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Managerial, Institutional and Evolutionary Approaches to Environmental Problems: Welfare and Policy Implications Jonathan Michie University of Oxford and Christine Oughton SOAS, University of London

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Title: Managerial, Institutional and Evolutionary Approaches to Environmental Problems: Welfare and Policy Implications Jonathan Michie University of Oxford and Christine Oughton SOAS, University of London


1
Managerial, Institutional and Evolutionary
Approaches to Environmental Problems Welfare and
Policy Implications Jonathan Michie University
of Oxford and Christine Oughton SOAS, University
of London
  • New Directions in Welfare
  • A conference for economists and policy makers
  • St Catherines College, Oxford University
  • Oxford 29 June - 1 July 2009

2
  • Climate change is the greatest challenge
    facing humanity at the start of the 21st Century.
    Failure to meet that challenge raises the spectre
    of unprecedented reversals in human development.
  • United Nations Development Programme (2008),
    Human Development Report 2007/08

3
Welfare Effects
  • Negative externalities generate social costs
  • In the case of environmental damage, social costs
    may be
  • difficult to observe
  • greater in countries far from where they were
    generated
  • greater in the future than at the time of
    generation

4
  • The nature of the problem

5
Source United Nations Development Programme,
Human Development Report 2007/08
6
Source United Nations Development Programme,
Human Development Report 2007/08
7
  • Recent observations confirm that, given high
    rates of observed emissions, the worst-case IPCC
    scenario trajectories (or even worse) are being
    realised. For many key parameters, the climate
    system is already moving beyond the patterns of
    natural variability within which our society and
    economy have developed and thrived. These
    parameters include global mean surface
    temperature, sea-level rise, ocean and ice sheet
    dynamics, ocean acidification, and extreme
    climatic events. There is a significant risk that
    many of the trends will accelerate, leading to an
    increasing risk of abrupt or irreversible
    climatic shifts.
  • The International Scientific Congress on
    Climate Change 10-12 March 2009 Copenhagen

8
  • Does standard economic theory provide an adequate
    framework to deal with environmental problems,
    their welfare implications, ethical issues and
    policy design?
  • What can managerial, institutional and
    evolutionary approaches offer?

9
Standard Neoclassical Analysis
  • Based on a representative firm or agent
  • Firms behaviour is explained by assuming
    instrumental rationality decisions are reduced
    to calculus and marginal analysis
  • There is no scope for managerial
    decision-making
  • Cost curves are assumed to be well behaved
  • Innovation is a bolt on to standard analysis
  • Consumer preferences are exogenous

10
Standard Welfare Analysis
  • It is possible to identify an optimal level of
    pollution or abatement
  • For example, in the case of carbon emissions, the
    optimal level occurs where the marginal abatement
    cost equals the marginal social cost of carbon
  • Market based instruments e.g. carbon trading
    schemes can be shown to be efficient

11
Problems
  • Are cost curves well behaved?
  • The representative agent/firm whom/what does it
    represent (Kirman, 1992)?
  • Innovation how do firms innovate?
  • Is there a trade-off between abatement and social
    cost?
  • Rationality is instrumental rationality an
    adequate model of business and consumer behaviour?

12
Badly-behaved cost curves?
The chief obstacle against which they firms
have to contend when they want gradually to
increase their production does not lie in the
cost of production which, indeed, generally
favours them in that direction but in the
difficulty of selling the larger output of
goods Sraffa (1926, p. 543) at the empirical
level, nobody doubts that in any economic
activity which involves the processing or
transformation of basic materials in other
words, in industry increasing returns dominate
the picture. Kaldor (1972)
13
The myth of the representative firm
  • The question of what makes for good policies
    is what the business management field is all
    about.
  • in most of economics, firms are treated as
    simple entities management chooses the policies
    that will maximize firm profits. The question
    that is at the centre of concern in the business
    management field is assumed trivial to answer.
    And since it is, all firms in the same economic
    context are presumed to have the same policies
    those that are best in that context and to do
    the same thing.
  • (Nelson, 1991, p. 347)

14
Innovation
  • To be successful in a world that requires that
    firms innovate and change, a firm must have a
    coherent strategy that enables it to decide what
    new ventures to go into and what to stay out of.
    And it needs a structure, in the sense of mode of
    organization and governance, that guides and
    supports the building and sustaining of the core
    capabilities needed to carry out that strategy
    effectively.
  • If one thinks within the frame of evolutionary
    theory, it is nonsense to presume that a firm can
    calculate an actual best strategy. A basic
    premise of evolutionary theory is that the world
    is too complicated for a firm to comprehend, in
    the sense that a firm understands its world in
    neoclassical theory. (Nelson, 1991, pp. 68-9)

15
Systems of Innovation
  • the network of institutions in the public and
    private sectors whose activities and interactions
    initiate, import, and diffuse new technologies
    (Freeman, 1987, p. 1).

16
Institutions
  • That institutions affect the performance of
    economies is hardly controversial. That the
    differential performance of economies over time
    is fundamentally influenced by the way the
    institutions evolve is also not controversial
    the institutional framework (of rules, norms, and
    enforcement characteristics) together with the
    traditional constraints (budget, technology) of
    economic theory determine the opportunities
    available at any moment in time. (North, 1993,
    pp. 242-243).

17
  • A central insight provided by the
    systems-of-innovation approach is that firms do
    not generally innovate in isolation, but do so in
    interaction with other organizational actors
    (such as other firms, universities, or
    standard-setting agencies) and that this
    interaction is shaped by (and shapes) the
    framework of existing institutional rules (laws,
    norms, technical standards). The approach takes
    into consideration the actions of both firms and
    governments. In short, this conceptual approach
    regards innovation as a process of interactive
    learning. (Edquist, 2001, p. 1623)

18
Implications
  • A major implication of the characteristics of
    cumulativeness, tacitness, and partial
    appropriability of innovation is the permanent
    existence of asymmetries among firms, in terms of
    their process technologies and quality of output.
    That is, firms can be ranked as better or
    worse according to their distance from the
    technological frontier. (Dosi, 1988, 1155-1156

19
Is there always a trade-off?
  • The Porter Hypothesis and SEM question the
    trade-off between abatement and profitability
  • If innovation and SEM are profitable why dont
    all firms use them?
  • Firms environmental strategies are subject to
    bounded rationality and/or procedural rationality
  • Suggests a role for policy to overcome bounded
    rationality and lock-in to procedural rationality
  • Strategic environmental management and regulation
    can become important competitive tools

20
Strategic Environmental Management
  • The opportunities for this kind of strategic
    repositioning are thought to originate in broad
    social and environmental trends. Hart (1997)
    argues that while bottom-up pollution-prevention
    programs have saved companies millions of
    dollars (67-68) with increased cost savings
    and hence profits coming from reduced waste and
    energy use the best is yet to come. He points
    to the smaller number of firms that have begun
    reorienting their long term strategies, and plans
    for revenue growth, around solving sustainable
    development problems where their basic
    capabilities give them expertise. (Goldstein,
    2002, p. 497).

21
Evidence and policy implications
  • Goldstein (2002) looked at environmental projects
    in 17 companies, 16 increased profitability
  • Cambridge Econometrics and AEA Technology
    undertook 65 case studies and found significant
    cost savings from increased resource productivity
    (both as a of value added and as a of
    profits)
  • Role for policies to promote training in SEM

22
Rationality
  • Does instrumental rationality provide an adequate
    model of agents behaviour?
  • What about other models of rationality?
  • Bounded rationality
  • Procedural rationality
  • Expressive rationality
  • Kantian Rationality
  • How do we explain cooperative behaviour and
    trust, do institutions matter?
  • Do firms have an ethical or CSR dimension to
    their strategies?

23
The Tragedy of the Commons
  • No
  • Externalities Externalities
  • Externalities (1, 1) (5, 0)
  • No externalities (0, 5) (3, 3)

24
The Tragedy of the Commons
  • No
  • Externalities Externalities
  • Externalities (1, 1) (5, 0)
  • No externalities (0, 5) (3, 3)

25
Limits of Instrumental Rationality
  • Two so-called irrational agents could do better
  • Its not easy to explain cooperation under IR
    it can be done (e.g. Axelrod, 1981) but it
    requires
  • an indefinite time horizon (and therefore a
    belief in the possibility of ones own
    immortality) and the existence of a player (or
    group of players) who starts by cooperating
  • or a finite time horizon and asymmetric
    information with the injection of a rogue
    irrational cooperative player (e.g. Kreps and
    Wilson)

26
Policy Implications
  • Neoclassical analysis relies on market-based
    instruments that change monetary payoffs
  • Managerial approaches point to regulatory
    policies that rule out certain strategies and
    policies that catalyse innovation (possibly in
    combination with taxes)
  • Voluntary business policies rely on cooperation
    depend on other models of rationality
  • Innovation and SEM change the structure of the
    game (relative payoffs)
  • International agreements change the game from
    non-cooperative to cooperative

27
Voluntary Actions, Rationality
28
Regulation, Innovation and Abatement
29
Complex Systems Theory
  • Views the economy as part of a complex system,
    made up of many different agents
  • Complex systems may be distinguished from simple
    systems by virtue of the fact that the actions of
    individual agents have macroeconomic or system
    wide effects
  • Allows the incorporation of different managerial
    strategies, institutions, innovation, diffusion,
    lock-in and evolution

30
Examples of System Wide Effects
  • Externalities that result in system wide
    changes
  • Firms cutting back production ? unemployment and
    recession
  • Lock-in to inefficient technologies
  • QWERTY keyboard
  • Petrol cars
  • Carbon intensive technologies

31
Sources of Lock-in
  • Economies of scale in production
  • Network externalities
  • System effects in education and training
  • Conventions in production (by firms) and transfer
    of inefficient technologies to developing
    countries
  • Inertia in consumption patterns

32
Policies to deal with lock-in
  • Market based instruments may not be effective (in
    isolation) at dealing with lock-in
  • Regulatory instruments, such as standards,
    conventions may be more effective and induce
    innovation
  • Training in SEM
  • Policies for creation and diffusion of innovation
  • Policies to nudge consumer choices
  • International coordination

33
Conclusions
  • Market based instruments are good at changing
    financial incentives they may induce technical
    change but they dont help much with lock-in and
    they ignore other determinants of innovation
  • Managerial, institutional, evolutionary
    approaches offer a wider and more sophisticated
    set of policy instruments
  • We need a better theoretical understanding of
    firms behaviour and of complex systems

34
  • To achieve the societal transformation
    required to meet the climate change challenge, we
    must overcome a number of significant constraints
    and seize critical opportunities. These include
    reducing inertia in social and economic systems
    building on a growing public desire for
    governments to act on climate change removing
    implicit and explicit subsidies reducing the
    influence of vested interests that increase
    emissions and reduce resilience enabling the
    shifts from ineffective governance and weak
    institutions to innovative leadership in
    government, the private sector and civil society
    and engaging society in the transition to norms
    and practices that foster sustainability.

International Scientific Congress on Climate
Change 10-12 March 2009 Copenhagen
35
  • Tim Foxon, Jonathan Köhler and Christine Oughton
    (eds) 2008, Innovation for a Low Carbon Economy,
    Edward Elgar.
  • Complexity Economics for Sustainability
  • ESRC seminar series is organised by Dr Tim Foxon
    (Principal), Dr Terry Barker, Professor Jonathan
    Michie and myself
  • Simon Dietz, Jonathan Michie and Christine
    Oughton (eds) The Political Economy of the
    Environment, Routledge, forthcoming.

36
  • First seminar held at Oxford University November
    2008 papers can be found at
  • http//www.see.leeds.ac.uk/research/sri/projects/e
    src-research-seminar-series.htm
  • Second at University of Bolzano
  • http//www.unibz.it/en/economics/events/Innovation
    Systems_researchseminar.html
  • Third at University of Leeds 23-24 June 2009
  • Next seminar
  • 3-4 December 2009, University of Cambridge
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