ENVIRONMENTAL ECONOMICS

As the entry on "Economics: Orientation" points out, welfare economics puts the "satisfaction of individual human desires at or near the top of its own internal moral hierarchy." Two economists observe, "The basic premises of welfare economics are that the purpose of economic activity is to increase the well-being of the individuals that make up the society, and that each individual is the best judge of how well off he or she is in a given situation" (Stokey and Zeckhauser 1978, p. 277).

Environmental economics builds on the theory of welfare economics (or microeconomics) and in particular the view—prepresented as an ethical theory—that the satisfaction of preferences taken as they come ranked by the individual's willingness to pay (WTP) to satisfy them is a good thing because (by definition) this constitutes welfare or utility. According to economist David Pearce (1998, p. 221), "Economic values are about what people want. Something has economic value—is a benefit—if it satisfies individual preferences." This approach uses maximum WTP to measure how well off the individual believes a given situation makes her or him. A representative text states, "Benefits are the sums of the maximum amounts that people would be willing to pay to gain outcomes that they view as desirable" (Boardman, Greenberg, Vining, et al. 1996).

Preference Satisfaction

The attempt to link preference satisfaction (and therefore WTP) with well-being or benefit, however, encounters four problems. First, one may link preference with welfare by assuming that individuals prefer what they believe will make them better off. Research has shown, on the contrary, that with respect to environmental and other policy judgments, people base their values and choices on moral principles, social norms, aesthetic judgments, altruistic feelings, and beliefs about the public good—not simply or even usually on their view of what benefits them. The basis of environmental values in moral principle, belief, or commitment rather than self-interest severs the link between preference and perceived benefit or welfare.

In recent decades, environmental economists have put a great deal of effort into developing methodologies for measuring the benefit associated with goods—sometimes called "non-use" or "existence" values—that people care about because of moral beliefs, aesthetic judgments, or religious commitments, rather than because of any benefit or welfare change they believe those goods offer them. According to economist Paul Milgrom (1993, p. 431), for existence value to be considered a kind of economic value, "it would be necessary for people's individual existence values to reflect only their own personal economic motives and not altruistic motives, or sense of duty, or moral obligation." The difference between what people believe benefits them (economic motives) and what they believe is right (moral obligation) divides economic value from existence or non-use value. The attempt to translate moral beliefs and political judgments into economic benefits—principled commitments into units of welfare and thus into data for economic analysis—may continue to occupy economists for decades to come, because many logical, conceptual, and theoretical conundrums remain.

Second, the statement that the satisfaction of preference promotes welfare states a tautology if economists define "welfare" or "well-being" in terms of the satisfaction of preference, as generally they do. Concepts such as "welfare," "utility," and well-being" are mere standins or proxies for "preference-satisfaction" and so cannot justify it as a goal of public policy.

Additionally, if "well-being" or "welfare" refers to a substantive conception of the good, such as happiness, then it is simply false that the more one is able to satisfy one's preferences, the happier one becomes. That money (or income—a good surrogate for preference satisfaction) does not buy happiness may be the best-confirmed hypothesis of social science research. Thus, the thesis that preference satisfaction promotes welfare appears either to be trivially true (if "welfare" is defined as preference satisfaction) or empirically false (if "welfare" is defined as perceived happiness).

Third, if preferences are mental states, they cannot be observed. If they are inferred or "constructed" from behavior, they are also indeterminate, because there are many ways to interpret a person's actions as enacting a choice, depending on the opportunities or alternatives the observer assumes define the context. For example, the act of purchasing Girl Scout cookies could "reveal" a preference for eating cookies, supporting scouting, not turning away the neighbor's daughter, feeling good about doing the right thing, avoiding shame, or any of a thousand other possibilities. Choice appears to be no more observable than preference because its description presupposes one of many possible ways of framing the situation and determining the available options.

Fourth, few if any data indicate maximum WTP for any ordinary good. When one runs out of toothpaste, gets a flat tire, or has to buy the next gallon of milk or carton of eggs, one is unlikely to know or even have an idea about the maximum one is willing to pay for it. Instead, one checks the advertisements to find the minimum one has to pay for it. It is not clear how economists can estimate maximum WTP when all they can observe are competitive market prices. Competition drives price down to producer cost, not up to consumer benefit. For example, one might be willing to pay a fortune for a lifesaving antibiotic, but competition by generics may make the price one actually pays negligible.

The difference between price and benefit is clear. People usually pay about the same prices for a given good no matter how much they differ in the amount they need or benefit from it. People who benefit more and thus come first to the market may even pay less, for example, for seats on an airplane than those who are less decided and make later purchases. Thus, maximum WTP, which may correlate with benefit, cannot be observed, while market prices, which can be observed, do not correlate with benefit.

Market Prices

Environmental economists also propose that the outcome of a perfectly competitive market—one in which property rights are well defined and people do not encounter extraordinary costs in arranging trades and enforcing contracts—defines the way environmental assets are most efficiently allocated. Market prices constantly adjust supply and demand—the availability of goods to the wants and needs of individuals. As the "Orientation" entry observes, a perfectly competitive market may be used to define the idea of economic efficiency—the condition in which individuals exhaust all the advantages of trade because any further exchange would harm and thus not gain the consent of some individual.

Economists often explain the regulation of pollution not in moral terms (trespass, assault, violation of rights or person and property) but in terms of the failure of markets to "price" goods correctly. Suppose for example a factory emits smoke that causes its neighbors to bear costs (such as damage to property and health) for which they are not compensated. The factory, while it may pay for the labor and materials it uses, "externalizes" the cost of its pollution. When only a few neighbors are affected, they could negotiate with the factory, either paying the owner to install pollution-control equipment (if the zoning gave the factory the right to emit smoke) or by accepting compensation. The factory owner and the neighbors would bargain to the same result; the initial distribution of property rights determines not the outcome but the direction in which compensation is paid. This is an example of the second theorem described in the "orientation" entry, according to which the initial distribution of goods and services does not really matter in determining the outcome of a perfectly functioning market.

Where many people are affected, as is usually the case, however, the costs of bargaining ("transaction costs") are large. Economists recommend that the government tax pollution in an amount that equals the cost it "externalizes," that is, imposes on society. The industry would then have an incentive to reduce its emissions until the next or incremental reduction costs more than paying the tax—the point where in theory the cost (to the industry) of reducing pollution becomes greater than the benefits (to the neighbors). Such a pollution tax would "internalize" into the prices the factory charges for its products the cost of the damage its pollution causes, so that society will have the optimal mix of those products and clean air and water.

Many economists point out, however, that the government, in order to set the appropriate taxes or limits, would have to pay the same or greater costs as market players to gather information about WTP for clean air or water and willingness to accept (WTA) compensation for pollution. Pollution taxes, to be efficient, "should vary with the geographical location, season of the year, direction of the wind, and even the day of the week ..." (Ruff 1993, p. 30). The government would be "obliged to carry out factual investigations of mind-boggling complexity, followed by a series of regulatory measures that would be both hard to enforce and valid only for a particular, brief constellation of economic forces" (Kennedy 1981, p. 397). Thus, regulation is unnecessary when transaction costs are small (because people can make their own bargains) and unfeasible when they are great (because the government would have to pay them).

By arguing that emissions be optimized on economic grounds—rather than minimized on ethical grounds—economists reach an impasse. According to Ronald Coase, "the costs involved in governmental action make it desirable that the 'externality' should continue to exist and that no government intervention should be undertaken to eliminate it"(1960, p. 25–26).

Maximum WTP

Economists regard the ubiquitous and pervasive failure of markets to function perfectly as a reason that society, in order to achieve efficiency, should transfer the power to allocate resources to experts, presumably themselves, who can determine which allocations maximize benefits over costs. By replacing market exchange with expert opinion to achieve efficiency, however, society would sacrifice many non-allocatory advantages of the market system. For example, by making individuals responsible for decisions that affect them—rather than transferring authority to the government to act on their behalf—markets improve social stability. People have themselves, each other, or impersonal market forces to blame—not the bureaucracy—when purchasing decisions do not turn out well for them.

Economists have encountered logical and conceptual hurdles, moreover, in their efforts to develop scientific methods for valuing environmental assets and thus for second-guessing market outcomes. First, there is little evidence that economic experts are able to assemble information about WTP and WTA any better than market players when the costs of gathering that information are high. Second, economic estimates of benefits and costs when made by government agencies become objects of lobbying, litigation, and criticism. Experts can be hired on both sides of any dispute and then produce dueling cost-benefit analyses (Deck 1997). Third, when society transfers power to scientific managers, even if they are trained welfare economists, it courts all the problems of legitimacy that beset socialist societies, which likewise may rely on scientific managers to allocate resources.

Institutional Approaches

Pollution control law, from a moral point of view, regulates pollution as a kind of trespass or assault, on analogy with the common law of nuisance. Statutes such as the Clean Air Act and Clean Water Act, moreover, explicitly rule out a cost-benefit or efficiency test and pursue goals such as public safety and health instead (Cropper and Oates 1992). For this reason, the government often limits to "safe" levels the maximum amount of various pollutants industries and municipalities may emit into the water and air. To determine what levels are "safe enough" legislators and regulators have to consider the state of technology and make ethical and political judgments. To help society attain the mandated levels in the most cost-effective ways, economists have made an important contribution to environmental policy by urging government to create market-like arrangements and thus to generate price signals for allocating environmental goods for which markets do not exist.

For example, the Environmental Protection Agency, by creating pollution permits or allowances that firms can buy and sell under an aggregate total ("CAP"), gave industries incentives to lower emissions of lead, smog, and other pollutants to below permitted levels, because they could sell at least part of the difference to other companies that find emissions more expensive to reduce. Tradable rights in environmental assets (from emission allowances to rights to graze the public range) show that incentives matter; marketable permits can reduce pollution more effectively and at lower cost than "command and control" policies. In addition, market arrangements decentralize decisions by encouraging industries to make their own bargains to attain the overall "CAP" rather than to conform to one-size-fits-all regulation.

Environmental economics has enjoyed success in helping society construct market-like arrangements for achieving in the most cost-effective ways environmental goals, such as pollution-reduction, justified on moral, political, and legal grounds. Environmental economics as a discipline has been less successful in finding scientific methods to second-guess or replace markets in order to achieve goals it itself recommends, such as preference-satisfaction or efficiency, that are not plainly consistent with moral intuitions, legislation, or common law traditions.

MARK SAGOFF

SEE ALSO Ecological Economics;Economics and Ethics;Environmental Ethics;Market Theory.

BIBLIOGRAPHY

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