Zili Yang’s monograph, titled “The Environment and Externality: Theory, Algorithms and Applications,” was published in December by Cambridge University Press.

“If we don’t cooperate, if each individual strives for their own interest, collectively we create an economy with uncontrolled pollution,” says Yang, a professor of economics who joined Binghamton’s faculty in 2002. “If we cooperate, pollution can be controlled efficiently.”

Some ideas in the book are inspired by the RICE model (Regional Integrated Climate-Economy model) made famous by William Nordhaus. The 2018 Nobel laureate was Yang’s doctoral adviser at Yale University.

Think of the global economy as a cake to be shared among countries. It can be sliced in various ways. Right now, some slices are very large and others are quite thin. As economists think about ways to address climate change and reduce pollution, few if any countries are willing to go away from the table with a smaller piece of that cake.

Yang wants to find a way to divide the cake as fairly as possible. This cutting method is at the core of his work.

Yang begins the new book with a brief discussion of the concept of externality. When some people’s or countries’ welfares are affected by others’ activities without their explicit consent, then externality exists, he writes.

This is a core challenge of environmental economics. Why? Because all pollution hurts people. It may not harm you personally, but it’s hurting someone.

When people, countries or regions cooperate, they internalize this externality. The cake gets bigger, so to speak, but when it’s sliced some countries may still walk away with less than they had before.

“Most times it’s politically infeasible,” Yang says.

His goal? Come up with a cutting method where every country gets a larger slice of the new, larger cake.

The method many economists employ basically says we sum up all agents or countries to form a social welfare function (so 15 countries equals 15). Countries are treated as equals, whether they’re small or large and whether the climate impacts they face are significant or minimal.

“The ‘equal’ way is not fair,” Yang says.

Yang doesn’t think that Fiji and the United States should be weighted equally, for example. He would say 15 countries equals n; if you’re more significantly affected, you should be expected to do more to fix the problem. Likewise, if a country is responsible for more emissions, it should be responsible for more mitigation costs.

His method recognizes that countries have to see how their circumstances will be improved. “You can’t force people to collaborate if it makes them worse off than when they weren’t cooperating,” he says.

Yang is also the author of “Strategic Bargaining and Cooperation in Greenhouse Gas Mitigations,” published in 2008 by MIT Press.

In his earlier work, Yang worked with the RICE model to “cut the cake” fairly. What he came up with took months of trial and error.

In the new monograph, he outlines an algorithm that makes an accurate cut on the first attempt, no trial and error required. He says the outcome and its elegance surprised him.

“I apply the theory and try to tell non-economists about it so it can be useful in policy,” Yang says. “My conclusion is unique.”

Other methods rely on a second round of “cake cutting” to ensure greater fairness. Yang attempts to build in that fairness to start, then executes just one round of cutting. Most models accommodate three regions; his allows many more.

Some of Yang’s thinking is also based on understandings of bargaining that come from the work of Nobel laureate John Nash. In the early 1950s, Nash articulated the strategic interactions possible between two or more decision makers.

How do we make sure two people (or countries, or regions) want to cooperate? Yang says you have to ensure that both are better off if they work together than if they do not.

This is one reason that Yang is somewhat critical of the Paris climate accords; he thinks they don’t call for enough cooperation. The climate targets are too rigid, and countries’ actions are too independent, he says.

Yang hopes the ideas in his new book will be put to practical use. He provides all the algorithms so others can check his work, and the publisher will make a paperback copy available for sale, which may make it appealing as a textbook.

Jon M. Conrad, professor of resource economics at Cornell University, says the book will become an essential text for graduate-level courses in environmental economics. “Yang does a masterful job of determining the optimal level of externality in both static and dynamic models under cooperative, non-cooperative and coalitional solutions,” he wrote in a review of the book.

Yang sees himself as a scientist out to challenge established ways of thinking.

“You have to be skeptical,” he notes. “I don’t necessarily accept established results without questioning them. You want to find something other people haven’t noticed.”

This is what she sees: People pay extra for an Energy Star home, expecting its greater energy efficiency will save money. They apparently plan to recoup the extra cost of purchase by passing it along to the next owner. Except they don’t, Carrión-Flores says. “People who pay a premium expect increased value,” the environmental economist says. “Developers are selling houses at a premium, but when I analyze the repeat sale, the owners are not selling at a premium.”

Carrión-Flores looked at sales of homes in Gainesville, Fla., from 1997 to 2009. She corrected for differing neighborhoods, arm’s-length transactions, house layout and the collapse of the housing market in 2008. The numbers tell a very real story: Within five years, owners no longer recoup the extra cost to buy Energy Star’s efficiencies. Carrión-Flores has several hypotheses:

• The federal Energy Star program didn’t keep up with local building codes. In the first years of the study, Energy Star homes were 20 percent more energy efficient than houses built simply to code. But by the last years, local code had become more stringent, and Energy Star homes were only 13 percent more efficient. That makes the Energy Star home’s value difficult to compare.
• Owners don’t know how to market their Energy Star homes. It’s not as simple as laying out a year’s worth of utility bills because of variations in individual energy use — such as how warm or cool one keeps a house or how much laundry one does or how long the lights are left on.
• The original owners are satisfied with the lower utility costs and don’t feel the need to recoup the investment through a higher sale price.

Carrión-Flores notes that Gainesville is just one market. Others have different building codes, housing stock and energy needs. Energy in Gainesville is primarily electricity to power air conditioners while other markets need natural gas or oil to provide heat. Some markets have older housing or static codes, or both. “The story is more complex than we think,” says Paul Hirsch, an environmental studies professor at the SUNY College of Environmental Science and Forestry who focuses on environmental policy and sustainable development. “None of these things have one variable.”

If your answer is the first farmer, you are in good company. For decades, economists could find no monetary benefit to managing access to groundwater. But, as researchers at Binghamton have proven, you and all those economists are wrong.

“We know that groundwater is a problem around the world,” environmental economist Neha Khanna says. “Groundwater is being depleted. You can talk to anybody on the street and they’ll say, ‘I know that, and we need to start thinking about it.’ Strangely, though, economists have always believed that if we put in some sort of system to manage water, it wouldn’t lead to much gain in terms of overall welfare. We have pretty much ignored the issue.”

In the 1980s, several prominent economists analyzed the possibilities. They found such marginal gains from managing access to groundwater that it became an established result among economists: There’s no reason to implement water-management systems. They even gave it a name, the Gisser and Sanchez Effect, after the authors of a seminal 1980 paper.

A different approach

Models in the economics literature have treated the physics of water flow in a simplistic way, notes Khanna’s colleague Andreas Pape, assistant professor of economics at Binghamton. The traditional method — the “bathtub model” — supposes that when you draw water from an aquifer, the water level drops evenly thoughout. But a bathtub is a poor stand-in for an aquifer, he says. For one thing, the depth of the water is irregular because water moves gradually through the ground rather than instantly like a giant underground pool. Changes in the type of rock or soil surrounding the water also affect how quickly the water flows through the ground.

“If you take a straw and suck some water from a glass, you can see the level of the water dropping evenly,” Khanna says. “But that doesn’t happen in an aquifer. The water is flowing through the materials in the soil: the sand, the clay and so on. It’s more like when you take a sip of a smoothie through a straw. You can sometimes see a little depression right around the straw. And that’s what happens with groundwater around a well.”

Hydrological models, on the other hand, do a much better job of mapping and predicting water flow in aquifers. Such models are of vital importance to states that rely heavily on agriculture, and these states often employ hydrologists who study water resources in great detail. Their models, however, don’t generally take economic concerns into account. For example, Khanna says, these calculations wouldn’t be concerned with how “expensive” water is; that is, whether it is easily accessible or must be pumped from a great depth.

An interdisciplinary team at Binghamton set out to build an economic model with a more sophisticated view of the physics of water flow, one that could take advantage of the latest geographic information systems (GIS) data. Economists Khanna and Pape were joined by their doctoral student, Todd Guilfoos, as well as hydrologist Karen Salvage.

What they came up with combines an optimization model — that’s the traditional economics piece — and a simulation model, which is where the hydrogeology comes in. Tying it all together was Pape’s expertise in agent-based modeling, a technique that’s becoming more mainstream even though its use in economics is still fairly new.

After developing confidence in the model during trials with hypothetical scenarios, they were ready for a real-life challenge. Guilfoos settled on California’s Central Valley Aquifer, where Bakersfield is the major population center. Kern County, Calif., had GIS maps that included detail about which crops were being grown. Some crops use more water than others — alfalfa needs more water than carrots, for example — Guilfoos says, and that information was used as a proxy for demand for water in the model. They also included information on well location, long-term precipitation that recharges the aquifer and much more. With help from Kevin Heard, assistant director of Binghamton’s GIS Campus Core Facility, the economists imported these GIS maps into their model.

“Twenty years ago, maybe even 10 years ago, we didn’t have the computing power to do this,” Khanna says. But these new tools provide a way to reexamine issues in economics, even ones that seem to have been settled definitively.

One scenario in the Binghamton model supposes there’s no management: Farmers take as much water as they want. The other, Pape says, involves taxing the water extracted at each well to curb overuse of the aquifer. “Then,” he says, “we compare the long-term profits of the farmers under the two scenarios and measure the difference.”

The findings

Previous work showed very small gains from water-management plans. The new model shows savings of several magnitudes higher when the hydrogeology is taken into consideration. It predicts increased profits for Kern County farms involved in a water-management system — over the course of perhaps 80 years. “That’s how far into the future we’re looking,” Guilfoos says, “but they actually start to see profits much, much earlier than that, within a decade or so.”

Farmers understand at one level that they have an impact on each other, he says, but because aquifers are so large, the individual farmers don’t necessarily see that their use has much of an effect on water levels. The model shows that heavy users would receive more benefits from a management system, he says.

And when the economists talk about “benefits,” they mean actual dollars and cents, not just a feeling of moral superiority: “We found that there is, in fact, a lot to be gained in terms of economic welfare from managing water,” Khanna says.

How is that possible? Pape puts it this way: “Let’s say there are two neighboring farmers. Each is trying to decide, ‘Should I withdraw another gallon of water today?’ Suppose that if he does, he adds $1 to his future pumping costs and $1 to the pumping costs of his neighbor. So the public cost — the total social cost — of the pumping is $2, but the private cost — the cost facing just him — is $1. Left to his own devices, the farmer will consider the cost to be $1 and impose the extra cost on his neighbor. Since pumping seems cheap to him ($1 instead of $2), he pumps more than he would otherwise. However, his neighbor is making the same decision! As a result, they both impose extra costs on each other.

Both neighbors would be better off if they chose to pump less, that is, if they recognized that the cost of pumping is $2, not simply $1. The policy remedy in this case, therefore, is to assign a tax of $1. Then both farmers will be deterred from overdrawing water, making them both better off.”

The tax is essentially a tool to bring about the conservation of water, Guilfoos notes. “This conservation of water decreases the cost of extracting water in the future, and people don’t have an incentive to save water for the future on their own,” he says. “Conserving water reduces farmers’ profits now but increases the farmers’ total profit in the long run. And we demonstrate that conserving groundwater can be significant to long-term profits, which is new to economics.”

As the group begins to look at other aquifers, Guilfoos says, they are seeing some variations. “The significance of the gains depends on the aquifer,” he notes. “We did find significant gains in Kern County. We found small overall gains in another aquifer in Pecos, Texas. Not all aquifers are going to have large gains; it depends on the dynamics of demand, well placement and how fast the water moves.”

Guilfoos has presented the Kern County research at several conferences, and the team recently submitted a paper to Environmental and Resource Economics, a flagship European journal, for review. Guilfoos is focusing on new data from Kansas now. Through the Kansas Water Office, he obtained detailed maps on well location, soil types and crops. This has enabled him to develop detailed economic models for the Kansas section of the Ogallala aquifer, the largest in the United States.

Policy implications

“Now we can say it’s important to manage water,” Khanna says. “But the next question is, ‘How do we manage that water?’ As an economist, the ultimate driver for me is a desire to affect policy.”

As the team looks to policy recommendations, they’ll try to assess what can be done reasonably, given the current economic and political environment. Which policy should be pursued? Should there be a price for water? Should states consider managing well locations? How do you get the stakeholders to talk to one another, especially when the boundaries of an aquifer don’t necessarily line up with county or state lines?

Guilfoos notes that the implementation need not be mandated from the top down. There are lots of ways to manage water resources, he says, from the local level up to the federal level. He and his colleagues do see an opportunity to influence policy, likely starting with the Kansas project, as there’s already the political will there to make changes.

Once there’s an American example, Khanna envisions putting the research into practice in arid regions of countries such as China, India and Spain. She says, quite simply: “We need to look at this collectively.”

In a study published recently by The Journal of Socio-Economics, Yang reports that an aversion to the number 4, combined with a preference for the numbers 6 and 8, may translate into a “surcharge” of as much as 1.4 percent of China’s gross domestic product.

In China, the world’s second-largest economy, superstition plays an important role in the pricing of consumer goods. The number 4 shares the same sound as “death” in Chinese; 6 is a lucky number that represents “smooth”; and the number 8 sounds like the word “prosperity” in Chinese.

It’s not uncommon for a culture to have such preferences, Yang notes: Consider Americans’ aversion to the number 13. The difference is that the Chinese superstition has significant economic implications.

Yang, who grew up in China and travels there several times a year, had made casual observations about the effect of these superstitions in the past. When he set out to test his theory, he hired someone to collect random prices from Chinese shops without telling him what kind of research he was doing. In the end, Yang analyzed more than 11,000 Beijing-area prices of items in five categories: food, electronics and appliances, clothing, real estate and services.

“Through meticulous analysis of the collected data, I conclude that retailers in China could have gained as much as an extra 4.16 percent by manipulating price tag numbers to take advantage of superstitions,” he writes, “which could translate into as much as 1.40 percent of annual GDP in 2007, where these retailer gains are consumer losses.”

Essentially, any time a Chinese retailer changes the price of an item to avoid the number 4, he uses a higher number. The practice leads to higher prices; Yang found that 4 is significantly under-represented and that 8 is significantly over-represented in the final digit of prices.

Previous studies in marketing journals have identified this pattern, but haven’t addressed the winners and losers it creates. “The use of superstitious numbers in pricing and the exploitation of superstition in retail sales is more than a cultural phenomenon,” Yang writes. “Given its ubiquity, the use of superstitious numbers in prices should not be viewed as a mere marketing gimmick either.”

It’s this conclusion that distinguishes Yang’s paper, which was highlighted in the January/Febrary edition of Harvard Business Review.

“Consumers overpay for what they purchase in China in general,” he says. “There’s a lot of profit margin, which means there’s a lot of room for manipulation.”

Yang, whose research primarily focuses on energy and environmental economics, tackled the question of lucky numbers on a lark. He may return to this topic for a future project, though: He’d like to examine consumer purchase patterns as they relate to “lucky” numbers in China.

“If global warming is factually true — and I’m not making a scientific judgment here — then a rational government should do something,” said Yang, a professor of economics. “And suppose, hypothetically, that climate change is not true. You can burn fossil fuels all you like. Sooner or later you will still run into a situation that requires you to adopt a new technology. If we use climate change as an excuse for arriving sooner at alternative energy, it does not hurt anybody.”

Yang uses game theory to create a cost-benefit analysis of actions countries could take to curb global warming. His work is not political, but rather applies modeling and logic to the issue. “Advocates make the argument, sometimes without justification, and are quite emotional,” he said. “My approach shows the incentive to do something.”

Yang believes that the economic issues associated with climate change must be considered in tandem with the natural sciences. Researchers who work from this multidisciplinary perspective have created “integrated assessment,” or IA, models, which take into account climatology, ecology, regional sciences and engineering as well as economic concerns.

There are several IA models, including an influential system that Yang had a role in developing while he was a graduate student at Yale University in the 1990s. That model, named RICE (the Regional Integrated Model of Climate and the Economy), is fairly simple and small, said Yang, who has also worked on much larger models.

Yang said he thinks a small model such as RICE is “beautiful,” though the algorithm and simulation scenarios might seem complex to non-experts. “A simple model can tell more stories,” he explained.

In his book, Yang takes the RICE model and brings it to bear on another hot area in economics: game theory. Game theory allows economists to examine the decision-making process in a scenario in which there are multiple people making decisions and those actions affect the other people.

Yang writes in Strategic Bargaining and Cooperation in Greenhouse Gas Mitigations that he observed integrated assessment and game theory as “twin peaks in economic research on climate change” unconnected by any bridge. He set out to change that, with a powerful computer and research funding from the Department of Energy.

Among the book’s most important conclusions is that climate agreements cannot require too much of industrialized nations or too little from the rest of the world. “With climate change, everybody contributes to the problem,” Yang said. “Everybody emits CO2. And the environmental damage will be felt by everybody. So in that situation, it is not efficient to have only some countries shoulder the burden.”

Yang’s research has attracted international attention. Yang spoke last summer at a climate-change conference in Venice and spent the fall 2009 semester on sabbatical at the Université Catholique de Louvain in Belgium.

“Zili Yang’s book provides a clear explanation of important analytical tools that are crucial to understanding and analyzing a country’s incentive to control climate change,” said Carlo Carraro, an environmental economist who is rector of the University of Venice and was an organizer of the conference there. He added that Yang’s model provided “crucial information” to policymakers who participated in the 2009 climate negotiations in Copenhagen.

Influencing such discussions is at the core of Yang’s ambitions for his work.

“Fifteen years from now, from a science point of view, everything about climate change should be clear,” he said. “But at that time, will human beings still be able to do something? It’ll probably be too late. Now people debate whether global warming is true. What economists can do is to suggest some kind of reasonable policy approach.”