Double Irreversibility and Environmental Policy Timing

The timing of environmental policy typically takes place within a framework in which uncertainty over the future impact of pollution and two different kinds of irreversibilities interact. The first kind of irreversibility concerns the sunk cost of environmental degradation; the second is related to the sunk cost of environmental policy. Clearly, the two irreversibilities pull in opposite directions: policy irreversibility leads to more pollution and a less/later policy, while environmental irreversibility generates less pollution and a more/sooner policy. Using a real option approach and an infinite time horizon model, this paper considers both irreversibilities simultaneously. The model first is developed by paying particular attention to the option values related to pollution and policy adoption. The environmental policy we consider consists in increasing the natural assimilation rate. Solving the model in closed form then provides solutions for both the optimal pollution level and the optimal environmental policy timing. Finally, we provide a numerical example with the purpose of appraising which irreversibility has the prevailing effect and what is the overall impact of both irreversibilities on pollution and policy timing.     

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.