Ecological Economics 33 2000 299 – 311
ANALYSIS
Efficiency and applicability of economic concepts dealing with environmental risk and ignorance
Frank Wa¨tzold
Department of Ecological Economics and En6ironmental Sociology, UFZ-Centre for En6ironmental Research Leipzig-Halle Ltd., PO Box
2
, Leipzig
04301
, Germany Received 12 July 1999; received in revised form 8 November 1999; accepted 8 November 1999
Abstract
The paper examines the efficiency and applicability of various economic concepts dealing with environmental uncertainty. Their applicability is analysed by classifying environmental uncertainty according to different criteria.
Using such a structure, it can be shown that while the economic concepts are able to deal satisfactorily with some types of environmental uncertainty they are unable to deal with others adequately. The analysis of efficiency
distinguishes between environmental risk in which the decision-maker is aware of the distribution function of the random variables and ignorance in which the decision-maker does not know the relevant distribution functions.
The concept of a risk premium proposed by Siebert, the policy recommendation to promote integrated technologies, and the environmental assurance bonding system developed by Costanza and Perrings are examined in terms of
efficiency and applicability. The analysis reveals the following: i the application possibilities of the three concepts differ significantly; ii a concept which concentrates on the reduction of risk may lead to an increase in ignorance;
iii while an economic concept may be efficient in the context of risk, it can be inefficient when ignorance exists; iv a trade-off exists between the possibility to precisely state whether an economic concept is efficient and the scope of
its applicability. © 2000 Elsevier Science B.V. All rights reserved.
Keywords
:
Environmental ignorance; Environmental risk; Risk premium; Integrated technologies; Environmental bonds www.elsevier.comlocateecolecon
1. Introduction
The environmental impact of emissions arising from the consumption or production of commod-
ities is often only partially known — if at all.
1
In other words, environmental uncertainty exists.
2
A good example to illustrate the severity of this
problem is the discovery of the damaging proper-
2
I only consider the case where all actors share the same level of uncertainty. Funtowicz et al. 1998 point to the
importance of reciprocal learning between public and experts when they have different levels of information and Lewis
1996 gives an overview of the literature dealing with asym- metric information between regulator and polluter.
Tel.: + 49-341-235-2670; fax: + 49-341-235-2511. E-mail address
:
waetzoldalok.ufz.de F. Wa¨tzold
1
For the purpose of simplification, I shall concentrate on emissions. However, the analysis can also be applied to other
human activities that affect the environment. 0921-800900 - see front matter © 2000 Elsevier Science B.V. All rights reserved.
PII: S 0 9 2 1 - 8 0 0 9 9 9 0 0 1 4 8 - 2
ties of chlorofluorocarbon CFC. At the end of the 19th century, CFC was first produced in labo-
ratory experiments. Industrial production started 30 years later, and being neither flammable nor
toxic, CFC was assumed to be an ideal material in environmental terms. Only in 1974, with 750 000
tons of CFC being emitted annually, was the damaging impact of CFC on the ozone layer
discovered. The fact that this was a purely chance discovery reveals just how momentous environ-
mental uncertainty can be.
Nowadays we can distinguish between a num- ber of economic concepts dealing with environ-
mental uncertainty.
3
The aim of this paper is to develop a procedure to analyse the applicability of
such concepts and their ability to induce efficient abatement activities. Furthermore, this procedure
is applied to some of the existing concepts. Start- ing with Weitzman 1974, the focus of most of
the literature evaluating different policies under uncertainty has been a welfare analysis of price
versus quantity control instruments when the de- cision-maker is uncertain about the marginal
damage and the marginal abatement cost func- tion.
4
Uncertainty is generally modelled such that the decision-maker knows the distribution func-
tion of the random variables see e.g. Weitzman, 1974; Adar and Griffin, 1976; Watson and Rid-
ker, 1984. This type of uncertainty can be called environmental risk. Funtowicz and Ravetz 1993
pointed out that such a way of modelling uncer- tainty is suitable for environmental problems
where ‘low uncertainty exists’. They call this the domain of ‘normal applied science’. However,
such modelling is inadequate for environmental problems in which the level of complexity and
fundamental uncertainty is high e.g. the green- house effect. Here, a new approach is required,
which they call ‘post-normal science’.
This paper takes into account high levels of complexity and uncertainty as well as the diversity
of environmental problems in two ways: Firstly, the efficiency analysis for a world of certainty and
for a world of risk is modified with respect to a situation of environmental ignorance. In such a
situation, the decision-maker is unaware of the distribution function of the random variables.
Secondly, the diversity of environmental problems gives rise to the question of whether all concepts
dealing with environmental uncertainty are appli- cable to all environmental problems. To answer
this question, a taxonomy is developed to deter- mine the applicability of the various concepts.
The efficiency and applicability of three different approaches are examined.
The concept of a risk premium proposed by Siebert 1998 argues that emission targets should
be lower in a world of risk compared to a similar setting in a world of certainty. This is an example
of an approach which only takes into account environmental risk and ignores environmental ig-
norance. By contrast, the promotion of technolo- gies that reduce a broad spectrum of emissions by
changing the production process integrated tech- nologies is an example of a policy recommenda-
tion which takes into account environmental ignorance. As the reduction of as many emissions
as possible is favoured, emissions which are not known to be harmful are also reduced. The envi-
ronmental assurance bonding system proposed by Perrings 1989 and Costanza and Perrings 1990
can be regarded as an example of an approach which does not directly focus on the reduction of
emissions by the policy-maker, but is designed to make companies responsible for the unknown en-
vironmental impact of their activities. It entails levying a bond when the environmental impact of
a firm’s innovative activity is unknown. Should damage be caused, a corresponding proportion of
the bond is forfeited. While these approaches are in some respects complementary e.g. environmen-
tal bonds may induce firms to use integrated technologies, each of them takes it own specific
approach to enviromental uncertainty. This re- sults in a different assessment in terms of appli-
cability and efficiency, and justifies their separate treatment.
The analysis reveals that the introduction of ignorance has important repercussions for the
3
As explained below these economic concepts are quite dissimilar. I use the words ‘concept’ or ‘approach’ as a generic
term.
4
Batabyal 1995 gives an overview of the literature follow- ing Weitzman 1974.
evaluation of the various approaches: A concept which concentrates on the reduction of risk may
lead to an increase in ignorance, and, while an economic concept may be efficient in the context
of risk, it can be inefficient when ignorance exists. In addition, it can be shown that the application
possibilities of the three concepts differ signifi- cantly. Combining the results of the efficiency and
applicability analysis, a trade-off can be derived between the possibility to precisely state whether
an economic concept is efficient and the scope of its applicability.
The taxonomy of environmental uncertainty is developed in Section 2.1, and what efficiency
means in the context of risk and ignorance is defined in Section 2.2. The following section pre-
sents the three different approaches and their assessment with respect to applicability and effi-
ciency. The final section summarises the main results and combines the analysis of efficiency and
applicability.
2. How to evaluate applicability and efficiency?
