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Economic Currents

Keep up to date with the latest UHERO news.

The Role of Impatience in Sustainable Growth

Sustaining economic growth requires appropriate husbandry of our natural capital resources (e.g. fish, trees, freshwater, and coral).  But how much conservation is optimal? According to proponents of "strong sustainability," natural capital should never be depleted. This is inconsistent with maximizing economic welfare however. In less developed economies, for example, depleting natural capital may be the best way for an economy to accumulate the produced capital (e.g. buildings, transportation infrastructure, and machinery) that is needed to increase the productivity of labor.

Depending on current resource stocks, optimal economic growth may require either drawing down or building up natural capital to its optimal steady state level. For non-renewable resources such as oil, this often means substituting more abundant resources (e.g. clean coal) and eventually transitioning to renewable resources such as solar energy.

In addition to balancing the uses of natural and produced capital, sustainable growth requires intergenerational equity. Simply put, this is the principle of non-discrimination against future generations. By adding the non-discrimination requirement to the problem of welfare maximization in an economy whose production is dependent upon both produced and natural capital, we get conditions for optimal and sustainable growth. As it turns out, the conditions are familiar to economists, albeit from different parts of economics. From growth theory, we have the Ramsey (1928) requirement that produced capital should be accumulated in each period until its marginal product falls to a multiple of the growth rate of consumption. In the long run, as consumption approaches its golden rule level, the target marginal product goes to zero. The same condition applies to natural capital. And from resource economics we have the extended Hotelling (1931) condition that the resource should be depleted (or accumulated) in each period until net marginal benefit of that resource -- typically the resource price minus its extraction or harvesting cost -- is equal to the marginal opportunity cost of harvest that is imposed on future generations.

This formulation contains a paradox however. If individuals are impatient, i.e. they prefer consumption now to equal consumption later, how can society impose the condition of intergenerational neutrality, i.e. require that consumption in different periods be weighted equally? This would seem to violate the condition of consumer sovereignty, i.e. the requirement that social welfare and justice should be based on individual preferences (as well as social weightings thereof). We resolve this paradox with a model of overlapping generations. This allows us to consider a representation of social justice that eschews intergenerational discrimination, while simultaneously allowing individuals to be impatient regarding their own welfare. The surprising result is that while individual impatience matters for the lifetime consumption plan of the individual, it does not matter for aggregate consumption. Optimal and sustainable growth in the aggregate is therefore still governed by the Ramsey and extended Hotelling conditions.

What does optimal and sustainable growth imply for the evaluation of environmental projects? In particular, the present values of global programs to mitigate global warming depend crucially on the project discount rate. Does intergenerational justice require that the project discount rate be zero? It does not. From principles first established by Irving Fisher around the turn of the 19th century, the project discount rate depends on the productivity of capital as well as the social rate of impatience. Even if individuals were not impatient, the inherent productivity of capital would still result in a positive interest rate. Nonetheless, intergenerational equity may indeed imply that the appropriate discount rate is small, especially if global warming and the rate of technological improvement limit growth in the very long run. Indeed Sir Nicolas Stern has suggested a rate of only 1.4% for discounting the benefits of climate mitigation.

What are the implications of intergenerational equity for the deficit and the national debt? From the Ramsey condition, deficits and debt are consistent with sustainable growth but only so long as they finance investments with positive present values. Since future generations don't vote in current elections, debt may be a politically-expedient device to transfer resources from the future to the present, even when doing so reduces the welfare of future generations more than it increases the welfare of current voters. Economists can stand against this and other perversions of democracy by rendering the intergenerational consequences of social profligacy more transparent.

-- Lee Endress, James Roumasset, and Christopher Wada

References

Endress, L., Pongkijvorasin, S., Roumasset, J., Wada, C.A., 2013. “Intergenerational Equity with Individual Impatience in a Model of Optimal and Sustainable Growth.” Resource and Energy Economics (forthcoming).

Endress, L., Zhou, T., Roumasset, J., 2005. “Sustainable growth with environmental spillovers.” Journal of Economic Behavior and Organization 58(4), 527-547.

Hotelling, H., 1931. “The economics of exhaustible resources.” The Journal of Political Economy 39, 137-175.

Ramsey, F.P., 1928. “A mathematical theory of saving.” Economic Journal 38(152), 543-559.

READ THE WORKING PAPER

 

Note: This research extends earlier work by Endress et al. (2005) and is forthcoming in the peer-reviewed journal, Resource and Energy Economics (Endress et al., 2013). For more applications of economic principles to natural resource and environmental management problems, visit UHERO’s Project Environment (link to: http://www.uhero.hawaii.edu/45/project-environment).


Hawaii's Energy Future

Last week's Asia Pacific Clean Energy Conference has focused the spotlight on Hawaii's energy future. Governor Abercrombie opened the conference with a strong commitment to installing an undersea cable between Oahu and Maui. The Blue Planet foundation unveiled their "Energy Report Card" during a keynote address by Henk Rogers. Meanwhile, recent coverage by NPR discussed switching to natural gas as an alternative to Hawaii's oil dependence. 

The Hawaii Clean Energy Initiative set the vision for the state to move toward renewable and cleaner sources of energy. There are numerous pathways and decision on the best pathway is fraught with debate.

The Governor's comments juxtaposed to strong resistance to the undersea cable suggests that there needs to be on-going discussion of what energy portfolios will likely emerge in separated versus linked islands scenarios - including environmental and economic impacts.

Moreover, there is also concern over the high cost of energy. As many renewable sources are still relatively costly (or difficult to locate) there is also consideration of switching to natural gas as a "bridge fuel." The future price of liquefied natural gas is uncertain and, while it is cleaner burning than oil, there is concern that its full environmental impact is not necessarily an improvement over the status quo.

In addition, environmental groups such as Blue Planet in their "energy report card" bring up concerns about the lack of guiding policy for the transportation sector. Policies that complement transportation as well as electricity have a place in the discussion as well.

UHERO's ongoing research is looking at ways to cost-effectively achieve GHG reduction and meet the state's clean energy goals.

---Makena Coffman


The Water-Energy-Food Nexus

The water-energy-food nexus is one of the most important and fundamental global environmental issues facing the world today. The US Geological Survey estimates that the United States used 201 billion gallons per day (bgd) of freshwater for thermoelectric power generation and 128 bgd for irrigation in the year 2005. Combined, energy generation and irrigation accounted for roughly 80% of all water withdrawals over that period. At the same time, energy is a key input for the production of freshwater. A 2006 study prepared for the California Energy Commission estimated that the electricity required to process one million gallons of water in a typical urban water system ranges from 4,000 kWh per million gallons in Northern California to 12,700 kWh in Southern California, and water-related energy use comprised over 19% of total energy use in the state. Although the wide range in values suggests that water-related energy use depends on a variety of location-specific factors, the interconnectedness of the resources is clear.

As demand for each of the resources grows, examining tradeoffs will become especially important. For example, biofuels may be developing into a viable alternative to petroleum, but the implications for water resources will be considerable. The UHERO Project Environment team will be working with the Research Institute for Humanity and Nature to develop a framework capable of quantifying such tradeoffs. The project will focus heavily on coastal regions in the Asia-Pacific “Ring of Fire”. For more on economic approaches to water and energy management, visit UHERO’s Project Environment.

---Christopher Wada


Coastal Zone Management in Hawaii

Hawaii has 750 linear miles of coastline that include all of our beaches, an array of cliffs, bays and other features that count among our most treasured natural resources. Development of these resources is a key source of economic growth, but ensuring that this development is carried out in a manner that preserves, protects and (where possible) restores them is important for their long term value.

Since 1975 a permitting system administered by each county has been the primary vehicle for managing development of the coastal zone. To support decision making in the permitting process, The UHERO Project Environment team collaborated with the State Office of planning to review the way benefits provided by the program are evaluated.

Project Environment was asked to identify a set of key ecosystem services to study, selecting the services on the basis of their measurability and expected value. The final list included public access, beach and shoreline protection, marine resources, and scenic and open space. Other important but difficult to measure benefits, discussed but not incorporated in the methodological assessment, include those related to cultural values and practices.

The UHERO team visited various project sites in each of the four counties across the state and concluded that benefits of the permitting process are very site-specific, rendering a statewide assessment via benefit transfer – a valuation method that adjusts estimated values from studies completed in other locations – impractical. Instead, original valuation methods were recommended for each site, depending on the type of ecosystem service protected or enhanced, site characteristics, and the type and number of users, among other things. For example, an encroachment removal and dune restoration project at Charley Young Beach (Kihei, Maui) was estimated to have doubled the usable beach width, while expanding view corridors, reducing erosion, and replenishing sand dunes. Estimating the value of each of those benefits requires different data and methods.

 

 

The final report discusses potential valuation methods for seven case studies throughout Hawaii, and includes a primer on valuation methods, with pros and cons, as well as data requirements for each. For more on economic valuation of environmental services in Hawaii, visit UHERO’s Project Environment.

-- Christopher Wada


An Insight on the Cost of Paradise

Whether visitors or residents in Hawai‘i, we are all aware of the high cost of living in paradise. One major contributing factor is the cost of energy. Households in Hawai‘i pay 4 times more than the average US household and nearly 7 times the households in Utah, where the residential energy cost is the cheapest in the nation.* While the US average for April 2013 hovered at 12 cents/kwh, Hawai‘i paid 37 cents/kwh for electricity in the residential sector.**

Breaking down residential energy consumption by source provides more insight into the high cost of living in Hawai‘i. While households in Hawai‘i supply their energy needs mainly by electricity (90%) at $110/mmbtu (equivalent to 37 cents/kwh), the two major sources in the US—natural gas and electricity—each comprise 42% of energy consumption, at roughly $5/mmbtu (equivalent to 1.7 cents/kwh) and $35/mmbtu (equivalent to 12 cents/kwh), respectively (see Figure 1). Hence, Hawai‘i is not only consuming a larger share of electricity, but also at skyrocketing prices. In contrast, the US is consuming a smaller portion from electricity at significantly discounted prices compared to Hawai‘i. This, combined with a large share of cheap natural gas in the US household consumption portfolio explains the large disparity in the cost of energy—particularly in the residential sector—in Hawai‘i and the US. Note however that switching to natural gas in Hawai‘i is not straightforward because of the logistics and infrastructure costs (liquefaction, shipping, regasification) of bringing natural gas to Hawai‘i.

 

-- Sherilyn Wee

 

 

*http://www.eia.gov/state/seds/data.cfm?incfile=/state/seds/sep_sum/html/sum_pr_res.html&sid=US **http://www.eia.gov/electricity/monthly/epm_table_grapher.cfm?t=epmt_5_6_a


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