Environmentalism and Economic Freedom - Literature review Example

It is often the case that where issues of the economics of environment or the so-called environmental economics are concerned, neo ical theoriesare invoked to find solutions to vexatious and complex issues. Many environmental economists often bemoan the fact that the market appears to offer no practical solutions to environmental issues like pollution (Black, 1998). However, there is a way out when the Austrian Theory of Environmental Economics is applied to solve the issues of environment. Neo-classicalists often point to the need for governmental intervention in the markets to solve economic issues and this is the case with environmental issues as well. As mentioned above, this need not be the case always and if the Austrian approach to environmental economics is taken, then we can find solutions to environmental issues. Of course, the intention here is not to dismiss neo-classical approaches towards environmental economics as there are several areas in which the Austrian School flounders and where neo-classical theories are best applied (Rothbard, 1982). Rather, the point here is that a nuanced approach towards environmental economics is needed if one wishes to solve the numerous problems that the environmental economics throws up. This paper compares and contrasts the neo-classical approach with that of the Austrian School and provides some directions on how these approaches deal with the issue of pollution externalities. A brief discussion on externalities and pollution externalities in particular along with a theoretical comparison of the two approaches to economics is done at the beginning. The specific issue of the approaches towards solving the issue of pollution externalities is then taken up and the concluding part is about how to implement the solutions offered by these two approaches along with a critique of the proposed solutions. The emphasis in this paper is on the implementation of the approaches rather than a purely theoretical discussion. In the neo-classical perspective, “economics is conceived as the allocation of scare resources among alternative ends.” This axiom assumes rationality in human behaviour and the principle of profit maximizing as the motive for human behaviour (Reisman, 1996). Hence, the theory can be considered as “positive” since economic growth is emphasized and the methods used to study science are applied to solving economic problems. However, the conditions under which neo-classical economics works best is the case of perfect competition which has been shown as an ideal and something that is rarely achieved in practice. Considering the fact that neo-classical economics envisions four market types: monopoly, monopolistic competition, oligopoly and perfect competition and that only under perfect competition can the tenets of neo-classical approaches work best, it would be fair to say that neo-classicalists often fall short as far as issues of environmental economics are concerned since the very definition of property rights and the means to enforce them is at the heart of solving environmental issues (Reisman, 1996). The main criticism against neo-classicalists is that they expect the government to intervene because their models are based on situations that do not achieve the ideal of perfect competition as well as clearly defined property rights which is needed for perfect competition (Rothbard, 1982). More on this later, and at the moment let us consider the Austrian Approach to economics. Austrian Economists view the profession as the study of human action or Praxeology which is fundamentally about how individuals act with a sense of purpose to achieve chosen ends. It follows from this that the ultimate end of human action is the fulfilment of the desires (in part or full) of the economic actor. Hence, efficiency is individual goal seeking process rather than value maximizing and inefficiency arises only when the means chosen to achieve the ends are inconsistent with the desired goal. To elaborate further, costs incurred are “the private experience of an individual [is] the sole foundation of factual knowledge” and hence are subjective (Rothbard, 1982). The next axiom of the Austrian Branch of Economics is that group behaviour can be reduced to the study of individuals that make up those groups and hence the interactions between individuals are studied. This is the reason for prominent Austrian economists to reject macroeconomics and holism and this is the line taken by the famous economist, Karl Popper as well (Rothbard, 1982). The point about the Austrian school is that the theory is all about removing interpersonal conflicts. Hence, the overriding emphasis on studying individual behaviour rather than group behaviour and the solutions that are offered by the Austrian school are likewise more market based than the neo-classicalists since the former hold that the market if left alone can solve most of the economic issues. Given this introduction to the two schools of economics, it would be pertinent to start the discussion about pollution externalities before contrasting the two approaches. The definition of externalities is as follows: “Externalities arise when certain actions of producers or consumers have unintended external (indirect) effects on other producers or/and consumers.” Externalities can be positive and negative. A positive externality is a transfer of technology that happens when industries relocate to other countries and where the effect of such relocation is to introduce the new technology to the target country. Negative externalities happen when the effect of production is to cause extra cost on others as happens when an industry is polluting and hence this leads to others in the vicinity suffering because of the pollution. The issue per se is not about pollution (in this paper) but on who bears the cost and how they do it. If left alone, the polluting industries do not pay for the cost of pollution and the costs are external meaning that the cost is not factored in the cost of production (Nordhaus, 1975). This means that pollution is not a pecuniary externality wherein the costs of pollution are transmitted through the price mechanism and altered prices. This leads to economic inefficiencies which mean that a way has to be found to internalize pollution costs. Hence, the mechanism by which who pays for the cost of pollution and how they pay is discussed here and the two schools of thought are compared (Reisman, 1996). To take the neo-classical approach first, let us take the example of a factory discharging effluents into a river along which a hotel is also situated. The increased waste that the factory dumps in the river that is used for recreation by the hotel imposes an extra cost on the hotel and which the factory is not bearing leading to inefficient allocation of the river. Since neo-classicalists are primarily concerned with the efficient allocation of resources, this is a classic example of pollution externalities which must be dealt with. If the polluter has to pay, then the issue of property rights and the structure of such rights come to the fore since there has to be a basis for the polluter to internalize this cost. However, there are no clearly defined property rights for goods like air or water and a clear structure of such rights which makes it impossible for the polluter to monetize the cost of such externalities. The solution according to neo-classicalists is to ask the government to intervene either through centralized taxes (also called Pigovian taxes) or through decentralized tradable permits (which are based on the Coase theorem) (Coase, 1960). The rationale behind the need for governmental intervention is that the government has the duty to operate in the public interest and hence must correct the market failures by internalizing the costs. The first best solution of making the polluter monetize the costs or internalize them is not possible leading to inefficiencies and hence the government has a role to bring the economy close to efficiency through the two instruments discussed above: taxes and tradable permits. This is the bare bones approach of the neo-classicalists towards environmental issues like pollution externalities (Hayek, 1952). A detailed discussion of the merits and demerits of such solutions is done after the Austrian approach is discussed. The Austrian approach is to operate through unhampered markets where the reasoning is that if the markets are allowed to do their work without any sort of intervention, solutions to pollution externalities can be found. Hence, property rights, private ownership and free markets (without any interventions) form the basis of the Austrian approach. According to this approach, pollution and the externalities imposed by it are not market failures but more of an interpersonal conflict. Since we discussed the aspect of Austrian economics being all about resolving interpersonal conflicts earlier in the paper, the solution according to them would be to privatize all goods and services. Since pollution in this case is caused by a lack of clearly defined property rights, the Austrian economists argue that it is not too abstract to think about privatizing public goods like streets, lakes and motorways. Though this seems farfetched, there are many prominent Austrian economists who argue that private ownership of public goods dramatically increases efficiency and imposes responsible usage of resources. In our case, once all the property rights are defined, it is easy to make the “polluter pay” and if the factory dumps its waste in the river, it clearly violates the property rights of the hotel (which would have rights over the river since it is used for recreation). In this case, the hotel can sue the factory for violation of the property rights of the hotel. The factories can then have a choice of paying for the pollution, confine it to his own property or better, eliminate the pollution altogether (Hoppe, 2004). The responsibility of ending the conflict over the pollution now rests with the polluter and there is no need for any external intervention. Hence, there is no central planning authority determining the efficient levels at which the economy works and the market mechanism has found a solution to the problems of pollution externalities. This approach by the Austrians towards the environmental issues has gendered a new field called Austrian Environmental Economics and this field is quite popular among the emerging generation of economists (Rothbard, 1982). If we take a nuanced view of both of the approaches towards pollution externalities, we find in the neo-classical realm, a mixture of taxes and tradable permits would be better as a practical solution rather than a single mechanism. However, the problem with the neo-classical approach is that it requires the government to intervene whenever there is a market failure and considering the fact that the administrative implementation and legal enforcement (when there are conflicts between the parties) can be both cumbersome and time consuming, these governmental interventions have the effect of making the market mechanism inefficient rather than the original intent of correcting market inefficiency (Block, 1998). On the other hand, the Austrian approach of having the market solve all the problems is also slightly problematic when one considers the issue of how the issues related to the ozone layer, acid rain or global warming have to be tackled. To this criticism of both theories, the neo-classicalists point to the way in which a hybrid solution can be found that involves a mixture of taxation and tradable permits where there is a clear definition of the implementation mechanism and hence no scope for ambiguity. The Austrian Schools’ answer to the criticism against their approach is to provide a mechanism wherein the “First come first served” principle of who comes first to the pollution forms the basis of the “polluter pays” principle (Rothbard, 1973). The point here is that the basic debate is over whether a market left to “it” would solve all problems or whether the government needs to intervene periodically to set right the market deficiencies and inefficiencies. There is a branch or a sub-topic within neo-classical economics that is called welfare economics and which involves making normative judgements about the desirability’s of outcomes. The main purpose of welfare economics is to study the effects of the various economic policies on society. The raison d’être for welfare economics is the maximisation of welfare and to allocate scarce resources in the best possible way. The main objection to welfare economics is that there is no way to measure welfare. Making value judgments about whether a person is better off or worse off is one thing and measuring such happiness or distress is another. Hence, the neo-classicalists as well as the proponents of welfare economics resort to a set of assumptions centred on “optimality”. The reasoning behind this is that the “social optimum” or economic efficiency which is also called “Pareto Optimality” is impossible to attain without changing the resource allocation which leads to the situation where one person is better off at the expense of another and hence leads to a situation that is back to square one. So, the neoclassicalists and the welfare economists make assumptions about economic efficiency and perfect competition that have been detailed in the discussion in the preceding paragraphs. The reason for mentioning the welfare economics point of view is to highlight the assumptions that underlie neoclassical theories and to delineate the sets of principles under which markets are supposed to work (Block, 1989). The way in which taxes and tradable permits are sought to be justified by neoclassicalists is questioned by Austrian economists who see such attempts as harmful and dangerous. The first objection that they have towards these solutions is that assumptions of perfect competition are idealistic and useless considering the various points that were made in the previous paragraph. Secondly, the measurement of costs is subjective and the ways in which costs are levied indicate that they exist in the minds of the decision makers and nowhere else. Third, opportunity costs cannot be measured precisely and the outcomes of such opportunity costs cannot be known. Finally, the assumption of static equilibrium is flawed considering the ever changing and dynamic world that we have and hence there is scope for miscalculation. It is because of these reasons that the Austrian economists insist on complete privatization and private ownership of even the public goods (Rothbard, 1971). However, the way in which they have sought to impose their ideas on abstruse problems like rivers (as in the example that was discussed in this paper) has given rise to critics of the Austrian school dismissing them as too abstract for everyday problems of public goods. Hence, the present stalemate in ascribing economic costs and calculating externalities for many environmental problems. However, this is not to say that there is no solution to such problems. It is to say that a mixture of different approaches has to be used to solve the complex and contentious issue of pollution externalities. The preceding discussion has showed that the neo-classicalists believe that the market cannot solve the problem of pollution externalities which leads to inefficiencies and therefore the markets are deemed to fail in this aspect. Hence, the argument goes that the government has to intervene to correct these market failures is necessary. On a broader level, this is what has happened over the last three years in the United States and elsewhere where in the aftermath of the global recession, governments had to intervene in a big way to correct the deficiencies arising out of market failures. This only adds to the contention of those who find fault with market mechanism and ask the governments to “steady” the “hidden hand” of the market whenever there is an issue with it. Austrian economists argue that if there is a need for government to intervene in the markets, then that is a violation of the principles underpinning the market economics and hence the solutions are privatization, the “first come first served” principle to define property rights and to enforce such rights, the “polluter pays” principle. It goes without saying that there is no approach without controversy and there can be a way out by resorting to market based solutions as and when possible and a bit of governmental intervention whenever there is a market failure. The point here is that economics as a profession is not an exact science and prone to certain uncertainties. We are in the midst of a revolution in the social sciences where old assumptions are being questioned and new theories of behaviour put forward. Particularly, the emphasis on the behavioural side of economics means that there is a movement towards accounting for individual differences and irrationality instead of assuming perfect rationality and perfect competition. This nuanced view has also meant that markets are not held as gospel and there is an allocation for market failure. In conclusion, the two approaches discussed here have their strengths and weaknesses and it is only with an application of one’s mind that a solution to the problem of pollution externalities can be found. References 1. Block, W. (1998) Environmentalism and Economic Freedom: The Case for Private Property Rights. Journal of Business Ethics. Netherlands: Kluwer Academic Publishers. 2. Coase, R. (1960) The Problem of Social Cost. Journal of Law and Economics 3, 1-44 3. Hayek, F. von (1952) The Counter-Revolution of Science: Studies on the Abuse of Reason. Glencoe, IL: Free Press 4. Hoppe, H.H. (2004) The Ethics and Economics of Private Property. USA: Mises Daily Article. 5. Nordhaus, W.D. (1975) The Political Business Cycle. London: Palgrave. 6. Reisman, G. (1996) Capitalism: A Treatise on Economics. London: McGraw-Hill 7. Rothbard, M. (1982) Ethics of Liberty. USA: Atlantic Highlands, N.J.: Humanities Press. 8. ────. (1982) Law, Property Rights, and Air Pollution. USA: The Cato Journal (vol. 2, no. 1) 9. ────. (1973) For a New Liberty. Great Britain: Collier Macmillan Publishers, London 10. ────. [1971] (1999) Education. Free and Compulsory. USA: The Ludwig von Mises Institute. 11. ────. (1989) Economics and the Environment: Reconciliation. Canada: The Fraser Institute Read More