DRI-221 for week of 11-25-12: Free-Market Environmentalism

An Access Advertising EconBrief:

Free-Market Environmentalism

Stop a random passerby on the street and ask: “What are the three most important functions of government?” One of the answers would surely be: “To protect the environment.” Ask a sample of academicians “Why can’t we simply step back and allow markets to work freely and without interference by government?” and the leading answer would probably be: “Because the adverse effects on the environment would be too numerous and large.” Ask anybody what the biggest threat to the environment is and the answer will probably be something on the order of: “Greedy corporations and businessmen.”

The linkage between free markets and the physical environment may be the most misunderstood relationship in all of economics. It is often overlooked even by professional economists. To the general public, it is a complete mystery.

The Roster of Environmental Disaster

If government action is required – or thought to be required – to protect the environment against disaster, what kind of disaster is in prospect? A backward glance at history supplies various cases and kinds of environmental disaster. Industrial society has inflicted atmospheric pollutants on the air, producing high levels of smog, ozone and particulates in major cities like Los Angeles, Chicago, London, Tokyo, Bombay, Shanghai and St. Petersburg. Cities and towns have polluted water sources by allowing raw sewage to drain directly into them. Dumps and landfills have accumulated unsafe levels of toxins through careless disposal of waste products.

Pollution is not the only type of environmental damage. Land has been abused in myriad ways – through over-cultivation, over-grazing and over-fertilization. Aside from pollution, water has been overused and misused. It has also suffered damage at its sources. Although the process of evolution features extinction as an integral element, living species have been driven to or near extinction by human beings acting outside the boundaries of nature.

Americans have been schooled in the lore of these disasters. The extinction of the North American passenger pigeon in the 19th century, the near-extermination of the bison and the virtual disappearance of the wolf and the bald eagle are the staples of schoolbooks. Likewise the fate of the Dust Bowl in the 1930s and the problems of Southern farming prior to the development of crop rotation methods. Less well-known but no less telling are contemporary abuses resulting from Western cattle ranges and federal farm subsidies.

Virtually all of these examples are given a stylized narrative in which greed and capitalism are faulted. Heedless, bloated industrialists created pollution in order to fatten their profits while blackening the lungs of little children. Eastern meat-packers killed off the passenger pigeon. Rapacious buffalo hunters and their railroad bosses nearly did in the buffalo, ruining the civilization of the American Indian as a consequence. Farmers were too greedy; they should have settled for lower profits and planted fewer crops so as not to overwork the land.

The problem with these explanations is that they are morality tales rather than logical sequences. They provide no clue as to how disaster might have been avoided other than “make bad men with bad motives do good things instead.” The real story of past environmental disaster and prospective environmental policy incorporates the role played by markets and two key free-market institutions – property rights and prices. Disaster ensues when both of these are missing.

The Tragedy of the Commons

Ecologist Garrett Hardin is credited with enunciating the principle of the tragedy of the commons. Passenger pigeons and bison were not privately owned resources; they were a common resource, available to all at no nominal charge. Private owners would have realized that the cost of allowing animal numbers to dwindle below the reproduction point was prohibitive, but in a commons nobody takes that cost into account.

It is important to realize that the “tragedy” had nothing to do with morality per se and everything to do with the institutional framework in which consumption occurs. Pious, religious people; socialists; conservatives; libertarians – everybody behaves pretty much the same when faced with a commons. And they behave similarly in a free-market environment as well.

Property Rights and the Environment

A right to property is embedded in free-market economics and political philosophy. It dates to John Locke and Adam Smith and the founding fathers of the United States. In order to be effective, property rights must include not only ownership, but also the right to control the use and disposal of property. These guarantee that the rights holder has an incentive to protect and conserve the value of the property, which is a (potentially) valuable asset.

Americans have consumed vast annual quantities of beef for well over a century. Why did the comparatively modest demand for passenger pigeons suffice to eradicate them while cattle thrive despite the enormous demand for beef? Cattle are owned; their owners insure that breeding stock survive to reproduce the breeds and maintain the tremendous investment of the owners. Passenger pigeons had no owners; hunters had no practical option but to maximize their kill to get the most out of the limited supply while it lasted. Nobody derived specific benefit from preserving the species, so it vanished.

The bison were well on the way to a similar fate until the conservation movement – the precursor of environmentalism – stepped in, led by Teddy Roosevelt. The public sector barely managed to preserve a precarious survival for the bison until the private sector began commercially harvesting the animal, thus guaranteeing the survival of the species. The bald eagle and wolf were once threatened by hunters, not for their meat but to protect them from taking privately owned animals as prey. Their existence continues to be precarious despite their so-called “protected status” as “endangered species.” Why? Because they have no owners; nobody has a vested economic interest in their survival, only in their extermination. True, they have defenders who are emotionally committed to their well-being, but history and logic tell us that emotion is no substitute for economics.

The clinching argument for property rights as the key to environmental protection was made in Africa, not America. In 1990, economist Tyler Cowen noted that Africa had long struggled with the problem of elephant poaching by hunters. Because the African elephant was rapidly nearly extinction, hunting was banned on the continent. But ivory from elephant tusks was prized throughout Asia for various uses ranging from piano keys to billiard balls to aphrodisiacs. Poachers were willing to flout the law to get ivory for the lucrative black market, and African governments were reluctant to devote the substantial resources necessary to police vast land areas merely in order to save a small population of elephants whose value was merely symbolic and emotional.

In 1979, some African countries began allowing private ownership and commercial harvesting of elephants. Sure enough, elephant populations in countries allowing private property rights in elephants – Zimbabwe, Malawi, Namibia and Botswana – grew to robust levels. Owners had the motivation necessary to protect and breed their elephants. They also had the advantage of having to police only their own delimited property lines. Meanwhile, neighboring countries that did not allow private property rights – Kenya, Tanzania and Uganda, among others – saw continual declines. Kenya’s elephant population fell from 140,000 at the start of its hunting ban to 16,000 as of 1990. From 1970 to 1990, Tanzania’s population fell from 250,000 to 61,000; Uganda’s fell from 20,000 to 1,600.

Today, the principle is well-recognized in its application to ocean fisheries, which are threatened by depletion because they are mostly a public commons rather than protected by private ownership. Large areas of Africa feature barren terrain interspersed with healthy grasslands. The grasslands are privately owned; the barren spots are public lands that have been reduced to desert by over-grazing of nomadic herds. Public roads are the most familiar negative case of the commons and property rights at work, although they are seldom recognized as such. Because roads are publicly owned, nobody owns them. Everybody has an incentive to use them at will and without taking costs imposed on others into account. The inevitable result is rush-hour congestion and gridlock. An owner, though, would not allow that state of affairs to persist. That brings us to the other vital element of free-market environmentalism: prices.

A Price is Right

People react badly to the idea of private ownership because they believe that a private owner will somehow hoard or guard a resource “for themselves.” But it will very seldom be in the owner’s interest to prevent exploitation of a resource, simply because public demand will make it worthwhile to make it available. Because the resource has long-term value, the owner will want to use it only to the extent, and in such a way that, the long-term value is preserved. This notion is strikingly congruent with the idea of “conservation” that formed the original basis of the environmental movement.

Limitation of usage implies limitation of demand. The classic means to this end is charging a price for usage, which rewards the owner while signaling to the user that the resource is limited in quantity. Higher prices limit demand more effectively than lower prices; whether they are more rewarding to the owner technically depends on the price-elasticity of demand, or the responsiveness of buyer demand to changes in price when the other determinants of demand (income, tastes, prices of substitute and complementary goods) are unchanged.

Once again, people instinctively react against paying a price for goods and services. “Free” sound intuitively preferable. But free is only better in the very rare cases when the goods really were provided at no cost. Sunshine is truly a free good. Tangible goods and most services merit a price because this allows the buyer to compare the expected value received from consumption with the cost of production embodied in the price. (That cost of production will reflect the value of alternative output foregone in the production of the good under consideration.) Politicians who promise us free stuff are doing us no favor, since this merely wastes resources and ultimately gives us less stuff to enjoy.

Because resources in a commons are not owned, they typically do not command a price. Sometimes governments will try to remedy this deficiency by assigning a price of sorts to publicly owned goods, but this price does not reflect the true cost of production and the value of foregone alternative output because the government price is not the outcome of a competitive market. This kind of price – not prices charged by private owners – is the one of which the public should beware.

The failure to charge a (proper) price is the second major source of environmental disaster. For well over a century, municipalities have charged a flat fee for water usage. In effect, this levies an effective price of zero, since the flat fee does not change no matter how many times the consumer turns on the tap. (A true price is marginal, applying to each successive unit purchased.) Consequently, this encourages consumers to use water not only for drinking and bathing, but for washing dishes, cars and dozens of successively lower-valued uses. Meanwhile, the actual production of water requires resources for distribution and purification. Those resources have alternative uses that merit the application of a price tag on each successive unit of water consumed.

Various parts of the western United States, such as the Central Valley in California, would be unsuitable for agriculture without irrigation. The federal government has built dams, diverted streams and distributed water far below cost to farmers. This has enabled the production of crops that would otherwise not be produced. The future survival of the Colorado River, perhaps the key waterway in the southwestern U.S., is imperiled due to repeated impoundment of its waters for use by farmers and ranchers. Because the river is not owned, the farmers and ranchers do not pay a proper price for its use – and the river is on the road to extinction. Not only that, the land is being used in ways for which it is inherently unsuited. This is a classic tragedy of the commons and failure of pricing.

Good Guys and Bad Guys

The simplistic environmentalist tale reduces life to a cinematic conflict between good buys and bad guys, in which the outcome depends on the strength and purity of the participants. Today, American colonists and founders are cast as bad guys who despoiled the purity of the North American wilderness. American Indians are cast as the good guys, the “indigenous peoples” who lived in harmony with nature a la Rousseau. And American frontiersmen did indeed kill game and clear land without concern for the consequences of their actions on the supply.

But so did the Indians. The Plains Indians, for example, routinely migrated throughout a region, killing off buffalo and other game and freely polluting and despoiling land in their immediate vicinity. After all, they had no need to conserve natural resources when their numbers were so tiny in a vast natural preserve the size of North America. When local resources became scarce, they simply moved on. Then as now, economics was the prime mover, not philosophy or morality.

Air Pollution – the Special Case

The reader will have observed the absence of air pollution in the property rights and pricing examples discussed thus far. The logic previously developed explains that. Unlike animals, land and water, air is much less amenable to private ownership. (Nation states assert ownership to “air space,” so clearly the concept of owning air is not infeasible. The trick is to bring it within the private domain.)

Once more, it is tempting to treat the issue of air pollution as a morality tale. And once more, this temptation should be resisted. The world’s worst cases of air pollution are located within the borders of socialist or communist states, ostensibly dedicated to principles of social justice, public ownership and fair shares for all. Air is a classic commons, and the basic principles of property and pricing apply just as strongly to good guys as to bad guys. Indeed, in this context it would seem that the only good guys are those who strive to bring property rights and pricing to the public.

While the general public associates capitalism with pollution, the truth is just the opposite. The most capitalistic countries should be the least-polluting ones in theory and tend to be least-polluting in practice. This agrees with common sense (a quality in short supply among the general public). Capitalism operates under private property. Private owners don’t want to run down the value of their property or allow others to do so; thus, they are averse to pollution. Socialism implies public (i.e., government) ownership, which means the absence of incentive to protect property value and impede polluters. Passing laws to make government responsible does not actually make government responsible – as the old saying goes, who watches the watchers? Consequently, it is not surprising that Soviet Russia and Communist China were the champion polluters of the 20th century. In the U.S., the famous case of Love Canal was originated not by Hooker Chemical Co. but by the government to whom they sold their property, which actually polluted the canal.

The modern-day environmental movement is sometimes dated from the publication of Rachel Carson’s book Silent Spring in 1962. This is the point when the movement changed from emphasizing conservation to promoting a vague, indefinable concept of “the” environment as a holistic entity rather than a collection of heterogeneous elements. Prior to this, the strongest opponents of pollution were libertarian political philosophers like Murray Rothbard – the same people who were also the strongest defenders of free markets and capitalism. These libertarians took a per se approach to air pollution, forbidding it in principle as a violation of property rights.

More recent free-market environmentalist approaches take a different tack, noting that the economic approach is to compare the costs and benefits of any activity. If the benefits of steel production outweigh its costs – even when pollution costs are taken into account – then forbidding steel production in order to cut pollution to zero is too harsh. The idea should not be to ban pollution altogether – it should be to encourage efficient production in which the benefits of the produced output outweigh the costs of production including pollution. When regulating pollution, the emphasis should be on cost-effective pollution abatement. That is, we want to urge producers to find the best, least-costly ways to limit pollution.

In the past, governments have regulated industrial pollution by hiring experts to dictate the “right” ways to produce things, then requiring businesses to follow those rules. But the problem is that this “one-size fits all” approach is very inefficient. As F.A. Hayek noted, free markets are superior because they generate information about “the economics of particular time and place.” Each business should have the freedom to decide the best way to cut pollution based on its own particular circumstances and sources of expertise. Instead of telling businesses how to produce, government should simply tell businesses what outcome to achieve in terms of pollution reduction, and then leave the means of achieving that outcome to them.

Large Numbers and Small

For many years, economists believed that government regulation was the only way to handle all issues involving the environment. Because the existence of a commons entailed costs that a user would never take into account, so the argument went, the action of government was required to bring these costs into play. The cost was called an “externality” because it was external to the calculations of those participating in the non-governmental production and consumption of the good. Government would enter the picture by levying a tax on the good equal to the amount of the externality, thus “internalizing” it and forcing the user to take that cost into account in his or her consumption decisions.

In 1960, law-and-economics specialist Ronald Coase stunned the economics profession by pointing out that, in general, this approach was wrong. The problem was not an externality; the problem was the absence of property rights caused by the commons. The minute property rights are assigned, the rights holder has an incentive to internalize the externality without any interference by government. In fact, this solution is greatly preferred to government action since the property owner will probably know the costs involved while the odds are greatly against government knowing the correct size of the tax necessary or having an incentive to levy it even if it did know. This Coase Theorem eventually (and belatedly) earned Coase the Nobel Prize in economics.

Because the Coase solution will necessitate negotiation between property rights holder and counterparty (property owner and consumer, say), this still leaves air pollution as the hard case. The usual circumstances of industrial pollution involve very large numbers of third parties affected by the pollution. The business owner(s) will find it prohibitively costly to negotiate with each victim individually and the victims will find it too costly to organize in order to negotiate with the business owner. Thus, this “large numbers” case still leaves a role for government as regulator of air pollution.

Not Market Failure – Education Failure

The logic of free-market environmentalism is compelling – so much so that it extends beyond the environmental domain. Specialists in monetary and financial economics have pointed out that the federal government turned banking into a commons through federal insurance programs. The FSLIC and FDIC were ostensibly intended to reduce worry of S&L and bank failures by insuring deposits up to stated values. Unfortunately, this allowed owners of financial institutions to take investment risks beyond the norm because neither they nor the depositors were worried about the consequences – the taxpayers were the ones ultimately on the hook if the S&L or bank went bust due to bad investments. Thus, both the S&L crisis of the early 1980s and the financial crisis of the late 2000s were tragedies of the commons, analogous to the environmental disasters reviewed above.

In view of all this, why isn’t the logic of free-market environmentalism widely known and practiced? The only answer must be that the economics profession, whose members are disproportionately members of and supported by government, has done a deplorable job in educating the public about economics. If economists refuse to teach economics, who can we look to?

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