REVIEW: ENVIRONMENTAL MARKETS

ENVIRONMENTAL MARKETS: A Property Rights Approach, 

by Terry L. Anderson and Gary D. Libecap

Published in 2014 by Cambridge University Press.

Environmental conflicts naturally arise between those who have competing uses for environmental resources, whether it’s enjoying clean air and clean water, or using air and water to some degree as part of the manufacturing of goods and the rendering of services.

Another conflict is between present and future users of environmental resources, such as the issue of overfishing, a competition between those who want fish now and those who want a sustainable yield in the future.  We have benefits and costs and different users and different potential distributions of the benefits and costs.

Environmental conflict is especially noticeable in the “tragedy of the commons,” where a lack of ownership of the common resource means that no user has a strong incentive to preserve it, nor an effective means to do so alone.

The authors investigate the degree to which market solutions can be used to optimize the use of environmental resources. They note, "Environmental economics often focuses on the failure of markets to allocate and manage natural and environmental resources efficiently.  Under the banner of externalities, markets fail either because private costs are less than social costs or because private benefits are less than social benefits.” Either way, there results an overuse of the environmental features or an underuse.

Generally, proposed remedies are to use taxes or quotas to reach the optimal amount of environmental use.  Is not clear whether the costs of establishing taxation and regulation regimes outweigh the benefits they provide.  Taxes and regulations are not expected to produce optimal outcomes, especially when political factors weigh heavily.  For example, “fishing season limits have been a common regulatory response to overharvest, but they generally result in twenty-four-hour fish derbies, excessive investment in capital and labor to win the derby, and a glut of fish during the season.…national Parks [are] overused and underfunded and national forest management paralyzed by litigation and the demands of competing groups.”

“As with regulation and taxes, property rights and market exchange are costly, and it may not always be the case that it is socially optimal to solve the environmental or resource problem.”

This book explores how to use property rights and markets to allocate environmental resources, and it compares this to the regulatory and tax alternatives.  It was heavily influenced by the work of Nobel-prize-winning economist Ronald Coase and his article “The Problem of Social Costs.”

“We do not contend that markets can solve all environmental problems or that political approaches always fail.  Rather we offer a lens through which we can tackle environmental problems using property rights and markets and compare them to the regulatory and tax alternatives.”

One of the book’s goals is to show government leaders and policymakers how to reduce transaction costs to enable market-based solutions and private incentives to improve environmental quality and productive use.

Government can help shape of the creation of markets for willing buyers and willing sellers in the environmental area, such as rights to water usage.

“As environmental economists, we cannot resist the efficiency gains that markets can provide, but we also embrace the potential of markets to go hand-and-and with financial improvements.”

 “Groundwater supplies more than 50% of the drinking water in the United States and is a major source of irrigation.” The users of this groundwater essentially engage in competition, by competitive pumping.  It’s like several people sharing a soda with their straws in the same glass.  While drinking rapidly has disadvantages, the slow drinker ends up with much less of the soda.

Now, preventing the over-use of such resources is done by government intervention through regulation and taxation Just as there can be market failure, “there can be gov’t failure as well when policies are mold by interest-group politics and by political and regulatory changes that may do little for the environment or the provision of public goods.”

In fact, neither government nor market approaches are perfect.

Two types of analysis are common: positive analysis, dealing with what is factual, and normative analysis, dealing with what various parties prefer.

Some consideration should be given to the distribution of the costs and benefits among different classes of people.  “Although environmental justice can be portrayed as an effort to provide improved conditions for poor and under-served populations, environmental regulations themselves raise costs and are often regressive.”

The tendency is to over-use the virtually free environmental factors, so that the government is then called upon to restrict this over-use, by setting quotas or fees or taxes, and then perhaps trying to compensate some of those who have lost out due to the government intervention.

“if environmental markets or more cost-effective, there are greater surpluses to compensate those who were alarmed by the policy.”

For example, development of oil and natural gas sources in the Arctic carries with it some environmental risk, to be balanced against the value of increased energy supplies.  Pumping out reservoirs of oil and gas and even water deplete these, giving an incentive to those doing the pumping to remove these fluids as rapidly as possible before someone else take them.

In situations where the users of the environment are spread over a large area, they’re often unaware of the impact that they and their distant neighbors are having on the environmental resource.  Those upstream in a river will have a distinct perspective from those downstream.  As the saying goes, “Where you stand often depends on where you sit.” Often, these parties will be indifferent governmental jurisdictions, complicating matters further.

Those who enjoy a clean air, may have unrealistic requirements, and those who use it may be ignorant or uncaring about the impact of dirtier air on others.  The tragedy of the commons is reciprocal. 

Access without limitations leads to over-use and under-protection.  “…open-access problems persist [because] it is costly to define and enforce rules via regulation or environmental markets regarding who has access, who bears the cost and benefits of decision-making, and who can capture the value of scarce environmental resources.”

Approaches using government for laws and regulations lead to continuing interaction in the public body politic as various interest groups, including “the public,” try to better their positions.  Recognizing property rights to certain environmental elements can also lead to continuing competition in the market and in the courts by the parties involved.  Various cap-and-trade schemes make emission limits property values in themselves.

Making and changing laws and regulations has an impact on the public, politicians, and businesses, so that this becomes the subjects of legal, political, and economic competition.  “…regulation is controversial and may not always be the low-cost solution.”

Although taxes can be set to discourage over-use and to compensate those who suffer from the use by others of the environmental resource, the optimal level of taxation is quite difficult to determine.  Currently, this taxation approach with compensation has rarely been adopted. 

In contrast, well-defined, enforceable property rights give the owners incentives to use the resources prudently, in the present and considering the future. These rights may be owned by individuals or organizations of one type or another.  Prudent use maximizes the benefits to the owner. Innovation is rewarded.  Markets often adjust more rapidly to change than can government entities.

Property rights require the owner to be able to identify and legally protect ownership of the asset and to transfer the asset through market exchange.  If the costs of ownership and transfer are too high, compared with the value of them, then the definition of such property becomes less attractive.

Property rights are more readily assignable for static and observable resources such as land than for mobile resources such as river water or hidden resources such as groundwater. Where excluding others from using the resource is difficult or impossible, government can try to make the use of the resource a right rather than the resource itself, the basis of “cap-and-trade” emissions limit markets, where more cost-efficient emitters can profit by selling some of their unused rights to emit.  The authors give some reasons why cap-and-trade schemes have worked less well than quotas on fishery catches.

Property rights are ownership of an asset that, with the owner paying the costs and obtaining the benefits, avoid the problem of the “tragedy of the commons.”

“There is no simple analysis, however, that can tell us whether markets are better than regulation of vice versa. The answer depends on the relative costs and benefits of alternative institutions.”

MONO LAKE (CALIF) --- RIPARIAN RIGHTS

“…Mono Lake, an alkaline and hypersaline body of water, 300 miles northeast of the city [LA].  The landowners held riparian water rights under California law that gives all landowners whose property is adjoining to a body of water the right to make reasonable use of it.  If there’s not enough water to satisfy all users, allotments are generally fixed in proportion to frontage on the water source.  These rights cannot be sold or transferred other than with the adjoining land, and water normally cannot be transferred out of the watershed because of impairment to downstream rights holders.”

“Between 1941 and 1981, the lake’s level fell about 46 feet and surface area receded from 90 to 60 square miles.” Environmental groups proceeded to sue to limit Los Angeles’s use of Mono Lake water. Ultimately, a commission ruling held that water diversions were to be stopped until the lake’s level could rebound to a target of 6377 feet.  This level is not likely to be met before the year 2021.  Many alternatives would likely have been economically preferable in comparison to a wholly stopping the diversions.  “Once property rights were rejected, the basis for bargaining was lost.”

“the more secure, durable, and complete our property rights, the more affective they are for limiting losses of the common pool.” Ownership can be transferred, and others can be excluded, preventing the losses due to open access.…  When transaction costs are positive, property rights are never whole, compensation to aggrieved parties is unlikely to be fully sufficient, monitoring is incomplete, and rent dissipation is never fully constrained.  Transaction costs also hold for government regulation.…”

One can expect political opposition from those who benefited from open access, for as long as the resource maintains some value.  Some of this opposition can be mitigated to compensation losers.  Not only do regulators have to decide who is to be compensated but also for how long and for what amounts.  In regulating fisheries, for example, sometimes the surplus equipment has been bought by the government to compensate the owners.

It often takes a crisis of a diminished environmental resource to get the stakeholders to work toward a solution, be it market-driven or government-run. As the value of the resource diminishes, the losers have less to lose and the winners have perhaps more to gain.

The authors categorize four “mechanisms for allocating property rights”: “pure political distribution, uniform allocation, auction, and grandfathering or first-possession.’”

Political distribution works best when the government can be trusted and held accountable. However, even rich resources can be dissipated in supplying political favors to the well-connected.

Uniform allocation, equal sharing, sounds attractive while avoiding “equal access” to qualified claimants. Lotteries work this way. A race to obtain Federal land in Oklahoma ended up being quite costly and of questionable fairness. The Oklahoma “Sooners” are said to be those who left the starting line sooner than prescribed in April 1889 or were on the land already, hiding out. Equal partition is easier to measure than extent of prior use or time of first possession. Lotteries for hunting licenses are examples. If such licenses can be resold, “uniform allocation will ultimately place ownership rights in the hands of those people who value them most highly.” Three issues arise: prior owners, minimal resource values, lack of political advantage to allocating the licenses.

 Auctions raise money for the original owners (government or private) and place the resources with those who value them most, as reflected in their bids. They are hard to organize and will be resisted by current private owners.

Grandfathering, the right of first possession, is the “most common allocation mechanism.” Usually the initial ownership was obtained by being first to claim it. Some owners will have invested heavily in using the resource, and having out-competed others, they may be the low-cost, high-value users already. Respecting those rights suggests to others that theirs will be respected also, favoring investment. Criticisms include: not fair to late-comers, gives away “rents” that could go to the government, can produce ownership concentration, and requires arbitrary selection of the “starting time” for grandfathering, the baseline period.

The authors give four sets of examples of the evolution of environmental property rights into markets: “water rights, conservation credits, emission allowances, and tradable fishery shares.”

The rights that are studied are not quite simple property rights but rather usage rights that can be traded as though they were property.

Such rights are not as secure from political interference as simple land property rights are.  These usage privileges are therefore riskier as investments than simple land property ownership is.  This weakens the environmental market to some degree.  Property rights must be protected from regulatory takings to allow markets to improve environmental quality.

The Oregon Water Trust started in 1993 as a nonprofit organization designed to help maintain and restore stream quality using market forces.  It required some changes in law to go from the Western principle of “use it or lose it.” Leaving stream water unused had to be redefined as a “beneficial use.” The owners of water rights were allowed to assign them to others for environmental purposes.  Many of their rivers and streams were suffering from excessively low flows due to diversions and appropriations. 

The Trust worked to develop relationships with all stakeholders.  Its focus on the smaller of the streams enabled it to make bigger changes in their conditions.  The Trust generally uses short-term leases.  The leased water is not removed from the stream, reverting to its original use at the end of the lease.  Approximately 30% of the restricted use has been donated and 70% has been obtained through the leasing options.

The authors identify several conditions that have helped the Oregon Trust be successful: first, the parties must share in the goal of protecting the environmental resource; second, there needs to be differences in the value of the resource between its use in production and its use to protect environmental quality; third, environmental use has got to be recognized legally; fourth, the parties involved must trust each other; fifth, historical uses of the resource must not be placed at risk; sixth, bureaucratic interference must be minimized; and seventh, there must be mechanisms for buyers and sellers to get together, to bargain, and to have such agreements enforced.

A second example is the Colorado-Big Thompson Project that brings water across the Rocky Mountains from the Colorado River Basin in the west to the South Platte River Basin in northeastern Colorado. 

“The Colorado – Big Thompson has by far the most active water market in the western United States in terms of numbers of trades and sales.  For this reason, we have more data and can illustrate the nature and timing of exchanges.” The water is traded in uniform water units, each a share of the annual amount of water available from the Project.  This will fluctuate annually.  

The shares are identical to reach other.  As time has gone on, the urban uses have been more valuable than the agricultural uses, and the market has reflected that.  If they have bought more than they need, cities can choose to lease back the units that they’ve purchased in times when agriculture has the greater need.  The most active trading is typically moving the water from agricultural uses to urban uses.  The values of the shares have turned out to be quite similar, on the average, for the urban and the agricultural uses. 

Essentially, a market price for water in the region has been developed.

In the future, population growth and increased environmental and recreational demand along with traditional and uses is expected to make water scarcer and more valuable in the western states. The impact of any warming trend remains to be determined.

This book should be read by all who want to be involved in debates over environmental policy and would make an excellent text for a college course.

Douglas Winslow Cooper, Ph.D.

formerly, Associate Professor of Environmental Health Physics

Harvard School of Public Health. 

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