Double Irreversibility and Environmental Policy Design

The design of environmental policy typically takes place within a framework in which uncertainty over the future impact of pollution and two different kinds of irreversibilities interact. The first kind of irreversibility concerns the sunk cost of environmental degradation; the second is related to the sunk cost of environmental policy. Clearly, the two irreversibilities pull in opposite directions: policy irreversibility leads to more pollution and a less/later policy while environmental irreversibility generates less pollution and a more/sooner policy. Using a real option approach and an infinite time horizon model, this paper considers both irreversibilities simultaneously. The model first is developed by paying particular attention to the option values related to pollution and policy adoption. Solving the model in closed form then provides solutions for both the optimal pollution level and the optimal environmental policy timing. Finally, the model is "calibrated" with the purpose of appraising which irreversibility has the prevailing effect and what is the overall impact of both irreversibilities on pollution and policy design.

[1]  Franz Wirl,et al.  Consequences of irreversibilities on optimal intertemporal CO2 emission policies under uncertainty , 2006 .

[2]  Charles D. Kolstad,et al.  Fundamental irreversibilities in stock externalities , 1996 .

[3]  Robert S. Pindyck,et al.  Irreversibilities and the Timing of Environmental Policy , 2000 .

[4]  Klaus Keller,et al.  Uncertain climate thresholds and optimal economic growth , 2004 .

[5]  Janice C. Eberly,et al.  A Unified Model of Investment Under Uncertainty , 1993 .

[6]  Alistair Ulph,et al.  Global Warming, Irreversibility and Learning , 1997 .

[7]  Thomas Pfeiffer,et al.  The Irreversibility Effect and Agency Conflicts , 2012 .

[8]  Charles D. Kolstad,et al.  Learning and Stock Effects in Environmental Regulation: The Case of Greenhouse Gas Emissions , 1996 .

[9]  Christopher E. Clarke.  A Question of Balance , 2008 .

[10]  Nicolas Treich,et al.  Decision-Making Under Scientific Uncertainty: The Economics of the Precautionary Principle , 2003 .

[11]  R. Pindyck.  Irreversibility, Uncertainty, and Investment , 1990 .

[12]  W. Nordhaus.  Managing the Global Commons: The Economics of Climate Change , 1994 .

[13]  C. Henry.  Decision-Making Under Scientific , Political and Economic Uncertainty , 2006 .

[14]  J. Michael Harrison,et al.  Instantaneous Control of Brownian Motion , 1983, Math. Oper. Res..

[15]  C. Henry.  Investment Decisions Under Uncertainty: The "Irreversibility Effect." , 1974 .

[16]  William D. Nordhaus,et al.  Managing The Global Commons , 1994 .

[17]  Bruce A. Forster,et al.  Optimal pollution control with a nonconstant exponential rate of decay , 1975 .

[18]  Larry G. Epstein.  DECISION MAKING AND THE TEMPORAL RESOLUTION OF UNCERTAINTY , 1980 .

[19]  Marcel Boyer,et al.  Bayesian Models in Economic Theory , 1984 .

[20]  A. Beltratti.  New directions in the economic theory of the environment: Growth with natural and environmental resources , 1997 .

[21]  C. Taylor,et al.  Stern Review: The Economics of Climate Change , 2006 .

[22]  K. Arrow,et al.  Environmental Preservation, Uncertainty, and Irreversibility , 1974 .

[23]  Alejandro Mosiño.  Producing energy in a stochastic environment: Switching from non-renewable to renewable resources , 2012 .

[24]  Caam Cees Withagen,et al.  Optimality of irreversible pollution accumulation , 1996 .

[25]  A. Fisher,et al.  Global Warming, Endogenous Risk, and Irreversibility , 2002 .

[26]  Xin Guo,et al.  Irreversible Investment with Regime Shifts , 2002, J. Econ. Theory.

[27]  G. Chichilnisky.  Global Environmental Risks , 1993 .

[28]  Richard S.J. Tol,et al.  The marginal damage costs of carbon-dioxide emissions’ , 2005 .

[29]  Robert S. Pindyck,et al.  Optimal timing problems in environmental economics , 2002 .

[30]  Fabien Prieur,et al.  The environmental Kuznets curve in a world of irreversibility , 2007 .