Environmental Economics

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ENVIRONMENTAL ECONOMICS

In dealing with environmental questions, economists emphasize efficiency, social welfare, and the need for cost accountability. A basic principle for efficiency is that all costs be borne by the entity who generates them in production or consumption. For example, production and consumption of diesel fuel will be socially inefficient if significant resulting costs are shifted to others who happen to be downwind or downstream from the refinery that makes the fuel or the truck that burns it. The benefits of making and using the fuel should exceed the cost—society at large—or else the process reduces total social welfare.

Information is the key to such internalizing "external costs." If the generator of pollution damage is known, along with the victim and the size of the damage, then the polluter can be held accountable. Historically, if wrongful damage is done, courts in the United Kingdom, the United States, Canada, and nations with similar legal systems have been willing to force compensation by polluters or, when the damage is great enough, to order cessation of the pollution. Small damage is ignored. But if no one knows whether the damage is serious, or who caused it, then regulation may be instituted to cope with it. However, since the regulator may not know more than courts could learn at trial, the results of regulation vary from increasing efficiency to reducing it. An analysis of the problems facing a regulator provides context for examining the key issues in environmental economics.

Cost accountability will be most prevalent when property rights to land and resources are clearly defined. Clear property rights make the owners of a resource responsible, in most countries, for the way that resource is used and for the harms it may cause others. An owner's right to the use of property does not include the right to use it in ways that impose a cost on others. In such cases, courts have historically held owners of a polluting plant or business responsible for harm they may cause other parties. Clear property rights make owners face the cost of inefficient use of a resource and thus encourage owners to ensure that their property or equipment is put to the most highly valued use. Property rights provide what economists consider the incentives to ensure that resources are used efficiently (maximizing net value) and in a way that constrains negative impacts on other individuals.

When ownership rights are less well defined, or not easily defended, the incentives for resource owners to efficiently use resources in a safe, non–polluting way, are decreased or removed. Individuals are less likely to take expensive, time-consuming action to protect a resource that they do not own, and by which they are not directly affected financially. For instance, most landowners would be quick to take action to prevent garbage generated by a local business from piling up in their own backyard. However, they would be less likely to take actions to prevent the same business from polluting a nearby lake or river. The reason is that any one individual has less direct, or at least less obvious, interest in the lake or river, than they do in their own property—and usually less ability to affect the outcome.

This incentive problem is increased as the number of polluters and the number of land owners increase so that it is difficult to pinpoint specific incidents of pollution and their effect on individuals. The case of air pollution from cars and multiple factories is a classic example of this information problem. In a large metropolitan area, there are millions of automobiles and many factories that could contribute to air pollution. There are also millions of individuals who could be harmed by that pollution. But it is generally difficult, if not impossible, for one individual to identify a specific problem they have experienced due to air pollution and then to pinpoint the source of that problem. Such situations, where property rights are not well defined, as is the case with air, and where it is difficult to identify a particular source of pollution, often lead to calls for government regulations to prevent a certain activity, or to reduce a certain activity such as exhaust from automobiles, in an effort to prevent harm to others.

Just as in the decision-making process of individual land owners, incentives are important in the government decision-making process. Economists have identified a characteristic of the government decision-making process that can allow the concerns of special interest groups can take precedence over the interest of the general public. The principle of rational voter ignorance states that since the cost of obtaining information about political issues is high, and any individual voter is likely to pay a small portion of the cost as well as reap a small portion of the benefit of any government action, individual voters are not likely to take the time to become well informed on specific issues. In contrast, politically organized special interest groups, such as firms in a polluting industry, will pay a heavy price for any new regulations that might be directed toward them. Therefore, they have a financial incentive not only to be well informed on the issues affecting them, but also to spend time and money trying to influence the government to ensure that they do not bear the cost of regulations.

With strong incentives for businesses and other special interest groups, and weak incentives for individual voters, it is not surprising that many environmental regulations have often been less successful at preventing harm than the more traditional property rights-based approaches. Thus, while privately owned lands and resources are generally healthy and well preserved, many resources that are not owned, such as air or many waterways, are polluted.

Many economists have therefore become disappointed in the effectiveness of traditional regulatory solutions to environmental problems. They look to market incentives such as those provided by private property rights, and market-like mechanism, where polluters must bid for or trade for the right to release potentially harmful emissions, as policy alternatives.

Richard L. Stroup

See also: Acid Rain; Air Pollution; Atmosphere.