On the Market for Ecosystem Control
By Jason Scott Johnston
INTRODUCTION
The paper theorizes about alternative institutions for managing environmental resources. The traditional command and control approach to public environmental resource regulations uses the threat of sanctions to induce private enterprises to reduce the harm their activities do to other public resource users. By definition, this approach succeeds only when sanctions are credible and sufficiently severe that firms find it cheaper to comply with regulatory commands than pay the sanction for non-compliance. Command and control regimes are inherently limited, for as resource use increases in intensity and becomes increasingly decentralized with economic growth, command and control regimes effectively regulate a smaller and smaller proportion of activity. Even more importantly, the very success of command and control environmental regulation in improving the quality of publicly held natural resources creates a demand for further improvements, but these improvements are costly and cannot be funded without further development. Whereas traditional public resource regulation has focused on controlling existing private uses of public resources, the next generation of environmental and natural resource regulation will increasingly view the private development of public resources as an instrument for environmental restoration. This transformation has a number of important consequences.1 Inasmuch as it will ask the private sector to do more than ever before for the public environment, one such consequence is that the next generation of environmental and natural resource regulation will in a very sense represent a substantial privatization of traditionally public regulatory functions. The question for the future is how to realize the enormous potential efficiency gains from regulatory privatization while ensuring that privatization protects important remaining public values.
In this Article, I approach this question from an admittedly rather general and abstract point of view, by comparing the incentives of resource users and managers under public versus private natural resource ownership.2 I begin with an analysis of the incentives confronting public land managers. Multiple use management of the public lands is inherently contradictory.3 Public resource managers operate under statutory mandates to manage the resource so as to maximize its long term, sustainable value. But those managers have multiple principals with conflicting preferences over resource use. As use intensity increases with the level of economic development and national wealth, the intensity of conflict among competing user groups increases as well. Users have an incentive to make their legally insecure use rights politically secure by eliminating competing uses. In this way, multiple uses actually incentivize overuse. An even more serious problem may be called political adverse selection. By allowing a use that degrades the value of the resource for other, competing use types, public managers effectively change their constituency. Dissatisfied users go elsewhere, leaving only the preferred user group, which in turn has an enhanced incentive to push for more stringent regulation that favors the preferred use.
Thus, unlike managers of publicly traded corporations, public resource managers may actually enhance their political support by pursuing policies that decrease total potential value. Such policies are very often justified on the ground that they make valuable natural resources accessible to citizens regardless of wealth and ability to pay. It is true that under non-price allocation by queue and wait-list - the traditional methods under public management - the poor are not excluded. But the greatest beneficiaries of such non-price allocation methods are individuals whose wealth is primarily in the form of physical rather than human capital, and inefficient, older companies with a low internal rate of return on investment. The cost of waiting on line for access is highest for individuals with a high opportunity cost of time, and for firms that have much better things to do with their capital than to lobby for continued free access to publicly held resources.
Under market provision, by contrast, highly competitive consumer and business credit markets may make even the most valuable natural resources accessible to a wide spectrum of consumers and businesses, regardless of their current physical asset holdings. It might well be thought that the extension of consumer credit to the market for natural resource services will surely cause the virtual “malling” of American wilderness, that is, the elimination of areas preserved for very low intensity human use. As a general matter, this is incorrect. Even wilderness may be provided by the market. However, the fundamental economics of wilderness preservation - that the per user value to wilderness users increases as the number of users falls and the size of the preserve increases - will limit market provision to situations in which the cost of wilderness acquisition and preservation is low relative to willingness to pay.
Such conditions - very high willingness to pay for wilderness and effective technologies of monitoring and exclusion - were not present in the United States until relatively recently. The withdrawal of hundreds of millions of acres of federal land from private sale and development that began in the late nineteenth century has traditionally been justified by evidence that private owners had vastly overexploited their resources. It is true that private resource owners may have too strong an incentive to develop wilderness, developing even when the present value of wilderness preservation exceeds the return from developing. But this social inefficiency is not due to private ownership, but rather to incomplete capital markets that prevent private resource owners from realizing a present-day return from the preservation of future wilderness value. With the tremendous growth of capital markets over the last decade, virtually any asset can be securitized. Thus the development of capital markets has removed perhaps the strongest objection to the large-scale privatization of natural resources.
Even if one grants that natural resource preservation may be privately provided on robust markets, it is much more difficult to imagine private provision of environmental regulation. It is difficult to imagine because what I mean by private environmental regulation is not the development of tradeable pollution permits under cap and trade schemes, such as the acid rain program under Title IV of the 1990 Clean Air Act Amendments. What I mean is more radical: the replacement of our current regime - under which the state owns air, water, and groundwater and federal and state government regulates the use of those resources as waste receptacles - with a regime under which air, water, and groundwater are privately owned, and private (or local public) entities hold entitlements to determine when and whether those resources may be used for waste deposition. As a conceptual matter, what defines private environmental regulation is not the creation of tradeable permits to pollute, but rather the creation of private rights in the natural resources - air, water, groundwater - that are harmed by pollution.
Private environmental regulation differs profoundly from public regulation along three crucial dimensions: the nature of the entitlement to a clean environment; boundaries delimiting resource ownership; and, resource valuation. Under most current environmental statutes, public regulators get absolute entitlements (e.g., the “zero discharge” goal of the Federal Water Pollution Control Act of 1972). The basic political calculus governing the behavior of public regulators is that regulations cannot be imposed when their net political benefits are too low. Even if statutes give regulators absolute entitlements, the constraint that regulation be credible drives regulators to relax standards and enforcement. Perhaps most important, public regulators are (and should be) legally constrained in their ability to accept payments of money from regulated entities in exchange for agreements waiving enforcement or relaxing standards. This means not only that the effective entitlements held by public regulators are actually quite weak, but that the opportunity for Pareto-improving exchange is extremely limited (to situations in which an in-kind exchange can be found). By contrast, private regulators holding tradeable entitlements will often generate superior outcomes even when their entitlements are limited and blurry.
The necessarily political regulatory boundaries characterizing cooperative federalism in environmental regulation are notoriously ill fitting. State boundaries, for instance, are both too large (in the sense that lots of pollution has highly localize effects) and too small (because pollution spills over state boundaries).8 But interstate trading to overcome cross-boundary spillovers requires that interstate entitlements be defined. Such definition - that, for instance, the citizens of New Jersey have a right vis-a-vis the citizens of Ohio with respect to particular types of airborne emissions - is often politically impossible. Arbitrariness in initial regulatory boundary determination is far less serious under private provision, because private regulators are free to re-contract and consolidate regulatory boundaries, controlling pollution and undertaking restoration whenever they can capitalize the gains from so-doing.
The fact that many of the gains from environmental improvement accrue to public goods means, however, that private environmental regulators will always fail to fully internalize the gain from improvements to environmental resources. But so too are many gains missed under federal environmental regulation. Federal environmental regulators are much like national franchisers. Their incentive is to focus on regulatory products that have large national markets, while realizing political cost economies by shifting regulatory compliance cost to those entities - such as large oligopolistic companies - that are in the best position to spread and hide the cost. Over the past thirty years, such a strategy has brought big environmental improvements. But the very success of first generation command and control regulation has meant that private property owners will capitalize on an increasing share of further improvements. Such capitalization directly lowers the political return to federal regulators from further improvements. There remains, moreover, an entire category of sub-market regulatory products - those that bring large but locally and sectorally concentrated gains and costs - that centralized regulation has missed.
Private provision, subject to appropriate regulatory oversight, has increasingly become the means by which such gains are realized. In the form of Brownfields redevelopment, habitat conservation plans, wetlands mitigation banking, and performance-based regulatory reform initiatives, the movement to privatized provision of environmental restoration has in fact already begun. My model provides a theoretical foundation for that movement and a guide for future institutional change to ensure that its promise is realized.
The paper theorizes about alternative institutions for managing environmental resources. The traditional command and control approach to public environmental resource regulations uses the threat of sanctions to induce private enterprises to reduce the harm their activities do to other public resource users. By definition, this approach succeeds only when sanctions are credible and sufficiently severe that firms find it cheaper to comply with regulatory commands than pay the sanction for non-compliance. Command and control regimes are inherently limited, for as resource use increases in intensity and becomes increasingly decentralized with economic growth, command and control regimes effectively regulate a smaller and smaller proportion of activity. Even more importantly, the very success of command and control environmental regulation in improving the quality of publicly held natural resources creates a demand for further improvements, but these improvements are costly and cannot be funded without further development. Whereas traditional public resource regulation has focused on controlling existing private uses of public resources, the next generation of environmental and natural resource regulation will increasingly view the private development of public resources as an instrument for environmental restoration. This transformation has a number of important consequences.1 Inasmuch as it will ask the private sector to do more than ever before for the public environment, one such consequence is that the next generation of environmental and natural resource regulation will in a very sense represent a substantial privatization of traditionally public regulatory functions. The question for the future is how to realize the enormous potential efficiency gains from regulatory privatization while ensuring that privatization protects important remaining public values.
In this Article, I approach this question from an admittedly rather general and abstract point of view, by comparing the incentives of resource users and managers under public versus private natural resource ownership.2 I begin with an analysis of the incentives confronting public land managers. Multiple use management of the public lands is inherently contradictory.3 Public resource managers operate under statutory mandates to manage the resource so as to maximize its long term, sustainable value. But those managers have multiple principals with conflicting preferences over resource use. As use intensity increases with the level of economic development and national wealth, the intensity of conflict among competing user groups increases as well. Users have an incentive to make their legally insecure use rights politically secure by eliminating competing uses. In this way, multiple uses actually incentivize overuse. An even more serious problem may be called political adverse selection. By allowing a use that degrades the value of the resource for other, competing use types, public managers effectively change their constituency. Dissatisfied users go elsewhere, leaving only the preferred user group, which in turn has an enhanced incentive to push for more stringent regulation that favors the preferred use.
Thus, unlike managers of publicly traded corporations, public resource managers may actually enhance their political support by pursuing policies that decrease total potential value. Such policies are very often justified on the ground that they make valuable natural resources accessible to citizens regardless of wealth and ability to pay. It is true that under non-price allocation by queue and wait-list - the traditional methods under public management - the poor are not excluded. But the greatest beneficiaries of such non-price allocation methods are individuals whose wealth is primarily in the form of physical rather than human capital, and inefficient, older companies with a low internal rate of return on investment. The cost of waiting on line for access is highest for individuals with a high opportunity cost of time, and for firms that have much better things to do with their capital than to lobby for continued free access to publicly held resources.
Under market provision, by contrast, highly competitive consumer and business credit markets may make even the most valuable natural resources accessible to a wide spectrum of consumers and businesses, regardless of their current physical asset holdings. It might well be thought that the extension of consumer credit to the market for natural resource services will surely cause the virtual “malling” of American wilderness, that is, the elimination of areas preserved for very low intensity human use. As a general matter, this is incorrect. Even wilderness may be provided by the market. However, the fundamental economics of wilderness preservation - that the per user value to wilderness users increases as the number of users falls and the size of the preserve increases - will limit market provision to situations in which the cost of wilderness acquisition and preservation is low relative to willingness to pay.
Such conditions - very high willingness to pay for wilderness and effective technologies of monitoring and exclusion - were not present in the United States until relatively recently. The withdrawal of hundreds of millions of acres of federal land from private sale and development that began in the late nineteenth century has traditionally been justified by evidence that private owners had vastly overexploited their resources. It is true that private resource owners may have too strong an incentive to develop wilderness, developing even when the present value of wilderness preservation exceeds the return from developing. But this social inefficiency is not due to private ownership, but rather to incomplete capital markets that prevent private resource owners from realizing a present-day return from the preservation of future wilderness value. With the tremendous growth of capital markets over the last decade, virtually any asset can be securitized. Thus the development of capital markets has removed perhaps the strongest objection to the large-scale privatization of natural resources.
Even if one grants that natural resource preservation may be privately provided on robust markets, it is much more difficult to imagine private provision of environmental regulation. It is difficult to imagine because what I mean by private environmental regulation is not the development of tradeable pollution permits under cap and trade schemes, such as the acid rain program under Title IV of the 1990 Clean Air Act Amendments. What I mean is more radical: the replacement of our current regime - under which the state owns air, water, and groundwater and federal and state government regulates the use of those resources as waste receptacles - with a regime under which air, water, and groundwater are privately owned, and private (or local public) entities hold entitlements to determine when and whether those resources may be used for waste deposition. As a conceptual matter, what defines private environmental regulation is not the creation of tradeable permits to pollute, but rather the creation of private rights in the natural resources - air, water, groundwater - that are harmed by pollution.
Private environmental regulation differs profoundly from public regulation along three crucial dimensions: the nature of the entitlement to a clean environment; boundaries delimiting resource ownership; and, resource valuation. Under most current environmental statutes, public regulators get absolute entitlements (e.g., the “zero discharge” goal of the Federal Water Pollution Control Act of 1972). The basic political calculus governing the behavior of public regulators is that regulations cannot be imposed when their net political benefits are too low. Even if statutes give regulators absolute entitlements, the constraint that regulation be credible drives regulators to relax standards and enforcement. Perhaps most important, public regulators are (and should be) legally constrained in their ability to accept payments of money from regulated entities in exchange for agreements waiving enforcement or relaxing standards. This means not only that the effective entitlements held by public regulators are actually quite weak, but that the opportunity for Pareto-improving exchange is extremely limited (to situations in which an in-kind exchange can be found). By contrast, private regulators holding tradeable entitlements will often generate superior outcomes even when their entitlements are limited and blurry.
The necessarily political regulatory boundaries characterizing cooperative federalism in environmental regulation are notoriously ill fitting. State boundaries, for instance, are both too large (in the sense that lots of pollution has highly localize effects) and too small (because pollution spills over state boundaries).8 But interstate trading to overcome cross-boundary spillovers requires that interstate entitlements be defined. Such definition - that, for instance, the citizens of New Jersey have a right vis-a-vis the citizens of Ohio with respect to particular types of airborne emissions - is often politically impossible. Arbitrariness in initial regulatory boundary determination is far less serious under private provision, because private regulators are free to re-contract and consolidate regulatory boundaries, controlling pollution and undertaking restoration whenever they can capitalize the gains from so-doing.
The fact that many of the gains from environmental improvement accrue to public goods means, however, that private environmental regulators will always fail to fully internalize the gain from improvements to environmental resources. But so too are many gains missed under federal environmental regulation. Federal environmental regulators are much like national franchisers. Their incentive is to focus on regulatory products that have large national markets, while realizing political cost economies by shifting regulatory compliance cost to those entities - such as large oligopolistic companies - that are in the best position to spread and hide the cost. Over the past thirty years, such a strategy has brought big environmental improvements. But the very success of first generation command and control regulation has meant that private property owners will capitalize on an increasing share of further improvements. Such capitalization directly lowers the political return to federal regulators from further improvements. There remains, moreover, an entire category of sub-market regulatory products - those that bring large but locally and sectorally concentrated gains and costs - that centralized regulation has missed.
Private provision, subject to appropriate regulatory oversight, has increasingly become the means by which such gains are realized. In the form of Brownfields redevelopment, habitat conservation plans, wetlands mitigation banking, and performance-based regulatory reform initiatives, the movement to privatized provision of environmental restoration has in fact already begun. My model provides a theoretical foundation for that movement and a guide for future institutional change to ensure that its promise is realized.