Bay Journal

Economic research shows that sparing the rod spoils the Bay

  • By Dennis M King on December 01, 2004
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With all of the attention being given to scientific questions about whether the health of the Chesapeake is bad or very bad, there has hardly been time to focus on a more important public policy question: Why have years of highly publicized intergovernmental agreements and voluntary alliances, partnerships, and stakeholder initiatives left the Bay in such bad or very bad shape?

The 2004 Nobel Prize in Economics was awarded to two researchers, Edward Prescott of Arizona State University and Finn Kydland of Carnegie Mellon University, for work that is not only applicable to this question, but identifies new strategies and data that will be required to put Bay restoration efforts on the right track.

Not surprisingly, their work does not involve science or improved hydrological/ecological models of how the Bay works; it involves economics and improved models that explain why certain types of public policies fail to affect individual decision-making.

The Basic Model

The research that won the 2004 Nobel prize in economics starts with the simple model of our capitalist system which is based on two rules: 1) allowing individuals to act in their own best interest will result in the greatest overall good; and 2) where decisions that are in the best interest of an individual will cause unacceptable public harm (such as rigging markets or dumping nutrients in the Bay), the government will pass laws that provide incentives and impose penalties, which will make it in the interest of those individuals not to make those decisions.

In this model of how people live and expect their neighbors to live, there is no significant role for voluntary initiatives, especially those that involve asking individuals to restrict their resource use decisions for the sake of the common good. This alone provides useful insight into why Bay restoration efforts have been failing. But the two economists went much further. Like most economists, they characterize appeals for voluntary initiatives as a typical self-interested tactic used by groups who want to continue making decisions that are not in the public interest and who desire to avoid and delay the imposition or enforcement of laws that would force them to change their behavior.

And, like most economists, they expect that where voluntary initiatives appear to be effective, it is only because people determine that if they do not “voluntarily” change their decisions now, laws will be put in place that will force them to change their decisions later at a higher cost.

Their research went beyond the futility of relying on voluntary initiatives and focused on what they labeled “time inconsistency problems” with the way public agencies use regulations to try to change private decision-making.

In case after case involving financial and real estate markets, flood insurance and environmental compliance, research showed that where people do not expect regulations to be implemented consistently over time they will choose to “game” the system, and will significantly discount the expected cost (penalty) of not complying. In these situations, which the researchers found to be very widespread, people believe that the government may yield to one kind of political pressure to pass laws now, but can be expected to yield to other political pressures later, which will prevent the enforcement of those laws or the imposition of significant penalties.

Prescott and Kydland used their case studies to show conclusively that the success or failure of regulatory systems depends primarily on bottom-up “microeconomic” decisions about how easy it is to “game” regulatory programs, and far less than was previously thought on “macroeconomic” governmental decisions about how regulatory programs are supposed to work. They drew one simple, but very important conclusion: “If governments cannot commit themselves credibly to a specific course, their attempts to regulate are likely to be futile.”

Applications to Bay Restoration

Using the most simple “self-interested man” model would predict that in the absence of any environmental laws, the millions of homeowners, farmers and businesses in the Chesapeake watershed would decide to spend nearly nothing to treat their waste, and would merely let it drain off or pump it off their property into the nearest stream.

Tweaking this model a bit to more accurately depict the actual situation where everyone faces weak, rarely enforced environmental laws, and prospects of small and easy-to-avoid penalties if they are caught, the model outcome would be the same—bad or very bad prospects for the Bay.

If this model is generally correct, we are still two steps away from having a useful strategy for restoring the Chesapeake. We need to move away from voluntary programs and toward legally binding restrictions on withdrawals and emissions that harm the Bay. And, we need legislators and policy-makers to commit to a course that involves a credible and consistent imposition of meaningful penalties for violating those restrictions.

The Basic Lesson

The lesson from this work seems to be that we should abandon the idea that has guided much thinking in the Bay region—that people are public-minded and can be persuaded to cooperate in cleaning up the Bay by voluntarily limiting their land and water use decisions.

Instead, we should assume that they are self-interested, and make their decisions based on a kind of personal benefit/cost analysis that in many cases may barely include any consideration of the Bay.

For example, when estimating the cost of not complying with laws to control nutrients and sediment runoff, or limit tree removal, or apply less fertilizer, or avoid creating impervious area, or whatever, businesses, farmers and other land and water users in the Bay watershed can be expected to run through a mental calculation that includes factors such as the likelihood that:

  • They will be caught;
  • They will then be charged;
  • Busy prosecutors in Maryland or Virginia will pursue them;
  • If pursued the prosecutors would prevail; and
  • Significant penalties would be imposed.

This new research shows that people will also discount these risk-adjusted, expected costs even further by considering all of the legal and political options they will have in the future to avoid or reduce penalties if laws are vague or kept intentionally flexible.

Model and Data Needs

Based on this research, what changes should be made in the modeling and data collection efforts that are under way to support restoring the Bay?

First, this work suggests that attention should shift from reconciling hydro-ecological Chesapeake models so they can more consistently forecast the rate of decline of the Bay, and toward what might be called “environmental enforcement economic models” that can be used to establish and enforce consistent laws that provide a credible deterrent to decisions that harm the Bay.

Second, focus less on data about the Bay itself, and more on data related to the factors that go into the various benefit/cost calculations that are made by millions of people as they make decisions that affect the Chesapeake Bay.

A good place to start would be to undertake these five steps:

  • Develop a taxonomy of types of decision-makers and specific types of decisions that adversely affect the bay;
  • Develop decision-making cost/benefit models for each of them;
  • Initiate real-time observing systems to monitor how these decisions are being, and could be, affected by laws supported by various levels of commitment to monitoring, enforcement, prosecution, penalties and so on;
  • Determine the “gaming” strategies these private decision-makers will use to avoid penalties; and
  • Determine what countervailing public actions are necessary to minimize the effectiveness of these “gaming” strategies.

Conclusion

The market system that fuels the great U.S. economy relies on individual decision-making, not collective action. It’s time for the Bay restoration community to decide to work within this market system by changing specific economic penalties and incentives, rather than attempting to override market-forces with direct appeals for collective action.

Recent economic research, including the work that won the 2004 Nobel prize, shows that if the political will is there, the strategies needed to succeed are surprisingly simple.

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About Dennis M King
Marissa Spratley is the communications specialist for the Alliance for the Chesapeake Bay.
Read more articles by Dennis M King

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