Comments John Whitehead has made

Here is my post on the same article ...

... over at the Environmental Economics blog. The bottom line is that I think the companies are exaggerating the cost savings, but still, it is good news to hear.

"There is no such thing as a free lunch." Does the adage not apply to the environment? Can strict environmental policy lead to "win-win" situations?

Business Week magazine seems to think so.

First, some economic principles. Textbook theory says that profit maximizing business firms that compete with other profit maximizers will produce goods and services at the lowest possible cost. Environmental policy leads to increased production costs as firms must divert labor and capital away from production and toward clean up activities.

The Porter Hypothesis, on the other hand, argues that environmental policy will actually reduce the costs of production as firms discover efficiencies (free money, courtesy of a suggestion from Uncle Sam).

An article in this week's Business Week mag, Top Green Companies, provides examples of the Porter Hypothesis. It seems that U.S. business firms are realizing that climate change is happening and that the government will attempt to regulate greenhouse gases at some point in the future. In response they are readying themselves in advance.

For example, if firms are expecting that the environmental policy involves marketable emissions permits, then a rational response is to develop technology to lower their abatement costs ("endogenous technical change") so that they can sell their permits on the open market, making money. Spillover efficiencies reduce costs overall.

In the BW article each of the top ten green companies claim that they have reduced emissions and cut costs. Number one reducer DuPont has:

Reduced energy consumption 7% below 1990 levels, saving more than $2 billion -- including at least $10 million a year by using renewable sources

Yet, much of the economic research leaves me wondering if these companies are fibbing a bit. From the abstract of a Sept 2005 JEEM article:

...in the presence of learning, implementing a stricter environmental policy with the aim to reach a certain target of emissions reduction has a stronger negative effect on industry profits, which implies quite the opposite as to what is described by the Porter hypothesis.

Another recent paper illustrates how and why some firms (8-24%) might experience increased profits with regulation while overall industry costs rise.

Most environmental economists, I think, remain skeptical that there is free money associated with stricter environmental policy. The research that supports the Porter Hypothesis always seems, to me, to focus on extreme situations and tortured logic (note: this observation is based solely on my shallow understanding of this literature). If anything, the "top green companies" are (1) picking the "low hanging fruit" that wasn't worth picking without the incentive to abate or (2) attributing unrelated cost savings to environmental innovation.

I'm sticking with my simple upward sloping marginal abatement cost curve that implies increased production costs with reduced emissions. On Things are a'changin' in the business world posted 3 years, 11 months ago 1 Response

In defense of environmental economists

Admittedly, environmental economists sometimes come across as all-knowing smarty pants when it comes to telling our side of the story about understanding human behavior. We think that people tend to behave rationally and that this predictability can be used to influence behavior so that environmental damages are balanced with profits, jobs and economic growth. But what we don't always say is that our models don't explain everything (neither do the models of other social scientists). Understanding human behavior is complex and all of those involved in the social science disciplines should admit that fact and stop squabbling over who understands the most about human behavior.

Economists think that people behave rationally. This means that as the benefits of any activity increase (decrease) the pursuit of the activity will increase (decrease). And, as the costs of any activity increase (decrease) the pursuit of the activity will decrease (increase).

We do try to test these propositions scientifically, at least as scientifically as you can do so outside of the laboratory and with data from real people. For example, environmental economists have tested demand theory for the past 50+ years by examining the relationship between distance traveled to recreation sites (e.g., fishing holes, scenic wonders) and the number of trips. As it turns out, the number of trips declines with increasing distance (i.e., travel cost). The demand curve slopes downward. Bingo! Those outdoor recreationists are rational (at least in the way that we define rationality). The "mythical" ration (wo)man? Nope. The real life rational (wo)man.

It is true that recent advances integrating social psychology and economics (i.e., behavioral economics) has uncovered a bunch of instances where people are not so rational. It seems to me, and others, that this economic behavior is very insightful but not the norm. It explains the anomolies but neoclassical economics still explains the core of economic behavior.On Market mechanisms are your friend posted 4 years ago 13 Responses