First Principles

I have often regretted not studying economics formally. I thus decided to do some theoretical studying of the subject with a couple of primers borrowed off friends and the net. One of the most important lessons that economics teaches is that incentives matter, as Steven L. Landsburg of Armchair Economist fame writes.

Incentives is one the most basic principles of human behavior and ought not to require textbooks. There are two ways of looking at why this forms the cornerstone of successful public policy. The first is to look at the effect that disincentives have on people and institutions, civil servants are the best ones to observe– as argued here.

Government servants have a lot to fall back on- like paid housing and scandals brushed under carpets– quite normally therefore, they too respond to incentives and do no work! Why do government agencies have such a poor record managing natural resources and public lands for example? The problem is that government officials and staff respond only too well to the signals government sends.

“All decisions in an agency are made on the basis of information and incentives– Current institutions systematically generate both bad information and perverse incentives…” Public officials act in their self-interest no less than individuals in the private sector, and that bad government policies result because, unlike private decision making in the marketplace, public officials are not rewarded for efficiency or punished for waste.

Manmohan Singh just returned after witnessing a pathetically dilapidated and strictly regulated public natural reserve– Corbett Park, the PM was inspired by all the attention the film Kaal was attracting (obviously people find nothing objectionable about the fact that the ecological fabric of India considered an upholder of national pride and of national importance requires a film to get the government to pay some attention) and decided it was time to give the Tiger a second thought.

Post visit at a press conference he said: “We need to have better regulations in place”, for someone painted the head of economic reforms in India this a display of either remarkable buckling under political pressure or just plain bias to keep the chasm between environmentalism and economics alive!

The best way to perhaps illustrate the effect of incentives is the way it is applied to ecological conservation. Ramchandra Guha, in his book on the Ecological History of India tells us the story of ecological preservation. It goes something like this: Under British Rule, large tracts of forest land were open for hunting hitherto managed by individual tribal communities.With this phenomenon came forest laws, originally designed to protect the rights of the British to hunt in these areas from anybody who might claim ownership to them such as indigenous people.

Then came independence. India without alteration adopted these same laws (Water and Air Acts came later) and transferred ownership to the State. In the late fifties and sixties, driven by Nehru-Gandhian ideal of self-sufficiency India adopted an aggressive timber policy. The policy replaced 72% (At that time 15% of India’s surface area was forest cover. Now India has 6% forest cover- out out which 2% is natural and the rest is cultivated forest) of India’s natural forests with cultivated forests consisting entirely of Eucalyptus trees.

Why was this a problem? Because Eucalyptus plantations destroy land- in effect monoculture robs the soil of nutrients in a manner that it is never capable of cultivating any other crop ever again. Monocultures are also notoriously prone to rampaging disease. Needless to say this was an ecological disaster.

The seventies also saw another ecological disaster– Indira Gandhi’s massive drive to save the Indian Tiger. Under Indira Gandhi, thousands of acres of land were isolated as Tiger ‘hotspots’ and granted protected status. Not surprisingly, the tiger population promptly dwindled in the next decade. For one, any ‘protected status’ granted to any animal by the government is protected merely on paper.

Far worse was the damage done by the declaration of Tiger hotspots. While poaching had existed prior to this, the areas where tigers lived were unknown and many unexplored. Once declared, surveyed and ‘protected’ by the government– poaching became much easier– with forest officers only too willing to help for money!

Environmentalists share a common goal of trying to protect the environment. Markets are simply one means of achieving that goal. Free-market environmentalists are environmentalists who believe that in many–though not necessarily all–situations, markets will do far more to protect the environment than regulation or bureaucracy. Most socialists would argue that the ‘free-market’ is capitalist. Environmentalism however, is completely nonpartisan: neither liberal nor conservative, left nor right.

Here’s how incentives would work with ecological concerns: “The free-market movement has done a more efficient job in preserving the environment. Instead of relying on the coercion of the state, free-market conservationists use the voluntary mechanism of the market. They purchase land they want to conserve. And as with all voluntary transactions, both parties involved are better off than they were before. The purchaser exchanges money for property he places a higher value on, and the owner exchanges his property for money he values more than his property. ”

The Nature Conservancy has been an innovator and leader in free-market environmentalism. They take voluntary contributions and purchase ecologically valuable property. With more than a million members, they have been able to conserve 14.5 million acres in the United States and 83.5 million acres in other countries. Other groups followed their model, most on a smaller and more local scale, but almost all highly successful.

The trouble with environmental policy making in India is pretty much the same as it is with all others. They ignore incentives. Like Terry L. Anderson of PERC puts it, “Conventional environmental policy making presupposes that only government action can improve environmental quality. In this view, environmental problems arise from ‘market failures’ that produce ‘externalities.’ Government regulation is needed to correct environmental concerns that the market has ‘failed’ to handle because they are ‘external’ to the price signals that regulate marketplace transactions. Environmental policy justifies the regulation of economic activity because it assumes all activities from purchasing clothing to driving a car to turning on a light bulb– have an impact on the environment that is not factored into the cost of the product or service.”

There are parts to this argument that are true. Neo-classical economics for example does not factor in the cost of environmental degradation. There are two ways to get around this: 1) Green Economics and Natural Resource Accounting which uses a nifty tool called cost-benefit analysis– read more about it here or 2) We can create markets.

It is a misconception that every environmental problem results from a conflict between a marketed resource (for example, timber) and a non-marketed resource (for example, scenic beauty). In such a conflict, the non-marketed resource loses because resource managers have no incentive to protect such resources. So people see the marketed resource as the threat and the non-marketed resource as the innocent victim. Not true!

Markets are actually very effective at allocating resources and in insuring sustainability–provided that those resources are marketed. The real problem is the lack of markets for some resources. Markets seem morally wrong because investors tend to focus only on how it works to generate short-term profits. But markets also give investors an incentive to look at the long term. If they invest in a factory and then let the factory deteriorate, they won’t get much for it if they decide to sell it.

This is exactely what will drive somebody with a large tract of land and a rare species of the bald eagle on it, to preserve it as opposed to cutting it down- because the Nature Conservancy or me will be willing to pay to preserve the bald eagles because we LOVE bald eagles! This idea is called the peltzman effect. Rather than viewing the world in terms of market failure, we should view the problem of externalities as a failure to permit markets and create markets where they do not yet–or no longer exist.

Resources that are privately owned and are in the marketplace so to say, are taken care of. Resources that are un-owned or politically controlled are a mess– a phenomenon called the tragedy of the commons whose best example is the world’s fisheries (and Indian roads!).

“… At the heart of free market environmentalism is a system of well-specified property rights to natural resources, — behind every tree should stand an owner who can act as its protector…” as Terry Anderson, PERC puts it! The fact is that decentralized tools such as user fees, incentives, and markets will solve problems better than centralized tools such as subsidies, bureaucracy, and regulation.

“History also shows that countries that have embraced free trade have seen their environments improve along with their economies, while those that closed their economies have fouled their air and water even as their economies stagnated….” From the Soviet Union to China to India, centrally planned or closed economies have a pitiful environmental legacy that is only now being reversed as entire sectors are privatized and opened to competition and investment.

The fundamental problem is that government regulation doesn’t work very well. Those who are regulated usually end up controlling the process and warp the regulations to their own benefit. This means that regulation should be a last resort, and whenever we can we should try to find alternatives. If we can make markets work, they are usually the best alternative of all.