The invisible hand saves the world!

The new issue of the Economist has an editorial and cover story about what it calls “environmental economics”, or how to use market mechanisms to protect the planet from harm.

The editorial seeks to compare and contrast the “mandate, regulate, litigate” approach of the traditional environmental movement and the market-based approaches offered by innovative environmental thinkers. Whereas the traditional green thinker would say “you can’t do things which hurt the planet and the Government will punish you if you do”, the innovative green thinker would say “you can do things which hurt the planet, but so long as you’re willing to pay for the environmental consequences of your actions”.

However, the idea that government regulation and market-based solutions are somehow polar opposites is quite misleading. Markets only work because they have rules governing them. The sharemarket only functions because there are piles of statute books regulating what you are and aren’t allowed to do. And the environmental trading of which the Economist speaks – such as tradable fishing quotas or carbon emissions trading – are only possible if someone (i.e. government) sets the rules of the game.

One example is the issue of the fuel efficiency in cars. One way you can deal with the issue of polluting cars (which cause air pollution, and thus respiratory disease and global warming) is implement an average fuel efficiency standard that all cars importers have to abide by. That is, the average efficiency of all the vehicles each dealer imports would have to reach a certain standard. You could then allow car importers to buy and sell emissions allowances between themselves: so a dealer which wants to bring in lots of gas guzzlers could buy the right to do so from a car dealer who wants to bring in only cars which have very good fuel efficiency. That’s a perfectly reasonable way of tackling the problem of fuel emissions, and it is market-based. But the point is that this only works if you have a government setting up the trading system in the first place.

The Economist talks about a similar idea: companies that want to degrade wetlands paying money to environmental groups who preserve wetlands. Again, this is a nice idea: but it only happens if there is a regulatory framework which compels businesses to constrain the environmental effects of what they do.

The Economist‘s cover story discusses the idea of externalities – where the costs of a particular economic decision are not borne by those who make it:

When a piece of natural habitat is ploughed, for example, the conversion may make sense to the land owner, but it may also damage fisheries downstream, increase flooding and clog rivers with sediment. This makes those who lose out angry. It can also, in some circumstances, subtract from, rather than add to, a country’s total wealth.

This interconnectedness is the core of the Green message. What a business on that side of the road does affects a business on this side of the road. If by “the market”, you mean, “anyone can do what they want”, then what you get is an incentive for everyone to pursue profit and an incentive for no-one to ensure that we don’t trash the planet in the process. However, if you mean “we’ll set up frameworks whose overall purpose is to ensure we don’t trash the planet but within which people have latitude to act as they please and pursue self-enrichment”, then you have one credible strand of green thought.

Consider this extract from the Economist piece :

Public goods are those which are in everybody’s interest to have, but in no one’s interest to provide. Clean air, for example, or, more controversially, the preservation of rare species of plant or animal.

This is precisely the Green message: the Government should be providing a regulatory framework which ensures that it’s in everyone’s interest – businesses’, individuals’, government agencies’ – to act sustainably, to ensure that we have clean air, that we preserve biodiversity, etc.

The great worry is that, without this government involvement, we’ll be left with a pile of dollar bills but no clean water to drink. I, for one, would like people to have both.

4 Comments Posted

  1. I’m a firm believer in the wonders of free markets. As long as you keep an eye on them, they can do wonders for you.

    But ‘fake markets’ such as you propose creating for fuel efficiency of imported cars – they always make me suspicious. They’re always harder to get right than people think.

    Take your example of fuel efficiency. You could do all sorts of funky or odd things relating to the efficiency of cars being imported. So: is one vehicle’s efficiency equivalent to anothers? Because forcing a truck to the same standards as a car is unfair… but if you try to have two standards you distort the market (this is where SUVs came from – they managed to get classed as ‘trucks’ in the US for vehicle emission standards, which made them cheaper to produce than many cars).

    If you want to make use of the invisible hand to improve fuel efficiency, then don’t mess around trying to create a market in fuel efficiency. Just slap a whopping huge tax on petrol. That will cause the invisible hand of the market to sort things out. The irony is that this would be seen by many commentators as the Greens ‘interfering with the free market’ – whereas absolute fuel efficiency standards would just be seen as govt regulation as usual.

  2. Thanks for your reply post. I see your point on levying import cars as a way of grandparenting the system. Likewise, the poor do have dunga cars. This could be mitigated by some formula which favours cars already in existence, as opposed to new cars.

    The state, in consultation with its citizens, writes the rulebook. We agree there 🙂 I wasn’t trying to say that my take on a possible system is better than yours either, merely showing it all comes down to the old political game of who sets what and how.

    It seems the Greens are on the cusp of something big, if only they can lose the watermelon suit.

  3. Your system has promise too. Mine was just an example.

    I do have this sense, though, that it’d be easier to improve the fuel efficiency of the car fleet by dealing with which cars enter the country, rather than by trying to improve those that are already here.

    It’d also concern me that the poor, who would at the moment tend to have the oldest and thus probably the least fuel efficient cars, would be disproportionately hit by any market mechanism on cars already here. And I do believe businesses, just like individuals, should pay for the environmental effects of their actions, so I don’t see it as too problematic that car importers would have some constraints on what cars they bring into the country.

    Whatever: the point is, whether we use your model or mine for improving the fuel efficiency of the car fleet, is that you can only utilise a market mechanism if the government sets its parameters in the first place.

    And as for the Greens being more Red than Green thing (or “The Watermelon Greens” as some like to call us), I think this is more a media creation than a reality. When it comes to economic policy, the Greens certainly do not conform to the socialist dichotomy of market is bad/state is good. The NZ Greens are comfortable with market mechanisms being used to solve certain environmental problems. Kyoto has our support. The fuel efficiency example I sketched above is one that Jeanette has been advocating for a good while. But I keep coming back to the same point: you can’t use market mechanisms to address issues without government setting the market’s parameters in the first place.

    Sure, there are some aspects of Green policy which seems to come from a traditional leftist standpoint, such as views on foreign ownership and free trade agreements and foreign policy. However, at core, all of these policies are actually built around an attempt to preserve human rights that the Greens hold very dear, not some innate belief in the inherent virtue of an all-powerful state. To be sure, there are arguments around whether these policies do in fact uphold the human rights they seek to uphold, but that is what, in my view anyway, motivates them.

  4. Thanks for pointing out the link to the Economist. It neatly demonstrates the shift in mindset required if Green ecopolicy is to be effective.

    The NZ Greens are perceptually placed amongst their overseas lookalikes in Europe and America, in that they are seen to be more Red than Green. If the Greens are to gain more political credibility and mainstream support, they must clear the air and admit that free market mechanisms are the best tool for the job.

    The carbon credits model is great. It uses the market to set the price of minimising harm, thus relieving everyone of a great deal of red tape. Setting the right initial conditions, however, is not so simple.

    Taking your example of polluting cars. Why should the burden of pollution charges lie with car importers? A poorly-maintained car pollutes worse than a well-tuned one. Pollution is an ongoing opportunity cost, and therefore would be more applicable as a WOF debit/credit.

    “Oh great,” says the consumercitizen. “Another running cost.” Such a policy is all stick and no carrot. “Ah,” says the new, improved Green economist. “If your car has above average efficiency, you get a credit to trade on your WOF.”

    “Nice one!” says the consumercitizen. “The market rewards me for being environmentally friendly! A responsible petrolhead with a tuned-up car could trade this credit for a noise pollution debit on their Bass Amp.”

    It’s overly-simplistic, but I hope you see my point. There are other factors to take into account regarding car pollution. Allocation, distribution and definitions of these factors need to be clarified if any system is to be effective, let alone understood by the public.

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