Program Lecture 3 Resilience And The Knowledge Revolution

Program on Information and Resources Columbia UniversityProgram on Information and Resources Columbia University 11
Resilience and theResilience and the
Knowledge RevolutionKnowledge Revolution
Pegram LecturesPegram Lectures
Brookhaven National LaboratoriesBrookhaven National Laboratories
Graciela ChichilniskyGraciela Chichilnisky
UNESCO Chair in Mathematics and EconomicsUNESCO Chair in Mathematics and Economics
Columbia UniversityColumbia University

Program on Information and Resources Columbia Universi2
Human impact on the environmentHuman impact on the environment
is uncertainis uncertain
CLIMATE CHANGECLIMATE CHANGE
ANDAND
BIODIVERSITY DESTRUCTIONBIODIVERSITY DESTRUCTION
These are global problems.These are global problems.
They are new. Science is uncertain.They are new. Science is uncertain.

INTERGOVERNMENTAL PANEL ON CLIMATE CHANGEINTERGOVERNMENTAL PANEL ON CLIMATE CHANGE
SCIENTIFIC ASSESSMENT OF CLIMATE CHANGESCIENTIFIC ASSESSMENT OF CLIMATE CHANGE
Policy-Makers SummaryPolicy-Makers Summary
July 1990July 1990
Under a Business-as-Usual Scenario of Greenhouse Gas Emissions:Under a Business-as-Usual Scenario of Greenhouse Gas Emissions:
●●Global Mean TemperatureGlobal Mean Temperature will increase at a rate of 0.3°C perwill increase at a rate of 0.3°C per
decadedecade
(with uncertainty range of 0.2°C to 0.5°C per decade)(with uncertainty range of 0.2°C to 0.5°C per decade)
1°C above present by 20251°C above present by 2025
3°C above present by end of next century3°C above present by end of next century
●Rate of increase will be uneven and will vary regionally (e.g. ,●Rate of increase will be uneven and will vary regionally (e.g. ,
higher over land).higher over land).
●●Global Mean Sea LevelGlobal Mean Sea Level is expected to rise 6 cm per decade (with anis expected to rise 6 cm per decade (with an
uncertainty range of 3-10 cm per decadeuncertainty range of 3-10 cm per decade
20 cm above present by 203020 cm above present by 2030
65 cm above present by end of next century65 cm above present by end of next century

●● Most of the destruction of theMost of the destruction of the
earth’s ecosystems is driven byearth’s ecosystems is driven by
economic incentiveseconomic incentives
●Forests, where most known●Forests, where most known
biodiversity resides, are clearedbiodiversity resides, are cleared
for the extraction of naturalfor the extraction of natural
resources (oil, wood products) orresources (oil, wood products) or
to give way for cash crops andto give way for cash crops and
grazinggrazing

The globalization of the worldThe globalization of the world
economy since World War II haseconomy since World War II has
intensified a pattern of resourceintensified a pattern of resource
use by which developing nationsuse by which developing nations
extract most natural resources,extract most natural resources,
exporting them to industrial nationsexporting them to industrial nations
at prices that are often belowat prices that are often below
replacement costsreplacement costs

To solve the environmental dilemmaTo solve the environmental dilemma
we must cut the link between resourcewe must cut the link between resource
use and economic progress.use and economic progress.
The key is to achieve a new type ofThe key is to achieve a new type of
industrialization, which is not based onindustrialization, which is not based on
resource exports:resource exports:
a knowledge intensive form ofa knowledge intensive form of
economic progress.economic progress.

●● We must incorporate theWe must incorporate the
dynamics of markets in thedynamics of markets in the
management of ecosystemsmanagement of ecosystems
● The market has become a● The market has become a
key institution in thekey institution in the
destruction of the earth’sdestruction of the earth’s
ecosystems. No policy thatecosystems. No policy that
ignores this fact can succeed.ignores this fact can succeed.

MARKETSMARKETS
are the dominant institution in theare the dominant institution in the
global economy.global economy.
As the century turns, the market itselfAs the century turns, the market itself
is evolving.is evolving.

TWO MAJOR TRENDSTWO MAJOR TRENDS
 The Knowledge RevolutionThe Knowledge Revolution
 Global Environmental IssuesGlobal Environmental Issues
Lead to new and fundamentalLead to new and fundamental
different types of marketsdifferent types of markets

Markets are widely used institutionsMarkets are widely used institutions
They are decentralized, and can beThey are decentralized, and can be
efficient.efficient.
But global environmental marketsBut global environmental markets
trade unusual goods:trade unusual goods: privatelyprivately
produced public goodsproduced public goods
Biodiversity is oneBiodiversity is one
The planet’s atmosphere is anotherThe planet’s atmosphere is another

EXAMPLESEXAMPLES
 The trading of SOThe trading of SO22 in the Chicagoin the Chicago
Board of Trade since 1993, followingBoard of Trade since 1993, following
the Clean Air Actthe Clean Air Act
 Water markets in Australia – water isWater markets in Australia – water is
the most scarce resource in thethe most scarce resource in the
world todayworld today

Market for Emission PermitsMarket for Emission Permits
Annex I Countries are givenAnnex I Countries are given
allocations of property rights onallocations of property rights on
emissions summing up to the 1990emissions summing up to the 1990
level, and they can trade these freelylevel, and they can trade these freely
among themselvesamong themselves

●● Environmental MarketsEnvironmental Markets
● Markets for Knowledge● Markets for Knowledge
Both trade new and different typesBoth trade new and different types
of goods:of goods:
Privately Produced PublicPrivately Produced Public
GoodsGoods
(PPP)(PPP)

The Knowledge RevolutionThe Knowledge Revolution
In many countries, is leading to aIn many countries, is leading to a
new economy, with differentnew economy, with different
environmental problems and newenvironmental problems and new
opportunities for action.opportunities for action.
Examples: Asian Tigers and LittleExamples: Asian Tigers and Little
tigers, parts of India and Barbados.tigers, parts of India and Barbados.

The Knowledge RevolutionThe Knowledge Revolution
 US leads the pack because of itsUS leads the pack because of its
property-rights systems and financialproperty-rights systems and financial
markets.markets.
 Japan lost in the software raceJapan lost in the software race
because of property-rights systems.because of property-rights systems.

●● This is not a :”service economy”This is not a :”service economy”
as previously thought.as previously thought.
● It is a new economy using● It is a new economy using
knowledge rather than capital asknowledge rather than capital as
the most important input ofthe most important input of
production.production.
● Fossil fuels are now replaced by● Fossil fuels are now replaced by
information technologyinformation technology

Sunrise sectors are knowledge intensive:Sunrise sectors are knowledge intensive:
biotechnology, telecommunications, financial markets,biotechnology, telecommunications, financial markets,
health services and entertainment and culture.health services and entertainment and culture.
MORE AMERICANS WORK IN BIOTECHNOLOGY THAN IN THEMORE AMERICANS WORK IN BIOTECHNOLOGY THAN IN THE
ENTIRE MACHINE TOOL INDUSTRYENTIRE MACHINE TOOL INDUSTRY
MORE AMERICANS MAKE SEMICONDUCTORS THANMORE AMERICANS MAKE SEMICONDUCTORS THAN
CONSTRUCTION MACHINERYCONSTRUCTION MACHINERY
THE TELECOMMUNICATIONS INDUSTRY IN NORTH AMERICATHE TELECOMMUNICATIONS INDUSTRY IN NORTH AMERICA
EMPLOYS MORE PEOPLE THAN THE AUTO AND AUTO PARTEMPLOYS MORE PEOPLE THAN THE AUTO AND AUTO PART
INDUSTRY COMBINEDINDUSTRY COMBINED
FOSSIL FUEL IS REPLACED BY INFORMATION TECHNOLOGYFOSSIL FUEL IS REPLACED BY INFORMATION TECHNOLOGY

““New Economy” ExamplesNew Economy” Examples
 The US health and medical industryThe US health and medical industry
alone has become larger thanalone has become larger than
defense, and also larger than oildefense, and also larger than oil
refining, aircraft, autos, auto parts,refining, aircraft, autos, auto parts,
logging, steel and shipping putlogging, steel and shipping put
togethertogether
 More Americans work inMore Americans work in
biotechnology than in the entirebiotechnology than in the entire
machine tools industrymachine tools industry

Consumers now spend more onConsumers now spend more on
home electronics than on new carshome electronics than on new cars
 $95 billion a year on home$95 billion a year on home
computers, TVs and stereos.computers, TVs and stereos.
 $85 billion a year on new cars.$85 billion a year on new cars.

Productivity is driven by theProductivity is driven by the
knowledge sectorsknowledge sectors
 According to the Federal ReserveAccording to the Federal Reserve
Board, US industrial production inBoard, US industrial production in
1997-98 increased at a strong 4.1%1997-98 increased at a strong 4.1%
annual rate, 4.4% during 1996.annual rate, 4.4% during 1996.
 Take away computers andTake away computers and
semiconductors and the rate drops tosemiconductors and the rate drops to
2.2%2.2%

Productivity is driven by theProductivity is driven by the
knowledge sectorsknowledge sectors
 According to the Bureau of EconomicAccording to the Bureau of Economic
Analysis, total US industrialAnalysis, total US industrial
production in 2002-2003 increasedproduction in 2002-2003 increased
at a 2.17% annual rate, 4.19%at a 2.17% annual rate, 4.19%
during 2000.during 2000.
 Take away the production ofTake away the production of
computers and electronic products,computers and electronic products,
and this drops to 1.72% (2003) orand this drops to 1.72% (2003) or
3.41% (2000).3.41% (2000).
www.bea.gov: Gross Output by Industry in Current Dollars

The New Economy Starts to Hit HomeThe New Economy Starts to Hit Home
Increases in personal spending:Increases in personal spending:
Key old economy itemsKey old economy items
Motor vehicles: 0.3%Motor vehicles: 0.3%
Food: 0.6%Food: 0.6%
Major Appliances: 1.1%Major Appliances: 1.1%
Clothing: 2/3%Clothing: 2/3%
Average: 0.9%Average: 0.9%
Key new economy itemsKey new economy items
Home telephone services: 8.8%Home telephone services: 8.8%
Entertainment & recreation services: 12.4%Entertainment & recreation services: 12.4%
Cable TV: 13.4%Cable TV: 13.4%
Brokerage and other financial services: 15.6%Brokerage and other financial services: 15.6%
Average: 12.5%Average: 12.5%
Source: Business Week, March 23, 1998Source: Business Week, March 23, 1998

●● Today more AmericansToday more Americans
make semiconductors thanmake semiconductors than
construction machineryconstruction machinery
● The telecommunications● The telecommunications
industry in North Americaindustry in North America
employs more people than theemploys more people than the
auto and the auto partsauto and the auto parts
industries combinedindustries combined

Source: “Comparing economic and scientific wealth” of the article “The Scientific Impact of Nations”
by David A. King, Nature, July 15, 2004, p. 311-316.

Sources: Pisa. www.pisa.oecd.org. World Bank. www.worldbank.org.

Knowledge Sector (% of GDP)
U.S. BEA 2007, Knowledge Sector: Computer and electronic products; information; finance and insurance;
professional, scientific, and technical services; management of companies and entreprises
Sources: US Bureau of Economic Analysis (BEA) 2007 data www.bea/gov. World Bank. www.worldbank.org

Sources: World Bank. www.worldbank.org. World Resource Institute (WRI). www.wri.org

Sources: US Bureau of Economic Analysis (BEA) 2007 data. www.bea/gov
Energy Information Administration (EIA). www.eia.doe.gov/

LEADING THE WAY TO ECO-FRIENDLY PROFITSLEADING THE WAY TO ECO-FRIENDLY PROFITS
Some major manufacturers have decided to do more than reduceSome major manufacturers have decided to do more than reduce
waste and clean up pollution. They are developing products andwaste and clean up pollution. They are developing products and
processes that make it profitable to be environmentally friendly.processes that make it profitable to be environmentally friendly.
DUPONTDUPONT has co-developed 3GT, a bioengineered polyester fabrichas co-developed 3GT, a bioengineered polyester fabric
made from cornstarch that is lower in cost than oil-basedmade from cornstarch that is lower in cost than oil-based
polyester and can be recycled indefinitely.polyester and can be recycled indefinitely.
SONOCOSONOCO has created an rectangular “paper can” for Lipton Icedhas created an rectangular “paper can” for Lipton Iced
Tea that is 70% recyclable.Tea that is 70% recyclable.
3M3M has developed a plastic coating for the Navy to replace painthas developed a plastic coating for the Navy to replace paint
on trucks, ships and trains. It’s lighter than paint, which leads toon trucks, ships and trains. It’s lighter than paint, which leads to
greater fuel efficiency.greater fuel efficiency.
S.C. JOHNSONS.C. JOHNSON reformulated Raid roach killer, converting from areformulated Raid roach killer, converting from a
solvent-based to a water-based formula.solvent-based to a water-based formula.

ELECTROLUX’ELECTROLUX’ environmental products, including solar-poweredenvironmental products, including solar-powered
lawn mowers, chain saws lubricated with vegetable oil, and waterlawn mowers, chain saws lubricated with vegetable oil, and water
saving washing machines, generated 3.8% higher profits last yearsaving washing machines, generated 3.8% higher profits last year
than the company’s conventional products.than the company’s conventional products.
TOYOTATOYOTA is introducing a hybrid car that gets 66 mph on ais introducing a hybrid car that gets 66 mph on a
combination of gasoline and electricity.combination of gasoline and electricity.
A. FINKL & SONSA. FINKL & SONS, a Chicago steel forger, recycles more than 955, a Chicago steel forger, recycles more than 955
of its solid waste and has cut energy use by 36.4% over 10 years,of its solid waste and has cut energy use by 36.4% over 10 years,
making it one of the most efficient forgers in the world.making it one of the most efficient forgers in the world.
BRITISH PETROLEUMBRITISH PETROLEUM has invested $160 million in developing solarhas invested $160 million in developing solar
energy and is building a completely solar-powered Olympic village forenergy and is building a completely solar-powered Olympic village for
the 1998 Summer Games in Australia.the 1998 Summer Games in Australia.

The Developing World can leapfrogThe Developing World can leapfrog
and avoid resource intensiveand avoid resource intensive
industrializationindustrialization
The successful Asian tigers relied onThe successful Asian tigers relied on
technology exports, such as consumertechnology exports, such as consumer
electronicselectronics
In the last ten years India developed aIn the last ten years India developed a
Software industry worth $4 Billion USD inSoftware industry worth $4 Billion USD in
exports to 36 countries, one of the mostexports to 36 countries, one of the most
dynamic in the worlddynamic in the world

In recent years, nearly one-thirdIn recent years, nearly one-third
of new tech companies in theof new tech companies in the
Silicon Valley have beenSilicon Valley have been
headed by Indian or Chineseheaded by Indian or Chinese
executivesexecutives
USA Today, February 24, 1999USA Today, February 24, 1999

Knowledge intensive growth isKnowledge intensive growth is
here today.here today.
It is the future.It is the future.
How to achieve the transitionHow to achieve the transition
with minimum cost?with minimum cost?

Knowledge and GlobalKnowledge and Global
Environment AssetsEnvironment Assets
 Are not standard public goods suchAre not standard public goods such
as law and orderas law and order
 They are mostly produced privately,They are mostly produced privately,
rather than by the governmentrather than by the government
 They are costly to produceThey are costly to produce

Privately Produced Public GoodsPrivately Produced Public Goods
are goods which are not “rival” inare goods which are not “rival” in
consumption, but are privately produced.consumption, but are privately produced.
We all produce emissions but theWe all produce emissions but the
atmosphere is the same for us all.atmosphere is the same for us all.
We produce knowledge privately but canWe produce knowledge privately but can
share all of it with others without losing it.share all of it with others without losing it.

Knowledge and Global Environment areKnowledge and Global Environment are
Why are they public goods?Why are they public goods?
●● Knowledge is not “rival” inKnowledge is not “rival” in
consumption – it can be sharedconsumption – it can be shared
without losing itwithout losing it

SimilarlySimilarly
 Global environmental assets such asGlobal environmental assets such as
the carbon content of thethe carbon content of the
atmosphere are one and the sameatmosphere are one and the same
for everybody on the planet. Thesefor everybody on the planet. These
are physical properties, independentare physical properties, independent
of the economic institutions.of the economic institutions.

The Paradox of KnowledgeThe Paradox of Knowledge
 It is costly to produceIt is costly to produce
 It can be duplicated without losing it. ItIt can be duplicated without losing it. It
can be shared at no costcan be shared at no cost
Because it is costly, without property rights, suchBecause it is costly, without property rights, such
as patents, there is no incentive to produceas patents, there is no incentive to produce
knowledge.knowledge.
Example: Japan has no property rights onExample: Japan has no property rights on
software, and produces almost none.software, and produces almost none.

Yet because it can be shared at no cost, anyYet because it can be shared at no cost, any
restriction on the use of knowledge is inefficient.restriction on the use of knowledge is inefficient.
For example:For example:
Patents are inefficient because they arePatents are inefficient because they are
monopolies (Stiglitz).monopolies (Stiglitz).
We need new systems of property rights forWe need new systems of property rights for
knowledge.knowledge.
What is the solution?What is the solution?

Markets for PPP goods areMarkets for PPP goods are
different from the classicaldifferent from the classical
markets.markets.
They require new systems ofThey require new systems of
property rights.property rights.

Traditional MarketsTraditional Markets
First Theorem of Welfare EconomicsFirst Theorem of Welfare Economics
The allocation resulting from a competitiveThe allocation resulting from a competitive
market equilibrium with private goods ismarket equilibrium with private goods is
Pareto efficient.Pareto efficient.
This theorem is independent of the distributionThis theorem is independent of the distribution
of property rights. For example, all but twoof property rights. For example, all but two
traders may have zero endowments oftraders may have zero endowments of
property rights and the resulting equilibriumproperty rights and the resulting equilibrium
is still Pareto efficient. This requires all goodsis still Pareto efficient. This requires all goods
to be private goods, with rival consumption,to be private goods, with rival consumption,
and privately owned.and privately owned.

Public goods change mattersPublic goods change matters
A public good is a good which is notA public good is a good which is not
“rival” in consumption: this is not an“rival” in consumption: this is not an
economic or legal definition buteconomic or legal definition but
rather a physical constraint.rather a physical constraint.
Examples: Knowledge , theExamples: Knowledge , the
concentration forconcentration for COCO22 oror CFC’sCFC’s in thein the
atmosphere or the planet, availableatmosphere or the planet, available
biodiversity is the planet.biodiversity is the planet.
This leads toThis leads to

A New First Welfare Theorem in MarketsA New First Welfare Theorem in Markets
withwith
in which equity and efficiency are closelyin which equity and efficiency are closely
linkedlinked

are goods which are not “rival” inare goods which are not “rival” in
consumption, but are privatelyconsumption, but are privately
produced.produced.
We all produce emissions but theWe all produce emissions but the
atmosphere is the same for us all.atmosphere is the same for us all.
We produce knowledge privately butWe produce knowledge privately but
can share all of it with others withoutcan share all of it with others without
losing it.losing it.

A competitive market with propertyA competitive market with property
rights on knowledgerights on knowledge
An economy hasAn economy has HH countries or traderscountries or traders
who consumewho consume NN private goods andprivate goods and
one public good, Knowledge. Theyone public good, Knowledge. They
trade private goodstrade private goods xx ∈∈ RRNN
andand
licenses giving the rights to uselicenses giving the rights to use
knowledge,knowledge, aa ∈∈ RR..
TraderTrader hh has finite resources which arehas finite resources which are
allocated to produce either privateallocated to produce either private
goods or knowledge.goods or knowledge.

For each trader, there is a tradeoffFor each trader, there is a tradeoff
between producing more private goodsbetween producing more private goods
and producing more knowledge.and producing more knowledge.
However, more knowledge leads toHowever, more knowledge leads to
higher productivity. Formallyhigher productivity. Formally
∀h, xh = φh (ah, a), with ∂φh < 0,
a = Σah and ∀h , ∂ xh > 0
or a = sup ahh ∈ H
∂ah
∂a

Countries or traders have property rightsCountries or traders have property rights
ΩΩhh ∈∈ RRNN
on private goods and ownon private goods and own
licenses that allow them to uselicenses that allow them to use
knowledge,knowledge, aahh ∈∈ RR..
Traders derive utility from use of privateTraders derive utility from use of private
goodsgoods xx..
Through negotiable licenses knowledge isThrough negotiable licenses knowledge is
available to all.available to all.

Traders may use their licenses toTraders may use their licenses to
access knowledge or may sell theiraccess knowledge or may sell their
licenses in the market. If they wishlicenses in the market. If they wish
to use more knowledge than theirto use more knowledge than their
licenses allow, they buy morelicenses allow, they buy more
licenses in the market.licenses in the market.
Markets for licenses areMarkets for licenses are
competitive.competitive.

Market equilibrium with knowledgeMarket equilibrium with knowledge
Each trader maximizes welfareEach trader maximizes welfare
Max uMax uhh(x(xhh))
s.t.s.t. xxhh == φφhh (a(ahh,a) + q (a,a) + q (ahh – a– ahh))
the value of consumption equals the value ofthe value of consumption equals the value of
production plus the value of licenses bought orproduction plus the value of licenses bought or
sold, and all markets clear:sold, and all markets clear:
ΣΣaahh == ΣΣaahh = a= a

First Welfare Theorem for Markets withFirst Welfare Theorem for Markets with
TheoremTheorem
In and economy withIn and economy with kk≥2≥2 traders,traders, jj≥1≥1
private goods and a privately producedprivate goods and a privately produced
public good, there exists at most a one-public good, there exists at most a one-
dimensional manifold of property rightsdimensional manifold of property rights
allocations on the use of the public goodallocations on the use of the public good
(allocation of “permits”) from which the(allocation of “permits”) from which the
competitive equilibrium is Pareto efficient.competitive equilibrium is Pareto efficient.
This is the Manifold of Efficient Allocations ofThis is the Manifold of Efficient Allocations of
Property RightsProperty Rights

Theorem 1Theorem 1
((Chichilnisky, Heal and Starrett, 1993)Chichilnisky, Heal and Starrett, 1993)
There is only a finite number of waysThere is only a finite number of ways
of distributing licenses of propertyof distributing licenses of property
rights on the use of PPP goodsrights on the use of PPP goods
between the traders so that thebetween the traders so that the
market equilibrium in Paretomarket equilibrium in Pareto
efficient.efficient.

PolicyPolicy
Those who have fewer endowmentsThose who have fewer endowments
of private goods must be endowedof private goods must be endowed
with more property rights on the usewith more property rights on the use
of the PPP good. Otherwise, theof the PPP good. Otherwise, the
market does not operate efficiently.market does not operate efficiently.

●● Efficiency and distribution areEfficiency and distribution are
connected in markets with PPP goods.connected in markets with PPP goods.
● A measure of equity is necessary for● A measure of equity is necessary for
efficiency.efficiency.
● Markets with knowledge and● Markets with knowledge and
environmental assets require equityenvironmental assets require equity
for efficiencyfor efficiency

Policy ConclusionsPolicy Conclusions
 Markets with knowledge require someMarkets with knowledge require some
equity to function efficientlyequity to function efficiently
 It is standard to favor lower incomeIt is standard to favor lower income
groups in knowledge-use. Examples aregroups in knowledge-use. Examples are
school subsidies for low income groupsschool subsidies for low income groups
and school vouchers.and school vouchers.
 The system of property rights proposedThe system of property rights proposed
here is different from patents, becausehere is different from patents, because
there is no exclusivity. Patents arethere is no exclusivity. Patents are
exclusiveexclusive

Policy ConclusionsPolicy Conclusions
 The system proposed here consists ofThe system proposed here consists of
negotiable licenses which are accessible tonegotiable licenses which are accessible to
all, together with a covenant and a systemall, together with a covenant and a system
of property rights allocation (such asof property rights allocation (such as
auctions) that favors those with lowauctions) that favors those with low
income.income.
 There exists microchips (WaveThere exists microchips (Wave
Technology, Inc.) that can measure theTechnology, Inc.) that can measure the
use of knowledge as required for theuse of knowledge as required for the
implementation of these results.implementation of these results.

Traders may use their licenses toTraders may use their licenses to
access knowledge or may sell theiraccess knowledge or may sell their
licenses in the market. If they wishlicenses in the market. If they wish
to use more knowledge than theirto use more knowledge than their
licenses allow, they buy morelicenses allow, they buy more
license in the market.license in the market.
Markets for licenses are competitiveMarkets for licenses are competitive

A VISION OF A NEW ECONOMYA VISION OF A NEW ECONOMY
Very innovative in the use of knowledgeVery innovative in the use of knowledge
Very conservative in the use of resourcesVery conservative in the use of resources
Centered on diversity and human capitalCentered on diversity and human capital
New types of markets based on propertyNew types of markets based on property
rights of enviromental use and knowledgerights of enviromental use and knowledge
Offering the prospect of substantial economicOffering the prospect of substantial economic
progress without damaging the ecosystemsprogress without damaging the ecosystems
that support life on Earththat support life on Earth

US Policy in the World Economy:US Policy in the World Economy:
 Help create International Markets forHelp create International Markets for
Trading Property Rights on the Use ofTrading Property Rights on the Use of
Global CommonsGlobal Commons
 Possibly in conjunction with GATT or WTOPossibly in conjunction with GATT or WTO
 Ensure Efficient Market Functioning forEnsure Efficient Market Functioning for
whichwhich
 Those regions with fewer endowments ofThose regions with fewer endowments of
private goods must be endowed with moreprivate goods must be endowed with more
property rights on the commonproperty rights on the common
environmental assets. Otherwise theenvironmental assets. Otherwise the
market cannot operate efficiently.market cannot operate efficiently.

●● What are the institutionsWhat are the institutions
needed to implementneeded to implement
emission trading?emission trading?
●● How to ensure efficiencyHow to ensure efficiency
and fair trading?and fair trading?

To answer these questions, aTo answer these questions, a
global financial mechanismglobal financial mechanism
must be designed that reflectsmust be designed that reflects
full equitable and activefull equitable and active
participation of developing andparticipation of developing and
industrial nationsindustrial nations

An International Bank for EnvironmentalAn International Bank for Environmental
Settlements can help achieve this goalSettlements can help achieve this goal
 the IBES will help to obtain economicthe IBES will help to obtain economic
value from environmental assetsvalue from environmental assets
without destroying themwithout destroying them
 will help bridge the gap betweenwill help bridge the gap between
developing and industrial countriesdeveloping and industrial countries
 Will provide a forum for adjusting toWill provide a forum for adjusting to
new scientific findingsnew scientific findings

The IBES could help organize andThe IBES could help organize and
broker:broker:
 The trading of rights on the use ofThe trading of rights on the use of
global airwavesglobal airwaves
 The trading of rights on greenhouseThe trading of rights on greenhouse
gases emissions and biodiversity usegases emissions and biodiversity use
 The trading of environmental bondsThe trading of environmental bonds
and earth stocksand earth stocks
 The trading of options and otherThe trading of options and other
derivatives based on the abovederivatives based on the above

The IBES could alsoThe IBES could also
 Securitize profit sharing agreementsSecuritize profit sharing agreements
on genetic blueprintson genetic blueprints
 Securitize profitable investments inSecuritize profitable investments in
aquifers, watersheds, biological soilaquifers, watersheds, biological soil
enhancement and fisheriesenhancement and fisheries
 Provide bridge financing and creditProvide bridge financing and credit
enhancement facilities for all theenhancement facilities for all the
aboveabove

The case for an International Bank forThe case for an International Bank for
Environmental Settlements (IBES)Environmental Settlements (IBES)
Based on new economic findings onBased on new economic findings on
the existing proposal for tradingthe existing proposal for trading
carbon permits, an IBES can becarbon permits, an IBES can be
created whichcreated which
●●will be self-financingwill be self-financing
●●will offer a combination of marketswill offer a combination of markets
solution and continuing multilateralsolution and continuing multilateral
negotiationsnegotiations

An International Bank forAn International Bank for
Environmental Settlements (IBES)Environmental Settlements (IBES)
 GIVES ACCESS TO INTERNATIONALGIVES ACCESS TO INTERNATIONAL
CAPITAL MARKETS FOR FUNDINGCAPITAL MARKETS FOR FUNDING
CONSERVATIONCONSERVATION
 TO ALLEVIATE DEFAULT RISKS:TO ALLEVIATE DEFAULT RISKS:
CREDIT ENHANCEMENT BY WORLDCREDIT ENHANCEMENT BY WORLD
BANK OR GEFBANK OR GEF

The population explosion sinceThe population explosion since
World War II put stress on waterWorld War II put stress on water
resources globallyresources globally
Clean water is the most scarceClean water is the most scarce
resource around the worldresource around the world

●● IBES provides an institutional frameworkIBES provides an institutional framework
that combines the best aspects of freethat combines the best aspects of free
markets and multinational policymarkets and multinational policy
● IBES can offer a continuing way to draw● IBES can offer a continuing way to draw
capital from global financial markets tocapital from global financial markets to
support global environmental policysupport global environmental policy
● IBES will regulate and monitor compliance● IBES will regulate and monitor compliance
of trading of carbon permits globallyof trading of carbon permits globally
(borrowing, lending and derivatives)(borrowing, lending and derivatives)

Policies To Avert Climate ChangePolicies To Avert Climate Change
Policies to prevent climate changePolicies to prevent climate change
focus mainly on curtailing emissionsfocus mainly on curtailing emissions
of carbon dioxide (COof carbon dioxide (CO22), the most), the most
important greenhouse gas.important greenhouse gas.
●● Regulatory ApproachesRegulatory Approaches
●● Market ApproachesMarket Approaches
--- Carbon Taxes--- Carbon Taxes
--- Joint Implementation--- Joint Implementation
--- Tradable Permits--- Tradable Permits

Policies To Prevent Climate ChangePolicies To Prevent Climate Change
Carbon TaxesCarbon Taxes
A mechanism to reduce carbon emissions is a carbon tax –A mechanism to reduce carbon emissions is a carbon tax –
a tax levied on all fossil fuels in proportion to their carbona tax levied on all fossil fuels in proportion to their carbon
contents.contents.
●●By raising the cost of fuels and energy intensive products,By raising the cost of fuels and energy intensive products,
this tax would discourage all fossil fuel use in proportion tothis tax would discourage all fossil fuel use in proportion to
their carbon contents and encourage the development oftheir carbon contents and encourage the development of
less carbon-intensive alternatives.less carbon-intensive alternatives.
●●A recent statement by leading economists favors taxesA recent statement by leading economists favors taxes
over a regulatory approach. However, taxes increaseover a regulatory approach. However, taxes increase
government’s intervention in the economy and are out ofgovernment’s intervention in the economy and are out of
public favor in today’s market-oriented environmentpublic favor in today’s market-oriented environment

Joint ImplementationJoint Implementation
This is a mechanism that allows a firm in oneThis is a mechanism that allows a firm in one
country to invest in a project that reducescountry to invest in a project that reduces
emissions in another country, and to receiveemissions in another country, and to receive
credit for those reductions at home. It wascredit for those reductions at home. It was
proposed by President Clinton on October 22,proposed by President Clinton on October 22,
1997. An example might involve Norway and1997. An example might involve Norway and
Poland. International joint implementation of COPoland. International joint implementation of CO22
emissions reductions would allow a utility inemissions reductions would allow a utility in
Norway to achieve an emissions reduction byNorway to achieve an emissions reduction by
contracting to pay a factory in Poland to installcontracting to pay a factory in Poland to install
more fuel-efficient furnacesmore fuel-efficient furnaces

Tradable PermitsTradable Permits
●● This is the most market-oriented and efficient approach,This is the most market-oriented and efficient approach,
which is already used for sulfur dioxide permits in thewhich is already used for sulfur dioxide permits in the
Chicago Board of TradeChicago Board of Trade
●● One argument for tradable permits is the perceivedOne argument for tradable permits is the perceived
political difficulty of proposing a change in the tax structurepolitical difficulty of proposing a change in the tax structure
●● The most difficult issue in the use of tradable permits isThe most difficult issue in the use of tradable permits is
how to allocate them to potential users. For small fuel usershow to allocate them to potential users. For small fuel users
tradable permits could cause administrative burdenstradable permits could cause administrative burdens

Carbon taxes or tradable permits increaseCarbon taxes or tradable permits increase
the cost of energy and could reducethe cost of energy and could reduce
economic growth. Different models showeconomic growth. Different models show
different impacts.different impacts.
Despite the complexity of the models, onlyDespite the complexity of the models, only
a handful of easily understandablea handful of easily understandable
assumptions are important in determiningassumptions are important in determining
the simulation results.the simulation results.

TTHEHE PPREDICTEDREDICTED IIMPACTS ONMPACTS ON GDPGDP ININ 20202020 OFOF SSTABILIZINGTABILIZING
COCO22 EEMISSIONS ATMISSIONS AT 19901990 LLEVELS:EVELS: TTHEHE EEFFECT OFFFECT OF CCHANGINGHANGING
UUNDERLYINGNDERLYING AASSUMPTIONSSSUMPTIONS
Source: Shackleton, R. et al (1992) The Efficiency Value of Carbon Tax Revenues. Washington, D.C.: U.S. Environmental Protection Agency.

The International Bank forThe International Bank for
Environmental SettlementsEnvironmental Settlements
Win-Win SolutionsWin-Win Solutions
●● Uncertain though they are, there are costs associated withUncertain though they are, there are costs associated with
doing nothing in the face of rising greenhouse gasdoing nothing in the face of rising greenhouse gas
concentrations.concentrations.
●● The few models that do take expected damages fromThe few models that do take expected damages from
climate change into account predict that a carbon tax set atclimate change into account predict that a carbon tax set at
an appropriate rate, with revenues recycled efficiently backan appropriate rate, with revenues recycled efficiently back
into the economy, actually improves economic welfareinto the economy, actually improves economic welfare
(Nordhaus and Young, 1996; Jorgenson et al., 1995;(Nordhaus and Young, 1996; Jorgenson et al., 1995;
Nordhaus, 1994, 1993).Nordhaus, 1994, 1993).

GDPGDP LLOSSOSS (1990-2010)(1990-2010) UUNDERNDER AALTERNATIVELTERNATIVE
RRECYCLINGECYCLING OOPTIONSPTIONS
Source: Shackelton, R. et al (1992) The Efficiency Value of Carbon Tax Revenues. Washington, D.C.: U.S. Environmental Protection Agency.

A Win-Win ProposalA Win-Win Proposal
 A market-based approachA market-based approach
 Global Trading, Clearing andGlobal Trading, Clearing and
Settlement of Tradable CarbonSettlement of Tradable Carbon
PermitsPermits
 International Bank for EnvironmentalInternational Bank for Environmental
Settlements (IBES)Settlements (IBES)

 A market-oriented institutionA market-oriented institution
 Acts as an intermediary, organizes andActs as an intermediary, organizes and
regulates global trading of carbon permitsregulates global trading of carbon permits
and other environmental assetsand other environmental assets
 Governance and operating budget decidedGovernance and operating budget decided
by the nations of the worldby the nations of the world

The IBES MandateThe IBES Mandate
●● To enhance wealth generation while protectingTo enhance wealth generation while protecting
the environment.the environment.
It will accomplish this by:It will accomplish this by:
●● Providing liquidity and economic return fromProviding liquidity and economic return from
environmental assets (such as forests) whileenvironmental assets (such as forests) while
ensuring judicious use.ensuring judicious use.

How IBES OperatesHow IBES Operates
Preserving national sovereign rights, IBES will:Preserving national sovereign rights, IBES will:
- Act as an intermediary in multilateral- Act as an intermediary in multilateral
borrowing and lending of permitsborrowing and lending of permits
- Trade options on carbon permits in the- Trade options on carbon permits in the
futurefuture
- Clear and settle multinational transactions- Clear and settle multinational transactions
- Ensure market integrity and efficient price- Ensure market integrity and efficient price
mechanisms (such as SEC, CFTC)mechanisms (such as SEC, CFTC)

How IBES OperatesHow IBES Operates
- Once the world’s ceiling of emissions is- Once the world’s ceiling of emissions is
agreed upon, permits can be allocatedagreed upon, permits can be allocated
following a sliding rulefollowing a sliding rule
- Starting from today’s usage, the rule moves- Starting from today’s usage, the rule moves
towards an incentive system allocating moretowards an incentive system allocating more
to those who emit lessto those who emit less
- Auctions can be used to allocate permits- Auctions can be used to allocate permits
efficientlyefficiently

The IBES: A Win-Win SolutionThe IBES: A Win-Win Solution
The industrial nations have more capital. TheThe industrial nations have more capital. The
developing nations are richer in thedeveloping nations are richer in the
environmental account. They emit less carbonenvironmental account. They emit less carbon
and have most of the world’s forests and 80% ofand have most of the world’s forests and 80% of
its biodiversity. According to the economicits biodiversity. According to the economic
models, there are gains to be made from trademodels, there are gains to be made from trade
while insuring judicious use of environmentalwhile insuring judicious use of environmental
assets.assets.

Source: Earthrends World Resource Institute (WRI)

Source: Chichilnisky, G. and Eisenberger, P. Energy Security, Economic Development and Global Warming: Addressing
short and long term challenges. International Journal of Green Economics, 2009

Sources:
1. FloodSmart.gov
2. California Department of Insurance
3. California Department of Insurance and National Association of Insurance Commissioners (the two sources differ by $.1) http://www.
aic.org/Releases/2007_docs/NAIC_Releases_Homeowners_Ins_Report.htm, and http://www.
naic.org/documents/research_stats_homeowners_sample.pdf

Sources: Duncan Foley, “The Economic Fundamentals of Global Warming” 2007
http://www.santafe.edu/research/publications/workingpapers/07-12-044.pdf

Sources: Millennium Ecosystem
Assessment. Ecosystem and Human
Well-Being: Biodiversity Synthesis(2005)
http://www.millenniumassessment.org/en/i
ndex.aspx

Program Lecture 3 Resilience And The Knowledge Revolution

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Program Lecture 3 Resilience And The Knowledge Revolution