Market-based environmentalism and the free market: substitutes or complements?

• Author: Hill, Peter J.

Roy Cordato has presented an insightful critique of market-based environmentalism. His analysis provides several reasons why one should be suspicious of recent attempts to shape environmental policy through the use of "market-based" rules. Four of Cordato's criticisms are especially telling.

First, environmental problems exemplify not market failure but institutional failure. The lack of well-defined and -enforced private property rights causes the voluntary interaction of individuals to produce undesirable outcomes.

Second, people err by characterizing environmental problems as the overuse of certain resources, independent of whether such use harms people's ability to formulate and execute plans. Thus, many efforts to reform public policy amount to attempts to keep certain resources from being used, whether or not such use represents an infringement of anyone's rights. Humans cannot inhabit this planet without using resources. The relevant question is: What sorts of rules facilitate human cooperation and the satisfaction of human desires? Of course, such desires may include the preservation of certain species or resources, but a well-functioning market allows individuals to satisfy these desires only if they make acceptable payments when they use other people's property for such preservation. Unfortunately, when government coercion is involved, people can use the political process to achieve ends for which they are unwilling to pay.

Third, it is difficult to implement appropriate market-based environmentalism because the political process does a poor job of measuring subjective costs and benefits. Instead, people with their own agendas can pervert the process to achieve ends that impose substantial costs on others. Statists, bureaucrats, or radical environmentalists can use many of the market-based environmental proposals to accomplish purely political ends. Economists often act as if choosing the optimal tax level or deciding how many tradable pollution permits should be created is a straightforward matter easily accomplished through the political process. They give little consideration to the influence of the special-interest groups who capture the process to achieve their own purposes (Mitchell and Simmons 1994).

Fourth, Cordato correctly identifies the hubris of much environmental policy. Such policy presumes that the solutions are known and need only be implemented, thus ignoring the importance of the discovery process. Having frozen environmental policy into a particular configuration, people have little capacity for adaptation as they learn of and encounter changes in preferences and resource availabilities. Although market-based environmentalism (MBE) can be more adaptive than command-and-control techniques, it remains less flexible than a true market order.

Cordato's insights are valuable, but he does not go far enough. He identifies the solution to environmental problems as well-defined and -enforced private property rights, but he does not provide a theory or evidence of how such property rights come into being. Without a framework for such analysis, we can only make categorical statements that are not very constructive. But we need to assess whether particular policy innovations are helpful or harmful in moving us toward a more effective structure of property rights. Cordato closes his paper by saying,

The primary choice is not between command-and-control and market-based policies. Instead, it is between free-market policies, based on clearly defining and protecting property rights, and socialist--or, perhaps more precisely, mercantilist--policies, based on furthering the societal and personal goals of politicians and special-interest groups. The latter includes both command-and-control policies and those labeled "market-based."

But exactly what are these free-market policies based on clearly defining and protecting property rights? Do such policies involve any role for government? If so, what is it? Cordato criticizes economists who use the nirvana model of perfect competition to analyze "market failure" and make policy prescriptions. However, Cordato himself may have slipped into nirvana thinking by urging a regime of pure private property rights but giving no attention to the transaction costs inherent in the definition and enforcement of those rights. While recognizing the importance of Cordato's insights into some of the problems of market-based environmental policy, one who takes a transaction-cost approach may view MBE somewhat more favorably.

Transaction Costs and the Role of Government

Market solutions are superior to coercive ones because voluntary exchange offers the assurance that social interactions are mutually advantageous. However, transaction costs prevent some potentially profitable voluntary exchanges from taking place. Through the use of appropriate rules, government can provide feasible alternatives. In the standard examples of roads and national defense, the transaction costs of individual exchange are high and the free-rider problem substantial. Thus, there is at least some potential for using tax-financed provision of these public goods as a corrective mechanism. Of course, government provision of public goods is fraught with numerous problems, and one ought not be overly optimistic...