College of Business: University of Illinois at Urbana-Champaign

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Field of Green: Exploring Environmental Economics


11/27/2007



Don Fullerton considers himself an environmentalist, but he readily concedes that like-minded folks may fervently disagree.

That’s because Fullerton, a visiting professor of finance, is an environmental economist.

“Which is all sort of ironic, because environmentalists tend to hate economists,” he says with a laugh.

But Fullerton explains the divergence in simple terms. He believes that the environmental benefits ought to exceed economic costs of any program to reduce or clean up pollution.

“Environmentalists don’t like that view, because they would always want more pollution abatement. They may believe pollution is inherently wrong, so we should have none of it,” says Fullerton, who arrived at the University of Illinois this fall to join the newly established Center for Business and Public Policy. “That’s not realistic. The only way to have no pollution is to have no economic activity.”

Fullerton has studied how government policies influence consumer behavior in the context of environmental issues. He has focused his research on two hot-button issues: garbage collection and vehicle emissions.

In both spheres, Fullerton has found that government mandates to reduce pollution often fail because governments do not implement the cheapest manner of abatement. For example, costly pollution control equipment may be required on every car, when it could be skipped on cars that are driven very little. In addition, individuals may find ways to get around the mandates, resulting in more environmental damage rather than less.

Making Cents of Waste

Fullerton’s interest in environmental economics was piqued when he saw a Wall Street Journal article 20 years ago about a municipality in Pennsylvania that decided to shun traditional garbage collection and start anew. Instead of collecting a monthly subscription fee, the town initiated a charge based on each bag of garbage collected, assuming that this policy would have the desired effect of reducing pollution and increasing recycling.

But Fullerton found that, in both theory and practice, this isn’t always the case. In one community that changed to the price-per-bag method, he and a graduate student went out into the field and measured the amount of curbside garbage to be collected from 100 households—the weight and the number of bags as well as the weight of the recycling. They measured before the change went into effect and then went back again several months later and repeated the exercise.



What they found was that the number of bags was significantly reduced. In fact, the number of bags fell by 37 percent. However, the weight of each bag increased—so people were simply stuffing more in each bag. The overall weight of their garbage decreased by only 14 percent. And while the amount of recycling went up, the increase was only one-third of the missing garbage amount.

What may account for a lot of the difference is another “market” for garbage—illegal dumping and burning. These illicit practices are difficult to measure, and their ramifications are even more difficult to price in this “market.”

“Yes, a bag of garbage is socially costly,” says Fullerton. “It has external pollution attributes, so many have proposed a charge per bag of garbage. But it is not as costly as that same bag of garbage thrown into the woods or a vacant lot, or thrown out the car window by the side of the road. As soon as you assume that a given bag of garbage is more costly when dumped than when put in a landfill—which must be true— then instead of charging for garbage collection we should be subsidizing it. The policy implications are the exact opposite.”

Fullerton suggests that cities continue municipal garbage service without the price per bag, but market it as a depositrefund system. Instead of bringing those soda bottles back to the store for a mere 10 cents each, this deposit-refund model takes on a more big-picture flavor. When a purchase is made at a store, an extra fee would be collected that would “reflect the social external damages from dumping that item.” The refund then would be “free” collection.

“Cities already do this implicitly when they have sales tax and free collection,” Fullerton says. “The way in which an explicit policy may improve the circumstances a little bit is to have differential rates on products that are more damaging than others.”

Fueling Success

Fullerton sees the regulation of vehicle emissions as a situation analogous to the garbage example, as governments around the world have tried to reduce air pollution by mandating various ways to get people to drive less—and unintended consequences result. Fullerton explains the example of Mexico City, where the government enacted a plan known as “One Day Without a Car,” a program intended to improve air quality in the notoriously dirty city. What it means is that for one day a week, cars with a certain license plate number would not be allowed on the road.

To circumvent this law, families often buy another car— with a different license plate number—usually an older car that has poorer emission controls.

“Mandates certainly can work,” says Fullerton, “but only if the government mandates the cheapest form of abatement. The problem is that the government doesn’t necessarily know what the cheapest forms are, and they usually get it wrong. People have examined these command-and-control mandates, and yes, they can achieve some abatement, but they’re several times more expensive, depending on the program.”

So how do we reduce pollution from vehicle emissions? Just as all garbage pollution can’t be taxed directly—with no way to measure the amount of illegal dumping or burning—Fullerton says that no current mechanism can adequately measure and tax the pollutants an individual puts into the air by driving a car.

“The question, then, is how to design a workable combination of taxes and subsidies: How should policy change the price of each observable driving activity? What should have a higher price, and what should have a lower price? The best pricing would induce the same behaviors you would like to get from an ideal, but unavailable, tax on emissions,” says Fullerton.

His economic analysis shows that:

• While unpopular, a gasoline tax is a logical place to start. “You can tax gasoline at different rates that depend on the composition of the gasoline. You can have a higher rate on dirty gasoline and a lower rate on clean forms of gasoline or ethanol.”
• Vehicles could be assessed an “environment” tax when purchased. “You can have a higher rate on the dirty ones and a lower rate on the clean ones, and you could even subsidize the purchase of the cleaner ones.”
• Annual registration fees, often assessed by state or local governments, could vary in a way that depends on the cleanliness of the vehicle. “So if you want to pay a lower annual fee on your own car, you could take it to the inspection and maintenance facility and fix the broken pollution control system. Even without that annual fee, policy could subsidize people for fixing their pollution control system.”

It’s Not Cheap Being Green

Fullerton sees the public’s acceptance of the reality of global warming as a catalyst for change, on a micro- and macroeconomic scale. In the meantime, he will continue to investigate how to help the environment economically, one car or one garbage bag at a time.

As an economist, he believes he can do that by examining the marketplace and finding policies that will help achieve the cheapest methods of pollution abatement— because the cheaper the methods, the more likely they will be accepted by the public and implemented by policy.

“That’s why a cost-benefit analysis is useful, to design policies that help cut pollution in the cheapest possible ways— then we can afford more pollution control measures than if done in these expensive ways,” he says. “Ultimately, that’s what environmentalists and environmental economists both want— efforts that will have the most positive impact on the environment.”

Sidebar: A Learning Environment That’s Environmentally Friendly

When the new College of Business Instructional Facility opens in the Fall of 2008, it will be the first green building on campus, with a design that makes it not only comfortable and state-of-the-art but also energy efficient and environmentally friendly.

That means it will have more insulation, triple-pane windows, photo sensors to dim the lights gradually as more daylight enters the room, a displacement air system to move cool and warm air more efficiently, plantings on portions of the roof, and minimal paving to help dissipate heat. In addition, a photovoltaic array on the auditorium roof will capture sunlight that will be converted to electricity to provide 8 to 9 percent of the building’s energy needs. Other environmentally friendly measures include automatic and measured lavatories to conserve water and a commitment to recycling construction waste, which at this stage of the building process stands at 90 percent.

By achieving such objectives, it is expected that the facility will receive gold certification through LEED, the Leadership in Energy and Environmental Design rating system of the U.S. Green Building Council.

What does environmentally friendly mean from an economic standpoint? In the case of the Business Instructional Facility, it means that the initial investment in green design will pay significant dividends in energy savings over the life of the building. In fact, computer modeling done by Atelier Ten, an environmental design firm, estimates that the 160,000-square-foot building will be 40 to 50 percent more energy efficient than other campus buildings of comparable size.

“We are exceptionally proud to be the first campus building with the distinction of green design,” says Dean Avijit Ghosh. “As a College of Business, it’s important to us to show leadership in this area. It is another sign of our commitment to innovation and stewardship.”

Sidebar: At the Center - Exploring How Public Policy Impacts the Economy

Don Fullerton is one of 13 University of Illinois faculty members serving as research associates in the College’s newly established Center for Business and Public Policy. The mission of the multidisciplinary Center is to provide intellectual leadership and to promote research that advances our understanding of the effects of public policy on the economic environment in which businesses operate.

Because expenditures by federal, state, and local governments comprise nearly one-fifth of the U.S. Gross Domestic Product, the government plays a variety of roles relevant to business. The government is a consumer of private sector goods and services, a provider of critical economic infrastructure and human capital, an investor in research and development, and a partner or competitor in providing services such as retirement security and health care insurance. In addition, the government writes the rules under which markets operate, with far-reaching consequences in areas as diverse as labor market practices to financial market disclosures to environmental standards. And obviously, as a taxing body, the government significantly influences the behavior of businesses in both product and financial markets.

According to Jeffrey Brown, William G. Karnes Professor of Finance and director of the Center, understanding the impact of public policy is crucial for today’s business leaders. And the Center can play a valuable role in helping that happen. “By supporting leading researchers, the Center will help business operate more effectively in the current policy environment and will also provide guidance to policymakers about the effects of public policy on the economy.”

Faculty Research Associates in the Center for Business and Public Policy:

• Jeffrey Brown, Finance
• Kristine Brown, Labor & Industrial Relations
• Steve D’Arcy, Finance
• Don Fullerton, Finance
• Fred Giertz, Economics
• David Hyman, Law
• David Ikenberry, Finance
• Richard Kaplan, Law
• Charles Kahn, Finance
• George Pennacchi, Finance
• Josh Pollet, Finance
• Michael Weisbach, Finance
• Scott Weisbenner, Finance

Related Information:

Perspectives Magazine - Fall 2007 Issue (PDF file)

UIUC College of Business