Week 4 - Assignment: Assess Distributive Policy Administration at the Agency Level and Week 5 - Assignment: Evaluate the Political Backlash of Failed Policies

Koji Noda is an associate professor of economics at the Tokyo Keizai University (Japan). This research was partly supported by JSPS KAKENHI Grant Number 26310301. The author is very grateful to the referees and Shunichi Teranishi, an emeritus professor at Hitotsubashi University, for their comments and suggestions. All remaining errors are the author’s own.

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©2018, Journal of Economic Issues / Association for Evolutionary Economics

JOURNAL OF ECONOMIC ISSUES

Vol. LII No. 1 March 2018

DOI 10.1080/00213624.2018.1430945

Institutional Economics as Theory of Policy Change:

Impact of Past Policy Failures on Present Policy

Koji Noda

Abstract: Social scientists have developed several theories for understanding or

evaluating policy change over time. Since all costs or benefits are not internalized

owing to positive transaction costs, policymaking is always implemented under cost

underestimation conditions and, therefore, is imperfect. I call this trait policy failure in this article. Furthermore, I show that a new framework combining the social

costs approach and the legal/economic approach in institutional economics is

suitable and can be applied to evaluating how past policy failures affect present

policy, providing as an example the Fukushima nuclear disaster in Japan.

Keywords: institutional economics, legal/economic approach, policy change,

rights structure, social costs approach

JEL Classification Codes: B52, K32, Q58

The age-old question of how public policies change over time is still salient because a

definitive answer is yet to be found. New theories have sought to explain the process

by introducing new understanding of the underlying mechanisms of policymaking

(e.g., Kingston and Caballero 2009; Mahoney 2000). As Daniel W. Bromley (1989,

1991) and Douglass C. North (1990) have shown, numerous economics scholars have

traditionally recognized institutions that regulate people as a rule of the game

embedded in the social structure. They have seen them as especially focusing on legal

relations. In fact, many legal rights, such as copyrights, abstraction licenses, and

contracts, are relevant to this study. For example, when a person rents a movie from a

store, this transaction is based on a contract, and he/she is forbidden from destroying

the movie. His/her rights include both what he/she can do and cannot do. In order

to understand institutions and public policies, many economics scholars have thus

analyzed such legal relationships between actors over goods, services, and resources

(e.g., Furubotn and Richter 2005; Mercuro and Medema 1997; Vatn 2005).

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As new institutional economics indicates, since not all benefits and costs are

internalized, policymaking (with imperfect estimation of costs and benefits) leads to

the inequitable distribution of costs and liabilities due to positive transaction costs. I

term this policy failure in this article. If policy failures are recognized, one needs to understand and evaluate how past policy failures affect present policy, and to

determine who must bear the costs of failure. I also examine who is forced to bear the

unintended costs associated with policy change and propose a solution to remedy the

problems due to such policy failure. If a past policy failure negatively affects the path

or content of present policy, how can the channel of impact be understood or

evaluated?

I propose a simple framework to answer the above question using institutional

economics, specifically by combining the social costs approach advocated by K.

William Kapp and the legal/economic approach advocated by John R. Commons,

Ezra J. Mishan, Warren J. Samuels, and Daniel W. Bromley. Institutional economics

focuses on how political power leads to economic performance and insists that a

mechanism determining who bears how much of the costs of policy establishment or

policy change is crucial to evaluating public policy.

Kapp developed the social costs approach to critically analyze the cost-benefit

analysis of mainstream economics, and attempted to establish his institutional

economics with positive influences from Thorstein Veblen and Gunnar Myrdal, with

Kapp’s ideas and theories being reevaluated in Europe (Berger 2008; Elsner, Frigato

and Ramazzotti 2012; Kapp 2011, 2016; Swaney 2007; Swaney and Evers 1989). On

the other hand, the legal/economic approach is a classical and traditional method in

institutional economics. It recognizes that the first rights holders obtain more political

power from their vested rights, and emphasizes that scholars should evaluate whether

an institutional or policy establishment is fairly determined. This will also help

investigate the costs the non-holder is forced to bear when institutions or public

policies change (Bromley 1991; Mercuro and Medema 1997; Mishan 1971, 1974;

Samuels 1995; Vatn 2005). Despite having similar features, the social costs approach

and the legal/economic approach can be considered independent. However, I show

that these two approaches can be combined.

I organize this article as follows. In the next section, I discuss the importance of

welfare effects as emphasized by Mishan and the controversy of path-dependence. An

understanding of welfare effects would show why the first structure of legal rights is

crucial to evaluating policy change, and an understanding of the controversy of path-

dependence would highlight the importance of the mechanism through which a

public policy changes and in what direction it changes. In the third section, I propose

a new, simple framework illustrating how the failure of a past policy affects current

policy, combining the social costs approach and the legal/economic approach. In the

fourth section, I demonstrate that this simple framework is useful and pragmatic by

applying it to the environmental policy implemented in Japan to remedy the serious

damage caused by the Fukushima Daiichi nuclear disaster of 2011, one of the most

important political and environmental issues in the world. In the final section, I offer

my conclusions.

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Why Is the First Policy Crucial? In What Direction Does Public Policy

Change?

The Importance of Welfare Effects

Mishan emphasized that welfare effects are essential to evaluating policy change.1 To

explain welfare effects in this subsection, I first consider the property rule as an

entitlement rule.2 Since the rights holder can refuse an offer from a non-holder under

this rule, the rights holder has final control over the transactions in goods or services.

The legal rights holder is thus in a stronger position than the non-holder under the

property rule. On the other hand, the non-holder has to pay a certain amount of

money to induce the rights holder to sell those rights. Under the property rule, the

non-holder cannot avoid bearing almost the entire costs (including transaction costs),

and has to pay more money to the rights holder. In general, the rights holder’s

willingness to accept (WTA) does not necessarily correspond to his/her willingness to

pay (WTP) when he/she becomes the non-holder. This is also applicable to the

relation between individuals. This difference indicates that the rights holder always

has an advantage in voluntary rights transactions, but this depends on the entitlement

rule regulating who bears how much of the costs, including transaction costs. Mishan

(1971, 1974) indicated that the gap between the WTA and WTP was associated with

the current rights structure.

Welfare effects suggest that the rights holders under past policy have stronger

political power and can maintain the status quo when the public policy changes to

remedy past policy failures. As Mishan pointed out, if, for instance, the government

established an environmental policy requiring firms or offices to obtain permission to

discharge pollutants from the citizens or the potential victims of environmental

pollution, the corresponding rights holder would be the citizens or the potential

victims. Such firms or offices would, therefore, be obliged to pay the non-holder’s

share of costs for these economic activities. Given the contrast between this process

and the current practices worldwide, Mishan (1971, 1974) examined whether the

present situation was unfair (see also Oka 2006).

Positive transaction costs and welfare effects show that the rights structure is very

important in evaluating the distribution of income as well as the efficiency of resource

allocation. “The very concept of efficiency, the rules and conventions by which

efficiency is measured, are themselves largely defined by the actual institutional set-up,

and efficiency-based explanations will easily end in circularities. The efficiency claims

become embedded in the assumptions of the analysis” (Vatn 2005, 190). To evaluate

policy change, I first analyze whether the costs of policy change are fair and then

evaluate how much of these costs should be borne by the non-holder. To determine

1 Since Mishan analyzed the welfare effects associated with the Coase theorem controversy, I should

discuss it comprehensively. However, I will take up the critical investigation of the Coase theorem in a

future study owing to lack of space here. 2 See the next section for a definition of the property rule.

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this, I specify how past policy failures negatively affect present policymaking or the

public policy structure.

The Controversy of Path-Dependence

Social science focuses on whether public policy is stable and how self-reinforcing

or self-undermining is its mechanism. This is seen as the controversy of path-

dependence. James Mahoney (2000) mentions four schools of thought on self-

reinforcing mechanisms in path-dependence. I refer to the tendency of existing

institutions or public policies to maintain the status quo as a positive effect and the

tendency to cause institutional or policy change as a negative effect. First, the

functional explanation focuses on how an individual institution depends on the

entire institutional structure and the strength of complementarities between

institutions. In this approach, institutions may undergo change through exogenous

shocks. Second, the legitimation explanation recognizes that institutions persist when

the actors involved consider them correct or legitimate, and that the actors voluntarily

select institutional change if they think otherwise.

Third, the utilitarian explanation recognizes that institutions are established or

changed through cost-benefit analyses, assuming individual rationality. Institutions

remain stable because of self-reinforcing mechanisms, such as increasing returns.

Good examples of the utilitarian explanation are found in North (1990) and Paul

Pierson (1993, 2000, 2004). According to North (1990), institutions are always

imperfect because of positive transaction costs, and regulate the actions of both

persons and organizations as a rule of the game. Under this approach, the purpose of

a state or nation is to reduce transaction costs and promote market efficiency.

However, according to North (1990), institutions may promote inefficiency.

Furthermore, institutional change is incremental because of increasing returns (and

the political pressure of vested interests). Since individuals or organizations always try

to control future returns, this becomes a source of institutional change. This is the

reason why institutions gradually change. Fourth and finally, the power explanation

assumes that each actor selects options through cost-benefit analyses, and that

institutions distribute unfair power among actors. Unfair or unequal power

distribution is a source of conflict and institutional change. Many social science

scholars have understood that power relations are crucial to understanding

institutional or policy change (e.g., Knight 1992; Libecap 1989; Moe 2005; Thelen

1999, 2003). The power explanation functions as a classical framework.

The legal/economic approach gives importance to vested rights and uses the

power explanation to understand institutional or policy change. According to Warren

J. Samuels (1995, 573), “[i]nstitutionalists insist that the ultimate determinant of the

allocation of resources is not some abstract market mechanism but the institutions,

especially the power structures, which structure markets and to which markets give

effect.” Statutes or enforcement regulations are “the outcome of the policymaking

process, and more specifically, of the interaction between the groups supporting the

respective forces of continuity and change and the power that each can bring to bear

on this process” (Mercuro and Medema 1997, 114).

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121

Contrary to the path-dependence approach, some scholars in public policy

theory focus on the negative effects promoting policy change through self-

undermining mechanisms. For example, Kent Weaver (2010) attempts to explain

policy change based on the power explanation, and indicates that losers may have

significant roles in policy change. Negative effects are associated with the power

explanation because politics represent struggles over benefits and costs, and political

struggles may increase when institutions or public policies change (see also

Ebbinghaus 2005; Jacobs and Weaver 2015).

When negative effects are not considered, only external shocks (i.e., the Great

East Japan earthquakes) are a source of policy change. Thus, one needs to examine

how both positive and negative effects impact policymaking, and determine which

factor leads to negative or positive institutional effects. Policymaking is the arena

where those, who want to maintain the status quo, and those, who want policy

change, negotiate, and statutes or enforcement regulations are the result of political

struggles. Moreover, in view of both effects, the power explanation is most appropriate

to understanding policy change, and one should empirically analyze it to trace the

policymaking and legislative processes, as well as the structure of legal rights.

A Potential New Framework for Evaluating Policy Change Using Institutional

Economics

Unaccounted Social Costs as Key Concept

Both mainstream economics and new institutional economics have used the term

social costs, defined as the total of the private costs borne by private actors and the

external costs the private actors do not bear but force others to bear. On the other

hand, Kapp used the term social costs to indicate the harmful effects that a third party

or the environment is forced to bear. Since Kapp argued that considering who the

victims are and how much of the costs they bear are theoretically and empirically

important for economics, he intentionally replaced the mainstream economics

concept of external costs with that of social costs (Barger 2008; Kapp [1950] 1975,

1963, 1978, 2011, 2016; Oka 2006; Swaney 2007; Teranishi 2002).3 In addition,

Kapp emphasized that social costs are recognized or internalized through institutions

or public policies reflected by the inhomogeneous distribution of political power

among actors, and institutions should be understood as some social relationships that

regulate uniform patterns of actors’ thoughts and action and result in self-

perpetuating, cumulative, and move-around consequences (e.g., Kapp 1963, 2011).

Figure 1 shows the relationship between social losses, social costs, and social

expenses. While Kapp, more or less, recognized that part of social losses or social costs

could be physical or monetary and might include irreversible or reversible damages,

3 The social costs approach has been one of the most influential methods followed by Japanese

environmental economists like Kenichi Miyamoto and Shunichi Teranishi because of the severe

environmental pollution after the 1950s in Japan.

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one needs to distinguish social losses as a value in use and social costs as a value in

exchange so as to avoid misunderstanding Kapp’s social costs theory. For example, if

land is a free good, which is maintained under open-access conditions in a resource

management regime, its exchange value will be zero — that is, it will be free. Now, if

this land is polluted, the social costs of such pollution will be taken as zero because

the exchange value of the land is zero. However, this fails to accurately estimate the

impact of pollution, which is not zero in the overall economy. By using an

approximate evaluation method based on politics, irreversible social losses may be

partly internalized and compensated to victims as social expenses, but this amount of

social costs will generally be smaller than the amount of social losses (Miyamoto 2007;

Teranishi 1984, 2002; Yokemoto 2007).4

Figure 1. The Relationship Between Social Losses, Social Costs, and Social Expenses

Source: Teranishi (2002); Yokemoto (2007).

When evaluating the impacts of policy change, one should note that how the

monetary estimates of social losses are recognized or counted in policymaking will

depend on the current situation. Two approaches are used to estimate social costs: (i)

the econometric method, for example, which is a contingent evaluation, and (ii) a

method based on aggregating the actual social expenses. Social expenses include the

payment of compensation for damage after an event occurred, as well as the payment

to regulate policymaking or public policy after the second stage, such as raising the

4 According to Teranishi (1984), social expenses include five types of costs: (i) costs to prevent social

losses, (ii) costs to reduce social losses, (iii) costs to recover social losses, (iv) costs to remedy damages, and

(v) the administration costs arising from the previous four costs. As the previous example of social expense

shows, the term social costs partly overlaps with transaction costs.

Social losses

Social expenses

Social costs Irreversible

social losses

Unaccounted

social costs

Institutions including political power relations

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effluent standard. Note that the amount of social costs internalized as social expenses

and the amount not accounted for and internalized depend on the current situation.

In general, such approximations result in the underestimation of social losses or social

costs (Teranishi 1984, 2002; Yokemoto 2007).

If statutes or enforcement regulations control the amount of social expenses

paid, the distribution of private costs and unaccounted social costs is determined

concurrently. Shunichi Teranishi (2002) emphasizes that the concept of unaccounted

social costs is key to understanding the importance of the social costs approach. For

example, the first policy prohibits a factory from discharging over 0.05 ppm of

mercury per day into rivers. The policy sublimates this cost to part of the factory’s

private costs. At the same time, the citizens and the environment have to tolerate the

pollution from the discharge of mercury within the limit of 0.05 ppm per day as part

of their private costs. If the policy does not regulate the effluence of cadmium into

rivers, the environmental pollution due to this non-regulation would become part of

the unaccounted social costs. This imperfect part of public policy is always the result

of positive transaction costs, such as imperfect technological knowledge. Thus, this

defect in the first policy accelerates the increase in social losses or social costs and is a

source of institutional or policy change requiring social costs to be internalized to a

much greater extent.

The Rights Structure for Analyzing the Distribution of Costs or Liabilities for

Actors in Statutes or Enforcement Regulations

Statutes or enforcement regulations control the distribution rule of how much

of social costs are not considered or how much of social expenses are paid. The extent

of the distribution rule dramatically depends on the structure of rights. Many social

science scholars have proposed the definition of rights as a bundle of rights or an

analytical framework of rights. For example, Anthony M. Honoré (1961) recognizes

the concept of full ownership based on eleven elements of rights, such as the right to

possess or the right to manage. Edella Schlager and Elinor Ostrom (1992) introduce

five categories of actors involved in resource management regimes and five elements

of rights, such as the right to access or the right to alienation. Christopher Galik and

Pamela Jagger (2015) attempt to combine the Schlager-Ostrom framework with the

Hohfeld-Commons framework, as I indicate below. However, there is no consensus

on what the rights (including property rights) are and how one should understand the

rights structure. Each framework has both advantages and disadvantages. As I show in

the next section, the rights structure framework Bromley (1991) indicates is one of the

most comprehensive and pragmatic frameworks used to empirically analyze the

distribution rule for private costs and unaccounted social costs.5

5 A future issue is to compare the advantages and disadvantages of each type of rights structure

framework and to reveal the most meaningful and useful rights structure framework. Indeed, the term

property rights is used in several contexts. Daniel H. Cole and Peter Z. Grossman (2002) indicate that new

institutional economics scholars, who tend to consider property rights as a mere possession of goods or

services, and legal scholars understand the term differently (see also Hodgson 2015).

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Because of the positive influence of Wesley Hohfeld, Bromley’s rights structure

framework requires that rights should be understood as a bundle of rights. The rights

structure involves not only the mutual relationship between the rights holders and

others over goods, services, and resources, but also the social relationship of how the

specified group or the government, which has the authority to manage or control

natural resources and the society, would restrict the rights holders’ or others’

behaviors and protect the legal interest of the rights holder. Bromley (1991, 2016)

recognizes the rights structure as the aggregate of three dimensions: (i) the legal dual

relation between actors, (ii) the fundamental entitlement rules, and (iii) resource

management regimes.

The first and most important dimension is the legal dual relation between

actors. This has been defined by Hohfeld (1913, 1917) and Commons ([1924] 1995),

and has four forms: (i) right/duty, (ii) privilege/no right, (iii) power/liability, and (iv)

immunity/no power.6 It specifies the legal relations between the rights holders and

non-holders over goods, services, or resources. For example, if person X has a right

over a resource, he/she can use it — here, the term “use” has a broad meaning — in an

approved context, and person Y has a duty not to interfere with the right of person X.

The privilege/no rights relationship defines a situation of no legal correlation between

person X and person Y. If person X has power, he/she could change the existing

rights structure. Here, person Y is liable to obey it. If person X has immunity, he/she

can refuse to change the existing rights structure, in which case person Y has no

power to change the existing rights structure (see also Cole and Grossman 2002).

According to Guido Calabresi and A. Douglas Melamed (1972), the second

dimension provides the fundamental entitlement rules by which the state can protect

the rights holder. This has three forms: (i) the property rule, (ii) the liability rule, and

(iii) the inalienability rule. The entitlement rule means the distribution rule of rights

to determine who bears how much of the costs (including transaction costs) when all

or part of the existing rights would be transferred. Now, if person X has a right and is

protected under the property rule, he/she has the right to decide whether and how

much right to give based on free will. This is found in normal market transactions.

However, if person X has a right and is protected under the liability rule, he/she may

suffer a loss without his/her willingness. If person Y pays a reasonable amount, all or

part of the right of person X may be withdrawn regardless of his/her willingness. This

is the liability rule found in well-known domains, such as the Fifth Amendment of the

U.S. Constitution. Under the inalienability rule, the transfer of rights may be

prohibited or restricted.

The third dimension is the resource management regimes, determining who

owns resources, who has the power to restrict individuals in society in order to

maintain or improve social welfare, and who has the liability to obey such restrictions.

6 Commons ([1924] 1995) replaces the term privilege/no right with liability/exposure. In addition,

Bromley (2016) attempts to combine the first dimension of the actors’ legal dual relation and Honoré’s

framework.

Institutional Economics as Theory of Policy Change

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This takes four forms: (i) private property, (ii) public property, (iii) common property,

and (iv) open access (non-property). While public property means that the state owns

all resources and the power to control individuals, private property means that

individuals or organizations own the resources and can use them for their own self-

interests. Common property has the nature of both private and public property (e.g.,

Bromley 1991), but the essence of common property is autonomy. That is, it is not

the government, but local organizations that finally decide the conditions for

managing or controlling natural resources. Open access means that no one owns the

resources and everyone can use them.

To understand the complexity of an actual rights structure, I will examine the

water laws in Oregon as an interesting example. Since water essentially contains

several complicated characteristics like liquidity, the rights structure related to water

may be complicated everywhere. The first modern water law in Oregon, established in

1909, adopted an appropriative water rights system. By this, water itself belongs to the

public — that is, water comprises public property. While a water rights holder has the

right to abstract or use the water flowing into rivers with several restrictions, such as

approved volume of water, others have a duty not to interfere with his/her right.

Although this dual legal relationship is basically restricted to the function of water in

terms of economic interests, a policy failure that could not concretely regulate the

functions relating to other interests like environmental value has actually worked as a

monopoly of water resources by water rights holders. Thus, to remedy this policy

failure, the Oregon state government established in-stream water rights to protect the

water and value of in-stream flows, such as the river ecosystem or recreation, in 1987.

Since in-stream water rights are held in trust by the state government, they comprise

public property. Note that only the water interests related to environmental or

recreational interests are legally protected as in-stream water rights. Although the in-

stream water rights system fundamentally adopted the same rules as the appropriative

water rights system, the two water rights structures coexist in Oregon (for details, see

Noda 2011).

Thus, the rights relating to natural resources may be subdivided at several levels,

with multilayered rights structures found in the real world even when scholars analyze

the same natural resources. Furthermore, one needs to study who holds the final

authority to manage or control natural resources. This is one of the essences of

ownership. It is what differentiates the nominal term from the real one. One also

needs to develop a more accurate rights structure framework. For example, public

property seems to be a simple concept, but what does the state actually mean by this?

In general, modern nations declare the sovereignty of the people, and citizens can

influence the government through voting and/or protest demonstration. Even if the

citizens are the nominal owners, they cannot always and directly decide on managing

or controlling natural resources. Thus, the government rather than the citizens may

virtually be the owner of natural resources — at least, in the sense that the government

behaves as if it is the owner. To study who holds the final authority of managing or

controlling natural resources, one should analyze the actual situation of the political

constructions in question.

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Main Features of the Proposed Framework

Applying Power Explanation to Policymaking

Positive transaction costs always result in imperfect policymaking, for example,

due to lack of technological information on pollution abatement. This framework

starts with political negotiations over the costs that those who cause the problems

should bear and the costs that a third party or the environment is forced to bear. The

political power relations between those expecting to establish or change public

policies and those who oppose it affect the making or changing of the policy. Once

statutes or enforcement regulations are established, they work as formal rules and can

decide on how to internalize the costs of the actors. Thus, when one analyzes the

impact of the distribution of costs or liabilities on the first policy, one should focus on

the rights structure in the statutes or enforcement regulations.

An Increase in Unaccounted Social Costs as a Mechanism of Policy Change

As Figure 2 shows, my proposed framework adopts the power explanation and

the increase in unaccounted social costs as mechanisms of policy change. As the legal/

economic approach emphasizes, the government is legally required to protect the

rights holders’ vested rights. For example, discharging environmental pollution is

legally or socially allowed as long as it does not conflict with the effluent standard.

Thus, through statutes or enforcement regulations at the first stage, the government

can regulate the internalized social expenses, as well as the distribution of private costs

and unaccounted social costs. Unaccounted social costs occur also from imperfect

policymaking under positive transaction costs and hence increase over time.7 Such an

increase is a source of policy change that requires the unaccounted social costs

occurring at the first stage to be internalized. Exogenous shocks may accelerate policy

change, but the timing of change depends on political or social factors.

In policymaking at the second stage, the most important point is to find out

how much of the unaccounted social costs of the first policy should be internalized.

The logic here is similar to finding out how much of the costs are internalized by

actors through statutes or enforcement regulations and how much of the social

expenses are additionally realized in the second policy stage. If all categories of costs

are available as a numerical value, one can easily evaluate the impact of the policy

change. However, since this situation is usually rare owing to lack of necessary

information, one evaluates the impact approximately. Whereas the analysis of the

policy process or policy history plays a complementary and major role in increasing

the precision of the analysis, one obtains an approximate evaluation by comparing the

past rights structure with the new rights structure. This is because the extent of social

7 Of course, the first policy may resolve the problem in question, but I consider this a rare case.

Institutional Economics as Theory of Policy Change

127

expenses depends on the rights structure determining who pays how much of the

costs. However, once the second policy actually regulates the new distribution of

private costs or unaccounted social costs, one may be able to assess the unaccounted

costs in the first policy.

Figure 2. Logic of Policy Change in the Proposed Framework

Applying the New Framework to the Environmental Policy Enacted in

Response to the Fukushima Daiichi Nuclear Disaster of 2011

Short Policy History Associated with the Fukushima Daiichi Nuclear Disaster

The Fukushima Daiichi Nuclear Plant, owned by the Tokyo Electric Power Company

(TEPCO), experienced a meltdown in March 2011. As of October 27, 2017, a total of

34,587 people were evacuated from the Fukushima Prefecture, where the Fukushima

Daiichi nuclear plants are located (Fukushima Prefecture Government 2017). The

Fukushima Daiichi nuclear disaster has influenced social, political, cultural,

economic, regional, and institutional aspects in Japan. I, however, focus only on the

institutional issues related to the payment of compensation to victims.

The Act on Compensation for Nuclear Damage (the Compensation Act) and

the Act on the Indemnity Agreement for Compensation of Nuclear Damages (the

Indemnity Agreement Act) were the main policies before the Fukushima Daiichi

Exogenous shock→

　 　→

→

↑

Exogenous shock

First policy Second policy

Decision of who bears how much of

the social expenses 1 ↓

Unaccounted

social costs 1

Enactment of statute 1 or enforcement regulation 1

Private costs 1

Increase of the social losses Policymaking over determining how much of the unaccounted social costs 1 under the power relations 2

and positive transaction costs 2

Policymaking for internalizing the social costs under

the power relations 1 and positive transaction costs 1

Analysis of the

rights structure 1

Increase of the unaccounted social costs

Enactment of statute 2 or enforcement

regulation 2

Decision of who bears how much of

the social expenses 2 ↓

Unaccounted

social costs 2

Private costs 2

Analysis of the

rights structure 2

Policy failures 1

Policy failures 2

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nuclear disaster.8 The Compensation Act has three features with regard to cost

distribution: (i) no-fault liability, (ii) centralization of liability (by which only a nuclear

operator needs to pay compensation for nuclear damage), and (iii) unlimited liability.

A nuclear operator is required to ensure its financial security through a private

contract, an indemnity agreement for nuclear damage, or a deposit. The maximum

amount of financial security was just JPY 5 billion per plant from March 1962 to

October 1971.9 This was increased to JPY 120 billion per plant in January 2010. If a

disaster like an earthquake or a tsunami led to a nuclear accident, the central

government would pay the amount of financial security based on the Indemnity

Agreement Act (OECD 2012; Osaka 2012; Schreurs and Yoshida 2013; Takahashi

2012a, 2012b; Weitzdörfer 2014; Yamaguchi 2015).

As Yasufumi Takahashi (2012a) shows, both the Compensation Act and the

Indemnity Agreement Act stipulated that the nuclear operator should pay the amount

of compensation that is beyond the previously acquired financial security by selling its

own assets. Although the central government could financially support the nuclear

operator to compensate the victims and maintain the country’s nuclear policy, the

amount of central government financial support was not clear. The Fukushima

Daiichi nuclear disaster generated a robust political debate on the extent of social

expenses that should be internalized. Because the Compensation Act and the

Indemnity Agreement Act led to policy failure (as I show in the next subsection), the

central government was forced to enact the Nuclear Damage Compensation

Facilitation Corporation Act (the Facilitation Corporation Act) in August 2011. In

May 2011, the central government declared that TEPCO should bear the primary

compensation costs for nuclear damage (Yamaguchi 2015).

Nevertheless, the central government did not want TEPCO to experience an

asset deficiency and/or legal liquidation, and so decided to provide financial support

to TEPCO under the Compensation Act and the Facilitation Corporation Act

(Takahashi 2012a, 2012b; Yomiuri Shimbun 2012). The Facilitation Corporation Act

was revised to become the Nuclear Losses Indemnity-Reactor Decommissioning

Support Machinery Act (the Indemnity-Reactor Act) in August 2014. Under this Act,

the central government could provide financial assistance to TEPCO through three

methods: (i) by granting funds based on government bonds, (ii) by granting additional

funds if the funds based on government bonds are insufficient for payment of

compensation, and (iii) by providing loans through a private financial institution with

government guarantee (Oshima and Yokemoto 2014; Takahashi 2012a, 2012b;

Yamaguchi 2015).

The central government established the present Nuclear Damage Compensation

and Decommissioning Facilitation Corporation (NDCDFC) as an intermediary

8 Shunichiro Koyanagi (2015) historically analyzes the policymaking process of the Compensation

Act. This section does not address the policymaking process in order to simplify the description. 9 In the process of drawing a bill, the financial security amount of JPY 5 billion was already decided

in October 1959 considering the ability of private insurance to pay (Koyanagi 2015).

Institutional Economics as Theory of Policy Change

129

between the central government and TEPCO.10 TEPCO and other nuclear operators

are expected to pay their liability to NDCDFC, which is effectively the central

government. The amount of money that the central government could lend TEPCO

to meet the payment of compensation or costs related to decontamination efforts was

increased from JPY 5 trillion to JPY 9 trillion in 2014. Moreover, the management of

TEPCO changed from private to public because NDCDFC bought the stock of

TEPCO for JPY 1 trillion and gained majority voting rights. However, the central

government still believes that the management of TEPCO should return to the

private sector in the future (Oshima and Yokemoto 2014; Takahashi 2012a, 2012b;

Yamaguchi 2015).

How Much of Social Expenses Are Paid?

How much of the social losses incurred are actually social expenses? Under the

Compensation Act as the first policy, electric companies had to bear the given

financial security, but the amount of compensation the electric companies or the

central government had to pay was ambiguous. As Table 1 shows, the total amount

that TEPCO or the central government paid or determined to pay as social expenses

was more than JPY 21.5 trillion as of December 2016. The compensation paid to

victims alone was JPY 7.9 trillion, which figure was reached through voluntary

negotiations between the victims and TEPCO, the Dispute Settlement Center for

Nuclear Disaster Compensation (DSCNDC), and trials. Both the compensation

amounting to over JPY 7.9 trillion and the office expenses comprised private costs for

TEPCO under the second policy (NDCDFC and TEPCO 2017; Oshima and

Yokemoto 2014, 2017; Yamaguchi 2015; Yokemoto 2016).11

An example for the irreversible social losses related to the Fukushima Daiichi

nuclear disaster is the compensation paid for a lost hometown. Such compensation

has not been paid by TEPCO so far. In other words, the irreversible social losses due

to a lost hometown remain the unaccounted social costs the victims are forced to

bear. Once a community is forced to cease, for example, by the Fukushima Daiichi

nuclear disaster, it cannot be perfectly restored because several residents have no

choice but to settle at other places in order to secure their living. Such deterioration

shows that irreversible social losses occur in the real world. Indeed, several plaintiffs

have appealed to courts for payment of compensation for lost hometowns. If the

plaintiffs win and the courts rule that the compensation for lost hometowns should

be paid, the irreversible social losses relating to lost hometowns will partly become

10 The Nuclear Damage Liability Facilitation Fund was a successor agency of NDCDFC. 11 Two types of social expenses can be recognized as transaction costs: (i) administrative expenses

(excluding decontamination costs) for which the central government paid, JPY 387.8 billion, and (ii) the

office expenses borne by TEPCO toward payment of compensation for damages, JPY 77.7 billion (Oshima

and Yokemoto 2014; Yokemoto 2016). These represent transaction costs in a narrow sense. Initially,

TEPCO had complicated forms to apply for compensation, and “these long and complicated forms delayed

compensation” (Osaka 2012, 441). Such costs are also transaction costs, but I omit them here for lack of

data.

130

Koji Noda

social expenses. However, note that compensating such irreversible social losses also

means the conversion of infinite and irreversible damages to limited and restorable

losses, for example, through a social institutional device like the courts. Again, while

the amount of social expenses of over JPY 21.5 trillion is very large, it could be

underestimated because part of the social costs and irreversible social losses has not

yet been paid (Oshima and Yokemoto 2014, 2017; Yokemoto 2016).

Table 1. The Social Expenses Related to the Fukushima Daiichi Nuclear Disaster

Source: Oshima and Yokemoto (2017, 36).

Since the central government knew that nuclear damage could rise beyond any

financial security, the compensation level considered for nuclear damage was

obviously underestimated. This could be a policy failure for the government. A

comparison of the financial security with social expenses (JPY 21.5 trillion), or with

just the compensation for nuclear damage (JPY 7.9 trillion), clearly shows that the

social expenses related to nuclear damage are underestimated. In addition, a

comparison of the compensation of JPY 21.5 or 7.9 trillion with the estimated net

income of TEPCO of JPY 133.8 billion for FY 2009, or with its net assets of nearly

JPY 2.5 trillion for FY 2009 (TEPCO 2010), shows that the social expenses related to

the Fukushima Daiichi nuclear disaster amount to more than the private benefits that

TEPCO could bear under the first policy. Again, note that the above estimation of

social expenses was made after the event and hence depends on institutional factors

like the rules of the game, budget, and political power relations in policymaking at the

second stage.

Change of the Rights Structure and Its Implications

As Figure 3 shows, the policy change from the Compensation Act to the

Indemnity-Reactor Decommissioning Act altered the underlying rights structure.

First, the nuclear plant operation relationship takes a right/duty relation. Here,

Unit: JPY trillion

Compensation payment 7.9 36.7%

Restoration

Costs of decontamination 4.0 18.6%

Construction costs for temporary

storage installation 1.6 7.4%

Costs for abolishing the Fukushima Daiichi Nuclear

Plants (including contaminated water

countermeasures)

8.0 37.2%

Total 21.5 100.0%

Institutional Economics as Theory of Policy Change

131

TEPCO has the right to operate a nuclear plant under the central government’s

control and the citizens have a duty not to interfere with TEPCO’s right. This

relationship is maintained under the Indemnity-Reactor Decommissioning Act. In

addition, because the right/duty relation is associated with the type of compensation

for nuclear damage, victims have a right to receive compensation for nuclear damage

and TEPCO has the duty to pay it. The exact position of the victims’ rights could not

be assessed because TEPCO did not have the required amount of money (over JPY

7.9 trillion) and the financial support that the central government was prepared to

provide was not clearly determined. However, the amount of compensation expanded

because of the substantial compensation liability for damage. The Great East Japan

Earthquake as exogenous shock partly broke through the path-dependence caused by

past policy failures.

Figure 3. Change of the Rights Structure Related to the Fukushima Daiichi

Nuclear Disaster

Second, the entitlement rule under the Indemnity-Reactor Decommissioning

Act has not fundamentally changed. Victims have an expanded right to receive

compensation for damage, and TEPCO has a duty to pay compensation under the

liability rule based on liability without fault and unlimited liability. The amount of

compensation is certainly expanded, but the structure of the entitlement rule related

to compensation remains unchanged. Although voluntary negotiations are restricted

by several guidelines of DRCNDC’s superior body, which follows TEPCO, the latter

can institutionally refuse to make payments of all or part of the victims’ compensation

claims. TEPCO has a duty to pay compensation for damages, but retains the political

power to decide who should receive how much compensation.

Third, NDCDFC obtained stock in TEPCO and TEPCO became a public

sector property. Thus, the managerial relationship between the central government

and TEPCO changed from immunity/no power to liability/power, with a

Private property

Funding

Payment

Funding

Payment

Managerial relationship: power/liability

Payment

Two kinds of insurances/

financial support with ambiguous limit

of compensation

The rights structure under the Indemnity-Reactor Decommissioning ActThe rights structure under the Compensation Act

Public property

Compensation

immunity/no power

Compensation

right/duty (liability rule)

right/duty

Managerial relationship:

right/duty

expanded right/duty

(liability rule)

Nuclear plants Fukushima Daiichi nuclear plant

(abolition) and other nuclear plants of TEPCO

Other nuclear operators

TEPCO

under temporal public property

The central government

NDCDFC

Electric companies

(including TEPCO)

Citizens or

potential victims

Victims

Citizens

The central government

132

Koji Noda

complicated process of financial support from the central government that made

TEPCO’s nuclear plants publicly owned. However, note that this is a temporary

phenomenon during a transition period. Following the disaster, the central

government and TEPCO had to pay large compensation for nuclear damage since

March 11, 2011. As I show, however, the rights structure has not changed much

under both the Compensation Act and the Indemnity-Reactor Decommissioning Act,

because the entitlement rule is essentially similar to the liability rule, and the dual

relationships between TEPCO and the victims or citizens remain almost unchanged.

Future Argument Points to Evaluating Policy Change

It is still early to evaluate the presence or impact of path-dependence or the lock-

in effect by controlling for the compensation paid for nuclear damage. However, I

offer three important arguments in this article. First, the central government

dramatically changed the amount of costs TEPCO should bear, but agreed to bear

part of the costs associated with decommissioning the Fukushima Daiichi Nuclear

Plant — that is, the costs associated with the leak of radioactive contaminated water

(Oshima and Yokemoto 2014; Yamaguchi 2015). In addition, the central government

and TEPCO proposed a new policy by which the compensation for damage will be

gradually tapered off. For example, the Evacuation Directive Lift Prepared Area and

the Restricted Habitation Area in the Fukushima prefecture is abolished as of March

31, 2017, and the compensation for mental damage (JPY 100,000 per month per

person) in both areas will be stopped in April 2018 (Nihon Keizai Shimbun 2016).

Therefore, the total costs that TEPCO actually bears cannot be confirmed. This is still

a significant political problem, and it is crucial to evaluate this policy change.

Second, one of the guidelines of DRCNDC’s superior body basically determines

the compensation for mental damage based on the rule of compulsory automobile

liability insurance for traffic accidents, but debates continue on whether it is rational

to apply this rule (e.g., Urakawa 2013). This indicates a past policy failure because the

referred rule was not determined before a nuclear accident. Once the criterion to

decide the compensation to be paid as part of social expenses is adopted and

continues to influence the actual negotiations, it will codify and display path-

dependence or the lock-in effect, making it difficult to change the entitlement rule

under which victims could receive more compensation.

Third, as I explain above, the central government will have to sell its TEPCO

stocks to recover the estimated costs related to decontamination efforts and the

amount paid for TEPCO stock — that is, JPY 5 trillion. In order to improve the

business conditions of TEPCO, the central government changed its policy from one

by which TEPCO had to bear all costs to one by which the central government will

bear the costs of constructing temporary storage installations. This policy change

suggests the relapse of a negative tendency like inhibiting the increase in social

expenses or reverting to past policy because the compensation to be paid for nuclear

damage due to past policy failure is too large.

Institutional Economics as Theory of Policy Change

133

Conclusion

I proposed a simple framework by combining the social costs approach and the legal/

economic approach in institutional economics to explain how public policy changes

over time — specifically, how past policy failures negatively affect present policy.

Because not all costs or benefits are internalized due to positive transaction costs,

public policy is always imperfect. The extent to which social costs are internalized as

social expenses depends on several factors in policymaking. As the legal/economic

approach emphasizes, who holds a right and how this is protected are issues affecting

both income distribution and resource allocation. The failure to internalize social

costs in a previous stage may result in policy changes in the subsequent stage. In

addition, the concept of welfare effects indicates that the rights holder at the previous

stage may enjoy more advantages through the protection of vested rights. Thus, the

analysis of policy history or continuous policy processes is crucial to evaluating actual

policy change. This framework can be effectively applied to analyzing other cases in

environmental or public policy, but this might require further historical and empirical

studies. This framework needs to be tested using more case studies.

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