Distributional Effects of Environmental Markets

Insights and Solutions from Economics

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Perhaps more than at any point in history, governments, conservation groups, and private organizations are harnessing property rights and markets to manage common-property resources such as fish, water, groundwater, biodiversity, and climate. Anecdotes suggests that the allocation of rights or permits, the rules governing ownership and trading, and the longevity and security of rights are paramount to adoption and long-run success. In particular, the distributional consequences of different trading structures can significantly impact the likelihood of adoption of environmental markets, enforcement success, long-term viability of the market, public perception of the market, and even efficiency of outcomes. For example, if too many groups are disadvantaged or excluded from the rights-allocation process, or if all of the economic benefits of improved management are taxed or auctioned away at the outset, then an otherwise successful market approach may become politically unviable.

Despite growing evidence that the distributional consequences of environmental markets can play a central role in their adoption and durability, only a small body of scholarship explicitly tackles these challenges. In July 2018, the Property and Environment Research Center (PERC) hosted a workshop to assemble world-class researchers and practitioners to shed light on the ways in which environmental markets could be better designed and implemented to explicitly account for distributional concerns. To achieve this goal, we attempted to make three contributions: First, we sought to convene leading researchers on the distributional effects of environmental markets. Second, we commissioned a set of short papers and presentations by these experts, with the goal of proposing novel and actionable approaches to account for distributional effects in market design and implementation. Third, we sought to pair each presentation with an applied practitioner with on-the-ground experience who could help hone the idea either into a more applied, policy-relevant research contribution, or, in some cases, even into an actual policy proposal.

What is the justification for better understanding the role market design plays in the distributional consequences of the transition to market-based environmental protection? Our motivation stems from the belief that by better understanding this connection, future environmental markets can be designed for increased uptake and durability, and that this information will likely also lower the cost and ultimate success of implementation.

Workshop Format

The format of the workshop was non-traditional. We commissioned a total of 10 papers from internationally regarded scholars in some aspect of the distributional consequences of environmental markets. These scholars proposed their own paper topics, and workshop organizers helped refine these topics to ensure a well-rounded final set of ideas. The papers were deliberately written to contribute to the format of the workshop—they were short, concise and provocative, and were not simply carved out of existing papers written for a different audience. The papers were both theoretical and empirical. In some cases, they were highly generalized across environmental goods—for example, an examination of the role initial allocation plays in distributional effects. In other cases, papers were focused specifically on one environmental domain, such as fishery or air pollution rights.

Based on the content of each paper, workshop organizers identified a suitable discussant to make detailed comments on the conceptual contribution and applied relevance of the ideas being proposed. These discussants were selected from academia, non-governmental organizations, and government agencies. Following the workshop, presenters polished their written contribution based on the discussion, and discussants produced a short summary of their comments. These contributions are compiled in this volume.

Contributors

Lead authors and discussants were selected from a range of universities, non-governmental organizations, and agencies. Here we briefly summarize the paper topics and contributors’ backgrounds.

  • Spencer Banzhaf is a professor of economics at Georgia State University, research associate at the National Bureau of Economic Research, and a senior fellow at PERC. Spencer’s paper concerns how to allocate environmental rights to communities to better account for environmental justice. Spencer’s discussant is Kelly Maguire, the Chief of the Conservation and Environment Branch of the Economic Research Service at the U.S. Department of Agriculture, who also spent 19 years as an economist at the U.S. Environmental Protection Agency.
  • Corbett Grainger is a professor of applied economics at the University of Wisconsin, Madison. Corbett’s paper examines the strategic siting of air pollution monitors and argues that their biased placement exacerbates environmental justice concerns. Corbett’s discussant is Sam Collie, a PhD student in the Bren School of Environmental Science & Management at U.C. Santa Barbara and a Sustainable Water Markets fellow.
  • Kelsey Jack is a professor of environment and development economics at U.C. Santa Barbara and a Faculty Research Fellow at the National Bureau of Economic Research. Kelsey’s paper examines whether using auctions to allocate payments for ecosystem services in developing countries systematically disadvantages the poor. Kelsey’s discussant is James Salzman, a professor of environmental law at U.C. Santa Barbara and UCLA whose scholarship and applied work is in ecosystem service provision.
  • Kailin Kroetz is a fellow at Resources for the Future (Washington, D.C.) in the Land, Water, and Nature program. Kailin’s paper examines whether implementing an environmental market in a fishery (called “catch shares”) leads to leakage where fishermen exit that fishery, and enter less-regulated fisheries, thus undoing some of the environmental benefit of the market. Kailin’s discussant is Jono Wilson, who is a lead scientist on global fisheries for the Nature Conservancy, one of the world’s leading conservation-based non-governmental organizations.
  • Kyle Meng is a professor of environmental economics at U.C. Santa Barbara, a Faculty Research Fellow at the National Bureau of Economic Research, and a former fellow at Environmental Defense Fund. Kyle’s contribution focused on the environmental justice effects co-pollutants in California’s cap and trade program. Kyle’s discussant is Larry Goulder, an economics professor from Stanford University and a fellow at the National Bureau of Economic Research.
  • Dominic Parker is a professor of economics at University of Wisconsin, Madison, and a senior fellow at PERC. His paper examined the distributional effects of conservation easements, focusing on the tax policies that incentivize landowners to donate easements to land trusts. Nick’s discussant is Mike Conner, the director of land protection in California for the Nature Conservancy.
  • Kathleen Segerson is a distinguished professor of environmental economics and associate dean at the University of Connecticut. Kathleen’s paper examines the distributional and efficiency implications of allocating property rights in environmental markets to groups instead of to individuals. Kathy’s discussant is Merrick Burden, a senior economist with the fisheries solution center at the Environmental Defense Fund.
  • Matthew Zaragoza-Watkins is an assistant professor of energy and environmental economics at Vanderbilt University. Matt’s paper concerns the possible distributional effects of leakage that can arise from carbon pricing policies. Matt’s discussant is Dan Kaffine, a professor of environmental economics and a Renewable and Sustainable Energy Institute fellow at University of Colorado, Boulder.
  • Christopher Costello is a professor of resource economics at U.C. Santa Barbara, a research associate at the National Bureau of Economic Research, and a senior fellow at PERC. Chris’s paper examines the efficiency and equity consequences of alternative approaches to initially allocating rights in an environmental market. Chris’s discussant is Nicole Sarto, a senior specialist at the fishery solutions center at Environmental Defense Fund.
  • Andrew Plantinga is a professor of resource economics at U.C. Santa Barbara. Andrew’s paper examines the distributional consequences of using market-based mechanisms to manage spatially connected and spatially heterogeneous natural resources. Andrew’s discussant is Kerry Smith, a regent’s professor of economics and a distinguished sustainability scientist at Arizona State University.
Themes

Each of the paired papers and discussant comments compiled in this volume represents an important advancement in both our academic understanding of the distributional effects of environmental markets and in the practical solutions that might be applied in real-world settings. These ten distinct contributions fall roughly into three thematic areas. In what follows, I attempt to succinctly highlight the key contributions of each paper within these themes, with a focus on how the paper and discussion contribute to our understanding of distributional effects.

Theme 1: Environmental Justice Concerns and Solutions

That disadvantaged communities tend to experience disproportionate levels of pollution has been well-established in the literature, and it is this finding that underpins the field of environmental justice. But to focus more explicitly on solutions, a more nuanced set of questions may be warranted. These questions concern issues such as: (1) whether the correlation between race or income and pollution is causal, (2) whether regulators focus pollution control toward rich, advantaged communities, (3) whether gentrification is the ultimate outcome of a cleaner environment, and (4) whether institutional solutions exist that empower communities with sovereignty and bargaining power over environmental quality. These are exactly the kinds of questions tackled in several papers in this volume.

Spencer Banzhaf argues that a Coasean approach (after the Nobel Prize-winning economist Ronald Coase) could be taken to help resolve environmental justice concerns between a community and a polluter. He argues that if rights (for example, to a clean environment) are allocated to communities, then any bargaining between the community and the polluter could plausibly lead to an actual Pareto improvement, in which all parties are better off. Under this line of thinking, there is an important role for environmental justice advocates as facilitators of low-transaction-cost bargaining and to ensure that rights (to communities) of a clean environment are not expropriated.

Corbett Grainger examines whether air pollution regulators strategically site pollution monitors in clean locations away from disadvantaged communities. This is difficult to study empirically because it is hard to know the pollution levels in areas without air pollution monitors. Grainger uses satellite data to show that these monitors are placed in atypically clean locations, that this leads counties to be erroneously labeled as “in attainment” with air quality standards, and that this systematically disadvantages poor neighborhoods. He concludes that new sensors and satellite technologies should be adopted to help overcome this strategic bias. Discussant Sam Collie raises the interesting question of whether Grainger’s findings are due to strategic placement (of monitors) or avoidance behavior (of people); this remains an open—and crucial—question.

Theme 2: Distributional Effects of Market Mechanisms

A central theme that emerged out of this workshop is that the way we design environmental markets can have significant distributional consequences. While these design features have received some attention because they may also affect efficiency, few scholars have specifically focused attention on the distributional implications of design features such as (1) ownership rights in alternative environmental markets, (2) how trading affects co-pollutants and environmental justice, (3) tax incentives for ecosystem service provision, and (4) conservation obligations across heterogeneous communities.

Kailin Kroetz tackled the complex and difficult-to-study issue of leakage in fishery markets. Because market-based fishery management is usually implemented one fishery at a time, there is a risk that regulated fishermen will sell their grandfathered rights and enter a less well-regulated fishery, possibly undermining the sustainability of the policy and affecting the distributional outcomes in both fisheries. She raises the profile and importance of leakage and, as echoed by discussant Jono Wilson, argues for a more coordinated policy across fisheries.

Environmental markets designed to solve one problem may help solve (or exacerbate) another problem. Kyle Meng examines this kind of “co-benefit” in California’s carbon cap-and-trade market. Because local air pollutants are typically co-emitted with carbon, a reduction in carbon emissions may also lead to a reduction in local air pollutants, and would thus improve air quality. Trading of carbon allowances means that some places will increase pollution while others decrease (though there will be a net decrease). Kyle examines whether this spatial reallocation of pollution exacerbates, or ameliorates, environmental justice concerns.

Dominic Parker also examines the distributional consequences of an incentive-based approach to environmental protection, focusing on federal tax incentives to provide conservation easements on land. Easements are voluntarily donated by a landowner, and as a consequence, the land is permanently conserved. In exchange, the landowner obtains generous tax incentives, though these tax incentives primarily extend to wealthy landowners. Parker raises concerns about the quality and additionality of conservation easements because, under current policy, donated land may be of questionable conservation value. On the other hand, his discussant Mike Conner argues that various practical mechanisms are in place to ensure robust conservation benefits from these easements.

While other authors focused on the distributional consequences of environmental policy across income, race, or other classes, Andrew Plantinga focuses on the distributional effects across space, for example across diverse communities. In his spatial model of a renewable resource, Plantinga argues that one owner’s resource extraction affects all other owners for mobile resources such as water, fish, and game. The common-pool nature of this problem leads to over-exploitation of such spatial resources, and Plantinga proposes a new market-based instrument, based on transferable conservation obligations, to overcome this challenge. Discussant Kerry Smith helps bridge this idea with important insights from the public economics literature.

Theme 3: Allocation of Rights and Responsibilities in Environmental Markets

Perhaps the most fundamental design feature of any environmental market is the initial allocation of rights and responsibilities to different actors. In practice, most environmental markets grandfather rights to historical users, and several authors comment that this can have important distributional, and even efficiency, consequences, though it is rarely studied. In this theme, authors tackle various challenges around the allocation of rights, and their research gives rise to several important new insights that could potentially improve buy-in, equity, durability, and efficiency of new environmental markets.

We often take for granted that rights will be allocated to an individual, such as a fisherman (for fish), a polluting facility (for air pollutants), or a farmer (for water). Kathleen Segerson challenges this assumption, and instead asks whether allocating to groups can bring previously unrecognized benefits. A group allocation of rights links members’ actions, and it has both distributional and incentive consequences. In this setting, the payoff is typically tied to group performance, rather than individual performance, which brings about free-riding incentives, social pressures, risk sharing, and other important features that are not obviously present when allocating to individuals. Discussant Merrick Burden emphasizes that group allocations can be contentious because members must agree on how to share benefits.

My own contribution argues that the initial allocation of rights can have important political economy consequences. If all rights are grandfathered for free, then incumbent resource harvesters are typically made better-off under the market than under a status-quo management system. This incentivizes them to endorse the market approach. But if rights are auctioned, are too costly, or if previously well-off users received small allocations, then it is likely that some incumbents will oppose the market. Other authors have argued that free allocations represent a windfall benefit, often to those who historically created environmental problems. I show that alternative approaches to allocation, based on a concept of “merit,” can both reward historically responsible actors and sufficiently reward incumbent resource users such that a broad set of stakeholders endorse the transition to an efficiency-enhancing market.

When an environmental market covers only part of an economic sector (for example, when one country unilaterally adopts a carbon cap-and-trade program), there is a risk of leakage –where price effects cause pollution to decrease where the market is implemented but increase in other locales. Matthew Zaragoza-Watkins examines leakage of this form for California’s carbon cap-and-trade program. To combat leakage there, an output-based subsidy is applied in the form of a free allocation of rights, which incentivizes increased output. This output-based subsidy dampens, or eliminates, the price response that would cause leakage. He finds that indeed emissions in California have decreased, but output has remained roughly constant, as a consequence of this policy.

In some cases, economic incentives involve direct payments for ecosystem services, where a landowner, fisherman, or other agent is paid to voluntarily provide an environmental benefit. To avoid the problem of additionality (where a large payment is made for a conservation action that would have occurred even without the payment), and thus incentivize truthful bidding, auctions are often used. Kelsey Jack asks whether these auctions disproportionately favor the rich—after all, the rich may be in a better position to place high bids. She finds just the opposite. Using a randomized field experiment in Malawi, she finds that auctions typically favor worse-off households.

Conclusions

This workshop has shown that as communities of people around the world increasingly run up against natural-resource constraints, environmental markets can be thoughtfully designed to deliberately account for distributional equity while simultaneously accounting for environmental protection and economic efficiency. Achieving these multiple objectives is possible because there are so many dimensions to the design of an environmental market, such as allocation of rights, to whom they are granted, the durability of rights, how environmental quality is monitored, and how co-benefits or co-costs are considered. A corollary is that the distributional consequences of a market may actually affect its efficiency because market approaches that are deemed unjust may fail to be adopted in the first place. This body of work represents a small, yet we hope provocative and informative, first step toward a much larger research agenda addressing the distributional effects of environmental market design.

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Table of Contents
Environmental Justice Concerns and Solutions

1. Environmental Justice and Coasean Bargaining by H. Spencer Banzhaf, Lala Ma, and Christopher Timmins
Response: Kelly Maguire

2. Environmental Justice and Ambient Air Pollution Monitoring by Corbett A. Grainger
Response: Sam Collie

Distributional Effects of Market Mechanisms

3. Fishery Catch Shares and Leakage of Impacts by Kailin Kroetz
Response: Jono Wilson

4. Is Cap-and-Trade Causing More Greenhouse Gas Emissions in Disadvantaged Communities? by Kyle C. Meng
Response: Larry Goulder

5. Distributional Effects of Conservation Easements by Dominic Parker
Response: Mike Conner

6. Transferable Conservation Obligations in Patchy Systems by Andrew Plantinga and Christopher Costello
Response: Kerry Smith

Allocation of Rights and Responsibilities in Environmental Markets

7. Distributional Implications of Group Performance Mechanisms by Kathleen Segerson
Response: Merrick Burden

8. Grandfathering by Merit by Christopher Costello, Charles Figuières, and Corbett Grainger
Response: Nicole Sarto

9. Leakage and Industrial Subsidies by Matthew Zaragoza-Watkins
Response: Daniel Kaffine

10. Auctioning Payment for Ecosystem Contracts by B. Kelsey Jack
Response: James Salzman

 

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