Market Failures and Thermodynamics

Quick Review

Excludability Excludable resource regime –One person can prevent another from using the resource –Necessary for markets to exist Non-excludable –No enforceable property rights due to technology or social institutions –Can’t charge for use –Markets not possible Some resources non-excludable by nature. None are inherently excludable. Excludability is a product of institutions.

Rivalness Rival Goods –My use leaves less for you to use –All ecosystem goods are rival Non-rival (or non-depletable) –My use does not leave less for you to use –Marginal cost for additional user = 0 –What is optimal price under MC=MB rule? –Rationing function of price leads to under-consumption –All non-rival resources are services

Rivalness Non-rival but congestible –Rival at high levels of use Anti rival –My use makes you better off –What's an example? Markets in non-rival resources lead to underconsumption. Inefficient. Rival or non-rival is an innate characteristic of the good, not a result of institutions

So What? Rival Non-rival, Anti-rival ExcludableNon-Excludable Market Good: cars, houses, land, oil, timber, waste absorption capacity? Tragedy of the non- commons: patented information, e.g. energy efficiency, pollution control tech. Pure Public Good: Information, most ecosystem services, e.g. climate stability, coastline protection, life support functions, etc. Open Access Regime: Oceanic fisheries, timber etc. from unprotected forests, waste absorption capacity Non-rival congestible Toll Good, club good: Roads, parks, beaches, etc. Free Rider Problem

Open Access The “Tragedy of the commons” Common property vs. open access Perverse feedback mechanism Will be dealt with in detail when discussing natural resource economics

Public Goods Free-riding No price signal as feed-back mechanism –Scarcity  price increase  innovation Lack of Incentives to produce them Lack of incentives to create technologies that provide them

Public Goods (cont.) Free-market enthusiasts don’t deny public good problem, but claim they are relatively unimportant Increasing scale and public goods Are life support functions relatively unimportant? Infrastructure as a public good We’ll return to this in discussion of natural monopolies

Non-rival & Excludable: tragedy of the non-commons Why do we have patents? When did patents come about? –1790s in US –1947 international, rarely used before 1980s

Do patents promote ecologically sustainable scale? Create inadequate incentives for inventions that provide or preserve public goods Raise costs for research that promotes the public good Example: new technology for highly efficient solar energy

Do patents promote socially just distribution? Samuel Slater, “Father of American Industry” Developed countries own 97% of all patents Raises costs for research that meets the needs of the poor “Standing on the shoulders of giants”

Do patents promote economically efficient allocation? Patents are monopolies Information is non-rival Too many patents may be slowing the progress of science, not increasing it –70 separate patents involved in Golden Rice. Wave of inventions preceded international patents

Market goods: The theory of Externalities

Externalities Definition –“an activity by one agent causes a loss (gain) of welfare to another agent” –“The loss (gain) of welfare is uncompensated” Completely Internal to the Economic Process. Why? How are these related to public goods?

Examples Agriculture –Ecosystem conversion  loss of ecosystem services –N,K runoff, dead zones etc. –Siltation –Louisiana wetlands –Factory farming Natural resource harvest –Depletion of ecosystem services –Oil production and Louisiana wetlands –Waste emissions Community Development –Income inequality and status –Crime reduction –Economic stability

Conversion of Mangrove Ecosystems to Shrimp Aquaculture

Structure, raw materials Building materials, charcoal, food Function, services Habitat, nursery Storm protection Waste absorption Climate stabilization Values of Natural Capital: Mangrove Ecosystems

Shrimp Aquaculture High short term profits, heavily promoted by economistsHigh short term profits, heavily promoted by economists Shrimp and fish for 3-5 yearsShrimp and fish for 3-5 years Carnivorous, net reduction in food productionCarnivorous, net reduction in food production Less protein than intact ecosystemLess protein than intact ecosystem Massive waste outputMassive waste output Irreversible(?) destruction of ecosystemIrreversible(?) destruction of ecosystem

On natural capital:On natural capital: Loss of Ecosystem servicesLoss of Ecosystem services On Fisheries (hence jobs, culture, etc.)On Fisheries (hence jobs, culture, etc.) Loss of fish productionLoss of fish production On culture?On culture? On social capital?On social capital? Impact of Conversion

‘Optimal’ pollution/degradation

What Can we Do? Regulations –Best management practices –Best available technologies –Caps on production Property rights –Let market figure it out

What Can we Do? Tax –Set price, let this determine Q at which demand = price Tradable quota –Set Q, let this determine price

Market Option I: Property Rights Market Option I: Property Rights Cattle production

Market Option I: Property Rights Market Option I: Property Rights Shrimp aquaculture

Property Rights Who owns the environment? polluter ‘rights’ sufferer rights What about future generations?

Optimal externalities Transaction costs –in absence of transaction costs, no negative externalities –What are transaction costs likely to be for externalities affecting public goods? Wealth effect Intergenerational externalities

‘Market’ Option 2: Pigouvian tax: Getting prices right tax

'Market' Option 3: Tradable Quotas: setting ecologically sustainable scale quota

Internal Nature of ‘Externalities’ Economic growth must imply loss of ecological function –Ecosystem services are ecological functions with value to humans Externalities from ecosystem structure lost Externalities from waste outputs If ‘externalities’ are unavoidable, they are not external

What’s better, tax or quota? Prices adjust to ecological constraints faster then ecosystems adjust to economic impacts Distributional impacts –Taxes –Quotas

Ignorance and Uncertainty Perfect markets require perfect information Asymmetric information –Nobel Prize in 2000 –Theory of the Lemon Irreducible ignorance Time lags Ecosystem function

Asymmetric Preference Formation What forms our preferences? In what direction are our preferences pushed, towards market or non-market goods?

Missing markets For a market to work, everyone must be able to participate Future generations can’t participate in today’s markets People without money cannot participate, e.g. many indigenous peoples How much would the Mona Lisa sell for if it were auctioned off in St. Albans? Infinite transaction costs

Missing markets Irreversible changes –Topsoil loss –Non-renewable resource use and emissions –Ecosystem loss and extinction –Redesigning community infrastructure to depend on non-renewables