Essay！！

Liability, Property rights, Moral suasion and Green Goods

Richard Martin

University of Victoria

October 30, 2019

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Review

So we have identified that the socially optimal level of pollution lies somewhere between zero pollution and maximal pollution.

In the absence of government intervention we would expect to see maximal pollution: if firms can dump pollution into the environment for free they will put no effort into reducing emissions.

The reason why maximal pollution is not socially optimal is that the damages associated with the pollution are external to the transactions associated with the production and consumption of the good.

In an ideal world the government would intervene to correct this externality problem.

In experiment 2 we saw two policy alternatives the government could use: an emissions tax, and transferable emission permits (TEP) a.k.a cap and trade.

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The policy spectrum

Policy Spectrum:

One dimension that environmental policies vary on is how involved the government is in limiting emissions. Emission taxes and cap and trade are in the middle of the spectrum

1 For emission taxes the government needs to set the tax rate, measure emissions and collect the tax but firms are free to choose their abatement strategy and level.

2 For cap and trade the government need to set the number of permits, somehow allocate the permits initially, keep track of the permit trades and measure emissions. Again, firms are free to choose their abatement strategy and level.

Today we focus on the decentralized end of the policy spectrum, where the involvement of the government is lower than in the case of emissions taxes or TEP.

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Decentralized solutions

Consider a noisy airport that is initially far enough outside a city to not adversely affect any humans.

Suppose that over time the city expands until the airport is inside city limits: now noise pollution is an externality. Who created the externality problem? Decentralized solutions takes an agnostic view towards who causes externalities. https://www.youtube.com/watch?v=OnDxxQugCI0

For decentralized solutions the government’s only role is to establish and enforce property rights. The government can give the property right to the source of the pollution (the right of free disposal) or to the recipient of the pollution (the right to a pristine environment). Once property rights have been established, the affected parties need to either negotiate a solution themselves or make use of the courts.

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Decentralized solutions

Advantages:

The affected parties should have the greatest incentives to resolve the problem. The affected parties should have the best information concerning damages and abatement costs.

Disadvantages:

Need to be able to define property rights over the environment which is somewhat problematic: who “owns” the environment? It is not like private land. Negotiation and the courts really only work where the number of counter parties are limited: most environmental problems we face do not fit this description.

The real value of decentralized solutions is they focus our attention on the bilateral nature of externalities: It takes at least two people to have a problem and it is not always clear who “created” the problem.

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Decentralized solutions Liability Laws

Liability Laws:

Suppose that the property right is given to the recipients of a pollutant: they are given the right to a pristine environment. If there is a source of the pollutant that is imposing damages on them they can take the source of the pollutant to court: the source can be liable for the damages created. While the court settlement compensates the recipient for the damages incurred the real benefit is that when the source is liable for the damages it causes these damages become internalized... solving the externality problem.

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Decentralized solutions Liability Laws

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Figure 1: Property rights to the recipient.

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Decentralized solutions Liability Laws

Liability Laws:

Suppose that the property right is given to the source of a pollutant: the source is given the right to free disposal. Suppose that some tree hugging protesters are preventing the source from creating any positive emissions. What damages are tree huggers imposing on the source (given emissions are zero when the firm has the legal right to produce maximal emissions Ē )? While a court settlement (could in theory) compensate the source for the damages incurred, the real benefit is that when the tree huggers are liable for the damages they cause these damages become internalized... solving the externality problem. Why in just in theory, not reality?

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Decentralized solutions Liability Laws

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Figure 2: Property rights to the source.

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Decentralized solutions complications

Liability Laws in practice:

Common vs. Civil Law. Strict liability vs. negligence. Burden of proof:

1 pollutant the sole cause of the damage. 2 pollutant released only by the source.

Legal standing is not consistent with an economist’s notion of WTP/WTA.

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Decentralized solutions Transaction costs:

The main impediment to decentralized solutions to environmental problems: Transaction costs.

Transaction costs are the costs associated with reaching and enforcing an agreement, whether negotiated or court determined. If transaction costs are too large the involved parties may fail to reach an agreement, in which case we end up with one of the extreme outcomes (zero or maximal emissions), neither of which are socially optimal. The greater the number of counter parties (sources and recipients) the larger are the transaction costs, and the less likely a decentralized solution (like liability) will solve the externality problem.

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Decentralized solutions Property rights:

As it was the case with liability, the main role of the government in a bargaining solution is to assign and enforce property rights.

The difference here is that we are going to look at negotiation between the affected parties in the absence of liability laws... can we still get a solution to the externality problem? We will consider two cases:

1 The government grants the right to a pristine environment. 2 The government grants the right to free disposal.

We will consider a particularly simple form of bargaining where the party without the property right makes an offer to the party with the property right. The offer is a price per unit of emissions or abatement (depending on the default level of emissions) Then the party with the property right chooses whether or not to accept the offer (depending on whether it makes them better off or not)

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Decentralized solutions right to a pristine environment

right to a pristine environment:

What level of emissions would we expect in the absence of a negotiated solution? In this case the emission source does not have the property right, so it makes the offer. What level of emissions creates the greatest surplus to bargain over? What price of emissions would yield the socially efficient level of emissions? What surplus does the agreement create for each counter-party?

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Decentralized solutions right to a pristine environment

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Figure 3: Property rights to the recipient.

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Decentralized solutions right to free disposal.

right to free disposal:

What level of emissions would we expect in the absence of a negotiated solution? In this case the emission recipient does not have the property right, so it makes the offer. What level of emissions creates the greatest surplus to bargain over? What price of abatement would yield the socially efficient level of emissions? What surplus does the agreement create for each counter-party?

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Decentralized solutions right to free disposal.

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Figure 4: Property rights to the source.

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Decentralized solutions Property rights: problems

Property rights: problems

transaction costs can prevent negotiation of mutually beneficial agreement: who should we give the property right in this case? free ridership: why should I contribute to the bribe to change behaviour when the associated benefit is non-excludable? inability for property owner to capture full social value of property: missing market for environmental attributes.

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Decentralized solutions Moral Suasion

Moral Suasion:

Rather than rely on extrinsic motives (carrot or the stick), we can appeal to morality: “do the right thing” e.g. littering, recycling. Sometimes the only option when monitoring or sanctioning of behaviour is not feasible. Sometimes we get spillover benefits: those less likely to litter are also less likely to pour pollutants down the drain. Problems:

1 The burden falls heavily on those with morals, while others contribute nothing.

2 Morality gives us little guidance on competing morally desirable objectives: it is great to protect the environment, but this comes at the expense of feeding and housing the poor, health care spending, education, etc.

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Decentralized solutions Green goods:

Green goods:

If consumers are willing to pay a premium for products that are less damaging to the environment we should see those products developed, provided that the markup is sufficient cover the additional cost of producing a green good. If a firm shifts its production towards green goods then, even in the absence of government policy, we should see a reduction in emissions. This was what was being argued for in “River Blue”.

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Decentralized solutions Green goods:

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Figure 5: Producing green goods shifts the MAC curve to the left

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