Double Irreversibility and Environmental Policy Timing

Authors


  • We would like to thank Stéphanie Jamet (OECD) and Julien Hugonnier (EPFL and SFI). We are grateful to the participants at the Environmental Meetings CORE-EUREQua-ECONOMIX for their comments. We also thank the participants at the “Monte Verità Conference on Sustainable Resource Use and Economic Dynamics – SURED 2008” that took place on June 1–6, 2008 in Ascona (Switzerland) and the participants at the conference “Frontiers in Environmental Economics and Natural Resources Management – AFSE 2008,” June 9–11, 2008, Toulouse, France.

Aude Pommeret, University of Lausanne and IMUS, Université de Savoie (IREGE-University of Savoie), 44 chemin de Bellevue, 74940 Annecy-le-Vieux, France (aude.pommeret@univ-savoie.fr). Fabien Prieur, LAMETA, University Montpellier I and INRA (prieur@supagro.inra.fr).

Abstract

The timing 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. The environmental policy we consider consists in increasing the natural assimilation rate. Solving the model in closed form then provides solutions for both the optimal pollution level and the optimal environmental policy timing. Finally, we provide a numerical example with the purpose of appraising which irreversibility has the prevailing effect and what is the overall impact of both irreversibilities on pollution and policy timing.

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