3.2 Institutional structure
In the case of environmental externalities, information on willingness-to-pay and opportunity cost will not directly emerge from the market. As was noted in Section 2, the market price of goods and services will not signal the relevant marginal cost of using the environment – information that the objective of efficiency is sensitive to. Information costs are important when analysing the relative efficiency of alternative structures for controlling externalities. What organisational arrangement will produce information about the costs and benefits of environmental management most efficiently?
3.2.1 Hierarchy
Hierarchies of external institutions consist of rules are a number of levels. Figure 9 shows a hierarchy of rules, beginning with a written constitution (which NZ does not have); statute law and regulations at the bottom. The hierarchy provides a basis for private contracts that occur at a decentralised level and how they are to be interpreted should disputes arise. Hierarchies of this nature provide a basis for creating order and maintaining consistency over time.
Hierarchies are characterised by status and authority being ranked vertically. The key function for a hierarchy of rules is to provide a basis for the evolution of internally consistent rules and governance. Higher order institutions (eg, Resource Management Act) provide a framework confining change and laying out how changes should be made at lower levels (eg, rules specified in regional plans). This is essential for a predictable functioning of the institutional system over time. A lack of hierarchy can inhibit institutional evolution and result in uncertainty.
3.2.2 Locus of control
When considering the institutional structure for dealing with the problem of externalities it is natural to ask: at what level should the environmental externality be resolved? To examine this question let us assume that non-point sources of pollution are having an adverse effect on the water quality of lakes in region 1 and region 2. Should pollution control activity be decided at the central or local level? To examine the arguments for and against national control of pollution let us assume:
yi = Fi(x)= net output per capita, where Fi(x) is unique to local environments, i = 1,2
p = (px, py) = price of pollution and net output, py= 1.
To begin, let us restrict our attention to region 1. Efficient use of the environment is priced at p1 where the price of pollution p1(x1) equals the marginal value productivity of pollution (F’(x1)p1). If we now consider two regions 1 and 2, located at their respective optima x1 and x2, we see that region 2 has lower pollution control costs because p1 > p2. However optimality for each local region is given by:
which violates the necessary conditions for Pareto optimality. In other words, pollution producing activity should be shifted from region 1 to region 2 because this will result in a smaller sacrifice in output in order to achieve the same level of environmental quality. Achieving equality in prices may be difficult because each locality might consider the adjacent community’s environment as a free good. The threat of relocation is considered as an argument in favour of central control. For example, assume that region 1 proposed a levy of p1 so that X1 could be attained. A large industry could act as a monopsonist and threaten to relocate which could lead to a decrease in regional welfare. This threat would be less credible if a national levy on pollution was implemented.
The strength of the argument for a national environmental pricing policy depends on the public good nature of the externality. If there are no spillovers between regions then there is no need for the price of pollution damage to be the same in the two areas. Even if regional interdependencies require identical prices for pollution damage this does not mean that regions should levy the same price on emissions. Differences in the relationship between emissions and damages may require different charges on emissions. The apparent economy of information is perhaps the strongest argument in favour of local control. In any event, if the Teibout (1956) hypothesis is accepted then relocation will tend to bring about national price uniformity in the long run.
If we were to vary population, incomes, tastes, topography, climate and so on, both price and quantity could be expected to vary across regions. Information on the equilibrium will not come cheap and we might ask the three questions which arise from the model shown in Figure 10. Will evaluation of costs and benefits be more accurate if made the responsibility of localities experiencing the costs and benefits? How will the correct price be determined? What is the cost of providing the information?
The logic of this model suggests the outcome associated with local decisions is efficient and the organisation need know nothing about the price attached to pollution elsewhere. Furthermore, a net-benefit maximising government organisation would not impose a different set of prices. Efficient pricing is therefore consistent with both state and local control and the issue becomes: which form of control is likely to yield more accurate information on costs and benefits?
The public good nature of the output (cleaner air) requires local decision making to consider those significantly affected by pollution. Unless it is a national externality, such as might exist with an endangered species, then it would appear that local organisations should be more efficient. In addition, it is plausible that local organisations have a comparative advantage in obtaining information on preferences and implementing decisions, provided of course, they are so empowered. However, there would be situations where economies of scale associated with certain projects that would give a national-level agency a comparative cost advantage. For example, although it might be reasonable for all ports to have an oil-spill strategy it would probably make sense to share the burden of supplying the necessary clean-up technology.
