problem with a view to artificial oxygenation of Baltic Sea deep waters and find that the expected welfare effects of oxygenation are negative, but constructing around ten pumping stations is optimal due to the value of the information provided by this experiment.