Markets and the Environment

Reading Jarrod Diamond’s Collapse makes me think that economists need a better understanding of ecological systems when we think about the appropriate role for government in combating environmental problems. Welfare economics has demonstrated the need for government intervention when information is imperfect or markets are incomplete. A lot of market failures can therefore be overcome by developing property rights and providing appropriate information. 

However, Jarrod Diamond’s Collapse makes me think that there are some unique features of environmental problems that our textbooks don’t address: 

1.       Long lags and Multiple Equilibriums: Environmental degradation, and its resulting economic consequences, is not immediately visible. There are thus long lags in price changes and resultant market responses. However, by the time the market adjusts, it might be too late. This is because multiple equilibriums in ecological systems means that environmental destruction is often a one-way street: it cannot be reversed. Diamond’s example is of deforestation which leads to erosion of all land, but overfishing is good current day example, where fish stocks cannot be replenished to its original level.       

 

2.       Systemic Risk and Long-Term Environmental Cycles: Human beings have short time horizons and we are not good at thinking about the risks of unlikely or catastrophic events. As our societies become increasingly inter-dependent, we benefit from the specialisation and exchange. However, inter-dependence also creates risk. Furthermore, fortuitous circumstances today could be nothing more than a centuries-long upward cycle. By increasing our systemic risk, we become more vulnerable to collapse when environmental circumstances change. Diamond cites the collapse of the Anasazi empire the US South-west where a complex inter-dependent society developed over a couple of centuries of good rainfalls, but imploded when rain become less frequent. 

These examples invoke less optimism in the market to adequately respond to risks of environmental destruction.