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Pollution control with uncertain stock dynamics: When, and how, to be precautious

Stergios Athanassoglou and Anastasios Xepapadeas. Journal of Environmental Economics and Management (2011), doi:10.1016/j.jeem.2011.11.001

Abstract:

The precautionary principle(PP)applied to environmental policy stipulates that,in the presence of un certainty,society must take robust preventive action to guard against worst case outcomes.It follows that the higher the degree of uncertainty,the more aggressive this preventive action should be.This normative maxim is explored in the case of a stylized dynamic model of pollution control with uncertain(in the Knightian sense)stock dynamics,using the robust control framework of Hansen and Sargent [12]. Optimal investment in damage control is found to be increasing in the degree of uncertainty,thus confirming the conventional PP wisdom.Optimal mitigation decisions,however,need not always comport with the PP.In particular,when damage-control investment is both sufficient lycheap and sensitive to changes in uncertainty,damage-control investment and mitigation may act as substitutes and a PP with respect to the latter can be unambiguouslyirrational. The theoretical results are applied to a calibrated linear-quadratic model of climatechange. The analysis suggests that a reversal of the PP with respect to mitigation, while theoretically possible, is very unlikely.

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Keywords: Knightian uncertainty, robust control, precautionary principle, pollution control, stock dynamics

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