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.     

Conspicuous consumption and generation replacement in a model of perpetual youth

This paper investigates household decisions in an overlapping generations model in which individual utility depends on a weighted average of consumption of one's peers. In contrast to representative agent economies, the consumption externality generally affects savings and growth rates. The effects critically depend on the rate at which labor productivity changes with age. For a high (low) rate, the externality lowers (raises) the steady state propensity to consume out of total wealth. The optimal allocation can be decentralized by a (reverse) unfunded social security system if the rate of labor productivity decline is high (low). In contrast to discrete time OLG models, the optimal steady state capital income tax is zero, in spite of the externality.     

Does a Recession Call for Less Stringent Environmental Policy? A Partial-Equilibrium Second-Best Analysis

This paper analyses second-best optimal environmental policy responses to real and financial shocks in a two-period partial equilibrium model with heterogeneous firms, an environmental externality, and credit constraints. We show that, to alleviate credit constraints and encourage investment, the second-best optimal emission tax falls short of marginal emission damages. The optimal response to shocks depends on how the shock affects the size of the environmental and credit market failures and the effectiveness of the tax in alleviating these market failures. Under mildly restrictive assumptions on functional forms, the optimal response to a (persistent) negative productivity shock or a tightening of credit is to reduce the emission tax. Our results are informative for how climate change policy should optimally change with the business cycle.     

Intertemporal consumption and debt aversion: an experimental study

This paper tests how subjects behave in an intertemporal consumption/saving experiment when borrowing is allowed and whether subjects treat debt differently than savings. Two treatments create environments where either saving or borrowing is required for optimal consumption. Since both treatments share the same optimal consumption levels, observed consumption choices can be directly compared across treatments. The experimental findings imply that deviations from optimal behavior are higher when subjects have to borrow than when they have to save in order to consume optimally, suggesting debt aversion. Signifiant under-consumption is observed when subjects have to borrow in order to reach optimal consumption. In line with previous experiments, weak evidence is found suggesting that subjects over-consume when saving is necessary for optimal consumption.     

Sorting the good guys from bad: on the optimal audit structure with ex-ante information acquisition

In a costly state verification model under commitment, the principal may acquire a costly public and imperfectly revealing signal before or after contracting. If the project remains profitable after all signal realizations, optimally the signal is collected, if at all, only after contracting, and it may be acquired randomly or deterministically. Moreover, audit is deterministic and targeted on some signal-state combinations. The paper provides a detailed characterization of the optimal contract and performs a comparative static analysis of signal acquisition strategy and payoffs with respect to enforcement costs and informativeness of the signal. We explore the robustness of the results, including commitment issues. The results are interpreted in light of the observed features of financial contracts, showing that the optimality of the standard debt contract with deterministic audit extends to a setting with random audit.     

Endogenous fertility,Ricardian equivalence,and debt management policy

This paper develops a model in which dynastic families optimally determine fertility. Government debt represents a tax on future generations and on childbearing; the Ricardian Equivalence Hypothesis does not hold. Debt is welfare reducing in that it distorts the fertility decision. An increase in government debt induces a decline in fertility and an increase in the steady state capital/labor ratio. If a government inherits an existing stock of debt, the 1st-best policy is to eliminate the debt immediately. In other situations the optimal debt management policy will not, in general, entail a total elimination of the debt.     

Regret theory and the competitive firm

This paper examines the production decision of the competitive firm under uncertainty when the firm is not only risk averse but also regret averse. Regret-averse preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. The extent of regret depends on the difference between the actual profit and the maximum profit attained by making the optimal production decision had the firm observed the true realization of the random output price. If the firm is not too regret averse, we show that the conventional result that the optimal output level under uncertainty is less than that under certainty holds. Using a simple binary model wherein the random output price can take on either a low value or a high value with positive probability, we show the possibility that the firm may optimally produce more, not less, under uncertainty than under certainty, particularly when the firm is sufficiently regret averse and the low output price is very likely to prevail.     

Spatial economic analysis of early detection and rapid response strategies for an invasive species

Economic impacts from invasive species, conveyed as expected damages to assets from invasion and expected costs of successful prevention and/or removal, may vary significantly across spatially differentiated landscapes. We develop a spatial–dynamic model for optimal early detection and rapid response (EDRR) policies, commonly exploited in the management of potential invaders around the world, and apply it to the case of the Brown treesnake (Boiga irregularis) in Oahu, Hawaii. EDRR consists of search activities beyond the ports of entry, where search (and potentially removal) efforts are targeted toward areas where credible evidence suggests the presence of an invader. EDRR costs are a spatially dependent variable related to the ease or difficulty of searching an area, while damages are assumed to be a population-dependent variable. A myopic strategy in which search only occurs when and where current expected net returns are positive is attractive to managers, and, we find, significantly lowers present value losses (by $270 m over 30 years). We find further that in the tradeoff between search costs and damages avoided, early and aggressive measures that search some high priority areas beyond points of entry even when current costs of search exceed current damages can save the island more ($295 m over 30 years). Extensive or non-targeted search is not advised however.     

Adaptation and Mitigation in Long-term Climate Policy

The paper analytically explores the optimal allocation of investments into mitigation and environmental adaptation against climate change damages at a macroeconomic level. The economic-environmental model is formulated as a social planner problem where adaptation and abatement investments are separate decision variables. The existence of a unique steady state is proven. A comparative static analysis of optimal investments leads to essential implications for associated long-term environmental policies. It is shown that the optimal policy mix between adaptation and mitigation is lower for countries with higher economic efficiency for all applicable parameter ranges. Data calibration and numerical simulations are provided to estimate practical validity of theoretical outcomes.     

On a Variation in the Economic Performance of Migrants by their Home Country’s Wage

Although the economic performance of migrants in the receiving country undoubtedly depends on qualifications, it is also affected by inclinations. Given the probability of return migration, a behavioural link is established between the incentive of migrants to save in their country of destination and the prevailing wage rate in their home country. It is shown that migrants coming from a low‐wage country optimally save more than migrants from a high‐wage country. Policy and research implications suggested by this savings behaviour are alluded to.     

Optimal unemployment insurance: transitional dynamics vs. steady state

In this study, we ask whether the presence of precautionary savings substantially reduces the optimal replacement rate in an European economy type characterized by high unemployment benefits and moral hazard. We build a simple job search model calibrated on French data and, in line with previous studies, find that the optimality criterion based on comparisons of steady states leads to a low optimal ratio. Yet, this result ignores potential transitional costs due to the necessity for agents to increase their savings and reduce their consumption whenever the ratio is cut. We therefore build a dynamic model taking full account of the transition, and show that a reduction in benefits reduces welfare. Even though the long-run optimal replacement rate is lower than the current one, transitional costs dominate long-run gains.     

Controlling a biological invasion: a non-classical dynamic economic model

This paper analyzes the optimal intertemporal control of a biological invasion. The invasion growth function is non-convex and control costs depend on the invasion size, resulting in a non-classical dynamic optimization problem. We characterize the long run dynamic behavior of an optimally controlled invasion and the corresponding implications for public policy. Both control and the next-period invasion size may be non-monotone functions of the current invasion size; the related optimal time paths may not be monotone or convergent. We provide conditions under which eradication, maintenance control, and no control are optimal policies.      

Bang for buck: cost-effective control of invasive species with different life histories

Strategies for controlling invasive species can be aimed at any or all of the stages in the life cycle. In this paper, we show how to combine biological data on population dynamics with simple economic data on control costs options to determine the least costly set of strategies that will prevent an established invader from continuing to increase. Based on biological data alone (elasticities of matrix population models), effective control strategies are sensitive to both life history and rate of population growth. Adding economic considerations, however, can cause the optimal control strategy to shift, unless the costs of intervention are the same across life stages. As an example, we apply our methods to oyster drills (Ocinebrellus inornatus), an economically important aquaculture pest that has been accidentally introduced worldwide. Control efforts are applied to local tidelands through manual removal of adults, although the life history characteristics of the species indicate a low population elasticity for adult survival. Aquaculturists are making bioeconomic decisions to remove adults vs. egg capsules, because of the relative ease of controlling each stage.     

Pay-as-you-go Social Security and the Distribution of Altruistic Transfers

This paper studies the impact of an unfunded social security system on the distribution of altruistic transfers in a framework where savings are due to both life cycle and random altruistic motivations. We show that the effect of social security on the distribution of these transfers depends crucially on the strength of the bequest motive in explaining savings behaviour. We measure this strength by the expected weight that individuals attach to the utility of future generations. On the one hand, if the bequest motive is strong, then an increase in the social security tax raises the bequests left by altruistic parents. On the other hand, when the importance of altruism in motivating savings is sufficiently low, the increase in the social security tax could result in a reduction of the bequests left by altruistic parents under some conditions on the attitude of individuals toward risk and on the relative returns associated with private saving and social security. Some implications concerning the transitional effects of introducing an unfunded social security scheme are also discussed.     

The endogenous formation of an environmental culture

This paper presents a mechanism explaining the surge in environmental culture across the globe. Based upon empirical evidence, we develop an overlapping generations model with environmental quality and endogenous environmental culture. Environmental culture may be costlessly transmitted intergenerationally, or via costly education.The model predicts that for low wealth levels, society is unable to free resources for environmental culture. In this case, society will only invest in environmental maintenance if environmental quality is sufficiently low. Once society has reached a certain level of economic development, then it may optimally invest a part of its wealth in developing an environmental culture. Environmental culture has not only a positive impact on environmental quality through lower levels of consumption, but it also improves the environment through maintenance expenditure for wealth-environment combinations at which, in a restricted model without environmental culture, no maintenance would be undertaken. Environmental culture leads to a society with a higher indirect utility at steady state in comparison to the restricted model.Our model leads us to the conclusion that, for societies trapped in a situation with low environmental quality, investments in culture may induce positive feedback loops, where more culture raises environmental quality which in turn raises environmental culture. We also discuss how environmental culture may lead to an Environmental Kuznets Curve.     

Sector-specific minimum wages,economic growth,and some policy implications

Economic growth is introduced in the urban unemployment model of Harris and Todaro. It is shown that in the steady state, the optimal savings ratio is greater than the golden rule savings ratio under full employment. Also the optimal proportion of total investment allocated to the urban sector is not necessarily higher than the optimal proportion under full employment.     

A bioeconomic model for determining the optimal response strategies for a new weed incursion

Invasions by non-indigenous plant species pose serious economic threats to Australian agricultural industries. When a new invader is identified a rapid response is critical, particularly if the invasive species has the ability to spread rapidly. An early decision is required whether to attempt to eradicate or contain the infestation, or do nothing and leave it to landholders to manage. These decisions should be based on economic considerations that account for long term benefits and costs. This paper describes a bioeconomic simulation framework with a mathematical model representing weed spread linked to a dynamic programming model to provide a means of determining the economically optimal weed management strategies over time, from the government’s perspective. The modelling framework is used to evaluate hypothetical case study invasive weed control scenarios in the Australian cropping systems. The benefit–cost ratios of invasion control are shown to be generally very high and clearly, there are significant benefits to be achieved by controlling highly invasive weeds when initial infestations are at a low level. Even if the invasion cannot be eradicated due to its high invasiveness or budget constraints, it still pays to maintain invasions at low levels.     

A Schumpeterian growth model with random quality improvements

A common assumption in the Schumpeterian growth literature is that the innovation size is constant and identical across industries. This is in contrast with the empirical evidence which shows that: (1) innovation size is not identical across industries and (2) the size distribution of profit returns from innovation is highly skewed toward the low value side, with a long tail on the high value side. In the present paper, we develop a Schumpeterian growth model that is consistent with this evidence. In particular, we assume that when a firm innovates, the size of its quality improvement is the result of a random draw from a Pareto distribution. This enables us to extend the class of quality-ladder growth models to encompass firm heterogeneity. We study the policy implications of this new setup numerically and find that it is optimal to heavily subsidize R&D for plausible parameter values. Although it is optimal to tax R&D for some parameter values, this case only occurs when the steady-state rate of economic growth is very low.     

Climate Policy Under Uncertain and Heterogeneous Climate Damages

We highlight that uncertainty about climate damages and the fact that damages will be distributed heterogeneously across the global population can jointly be an argument for substantially stricter climate policy even if uncertainty and heterogeneity in isolation are not. The reason is that a given climate risk borne by fewer people implies greater welfare losses. However, these losses turn out to be significant only if society is both risk and inequality averse and if climate damages are highly heterogeneous. We discuss how insurance and self-insurance of climate risk could theoretically mitigate this joint effect of uncertainty and heterogeneity and thus admit weaker climate policy. Insurance provides more efficient risk sharing and self-insurance allows strongly impacted individuals to compensate damages by increasing savings. We first use a simple analytical model to introduce the different concepts and then provide more realistic results from the integrated assessment model DICE.     

Financial intermediation with credit constrained agents

This paper studies the effects of financial intermediation on aggregate levels and the distribution of resources in an economy with credit-constrained heterogeneous agents and occupational choice. Whether an agent becomes an entrepreneur depends on a realized entrepreneurial ability and accumulated assets needed to finance a business project with uncertain returns. I compare a steady state of an economy with financial intermediation to an economy in which entrepreneurs must finance their projects only from their savings. The simulated economy with financial intermediation matches well the US data on the distribution of occupations and resources. The steady state welfare and efficiency gains from financial intermediation are large.