Whether property rights evolve from the bottom up or are assigned directly by government, they can provide important benefits by supporting environmental markets. Chapters 3 and 4 provided examples of the evolution of informal property rights and their role in providing environmental quality. In this chapter we turn to cases where environmental markets are based on formal property rights codified through a political and legal process. The examples are water rights, conservation credits, emission allowances, and tradable fishery shares. The details illustrate how environmental markets work and the nature of the property rights underwriting them.

In all of the cases, the rights are not based on fee simple titles but instead are use privileges. This distinction is important because privileges are just that, use opportunities that can be modified, reassigned, or revoked more easily by political or judicial action than is the case with formal title. Political action occurs through Congress and regulatory agencies, and judicial review through the courts. Use privileges have no constitutional takings protections, and monetary losses from government interventions are not compensable. Although use privileges give regulatory agencies greater flexibility, they are more uncertain and can have shorter time horizons and weaker incentives for investing in or reallocating the environmental resource than can more secure formal rights. When property rights are vague, environmental markets are weakened, and more environmental benefits must come from command-and-control regulation and tax policies. We examined the problems with those approaches in Chapters 2 and 3. A major lesson of this chapter is that property rights must be protected from regulatory takings if we are to harness markets to improve environmental quality. We provide examples of successful markets, some emerging ones, and some that have been weakened by political and bureaucratic intervention. This range of experiences reveals what is possible, what more remains, and what dangers can arise. We begin with two successful instances regarding water.

Environmental economics often focuses on the failure of markets to allocate and manage natural and environmental resources efficiently. Under the banner of externalities, markets fail either because private costs are less than social costs or because private benefits are less than social benefits. The former results in overuse of the environment such as overfishing, excessive air and water emissions, and overpumping of groundwater basins. The latter results in too little provision of public goods such as preservation of endangered species habitats, maintenance of adequate stream flows for recreation or pollution dilution, or investment in biodiversity.

The policy remedies for market failure include both taxes to raise private costs to social costs and regulation to hold quantities to the optimal amount. There is little discussion in the literature on the process through which taxes or regulations are devised and implemented that lead to socially beneficial improvements. Are the costs of securing tax or regulatory policies less than the benefits, or alternatively is the route one of rent seeking and interest-group politics? What motivates politicians and regulatory agencies to adopt taxes or regulations that lead to effective correction of the externality? Because taxes are rarely implemented, at least in the United States, the obvious question is why, if they are so beneficial? Is their absence an indication that political interests dominate efficiency goals? Similarly, command-and-control regulations are adopted to limit use of air, water, fisheries, forests, and other resources, but they are costly and often do not capture the incentives of resource users to engage in more optimal production. For example, in the case of fisheries, fishing season limits have been a common regulatory response to overharvest, but they generally result in twenty-four-hour fish derbies, excessive investment in capital and labor to win the derby, and a glut of fish during the season. Regulations on the number of vessels lead to larger ones with more sophisticated equipment to find and catch fish.

The objective of this book is to promote greater consideration of property rights and markets in addressing environmental problems. Although there is movement toward increased use of market approaches with the adoption of cap-and-trade in controlling air emissions, fishery harvests, and land use, there have been bumps in the road. Several environmental markets are thin with few trades, in others, prices have trended toward regulatory-set floors, and many have insecure property rights that limit incentives for long-term investment and conservation. We explore why that might be the case and what options exist for, and what benefits may be derived from, expansion. We believe that more can be done to improve the efficient provision of environmental quality through the greater definition of property rights and market exchange.

THE RECIPROCAL NATURE OF THE PROBLEM: NORMATIVE AND POSITIVE ANALYSIS

The manner in which our approach differs from standard presentations is that we recognize environmental problems as ones of reciprocal costs. Natural resource and environmental problems arise when people with diverse demands compete for the use of environmental goods. For example, the policy debate over air pollution levels reveals competition between those who want to use the air for low-cost waste disposal or to facilitate use of certain fossil fuels and those who want to breathe clean air, avoid the health effects of ingesting contaminants, have clear views of the surrounding terrain, or mitigate potential climate change. Debates over clear-cut forests reflect competition between those who demand wood products at low cost and seek maintenance of timber-based industries and communities and those who prefer forests for hiking trails, wildlife habitat, or carbon sequestration and the expansion of ecotourism. Concerns about overfishing indicate competition between those who want fish now, regardless of stock impacts, and those who want a sustainable yield into the future. In a positive sense, these are competing and conflicting demands. The different effects on welfare if one use dominates the other often are not obvious, although advocates on both sides have clear opinions. The ultimate answer depends upon the benefits and costs of each alternative and their distribution across society.

In a nutshell, this book has made the case for environmental markets based on well-defined, enforced, and transferable property rights. If all three exist, owners have an incentive to consider the full effects of their actions as they engage in Coasean bargaining to mitigate the losses of open access. Property rights – informal or formal, individual or group – help reduce the tragedy of the commons by assigning the costs and benefits of decisions, making the opportunity costs clear, limiting the race to capture rents, and allowing owners to reallocate resources across uses and across time. Property rights identify the relevant people who have a stake in the resource and who can engage in negotiation and contracting. Without them, there is little basis for bargaining. Absent exclusivity, any party can enter and compete for resource rents regardless of any agreement made by an initial group of users. Because everyone knows this potential, bargaining for environmental quality cannot gain much traction.

Property rights define expectations regarding entitlements from resource use, investment, coordination, and cooperation, relative to nonowners. They provide incentives for considering long-time horizons and for long-lasting collaboration. This certainly is necessary because most environmental and natural resource challenges involve the long term, require exclusion, and necessitate teamwork for solution. Secure property rights economize on the transaction costs of decision making, allowing market exchange, investment, and experimentation to take place quickly in response to new information regarding the environmental and natural resource asset. Given the limited scientific knowledge that often accompanies many open-access problems, the information generation and flexibility of markets are particularly critical.

In this chapter, we examine broader environmental and natural resource open-access problems that cross political jurisdictions. To get insights into what opportunities and challenges exist for the use of environmental markets, we examine case studies where multi-jurisdictional environmental markets have been implemented and where they have not. The nature of the underlying property rights helps to explain the differences in the potential for markets.

In earlier chapters, the analysis and examples indicated that environmental markets appear to work best when addressing more localized open-access problems that are narrow in scope, where property rights are secure, and where the parties involved share common incentives regarding resource conservation. Because immediate users often are both the source and the solution to the problem, they are more likely to internalize the costs and benefits of resolving it. At the local level, the costs of measuring and bounding environmental assets and demarcating property rights are generally lower. Moreover, confined open-access problems typically fall under a single political authority. In this situation, property rights, markets, and any distributional or administrative conflicts surrounding them are handled by politicians and bureaucratic officials who are at least loosely responsible to local political constituencies. Parties with more actual experience with the resource typically have the best information about it, the losses due to open access, the effects of human actions relative to more system-wide factors, and potential remedies.

We have emphasized the losses of open access attributable to individual efforts to capture resource rents in the absence of property rights. Although it is rational for individuals to ignore their effect on the overall value of an open-access resource, it can also make sense for individuals to act collectively to constrain their actions to protect and increase rents. The common solution proposed by economists is either private property rights that limit access or governmental regulation.

Another solution that has received more recent attention is a blend of informal property rights and local collective action known as common property resource management or CPRM. Common property resource management limits entry to individuals who are members of the group and excludes outsiders. CPRM generally works best if there are internal governance structures to link individual actions with group goals and if the state recognizes and enforces common property resource organizations and boundaries. Examples of CPRM include local grazing associations, fishing cooperatives, mutual irrigation companies, and groundwater management cooperatives. Common property can reduce over-exploitation relative to open access, but competitive incentives remain within the group to varying degrees, depending on institutional design and group cohesion. Accordingly, it may still be less efficient than sole ownership or, in some cases, than regulation.

As with environmental markets based on private property rights, CPRM can allow trade, but it is more often informal, usually among group members and sometimes involving the approval of community leaders. Casual water exchanges among farmers within irrigation districts in the western U.S. are an example of common property trade. Farmers within irrigation districts often do not have clearly-defined individual rights to water when the district holds the water rights. However, they have customary use claims that allow an irrigator to acquire additional water during a growing season from other irrigators on an informal basis.

As discussed in Chapter 1, we have a multitude of demands for environmental goods and services. Whether it is clean air and water, tropical rainforests, habitat for polar bears, open spaces, controls on carbon emissions, whales, or energy conservation, we are willing to spend time and money on getting more of the environmental goods we want. The problems we face are how to respond to changing demands, how to tradeoff competing demands against one another, and how to balance these with the desires for other goods and services in the economy. Addressing these questions requires that environmental policies be efficient or as cost-effective as possible. This chapter examines the role of government regulations as a way of improving environmental quality – which is the traditional approach – and compares it to environmental markets.

There are many different ways to produce environmental goods, ranging from markets with well-specified private property rights, the subject of Chapter 3, to governmental regulation, the solution considered in detail here. One reason for choosing government rather than markets is the potential for markets to fail in fully accounting for social costs and benefits.

As discussed in Chapter 1, we have a multitude of demands for environmental goods and services. Whether it is clean air and water, tropical rainforests, habitat for polar bears, open spaces, controls on carbon emissions, whales, or energy conservation, we are willing to spend time and money on getting more of the environmental goods we want. The problems we face are how to respond to changing demands, how to tradeoff competing demands against one another, and how to balance these with the desires for other goods and services in the economy. Addressing these questions requires that environmental policies be efficient or as cost-effective as possible. This chapter examines the role of government regulations as a way of improving environmental quality – which is the traditional approach – and compares it to environmental markets.

Having considered the prospects and pitfalls of government provision of environmental goods and services in Chapter 2, we now turn to the same for markets. In this chapter we carefully examine the arguments of Ronald Coase as they relate to property rights and bargaining costs in the context of environmental markets. Coase is noted for building his analysis on the assumption of zero transaction costs and for concluding that under that condition, resources will be efficiently allocated. We recognize the usefulness of this approach for understanding the relationship between property rights and social costs. Our emphasis in this chapter, however, is on the potential for markets to lower transaction costs relative to those encountered in governmental regulation and to thereby provide environmental goods and services more efficiently.

To be sure, transaction costs might impede market solutions when there are ill-defined and ill-enforced property rights that cannot be easily changed, large numbers of bargaining parties, free riders, limited or asymmetric information about the environmental problem, or non-competitive markets. We do not discount the importance of market transaction costs, but rather compare them with the transaction costs inherent in government regulation. One advantage of markets, even in the presence of such costs, is that they can be more flexible than government regulations in the face of changing resource values and technology. It is in the interest of market participants to respond effectively and quickly, particularly as the markets are more competitive. Government officials are not direct residual claimants in these situations and have more constituents and political interests to consider in determining how to react to new conditions. This explains why, for example, many government policies and agencies remain long after the conditions that led to their creation have disappeared.

When property rights to valuable environmental and natural resources exist, there are many potential benefits. It is possible to restrict competitive entry to avoid the losses of open access, to encourage long-term investment in the resource (including conservation), to promote exchange, which can channel the resource to higher-valued uses, and to avoid wasteful and potentially divisive conflict that occurs when valuable resources are open to all. Property rights – common and private – are useful as alternatives to government regulation for many environmental and natural resource problems. They may be the low-cost option, relative to regulation or tax policies, and they may better align users’ incentives with conservation or other mitigation goals.

Even with these advantages, property rights often are resorted to late in resource use after many of the rents have been dissipated from excessive exploitation. For example, in 1973, fishery economist Francis Christy called for the use of individual transferable quotas (ITQs) as property rights to the right to fish within an overall total allowable catch (TAC) to avoid overfishing. Serious adoption of ITQs did not occur for some 20 years when they were put into place in Iceland and New Zealand. Similarly, the notion of tradable emission permits as property rights to reduce air pollution was put forward by Thomas Crocker in 1966 and by J.H. Dales in 1968, but their adoption also took another 30 years. Further, when property rights are adopted, they often are limited. ITQs and emission permits in the United States are not legal property rights subject to takings protection, but use rights, subject to reassignment or termination by the government. Trading in ITQs is restricted to certain parties and the quantity of quotas that can be held. These limitations on property rights reduce the ability of environmental markets to more fully address the losses of the common pool. The question is why? In this chapter, we explore the political economy of property rights.