RENSSELAER
Lally School of Management and Technology
Hartford Campus
EMP 26
MGMT 6300 Business Economics
Prof. James P. Stodder
The Economic Value of Oxygen–
The disturbing undervaluation of Amazon rainforest benefits.
John D. Venables
20 February 2006
Business Economics
Market Imperfection of Public Goods
THESIS & ABSTRACT
Global markets fail to appropriately value the Amazon rainforest because the primary benefits
the rainforest provides the world—including vast amounts of oxygen, reduction of greenhouse
gases, global temperature regulation, half of the world’s species and unparalleled biodiversity1
(with its associated but presently undefined medicinal opportunities) plus one fifth of the world’s
fresh water supply—are all public goods. A compelling case in support of this argument might
be made with respect to each of these benefits individually. While these benefits are heavily
interrelated, aside from a few references, the scope of this paper is largely constrained to the
rainforest’s production of oxygen. The Amazon rainforest produces “over 20% of the world’s
oxygen supply”2, allowing all global citizens to benefit, yet no one to actually pay for it.
Amazon deforestation is advancing at an alarming rate because other less vital economic
interests prevail without due consideration of oxygen (or any of the other public benefits)
provided by the rainforest. To overcome the free rider problem, nations should be compensated
for the value of oxygen provided by the rainforest to enable the economic benefit of forest
conservation (production of oxygen) to exceed the economic benefit of deforestation
(unsustainable production of timber and agriculture), such that the interests of the global greater
good prevail.
OXYGEN AS A GLOBAL PUBLIC GOOD
Oxygen must first be established as a ‘good’. Acknowledging some potential for debate, I
contend that oxygen is a good because it is both continuously produced and consumed, and the
production of oxygen, albeit naturally occurring as opposed to occurring via the precise dictates
of man, can be stopped by destroying the “machinery” used to produce the oxygen (that is,
forests). Moreover, oxygen is subject to the economics of supply and demand. This point is
illustrated in an example below—although fortunately most of us have never encountered a
shortage in supply. Since oxygen consumption is essential for life and, aside from other
consumers of oxygen such as combustion and fire, consumption is fixed as a function of animal
respiration, demand is inelastic. Despite the inelastic demand curve, the price to date of oxygen
has been zero (allowing unlimited consumption for free). The inequity of this compensation for
the current output of the rainforest, relative to the opportunity cost of using the rainforests in
other ways, is the challenge presented in this paper.
A public good is hard or even impossible to produce for private profit because the market fails to
account for its large beneficial externalities. An externality occurs in economics when a decision
causes costs or benefits to stakeholders other than the person making the decision, often from the
use of common goods.3 Externalities cause market failure “when the price mechanism does not
take into account the full social costs and benefits of production and consumption.”4 In the case
of the rainforest, deforestation due to logging and agriculture cause the negative externality of
loss of the rainforest and its natural ability to produce oxygen (among other things). The
problem is not just an ethical problem, it is that the true cost to society—the marginal social
cost—is much greater than just the private cost.5
1
Mongabay: Tropical Rainforests of the World (last visited Feb. 17 2006)
<http://rainforests.mongabay.com/0101.htm>
2
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
3
Externalities, Wikipedia (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Externalities>
4
Externalities, Tutor2u, Economics Essential Glossary 2005 <http://www.tutor2u.net/glossary/advanced.asp>
5
Externalities, Wikipedia (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Externalities>
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Market Imperfection of Public Goods
A public good possesses two essential properties: it is non-rivalrous (once it is produced
everyone can benefit from it) and it is non-excludable (once produced it is very difficult, if not
impossible, to prevent access to the good).6 Therefore “non-payers can enjoy the benefits of
consumption for no financial cost.”7 Further, “public goods tend to be relatively indivisible; they
often come in such large units that they cannot be broken into pieces that can be bought or sold
in ordinary markets.”8 Examples of public goods include “… clean air and other environmental
goods.”9 Thus, oxygen is a global public good.
THE PROBLEM WITH OXYGEN
At standard pressure and temperature oxygen exists as a diatomic molecule, O2, in gas form. In
this form, oxygen is colorless—it can’t be seen, touched or tasted, yet it is essential to our very
survival. “Oxygen is a major component of air, produced by plants during photosynthesis, and is
necessary for aerobic respiration in animals.”10 Oxygen makes up about 21% of the earth’s
atmosphere, and derivatives of oxygen such as O3 (ozone) are also critically important to life on
earth.11 Oxygen’s form makes it a most unfortunate natural resource from an economic
standpoint—it is available equally to everyone and it cannot easily be contained, packaged or
sold. There is no traditional market for an item that is free and abundantly available at all points
on earth. Moreover, oxygen’s lack of scarcity causes few ‘consumers’ to give it any thought
whatsoever. Yet without oxygen, otherwise perfectly healthy human beings could not survive
more than a few minutes. To help recalibrate the economic value of oxygen, consider an airplane
cabin depressurization emergency. Who among us in sudden possession of a dysfunctional
oxygen mask would not unhesitatingly be willing to pay $500 to the person seated beside us for
their functional oxygen mask? Considering that oxygen is constantly consumed and must be
constantly produced, how can one assess oxygen’s real economic value, and how will this value
change as production declines?
The atmospheric abundance of free oxygen has largely been driven by photosynthetic
organisms.12 Photosynthesis is the process by which plants use the energy from sunlight to
produce sugar, typically using water and releasing oxygen.13 Photosynthesis allows vegetation to
absorb the carbon dioxide (CO2) created by animal respiration and other factors. The overall
chemical reaction of photosynthesis translates as “six molecules of water plus six molecules of
carbon dioxide produce one molecule of sugar plus six molecules of oxygen.”14 Because its
vegetation continuously recycles CO2, the Amazon rainforest has been described as “the lungs of
our planet.”15 CO2 contributes to the “greenhouse effect”—the warming of the earth’s surface
and lower atmosphere by the conversion of solar radiation into heat. Due to its climate and
6
Public Goods, Wikipedia, (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Public_goods>
Public goods, Tutor2u, Economics Essential Glossary 2005 <http://www.tutor2u.net/glossary/advanced.asp>
8
W. Bruce Allen, Neil A. Doherty, Keith Weigelt, Edwin Mansfield, Managerial Economics: Theory, Applications,
and Cases, 6th ed. (New York: W.W. Norton & Company, 2005), 778.
9
Public Goods, Wikipedia, (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Public_goods>
10
Oxygen, Wikipedia (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Oxygen>
11
Ibid
12
Ibid
13
Photosynthesis (last visited Feb.17 2006)
<http://www.emc.maricopa.edu/faculty/farabee/BIOBK/BioBookPS.html>
14
Ibid
15
Amazon Rainforest (last visited Feb. 17 2006) <http://www.blueplanetbiomes.org/amazon.htm>
7
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Business Economics
Market Imperfection of Public Goods
dense vegetation, photosynthesis occurring in the Amazon rainforest reduces global CO2 while
simultaneously producing more than 20% of the world’s oxygen.16
To further advance this line of reasoning, suppose not 20% but rather 100% of the world’s
oxygen supply was produced by the Amazon rainforest. Would the world’s developed countries
then be compelled to immediately stop, by any means necessary, the current deforestation?
Surely this is so. What percentage, then,—50%, 30%, 25%?—is the tipping point at which the
world will decisively intervene to cease this economic waste of a public good, so essential for
life on the planet?
FREE RIDER PROBLEM
Public goods are a type of market failure where market-like behavior of individual gain-seeking
does not produce efficient results. The production of public goods results in positive
externalities which are not compensated. Consumers are free to take advantage of public goods
without contributing sufficiently to their creation.17 In the case of oxygen all global citizens are
free riders, except for those who own or control the rainforests. The rest of us are continuously
using the output of their asset without compensating them in any way. From a national
perspective, heavily industrialized, wealthy nations, producing carbon dioxide greenhouse gasses
at a faster rate than their ability to convert them into oxygen, are enjoying a free ride on the
backs of the poor nations that own the forests. Free riders do not voluntarily exert any extra
effort or pay any compensation unless there is some inherent benefit or material reward for doing
so18, or unless governmental or other authority requires them to do so.
RAINFORESTS and DEFORESTATION
Today the world’s rainforests cover less than 5% of the Earth’s land surface (less than 2% of the
total surface), and just a few thousand years ago, tropical rainforests covered as much as 12%.19
Tropical rainforests are restricted to the small land area between the latitudes of 22.5º North and
22.5º South of the equator, otherwise known as the Tropic of Capricorn and the Tropic of
Cancer.20 The largest unbroken region of rainforest is in the Amazon River basin of South
America, and over half of this forest lies in Brazil (which equates to about 1/3 of the world’s
total remaining rainforest area.)21 Rainforests are rich in genetic diversity, “70% of the plants
identified by the US National Cancer Institute as useful to the treatment of cancer are found only
in rainforests and less than one percent of tropical rainforest species have been analyzed for their
medicinal value.”22 Rainforests also act as the world’s thermostat by regulating temperatures
and weather patterns.23
16
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
17
Public Goods, Wikipedia, (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Public_goods>
18
Ibid
19
Mongabay: Tropical Rainforests of the World (last visited Feb. 17 2006)
<http://rainforests.mongabay.com/0101.htm>
20
Ibid
21
Ibid
22
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
23
Ibid
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Market Imperfection of Public Goods
Figure 1. Annual Deforestation in the Amazon24
More than one-fifth of the Amazon rainforest has already been destroyed.25 The rate of
deforestation is staggering; “every second the size of a football field is lost, every day the size of
86,400 football fields is lost.”26 In 2004 alone more than 10,000 square miles were destroyed,
an area larger than state of New Jersey.27 Aside from the terrible loss of the rainforest itself, fires
related to the deforestation process have made Brazil one of the top greenhouse gas producers,
producing about 300 million metric tons of carbon dioxide per year. At a conference in 2004,
scientists warned that the increased pace of rainforest destruction has reduced the ability to
absorb greenhouse gases by millions of tons annually.28
Tropical deforestation results in the loss of 100 species per day.29 Some ecologists maintain that
the rate at which species are being lost is so high that, if it continues, paleontologists of the future
will look at the fossil record now being laid down and liken it to earlier mass extinctions such as
the one that killed the dinosaurs.30
THE ECONOMICS OF DEFORESTATION
Rainforests are threatened by unsustainable agriculture, ranching, mining, and logging
practices.31 Some of the deforestation is driven by national and international economic forces but
24
NASA Earth Observatory, Amazon, <http://earthobservatory.nasa.gov/Study/AmazonFire/amazon_fire3.html>
Amazon Rainforest, Wikipedia, (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Amazon_Rainforest>
26
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
27
“The Economy Booms, the Trees Vanish,” The Economist, May 19 2005,
<http://economist.com/agenda/displaystory.cfm?story_id=3996152>
28
Amazon Rainforest, Wikipedia, (last visited Feb. 17, 2006) <http://en.wikipedia.org/wiki/Amazon_Rainforest>
29
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
30
“Saving the Rainforest,” The Economist, May 10 2001,
<http://economist.com/opinion/displaystory.cfm?story_id=E1_GNTVGN>
31
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
25
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Market Imperfection of Public Goods
the majority serves no long term purpose; it results from subsistence activities at the local level.32
Deforestation in the immediate term is presently economically viable for locals as they forsake
environmental concerns in favor of the economic benefit of logging and agriculture.
In most forests, the obvious source of income is timber. Logging contributes 3-6% of the GDP
of tropical countries, and employs 3-8% of the workforce. However it is rarely sustainable
financially, least of all environmentally. Few commercial loggers expect to cut a particular
forest more than once.33 Most of the timber felled illegally in the Amazon rainforest is sold to
domestic buyers, in particular to the construction industry in Brazil’s richer southern states.34
The forest is also threatened by ranching and farming, including the export of soybeans.
Rainforest topsoil is very thin, with most nutrients contained in the upper one or two inches, and
it erodes easily once the shallow network of roots is gone. Extreme degradation of the land,
‘desertification’, occurs rapidly and causes deforestation to continue, each ‘desert’ abandoned for
the next plot of nearly arable land.35 Because farmers do not own the land they are cultivating,
there is no incentive to improve sustainability and little concern for the long-term effects of
erosion and the destruction of animal habitats.36
Under current practices, extractive industries (timber, oil, and mineral) promote development of
the short term booms that encourage permanent settlement. These booms and resulting
settlements can attract large numbers of poor seeking a better life. Once the extraction resource is
exhausted, the industry moves on to new areas leaving behind a degraded environment and
settlers dependent on subsistence agriculture and livestock.37
Worse, decades of successive Brazilian governments were obsessed with populating and
developing Amazonia, apparently worried that otherwise a foreign power might seize it. The
government offered lavish subsidies for people to resettle there. “Economic incentives such as
subsidies and tax breaks for forest developers distort the direct costs of harvesting and converting
tropical rainforests. The result is market failure where the prices of tropical timber products and
other goods derived from rainforest destruction do not reflect the full environmental costs… By
offering these incentives the government effectively makes it profitable for firms to convert
forest for development purposes where it normally would not be profitable.”38
Recent governments have cut these “perverse tax incentives”39 and subsidy schemes that
encouraged otherwise uneconomic forest destruction, and they have also enacted conservation
laws. But the primary aim of the government remains to reduce the high rate of poverty, and the
surest way to achieve this goal is through economic development—often at the expense of
conservation. Moreover, the federal and state institutions designed to protect Brazil’s forests are
32
Mongabay: Threats From Humankind (last visited Feb. 17 2006) <http://rainforests.mongabay.com/0101.htm>
“Not out of the woods,” The Economist, March 13 2003,
<http://economist.com/science/displaystory.cfm?story_id=E1_TGPNDVG>
34
“The Economy Booms, the Trees Vanish,” The Economist, May 19 2005,
<http://economist.com/agenda/displaystory.cfm?story_id=3996152>
35
Newbold, Heather, ed Life Stories (Berkeley: University of California Press, 2000), 206.
36
Schmidheiny, Stephan, “Changing course: A Global Business Perspective on Development and the Environment”
(Cambridge: The MIT Press, 1992), 144.
37
Mongabay: Threats From Humankind (last visited Feb. 17 2006) <http://rainforests.mongabay.com/0101.htm>
38
Ibid
39
“Saving the Rainforest,” The Economist, May 10 2001,
<http://economist.com/opinion/displaystory.cfm?story_id=E1_GNTVGN>
33
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Market Imperfection of Public Goods
weak, poorly coordinated and prone to corruption and influence peddling by illegal loggers and
the farming lobby.40
Perfectly competitive logging or agriculture organizations produce according to market
incentives or private costs. If one firm decides to internalize externalities, it experiences higher
costs than its competitors, likely driving it out of the market. Therefore, some form of collective
solution is required, such as government intervention on a globally cooperative scale.
‘OXYGEN-RICH’ NATIONS VIS-A-VIS ‘OIL-RICH’ NATIONS
Some nations are endowed with natural resources and specialize in the extraction and production
of these resources, for example, the development of the North Sea Oil and Gas in Britain and
Norway.41 Due to the industrial world’s appetite for oil, the wealth of otherwise poor middleeastern nations in natural possession of this resource has been dramatically enhanced. If oxygen
were not a freely distributed atmospheric gas, if it naturally remained where it was produced and
could be contained and packaged like oil, presumably industrialized countries would already be
paying for it. Should economically poor, oxygen-rich nations not be entitled to the same global
economic reward as oil-rich nations? Even more compelling, oil-rich nations deal only in
extraction, they need not maintain the environment in such a way that it continues to produce the
natural resource, in contrast with oxygen-rich nations, which have the added requirement for
continuing conservation and protection of their rainforests.
WHY THE POOREST NATIONS SUPPLYING OXYGEN FOR WORLD
CONSUMPTION SHOULD BE COMPENSATED
Fifty-seven percent of the world’s forests, including most tropical forests, are located in
developing countries, and nearly 90% of the 1.2 million people living in extreme poverty
worldwide depend on forests for their livelihood.42
Like most environmental assets, rainforests are endangered by their status as open-access
resources or as common property.43 The impact of global externalities is felt universally.
Brazil’s level of deforestation is greater than what would suit humanity as a whole. It is rational,
therefore, to devise ways to make conservation of the forest as rewarding for Brazil as it is for
the world, once the broader benefits and opportunity costs are taken into account.44
The rainforests provide vital products and services, among them water filtration and flood
prevention, bio-diversity and medicines, global weather regulation, and greenhouse gases
reduction and oxygen production. The Amazon rainforest supplies one out of every five hours of
oxygen for every human on the planet, and in fact, for every breathing creature. “The
40
“The Economy Booms, the Trees Vanish,” The Economist, May 19 2005,
<http://economist.com/agenda/displaystory.cfm?story_id=3996152>
41
Land, Tutor2u, Economics Essential Glossary 2005 <http://www.tutor2u.net/glossary/advanced.asp>
42
The Nature Conservancy: Facts about Rainforests (last visited Feb. 17 2006)
<http://nature.org/rainforests/explore/facts.html>
43
Mongabay: Threats From Humankind (last visited Feb. 17 2006) <http://rainforests.mongabay.com/0101.htm>
44
“Saving the Rainforest,” The Economist, July 22 2004,
<http://economist.com/opinion/displaystory.cfm?story_id=2941580>
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Market Imperfection of Public Goods
industrialized world must seek to find ways to finance the conservation of the world’s rainforests
by charging those who benefit from them.”45
In this case, global governmental intervention is required to save us from our individualistic
shortsightedness. A potential solution might be a global treaty imposing some form of an
oxygen tax on “consuming nations” to benefit the nations endowed with the rainforests, the
“producing nations”. The objective would be to tip the economic scale toward preservation. A
global oxygen tax could be defined to require strict law enforcement and satellite verification to
prevent payments if illegal or corrupt logging activities occur. It could also include a provision
to allow unencumbered access for scientists to perform non-destructive research of the
rainforests. Potentially a tax formula per hectare (10,000 m²) of rainforest could be devised
based on the density (ability to produce oxygen and reduce carbon) and scope of biological
diversity of the region and other factors, weighed as scientifically appropriate.
In principle, where EV = Economic Value:
EV per Hectare of Rainforest = (EV O2 Production + EV CO2 Reduction) + (EV Biodiversity) +
(EV Fresh Water) + EVn…
Industrialized nations might be assessed their share of the total tax based on a formula of their
nation’s consumption of oxygen combined with their output of carbon dioxide emissions.
While I am unaware of any other oxygen tax proposals, it is interesting that there already is a
proposal for “compensated reduction” of carbon emissions. The scheme would attempt to
discourage deforestation and give developing countries a bigger role in reducing greenhouse
gasses. Countries that reduce deforestation below a certain baseline would be able to sell carbon
certificates, which would theoretically make a hectare of forest more valuable than one of
pasture (though under the current plan not as lucrative as soya).46
In any case, conservation of rainforests offers global benefits and therefore ways must be found
to charge beneficiaries globally.47
COUNTER-ARGUMENTS & CRITICISMS
Economist Ronald Coase argued that individuals could voluntarily organize bargains to bring
about efficient outcomes and eliminate externalities without government intervention. However,
the “Coase Theorem” requires all three of the following: (i) that property rights are well defined;
(ii) that people act rationally; and (iii) that transaction costs are minimal.48 Not only are the
rainforest property rights ill-defined, but voluntary individual regulation to pay for “free” air is
not plausible.
45
“The Economy Booms, the Trees Vanish,” The Economist, May 19 2005,
<http://economist.com/agenda/displaystory.cfm?story_id=3996152>
46
“Saving the Rainforest,” The Economist, July 22 2004,
<http://economist.com/opinion/displaystory.cfm?story_id=2941580>
47
Ibid
48
Externalities, Wikipedia (last visited Feb. 17 2006) <http://en.wikipedia.org/wiki/Externalities>
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Market Imperfection of Public Goods
Libertarians might argue that voluntary or market solutions are preferable to government
provisions in almost every case including traditional public goods such as defense and roads.
However, presently the global market is not effectively controlling the rate of deforestation, nor
even is the local government. A banding together of global interests would undoubtedly be even
more unruly without government support some type of defined treaty or international regulation.
Subjective value criticisms hold that if the economic value of goods is subjective, then there is
no objective way to establish that a particular good is a public good. While this argument might
have merit for the potential value of presently undiscovered medicinal benefits from plants and
rainforest bio-diversity, no one can deny the real global requirement for oxygen and that modern
technology enables the estimation of a country’s CO2 output relative to its O2 output. As long as
the same measurements and methodologies are applied globally, it seems the benefit of a
country’s forests with respect to carbon dioxide reduction and oxygen generation could be
quantified in a reasonably objective manner.
The argument can be made that the Brazilian government should unilaterally solve this problem
by taxing materials such as timber produced from the rainforest to fund conservation efforts, in
effect increasing the price of exports to force global consumers to incur a portion of the cost of
deforestation. Supporters of this approach acknowledge that a multi-national trade agreement
would be required to insure that consumers would not move their demand to alternative sources
of supply and also that careful balancing would need to be managed to ensure that taxes imposed
on deforestation will generate enough revenue to pay for the subsidy supporting sustainable land
use. This tax would still be fueled by deforestation, presumably at a more sustainable rate, but
nonetheless on continued deforestation of ancient rainforests. Further, this approach does not
directly tax the consumers of rainforest O2 production or the benefactors of rainforest CO2
reduction, relying instead on rainforest product consumers to accept higher prices.
CONCLUSION
When a public good, such as a rainforest, is consumed for a local economic benefit without
regard to the positive externalities it provides, the economic market is operating imperfectly.
Global markets fail to fully value the Amazon rainforest because the primary benefits the
rainforest provides, including 20% of the world’s oxygen supply, carbon dioxide reduction,
global temperature regulation, immense biodiversity with associated medicinal opportunities,
and fresh water supply, are all themselves public goods. While these benefits are interrelated, the
economic value of some is more difficult to assess than others. It is the rainforest’s production
of oxygen that forms a seemingly straightforward and compelling case for international
government intervention to correct the market failure. A global oxygen tax levied on developed
nations that excessively produce CO2 while contributing limitedly to the global production of O2,
could be applied to benefit the poorer nations in control of the rainforests that currently have the
opposite balance—a balance essential to life on this planet. Intervention would seek to
overcome the current free rider problem and attempt to compensate the nations in control of the
rainforests in such a way so as to correct the market failure through economic reward of forest
conservation, which would exceed the current economic reward of deforestation, thereby
allowing the overall interests of the global greater good to prevail.
####
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