Economic Theory and the Environment

In the 1970s, economists described pollution and other environmental concerns as economic problems—external costs of production—that arise because markets fail to internalize in the prices of goods the costs of all the resources they consume. It soon became obvious, however, that public officials were no better able than private actors to gather and process the information needed to set optimal levels of pollution. Since the government confronts the same or greater information and bargaining costs as private parties, it is no more able than they to determine what people are willing to pay (or to accept) to gain or allow various outcomes. The government has confronted prohibitive costs when it has sought to measure the environmental losses caused by an episode of pollution—and defend those measurements.

In the early 1990s, for example, the government spent $30 million to commission experts to assess the damages associated with the discharge of DDT and PCBs into the Los Angeles Harbor. Tens of millions of dollars have funded Contingent Valuation (CV) studies of the non-use value of various environmental goods, such as the losses associated with the EXXON Valdez oil spill. EXXON commissioned Nobel laureates and other economists to debunk that study. Economists, like lawyers, take sides; economic estimates and valuations themselves become goods people are willing to pay for. No CV study, however expensive, has ever stood up as credible evidence in litigation.

Chastened by the transaction and information costs that bedevil official efforts to "get the prices right" or second-guess market outcomes, economists have turned to recommending ways that the government can create voluntary arrangements, such as markets in tradable rights and allowances, stakeholder negotiations, and governance committees, as ways to get to consensual and in that sense optimal outcomes. The question "what is the efficient allocation?" has given way to the question "what is the appropriate institution?" for governing resources such as watersheds and forests. When the government agency itself tries to govern, it becomes the object of rent-seeking, for example, zero-sum jockeying by opposing interest groups, which hire their own lawyers, economists, toxicologists, ecologists, and other experts. When these interest groups deal directly with each other by trading rights or by collaborating on decisions, they immensely reduce the transaction and information costs that tend otherwise to stymie environmental progress.

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