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Control and game-theoretic models of the environment
Journal of Economic Dynamics and Control 21 (1997) 899-903
Book review Anantha
K. Duraiappah
Institute for Environmental Studies, Vrije Universiteii, Amsterdam, Netherlands
C. Carraro and J.A. Filar (eds.) Control and Game-Theoretic Models of the Environment Annals of the International Society of Dynamic Games, Vol. 2 (Birkhauser, Boston, USA, 1995)
Control and Game-Theoretic Models of the Environment is a rigorous exercise in the analysis of the economics of pollution control, natural resource management and global environmental problems using optimal control and dynamic game techniques. Carraro and Filar have done an excellent job in collecting and organizing 15 interesting papers, some of which are very good. I personally found the papers using game theory most interesting and a valuable contribution to the existing literature. The book, as the editors state in their preface, focuses on dealing with the complex dynamic interactions which occur between economic and ecological systems as well as interactions within economic agents. This I believe is the other important contribution to the literature, as many of the existing work on environmental economics tend to focus only on: (1) the feed-forward linkages between the two systems but ignore the feedbacks between the systems which can be crucial for policy making purposes: and (2) ignore the game behavior between economic agents. Saying this, I was disappointed to observe that only two papers (paper by Yeung and Moretto) of a total of 15, in principal, model the feedback effects of environmental degradation on economic productivity. The other papers model the environment through the utility function, which I feel misses some very important dynamic characteristics of the environmental system and its ability to determine the boundary conditions or the environmental utilization space within which the economic system can operate in an optimal manner. The second disappointment with the book is the lack of computational models. The use of computational models would have allowed some of the modelers to use more complex but closer and realistic formulations of the two systems. As 0165-1889/97/$17.00 0 1997 Published by Elsevier Science B.V. All rights reserved PII SO165-1889(97)00008-O
900
AX
Duraiappah
/Journal
ofEconomic
Dynamics
and Control 21 (1997) 899-903
Beltratti states in her paper, the reason for the simplicity of the model is to ensure analytical tractability. However, in the process of simplification, important relationships are assumed away and that reduces the realism of the model for policy makers. Now, having got these two main criticisms of the book out of the way, let me discuss some of the strengths of the book and the potential use of its contents. Given the rather technical nature of the volume, it is unfortunate that the book can and will only be used by a small set of specialized audience. I say unfortunate because the results which many of the papers discuss can be useful guides for policy makers. It would have been useful and a unique idea if the editors had requested the authors of the papers to present a qualitative description of their models in an appendix; a reversal of the norm in which the mathematics is relegated to the appendix. This would have enlarged the potential audience for this book. The book is divided into three sections, the first deals with global environmental problems, the second with pollution issues and the third with natural resource management as well as pollution related problems. I found the third section a bit confusing and would have liked to have seen a clear distinction being made between sections covering global common issues, pollution problems and natural resource management; a few more papers on natural resource management and maybe a few less on pollution issues would have made this task a bit easier for the editors. The book starts out with an interesting introductory chapter by Vrieze. The author puts forward an argument which in principal states that nature and humans are in a continuous game, with each system continually reacting to each others actions. For example, he asserts that nature’s reaction to our ozone depletion behavior is to increase the level of incoming UV radiation which in turn causes skin cancer, and society’s reaction is the implementation of the Montreal protocol to curb the emission of ozone depleting substances. I personally find the argument a bit of extreme Gaiaism, and assuming that nature reacts within a game theoretic framework is like implicitly assuming that: (1) humans are not part of nature, which I personally think is a bit ignorant or arrogant; and (2) assigning nature the property of consciousness. Apart from these fundamental differences in opinion, I found the Vrieze paper a good introduction to the environmental problems of today, especially the North-South debate, and the contribution game theory could make to this crucial debate. Incidentally, none of the papers in the volume model nature in this manner. The first section on global issues starts with paper by Haurie and Zaccour on global environmental management. The paper serves as a good introduction to game theory and the modeling of economic systems and the global accumulation of emissions. The paper looks at how an international agency could identify an optimal international tax scheme based on a country weighting scheme.
A.K. Duraiappah /Journal
of Economic Dynamics and Control 21 (1997) 899-903
901
Unfortunately, the authors do not discuss how the weighting mechanism is determined, which incidentally is in most cases the stumbling block in international negotiations. It would have been interesting if, rather than a coupled constraint on emissions, a damage function which reflects varying damage costs across various emitters was used in the analysis. The game that evolves out of this framework would have been a more realistic representation of the real situation as it now stands in the international greenhouse gas emission reduction negotiations. The second paper in the first section is on the assimilative capacity of the ecosystem and is written by Cesar and de Zeeuw. The paper is informative and gives a good description on how different assumptions of the assimilative capacity of the ecosystem (from linear to non-linear systems) can result in very different outcomes. The paper highlights how irreversibility together with uncertainty in the ecosystem could be disastrous to the economy. The authors advice policy makers to acknowledge the importance of uncertainty in the ecosystem and demonstrate how stochastic optimal control systems can be useful guides for the analysis of environmental policies. The third paper in the section by Beltratti tackles the issue of the use of the global commons in a hypothetical scenario of two nations. The paper demonstrates how a non-cooperative steadystate solution is inferior to a cooperative steady-state solution, both environmentally as well as economically. The paper also addresses the role time preferences play and illustrates how higher time preferences lead to a non-linear deviation between the efficient and second-best solutions. The model presented is a bit simplistic which the author admits and suggests extensions to adapt the model to a particular resource. The fourth paper in this section by Kaitala and Pohjola discusses international agreements on greenhouse emissions. The authors rightly highlight the critical factors in the problem; varying damage costs from climate change as well as varying emission abatements costs across countries. The authors show how with increasing emissions, the desire for negotiations becomes more intense. The paper also demonstrates how side payments are an important criteria for negotiations and the role it plays in ensuring that agreements are self-enforcing. The last paper in this section by Hoe1 and Isaksen discusses the environmental or damage costs from different greenhouse gas emissions. Linking this study with the previous study of Kaitala and Pohjola gives the reader an idea of which gas and in which country to reduce greenhouse gases with minimum cost. The first paper in the second section is by Carraro and Topa and addresses the issue of the minimum rate of effluent taxation to induce firms to adopt new technology. The authors argue that just taxation by itself would not induce innovation, but a combination of innovation subsidy and environmental tax would give the incentive for firms to behave optimally. The results differ from the standard results which indicate that environmental taxes are sufficient to induce firms to adopt abatement measures to reduce emissions and eliminate the
902
A.K. Duraiappah f Journal of Economic Dynamics and Control 21 (1997) 899-903
need to reduce emissions by reducing output. However, these studies ignore R&D costs which the Carraro and Topa include in their model. The second paper in the section is by Ligthart and van der Ploeg and discusses endogenous growth models with environment as an input. The paper puts forward two cases, in the first case, the environment is treated as a stock while in the second case, the environment is treated as a renewable asset. The authors then look at first-best solutions versus second-best solutions in both the cases and analyze the steady-state balanced growth trajectories. Lump sum taxes, subsides as well as the role of marginal utility of environmental quality in determining the steady-state trajectories are also analyzed in the paper. The third paper by Verdier is a mix of the previous two papers. In this paper, the author focuses on the comparison between economic and welfare performance under two regimes, an emission tax regime versus a technological standard regime. The author demonstrates that under certain conditions, an emission tax may induce too much growth of the polluting industry and a technical standard could be superior; an important result which negates some of the economic superiority of emission taxes. The fourth paper by Xepapadeas on rate of return regulation has important lessons for industries in regulated monopolistic structures. Prime examples of sectors in this classification are electric utilities. The paper illustrates that under certain conditions, the presence of emission taxes in a regulated industry could in actuality increase emissions; a prime example of one distortion exacerbating the effects of another distortion in the market. The last paper in this section is by Moretto and focuses on the role, the physical features of fixed assets can play in determining the extent of pollution emissions. This is an interesting paper which looks at the use of tax as well as a subsidy system to protect the quality of the environment which in this case is also the firm’s physical capital. The notion of sustainable development at the firm level is introduced and the micro-economic modeling used in this paper, which demonstrates the important role the quality of the physical capital plays in firm production decisions, should be a role model for future micro studies. Section 3 starts with an interesting paper by Vincent which throws new light on resource management by incorporating the ESS principle within standard resource growth-type models. Standard renewable resource management models do not incorporate the concept of species fitness functions or evolution which the Vincent paper does. The second paper by Tahvonen focuses on pollution activities and its impact on harvesting activities. In his model, Tahvonen assumes that growth of a particular resource is affected by pollution. The resource owner has the option of reducing the pollution, but at a price. What is confusing in the model formulation is the role of the emitting activity. The author assumes that the resource owner has exclusive rights over the polluting activity. If this is the case, then the benefits from the polluting activity should be considered in the benefit function. What would have been interesting is to model the polluting activity as an output of the resource growth activity.
A.K. Duraiappah
1 Journal of Economic Dynamics
and Control 21 (1997) 899-903
903
Then the costs of abatement as well as the benefits from abatement can be considered within a holistic framework. But what the paper does address is the issue of irreversibility and the conditions under which it is optimal to pursue a strategy of sustainable management versus an irreversible management strategy. The third paper in this section focuses on management of stradding fish stocks and is written by Kaitala and Murno. It is an excellent paper which focuses on cooperative and non-cooperative management strategies between fishing nations near to the resouce stock and distant fishing nations. The fourth paper in this section is not related to resource management, but focuses on business cycles and their links with pollution. The author puts forward an interesting model which captures the inter-dependency between output and pollution and the resulting pollution on output. The author pays particular attention to the generally over looked variable of decaying carrying capacity of the environment and its impact on the economic system. The model is put forward as a game between sectors and the government. The author suggests that pollution can be a good explanatory variable for business cycles. A time-series analysis if possible could go a long way in supporting his theoretical proposition and would be a positive contribution to the growing field of evolutionary economics. I sincerely hope to see this in the future. The last paper in the section is by Krawczyk and focuses on the management of effluent discharge. The author models the problem as a Stackleberg game between a regional authority and a number of polluters. The interesting contribution of this paper is the use of a Decision Support Tool to identify the equilibrium when analytical methods fail. The book, in general, is an excellent introduction to researchers who are interested in using optimal control or dynamic game techniques in environmental problems. I for one found that some of the highly theoretical papers have good starting points for applied papers. For example, the paper by Tahvonen, with some modifications, provides an excellent reference and guide for an applied study on shrimp farming. The book also provides ample suggestions for potential research projects. I would recommend the book as a valuable source of information for academics and graduate students working in the area of environmental economics as well as in dynamic game theory.
Book review Anantha
K. Duraiappah
Institute for Environmental Studies, Vrije Universiteii, Amsterdam, Netherlands
C. Carraro and J.A. Filar (eds.) Control and Game-Theoretic Models of the Environment Annals of the International Society of Dynamic Games, Vol. 2 (Birkhauser, Boston, USA, 1995)
Control and Game-Theoretic Models of the Environment is a rigorous exercise in the analysis of the economics of pollution control, natural resource management and global environmental problems using optimal control and dynamic game techniques. Carraro and Filar have done an excellent job in collecting and organizing 15 interesting papers, some of which are very good. I personally found the papers using game theory most interesting and a valuable contribution to the existing literature. The book, as the editors state in their preface, focuses on dealing with the complex dynamic interactions which occur between economic and ecological systems as well as interactions within economic agents. This I believe is the other important contribution to the literature, as many of the existing work on environmental economics tend to focus only on: (1) the feed-forward linkages between the two systems but ignore the feedbacks between the systems which can be crucial for policy making purposes: and (2) ignore the game behavior between economic agents. Saying this, I was disappointed to observe that only two papers (paper by Yeung and Moretto) of a total of 15, in principal, model the feedback effects of environmental degradation on economic productivity. The other papers model the environment through the utility function, which I feel misses some very important dynamic characteristics of the environmental system and its ability to determine the boundary conditions or the environmental utilization space within which the economic system can operate in an optimal manner. The second disappointment with the book is the lack of computational models. The use of computational models would have allowed some of the modelers to use more complex but closer and realistic formulations of the two systems. As 0165-1889/97/$17.00 0 1997 Published by Elsevier Science B.V. All rights reserved PII SO165-1889(97)00008-O
900
AX
Duraiappah
/Journal
ofEconomic
Dynamics
and Control 21 (1997) 899-903
Beltratti states in her paper, the reason for the simplicity of the model is to ensure analytical tractability. However, in the process of simplification, important relationships are assumed away and that reduces the realism of the model for policy makers. Now, having got these two main criticisms of the book out of the way, let me discuss some of the strengths of the book and the potential use of its contents. Given the rather technical nature of the volume, it is unfortunate that the book can and will only be used by a small set of specialized audience. I say unfortunate because the results which many of the papers discuss can be useful guides for policy makers. It would have been useful and a unique idea if the editors had requested the authors of the papers to present a qualitative description of their models in an appendix; a reversal of the norm in which the mathematics is relegated to the appendix. This would have enlarged the potential audience for this book. The book is divided into three sections, the first deals with global environmental problems, the second with pollution issues and the third with natural resource management as well as pollution related problems. I found the third section a bit confusing and would have liked to have seen a clear distinction being made between sections covering global common issues, pollution problems and natural resource management; a few more papers on natural resource management and maybe a few less on pollution issues would have made this task a bit easier for the editors. The book starts out with an interesting introductory chapter by Vrieze. The author puts forward an argument which in principal states that nature and humans are in a continuous game, with each system continually reacting to each others actions. For example, he asserts that nature’s reaction to our ozone depletion behavior is to increase the level of incoming UV radiation which in turn causes skin cancer, and society’s reaction is the implementation of the Montreal protocol to curb the emission of ozone depleting substances. I personally find the argument a bit of extreme Gaiaism, and assuming that nature reacts within a game theoretic framework is like implicitly assuming that: (1) humans are not part of nature, which I personally think is a bit ignorant or arrogant; and (2) assigning nature the property of consciousness. Apart from these fundamental differences in opinion, I found the Vrieze paper a good introduction to the environmental problems of today, especially the North-South debate, and the contribution game theory could make to this crucial debate. Incidentally, none of the papers in the volume model nature in this manner. The first section on global issues starts with paper by Haurie and Zaccour on global environmental management. The paper serves as a good introduction to game theory and the modeling of economic systems and the global accumulation of emissions. The paper looks at how an international agency could identify an optimal international tax scheme based on a country weighting scheme.
A.K. Duraiappah /Journal
of Economic Dynamics and Control 21 (1997) 899-903
901
Unfortunately, the authors do not discuss how the weighting mechanism is determined, which incidentally is in most cases the stumbling block in international negotiations. It would have been interesting if, rather than a coupled constraint on emissions, a damage function which reflects varying damage costs across various emitters was used in the analysis. The game that evolves out of this framework would have been a more realistic representation of the real situation as it now stands in the international greenhouse gas emission reduction negotiations. The second paper in the first section is on the assimilative capacity of the ecosystem and is written by Cesar and de Zeeuw. The paper is informative and gives a good description on how different assumptions of the assimilative capacity of the ecosystem (from linear to non-linear systems) can result in very different outcomes. The paper highlights how irreversibility together with uncertainty in the ecosystem could be disastrous to the economy. The authors advice policy makers to acknowledge the importance of uncertainty in the ecosystem and demonstrate how stochastic optimal control systems can be useful guides for the analysis of environmental policies. The third paper in the section by Beltratti tackles the issue of the use of the global commons in a hypothetical scenario of two nations. The paper demonstrates how a non-cooperative steadystate solution is inferior to a cooperative steady-state solution, both environmentally as well as economically. The paper also addresses the role time preferences play and illustrates how higher time preferences lead to a non-linear deviation between the efficient and second-best solutions. The model presented is a bit simplistic which the author admits and suggests extensions to adapt the model to a particular resource. The fourth paper in this section by Kaitala and Pohjola discusses international agreements on greenhouse emissions. The authors rightly highlight the critical factors in the problem; varying damage costs from climate change as well as varying emission abatements costs across countries. The authors show how with increasing emissions, the desire for negotiations becomes more intense. The paper also demonstrates how side payments are an important criteria for negotiations and the role it plays in ensuring that agreements are self-enforcing. The last paper in this section by Hoe1 and Isaksen discusses the environmental or damage costs from different greenhouse gas emissions. Linking this study with the previous study of Kaitala and Pohjola gives the reader an idea of which gas and in which country to reduce greenhouse gases with minimum cost. The first paper in the second section is by Carraro and Topa and addresses the issue of the minimum rate of effluent taxation to induce firms to adopt new technology. The authors argue that just taxation by itself would not induce innovation, but a combination of innovation subsidy and environmental tax would give the incentive for firms to behave optimally. The results differ from the standard results which indicate that environmental taxes are sufficient to induce firms to adopt abatement measures to reduce emissions and eliminate the
902
A.K. Duraiappah f Journal of Economic Dynamics and Control 21 (1997) 899-903
need to reduce emissions by reducing output. However, these studies ignore R&D costs which the Carraro and Topa include in their model. The second paper in the section is by Ligthart and van der Ploeg and discusses endogenous growth models with environment as an input. The paper puts forward two cases, in the first case, the environment is treated as a stock while in the second case, the environment is treated as a renewable asset. The authors then look at first-best solutions versus second-best solutions in both the cases and analyze the steady-state balanced growth trajectories. Lump sum taxes, subsides as well as the role of marginal utility of environmental quality in determining the steady-state trajectories are also analyzed in the paper. The third paper by Verdier is a mix of the previous two papers. In this paper, the author focuses on the comparison between economic and welfare performance under two regimes, an emission tax regime versus a technological standard regime. The author demonstrates that under certain conditions, an emission tax may induce too much growth of the polluting industry and a technical standard could be superior; an important result which negates some of the economic superiority of emission taxes. The fourth paper by Xepapadeas on rate of return regulation has important lessons for industries in regulated monopolistic structures. Prime examples of sectors in this classification are electric utilities. The paper illustrates that under certain conditions, the presence of emission taxes in a regulated industry could in actuality increase emissions; a prime example of one distortion exacerbating the effects of another distortion in the market. The last paper in this section is by Moretto and focuses on the role, the physical features of fixed assets can play in determining the extent of pollution emissions. This is an interesting paper which looks at the use of tax as well as a subsidy system to protect the quality of the environment which in this case is also the firm’s physical capital. The notion of sustainable development at the firm level is introduced and the micro-economic modeling used in this paper, which demonstrates the important role the quality of the physical capital plays in firm production decisions, should be a role model for future micro studies. Section 3 starts with an interesting paper by Vincent which throws new light on resource management by incorporating the ESS principle within standard resource growth-type models. Standard renewable resource management models do not incorporate the concept of species fitness functions or evolution which the Vincent paper does. The second paper by Tahvonen focuses on pollution activities and its impact on harvesting activities. In his model, Tahvonen assumes that growth of a particular resource is affected by pollution. The resource owner has the option of reducing the pollution, but at a price. What is confusing in the model formulation is the role of the emitting activity. The author assumes that the resource owner has exclusive rights over the polluting activity. If this is the case, then the benefits from the polluting activity should be considered in the benefit function. What would have been interesting is to model the polluting activity as an output of the resource growth activity.
A.K. Duraiappah
1 Journal of Economic Dynamics
and Control 21 (1997) 899-903
903
Then the costs of abatement as well as the benefits from abatement can be considered within a holistic framework. But what the paper does address is the issue of irreversibility and the conditions under which it is optimal to pursue a strategy of sustainable management versus an irreversible management strategy. The third paper in this section focuses on management of stradding fish stocks and is written by Kaitala and Murno. It is an excellent paper which focuses on cooperative and non-cooperative management strategies between fishing nations near to the resouce stock and distant fishing nations. The fourth paper in this section is not related to resource management, but focuses on business cycles and their links with pollution. The author puts forward an interesting model which captures the inter-dependency between output and pollution and the resulting pollution on output. The author pays particular attention to the generally over looked variable of decaying carrying capacity of the environment and its impact on the economic system. The model is put forward as a game between sectors and the government. The author suggests that pollution can be a good explanatory variable for business cycles. A time-series analysis if possible could go a long way in supporting his theoretical proposition and would be a positive contribution to the growing field of evolutionary economics. I sincerely hope to see this in the future. The last paper in the section is by Krawczyk and focuses on the management of effluent discharge. The author models the problem as a Stackleberg game between a regional authority and a number of polluters. The interesting contribution of this paper is the use of a Decision Support Tool to identify the equilibrium when analytical methods fail. The book, in general, is an excellent introduction to researchers who are interested in using optimal control or dynamic game techniques in environmental problems. I for one found that some of the highly theoretical papers have good starting points for applied papers. For example, the paper by Tahvonen, with some modifications, provides an excellent reference and guide for an applied study on shrimp farming. The book also provides ample suggestions for potential research projects. I would recommend the book as a valuable source of information for academics and graduate students working in the area of environmental economics as well as in dynamic game theory.