Environmental law and economics
A. Allan Schmid
Law and economics has two contrasting approaches. One aspires to provide not only a positive theory of economic behaviour but also a guide to legal- economic policy choices.
Efficiency and maximization of net economic product are claimed to be that guide (Faure, 1995). The second provides only a substantive description of the impacts of legal alternatives on different parties, with little attempt to aggregate them. These approaches will be contrasted with respect to several major legal questions concerning the environment, including the choice of injunction or liability as relief to injury, externalities and ownership, use of markets versus governmental regulation, and the takings issue. These will illustrate some of the theoretical and empirical findings in the environmental law and economics literature.What is the appropriate relief when an actor causes environmental injury to another? The case of Boomer v. Atlantic Cement Co. (Court of Appeals of New York, 1970, 26 N.Y. 2nd 219, 257 N.E. 2nd 870) is often used to illustrate the problem (see Goetz, 1984). A large cement plant created smoke, dirt and vibration which damaged neighbours. The court found that the activity created a nuisance and awarded damages, but not an injunction. Cooter and Ulen (1988) argue that law and economics can provide an authoritative answer to the desirability of damages versus an injunction which legal analysis alone cannot. The landmark literature here is Calabresi and Melamed (1972) and Polinsky (1980). The authors argued that efficiency points to the awarding of damages to the many neighbours because otherwise there would be strategic bargaining and high transaction costs if an injunction caused the cement company to try to purchase the right to inflict these damages on the neighbouring homeowners. So cost minimization points to damages only since an injunction might leave the right in the hands of the homeowners even when the value was greater (net of transaction costs) in the hands of the cement company.
(See also Ogus and Richardson, 1977.)The efficiency literature assumes that the value to the cement company of use of the environment for noise and dirt deposit is greater than the use for the peace and quiet of home users. If efficiency is to be a guide to law, prices and values used to calculate efficiency must be independent of law and the assignment of rights. An alternative approach is provided by what Burrows and Veljanovski (1981) and Mercuro and Medema (1997) call ‘institutional law and economics’. While the efficiency approach uses the market price of homes with and without exposure to cement factory pollution, imagine that some homeowners have unique tastes and would not sell at these prices. The institutional approach asks whether these unique tastes are to count (Calabresi, 1985). They would count if the homeowners own the right to an injunction, but not if they only have the right to court-computed damages based on easily observed market values. Legal choice is then a choice as to whether the unique tastes are reasonable, a matter which judges have long taken as their domain.
Once the cement factory has made its investment at a specific site, it has specific assets whose salvage value is much less if the site must be abandoned. The right of injunction then gives the homeowners a strategic bargaining advantage to obtain any rents the factory might otherwise have enjoyed. An empirical study of the behaviour of Florida phosphate mine operators and farmers illustrates the point (Crocker, 1971). Phosphate processing released dust which damaged adjoining pastures. Under Florida law the farmers had the equivalent of the right of injunction via the state pollution control authority. The miners purchased the pasture land at prices substantially above its market value. The value of the land resource is not independent of the legal alternatives under consideration and thus cannot be used as a guide to choosing between them (Samuels et al., 1997).
Economists have often served as expert witnesses in environmental damage cases.
Among the most celebrated damage cases are those arising from oil spillage from tankers such as occurred in the wreck of the Exxon Valdez in Alaska and the Amoco Cadiz off the coast of France. To determine damage awards, economists have conducted contingent valuation studies asking people their willingness to buy the environmental products that were destroyed. But again, the economic value is not independent of rights. It is the rights determination that instructs whether the proper question for contingent valuation is willingness to buy (which assumes environmentalists do not own the resources) and willingness to sell (which assumes they are already owners).Externalities and ownership
The assignment of liability is equivalent to the assignment of ownership among incompatible users of a resource. The touchstone of much law and economics scholarship here is the work of Ronald Coase. The efficiency school of law and economics has interpreted his work to mean that distribution of ownership is not important to achieve efficiency when transaction costs are zero. The market would achieve efficiency as long as the government was definitive about the placement of liability and no other government action was necessary. This is in contrast to the idea that a tax or regulation is necessary to correct externalities. If the person who places the highest value on the resource is given ownership, he or she will refuse all lesser market bids and keep the resource. If the person with the lesser value is given ownership, he or she will sell to the person with the higher value and thus use of the resource is invariant with initial ownership. While the logic of this proposition is unassailable, Coase (1992) has now made it clear that most practical issues of resource conflicts involve transaction costs and thus initial ownership matters.
Coase and the institutionalists argue that conflicts over externalities are ubiquitous and reciprocal between alpha and beta, and the policy question is to decide which party to restrain.
Coase argues that, in a world of significant transaction costs, it is not possible to deduce a general rule of taxation, liability or whatever (see Parisi, 1995, for a summary). He supports the calculation of net benefits on a case-by-case basis with the presumption that any legal innovation which reduces transaction costs is desirable. Institutional law and economics suggests that transaction costs are often the means by which the interests of third parties are protected and the reduction of such costs is functionally equivalent to a redistribution of rights, opportunities and exposures (Schmid, 1983).Markets versus regulation
The efficiency approach to law and economics is the basis for a critique of many countries’ current policies requiring certain standards for discharges or specific technologies to be used by all firms engaging in certain resourceusing activities. Requiring all firms to use a particular wastewater treatment, for example, ignores the possibility of differences in costs among firms. Starting from some initial allocation of rights, if firms could buy waste discharge rights, those with cheap alternatives would sell and those with more expensive alternatives would buy the right to discharge rather than treat. Some countries are beginning to utilize pollution markets, but some people have objected to firms making profits from the right to pollute. As a positive proposition, groups striving to capture opportunities for profits do lobby for legal change to make it possible. At the same time, legal change is also driven by ideology. One powerful ideology is that firms should have only enough waste disposal rights to keep in business and generate employment. If technology improves, the environmental users should benefit from the achievement of higher quality, rather than the polluters having something to sell. Institutional law and economics suggests the interdependence between legal change and notions of fairness. The legitimacy of the market depends on the legitimacy of who has what to sell.
Takings or the extent of legal change
Legal systems in the English tradition make a distinction between legitimate change in the regulation of activity affecting the environment (police power) and legal change which constitutes a ‘taking’ which must be compensated by the government. Whether or not the legal system has a constitutional provision that limits the uncompensated consequences of legal change, the issue of compensation is present in all legal systems. The efficiency approach to law and economics applies the test of Pareto improvement: does the change make someone better off without making someone else worse off? So it might be asked whether a proposed zoning which would prevent a real estate development to preserve a scenic view would meet the test (Knetsch, 1983; Stephen, 1988, ch. 6).
But the Pareto test requires some assumption of initial rights to calculate. If we ask about the developer’s willingness to sell and forgo development, we assume that the developer has the right to create costs for the environmentalist. This presumes that the environmentalist is the buyer and has no land rights, but the rights situation could be reversed and the same test applied. If we ask about the environmentalist’s willingness to sell and forgo the view, we assume that the environmentalist has the right to withhold opportunities for the developer. Willingness to pay and willingness to sell may be equal, but need not be if there is a wealth or endowment effect (Schmid, 1995, 2004).
A zoning law may shift use of the view to the environmentalist when those users would not have been able to buy the view from developers. Is this a loss of efficiency? But some environmentalists would not sell if they were the owners of the view. The environment is not divisible, allowing some to sell and others to keep. The institutional law and economics approach finds that the Pareto rule does not dispose of the issue. Since value depends on the distribution of rights, it cannot be a guide to the choice of those rights (Samuels and Mercuro, 1992).
The government is not the only source of change affecting the value of a person’s opportunities. There are changes in technology, resource availability, population, preferences and so on. Many of these are subject to radical uncertainty and no law can fully anticipate them. When they occur, new interdependencies will arise and the inevitable question is who can seize them and who is subject to uncompensated losses. Samuels and Mercuro argue that the compensation problem is ubiquitous, that uncompensated takings are inevitable and that no analytically significant distinction can be made between legally and illegally imposed changes.
Human behaviour
The study of law and economics incorporates divergent views of human behaviour. Some find it sufficient to assume individual utility maximization involving largely unchangeable preferences. Others find it useful to acknowledge that people care about others and that preferences evolve and are subject to social interaction. Thus, for example, there are differences in predicting whether people follow environmental laws when the costs of enforcement and monitoring are high. Some would argue that law is only effective if it can be enforced, and others that there is some role for law as a statement of ideals which some may follow even if sanctions cannot be made effective. For example, it is difficult to police people who litter. Nevertheless, many people do not litter, even when avoidance has a cost and policing is impossible. One area where the behavioural postulate is critical is with respect to judges. If judges followed a narrow self-maximization principle, they would always sell their services to the highest bidder when these acts could not be monitored. The chaos that follows from the fact that some do, and that in some countries most do, suggests the value of self-imposed learned behaviour and makes the study of institutions which affect this learning a priority for scholarship.
References
Burrows. P. and C.G. Veljanovski (eds) (1981), The Economic Approach to Law, London: Butterworths.
Calabresi, G. (1985), Ideals, Beliefs, Attitudes and the Law, Syracuse, NY: Syracuse University Press.
Calabresi, G. and A.D. Melamed (1972), ‘Property rules, liability rules and inalienability: one view of the cathedral’, Harvard Law Review, 85, 1089-128.
Coase, R.H. (1992), ‘The institutional structure of production’, American Economic Review, 82, 713-19.
Cooter, R.D. and Thomas Ulen (1988), Law and Economics, Glenview, IL: Scott, Foresman.
Crocker, T. (1971), ‘Externalities, property rights and transactions costs: an empirical study’, Journal of Law and Economics, 14, 451-64.
Faure, M. (1995), ‘Economic models of compensation for damages caused by nuclear accidents’, European Journal of Law and Economics, 2, 21-34.
Goetz, C.J. (1984), Cases and Materials on Law and Economics, St Paul, MN: West Publishing. Knetsch, J.L. (1983), Property Rights and Compensation, Toronto: Butterworths.
Mercuro, N. and S. Medema (1997), Economics and the Law: From Posner to Post-Modernism, Princeton, NJ: Princeton University Press.
Ogus, A. and G. Richardson (1977), ‘Economics and the environment: a study of private nuisance’, Cambridge Law Journal, 36, 284.
Parisi, F. (1995), ‘Private property and social costs’, European Journal of Law and Economics, 2, 149-73.
Polinsky, A.M. (1980), ‘On the choice between property rules and liability rules’, Economic Inquiry, 18, 233-46.
Samuels, W.J., S.G. Medema and A.A. Schmid (1997), The Economy as a Process of Valuation, Cheltenham, UK and Lyme, USA: Edward Elgar.
Samuels, W.J. and N. Mercuro (1992), ‘The role and resolution of the compensation principle in society’, in W.J. Samuels, Essays on the Economic Role of Government, Vol. 1, New York: New York University Press.
Schmid, A.A. (1983), ‘Die Okonomische Theorie der Eigentumsrechte: Ein Besprechungsaufsatz’, in J. Backhaus and H. Nutzinger (eds), Eigentumsrechte und Partizipation, Frankfurt: Haag & Herchen.
Schmid, A.A. (1995), ‘The environment and property rights issues’, in D. Bromley (ed.), Handbook of Environmental Economics, Oxford: Blackwell, pp. 45-60.
Schmid, A.A. (2004), Conflict and Cooperation: Institutional and Behavioral Economics, Oxford: Blackwell.
Stephen, F.H. (1988), The Economics of Law, Ames, IA: Iowa State University Press.
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