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Polluting the Poor? A Market Solution to Our Pollution Problems

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In December 1991 World Bank chief economist Lawrence Summers signed an internal memo that seemingly endorsed the economic logic of polluting poor countries. As a policy matter, the memo defended “MORE migration of the dirty industries to the LDCs [Less Developed Countries]” for three reasons. First, it was less costly for “lowest wage countr[ies]” to absorb a higher share of the world’s pollution and toxic waste because the “foregone earnings” arising from “health impairing pollution” in these countries were so low. Second, since African countries “were vastly UNDER-polluted…and their air quality…probably inefficiently low,” exporting some “initial increments” of pollution to Africa “would probably have very low cost.” And third, pollution reduction “could be welfare enhancing” to people in rich countries where “[t]he demand for clean environment for aesthetic and health reasons” was higher than in poor countries.

When the memo got leaked to the public in February 1992, the reactions were swift. Environmentalists denounced it; the World Bank disavowed it; and Summers quickly disowned it. “[T]he way those thoughts were expressed [in the memo],” Summers admitted in 1998, “wasn’t constructive in any sense” when discussing “real issues about trade-offs between growth and the environment.”

Despite the controversy, Summers has made a compelling argument in the so-called “toxic memo” for how we can tackle the world’s pollution challenges. Does it make economic sense to have a poor country share a rich country’s pollution? Maybe it does.

According to the first fundamental theorem of welfare economics (FTW), when commodities are traded at publicly known prices and all agents are price takers, the market will find a way to ensure allocation is such that no one is made better off without simultaneously making at least one person worse off. That, in a nutshell, is what economists call Pareto efficiency. It’s Pareto efficient to transfer pollution from the rich to the poor provided that it is implemented through the competitive market.

Suppose that pollution is a commodity that can be traded at a publicly known price in the international market. By FTW, pollution will be Pareto efficiently allocated. Since multiple Pareto-efficient outcomes can result from a competitive market, it is possible that one such outcome is an inequitable allocation of pollution between rich and poor countries.

Let’s consider Nauru, a small Micronesian island country in the South Pacific with a population of 9,434 and a land area of 21 square kilometers. Nauru has a per capita GDP of $5,000 (2005 est.), placing it below 159 other countries. Nauruan life expectancy is 61.96 years for men and 69.47 years for women, significantly below the average life expectancy of 80 years in the industrialized world. Despite these statistics, the country is unique for being one of the world’s smallest polluters. According to the World Health Organization (WHO), Nauru released an annual average of 110.33 metric tons of CO2 into the atmosphere from 1991-2010.

Now let’s consider the United States with its population of 314 millions and land area of 9.8 million square kilometers. The U.S. has a per capita GDP of $51,749 (2012 est.), placing it above 180 countries in the world. American life expectancy is 76.19 years for men and 81.17 years for women. Unlike Nauru, the United States is one of the world’s biggest polluters, releasing an annual average of 5,416,659 metric tons of CO2 into the atmosphere between 1991 and 2010.

Given these glaring contrasts between the United States and Nauru, it is logical under FTW for the United States to sell its pollution to Nauru in the free market. Assuming no logistic and transaction costs, the United States and Nauru can enter into a bilateral agreement in which the United States would “dump” 100,000 metric tons of its CO2 in Nauru every year for the next 10 years, and in return the United States would compensate Nauru with a negotiated annual payment of, say, $100 million to offset potential health risks Nauruans would face. Under such arrangement, Americans are better off because they are breathing in less pollution, while Nauruans are no worse off because they are being compensated accordingly for any pollution-induced health impairments.That's Pareto efficiency.

Although the above argument is meant to help us think about the challenge of global pollution, it is not meant to be taken seriously as a practical policy prescription for two reasons. First, it is unrealistic to expect no logistic and transaction costs. Logistically, we do not (yet) have the technology to capture, store and transport a specified amount of pollution without incurring very high cost. In addition, finding countries willing to consume pollution at a given price is hard enough; negotiating an enforceable contract whose terms are satisfactory to all parties involved is even harder. Second, there are legitimate moral concerns that can and do prevent market-based solutions from receiving proper consideration in the policy arena.

Even so, the free market, whatever its moral limits, does seem to offer, in theory, some promising solutions to the world’s current pollution problems.