Pegram Lecture 3, August 10, 2012

Resilience and the
Knowledge Revolution™
Pegram Lecture No 3
Brookhaven National Laboratories, LI NY
Graciela Chichilnisky
www.chichilnisky.com
UNESCO Chair in Mathematics and Economics
Columbia University

Columbia Consortium for Risk 1
Management (CCRM)
www.columbiariskmanagement.net

Human impact on the environment
is uncertain
CLIMATE CHANGE
and
BIODIVERSITY DESTRUCTION

These are global problems.
They are new. Science is uncertain.

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INTERGOVERNMENTAL PANEL ON CLIMATE CHANGE
SCIENTIFIC ASSESSMENT OF CLIMATE CHANGE
Policy-Makers Summary
July 1990

Under a Business-as-Usual Scenario of Greenhouse Gas Emissions:

●Global Mean Temperature will increase at a rate of 0.3°C per
decade
(with uncertainty range of 0.2°C to 0.5°C per decade)
1°C above present by 2025
3°C above present by end of next century

●Rate of increase will be uneven and will vary regionally (e.g. ,
higher over land).

●Global Mean Sea Level is expected to rise 6 cm per decade (with an
uncertainty range of 3-10 cm per decade
20 cm above present by 2030
65 cm above present by end of next century
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● Most of the destruction of the
earth’s ecosystems is driven by
economic incentives

●Forests, where most known
biodiversity resides, are cleared
for the extraction of natural
resources (oil, wood products) or
to give way for cash crops and
grazing
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The globalization of the world
economy since World War II has
intensified a pattern of resource
use by which developing nations
extract most natural resources,
exporting them to industrial nations
at prices that are often below
replacement costs
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To solve the environmental dilemma
we must cut the link between resource
use and economic progress.

The key is to achieve a new type of
industrialization, which is not based on
resource exports:

a knowledge intensive form of
economic progress.
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● We must incorporate the
dynamics of markets in the
management of ecosystems

● The market has become a
key institution in the
destruction of the earth’s
ecosystems. No policy that
ignores this fact can succeed.
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MARKETS

are the dominant institution in the
global economy.

As the century turns, the market itself
is evolving.

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TWO MAJOR TRENDS
 The Knowledge Revolution

 Global Environmental Issues

Lead to new and fundamental
different types of markets

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Markets are widely used institutions
They are decentralized, and can be
efficient.

But global environmental markets
trade unusual goods: privately
produced public goods
Biodiversity is one
The planet’s atmosphere is another
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EXAMPLES
 The trading of SO2 in the Chicago
Board of Trade since 1993, following
the Clean Air Act
 The CO2 Kyoto Protocol carbon
market
 Water markets in Australia – water is
the most scarce resource in the
world today
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Market for Emission Permits*

Annex I Countries are given
allocations of property rights on
emissions summing up to the 1990
level, and they can trade these freely
among themselves*

* Chichilnisky and Heal “Carbon Taxes and Markets for Emissions Rights” OECD 1995

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● Environmental Markets*

● Markets for Knowledge

Both trade new and different types
of goods:

Privately Produced Public
Goods (PPP)
* Environmental Markets: Equity and Efficiency, G.Chichilnisky and G. Heal, CUP, New
York 2000
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The Knowledge Revolution™
In many countries, is leading to a
new economy, with different
environmental problems and new
opportunities for action.

Examples: California USA, Asian
Tigers and Little Tigers, parts of
India and Barbados.
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The Knowledge Revolution

 US leads the pack because of its
property-rights systems and financial
markets.

 Japan lost in the software race
because of property-rights systems.

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● This is not a ”service economy”
as was previously thought.

● It is a new economy using
knowledge rather than capital as
the most important input of
production.

● Fossil fuels are now replaced by
information technology
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Sunrise sectors are knowledge intensive: (1) IT, (2)
biotechnology, (3) telecommunications, (4) financial
markets, (5) health services, (6) entertainment and
culture.

MORE AMERICANS WORK IN BIOTECHNOLOGY THAN IN THE
ENTIRE MACHINE TOOL INDUSTRY

MORE AMERICANS MAKE SEMICONDUCTORS THAN
CONSTRUCTION MACHINERY

THE TELECOMMUNICATIONS INDUSTRY IN NORTH AMERICA
EMPLOYS MORE PEOPLE THAN THE AUTO AND AUTO PART
INDUSTRY COMBINED

FOSSIL FUEL IS REPLACED BY INFORMATION TECHNOLOGY

Management (CCRM)

“New Economy” Examples
 The US health and medical industry
alone has become larger than
defense, and also larger than oil
refining, aircraft, autos, auto parts,
logging, steel and shipping put
together
 More Americans work in
biotechnology than in the entire
machine tools industry
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Consumers now spend more on
home electronics than on new cars

 $95 billion a year on home
computers, TVs and stereos.

 $85 billion a year on new cars.

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Productivity is driven by the
knowledge sectors
 According to the Federal Reserve
Board, US industrial production in
1997-98 increased at a strong 4.1%
annual rate, 4.4% during 1996.

 Take away computers and
semiconductors and the rate drops to
2.2%
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Productivity is driven by the
knowledge sectors
 According to the Bureau of Economic
Analysis, total US industrial
production in 2002-2003 increased
at a 2.17% annual rate, 4.19%
during 2000.
 Take away the production of
computers and electronic products,
and this drops to 1.72% (2003) or
3.41% (2000).
www.bea.gov: Gross Output by Industry in Current Dollars
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The New Economy Starts to Hit Home
Increases in personal spending:
Key old economy items
Motor vehicles: 0.3%
Food: 0.6%
Major Appliances: 1.1%
Clothing: 2/3%
Average: 0.9%

Key new economy items
Home telephone services: 8.8%
Entertainment & recreation services: 12.4%
Cable TV: 13.4%
Brokerage and other financial services: 15.6%
Average: 12.5%

Source: Business Week, March 23, 1998

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● Today more Americans
make semiconductors than
construction machinery

● The telecommunications
industry in North America
employs more people than the
auto and the auto parts
industries combined
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Source: “Comparing economic and scientific wealth” of the article “The Scientific Impact of Nations”
by David A. King, Nature, July 15, 2004, p. 311-316.

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Source: World Bank. www.worldbank.org.

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Sources: US Bureau of Economic Analysis (BEA) 2012 data www.bea/gov. World Bank. www.worldbank.org

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Sources: World Bank. www.worldbank.org. World Resource Institute (WRI). www.wri.org

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Sources: US Bureau of Economic Analysis (BEA) 2012 data. www.bea/gov
Energy Information Administration (EIA). www.eia.doe.gov/
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LEADING THE WAY TO ECO-FRIENDLY PROFITS
Some major manufacturers have decided to do more than reduce
waste and clean up pollution. They are developing products and
processes that make it profitable to be environmentally friendly.

DUPONT has co-developed 3GT, a bioengineered polyester fabric
made from cornstarch that is lower in cost than oil-based
polyester and can be recycled indefinitely.

SONOCO has created an rectangular “paper can” for Lipton Iced
Tea that is 70% recyclable.

3M has developed a plastic coating for the Navy to replace paint
on trucks, ships and trains. It’s lighter than paint, which leads to
greater fuel efficiency.

S.C. JOHNSON reformulated Raid roach killer, converting from a
solvent-based to a water-based formula.

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ELECTROLUX’ environmental products, including solar-powered
lawn mowers, chain saws lubricated with vegetable oil, and water
saving washing machines, generated 3.8% higher profits last year
than the company’s conventional products.

TOYOTA is introducing a hybrid car that gets 66 mph on a
combination of gasoline and electricity.

A. FINKL & SONS, a Chicago steel forger, recycles more than 955
of its solid waste and has cut energy use by 36.4% over 10 years,
making it one of the most efficient forgers in the world.

BRITISH PETROLEUM has invested $160 million in developing solar
energy and is building a completely solar-powered Olympic village for
the 1998 Summer Games in Australia.

Carbon Capture and Enhanced Oil Recovery (EOR) can produce 23
years of additional petroleum consumption without imports in the US
(DOE)

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The Developing World can leapfrog
and avoid resource intensive
industrialization

The successful Asian tigers relied on
technology exports, such as consumer
electronics

In the last ten years India developed a
Software industry worth $10 Billion USD in
exports to 36 countries, one of the most
dynamic in the world

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In recent years, nearly one-third
of new tech companies in the
Silicon Valley have been
headed by Indian or Chinese
executives

USA Today, February 24, 1999

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Knowledge intensive growth is
here today.

It is the future.

How to achieve the transition
with minimum cost?
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Knowledge and Global
Environment Assets

 Are not standard public goods such
as law and order

 They are mostly produced privately,
rather than by the government

 They are costly to produce
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Privately Produced Public Goods
are goods which are not “rival” in
consumption, but are privately produced.

We all produce emissions but the
atmosphere is the same for us all.

We produce knowledge privately but can
share all of it with others without losing it.

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Knowledge and Global Environment are

Why are they public goods?

● Knowledge is not “rival” in
consumption – it can be shared
without losing it

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Similarly

 Global environmental assets such as
the carbon content of the
atmosphere are one and the same
for everybody on the planet. These
are physical properties, independent
of the economic institutions.

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The Paradox of Knowledge
 It is costly to produce

 It can be duplicated without losing it. It
can be shared at no cost

Because it is costly, without property rights, such
as patents, there is no incentive to produce
knowledge.

Example: Japan has no property rights on
software, and produces almost none.
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Yet because it can be shared at no cost, any
restriction on the use of knowledge is inefficient.

For example:

Patents are inefficient because they are
monopolies (J. Stiglitz)

We need new systems of property rights for
knowledge.

What is the solution?

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Markets for PPP goods are
different from the classical
markets.

They require new systems of
property rights.

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Traditional Markets
First Theorem of Welfare Economics

The allocation resulting from a competitive
market equilibrium with private goods is
Pareto efficient.

This theorem is independent of the distribution
of property rights. For example, all but two
traders may have zero endowments of
property rights and the resulting equilibrium
is still Pareto efficient. This requires all goods
to be private goods, with rival consumption,
and privately owned.

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Public goods change matters
A public good is a good which is not
“rival” in consumption: this is not an
economic or legal definition but
rather a physical constraint.
Examples: Knowledge , the
concentration for CO2 or CFC’s in the
atmosphere or the planet, available
biodiversity is the planet.
This leads to
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A New First Welfare Theorem in Markets
with

in which equity and efficiency are closely
linked

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are goods which are not “rival” in
consumption, but are privately
produced.

We all produce emissions but the
atmosphere is the same for us all.
We produce knowledge privately but
can share all of it with others without
losing it.
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A competitive market with property
rights on knowledge
An economy has H countries or traders who
consume N private goods and one public
good, Knowledge. They trade private
goods x ∈ RN and licenses giving the rights
to use knowledge, a ∈ R.

Trader h has finite resources which are
allocated to produce either private goods
or knowledge.

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For each trader, there is a tradeoff
between producing more private goods
and producing more knowledge.
However, more knowledge leads to
higher productivity. Formally

∀h xh = φh (ah, a), with ∂φh < 0,
∂ah
a = Σah and ∀h , ∂ xh > 0
∂a
or a = sup H h
h∈ a

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Countries or traders have property rights
Ωh ∈ RN on private goods and own
licenses that allow them to use
knowledge, ah ∈ R.

Traders derive utility from use of private
goods x.

Through negotiable licenses knowledge is
available to all.
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Traders may use their licenses to
access knowledge or may sell their
licenses in the market. If they wish
to use more knowledge than their
licenses allow, they buy more
licenses in the market.

Markets for licenses are
competitive.

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Market equilibrium with knowledge

Each trader maximizes welfare

Max uh(xh)

s.t. xh = φh (ah,a) + q (ah – ah)

i.e. the value of consumption equals the value
of production plus the value of licenses bought
or sold, and all markets clear:

Σa h = Σa h = a
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First Welfare Theorem for Markets with
Theorem

In and economy with k≥2 traders, j≥1
private goods and a privately produced
public good, there exists at most a one-
dimensional manifold of property rights
allocations on the use of the public good
(allocation of “permits”) from which the
competitive equilibrium is Pareto efficient.

This is the Manifold of Efficient Allocations of
Property Rights
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Theorem 1
(Chichilnisky, Heal and Starrett, 1993)*

There is only a finite number of ways
of distributing licenses of property
rights on the use of PPP goods
between the traders so that the
market equilibrium in Pareto
efficient.

*Environmental Markets: Equity and Efficiency, CUP Chichilnisky and Heal 2000

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Policy

Those who have fewer endowments
of private goods must be endowed
with more property rights on the use
of the PPP good. Otherwise, the
market does not operate efficiently.

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● Efficiency and distribution are
connected in markets with PPP goods.

● A measure of equity is necessary for
efficiency.

● Markets with knowledge and
environmental assets require equity
for efficiency

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Policy Conclusions
 Markets with knowledge require some
equity to function efficiently
 It is standard to favor lower income
groups in knowledge-use. Examples are
school subsidies for low income groups
and SUN Microsystem’s GDP dependent
price lists.
 The system of property rights proposed
here is different from patents, because
there is no exclusivity. Patents are
exclusive
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Policy Conclusions
 The system proposed here consists of
negotiable licenses which are accessible to
all, together with a covenant and a system
of property rights allocation (such as
auctions) that favors those with low
income.
 There exists microchips (Wave
Technology, Inc.) that can measure the
use of knowledge as required for the
implementation of these results.
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Traders may use their licenses to
access knowledge or may sell their
licenses in the market. If they wish
to use more knowledge than their
licenses allow, they buy more
license in the market.

Markets for licenses are competitive

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General Market Equilibrium of two nations trading knowledge and private goods

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A VISION OF A NEW ECONOMY
Very innovative in the use of knowledge

Very conservative in the use of resources

Centered on diversity and human capital

New types of markets based on property
rights of enviromental use and knowledge

Offering the prospect of substantial economic
progress without damaging the ecosystems
that support life on Earth

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US Policy in the World Economy:
 Help create International Markets for
Trading Property Rights on the Use of
Global Commons
 Possibly in conjunction with GATT or WTO
 Ensure Efficient Market Functioning for
which
 Those regions with fewer endowments of
private goods must be endowed with more
property rights on the common
environmental assets. Otherwise the
market cannot operate efficiently.

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● What are the institutions
needed to implement
emission trading?

● How to ensure efficiency
and fair trading?

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To answer these questions, a
global financial mechanism
must be designed that reflects
full equitable and active
participation of developing and
industrial nations

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An International Bank for Environmental
Settlements can help achieve this goal
 the IBES will help to obtain economic
value from environmental assets
without destroying them
 will help bridge the gap between
developing and industrial countries
 Will provide a forum for adjusting to
new scientific findings

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The IBES could help organize and
broker:
 The trading of rights on the use of
global airwaves
 The trading of rights on greenhouse
gases emissions and biodiversity use
 The trading of environmental bonds
and earth stocks
 The trading of options and other
derivatives based on the above
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The IBES could also
 Securitize profit sharing agreements
on genetic blueprints
 Securitize profitable investments in
aquifers, watersheds, biological soil
enhancement and fisheries
 Provide bridge financing and credit
enhancement facilities for all the
above
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The case for an International Bank for
Environmental Settlements (IBES)
Based on new economic findings on
the existing proposal for trading
carbon permits, an IBES can be
created which

●will be self-financing
●will offer a combination of markets
solution and continuing multilateral
negotiations
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An International Bank for
Environmental Settlements (IBES)
 GIVES ACCESS TO INTERNATIONAL
CAPITAL MARKETS FOR FUNDING
CONSERVATION

 TO ALLEVIATE DEFAULT RISKS:
CREDIT ENHANCEMENT BY WORLD
BANK OR GEF

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The population explosion since
World War II put stress on water
resources globally

Clean water is the most scarce
resource around the world

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● IBES provides an institutional framework
that combines the best aspects of free
markets and multinational policy

● IBES can offer a continuing way to draw
capital from global financial markets to
support global environmental policy

● IBES will regulate and monitor compliance
of trading of carbon permits globally
(borrowing, lending and derivatives)

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Policies To Avert Climate Change
Policies to prevent climate change
focus mainly on curtailing emissions
of carbon dioxide (CO2), the most
important greenhouse gas.
● Regulatory Approaches
● Market Approaches
--- Carbon Taxes
--- Joint Implementation
--- Tradable Permits
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Policies To Prevent Climate Change

Carbon Taxes
A mechanism to reduce carbon emissions is a carbon tax –
a tax levied on all fossil fuels in proportion to their carbon
contents.
●By raising the cost of fuels and energy intensive products,
this tax would discourage all fossil fuel use in proportion to
their carbon contents and encourage the development of
less carbon-intensive alternatives.
●A recent statement by leading economists favors taxes
over a regulatory approach. However, taxes increase
government’s intervention in the economy and are out of
public favor in today’s market-oriented environment

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Joint Implementation

This is a mechanism that allows a firm in one
country to invest in a project that reduces
emissions in another country, and to receive
credit for those reductions at home. It was
proposed by President Clinton on October 22,
1997. An example might involve Norway and
Poland. International joint implementation of CO2
emissions reductions would allow a utility in
Norway to achieve an emissions reduction by
contracting to pay a factory in Poland to install
more fuel-efficient furnaces
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Tradable Permits

● This is the most market-oriented and efficient approach,
which is already used for sulfur dioxide permits in the
Chicago Board of Trade

● One argument for tradable permits is the perceived
political difficulty of proposing a change in the tax structure

● The most difficult issue in the use of tradable permits is
how to allocate them to potential users. For small fuel users
tradable permits could cause administrative burdens

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Carbon taxes or tradable permits increase
the cost of energy and could reduce
economic growth. Different models show
different impacts.

Despite the complexity of the models, only
a handful of easily understandable
assumptions are important in determining
the simulation results.

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THE PREDICTED IMPACTS ON GDP IN 2020 OF STABILIZING
CO2 EMISSIONS AT 1990 LEVELS: THE EFFECT OF CHANGING
UNDERLYING ASSUMPTIONS

Source: Shackleton, R. et al (1992) The Efficiency Value of Carbon Tax Revenues. Washington, D.C.: U.S. Environmental Protection Agency.

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The International Bank for
Environmental Settlements
Win-Win Solutions

● Uncertain though they are, there are costs associated with
doing nothing in the face of rising greenhouse gas
concentrations.

● The few models that do take expected damages from
climate change into account predict that a carbon tax set at
an appropriate rate, with revenues recycled efficiently back
into the economy, actually improves economic welfare
(Nordhaus and Young, 1996; Jorgenson et al., 1995;
Nordhaus, 1994, 1993).

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GDP LOSS (1990-2010) UNDER ALTERNATIVE
RECYCLING OPTIONS

Source: Shackelton, R. et al (1992) The Efficiency Value of Carbon Tax Revenues. Washington, D.C.: U.S. Environmental Protection Agency.

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A Win-Win Proposal
 A market-based approach

 Global Trading, Clearing and
Settlement of Tradable Carbon
Permits

 International Bank for Environmental
Settlements (IBES)
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 A market-oriented institution

 Acts as an intermediary, organizes and
regulates global trading of carbon permits
and other environmental assets

 Governance and operating budget decided
by the nations of the world

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The IBES Mandate

● To enhance wealth generation while protecting
the environment.

It will accomplish this by:

● Providing liquidity and economic return from
environmental assets (such as forests) while
ensuring judicious use.

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How IBES Operates

Preserving national sovereign rights, IBES will:

- Act as an intermediary in multilateral
borrowing and lending of permits
- Trade options on carbon permits in the
future
- Clear and settle multinational transactions
- Ensure market integrity and efficient price
mechanisms (such as SEC, CFTC)
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How IBES Operates

- Once the world’s ceiling of emissions is
agreed upon, permits can be allocated
following a sliding rule
- Starting from today’s usage, the rule moves
towards an incentive system allocating more
to those who emit less
- Auctions can be used to allocate permits
efficiently

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The IBES: A Win-Win Solution

The industrial nations have more capital. The
developing nations are richer in the
environmental account. They emit less carbon
and have most of the world’s forests and 80% of
its biodiversity. According to the economic
models, there are gains to be made from trade
while insuring judicious use of environmental
assets.

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Source: Earthrends World Resource Institute (WRI)

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Source: Chichilnisky, G. and Eisenberger, P. Energy Security, Economic Development and Global Warming: Addressing
short and long term challenges. International Journal of Green Economics, 2009

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Sources:
1. FloodSmart.gov
2. California Department of Insurance
3. California Department of Insurance and National Association of Insurance Commissioners (the two sources differ by $.1) http://www.
aic.org/Releases/2007_docs/NAIC_Releases_Homeowners_Ins_Report.htm, and http://www.
naic.org/documents/research_stats_homeowners_sample.pdf

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Sources: Duncan Foley, “The Economic Fundamentals of Global Warming” 2007
http://www.santafe.edu/research/publications/workingpapers/07-12-044.pdf

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Sources: Millennium Ecosystem
Assessment. Ecosystem and Human
Well-Being: Biodiversity Synthesis(2005)
http://www.millenniumassessment.org/en/i
ndex.aspx

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Pegram Lecture 3, August 10, 2012

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