Ragnar Arnason
Comments on
Environmentally harmful subsidies:
- Developing a checklist OECD Workshop on
Environmentally harmful subsidies
7-8 November 2002
Basic considerations
1. There is a good (but not an unqualified)
economic case for removing (or reducing)
subsidies
2. There is an even better economic case for
removing economically harmful subsidies
(…if by “harmful” we mean deviation from the
“optimal harm”)
…..but
1. Not all subsidies are equally harmful
2. There are lot of counterexamples
(i.e. where subsidy is economically beneficial
and its removal a mistake)
$
MC0
MC1
p1
p0
q0
q1
q*
quantity
Therefore we need more information
• Basically, an empirical economic/environmental
general equilibrium model
• But, this is not available (…and not in sight)
• And environmental concerns are pressing
• Therefore we need some guidelines – a checklist
perhaps.
• But with almost no theory and little data this is
very difficult!
An illustration
Following Jan Pieters, assume:
• Government wants to reduce
environmentally harmful subsidies by a
given amount
• Which subsidies should it reduce and by
how much?
Two environmental goods: y and x
Social
indifference
curves
y
Budget
constraint
y*
x*
x
But this is too simplistic
• Environmental goods cannot really be
generated (or bought) at a constant rate.
• Subsidy reduction (may) produce
environmental goods
• That production is the output of the
economic and environmental GE-system
• If that production is well behaved (..not
particularly likely), it will look like:
Production of environmental goods
y
Production
possibility
frontier
x
A possible case
y
y*
x*
x
Another possible case
y
y*
x*
x
Yet another possible case
y
y*
x*
x
Back to the checklist
• A checklist is supposed to reflect this
– Not the optimal solution
– But the ranking of of alternatives for allocating
subsidy reductions.
– So, we can
• Do things in the right order
• Avoid drastic mistakes
Note: The ranking depends on the situation! It
cannot be invariant (over space, time, extent of
subsidies, output, cultures etc)!
Therefore,
to compile the checklist,
we need to know
1. The transformation frontier
2. The social preference (utility) map
3. In a dynamic context
The transformation frontier
(How do subsidy reductions translate into
environmental benefits)
•
•
•
For all environmental variables!
Requires intricate economic knowledge
(dynamic GE model)
Requires intricate environmental
knowledge (how does economic activity
really affect the environment)
We don’t have this knowledge!
The social utility map
• Basically environmental valuation
• This is a function of environmental quality
• This is a function of the state of the
economy (all economic variables)
We don’t have this knowledge!
We are like a man sent to the
supermarket to buy groceries
• He has a certain amount to spend
• But doesn´t know the price of the goods
(I.e. how much he gets for a given expenditure)
• He doesn’t know the utility generated by
the goods.
What can he do?
The problem is one of
choice under uncertainty
• Only if all outcomes are equally likely will it
be optimal to do nothing.
• Assuming constant risk over choices, the best
choice is to pick the most likely options.
• This is precisely what a good checklist is
supposed to do
• It increases the likelihood of a good choice
Jan Pieters checklist
• Not solidly founded in theory
• But impressively intuitive (and practical)
• Misses two important aspects:
– Corresponding to every subsidy is a tax
– The environmental gains must be valued
• Apart from this I found myself in general
agreement
Flow chart behind the checklist
Description of the subsidy
Policy filter effective
yes
no
Benign alternatives available
no
yes
Conditionality leads to higher
volumes
no
yes
Concentration of market power
yes
Subsidy
removal not
likely to be
environmentally
beneficial
Effects are
indeterminate
no
Environmental variables valuable
no
yes
Subsidy financing “problematic”
no
Subsidy removal likely to be
environmentally beneficial
End