Environmental Management (EM)

Course Instructor: L. Venkatachalam

Course Outline: Available in Virtual Classroom

Lecture -7:

 Many environmental problems arise due to ‘institutional failure’

o Institutions are rules of the game, devised by the human beings, to
constraint their behaviour, to bring cooperation and to bring an order
in their activities

 Types of Institutions: Formal and Informal

o Formal institutions –mostly written rules –created by governments and
public entities - provide context within which economic activities are
carried out (constitution, law, policies, etc) –do not change according
to person
o Informal Institutions: embedded in the minds of the people and society
–perceptions, attitudes, social norms, etc –
o Formal institutions are very important but, usually, formal and
informal institutions are combined to produce certain outcomes –in a
developing country, informal institutions do play a major role in
producing outcomes (Dixit)

 Based on real outcomes, institutions can be classified into: Inclusive

(promotes welfare of all) and extractive (promotes welfare of a small group
at the cost of welfare of a larger group).

 In the case of environmental problems:

o More inclusive institutions are employed to allocate normal goods and
services in the Indian economy but, such inclusive institutions are not
having any impact on efficient allocation of environmental goods and
services (e.g. introduction of high-yielding verities in agriculture has
increased food production significantly but, has not addressed the
problem of deterioration of soil quality)
 o Current institutions governing poor management of environmental
resources are usually extractive in nature (e.g. license raj has ended for
industrial growth but it has caused huge environmental damage)

o The right kind of inclusive institutions that are required for managing
environmental resources are yet to be identified or strengthened (e.g.
the market-based instruments for pollution control had not yet been
deployed in India)

 Institutions in the area of environmental management are required to reduce

transaction cost such a way that collective action among stakeholders will be
brought about to improve environmental conditions

 Most of the environmental problems are due to lack of well-defined property

rights or due to ill-defined property rights

 Property rights act as inclusive institutions in the area of environmental

management

 Designing appropriate institutions for collective action for environmental

management depends on the type of property rights regime

 Following are the major property rights regimes as far as environmental

resources are concerned:
o Public Goods
o State Properties
o Private Goods
o Common pool resources (or, open-access resources)
o Common property resources

 Public Goods:
o Once the good is provided, the marginal cost of providing the good to
one more consumer is almost zero
o Non-Excludability – this implies that once the public good is
provided, no potential consumer can be excluded from consuming it;
 in other words, the transaction cost of excluding the potential
consumer becomes exorbitantly high
o Non-Rivalry (or, Non- Substractability condition) –this implies that
one person’s consumption does not reduce the consumption of another
person
o Non-excludability conditions lead to encourage ‘free-riding’ among
the rational consumers; as a result, public goods will be under-
provided by the private operators
o Externalities cause market-distortions in the provision of
environmental public goods as well

 State Property or Nationalisation:

o In most cases, the public goods provisions are effected by the
governments
o Hence, many public goods are under state property
o If nationalisation of a resource generates positive net benefits and if
any other institution or institutional arrangement does not do that, then
nationalisation is desirable
o Nationalisation of a resource is economically justifiable only if the net
present value of doing so is the maximum!
o Government control of resources may lead to adverse redistribution of
benefits across stakeholders
o Example: tiger reserves or protected areas affecting local people, dam
projects affecting tribals; water transfer from irrigation tanks for urban
use affecting riparian farmers

 Private Properties or Privatisation:

o Excludability and subtractability conditions are applicable
o Private property leads to most efficient use of resources, avoiding
wasteful use and over-exploitation
o May be less useful if the resource becomes indivisible or the
ecosystem benefits from the resource use are of public goods in nature
o May not be efficient if private management generates larger social
costs
o Suppose the private resource also generates social benefits. In this
case, if private operators will reduce the size of the resource up to that
level where the marginal private benefit is equal to marginal private
cost, then private management of resource will lead to socially sub-
optimal level
 Common-pool resources (or, open-access resources):
o Charecterised by non-excludability and subtractability conditions
o Excluding the potential consumers (who can be free-riders) is
extremely costly and therefore, subtractability arises
o Prisoner’s dilemma among the users leads to tragedy of the
commons problem
o Users think that if they don’t use the resource, the other rational user
would use the share of other users as well
o Since the users of the resource have greater uncertainty over the
availability of resource for future use, each users tend to over-exploit
the resource
o Every one utilises an high discount rate leading maximising current
benefit and resource exploitation

 Solution:
o Command-and-control or government regulation
o Changing the norms of the economic agents
 Can we ask the users of the resource to follow restrain?
 Can we ask the consumers to consume less?

o Change in technology:
 E.g. Maldivian fishermen use a pole and line method of
catching tune, which does not deplete the stock of tuna.

o Assigning well-defined property rights:

 Quota system introduced by New Zealand restricting fish catch
indeed increased the fish catch over a period of time!
 Since quota system ensures that a fisherman is assured of a
fixed quota of fish every year, the fisherman will not have
incentive to over-fish
 Since every fisherman adheres to her own quota, she need not
have to worry about others catching her own share
 As quota system reduces fish catch and increases the minimum
stock that is required for sustainable yield, it increases both the
stock and flow of benefits over a period of time
  If the fishermen go to other areas not governed by quota system,
then it will lead to tragedy of the commons in these areas
(Indian fishermen going to Sri Lankan waters?)

o Garrett Hardin: private interest would lead to tragedy of commons

and therefore, government will have to manage

o Mancur Olson: a larger group cannot manage but, smaller groups

can. A market like competitive environment among the groups will
lead to efficient management

o Dasgupta and Heal: Privatization would result in efficient outcome

o Many criticised that Hardin misunderstood many of the ‘common

property resources’ to be ‘common pool resources’.

o So, tragedy of the commons may be an outcome in the case of

common pool resources (such as, deep sea fishery) but not in the case
of common property resources (such as, a community forest)

 Common Property Resources:

o Excludability of potential consumers or free-riders leads to non-
subtractability of the resource paving way for sustainable use of
resources

o Irrigation systems, community forests, small waterbodies, etc are the

examples of CPRs

o Well-defined user groups, clearly demarcated boundaries of the

resource, clearly identifiable benefits, low level of transaction cost
(due to peer monitoring) of monitoring, strong social capital, better
leadership, etc lead to strong collective action

o Sanctions, norms and rules designed by the users themselves govern

the resource management

o Reciprocal behaviour ensures collective action:

  Ultimatum game: the proposer has to share certain amount of
income (e.g. 90 per cent for herself and 10 per cent for the
other) between herself and another receptor. If the receptor
accepts the offer, then the respective amounts go to both –both
are benefitted. But, if the receptor rejects, none of them get
anything. In reality, results of ultimatum games suggests that if
the share is less then 30 per cent the receptor rejects the share
thereby punishing the proposer.
 Dictator game removes the conditionality of receptor rejecting
the share; rather, she has to accept whatever the share that the
proposer proposes. In this case, the proposer is expected to
retain most of her share with her and leaving only little (because
of rational behaviour). Here, the proposers were willing to offer
nearly 30 per cent to the receptors.
 Above games suggest that people adopt social preference and
are willing to sacrifice their own resources for the betterment of
others; similarly, they also punish the violators of norms and as
a result, the violators (free-riders) behave properly. This way,
the resource is maintained sustainably.
 Kudimaramath institution that managed irrigation systems in
south India for centuries together is a classical example of how
locally designed norms and cooperation among people sustained
irrigation management over several centuries
 Various other examples are available in the PPTs
 So, Elinor Ostrom who studied common property resource
management extensively concluded: neither the market, nor
the government but the community is capable of managing the
common pool resources sustainably

 What attributes of participants are conducive for overcoming collective

action problem?

a) The participants should realize that the problem in hand is important (for
example, people realise that crop damage by animals is very important
issue and needs to be tackled collectively)

b) Degree of autonomy for the group to take up collective action

c) Users foresee a future benefit (they should have low discount rate)
 d) Secured property rights to the user group

 The Design Principles

o Clearly defined boundaries (excludability; no benefit is enjoyed by
non-members; actions of non-members do not destroy the CPR)

o Congruence between appropriation and provision rules and local

conditions (rules reflect the specific attributes of the particular
resource –e.g. allocation rules may differ depending on scarcity of
water)

o Collective choice arrangements (individual’s participation in

modifying the collective rules –individuals comply to rules that they
may not even like, due to herd-behavior, reciprocal cooperative
behavior and bounded rationality)

o Monitoring is possible and not costly (transaction cost is low or

negligible)

o Graduated sanctions (violators punished as per the nature of the

violation – everybody knows others do also comply and if not, they
will be caught)

o Conflict resolution mechanisms (availability of low cost local arenas

to resolve conflicts –who has to be sent to do collective work, when,
whether all should participate in all work or only in specific activities,
etc)

o Minimal intervention by external agencies in rule making

o Appropriation, provision, monitoring, enforcement, conflict

resolution, and governance activities are organised in multiple layers
of nested enterprises.

o Social Capital plays a strong role in bringing collective action among

the members of the community
o Social capital refers to networks, relationship, bonding and bridging
among people in order to pursue a particular goal
o One of the objectives of social capital is to minimise the transaction
cost of cooperation
 o Physical capital wears out, while social capital increases when used
more
o The leadership quality does matter for collective action. The leader
should take into account the preferences of all members and promote
the welfare of every one. If the leader is dishonest, then required
collective action will not take place.
o Elite capturing (powerful people appropriating resources for
themselves) will affect CPR management adversely.

Lecture -8:
Market failure and Internalising Externalities:

 Markets are the most efficient institutions in allocating normal goods

and services

 Markets, however, may fail to clear when there exists an symmetric

information, if the good is a public good and if the transaction cost of
allocation is high

 Markets may fail in the presence of externalities too

 Externality:
o An unintended consequence of consumption of a commodity by
person A, produced by person B, affecting another person C
(third party) who is usually unrelated to the consumption and
production activities of person A and B.
o The production or consumption function of C is indeed altered
by A and B
o The externality is an exogenous factor to C

 Types of Externality:

o Positive externality –consumption or production of a

good/service by one person positively affecting the
consumption and production of a third party –e.g. vaccination
by one person generating positive benefits to others.
 o The welfare of the third party increases, in this case

o Negative externality – consumption or production of a good or

service by one person negatively affecting the consumption and
production of a third party –e.g. industrial pollution affecting
agricultural output

o The welfare of the third party deteriorates, in this case

 Different forms of Externalities:

o Production –Production externality –e.g. sunflower farms

(producing sunflower for an oil consumer)increasing the output
of honey in a neighbouring farm
o Production –Consumption externality –e.g. rose gardens
(producing rose for distant urban consumers) enhancing the
utility of tourists
o Consumption-Consumption externality –e.g. consumption of
good quality air by a polluting motorist affecting the
consumption of the quality air by a passer-by
o Consumption-Production externality –consumption of
pesticide-free products by people leading to increase the
agricultural output through reduced death of bees and increased
level of pollination

 In presence of externalities, the market will not allocate the

(environmental) goods and services efficiently!

 How to correct market failure by internalising externalities?

 Internalising externality refers to making the price of the commodity

associated with the externality to reflect the ‘true opportunity cost’ of
resource use!

o Command and control method

o Market-Based Method:
  Pigouvian Solution –tax and subsidy
 Coasian Solution –tradable permits
 Baumol and Oates –second-best solution

 Command and control method:

o Government commanding the level of pollution reduction (how
much to control) and controlling the method –such as, end of
pipe solution-of pollution control
o Usually, ineffective and inefficient because it does not provide
any incentive to polluters to control pollution by using
alternative approaches that are least-cost

o Useful when the pollution is hazardous

 Pigouvian solution

 Positive Externality:
o When positive externality prevails, the market, left alone, will
tend to under-provide the good that is associated with the
externality
o For example, private forestry not only generates private benefits
but also other ecosystem services benefiting larger society
(called, external benefits).
o The farmer cultivating forest on her private land will not have
incentive to expand the forestry to benefit the society also.
o The farmer will invest on forestry up to the private optimum
where her marginal private benefit is equivalent to marginal
social benefit
o The marginal social benefit (cost) includes marginal private
benefit (cost) and marginal external benefit (cost)- latter,
occurring to others
o (Diagram here)
o But the social optimum where the marginal social benefits and
marginal social costs are equal lies beyond private optimum, a
subsidy equivalent to the marginal external cost
o Since the social benefits are not being met with, there is a
deadweight loss
 o In order to eliminate the deadweight loss, the farmer will have
to be provided with a subsidy (equivalent to external benefit) so
that she could expand the size of the forests where the SMB
=SMC

 Negative externality:
o When negative externality prevails, the market, left alone, will
tend to provide the good that is associated with the negative
externality in excess of optimum level.
o For example, polluting commodity generates social costs in the
form of reduced agricultural output
o Since the polluter will not have incentive to reduce polluting
activity, the output of polluting commodity will be greater than
the socially optimum output
o But the social optimum where the marginal social benefits and
marginal social costs are equal lies below private optimum
o Since the social costs are not being met with, there is a
deadweight loss
o (DIAGRAM here)
o In order to eliminate the deadweight loss, the polluter will have
to be taxed (equivalent to external cost) so that she could shirk
the polluting activity
o Optimum Pollution based on MSB and MAC
 (DIAGRAM here)

 Pigouvian approach is criticised on the following ground:

o The MSB and MSC are prerequisite for Pigouvian solution
but estimating them in monetary terms is a difficult task
o However, many economic valuation techniques have been
developed to assign monetary values to non-market
environmental goods and services
o There may be other alternative options for controlling
pollution at a least cost –but, Pigouvian approach focuses
mainly on one solution.
o If the victims are willing to move away from polluted area
by accepting compensation and this being most efficient,
then this act is socially desirable
Lecture 9:
 How do we estimate the social benefits and social costs?

 Economic Value: Willingness to pay (WTP) for a good

 For market goods, the market price reflects the WTP value
 For non-market environmental goods, the value needs to be
estimated.

o Non-Market Valuation Methods

 Revealed Preference methods

o Market price
o Production function approach
o Hedonic Pricing Method
o Travel Cost method
o Replacement cost approach

 Stated Preference Method

o Contingent valuation method
o Choice experiment

 Economic Valuation –Introduction

 https://www.youtube.com/watch?v=q8AZHtF2f50

 https://www.youtube.com/watch?v=0CHIs9dLvxA

 Market-Based Methods:

 https://www.youtube.com/watch?v=M0ZdV5WU5K4

 Hedonic Pricing Method:

 https://www.youtube.com/watch?v=LkXVCQam5kw

 Travel Cost Method:

 https://www.youtube.com/watch?v=AjcQpzIBu1I

 Stated preference Method:

 https://www.youtube.com/watch?v=__xzmIG4L8s
 Coasian Solution:
o Fundamentally, all environmental problems arise due to lack
of property rights
o Assigning property rights would lead to market negotiation
producing efficient level of pollution in the absence of
transaction costs; who has the initial property rights does not
matter for the efficient outcome
o Individual agents are the best judges to decide what is good
for them (and not the government)
 Scenario:
o Suppose a leather-tanning unit is polluting a river system
which is used by a downstream farmer for irrigation purpose
(only two agents!)
o Right now, the pollution led into the river system is not
socially optimal since the polluter gains at the cost of the
victim
o All the benefits and costs of pollution are fully known to the
respective agents and the transaction cost of any future
negotiation between them is nil

 Assigning initial property rights to victim:

o Now, the government assigns the property right over the
water available in the river basin exclusively to the farmer
o The property right is well-specified, exclusive, transferable
and enforceable
o Assigning property rights to the victim now makes the
polluter worse off because, he can no longer pursue the
polluting activity now
o Since the transaction cost of negotiating with the owner of
the water (the farmer) is nil, the polluter now will make a
move to negotiate with the farmer
o The polluter will request the farmer to accept some level of
pollution; the farmer will say that accepting some level of
pollution would cause welfare loss to her
o The polluter will now say that she will compensate farmers’
welfare loss by way of transferring money
 o The polluter would be willing to transfer that amount of
money that is equivalent to her marginal value gained due to
letting pollution
o The farmer will accept the money equivalent to the marginal
benefit foregone due to pollution
o Optimum pollution will be arrived at that point where the
MB =MC
 Assigning Property Rights to Polluter:
o When the property rights are assigned to the polluter, then
the farmer will negotiate with the polluter to reduce pollution
o The farmer will bribe the polluter to reduce pollution and the
bribe amount would be either lesser than or equivalent to her
marginal gains from reduced pollution
o The polluter will accept that level of bribe which is either
greater than or equivalent to the value of loss of profit due to
reduced pollution
 Whether the property rights are assigned to the polluter or victim
does not matter, the outcome will be the same.
 (Both tax (compensation to the victim) and subsidy (victim paying
compensation to polluter) will produce the same outcome)
 How Coase theorem works for positive externality?
 If the transaction cost is high, then market will not solve the
problem;
 If the property rights is assigned to victim and if the victim faces
significant TC, then she will ask for more pollution to be reduced
(to cover up the TC) also and therefore, less pollution will be the
outcome
 If the property rights is assigned with polluter and she faces more
TC, then more pollution will be the outcome (including a case of
zero pollution control)
 So, initial assignment of property rights does matter for
determining the level pollution control when TC is significant
 Pigouvian solution requires that ALL externalities will have to be
internalized while Coasian solution suggests that only the
inefficient externality can be internalized (i.e. if the TC of
minisming externality is high, then uncontrolled externality is
desirable).
Example-1: Tradable Pollution permits

• Estimate total pollution load (e.g. 200 tons of TDS) from X number of
polluters

• Set a target level of pollution (e.g. 100 tons) to be allowed, based on

carrying capacity of a region/environmental media

• Issue permits up to the target level only (i.e. 100 units of permits –
each permit allows the polluter to emit 1 ton of TDS)

• Remaining pollution (i.e. 100 tons) will have to be controlled

• Who will buy permits and who will abate pollution?

• Suppose the average cost of controlling pollution is Rs.1.00 lakh per

tonne;

• There are low-cost polluters who can control pollution at Rs. 80,000
per tonne and others (high-cost polluters) can control it at Rs. 1.2 lakh
per tonne.

• High cost polluter would buy the permits (priced Rs. 1.00 lakh per
tone) and low cost polluters would buy it!

• Pollution is controlled at least-cost and therefore, market achieves

efficiency in pollution control!

Example-2: Tradable water rights in Bhavani basin

• Old canal farmers have ‘senior appropriation right’

• LBP: created to utilise only surplus water for dry crops (cotton, turmeric,
oil seeds, etc)

• LBP: crop violation -cultivation of highly water intensive crops (paddy

and sugarcane)

• LBP farmers: claimed entitlement over constant portion of water

• Old farmers opposed any diversion from their share

• LBP: modern system, more progressive farmers and higher level of

productivity and farm income
 • LBP: Water scarcity is acute and ‘turn’ system of irrigation

• Turn system:

• The sluices (84 of them) are divided into ‘odd numbered sluices’
and ‘even numbered sluices’

• 24 TMC for wet crops in ‘odd numbered sluices’ from August 15 th

to December, 15th

• 12 TMC for dry crops in ‘even numbered sluices’ from Dec. 16th to
March 15th

• Next year, the turn will change

• 308 sample farmers selected in the basin

• All sample farmers in the LBP prefer to buy and all (except one) in
the old system prefer to sell

• Altogether, we have identified 125 farmers as ‘potential buyers’

and 129 as ‘potential sellers’. The remaining 54 farmers (17%) in
our sample were not willing to participate in water trading.

• Around 65 per cent of the farmers in the sample group are willing
to have trade on irrigation water

Payment for Ecosystem Services (PES):

 Payment for Ecosystem Services (PES) scheme combines Pigouvian approach and
Coasian Approach
 This is a voluntary market-transaction mechanism (Coasian) where the beneficiaries
of ecosystem services pay compensation (Pigouvian subsidy) to the
suppliers/managers of these ecosystem services in order to continue to supply such
services on a sustainable basis.
o The PES is a:

• (1) voluntary transaction where

• (2) a well-defined ecosystem service (ES) (or corresponding land use) is

• (3) being ‘bought’ by a (minimum one) ES buyer

• (4) from a (minimum one) ES provider

• (5) if and only if ES provision is secured (conditionality).

• PES can also be seen as a mechanism for pricing services provided by nature that
have been formerly undervalued or unvalued, hence creating economic markets for
them.

• There are three types of PES:

1. Public payment schemes for private land owners to maintain or enhance

ecosystem services

• These types of PES agreements are country-specific, where governments have

established focused programs (e.g. forest management in Mexico and Costa
Rica). While specifics vary by program focus and country, they commonly
involve direct payments from a government agency, or another public
institution, to landowners and/or managers

2. Formal markets with open trading between buyers and sellers, either:

(1) Under a regulatory cap or floor on the level of ecosystem services to be

provided, or:

(2) Under voluntarily mechanism

3. Self-organized private deals in which individual beneficiaries of ecosystem

services contract directly with providers of those services

(See PPTs for more examples on PES).