Chapter 8: The Political Economy of Environmental Regulation and Resource Management Professor Steven C. Hackett Humboldt State University

Chapter 8: The Political Economy of Environmental Regulation and Resource Management

Professor Steven C. HackettHumboldt State University

Political Economy

Overview: What is political economy? A simple analytical framework

Supply of regulatory policyDemand for regulatory policyEquilibrium in the political market for regulation

Political Economy

Overview, Continued: Application: Political economy of environmental regulation Social choice theory and the median voter theorem Application: Self-governance of localized common pool resources Case: Montreal Protocol

What is Political Economy?

History: In the time between Adam Smith’s Wealth of Nations (1776) and John Stuart Mill’s Principles of Political Economy (1848), what is now called economics was more generally called political economy. The term political economy reflected the belief that politics and economics are inseparable, and in fact that political factors are crucial in determining economic outcomes.


History:

Much of the focus in political economy was on what we might now call the economics of public policy.


R. Keohane, 1984. After Hegemony. p. 21: Wherever, in the economy, actors exert power over one another, the economy is political.Alt and Shepsle, 1990. Perspectives on Positive Political Economy: Political economy is the study of rational decisions made in the context of political and economic institutions.


Allen Drazen, 2000. Political Economy in Macroeconomics, p. 7: Political economy begins with the observation that actual policies are often quite different from ‘‘optimal’’ policies, the latter defined as subject to technical and informational, but not political, constraints. Political constraints refer to the constraints due to conflict of interests and the need to make collective choices in the face of these conflicts.


Within microeconomics, political economy is an approach used to understand how political and legal institutions influence the economic behavior of people, firms, and markets, as well as the economics of how interest groups influence the formation of laws and regulatory policy.


From the standpoint of international economics, political economy is concerned with understanding how national policies influence international trade, investment, and finance, with the processes that lead to the formation of international economic treaties and institutions, and with the economic consequences of these laws and institutions.


Positive Political Economy:These relatively recent approaches to political economy – sometimes referred to as the new political economy – borrow economic approaches for modeling incentives as a way to understand the political and economic forces that shape public policy.


Example of Positive Political Economy:Investigate the role of campaign contributions in explaining post-election voting.


Normative Political Economy:Identifies “good” policy outcomes (consistent with a particular value system) and investigates how, given the existing political constraints, these good policy outcomes can be realized.


Example of Normative Political Economy:Lumber companies (or labor unions if you prefer) form a political action committee, construct a set of desired policy outcomes, and contribute to those candidates most likely to support the desired policy outcomes.


In chapter 4 we developed the economic theory of efficiency-enhancing environmental regulation. But since environmental regulation is an outcome of political processes, the nature of environmental regulation will reflect the economic forces at work in the political process. Therefore new political economy models can help us understand how environmental and natural resource regulations come about.

Economic Models of Political Economy and the Regulatory Process

Public choice school of thought and the supply of regulatory policy: Instead of assuming that politicians select policies that best serve the public interest, traditional public choice models start from the premise that politicians, like other economic agents, are motivated by incentives such as ideology, wealth, reelection, and power.

From this foundation one can model the supply of legislation or administrative rules.


The role of institutional structure: Legislative and administrative outcomes also depend on the institutional structure within which these activities occur. Shepsle and Weingast (1994) offer an accessible survey of the work that has been done on the institutional structure of the U.S. Congress. For example, issues such as party control, seniority, the role of committees and committee chairs, voting rules, and other aspects of procedure are important elements in understanding legislative outcomes. A different institutional structure governs the administrative rule-making process.


The capture theory of regulation and the demand for regulatory policy: What makes for a potent interest group? According to Stigler and Peltzman:The amount that each individual has at stake. Having more at stake means the individual will invest more money and effort.

The size of the group. Smaller groups are easier to organize and can more quickly come to agreement than large groups.


Support for the capture theory of regulation comes from a 1997 Los Angeles Times analysis of political giving by major U.S. corporations by Vartabedian. The largest corporate contributors tended to be those most heavily regulated by government or most dependent upon government for subsidies. Clearly these firms have a high demand for favorable regulation. By the same token, firms with a reputation for sound management, and which therefore have a relatively lower demand for favorable regulation, were found to be below-average contributors. From a sectoral point of view the largest political contributors came from the financial, military, oil, telecommunications, and tobacco industries.

The Political Market for Regulation

The demand for regulation derives from the various groups whose interests are served by regulation.

Interest groups organize around a common set of preferences, and therefore express a group willingness-to-pay for effective support of a regulation that reflects the marginal utility derived from the regulatory outcome. This willingness-to-pay is manifested in political currency that includes money payments and the provision of votes, volunteer effort, and endorsements.


Some examples of interest groups:

Firms oftentimes organize themselves in trade associations. Trade associations are likely to seek regulations that reduce their production costs, provide subsidies, erect entry barriers and constrain substitutes, and provide an environment more conducive for collusion.

Environmentalists organize themselves into groups that lobby for regulation that conserves or restores the environment.

Consumers may organize themselves into interest groups seeking lower product prices and product quality assurance.

Workers may organize into interest groups seeking more jobs, higher pay, and better working conditions.


According to Keohane (1999), The supply of effective support for regulation has three components, each reflecting the cost of supplying effective support for a particular regulatory outcome.

First, the supply of effective support for regulation is a function of the opportunity cost of the time and effort invested by the regulator in shepherding environmental legislation or administrative rules through the political process.


Components of the supply of effective support for regulation, continued:

Second, the supply of effective support for regulation is a function of the psychological cost of supporting regulation that may be in opposition to the personal preferences of the regulator. It is possible that this cost becomes negative if the regulation is in accord with the regulator's personal preferences.


Components of the supply of effective support for regulation, continued:

Third, the supply of effective support for regulation is a function of the opportunity cost of supporting regulation that can impair the regulator's probability of reelection or reappointment. As with the regulator's personal preferences, this opportunity cost can become negative if the regulation is in accord with the interests of the regulator's constituency and thus increases the likelihood of reelection or reappointment.


Equilibrium:

As we learned in Chapter 3, equilibrium occurs where supply and demand intersect. In the context of the political economy of regulatory policy, the equilibrium quantity represents the quantity of effective support for a policy, while the equilibrium price represents the price, in political currency, per unit of effective support.


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Changes in Equilibrium:

What factors might displace this equilibrium and cause an increase or a decrease in the equilibrium level of effective support for a particular regulation? An increase in demand might occur, for example, if a new interest group joins the coalition demanding the regulation. All else equal an increase in demand would cause an increase in the equilibrium quantity of effective support (and an increase in equil. price).


Changes in Equilibrium:

Likewise if polls indicate that constituents more strongly favor the regulation then this would increase the supply of regulation and therefore increase the equilibrium quantity of effective support. Each regulatory alternative will have its own supply and demand, and thus will have its own equilibrium level of effective support. Different regulatory alternatives will derive their demand from a different mix of interest groups, and will derive their supply from different regulator opportunity costs.


What determines whether a given equilibrium quantity of effective support will be sufficient to become law or policy?

Political institutions such as voting rules, filibuster and cloture rules, the role of committees, party control, seniority, and the requirements for overcoming a veto are a few of the many factors at play.

Applications: The Political Economy of Environmental Regulation

The Downing political economy model of an environmental regulatory agency:The model includes three groups: the polluter, those bearing the external costs, and the regulatory agency. The administrator(s) of the regulatory agency have the twin objectives of (i) maximizing agency budget and discretionary control, and (ii) improving environmental quality. Polluters and those bearing the external costs invest resources to influence the politicians who set the agency budget, and thus indirectly control the level of regulatory activity.


The Downing political economy model of an environmental regulatory agency:Analysis from this model indicates there is a feedback effect between the type of environmental regulation we observe (e.g., effluent fees, technology-forcing regulations) and the pattern of lobbying pressure exerted by the regulated firms.


Milliman and Prince political economy model of a polluting firm’s incentives for research and development (R&D) in innovative and less expensive ways of meeting the requirements of pollution-control laws. Firms that succeed in finding an innovative and lower-cost means of complying with pollution-control laws might influence the introduction of even more stringent environmental regulations. They argue that “firms, not regulatory agencies, often initiate [environmentally friendly] innovation and diffusion” (p. 248).


Hackett political economy model of a “patent race” for pollution-control technology, and the incentive for firms to lobby policy makers for more restrictive regulation of their own industry The winner(s) of the patent race find a cheaper method of clean production, and have an incentive to lobby government to create a more regulated environment where the innovators have a cost advantage over their rivals. Raising rival firms’ costs increases profit for the patent race winner.


Hackett political economy model of a “patent race” for pollution-control technology, and the incentive for firms to lobby policy makers for more restrictive regulation of their own industry Example: DuPont and the Montreal Protocol for control of halocarbons (CFC’s). DuPont’s development of less polluting substitutes gave it an incentive to join with environmentalists in lobbying for a ban on harmful halocarbons produced by rival firm ICI.


Maxwell, Lyon, and Hackett political economy model of voluntary self-regulation by polluting firmsFirms have an incentive to self-regulate if, by doing so, they can mollify environmental interest groups enough to head off more stringent regulations imposed by a regulatory agency.


Maxwell, Lyon, and Hackett model: Used Toxics Release Inventory (TRI) data to evaluate whether declines in the cost of organizing political resistance to pollution lead to a greater threat of increased government regulation, driving firms to self-regulate and reduce emissions. The TRI requires firms to self-report their emissions of certain toxic compounds and thus works to lower the information cost to citizen groups that lobby government for stricter regulations.


Maxwell, Lyon, and Hackett model: Since the TRI was instituted in 1989, toxic emissions per unit of manufacturing output have steadily declined, which is consistent with Maxwell, Lyon, and Hackett’s prediction. Moreover, states such as California that have a very high density of self-identified environmentalists are shown to have a more rapid reduction in toxic emissions per unit of manufacturing output than states with a lower density of environmentalists.


Maxwell, Lyon, and Hackett model: Thus by simply providing information on pollution emissions, the TRI makes it easier for citizens to threaten polluters with more stringent regulation, which in turn works to lower emissions by way of voluntary self- regulation in order to attenuate the threat of more stringent regulation.

Social Choice Theory

Social choice theory is a part of political theory concerned with collective decision-making, such as through voting in a democratic system of self-governance.

The seminal work in this field is by Nobel prize winning economist Kenneth Arrow in his 1951 book Social Choice and Individual Values (NY: John Wiley)

Social Choice Theory

One of the most prominent advancements in social choice theory is the Median Voter Theorem (aka median voter model).

Consider an election with the following characteristics:

Political candidates can (at least to some degree) commit to a political position in the minds of the voters

Median Voter Theorem – More Assumptions

Voters have single-peaked preferencessingle-peaked preferences, or policy bliss points, and can be described by a distribution function arraying them in a simple two dimensional policy space (e.g., left vs. right). If there is an odd number of voters, the median voter lies in the middle of the distribution.

Median Voter Theorem – More Assumptions

There are two candidates seeking election to a single member districtsingle member district (e.g., US House of Representatives districts, CA State Senate or Assembly districts).

The voting rule is that only one candidate can win (“winner-takes-all”) based on a plurality ruleplurality rule (candidate with the most votes wins).

Median Voter Theorem

Under these conditions, the plurality winner (or for that matter a simple majority winner) will position herself to advocate for the bliss point of the median voter.

In other words, under these conditions the candidates have a dominant strategy of advocating a centerist platform consistent with winning the median voter, as well as all the voters on either one side OR the other of the median.


If parties A and B want to capture the median voter, they should move towards the center. The red and blue areas represent the voters that A and B expect they have already captured.


Most elections in the U.S. feature single member district (winner-takes-all) plurality (or simple majority) voting rules – SMDP votingSMDP voting.

If the election can be described as a “location game” in which the two politicians first commit to a location in policy space, and then voters vote for the candidate closest to their bliss point, then the Nash equilibrium (and dominant strategy equilibrium) is for both politicians to commit to a location proximate to the median voter.

Duverger’s Law

Duverger’s Law asserts that winner-takes-all-plurality rule voting tends to eliminate small parties and create a stable two-party system.

The discovery of this tendency is attributed to Maurice Duverger, a French sociologist who observed the effect and recorded it in several papers published in the 1950s and 1960s.

Duverger’s Law

A two-party system develops spontaneously from the single-member district plurality voting system (SMDP), in which legislative seats are awarded to the candidate with a plurality of the total votes within his or her constituency, rather than apportioning seats to each party based on the total votes gained in the entire set of constituencies.

Duverger’s Law

A frequent consequence of Duverger's law is the spoiler effectspoiler effect, where a third-party candidate takes votes away from one of the two leading candidates.

Illustration – Duverger’s Law

% of Voters

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Left-Wing Values

Example: Left splinters, right maintains “party discipline” and wins

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Party Platform Locations

SMDP Voting Rules – Essential to Form an Internal Coalition

The dilemma for political parties in a single member district plurality voting system is maintaining an internal coalition of centrists and those on the tail of the distribution within the political party.

This is difficult because the dominant strategy locates the party candidate at the median voter, far from the voters in the tails of the distribution.

SMDP Voting Rules – Essential to Form an Internal Coalition

Internal coalition, two party politics alienates or marginalizes those at the tails of the distribution, and can result in low voter turnout.

Proportionate Voting Systems

In a proportionate voting system (used in varying degrees in most European countries), you can vote for a small party closest to your bliss point, and party representation in the legislature is in proportion to the percentage of the overall vote that each party receives.


In a proportionate voting system (used in varying degrees in most European countries) one can end up with many small parties.

In this case, a parliamentary government is formed by way of an external coalition of different parties.


External coalition, parliamentary style proportionate voting systems result in higher voter turnout, since those in the tails of the political distribution are explicitly represented in coalition government.


The dilemma in a proportionate voting system is maintaining an external ruling coalition of centrist parties and fringe or single-issue parties.

In proportionate voting systems there is a tendency for small parties small parties to have disproportionate powerto have disproportionate power in coalition governments because they can threaten to leave the coalition and throw government control to the “other” coalition.

Alternative Voting Systems

Another alternative that is consistent with the winner-takes-all system in the U.S. is the instant runoff system, which is being tried in San Francisco.

In an instant runoff system a voter can indicate their first, second, and third preferences when they vote. If there is no “first preference” simple majority winner, the candidate with the fewest “first preference” votes is eliminated, those who voted for the eliminated candidate have their “second preference” votes counted in a re-tabulation of votes. This continues until a simple majority winner is found.

Alternative Voting Systems

While instant runoff voting is more complicated, it has the advantage of allowing people to vote for “fringe” candidates closer to their own bliss point without inducing the “spoiler effect” that (according to Duverger’s Law) is intrinsic in winner-takes-all plurality systems.

To learn more, visit the Center for Voting and Democracy’s website: http://www.fairvote.org/irv/

Application of Social Choice Theory to Self-Governance of Local CPR’s

Hackett studied voting rules in CPR systems in which the appropriators are heterogeneous (e.g., fishermen wth large vs. small vessels). Suppose that the CPR system has been abused from overuse, and the appropriators have organized to reduce overall appropriation levels in order to manage the CPR more sustainably. The question is how the overall reduction in use will be divided among the individual appropriators.


Inclusive voting rules require a supermajority agreement in order for a proposal to pass. They are inclusive in that they require the consent of a supermajority. Consensus and unanimity are examples.

Exclusive voting rules allow proposals to pass with plurality or simple majority agreement.


Rule systems that change the original status quo shares of total resource appropriation redistribute wealth from one type of appropriator to another, and are therefore more likely to generate conflict.


Hackett identified the following trade-off: heterogeneous CPR appropriator groups with highly inclusive voting rules (such as consensus) will take a longer time to reach agreement because such voting rules make it easier to block agreements. This delay allows the CPR to continue to decline in productivity. Distributional rules that are approved, however, are less likely to result in large redistributions of wealth relative to the status quo, and so individual appropriators are less likely to fight and violate such rules, reducing future monitoring and enforcement costs.


In contrast exclusive voting rules, such as plurality or simple majority, reach agreement more rapidly, and so repair of the CPR system is not delayed. Yet if the majority does manage to impose rules that redistribute wealth from the minority to the majority, the agreement is more likely to be fought and violated by the minority in the future, resulting in higher monitoring and enforcement costs.


Hackett, Schlager, and Walker (1994) used laboratory experimental techniques (controlled and paid “role-play” exercises) to look at how heterogeneous CPR appropriator groups resolve this tradeoff.

They found that appropriators tended to select allocation rules proportionate with historical appropriation, and were able to reach agreements without excessive delays or conflicts.


The effects of appropriator heterogeneity and voting rules on the performance of CPR governance structures have been looked at for the case of oil and gas fields by Wiggins and Libecap (1985) and Libecap and Wiggins (1985).


Oil and Gas: Self-governance of oil fields is more

likely to succeed if there is minimal heterogeneity among the appropriators (e.g., differences in productivity).

Self-governance of oil fields is more likely to succeed if voting rules are more exclusive (e.g., 63 percent vs. unanimity voting rules).


Johnson and Libecap (1982) provide a similar analysis of the Texas Gulf Coast shrimp fishery, where shrimpers vary with regard to fishing skill. Heterogeneity in fishing skill created conflict over the type of government fishery regulations the various fishermen preferred: “For example, total fishing effort could be restricted through uniform quotas for eligible fishermen. But if fishermen are heterogeneous, uniform quotas will be costly to assign and enforce because of opposition from more productive fishermen” (p. 1010).


Field research generally indicates that rules linking CPR harvest shares to an appropriator’s historical level of harvest (tons of fish landed, acre-feet of irrigation water) or contribution (contributions for CPR upkeep, monitoring, or enforcement) are far more common than rules that simply divide CPR output equally. There is an aspect of fairness in rewarding greater contributions with larger shares, and sharing rules that differ markedly from historical use patterns tend to undermine individual cooperation with group efforts directed at sustaining the commons.

Political Economy of the Montreal Protocol

The Montreal Protocol is an international treaty that limits the use of halocarbons that harm the stratospheric ozone layer.

In studying the political economy of the Montreal Protocol and the role of DuPont and the British chemical firm ICI, Oye and Maxwell developed the concept of Olsonian and Stiglerian political circumstances.


In Olsonian political circumstances (named after Mancur Olson), the benefits of environmental regulation are more diffuse, spread thinly across many entities, while regulatory costs are more concentrated, weighing heavily on a few entities.

In Olsonian situations the many who receive relatively small benefits from regulation have little incentive to invest in policy influence activities, and face high organizational and coordination costs because of their large numbers.


Thus in Olsonian situations it is more difficult to get stable systems of regulation, meaning that regulatory controls for protecting the environment, for example, are relatively likely to be overturned due to the lobbying efforts of the few who bear the costs.


In Stiglerian political circumstances (named after George Stigler), the benefits of environmental regulation are more concentrated, heavily benefiting a few entities, while regulatory costs are more diffuse, weighing lightly on many entities.

In Stiglerian situations the few who receive relatively large benefits from regulation have a strong incentive to invest in policy influence activities, and face low organizational and coordination costs because of their small numbers.


Thus in Stiglerian situations it is relatively easier to get stable systems of regulation, meaning that regulatory controls for protecting the environment, for example, are relatively likely to be created and maintained due to the lobbying efforts of the few who receive the benefits.


Oye and Maxwell argue that the Montreal Protocol, which outlawed CFC production by the year 2000, gave a particularly strong advantage to firms like Du Pont that came up with CFC alternatives over their rivals that did not. In particular, Oye and Maxwell state that:

“Du Pont and Imperial Chemical Industries, Ltd. (ICI) experience with restrictions on CFCs represents a classic Stiglerian illustration of producers benefiting from regulations mandating product substitution” (pp. 193–94).

Documents

Chapter 8: The Political Economy of Environmental Regulation and Resource Management Professor Steven C. Hackett Humboldt State University