Essays in environmental market design

Abstract

This thesis consists of three essays on the design of environmental markets in the face of fast-approaching climate change. The first essay studies a water market used by irrigated farms inhabiting a connected river network in Australia's southern Murray-Darling Basin during a period of substantial environmental change (2007-2015). It uses new panel data to estimate shadow values of water for each farm from production functions identified with regulatory variation in river diversion caps. The estimates imply that observed water trades increased irrigated agricultural output by approximately 4-6%. Without this reallocation, output is the same as under an 8-11% uniform reduction in water resources, roughly the median reduction predicted for this region under 1C of global warming. The value of the water market is increasing and highly convex in water scarcity, with realized gains an order-of-magnitude greater during drought, concentrated in regions with stricter diversion limits and among farms with less rainfall. This suggests that retrospective analyses may understate the future value of trade in a changing climate and that a water market is an important institutional adaptation to climate change.

The second essay, written jointly with Daron Acemoglu, shows that, in a model without commitment to future policies, geoengineering breakthroughs can have adverse environmental and welfare effects by changing the (equilibrium) carbon price. In our model, energy producers emit carbon, which creates a negative environmental externality, and may decide to switch to cleaner technology. A benevolent social planner sets carbon taxes without commitment. Higher future carbon taxes both reduce emissions given technology and encourage energy producers to switch to cleaner technology. Geoengineering break-throughs, which reduce the negative environmental effects of the existing stock of carbon, decrease future carbon taxes and thus discourage private investments in conventional clean technology. We characterize the conditions under which these advances diminish--rather than improve--environmental quality and welfare, and show that given current estimates of costs and environmental damages, these conditions are likely to be satisfied.

The third essay, written jointly with Daniel Aronoff, introduces an empirical framework for valuing dynamic decentralized markets in environmental offsets. Such markets can provide flexibility to conserve a public good at lower cost, but raise concerns if offsets cannot perfectly substitute for the original public good. In our model, producers undertake long-run conservation activities to produce offsets, which they can either sell to individuals seeking to deplete the public good, or store costlessly on a ledger. The market clears in each period to maintain the total stock of the public good above a certain historical level. We estimate this model for a decentralized market in Florida wetlands, in which land developers purchase offsets from private producers to meet their obligations under the Clean Water Act. Our approach provides a way to (i) estimate the private gains from trade, (ii) predict the imperfect substitutability, in terms of flood risk, between extant wetlands and newly-created wetlands, and (iii) assess alternative market designs that preserve the original conservation objective but incorporate location-based pricing.