6.5 Solutions: property rights, regulations, and incentive policies

Learning objectives

After reading this module, students should be able to

• know why having clearly defined property rights might improve environmental outcomes and be aware of the limitations of that approach
• define several different types of command and control regulations, and understand their comparative advantages
• know what incentive policies (taxes and tradable permits) are, what they do, and what their strengths and weaknesses are

Introduction

Governments have implemented many policies to solve problems with environmental quality and natural resource depletion. Every policy is unique and deserves detailed individual analysis in the policymaking process—the devil is always in the details. However, economists have developed a taxonomy of policy types. This taxonomy helps us to understand general principles about how policies of different types are likely to perform and under which circumstances they are likely to work best. Policies are broadly characterized as either command-and-control or incentive policies. Command and control includes several types of standards. Incentive policies include taxes, tradable permits, and liability.

Property rights

In 1960, Ronald Coase wrote the pioneering article "The Problem of Social Cost" in which he put forth ideas about externalities that have come to be known as the Coase theorem ( Coase, 1960 ). The basic idea of the Coase theorem is that if property rights over a resource are well specified, and if the parties with an interest in that resource can bargain freely, then the parties will negotiate an outcome that is efficient regardless of who has the rights over the resource. The initial allocation of rights will not affect the efficiency of the outcome, but it will affect the distribution of wealth between the parties because the party with the property rights can extract payment from the other parties as part of the agreement.

To bring this abstract idea to life, we will draw on the classic example employed by generations of economists to think about the Coase theorem. Suppose a farmer and a rancher live next door to each other. There is land between them on which the farmer wants to plant crops, but the rancher's cows keep eating the crops. The farmer would like to have no cows on the land, and the rancher would like the farmer to stop planting crops so the cows could eat as much grass as they like. The efficient outcome is where the marginal benefit of a cow to the rancher is just equal to the marginal cost to the farmer of that cow's grazing. If the farmer is given property rights over the land, the rancher will have an incentive to pay the farmer to allow the efficient number of cows rather than zero; if the rancher has the rights, then the farmer will have to pay the rancher to limit the herd to just the efficient size. Either way they have incentives to negotiate to the efficient outcome because otherwise both of them could be made better off.