Introduction to Economics: Session 1SIO 295

Summer 2007

Three Motivational Examples -- Climate Change, Fisheries, Turtles

A. Responding to the Climate Change/Global Warming Challenge

Fundamentally an Economic Policy Issue: What choices do we, as a society, make?

-- Choices to Limit GHGs

-- Choices to Accommodate or Mitigate effects of global warming

• How do we choose?

-- What are the appropriate criteria to use to evaluate alternative choices?

Fundamental Economic Principle: Every economic choice involves "Trade-offs" or a weighing of Costs and Benefits

• Examples of Trade-offs in Climate Change

-- Limit GHGs now vs. Mitigate effects later (and limit GHGs later)

-- Reduce energy consumption vs. substitute cleaner alternative energy (e.g. nuclear)?

-- Tax carbon emission ("carbon tax") or enact transferable carbon emission permits (e.g "Cap and Trade")?

-- Reduce GHG emissions of developed nations first (e.g Kyoto Treaty) or reduce GHG emissions of all nations ("equitable burden-sharing")? -- or, should "rich” (who are responsible for the bulk of GHGs) first reduce their emissions before requiring "poor" to reduce their emissions and suffer lower economic growth?

Fundamental Economic Principle: All economic consequences (costs and benefits) can be measured (in principle) in monetary units

"In theory there is no difference between theory and practice, in practice there is." -- Yogi Berra

- Implication: The only consequences that are relevant for economic analysis are those that are valued by individual human beings

- Definition: The monetary value of a consequence (a cost or a benefit) is the amount of money an individual (or group of individuals) would be willing to accept (if a cost) or pay (if a benefit) to endure or obtain the consequence.

Fundamental Economic Principle: An Optimal or Best economic choice is always one that maximizes the (Net) Total Economic Value (the sum of all benefits less the sum of all costs).

- Note: An optimal economic choice is never unique since, at a minimum, alternative distribution of benefitscan (in principle) be defined without altering the (Net) Total Economic Value. This fact alone allows ample scope for negotiation, bargaining, etc.

Fundamental Economic Principle: For every sub-optimal economic choice, there is an optimal economic choice that (in principle) everyone (currently alive or who will be alive sometime in the future) would prefer to the sub-optimal choice.

(This Principle is a Proposition -- not an assumption)

- Note: Restricting economic choices to optimal ones should thus permit broad concensus to avoid making sub-optimal decisions.

Example or Implication: In principle, it should be possible to decide how much abatement (if any) of GHGs the world should undertake immediately.

Two Major Complicating Conceptual Problems with measuring economic values

1. Economic consequences of (nearly) any (significant) decision occur over time.

Fundamental Economic Principle: Identical consequences occurring at different dates (e.g. now vs. in the future) do not have the same economic value. In general, any given benefit is worth more if received sooner and any cost is less burdensome if incurred later.

-- Implication: Sacrifices made today (e.g. reducing energy consumption) to realize benefits far in the future (100 years from now) are difficult to justify with conventional rates of discount -- e.g. a $10,000 benefit 100 years from now is worth only $76 today, if the discount rate is 5%.

-- Ethical question: Should an individual 100 years in the future be valued lower than an individual alive today?

-- Trade-off question: What sacrifices should the (relatively) "poorer" current generation make to benefit a (relatively) "richer" future generation? E.g. Since our great-grandchildren will be much wealthier than us, how much should we sacrifice today (by reducing, say, our energy consumption) to benefit them?

2. Future consequences are rarely (if ever) known with certainty.

- Fundamental Economic Principle: To the extent that an individual is "risk-averse", the value of an uncertain (future) benefit is smaller than the "expected" value of (the distribution of) the (future) benefit. (Analogously for costs -- an uncertain cost is more burdensome than its expected value.)

-- Implication: If there is a non-negligible likelihood of "catastrophic" climate change consequences, then considerations of the amount of risk aversion of society dominate considerations of the appropriate discount rate to use.

-- Note: It may be useful to remember that society has dealt with (and continues to confront) other challenges that are potentially even more catastrophic than those of global warming -- e.g. an outbreak of nuclear warfare during the Cold War.

B. Sustainable Management of Fisheries

- The Problem: Numerous reports ("Pew Commission", Worms, et. al., etc.) document the declining levels of world fish stocks, including the collapse of many (e.g. Great Banks Cod -- c.f. Kurlansky). How can/should national and world fish stocks be sustainably managed?

- Origin of the Problem: Historically fishing has been (and continues to be in many fisheries) operated under the rules of Open Access and Capture -- i.e. anyone can fish and harvest whatever s/he can catch. Since no fisherman can therefore expect to catch any fish that left for next season, there is no economic incentive to leave any fish uncaught today to reproduce for the future. As a result, stocks tend to be fished beyond sustainable limits until they collapse.

Fundamental Economic Principle: A Common Property Resource (like an Open Access and Capture fishery) tends to be over-exploited since no individual using the resource has an incentive to consider how his/her actions may impose costs on others (e.g. through reducing the reproducing stock or, merely, by leaving less of the resource available for others). This has been called "The Tragedy of the Commons"

- Definition: The surplus value obtainable from the use of a resource (the difference between the benefits of using the resource -- e.g. market value or revenues -- and the costs of its exploitation) is called the "rent". Over-exploitation of a resource thus leads to "rent dissipation".

• Over the years numerous alternative policies have been adopted in national to reduce the amount of fishing effort and the amount of fish harvested -- e.g. licenses to fish, vessel registry, gear restrictions, season limits, area closures, quotas (total and individual), etc. These alternatives include both input and output restrictions and regulations.

Fundamental Economic Principle: The restriction of rights to fish change the incentives of fishermen and create implicit or explicit property rights that have economic value equivalent to the rents obtainable from the resource by exercising these property rights.

- Fundamental Economic Principle: The opportunity to freely trade rights (for money) always increases the net benefits of both the buyer and seller.

- Fundamental Economic Principle: The "Holy Grail" of fishery management is the establishment of a complete set of property rights or Individual Transferable Quotas (ITQs) where the sum of all individual quotas equals the optimal Total Allowable Catch (TAC). The optimal TAC is the amount of fish that can be sustainably harvested every period and maximizes the economic yield of the fishery.

- A distinction: There is a difference between the Maximum Sustainable Yield of a fishery its Maximum (Sustainable) Economic Yield. The Maximum Sustainable Yield is the maximum amount of fish that can be harvested every period (year, say) while leaving enough fish to reproduce enough the next period to continue harvesting that amount.

-- Query: Can you explain why it is not obviously optimal to maximize the sustainable yield?

Fundamental Economic Principle: Under "standard" conditions, the maximization of Net Benefits occurs where the Marginal Benefits equal the Marginal Costs.

- The Maximum Economic Yield of a fishery occurs at the stock level at which the value of the growth of the marginal fish (i.e. the value of the extra fish that could be sustainably harvested if the stock were marginally larger) equals the marginal cost of catching fish (i.e. the cost of catching the marginal fish).

Difficulties in Achieving the Fishery Management's "Holy Grail"

1. How should the "losers" be compensated, i.e. bribed so that they don't politically sabotage the establishment of an optimal policy? The use of "buy-back" programs is an example of attempts to compensate losers in establishing a better managed fishery.

2. Who or what agency can manage High Seas fisheries?

Under current International Law (including the Law of the Sea), ocean waters beyond the 200 mile limit are global common property and exploitable by any nation that chooses to fish them. As a result, the management of Highly Migratory Species (i.e. fish that move in international waters) requires an effective International Agreement or Treaty. Furthermore, for an International Agreement to be effective it must be self-enforceable, since under International Law, no nation can be obligated to join a treaty or abide by treaty that it has signed.

3. Informational problems may prevent an efficient solution to the management of fisheries.

Fundamental Economic Principle: Asymmetric information creates distortions that complicate obtaining high economic value

- Example: A fishery agreement to regulate harvest may be difficult to conclude if parties have different information about location of fish -- c.f. San Diego sea urchin fishery

4. Problems of verifiability and monitoring complicate the enforcement of agreements.

C. The Protection and Preservation of Sea Turtles

Problem: Among the world's endangered species, all species of sea turtles are to various extents endangered. The most endangered species is probably the Pacific Leatherback, which has perhaps fewer than 5,000 nesting females and which nests on only a handful of remaining beaches in the Eastern and Western Pacific. Threats to the continued existence of the Pacific Leatherback include: destruction of nesting beaches through coastal development and the destruction of forest coverage, egg harvesting and egg destruction by wild animals, entanglement in coastal fisheries' nets and lines, as bycatch in high seas long-line fisheries, and climate change that may erode beaches and alter temperatures of sand.

Why do we care? Sea turtles are a Global Public Good in that their very existence provides benefits to all human beings.

Definition: A Public Good is a commodity (a good or

service) that is consumed/enjoyed by all (i.e. is "non-rival" in consumption) and whose consumption/enjoyment cannot be limited or restricted to only those who can be forced to pay for its consumption/enjoyment (i.e. is "non-excludable"). A Global Public Good is a public good available to the entire world's population.

Fundamental Economic Principle: A public good tends to be underprovided (or underproduced) since consumers have an insufficient incentive to contribute for its provision as they cannot be excluded from consuming whatever amount is provided -- (this is referred to as The Free-Rider Problem of Public Goods) -- and producers/supplies have an insuffient incentive to supply an optimal amount of the good since they cannot charge all consumers for their consumption/enjoyment of the good.

- Note: The public good underprovided in the case of sea turtles may be thought of as sea turtle protection.

- Because of the public good nature of sea turtle protection, sea turtle conservation programs and policies are frequently financed and developed by NGOs, working with governments and communities containing nesting beaches -- viz. nesting beach protection and monitoring, maintenance of hatcheries, etc.

- Since sea turtles are listed as Endangered Species, there are legal requirements for governments to engage in direct protection activities -- e.g. (1) NMFS is obliged to regulate fisheries in manner not to endanger sea turtles. In addition, US Government restricts the importation of shrimp from nations that do not require Turtle Excluder Devices (TEDs) to be used in their shrimp trawl industry,

(2) the Hawai'i shallow-set long-line fishery (i.e. swordfish fishery) is operating under restrictions of gear and bait type (circle instead of J-hook, mackerel instead of squid bait), time closures, and -- most importantly -- caps on the total number of turtle "interactions" per year allowed.

- Restricting fisheries because of turtle by-catch under Endangered Species Act provisions creates an incentive for fisheries to support programs for turtle conservation ("mitigation measures").

Fundamental Economic Principle: Under standard conditions, if many activites contribute to the creation of a benefit (e.g. the provision of a public good, say), then at an optimal level of these activities (i.e. the set of activity levels yielding the "biggest bang for the buck") the marginal benefits provided by the expenditures on each activity must be equal. This principle is, however, also consistent with the requirement that some activities may required extensive expenditure (e.g. beach protection) before much is invested in other activities (e.g. costly fishery industry shut-downs.)