Posts in Free Market Environmentalism

In his book on the history of environmental controversies, A Climate of Crisis: America in the Age of Environmentalism, Patrick Allitt provides context for the debates. As two different reviewers point out, though, he misses the importance of the free market environmentalist perspective.

Writing in the Wall Street Journal earlier this year, Jim Huffman's review of the book praises Allitt’s reasoned approach:

Climate change has been the dominant environmental concern of the 21st century. Public discussion of the topic is less an informed exchange of ideas than a strident debate pitting alarmists against deniers—at least that is how each side labels the other. Both are secure in the knowledge that truth, reason and the moral high ground undergird their positions.

And thus it has always been with environmental policy. There was a brief period of productive collaboration during the Johnson and Nixon administrations, but thereafter "green" politics settled into a stark polarization as issues like hazardous waste, environmental racism, acid rain, the ozone layer and the Amazonian rain forest each came to the fore. Climate change is just the latest chapter.

It is this larger story that Patrick Allitt tells in A Climate of Crisis: America in the Age of Environmentalism. In recounting partisan battles, Mr. Allitt's objectivity is refreshing.

Allitt may be fair in his critique, but Huffman suggests he misunderstands the importance of free market environmentalism:

Mr. Allitt's critique of the relentless crisis mentality will lead many environmentalists to dismiss the book as anti-environmental, while anti-environmentalists will object to his conclusion that much conservation has been achieved at little cost to ordinary Americans.

Yet for all its balance, Mr. Allitt's account falls short in two important respects. He misunderstands "free-market environmentalists" and bundles them with the "Sagebrush Rebellion" of the late 1970s and the "Wise Use" movement of the late 1980s. There is little that connects them. While the last two, like today's protesters at Cliven Bundy's ranch in Nevada, advocated for state rather than federal control of the vast public lands of the West, they were dependent on the largess of a friendly public landlord. Free-market environmentalists urged property-based solutions, spurring tradable emission permits, congestion pricing on roadways, volume-based trash-collection fees, transferable ocean-fisheries quotas, and numerous other market approaches. Even EPA administrators "eventually realized," in Mr. Allitt's words, "that it would be better to allow manufacturers to trade in the right to pollute."

Yesterday, writing for the Library of Law and Liberty, Bill Dennis made a similar observation in his review of the book:

James Huffman, in his April 24, 2014 review of the Allitt book in the Wall Street Journal, correctly says that Allitt confuses the free market environmentalists and their property rights based perspective, with the Sagebrush Rebellion of the late 1970s and the Wise Use movement of the late 1980s that advocated state rather than national control of the public lands in the West and continued government subsidies for productive uses. Suffice to say, a property rights approach to environmental use was not a priority of these latter movements. But it is much worse than this, except for a few scattered paragraphs (mentioning, e.g., Terry Anderson, Don Leal, and Robert Nelson), he does not explicitly deal with the free market environmental approach at all, and seemingly does not know of its scholarship, which is institutionally located in Bozeman, Montana in two well known think tanks, Foundation for Research on Economics and Environment (FREE) and Property and Environment Research Center (PERC). Together these two institutes maintain wide networks of academic and public policy experts on most environmental questions. Here are few, with recent affiliations, who have worked in areas of interest to Allitt whom he might have drawn on to strengthen his text: Jonathan Adler, Case Western Reserve Law School, Cuyahoga River fire; Terry L. Anderson, PERC and the Hoover Institution, water and water rights, climate change; John Baden, FREE, and Richard Stroup, Montana State University, bureaucracy and environmental management, Love Canal; Daniel Benjamin, Clemson University, environmental risk; David Haddock, Northwestern University, externalities and the public interest; Peter J. Hill, Wheaton College, environmental property rights, wildlife, water, eco-tourism; Andrew P. Morriss, Dean, Texas A & M Law School, DTT, Rachel Carson and the silent spring; Robert Nelson, University of Maryland, on the pathologies of federal land management and environmentalism as a religion; Dominic P. Parker, University of Wisconsin and Walter N. Thurman, North Carolina State University, private land trusts and conservation, bees and pesticides; Randy T. Simmons, Utah State University, endangered species; Bruce Yandle, Clemson University, environmental regulation. By any standard, these are a distinguished group of scholars whose work should have been consulted.

As for Dennis' desire to read more about the rich history of private contributions to environmental enhancement, our current research agenda includes a broader and deeper examination of private conservation in the public interest.

The existence of “externalities” — effects (costs or benefits) of market transactions that are not experienced by those involved in the transaction, but are instead experienced by others, those “external” to the transaction —  is routinely proffered as a justification for governmental regulation of private economic activity.  Ronald Coase had a different view, however. In his seminal essay, “The Problem of Social Cost,” Coase never used the term — and with good reason. In Coase’s view, the word “externality” did not do much work.  In his introduction to The Firm, The Market, and the Law, Coase wrote:

the existence of “externalities” does not imply that there is a prima facie case for government intervention, if by this statement is meant that, when we find “externalities,” there is a presumption that governmental intervention (taxation or regulation) is called for rather than the other courses of action which could be taken (including inaction, the abandonment of earlier governmental action, or the facilitating of market transactions). . . .

. . . it is easy to show that the mere existence of “externalities” does not, in itself, provide any reason for governmental intervention. Indeed, the fact that there are transaction costs and that they are large implies that many effects of people’s actions will not be covered by market transactions. Consequently, “externalities” will be ubiquitous. The fact that governmental intervention also has its costs makes it very likely that most “externalities” should be allowed to continue if the value of production is to be maximized. This conclusion is strengthened if we assume that the government is not like Pigou’s ideal but is more like his normal public authority–ignorant, subject to pressure, and corrupt. Whether there is a presumption, when we observe an “externality,” that governmental intervention is desirable, depends on the cost conditions in the economy concerned. We can imagine cost conditions in which this presumption would be correct and also those in which it would not. It is wrong to claim that economic theory establishes such a presumption. What we are dealing with is a factual question. The ubiquitous nature of “externalities” suggests to me that there is a prima facie case against intervention, and the studies on the effects of regulation which have been made in recent years in the United States, ranging from agriculture to zoning, which indicate that regulation has commonly made matters worse, lend support to this view.

The concept of “externality” has come to play a central role in welfare economics, with results which have been wholly unfortunate. There are, without question, effects of their actions on others (and even on themselves) which people making decisions do not take into account. But, as employed today, the term carries with it the connotation that when “externalities” are found, steps should be taken by the government to eliminate them. As already indicated, the only reason individuals and private organizations do not eliminate them is that the gain from doing so would be offset by what would be lost (including the costs of making the arrangements necessary to bring about this result). If with governmental intervention the losses also exceed the gains from eliminating the “externality,” it is obviously desirable that it should remain.

(pp. 24-26)

As Coase notes, this was one of the points he sought to make in “The Problem of Social Cost,” and yet it is a point many seem to have missed. Coase’s essay is routinely cited for the proposition that the existence of “externalities” justifies governmental intervention, when Coase suggested nothing of the sort. Rather, the case for governmental intervention is made by showing that such intervention is likely to make things better — something that must be shown, and not merely assumed.

UPDATE: Coase made a similar point (and corrected some misperceptions) in his Nobel acceptance speech.

I now turn to that other article cited by the Swedish Academy, The Problem of Social Cost, published some 30 years ago. I will not say much here about its influence on legal scholarship which has been immense but will mainly consider its influence on economics, which has not been immense, although I believe that in time it will be. It is my view that the approach used in that article will ultimately transform the structure of microeconomics – and I will explain why. I should add that in writing this article I had no such general aim in mind. I thought that I was exposing the weaknesses of Pigou’s analysis of the divergence between private and social products, an analysis generally accepted by economists, and that was all. It was only later, and in part as a result of conversations with Steven Cheung in the 1960s that I came to see the general significance for economic theory of what I had written in that article and also to see more clearly what questions needed to be further investigated.

Pigou’s conclusion and that of most economists using standard economic theory was, and perhaps still is, that some kind of government action (usually the imposition of taxes) was required to restrain those whose actions had harmful effects on others, often termed negative externalities. What I showed in that article, as I thought, was that in a regime of zero transaction costs, an assumption of standard economic theory, negotiations between the parties would lead to those arrangements being made which would maximise wealth and this irrespective of the initial assignment of rights. This is the infamous Coase Theorem, named and formulated by Stigler, although it is based on work of mine. Stigler argues that the Coase Theorem follows from the standard assumptions of economic theory. Its logic cannot be questioned, only its domain. I do not disagree with Stigler. However, I tend to regard the Coase Theorem as a stepping stone on the way to an analysis of an economy with positive transaction costs. The significance to me of the Coase Theorem is that it undermines the Pigovian system. Since standard economic theory assumes transaction costs to be zero, the Coase Theorem demonstrates that the Pigovian solutions are unnecessary in these circumstances. Of course, it does not imply, when transaction costs are positive, that government actions (such as government operation, regulation or taxation, including subsidies) could not produce a better result than relying on negotiations between individuals in the market. Whether this would be so could be discovered not by studying imaginary governments but what real governments actually do. My conclusion; let us study the world of positive transaction costs.

If we move from a regime of zero transaction costs to one of positive transaction costs, what becomes immediately clear is the crucial importance of the legal system in this new world. I explained inThe Problem of Social Cost that what are traded on the market are not, as is often supposed by economists, physical entities but the rights to perform certain actions and the rights which individuals possess are established by the legal system. While we can imagine in the hypothetical world of zero transaction costs that the parties to an exchange would negotiate to change any provision of the law which prevents them from taking whatever steps are required to increase the value of production, in the real world of positive transaction costs such a procedure would be extremely costly, and would make unprofitable, even where it was allowed, a great deal of such contracting around the law. Because of this, the rights which individuals possess, with their duties and privileges, will be, to a large extent what the law determines. As a result the legal system will have a profound effect on the working of the economic system and may in certain respects be said to control it. It is obviously desirable that these rights should be assigned to those who can use them most productively and with incentives that lead them to do so and that, to discover and maintain such a distribution of rights, the costs of their transference should be low, through clarity in the law and by making the legal requirements for such transfers less onerous. Since this can come about only if there is an appropriate system of property rights, and they are enforced, it is easy to understand why so many academic lawyers (at least in the United States) have found so attractive the task of uncovering the character of such a property rights system and why the subject of “law and economics” has flourished in American law schools. Indeed, work is going forward at such a pace that I do not consider it over-optimistic to believe that the main outlines of the subject will be drawn within five or ten years.

Originally posted at the Volokh Conspiracy.

PERC’s Executive Director, Dr. Dino Falaschetti, recently visited the George W. Bush Institute, where he sat down with Dr. Eric Bing to discuss how economic growth affects the environment.

Q: Dino, PERC research is helping us better understand how economic growth relates to environmental quality. Is there a tradeoff between the two, or can we have both?

A: We can have both. Economic growth depends on our ability to increase productivity – that is, to make more goods and services with less inputs. Making more with less also advances environmental goals of conservation and sustainability. In this important sense, growth is green.

Q: If growth is green, then should principles for economic growth also apply to environmental amenities like water?

A: Yes! Research has long documented the importance of institutions for private property in creating economic wealth and distributing it widely. Interestingly, research also shows how property rights can improve environmental governance. As my colleagues argue in Greener than Thou, absent secure property rights, we tend to treat both our economy and environment like we treat rental cars, leaving the long-term care for someone else. The rental car companies (not the renters) clean and maintain the car, and do so because they face the benefits and costs of ownership.

To see the importance of property rights for conservation, consider the growing conflicts over scarce water resources.  Although water is vital for human welfare, we price it cheaper than dirt. The reason is that clearly defined and enforced water rights are incredibly rare; in most regions, water is an open-access resource governed by the principle of “use it or lose it.” So long as property rights are lacking for water resources, water users will not face the full consequences of their consumption, and water scarcity will only worsen.

Good news also exists. Entrepreneurs are creating water markets, and these markets have improved on rationing mechanisms like water-use-restrictions. Anglers and boaters on Oregon’s John Day River, for example, are contracting with farmers and ranchers over the use of instream flows. This market-based resolution of environmental conflict is creating benefits for both agricultural and recreational interests, and improving environmental quality by strengthening incentives to efficiently irrigate.

Q: Is anyone else succeeding with this approach?

A: Yes! PERC’s Enviropreneur™ Institute, for example, has helped over 200 alumni succeed professionally by resolving environmental conflicts through contracts, property rights, and markets. Markets and the process of exchange give people with different ideas and values regarding natural resources a way to cooperate rather than fight. When cooperation supplants conflict, gains from trade emerge.

HabiHut of Belgrade, Montana is also empowering environmental entrepreneurs, even where economic institutions fall short of ideals. HabiHut sells water filtration kiosks to entrepreneurs in Nairobi, Kenya. Because the kiosks are portable, they can avoid political red tape that frequently discourages entrepreneurial ideas from going to market. And it’s not only the entrepreneurs who are benefiting from access to such technology. Indeed, water quality and accessibility are also improving, as are local economic conditions. Before these businesses could start so freely, community residents often spent hours trying to find drinkable water and paid six times the price that entrepreneurs now charge.

Q: What stops environmental market solutions from emerging more broadly?

A:  In a word, politics.

Command and control approaches to governing economies and ecologies have a poor track record. But these approaches don’t fail for everyone. Rather, they persist by enriching an influential few at the expense of many.

By offering more productive incentives to individuals, and tapping local information in an inherently complex world, property rights and markets do better when measured against the objectives of economic performance and environmental quality. PERC has been a leader for more than thirty years in pushing environmental governance in this direction despite political interests in inefficiency.

There has been plenty of confusion surrounding the work of Ronald Coase since his article “The Problem of Social Cost” appeared in 1960 – so much, in fact, that two scholars wrote in 1992 that the so-called Coase theorem has “generated a negative externality for economists.” To clear up some of the confusion, we talked with Steven Medema for the next installment of PERC's Q&A series.

Few know more about the legendary economist and his impact on economic thought than Steven Medema. He is the author of many books and scholarly articles on the history of twentieth-century economics, with an emphasis on the work of Ronald Coase. His latest book, The Hesitant Hand: Taming Self-Interest in the History of Economic Ideas, was awarded the 2010 Book Prize by the European Society for the History of Economic Thought.

Medema is a professor of economics at the University of Colorado Denver and a 2011 PERC Lone Mountain fellow. For more of PERC’s Q&As, see the series archive.

Q: Ronald Coase’s 1960 article on “The Problem of Social Cost” had a tremendous impact on economics, including PERC’s work on free market environmentalism. What is the “Coase theorem” and how has it evolved in economic thought?

A: The Coase theorem tells us that if property rights over the relevant resources are well-defined and the costs of transacting are zero, parties who disagree over the use of those resources will negotiate to an efficient solution, regardless of to whom the property rights are assigned. The upshot of the theorem is that private negotiations or other market-like processes can efficiently resolve social cost (“externality”) problems such as those associated with air and water pollution. Of course, transaction costs are never zero, and much of the discussion of the theorem over the years has attempted to work out the possibilities and limitations of negotiated solutions when transaction costs are positive. Though much of the early reaction to the theorem was negative, the discussion has evolved into one that focuses somewhat less on the theorem per se (that is, with its highly restrictive assumptions) and somewhat more on departures from these conditions and how Coase-theorem-like processes may be operative under more realistic conditions.

Q: Over the years, people have come to refer to a hypothetical world of zero transaction costs as a “Coasian world.” Is this view accurate?

A: Those who refer to such a world haven’t read Coase very closely. The world of zero transaction costs is a fiction—but a sometimes useful fiction, not unlike a vacuum in physics. It was also a bedrock assumption of mainstream economics for ages, including of the economics against which Coase was reacting in “The Problem of Social Cost.” What Coase showed was that, in the world of neoclassical economics, government regulation was unnecessary for an efficient resolution of social cost problems. If property rights are assigned over the resources in question and there are no costs of transacting, the parties will efficiently resolve the problem through negotiation. So, Pigovian remedies are unnecessary in a Pigovian (costless transacting) world. But Coase’s emphasis was on the fact that the costs of transacting are not zero, and nor are the costs associated with government action to deal with social cost problems. The evaluation of how society should deal with such problems thus involves a comparison of the benefits and costs of alternative courses of action—including the possibility of allowing the problem to persist if the costs of “curing” it are worse than the disease itself.

Q: We hear a lot about the Coase theorem in environmental economics. How has the Coase theorem impacted discussions of environmental economics and environmental policy?

A: I think that its central impact has been in the way of making scholars—and later policy makers—aware of the possibility of using the exchange process to deal with social cost issues. Of course, the Coase theorem is an idealized construct that does not reflect the world in which we live. But by showing how property-rights-based solutions can generate private, efficiency-enhancing moves, the theorem opened the door to the subsequent analysis of exchange solutions in the real world, and thus to both theories and policies that employ such a framework.

Q: You suggest that the Coase theorem is widely recognized among environmental economists and taught in most textbooks, yet its relevance is often viewed as extremely limited. Why is this so? Why then are so many environmental economists interested in Coase?

A:  My sense is that most environmental economists see Coase as important because he emphasized that social cost problems are ultimately problems related to incomplete property rights. This makes Coase’s analysis the natural starting point for the analysis of social cost issues. The rub comes in where one goes from there. Some continue to hew to what we might call a “Pigovian” line—emphasizing that regulatory mechanisms or taxes are necessary to correct the problem—while others are more interested in exploring whether markets or market-like mechanisms can be utilized to resolve the problem. But there is broad general agreement that social cost problems have their roots on the property rights side, and this viewpoint owes to Coase.

Q: Discussions of environmental economics often center around externalities. Coase avoids this term. How has Coase’s work influenced the way we think about external costs?

A: My sense is that, at a minimum, he impressed upon some that social cost problems, or externalities, are reciprocal in nature. One can view this in two ways. First, it takes two to tango. That is, if A is generating smoke that harms B, B may be said to be as much the “cause” of the harm as A, since B could mitigate damages by, e.g., moving away. Second, A may be imposing harm on B, but to restrain A’s activity in favor of B is to impose harm on A. Some see this as a “right-wing” sort of point, but it is not. It actually has a long history in jurisprudence and was held by none other than J.R. Commons, a prominent Institutionalist economist and Progressive in who worked during the first half of the twentieth century. But value judgments often get in the way of sound reasoning when it comes to things like externalities, so not everyone has gotten on board with Coase’s notion of reciprocity.

Q: Critics of Coase often contend that transaction costs in markets are too high for Coasian-type bargaining to occur: negotiations can be costly, multiple parties can be affected, and information is diffuse. This is no doubt often the case, yet transaction costs are also present in the political process. How do these costs affect the way we understand Coase’s relevancy to environmental policy?

A: If one adopts an efficiency-based perspective on these things, the point to be taken is that there is no such thing as a determinate optimal solution to social cost problems. One can only come to grips with these things on a case-by-case basis, weighing the benefits and costs associated with alternative courses of action and recognizing that both markets/exchange and government activity have associated with them certain costs—often substantial. Coase is not about the Coase theorem; he was a strong advocate of comparative institutional analysis and that, at a minimum, economic benefits and costs have an important role to play in evaluating policy options. With this came a great concern about the costs associated with government action—costs that he (rightly) believed had been underplayed or ignored in the theory and practice of social cost policy.

Q: Why are concerns about equity so prominent in environmental discussions of Coase?

A: Probably because Coase focused so heavily on efficiency. But there was good reason for this—it was the language in which the welfare economics of social cost issues had been discussed for a half-century. And as we all know, there are plenty of occasions when the dictates of efficiency collide with some people’s sense of what is “right.” The very possibility that the “victims” of pollution should bribe the factory owners to reduce their pollution levels is anathema to many. Interestingly, though, Coase talks about larger concerns (“aesthetics and morals”) toward the end of “The Problem of Social Cost.” But since most readers failed to pay attention to his arguments beyond the Coase theorem material (the first 15 pages of a 44-page article), they didn’t seem to notice this.

Q: What can we take away from Coase’s work and apply to the area of free market environmentalism?

A: I believe that there are two key insights. The first is that markets/exchange can work to resolve certain social cost issues. The question is which ones, and this can only emerge from careful and patient study. The second is that neither markets nor government are panaceas. Both generate imperfect solutions, and the question is that of which of these imperfect solutions is best for dealing with the problem at hand. This, too, can only be determined from careful and patient study. Unfortunately, too many economists and policy makers do not want to hear such things. But “create markets” or “we need government to solve the problem” takes us nowhere. These are difficult problems, and we seldom find that difficult problems have easy solutions.