Optimal emission-extraction policy in a world of scarcity and irreversibility

This paper extends the classical exhaustible-resource/stock-pollution model with irreversibility of pollution decay, meaning that after reaching some threshold there is no decay of the pollution stock. Within this framework, we answer the question how the potential irreversibility of pollution affects the extraction path. We investigate the conditions under which the economy will optimally adopt a reversible policy, and when it is optimal to enter the irreversible region. In the case of irreversibility it may be optimal to leave a positive amount of resource in the ground forever. As far as the optimal extraction/emission policy is concerned, several types of solutions may arise, including solutions where the economy stays at the threshold for a while. Given that different programs may satisfy the first order conditions for optimality, we further investigate when each of these is optimal. We show that it is never optimal for the economy to stay at the threshold for a while before entering the irreversible region. The optimality analysis is then illustrated by means of a calibrated example. To sum up, for any pollution level, we can identify a critical resource stock such that there exist multiple optima i.e. a reversible and an irreversible policy that yield exactly the same present value. For any resource stock below this critical value, the optimal policy is reversible whereas with large enough resources, irreversible policies outperform reversible programs.     

Optimal emission-extraction policy in a world of scarcity and irreversibility

This paper extends the classical exhaustible-resource/stock-pollution model with irreversibility of pollution decay, meaning that after reaching some threshold there is no decay of the pollution stock. Within this framework, we answer the question how the potential irreversibility of pollution affects the extraction path. We investigate the conditions under which the economy will optimally adopt a reversible policy, and when it is optimal to enter the irreversible region. In the case of irreversibility it may be optimal to leave a positive amount of resource in the ground forever. As far as the optimal extraction/emission policy is concerned, several types of solutions may arise, including solutions where the economy stays at the threshold for a while. Given that different programs may satisfy the first order conditions for optimality, we further investigate when each of these is optimal. We show that it is never optimal for the economy to stay at the threshold for a while before entering the irreversible region. The optimality analysis is then illustrated by means of a calibrated example. To sum up, for any pollution level, we can identify a critical resource stock such that there exist multiple optima i.e. a reversible and an irreversible policy that yield exactly the same present value. For any resource stock below this critical value, the optimal policy is reversible whereas with large enough resources, irreversible policies outperform reversible programs.     

Intertemporal Emission Permits Trading Under Uncertainty and Irreversibility

This paper analyzes the effect of emission permit banking on clean technology investment and abatement under conditions where the stringency of the future cap is uncertain. We examine the problem of heterogeneous firms minimizing the cost of intertemporal emission control in the presence of stochastic future pollution standards and emission permits that are tradable across firms and through time. A firm can invest in clean capital (an improved pollution abatement technology) to reduce its abatement cost. We consider two possibilities: that investment is reversible or irreversible. Uncertainty is captured within a two period model: only the current period cap is known. We show that if banking is positive and marginal abatement costs are sufficiently convex, there will be more abatement and investment in clean technology under uncertainty than there would be under certainty and no banking. These results are at odds with the common belief that uncertainty on future environmental policy is a barrier to investment in clean capital. Moreover, under uncertainty and irreversibility, we find that there are cases where banking enables firms to invest more in clean capital.     

Energy Prices and Carbon Taxes under Uncertainty about Global Warming

This paper extends the strategic interactions between producers of fossil fuels concerned about their profits and a taxing government concerned about the consumers’ welfare for uncertainty: global warming follows an Itô -process. Stochasticity requires to differentiate between reversible and irreversible emissions in contrast to the deterministic version. The unconstrained (= reversible) case allows for a closed form solution but not the more realistic and constrained case. Nevertheless interesting analytical properties (e.g. about when to stop emissions, implicit conservation due to monopolistic supply) are derived and complemented by a numerical example.     

The environmental Kuznets curve in a world of irreversibility

This paper develops an overlapping generations model where consumption is the source of polluting emissions. Pollution stock accumulates with emissions but is partially assimilated by nature at each period. The assimilation capacity of nature is limited and vanishes beyond a critical level of pollution. We first show that multiple equilibria exist. More importantly, some exhibit irreversible pollution levels although an abatement activity is operative. Thus, the simple engagement of maintenance does not necessarily suffice to protect an economy against convergence toward a steady state having the properties of an ecological and economic poverty trap. In contrast with earlier related studies, the emergence of the environmental Kuznets curve is no longer the rule. Instead, we detect a sort of degenerated environmental Kuznets curve that corresponds to the equilibrium trajectory leading to the irreversible solution. I would like to thank Alain Venditti, Mabel Tidball, Alain Jean-Marie and Thierry Bréchet for their helpfull comments and suggestions. I am deeply grateful to an anonymous referee whose comments have greatly improved the paper.     

Is capital a collusion device?

Summary. We examine how irreversible capital reduces the possibility of a duopoly to sustain implicit collusion by grim strategies, when the product is homogenous and firms compete in quantities. Compared with the case of reversible capital, there are two countervailing effects: Deviation from an existing collusion is less attractive, because capital once installed causes costs forever. But the punishment will also be less severe due to the high capacity the deviating firm can build before punishment starts. The last effect dominates, meaning that the commitment value of capital is negative for all firms. If capital is irreversible, collusion breaks down for realistic magnitudes of interest rates. Received: April 30, 1999; revised version: November 30, 2001     

A Theory of Gradual Coalition Formation

We study noncooperative multilateral bargaining games, based on underlying TU games, in which coalitions can renegotiate their agreements. We distinguish between models in which players continue to bargain after implementing agreements ("reversible actions") and models in which players who implement agreements must leave the game ("irreversible actions"). We show that renegotiation always results in formation of the grand coalition if actions are reversible, but that the process may otherwise end with smaller coalitions. On the other hand, we show that the grand coalition cannot form in one step if the core of the game is empty, irrespective of the reversibility of actions.     

Sensitivity of optimal programs with respect to changes in target stocks: The case of irreversible investment

Consider an aggregative model of economic growth with changing technology and tastes, in which investment is irreversible. It is shown that initial decisions in finite-horizon optimal programs are insensitive to changes in terminal stocks, provided the horizon is long enough. This generalizes Brock's result, which was proved assuming investment to be reversible. The irreversibility constraint does not allow one to follow Brock's method of proof, using the dual (Shadow Price) properties of optimal programs. An alternative method of proof is developed, using a primal approach, and exploiting dynamic programming arguments.     

Optimal Emission Policy under the Risk of Irreversible Pollution

We consider an optimal consumption and pollution problem that has two important features. Environmental damages due to economic activities may be irreversible and the level at which the degradation becomes irreversible is unknown. Particular attention is paid to the situation where agents are relatively impatient and/or do not care a lot about the environment and/or Nature regenerates at low rate. We show that the optimal policy of the uncertain problem drives the economy in the long run toward a steady state while, when ignoring irreversibility, the economy follows a balanced growth path accompanied by a perpetual decrease in environmental quality and consumption, both asymptotically converging toward zero. Therefore, accounting for the risk of irreversibility induces more conservative decisions regarding consumption and polluting emissions. In general, however, we cannot rule out situations where the economy will optimally follow an irreversible path and consequently will also be left, in the long run, with an irreversibly degraded environment.     

Joint Ventures versus Fully Owned Subsidiaries: Multinational Strategies in Liberalizing Economies

As ceilings on foreign shareholdings are withdrawn during liberalization, multinationals enter through fully owned subsidiaries that compete with their own joint ventures, unless local partners permit them to raise their stakes. In a framework of quantity competition, this paper demonstrates that an entry threat is more credible when joint venture investment is reversible, the units are independently managed and the local stake is high. Further, profitability of horizontal merger between the units encourages a share reallocation, while its absence favours a new subsidiary. Under irreversible investment, the threat is less credible and both share reallocations or new subsidiaries are less likely.     

Rethinking the optimal level of environmental quality: justifications for strict environmental policy

Traditional environmental theory suggests that the optimal level of a pollution emission occurs when the marginal damage created by the emissions is equal to the marginal cost of reducing the emissions. We argue that the benefits from reducing pollution should be much more broadly defined to include at least three other sources of benefits. First, we develop a game-theoretic model in which firms may under-invest in cost-saving ‘green technologies’. Second, we demonstrate that consideration of future damages and abatement costs leads to a lower current optimal pollution level than that obtained in traditional models. Finally, we show that ecological complexity creates indirect pathways by which greater pollution increases the likelihood of generating irreversible environmental damage. This broader definition of the benefits of pollution abatement yields an optimal level of pollution that may actually be less than the level at which conventionally-measured marginal damages are equal to marginal abatement costs. Thus, environmental policy should be stricter.     

Tradeoffs between costly capacity investment and risk of regime shift

There is mounting evidence that increasing natural resource exploitation (e.g., fossil fuel extraction and consumption) could trigger irreversible dramatic ecological events like global warming. While capacity investment costs and the possibility to produce at full capacity are two factors that critically affect the exploitation rate, little is known about their effect on management. I generalize standard models of pollution control under the threat of dramatic regime shifts to investigate how optimal management changes with both factors. My analysis reveals that accounting for such factors gives rise to investment and emissions policies that challenge conventional wisdom. For instance, I find that under reasonable conditions, an exogenous threat of a doomsday event induces a cautious management strategy. Using parameters estimated from climatic data, my analysis shows that raising the discount rate can induce lower emissions, highlighting the complex interplay between the threat and both factors.     

Financial liberalization,private investment and portfolio choice: Financialization of real sectors in emerging markets

Using firm level panel data, we analyze the impacts of rates of return gap between financial and fixed investments under uncertainty on real investment performance in three emerging markets, Argentina, Mexico and Turkey. Employing a portfolio choice model to explain the low fixed investment rates in developing countries during the 1990s, we suggest that rather than investing in irreversible long-term fixed investments, firms may choose to invest in reversible short-term financial investments depending on respective rates of returns and the overall uncertainty in the economy. The empirical results show that increasing rates of return gap and uncertainty have an economically and statistically significant fixed investment reducing effect while the opposite is true with respect to financial investments.     

Are short‐term effects of pollution important for growth and optimal fiscal policy?

We study optimal fiscal policy in a stock‐flow model of the environment within an endogenous growth framework, where some pollutants have a lasting impact on environmental quality which is restored through abatement expenditure, while others dissipate and hence, have a short‐term effect on the environment. All pollutants, however, affect the productivity of a public good negatively. Given that short‐term pollution, although it dissipates, is irreversible in this sense, a government cannot ignore its negative effects since this type of pollution lowers the productivity of all inputs. We find that a larger negative effect of short‐term pollutants as well as a higher congestion effect of private capital leads to corrective fiscal policies with higher optimal income tax and abatement expenditure rates, which have favorable growth consequences. Interestingly, we find that the rate of short‐term pollution does not affect optimal fiscal policy while that of the long‐term pollution does.     

Environment, Asset Characteristics, and Optimal Effluent Fees

This article investigates theissue of optimal effluent fees in a frameworkwhere waste emissions are abated by investingin capital of which the pay-off is uncertainand the cost is fully sunk. The stock of wasteemissions harms an individual firm'sproduction, but the firm will underestimatethis external effect upon investing. Consequently, the firm will invest lesscapital, and thereby, pollute more than issocially desirable. The regulator, who can useeffluent fees to correct this, should imposelower effluent fees on irreversible investmentsthan on costlessly reversible ones whenuncertainty arises.     

The Optimal Time to License a Biotech "Lemon"

Genetically modified (GM) wheat is an example of an irreversible technology that will cause environmental and market externalities. The optimal time to license this irreversible technology is examined using real options theory. Given the likely spread of the GM wheat genetics in the environment, the decision to license and adopt GM wheat will increase future herbicide costs for both adopters and nonadopters. Also, without the ability to segregate GM and non-GM varieties, the market price of wheat is reduced for all producers. This creates a licensing dilemma due to the "lemon" characteristics of the new technology. (JEL Q18 , D62 )     

Energy Transition Under Irreversibility: A Two-Sector Approach

This paper analyses the optimal energy transition of a two-sector economy (energy and final goods) under irreversible environmental catastrophe. First, it proposes a general appraisal of optimal switching problems related to energy transition showing: (1) the possibility of a catastrophe due to accumulation of pollution; and (2) technological regimes with the adoption of renewable energy. Second, it numerically shows that for given baseline parameter values, the most profitable energy transition path may correspond to the one in which the economy starts using both resources, crosses the pollution threshold by losing a part of its capital, and never adopts only clean energy. Third, it extends the model to allow for additional investment in energy saving technologies. We then find that this additional investment favours full transition to the sole use of renewable energy. It is then profitable to take advantage of these synergies by jointly promoting deployment of clean energy and providing incentives for investment in energy saving technologies.     

Environmental Abatement and the Macroeconomy in the Presence of Ecological Thresholds

We study the environmental and economic effects of public abatement in the presence of multiple stable steady-state ecological equilibria featuring reversible hysteresis. The isocline for the stock of pollution possesses two stable branches. Assuming that the ecology is initially located on the upper (high pollution) branch of the isocline, a simple time-invariant temporary abatement policy can be used to steer the environment from the high- to the low-pollution equilibrium. In all models considered in this paper, a “cold turkey” abatement policy is optimal within the class of stepwise policies, i.e. the largest feasible shock should be administered for the shortest possible amount of time. The cold-turkey result is robust to alternative models for the economic system, although there is a capital feedback effect that either helps or hinders the speed of transition to the low-pollution equilibrium.     

Open-access renewable resources and pollution: Trade and policy implications in a two-country model

We examine the interaction between the relative inter-industry pollution externality and resource stock externality of harvesting in deciding trade patterns and welfare gains from trade in a two-country model (less-developed countries) with renewable resources in the absence of resource management. This paper focuses on the impacts of trade policies on resource conservation and welfare outcomes in two countries with different environmental management regimes. Differences in pollution management standards between both countries determine the direction of trade flow and gains from trade in a diversified production case. The country with a lower pollution intensity parameter, an exporter of resource goods, certainly experiences welfare loss in the post-trade steady-state and may also suffer a decline in utility throughout the transition path. However, a country with higher pollution intensity and importers of resource goods tend to gain from trade. Under national open-access resources, given that pollution is regulated up to a certain point in both countries, this study finds that implementing better restrictions on only one externality factor is not optimal from a post-trade welfare perspective. Lastly, from the point of view of policy suggestion, this paper offers an optimal trade policy that the economic and environmental effects of enforcing import tax on resource goods are likely to be Pareto-improving consequences compared to the implications of using an export tax.     

Pollution havens: international empirical evidence using a shadow price measure of climate policy stringency

Given the ambiguous empirical results of previous research, this paper tests whether support for a climate policy-induced pollution haven effect and the pollution haven hypothesis can be found. Unlike the majority of previous studies, the analysis is based on international panel data and includes several methodological novelties: By arguing that trade flows of dirty goods to less dirty sectors may also be influenced by changes in policy stringency, trade information on primary, secondary, and tertiary sectors are included. In order to clearly differentiate between dirty sectors and sectors with high pollution abatement costs, separate measures for pollution intensity and policy stringency are implemented. For the former, two intensities, namely the sectors’ carbon dioxide emission intensity and the emission relevant energy intensity, are used to identify dirty sectors. For the latter, an internationally comparable, sector-specific measure of climate policy stringency is derived by applying a shadow price approach. Potential endogeneity between climate policy stringency, trade openness and the trade balance is controlled for by employing a dynamic panel generalized method of moments estimator. The results provide evidence for a pollution haven effect that is also present for non-dirty sectors, i.e., a sector’s net imports rise in general if the sector faces an increase in climate policy stringency. Moreover, a stronger pollution haven effect regarding carbon dioxide intensive and emission relevant energy-intensive sectors is revealed. However, no support for the stronger pollution haven hypothesis can be found.