[Over an extended period ZNet has been publishing excerpts of chapters from Robin Hahnel’s latest book, Green Economics: Confronting the Ecological Crisis, available from M.E. Sharpe. Excerpts published here are not the full chapters which are made available inside the book. More information about the book and links to purchase it are below. Or, if you want, first, go to previous excerpts: Introduction / Chapter 1 / 2 / 3 / 4 / 5 / 6 / 7 / 8 / 9]
This chapter examines free-market environmentalism, a response with weak support elsewhere but strong support from conservative circles in the United States. According to this school of thought, government intervention to protect the environment is neither necessary nor desirable. Free-market environmentalists argue that government should limit itself to clarifying and enforcing property rights, leaving private parties to engage in negotiations without further government interference. According to free-market environmentalists, once property rights are clear, polluters and pollution victims can be relied on to reach agreements that lead to efficient levels of pollution through voluntary negotiations.
Free-market environmentalists base their laissez-faire policy on their interpretation of what is commonly referred to as the Coase theorem. However, a careful examination of what the Coase theorem says, and does not say, reveals that free-market environmentalism rests on porous ground and that its hands-off policy would utterly fail to protect the environment…. An accurate summary of the issues raised by the Coase theorem should read as follows:
(1) Even if there is only a single polluter and a single victim, even if it is clear who has the property right, even if there are zero transaction costs to negotiations, even if both parties have “complete information” (i.e., they know not only their own marginal profit or damage curve but the marginal profit or damage curve of the other party as well), even if both parties know that the other knows all this as well, even if both parties play rationally and know the other party will do likewise, even if players care only about the absolute size of their own payoffs, and even if the bargaining procedure is carefully structured, it is still quite possible that a polluter and victim might fail to reach an efficient outcome if either has reason to be concerned for her bargaining “reputation.”
(2) However, it is highly unlikely that Coasian negotiators would have “complete information.” In this case the party with the property right can exaggerate her profits or damages because her opponent has no way to know what they truly are, and when this occurs it is predictable that even “successful” Coasian negotiations will lead to grossly inefficient outcomes. If the polluter has the property right and the victim does not know what the polluter’s marginal profit curve looks like, the polluter has an incentive to exaggerate her profits from pollution, and “successful” Coasian negotiations will lead to more pollution than is socially efficient. If the victim has the property right and the polluter does not know what the victim’s damage curve looks like, the victim can gain by exaggerating her damages, and “successful” Coasian negotiations will lead to more abatement than is efficient. While this conclusion derives from an absence of complete information, the kind of omniscience that is necessary to conclude that negotiations will tend toward efficient levels of pollution is highly unrealistic for polluters and their victims, going considerably beyond the kind of perfect self-knowledge necessary to assume that competitive markets will lead to efficient outcomes. Moreover, the most important way that incomplete or private information causes inefficiencies is not by preventing polluters and victims from coming to agreements, but by permitting the party with private information to substitute a false bargaining game with less or no efficiency gain for the true bargaining game with a larger efficiency gain envisioned by Coase. In that case, inefficiency arises not only from failure to reach agreements but from inefficient agreements that are reached as well.
(3) If there are multiple victims of pollution, perverse free-rider and holdout incentive problems will doom separate negotiations between the polluter and each victim to failure. But if victims attempt to negotiate collectively, perverse incentives to misrepresent damages will lead to inefficient outcomes. In either case it is highly unlikely that voluntary negotiations when there are multiple victims will achieve efficient levels of pollution. To his credit, Professor Coase was aware of this limitation to his “theorem,” although he initiated the unfortunate practice of trivializing problems introduced by multiple victims as transaction cost problems when, in truth, they are far more fundamental problems of incentive incompatibility. A reasonable assessment of a host of perverse incentives that are likely to impact voluntary negotiations between polluters and multiple victims should lead us to expect failure, not success, even if the “transaction costs” of identifying potential victims and issuing them invitations to join a victim’s coalition are low….
In conclusion, the main reasons voluntary negotiations between polluters and their victims will not lead to efficient outcomes are not because of positive transaction costs or irrational behavior, but because negotiators seldom know their opponent’s true situation, which leads to perverse incentives to dissimulate, and because the existence of multiple victims creates perverse incentives for victims to free ride, hold out, and misrepresent the extent of damages. To treat the first problem as a lack of perfect knowledge is disingenuous because it is not the traditional assumption of perfect self-knowledge that is required, but instead a far more implausible assumption of “complete information” that is tantamount to social omniscience.To treat problems that arise when there are multiple victims as just more transaction costs trivializes serious incentive problems that go far beyond the time and expense of identifying and contacting multiple victims.
How careless interpretations of the so-called Coase theorem can be easily manipulated to undermine the case for government regulation is not hard to see. Even if the Coase theorem does not always apply because some premise is unmet, leaving the impression that it may apply, and implying that only inefficiencies in excess of the transaction costs of negotiating their elimination will occur, means that one can always argue that “voluntary” solutions to environmental problems should be explored first before “second-best,” “command and control” policies be considered. Given the enthusiasm for “market-based solutions” and the antipathy for regulation in the neoliberal era, it is hardly surprising that free-market environmentalism wields more influence on policy than is justified by its theoretical underpinnings….
Hopefully, the admittedly tedious argument presented in this chapter demonstrates why the realm of real-world situations where voluntary negotiations could be reasonably expected to provide efficient solutions to environmental problems is so small that free-market environmentalism no more deserves a seat at the policy table than miracles deserve a role in the operating room.
Green Economics: Confronting the Ecological Crisis by Robin Hahnel is available from M.E. Sharpe.
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