A Libertarian Perspective on Economic and Social Policy

Lecture 8

Environmental Policy

©2007 Jeffrey A. Miron

Introduction

• Environmental policy appears at first blush to provide a situation where interventionist policies make sense:– Pollution, global warming, depletion of scare

resources, elimination of endangered species, and other issues all seem to be problems for which private solutions do not readily exist.

• This perspective has an important grain of truth:– Environmentalism and libertarianism are fully

compatible when viewed from the right perspective.

Introduction, continued

• But:– The standard arguments for intervention are less

convincing than they might seem; private solutions are possible and appear to work in many instances.

– Further,many interventions do more harm than good, even granting that the laissez-faire outcome is not ideal.

• Thus, libertarians oppose a great many actual environmental policies used today, even though they endorse some that could/should be used in the appropriate circumstances.

Outline

• Basic Argument for Intervention: Externalities• Externalities, Property Rights, and Transactions

Costs: The Coase Theorem• Exhaustible Resources and Policy• Environmental Policy in Practice

– Recycling– Endangered Species Act– Clean Air and Water Acts

• The Takings Clause and the Fifth Amendment

The Standard Argument for Environmental Policy: Externalities

• Definition of an Externality: – “An externality arises when a person engages in an

activity that influences the well-being of a bystander and yet neither pays nor receives any compensation for that effect.” Mankiw (2004, p.204)

• Examples– Air and water pollution that results from farming,

mining, manufacturing– Air pollution from cars– Noise from airplanes

Standard Argument, continued

• If private actions generate externalities, laissez-faire outcomes can be inefficient:– For example, laissez-faire might lead to

excessive production of goods whose production generates pollution.

• Thus, government intervention, such as a tax on the polluting good, can improve welfare by reducing the amount produced / consumed and thus reducing pollution.

Comments on the Standard Argument for Intervention

• The usual analysis assumes the policy instrument is a tax (Pigou)– But policy could also address the externality by

targeting the quantity of output rather than its price. – Choice of instrument depends on auxiliary

considerations: uncertainty, evasion.

• The optimal tax is normally finite:– It is rarely efficient to eliminate pollution; there’s a

tradeoff between production of the good and the bad.– Thus, policies such as banning an externality-

producing good do not make sense.

The Coase Response to the Standard Externality Argument

• In some instances, private contracting can internalize externalities and thus achieve the efficient outcome without a policy intervention.

• Basic idea is that the persons who are adversely affected by an externality could pay to reduce or eliminate the externality-generating activity.– This approach does not always work because of

“transactions costs.”– This approach does not necessarily have the “right”

distributional implications.• But the approach provides a useful perspective

and appears to “work” in some instances.

An Example of the Coase Theorem

• Assume you have a roommate who plays loud music when you are studying. Say you are willing to pay $6 an hour for silence, while your roommate values music at $5 per hour.– Then you can pay your roommate a price between $5 and $6 per hour

to keep the music off. You are both willing to make the deal.– The outcome is efficient in the sense that the more highly valued

situation arises.• Now assume you are willing to pay $5 an hour for silence while your

roommate value music at $6 an hour.– Then the roommate will play the music because you are unwilling to pay

enough to make it in the roommate’s interest to have silence.– The outcome is still efficient.

• Thus, despite the externality, the efficient outcome occurs.• This does not mean everyone likes the outcome. But there is no

intervention that increases consumer surplus (there is no producer surplus in this example).

Coase and Property Rights

• What would change if there were rules about who “owns” the silence?

• For example, what if school policy stated that a dorm resident may play music only with consent of the roommate?

• Say roommate values music at $6 and you value silence at $5. The roommate pays for your consent, and there is music.– Same as outcome without the rule.

• Say roommate values music at $5 and you value silence at $6. Then there is silence.– Same as outcome without the rule.

Coase and Property Rights, continued

• We would arrive at the same conclusion if the school rule had been that your roommate always has the right to play music:– Silence if the roommate values music more than you

value silence, and vice versa.

• Thus, the outcome (silence versus music) is independent of the assignment of the property rights.

• This conclusion – that the efficient outcome occurs regardless of who owns the property rights – is known as the Coase Theorem.

Comments on the Coase Theorem

• The distribution of income does depend on the assignment of the property rights:– different payments depending on how assigned.

• The theorem has one critical assumption:– No barriers to contracting between the relevant

parties;– This assumption is also described as an absence of

transaction costs.• If you and your roommate refuse to talk; or if one

of you thinks bargaining over such issues is “wrong,” then the efficient outcome does not necessarily arise.

Comments on the Coase Theorem, continued

• The implications of the Coasian framework are far broader than environmental policy.

• In particular, the transaction cost perspective also helps explain the existence of vertical integration.

Limits of the Coase Theorem

• In some instances, the people adversely affected by an externality (e.g., air pollution) are dispersed, small entities that cannot easily coordinate their actions and pay a polluter not to pollute.– In other words, sometimes transactions costs are

large.

• In these instances, there is potentially a role for policy.– Best example is probably common resources such as

oceans, clean air.

Transactions Costs versusProperty Rights

• A common statement is that the problem for policy is that property rights have not been assigned or are not enforced:– Coase analysis shows this not exactly right, at least if

stated in this way;– The more fundamental issue is transactions costs.

• In many instances, however, an assignment of property rights reduces the transactions costs and is probably the most effective intervention.– So, the “absence of property rights” description is

reasonable if not exactly accurate in all cases.

Bottom Line on Coase

• Theorem suggests caution in assuming that policy interventions are needed simply because externalities exist.– Theorem shows that some can be addressed by purely private

actions.• The theorem also shows that, when private actions do

not seem adequate to obtain the efficient outcome, policy should think about reducing transactions costs / defining the property rights and then stepping back; direct pollution control policies are not necessarily needed.

• And, as usual, analysis must ask whether interventions do more good than harm, even if laissez-faire is inefficient.

Exhaustible Resources and Environmental Policy

• A different reason often given for environmental policies is that some resources (e.g., oil) are exhaustible.

• In fact:– Underlying assumption is usually wrong or

exaggerated– Even if accurate, the assumption that

exhaustibility implies a role for policy is wrong.

Are Exhaustible Resources Running Out?

• If this question means, is there less now than there was earlier, the answer is sometimes yes.

• But if this question means, is there less supply relative to demand, the answer in most cases is no.– In some cases, new discoveries have expanded proven

reserves.– In some cases, technology has facilitated using less of the good

per unit of output.– In some cases, new technologies have reduced demand for the

good.

• For all these reasons, demand relative to supply has typically declined, not increased:– Prices of raw materials show, if anything, a downward trend.

Is it a Problem if Society Depletes an Exhaustible Resource?

• No. Under plausible assumptions, the private market uses up an exhaustible resource at the optimal rate (Hotelling)– As the good becomes more scare, it’s price rises.– As the price rises, demand declines.– Over time, the resource depletes but at the socially

efficient rate, assuming competition in the resource extraction industry.

– If there is market power, the price is set too high, so extraction is slower than is socially efficient.

Tragedy of the Commons versus Exhaustible Resources

• The remarks above make one crucial assumption: – The good is privately owned and traded in standard

markets.• A different issue is whether there is efficient

extraction of a “common” resources such as fish stocks in the ocean or open grazing land:– In such cases, there is clear potential for excessive

use of the common resource and depletion at a rate faster than is socially optimal.

• The critical difference is the property rights / transactions costs issues.

Tragedy of the Commons, continued

• The Coasian way to think about the problem is that those harmed by rapid depletion – future generations – cannot in any obvious way “bribe” the current generation into using the resource more slowly.– Transactions costs are large.– So laissez-faire may be inefficient.

• But the Coasian perspective also suggests a mechanism for solving the problem:– Assign property rights– This gives the owners a long-run stake in the resource and eliminates

the need for transactions across generations.• Classic illustration is the fencing-in movement:

– Each farmer gets a fenced in plot, instead of using common land.– In practice, this approach often seems to work more smoothly than, say

limits on the amount harvested;– The reason is that the owner of a piece of the common resource has an

incentive to take good care of it.

Environmental Policies In Practice: Recycling

• One environmental policy that has grown enormously over the past several decades is government-mandated, residential recycling:– Note emphasis on mandated– Note emphasis on residential

• The particular programs to consider are those that have, e.g., separate curbside pickup of “recyclables” versus “trash.”

Recycling, continued

• What is the argument for governments to encourage recycling?

• The standard arguments are as follows:– Dumping trash in landfills has externalities.– Landfills are filling up.– Recycling reduces pollution because

production of new goods has externalities.

• All of these claims are mainly or completely wrong.

Landfills and Externalities

• The evidence is clear that landfills are by and large clean and safe.– Landfills are not toxic waste sites where commercial

material gets dumped.– Landfill is where residential garbage is dumped.– Landfill is regulated and has many environmental

protections.– Parks, golf courses, shopping centers, and the like

are routinely located on top of landfills.

Landfills are Filling Up

• This view shows basic ignorance of how landfills work:– It is not profitable to maintain substantial excess

capacity.– Instead, as one landfill gets filled, another opens up.– So many landfills are, at any point in time, getting

close to capacity.– But this does not mean space is running out.

• Moreover, capacity has not declined: fewer, but much larger landfills.

Landfills are Filling Up, continued

• The area available for landfill is so huge relative to the amount of garbage that it is not meaningful to think of landfill space as exhaustible.

• But even if landfill space is exhaustible, this does not imply any inefficiency, as noted above:– Price of landfill will rise and gradually increase

the private incentive to reduce trash.

Does Recycling Reduce Pollution?

• Take as given that production of new goods generates pollution– If substantial, this might seem to justify recycling.

• But recycling also generates pollution:– Cleaning recyclables uses toxic chemicals, which pollutes the

water, and consumes energy, which pollutes the air.– Plus, additional resources are needed to pick up, sort, haul the

recyclables.• So, there is no presumption that recycling generates less

pollution than simply producing new commodities.– And the evidence for most household recyclables is that on net

recycling is similar or worse.• Plus, recycling programs are expensive for the towns

that operate them (despite false claims to the contrary).

Does Recycling Reduce Pollution?, continued

• More generally, assume that the external costs are a given percentage of private costs:– This is roughly right if all production activities

generate pollution to a degree that depends on the value of what is produced.

• Then the approach that has lower private cost always has the lower social cost.

Recycling, Summary

• So, government mandated or subsidized recycling is difficult to justify.

• This is completely separate from whether private recycling can or should exist:– It does, and has, for centuries.– But it exists for situations where the private

costs of recycling are less than the private costs of “new” stuff.

Environmental Policies In Practice:The Endangered Species Act

• The ESA, passed in 1973, established a system of protections for species that are deemed to be in danger of extinction.– If a species is “listed” by the relevant federal

authorities, it is illegal to “harm” them, and the government tries to protect the species.

• The Act generates enormous controversy because it often restricts property owners from developing or using their land.

Why Protect Endangered Species?

• Two main possibilities:

• Particular species have substantial commercial, emotional, or recreational value.

• Diversity of species provides a social benefit.

Evaluating the ESA, I

• The first possible justification suggests a role for government policy if there are poorly assigned property rights and high transactions costs:– Whales in the ocean.

• In many instances, however, the species are on private land, so the property rights are assigned. Thus, the species is simply (or could be) an exhaustible resource.

Evaluating the ESA, II

• The second possible justification suggests there is a public good:– Everyone benefits from diversity, but no

individual person or group captures the full magnitude of these benefits.

• This argument is logical on a priori grounds; the question is whether it is empirically compelling.

Evaluating the ESA, III

• Critical question, therefore, is how the ESA works in practice:– Badly.

• The evidence marshaled by economists and others is that ESA basically protects megafauna (Bambi), with infinitesimal impact on diversity.

• One possible effect is pre-emptive destruction of habitats.

• And ESA imposes substantial costs on property owners:– Indeed, the original law forbade use of economics to

evaluate which species to list and protect.

The Clean Air and Water Acts

• Two environmental policies that seem like big successes are the Clean Air and Water Acts:– Adopted in 1970– Restrict or prohibit auto emissions, discharge

of pollutants from factories, farming, etc.

• The general view is that air, water are much cleaner than 35 years ago.

Clean Air and Water, continued

• This is an instance where it might seem the Coasian approach does not work well:– Hard to say who owns the air or water.

• This view may be approximately right.

• But the overall merit of the Clean Air and Water Acts is still debatable.

Clean Air and Water, continued

• A first issue is the value of any benefits achieved by the CAWA.– Even if air and water are cleaner, we need to think

about why we care and how much this is worth.– The evidence suggests definite effects, but certainly

finite effects.• The second issue is the costs imposed:

– These have been substantial.– It is easy for policy to become too aggressive.

• Without a careful analysis, we do not know which is greater.– Entirely possible the Acts have gone too far.

Clean Air and Water, continued

• The other issue is whether there are alternative approaches.

• One possibility is tradeable permits rather than command and control.– This approach has been adopted for some air

pollutants;– Appears to work better than quantity limits.

• So, within the general CAWA, there is room for improvement.

Clean Air and Water, continued

• A second key issue is whether to conduct this or other environmental policies at the federal versus state level.

• Federal makes sense under some assumptions:– Similar issues across states, and Feds do things “right.”

• But state policy makes sense if– Issues differ substantially across states.– Policy tends to expand excessively– Competition between states provides a counterweight to the

tendency of policy to become too aggressive.

• Thus, there are some specific issues (acid rain) for which state control might work poorly.

• But overall, it probably achieves a better balance.

The Taking Clause of the 5th Amendment

• The takings clause of the 5th amendment states:– “nor shall private property be taken for public use

without just compensation.”

• Laws like ESA seem blatantly inconsistent with this amendment.

• And, the amendment makes sense:– If there’s a social benefit, then it’s worth paying for. – This requirement helps discipline government policy.

The Taking Clause of the 5th Amendment, continued

• Consider, as an example, preservation of an endangered species that resides on private land.– Then, if there is a value, the government can just pay

the landowner for the land (or to protect the species).– All the rest of the ESA is unnecessary.

• Of course, if faced with an explicit “bill,” taxpayers might not want to pay up.– But that is healthy for making sensible choices.

Conclusions

• The presence of externalities potentially justifies environmental policies, but private actions can reduce or eliminate externalities if transactions costs are low and/or property rights are assigned.

• There are instances where intervention still makes sense, but attempting to address them from the Coasian perspective is likely to work better than many command and control approaches.

• Some environmental policies (e.g., mandated recycling) are difficult to justify under any reasonable assumptions.

• Even many “plausible” policies work badly in practice.• State control would likely improve the quality of

environmental policies.