Lecture 7

Property Rights, Externalities, and Natural Resource Problems

Byeong-Hak Choe
bchoe@geneseo.edu

SUNY Geneseo

September 11, 2024

The Economic Approach: Property Rights, Externalities, and Natural Resource Problems

The Pursuit of Efficiency

  • Environmental and natural resource problems arise from:
    • Ill-defined property rights
    • Non-competitive exchange conditions for these rights
  • Governmental pathways for remedies:
    1. Judicial remedies
    2. Legislative and executive regulation

The Pursuit of Efficiency

Judicial Liability Rules

  • Impose liability for environmental damages
  • Examples:
    • Oil spills
    • Accidental pollutant releases
  • Compensation awarded after the fact
  • Two main doctrines:
    • Strict liability and negligence
  • Strict liability applies to abnormally dangerous activities

The Pursuit of Efficiency

Judicial Liability Rules

  • Benefits of liability rules:
    • Create incentives for prevention through precedents
    • Can make accident prevention cheaper than dealing with damage
    • Correct inefficiencies by internalizing externalities
    • Align profit-maximizing decisions with efficiency

The Pursuit of Efficiency

Judicial Liability Rules

  • Limitations of judicial approach:
    • Requires case-by-case determinations
    • High transaction costs (court time, lawyers’ fees, expert witnesses)
    • Less efficient for large-scale or common disputes
  • Alternative to judicial approach:
    • Statutes or regulations for large-scale or common issues

The Pursuit of Efficiency

Legislative and Executive Regulation

  • Forms of legislative and executive remedies:
    • Setting pollution limits with fines for noncompliance
    • Imposing jail sentences or large fines as deterrents
    • Establishing zoning laws to separate incompatible land uses
    • Banning specific toxic substances (e.g., lead in gasoline)
    • Requiring safety equipment (e.g., seat belts in cars)
    • Regulating outputs, inputs, production processes, emissions, and production locations
  • Other strategies available to victims:
    • Promoting boycotts against problematic producers or products
    • Employee strikes or labor resistance

The Pursuit of Efficiency

Legislative and Executive Regulation

  • Addressing asymmetric information:
    • Mandating information disclosure for risky occupations
    • Requiring licensing for specialized workers
    • Providing safety information for potentially dangerous consumer products

The Pursuit of Efficiency

Legislative and Executive Regulation—Organic Foods Production Act

  • Driven by consumer willingness to pay premiums and need for market access
  • Organic Foods Production Act (OFPA) enacted in the 1990 Farm Bill
  • Objectives:
    • National standards
    • Consumer assurance
    • Facilitating interstate commerce

The Pursuit of Efficiency

Legislative and Executive Regulation—Organic Foods Production Act

  • USDA National Organic Program established for mandatory certification
  • National Organic Standards Board (NOSB) defines organic standards
  • Specific labeling requirements:
    • “100 percent organic”: only organic ingredients
    • “Organic”: at least 95% organic ingredients
    • “Made with Organic Ingredients”: at least 70% organic ingredients

The Pursuit of Efficiency

Can Eco-Certification Make a Difference? Organic Costa Rican Coffee

  • Environmental regulation of agricultural production in developing countries is challenging due to:
    • Numerous and dispersed producers
    • Inadequately funded/staffed regulatory agencies
  • Eco-certification could potentially address these issues by:
    • Allowing consumers to identify environmentally superior products
    • Creating financial incentives for producers through price premiums

The Pursuit of Efficiency

Can Eco-Certification Make a Difference? Organic Costa Rican Coffee

  • A study on certified organic coffee in Turrialba, Costa Rica, investigated the effectiveness of eco-certification:
    • Costa Rican farmers face pressure to lower costs in non-certified markets
    • Organic production typically involves higher labor costs and potential yield reduction
    • Costs of certification and annual monitoring are significant

The Pursuit of Efficiency

Can Eco-Certification Make a Difference? Organic Costa Rican Coffee

  • The study found that organic certification:
    • Improved coffee growers’ environmental performance
    • Significantly reduced use of pesticides, chemical fertilizers, and herbicides
    • Increased use of organic fertilizer
  • Key findings:
    • Certification was more effective in preventing negative practices than encouraging positive ones
    • Local inspectors tended to enforce prohibitions more vigorously than requirements for positive actions

The Pursuit of Efficiency

Private-Sector Remedies for Negative Externalities

  • Private-sector solutions to internalizing negative externalities involves the Coase Theorem:
    • When there are well-defined property rights and costless bargaining, then negotiations between the party creating the externality and the party affected by the externality can bring about the socially optimal market quantity.
  • While the market might be able to internalize some small-scale, localized externalities, it will not help with large-scale, global externalities.
    • The government may, therefore, have a role to play in addressing larger externalities.

The Pursuit of Efficiency

Public-Sector Remedies for Negative Externalities

  • Public-sector solutions to internalizing negative externalities are using market-based instruments:
    • Price instrument:
      • Corrective taxation or subsidy
    • Quantity instrument:
      • Tradable permits: They give the permit holder the right to pollute a certain amount.
  • These set of policies incorporate market principles into government policies, focusing on aggregate or market-level outcomes such as total pollution.

The Pursuit of Efficiency

Corrective Taxation/Subsidy

  • \(PMC\), \(PMB\): Private \(MC\),\(MB\)
  • \(SMC\), \(SMB\): Social \(MC\),\(MB\)
  • \(t\): Per-unit tax
  • Government can achieve the goal of internalizing the externality:
    • By taxing the steel producer an amount \(MD\) (for the marginal damage of the pollution) for each unit of steel produced.
    • By subsidizing the steel producer for every unit by which she reduces the steel production below some level, for example, her optimal level without government intervention.

The Pursuit of Efficiency

Cap-and-Trade

  • Key features of cap and trade (allowance trading):
    • Government sets a total allowable quantity of pollution (the cap)
    • Applies to a specific group of emitters (e.g., electric power sector, industrial sources)
    • Allocates allowances (tradable permits) to regulated entities
    • Each allowance corresponds to one unit of pollution
  • Market mechanism:
    • Firms with high abatement costs can buy allowances
    • Firms with low abatement costs can sell allowances

The Pursuit of Efficiency

Cap-and-Trade

  • Key outcomes:
    • Total pollution is fixed by regulation (the cap)
    • Allocation of pollution among firms is determined by the market
    • Individual firm abatement levels are not directly mandated
  • Real-world example:
    • U.S. sulfur dioxide cap-and-trade program, which began in 1995
    • Each allowance corresponded to 1 ton of SO\(_2\)
    • Targeted 3,200 coal plants nationwide
    • Created a market for SO2 emission allowances
    • 43% reduction from 1990 levels by 2007, despite 26% increase in electricity generation from coal-fired plants (1990-2007)