TROUBLE IN HAPPYVILLE
PAULR. PORTNEY is Vice President and Senior Fellow at Resources for the Future.
Introduction
About a year ago, I circulated the following hypothetical problem to my colleagues at Resources for
the Future, economists and noneconomists alike. Their responses were quite interesting and, in
some cases, surprising. I thought it might be interesting to try the experiment on a larger and more
diverse group of readers. Several referees mercifully agreed and I hereby invite you to ponder the
following
Is It Safe to Drink the Water?
You have a problem. You are Director of Environmental Protection in Happyville, a community of
1000 adults. The drinking water supply in Happyville is contaminated by a naturally occurring
substance that each and every resident believes may be responsible for the above-average cancer
rate observed there. So concerned are they that they insist you put in place a very expensive
treatment system to remove the contaminant. Moreover, you know for a fact that each and every
resident is truly willing to pay $1000 each year for the removal of the contaminant.
The problem is this. You have asked the top ten risk assessors in the world to test the contaminant
for carcinogenicity. To a person, these risk assessors-including several who work for the activist
group, Campaign Against Environmental Cancer, find that the substance tests negative for
carcinogenicity, even at much higher doses than those received by the residents of Happyville.
These ten risk assessors tell you that while one could never prove that the substance is harmless,
they would each stake their professional reputations on its being so. You have repeatedly and
skillfully communicated this to the Happyville citizenry, but because of a deep-seated skepticism
of all government officials, they remain completely unconvinced and truly frightened-still willing, that
is, to fork over $1000 per person per year for water purification.
The Questions
First, what are the annual benefits of removing the contaminant from the Happyville drinking water
system? (For you noneconomists, benefits are generally measured by willingness-to-pay). Are they
$1,000,000? Zero? Some number in between? This is not a trick question, nor should you read more
into it than I intend. I am simply interested in knowing what you think the "benefits" side of the
benefit-cost ledger should look like. Second, suppose that: (1) the contaminant was not naturally
occurring (as hypothesized above), but rather the result of industrial contamination; (2)
our estimate of $1000 per person for annual willingness-to-pay for purification was based on a state-
of-the-artcontingent valuation study (a survey designed to elicit individuals' valuations of
environmental programs);and (3) a lawsuit had been brought against the source of the
contamination. If your answer to the first question was $1,000,000 in annual benefits, would
you be willing to support a judgment of $1,000,000 in annual damages against that source, again
assuming that the world's best risk assessors told you they could find no evidence of
carcinogenicity?
ENVIRONMENT
Why do free-market thinkers turn to scientific risk analysis
instead of markets to set environmental policy?
Letting
Environmentalists'
Preferences Count
BY PETER VAN DOREN
Cato Institute
E E
NVIRONMENTAL POLICY QUESTIONS
often result in dueling scientific studies.
Typically, articles are published in scientific
or medical journals that claim exposure to
pollution results in increased morbidity or
mortality. Critics then respond in scientific
or policy journals with claims that the orig-
inal scientific articles were flawed and do not reflect "sound" sci-
ence. (For an example, see "The Arsenic Controversy," Fall 2001.)
The premise of the original scientific articles is that if the
negative effects of pollution are "real," then scientifically
informed government intervention should "fix" the problem.
The premise of the rebuttal articles is that because the best sci-
ence suggests the causal links are problematic or non-existent,
the proposed environmental regulation is an example of ille-
gitimate and unwarranted state action.
But why should those who prefer a cleaner environment have
to justify their preferences with scientific evidence? Markets are
neutral with respect to preferences. The function of markets is to
allow people to pursue their preferences subject to a budget con-
straint. Under most circumstances, market-oriented policy ana-
lysts would severely criticize any attempt to require people to jus-
tify their preferences for private goods through scientific analysis.
In fact, the market's delivery of private goods is not related at
all to the scientific validity of people's preferences. Markets can
and do supply organic lettuce regardless of whether it really is
"better" for your health. The market's ability to deliver Miller Lite
is not at all contingent on the resolution of the "Great-Taste, Less-
Peter Van Doren is editor of Regulation magazine and the author of Chemicals, Cancer
and Choices: Risk Reduction through Markets (Washington, D.C: Cato Institute, 1999).
Filling" debate. European consumers do not want genetically
modified food regardless of scientists' arguments that consumer
concerns about such food are without merit. And people pay
good money for light trucks because they feel “safer" in the vehi-
cles even though scientific evidence challenges that sentiment.
The ability of markets to cater to such varied (and perhaps
illogical) preferences is often celebrated as their chief virtue. So
why, then, do market advocates often require implicitly, and
sometimes explicitly, that environmentalists justify their prefer-
ences scientifically or through cost-benefit analysis, especially if
public goods are involved? Are preferences for clean air different
from preferences for pizza, cars, or organic lettuce? Why should
environmental preferences require scientific justification?
Peter Huber, whose 1999 book Hard Green drew sharp criti-
cism from the environmental left, noted in the book that sci-
entific analysis may not be sufficient to resolve environmental
policy disputes. According to Huber,
The axiology of science, its priorities of investigation and
research, the criteria for what to study and what not to, are
matters of taste, budget, values, politics: everything but sci-
ence itself. Scientific priorities... are themselves trans-scien-
tific... Science will never tell us just how much scrubber or
converter to stick on a tailpipe or smokestack, how much
sand and gravel at the end of sewer pipe, how much plastic
and clay around the sides of the dump. (p. xviii)
Even the invisible can have value, even the innocuous can
entail cost, if only because value and cost ultimately lie in the
mind of the beholder. People are entitled to dislike chemicals
32 REGULATION FALL 2003
value environ
much more ti
in their drinking water simply because they dislike them, ber extraction that could take place would be very expensive in
whether the distaste is for fluoride added deliberately by a some locations.
meddlesome government or tetrachloro-ethylene added
The private forest lands of northern Maine offer insight into
negligently by a noisome factory. People are perfectly enti-
this issue. The owners allow people to use them for hiking,
tled to prefer pure drinking water, even if contaminants
fishing, and camping in exchange for fees. But the owners do
cause them no harm, even if contaminants harden their
extract timber, which suggests that the willingness of people to
teeth. (p. 136)
pay is not sufficiently high to offset the profits from timber.
Thus, in some (perhaps most) settings, wilderness actually is an
Paul Portney made a similar point in his 1992 article “Trouble expensive commodity to provide because of its high opportu-
in Happyville." In that, he described a hypothetical town in which
nity costs, and its consumers do not want to pay enough for it.
1,000 residents were willing to pay $1,000 each to eliminate a nat-
ural contaminent from the water supply even though the top risk Public goods Air and water quality disputes are more challenging
assessors in the world claimed the exposure was benign. Portney
to analyze than the supply of wilderness for two reasons. First,
asked, what were the benefits of water purification and would the
while property rights have become defined and enforced for land,
reader support a tort judgement against a corporate “polluter" if property rights are not commonly found for the air and water.
the substance came from its discharges?
Thus, environmental politics involves continuous struggle over
How should markets process environmental preferences to implicit property rights and the wealth effects that flow from
arrive at choices? Are markets incapable of processing such such rights. Second, both air and water quality are "local" public
preferences into choices under certain circumstances, and, if so, goods (club goods) rather than private goods, thus individual dif-
what should be done instead? When faced with an environ- ferences in consumption — the primary method of reducing
mental issue, should we not have an economic policy analysis conflict associated with private goods — are not possible. Instead,
rather than an endless discussion of sound or unsound science? everyone's varied preferences for environmental goods can only
result in one jointly consumed outcome, which implies that even
ECONOMIC ANALYSIS
an efficient solution, difficult to achieve in itself, would leave most
Within an economic framework, environmental policy dis- people unhappy relative to their most preferred outcome.
putes, like all policy disputes, are about the distribution of Initial allocation problem One possible impediment to the
wealth and property rights, or about the ability of current mar- implementation of market-like solutions to air and water qual-
ket institutions to achieve efficiency. An economic analysis ity is that the initial ownership of property rights to air or water
would ask whether disputes about environmental goods are emissions not only has wealth effects, but also efficiency effects.
about the distribution of property rights or about efficiency, That is, those particular property rights (the right to a pristine
and whether the goods are private or public. It would take pref- environment) are so valuable relative to other assets that their
erences as given and ask whether markets can satisfy them initial allocation alters the willingness of people to pay for them
rather than argue that people should have different preferences and thus affects how much pollution exists. In such cases, the
because the ones they currently have are not scientifically based. initial distribution is the "whole ballgame” because it determines
For those private goods for which property rights already exist, the resulting equilibrium air and water quality.
normal market forces serve people's preferences under most cir- Under many circumstances, the initial allocation of property
cumstances, and discussions about the scientific validity of peo- rights does not affect the evolution of trades and thus does not
ple's preferences are irrelevant. As long as "environmental" and affect efficiency. For example, analog cellular phone licenses were
"non-environmental" goods (energy-efficient cars and gas guz- given away by the Federal Communications Commission in a
zlers, or biotech and organic foods, for example) are simultane- lottery. The licenses that were won by non-telecom companies
ously available in markets, people with varied preferences can were quickly sold to telecom companies that then built cellular
purchase the commodities they prefer.
phone networks. The wealth distribution, rather than the effi-
ciency of the cellular phone market, was affected by the arbitrary
Can markets supply wilderness? A skeptical environmental- initial allocation of property rights.
ist might ask, can markets provide empty, unused green space? But environmental quality may be different. For purposes of
Markets can provide any commodity as long as people are will- discussion, let us assign initial allocation of air quality rights to
ing to pay the owner more than the opportunity cost of using some members of the Sierra Club. If the environment were like
the assets for something else, and the consumption of the com- the cellular phone license example, the eventuallevel of pollution
modity can be restricted to those who pay the owner. Wilder- in Los Angeles, for example, would not be affected. The initial
ness owners can charge fees to all those who physically cross environmentally minded owners would accept money in return
the boundary of a wilderness as long as the transaction costs of for environmental degradation.
monitoring the boundary are not prohibitive.
Alternatively, air quality may be different from the cell phone
Even though wilderness can be provided by market forces as example. Initial ownership by environmentalists of air and water
long as people are willing to pay more than its opportunity costs, quality rights might reduce activity in industrial society signif-
in many cases those who like wilderness seem unwilling to do so. icantly because the environmentalists would not accept money
For example, to compensate a wilderness owner for all the sec- in return for allowing Los Angeles to exist (or, at least, Los Ange-
ond homes or ski resorts that could be built or the mineral ortim- les with its current air quality). The Sierra Club members likely
REGULATION FALL 2003
king,
insight into
pensive in
ENVIRONMENT
value environmental quality much more than other people and firms, which would benefit most from emissions expansion,
much more than the other assets they possess. Conversely, if would face difficulties similar to those faced by citizens.
polluters had unlimited rights to pollute, pollution levels might Another possible solution to the free-rider problem would be
be much higher because the willingness of environmentalists to to raise revenues to purchase emissions rights through the leg-
pay polluters to restrict emissions could be much less than the islative process or subsidize the activities of private groups to do
compensation the environmentalists would demand if they so. Some might see that as no different than the status quo policy
owned the initial rights. Thus, the initial allocation of air and of funding the Environmental Protection Agency, but emissions-
water quality rights may have large consequences on the result- rights purchases would make the relationship between costs and
ing level of air and water quality.
benefits more transparent and incremental. Congress would
Free-rider problem One reason the Sierra Club may be debate whether an extra $50 million to buy so many pounds of
unwilling to pay market rates for a cleaner environment is emissions rights (or subsidize a private organization that bought
because any air quality gains obtained with club funds could not rights) was worth the reduction in ambient exposure or whether
be restricted to those who contributed to restrict emissions. In acceptance of $50 million from polluters was sufficient compen-
other words, people would free-ride on the benefits purchased sation for increased ambient exposure. In such a debate, the costs
by Sierra Club "cleaner air fund" contributors.
of reduced pollution would not be hidden as they are now. Under
Conversely, if Congress created additional emissions rights, all current policy, standards are changed as if the resulting benefits
Can environmentalists and lobbyists channel their
energy away from lobbying and publishing pamphlets,
and toward creating and trading emission rights?
had no costs and thus were free goods.
Disputed rights problem Allocating initial emission rights to
incumbent polluters faces an additional difficulty: the disagree-
ment over what can be consumed and disposed of without third
parties' consent. To borrow again from Huber's Hard Green:
emitters would benefit from the lower prices that would result
from the increased supply. Those benefits could not be confined
to the firms that paid (lobbied) to create the additional rights. The
creation of additional emissions rights faces another obstacle:
The firms most likely to benefit from the right to emit are poten-
tial rather than existing firms, because the potential firms likely
would release the lion's share of the new emissions. As Robert
Crandall argued in his 1983 book Controlling Industrial Pollution,
traditional environmental protection, with its separate standards
for new and existing sources, serves the interest of existing firms
by erecting entry barriers to new firms.
What should be done about the "free-rider" problem? One
possibility would be to allow voluntary groups to solicit con-
tributions to pay to increase or reduce the supply of emission
rights. The free-rider problem does not result in zero provision
of public goods, just less-than-optimal provision.
But the free-rider problem easily could magnify the problem
over initial allocation of rights. To be more precise, the fear of the
effects of the free-rider problem motivates continued political
resistance by environmentalists to the creation of initial rights. If
firms gained the right to pollute and environmentalists had to buy
firms' rights to reduce emissions, the free-rider problem easily
could result in too little purchase of rights by environmental
groups and too much pollution relative to their preferences. Con-
versely, if citizens had the right to a pristine environment and
firms had to purchase pollution rights or compensate citizens for
the creation of additional rights, some firms would free ride on the
efforts of others, and less pollution would occur than in the sce-
nario in which firms had unlimited pollution rights. Firms would
likely face fewer free-rider problems than citizens, but potential
Labels like "externality" and its rough opposite, "privacy," set-
tle nothing. The rancher whose land abuts Yellowstone sees a
federally protected wolf straying from the park to hunt his
sheep. The rancher wants the wolf removed, at once, and by
force if necessary. And how, philosophically, is he very differ-
ent from a woman with an unwelcome fetus in her uterus?
Both can speak indignantly about autonomy and personal
freedom. And each will face an outsider who replies: The
space is not yours alone; I too have an interest in it.... With
pregnancy, as elsewhere, the "internal" gives way to the exter-
nal" where society says it does, no sooner or later. (p. 134)
Policy areas clearly vary as to how much the definition of prop-
erty is up for grabs, and the environmental area is one of the
least settled.
With air quality, the problem may be worse because both
environmentalists and industrial polluters envision the alloca-
tion of property rights as the end rather than the beginning of
the process. Even though some environmentalists pursue their
land-use goals through land purchases and development ease-
ments, they do not analogize to emission-rights acquisition.
And while firms are comfortable with buying and selling, under
current cap-and-trade emission rights policies, they cannot pay
anyone to increase aggregate emissions.
34 REGULATION FALL 2003
NEGOTIATING AWAY THE INEFFICIENCIES
cy, and whether the disputes are about private or public goods.
Although scientific studies and cost-benefit studies do not
Many environmental disputes are about the initial distribu-
resolve environmental policy disputes, such studies do serve an
tion of property rights to public goods such as air and water
important function: They demonstrate the possibility of large
quality. Firms want rights to their status quo emission behav-
gains to trade. For example, let us consider studies that demon- ior. Environmentalists do not want that to occur. Both believe
strate that cleaning up Superfund sites or arsenic contamina- that their ability to raise money to purchase rights to secure
tion of water supplies is very expensive relative to the number their preferred outcome relative to the status quo would be
of lives saved (valued at the conventional estimate of a statisti- limited. And they may be correct in their assessment.
cal life) and not worth the benefits.
Scientific studies do not resolve environmental policy dis-
The conclusion that one should draw from such studies is not putes. To be sure, scientific analyses often help people form their
that the preferences of environmentalists (who want contami- preferences and understand the cost-and-benefit consequences
nated, abandoned industrial sites to be cleaned up or arsenic of their preferences. In other words, studies that "demonstrate” a
removed from water supplies) should be different. Instead, one particular environmental regulation costs many orders of mag-
should conclude that the implicit property rights given to envi- nitude more per life saved than people appear to be willing to
ronmentalists by Superfund and arsenic regulation have created spend suggest the possibility of market exchange. If those citi-
the possibility of large gains to trade. Because compliance with zens on whose behalf government adopts costly environmental
Superfund or arsenic regulations is so expensive relative to the regulations were instead given the equivalent wealth transfer
benefits, those who bear
the costs of the regulation would pay a and the cost-benefit analyses are correct, then the "victims"
large amount to avoid cleanup. The alleged “victims" of pollution would not spend the money to reduce the environmental risk tar-
may well accept such a payment rather than accept the regulated geted by the regulation. Instead, they would use the money to
status quo in which litigation is much more common than reduce other risks or for other consumption. They would rather
cleanup. If those people were given the equivalent wealth transfer give up their right to be protected against a particular environ-
and the Superfund and arsenic studies (and others like them) are mental harm in return for money.
correct, then the victims" would not spend the money to reduce Thus, the main impediment to the creation of environmen-
the environmental risk targeted by the regulation. Instead, they
tal markets may be the unwillingness of the participants to
would use the money to reduce other risks or for other con- accept any definition of initial property rights. Instead, they
sumption. They would rather give up their right to protected prefer to use the political system to engage in continuous
against a particular environmental harm in return for money. wealth and property rights disputes. The difficult task is to
The initial allocation of cell phone rights also was "irrational" channel the energies of environmentalists and polluters into
because rights were given to people who did not know how to creating and then trading emission rights rather than publish-
build a cellular phone system. But the irrationality only affected the ing pamphlets and lobbying.
R
wealth distribution rather than the development of cell phones,
because the rights were easily traded to phone companies. No sci-
entific studies were commissioned to demonstrate that the alloca-
tion of cellular phone rights was not “sound science" because trad-
ing eliminated the irrationality of the initial allocation.
The biggest irrationality of environmental regulation is not its
allocation of rights to a pristine environment, but instead is its
not allowing the initial "irrationality" to be eliminated by subse-
quent trading. So, for example, giving people the right to cleaned-
up industrial sites at the expense of anyone with any legal con-
nection to the site (Superfund) has created vacant industrial sites
surrounded by poor unemployed people because no one is
READINGS
allowed to negotiate away from the initial rights allocation.
Another sensible reform would allow the amount of emis-
• "Appropriators vs. Expropriators: The Political Economy of
Water in the West," by Alfred G. Cuzan. In Water Rights, edited
sions in tradable-permit systems to go up rather than down
by Terry L. Anderson, Cambridge, Mass.: Ballinger and Pacific
only. Under cap-and-trade proposals, environmentalists can Institute, 1983.
purchase rights to decrease the supply of emissions, but cur-
Calculating Risks, by James T. Hamilton and W. Kip Viscusi.
rently polluters cannot pay anyone to accept an increased sup- Cambridge, Mass., MIT Press, 1999.
ply of emissions. If the purpose of cap-and-trade policies is to
Controlling Industrial Pollution, by Robert W. Crandall.
mimic markets, then the supply of emissions rights must be Washington, D.C., Brookings Institution, 1983.
flexible in both directions.
Hard Green: Saving the Environment from the Environmentalists, by
Peter Huber. New York, N.Y.: Basic Books, 1999.
CONCLUSION
Economic analysis of environmental policy disputes does not
"Trouble in Happyville." by Paul Portney. Journal of Policy
examine the validity of preferences. Instead, it asks whether poli-
Analysis and Management, Vol. 11, No. 1 (Winter 1992).
cy disputes are about the allocation of property rights or efficien-
REGULATION FALL 2003 35
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