To enhance the effectiveness of environmental policies, psychology is often adopted to design policies that speak to people’s hearts. We take a look at environmental economics and policy, as well as behavioural economics to explore how psychology can help reverse environmental damage. 

Notable American Economist Paul Krugman has been worried about the depletion of natural resources as global modern consumption rapidly soars: “We are living in a finite world. It requires us to adapt our economy to the reality of more expensive resources”. Within the last few centuries, environmental degradation and resource depletion has been occurring at an unprecedented rate, and anthropogenic factors have been identified as the ultimate contributing factor. Since humans are the major cause of environmental problems and human behaviour is largely driven by economic forces considering the pervasive role commerce plays in our daily lives, economics can potentially be a powerful tool to solve environmental problems, too.

Definition of Environmental Economics

Environmental economics is an area that studies the financial impact of economic policies, in which the overarching idea for this branch of economics is that environmental goods have economic value and their usage entails economic costs. An unregulated environmental good leads to “Tragedy of the Commons”, a phenomenon where individuals have access to a common-pool resource and act in their own interest, at the expense of other individuals. This can result in overconsumption, underinvestment, and depletion of resources. For instance, the overgrazing of grasslands or pollution of rivers by factories. These common-pool resources, when left unregulated, are almost certainly doomed to be destroyed. 

How then, do we prevent this “tragedy” from happening? Many environmental economists draw on the power of psychology, or, in other words, behavioural economics. 

What is Behavioural Economics?

In the 1980s, psychologists Amos Tversky and Daniel Kahneman invented a groundbreaking theory called loss aversion, postulating that “losses loom larger than gains”. They believe that losses create greater emotional impacts than equivalent gains. While the biological reason for this interesting behaviour is still unknown, the asymmetry in how human beings respond to equivalent monetary losses and gains can be harnessed to design effective environmental policies. Following this train of thought, charging people who do not recycle is more effective than rewarding those who do.

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environmental economics and policy Using Psychology in Environmental Economics and Policy

In 2015, the city of Hong Kong charged 50 cents for a plastic carrier bag and one year later, a drastic reduction of 90% in the use of plastic bags was reported. This is more effective than any previous policies that released on rewarding shoppers for bringing their own reusable bags. Similarly, plastic deposit funds – where consumers are charged more for plastic bottles and other goods with the promise of getting their deposit back – are more effective than measures that pay people to recycle. This is because consumers loathe losing the deposit they pay for bottles if they fail to recycle them. In Denmark and Sweden, their deposit-refund-schemes witnessed a high return rate at 80%. 

Hyperbolic discounting predicts that people choose short-term gratification over larger, longer-term rewards. Henry Ruderman, an economist from the California Institute of Technology,  found that consumers applied an implicit discount rate of 80% when deciding whether to invest in energy-efficient appliances. Hence those who pay $1 for an incandescent light bulb are unwilling to pay $5 for a fluorescent light bulb that lasts more than 5 times longer. The high discount rate suggests that governments should introduce mandatory standards to remove low-efficiency appliances from the market. Following this belief, Singapore set a minimum energy performance standard for air-conditioners while the EU banned energy-inefficient refrigerators. 

As the effects of climate change become more dire, from the recent fatal floods in China to the widespread wildfires across Europe and North America, it is clear that our natural resources are significantly threatened. It is crucial that we understand the worrying state of the global environmental situation and take action to protect the future of our economies and the world.  Fortunately, the actions we need to take can start small, and applying environmental economics and policy in governments, as well as behaviour economics, can help make a dent in reducing our current environmental degradation