smooth efficiencies to prevail: property rights have to be exclusive and the transfer and protection of contracted rights has to be free. This means, for the efficiencies of Coase to be realized in the above example, 1) both the rancher and the homeowner must have the full ability to control their land and the decisions made on it and, more importantly, 2) their negotiations and contracts must not cost time or money to negotiate, write, and enforce. Put in other terms, a free market system is efficient to the degree that actually sorting out agreements, coming to understandings, and designing fair rules and restrictions are socially and economically free or cheap. Similarly, it depends on enforcement (policing, monitoring, and punishing violations) of contracts and rights having no costs.
And in reality, of course, this is totally untrue. For our rancher and homeowner, the time it takes to negotiate the contract, the possible cost in lawyers, and the hidden cost of maintaining county court houses and civil servants to process and administer the contract are indeed quite high. Defining property rights for more intangible goods and services (e.g. biodiversity) is even more daunting. Enforcing contracts over incredibly complex systems (e.g. global climate) appears all the more impossible. The problem comes in the practical difficulty of assigning private rights to “fugitive,” mobile, intangible things – like air – clearly contracting the relations between owners, and enforcing the results. For an “air market” to function, the air must be owned by someone who paid for it, who can get value from it, who has an individual interest in keeping it clean, and who can legally challenge someone else who dirties it or violates a contractual agreement over its condition.
While in some ways such a market seems inconceivable (because it is difficult to enclose, see Chapter 4), recent evidence suggests that it may be possible. Rather than assigning rights to clean air, recent efforts in the United States and elsewhere have worked to give rights to pollute. In a specific example, in the early 1990s, the United States Environmental Protection Agency (EPA) set limits on industries for the emission of sulfur dioxide, a primary cause of acid rain. But rather than setting a limit on each factory, the total allowable level of pollution was divided into units and distributed to producers, in the form of credits that could be sold. Should a company find a cheap way to reduce their sulfur dioxide production below the level for which they held credits, they could sell the spare credits for a profit. More radically, if environmental groups believe that the limit on total emissions provided in the credit system is too high, and they are willing to pay to reduce it, they have the right to buy credits on the market, like anyone else, and simply take them out of circulation. This also has the effect of raising the scarcity and cost of pollution credits, creating incentives for industry to become even more efficient. Such a market has been in operation for 15 years and is only one of many such efforts (see more on “cap and trade” later in this chapter).
Whatever the flaws in such a system, it demonstrates that markets can function for all sorts of environmental goods and services, but that – as Coase suggests – to make them work, private property rights to nature must be clearly assigned to corporations or people. This is a logical and practical prerequisite to any market solution, but certainly one with serious social, environmental, and political implications, as we shall see.
Market Failure
There are several ways in which these market and contract-governed ways of living in nature might fail. Such market failures emerge from a mismatch between the assumptions of the market model and the real world. Chief challenges to market assumptions include the facts that 1) transactions are not by any means free (as per Coase’s assumptions), 2) contracts and property rights have to be defined and enforced often at great legal and regulatory expense, and 3) not all parties to negotiations have perfect and equal information. This is especially the case for environmental goods and services that are spread across a large population of individuals.
Market Failure A situation or condition where the production or exchange of a good or service is not efficient; this refers to a range of perverse economic outcomes stemming from market problems like monopoly or uncontrolled externalities
Transaction Costs In economics, the cost associated with making an exchange, including, for example, drawing a contract, traveling to market, or negotiating a price; while most economic models assume low transaction costs, in reality these costs can be quite high, especially for systems with high externalities
Consider, for example, the problem of the ranch and residence provided earlier, but now imagine it with thousands of scattered homeowners and hundreds of ranches. Under such circumstances, the complexity of working out discrete contracted negotiations becomes enormous, as does the problem of monitoring and enforcing the rights of different ranchers each operating with different rules with differing property owners.
There is also always a temptation for some people to wait to accrue benefits from other people’s negotiations without taking the time or energy to negotiate for themselves. Such a “free-rider” problem is typical of common property environmental problems (see Chapter 4). In such a case, the transaction costs of getting the problem sorted out contractually are simply much higher than the cost of the problem. Typically such cases lend themselves to regulatory and treaty-based, rather than market-based, solutions. For example, the system of tradable pollution credits that made acid rain reduction a success in the United States had to be created and enforced by the Environmental Protection Agency of that country, an entity with police powers paid for through federal taxation. Consider too, that reduction of sulfur emissions in Europe was managed through the creation of the “Helsinki Protocol,” a treaty agreement to achieve 30% reductions by 21 nations signing the document. Efficient markets require public investments. Free markets are rarely free.
Monopoly A market condition where there is one seller for many buyers, leading to perverted and artificially inflated pricing of goods or services
Monopsony A market condition where there is one buyer for many sellers, leading to perverted and artificially deflated pricing of goods or services
Other asymmetries also plague markets. One of the most serious is that of monopoly, where many buyers face one service provider or owner, or monopsony, where many sellers face a single buyer. In either case, the individual or firm is in a position to set prices and buy and sell goods or services free from competition and with no incentive to be efficient. Neither are such cases rare; the histories of the American and European capitalist economies are filled with cases where monopolies and monopsonies emerged through the concentration of wealth (in railroads, meat packing, and communication, among many). For environmental goods and services, the record has been equally spotty. Most municipal water provision in the United States, for example, was developed by private companies in the 1800s. The failure of these utility monopolies to efficiently manage and price water, however, led to the transition of most such utilities to state control.
A further problem is raised if we consider that many of the potential parties in a contractual arrangement or in a market have not yet been born. People may negotiate with one another over the relative value of cutting down a forest or enjoying its timber for construction, but what about people a hundred years from now? Do they have a place in such a market? A strict adherent to market logics would make no provision for such people. Getting environmental economics right is difficult enough without considering future generations, after all! Alternatively, it could be argued that both economic development and conservation in the present, in whatever market-negotiated combination, are always in the interest of future generations, who benefit from better economic and environmental conditions.
Market-Based Solutions to Environmental Problems
We have seen that markets
