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

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Chapter 8 The Political Economy of Environmental
Regulation and Resource Management

• Professor Steven C. Hackett
• Humboldt State University

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Political Economy

• Overview
• What is political economy?
• A simple analytical framework
• Supply of regulatory policy
• Demand for regulatory policy
• Equilibrium in the political market for regulation

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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

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What is Political Economy?

• History In the time between Adam Smiths Wealth
  of Nations (1776) and John Stuart Mills
  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.

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What is Political Economy?

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

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What is Political Economy?

• 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.

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What is Political Economy?

• 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.

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What is Political Economy?

• 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.

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What is Political Economy?

• 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.

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What is Political Economy?

• 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.

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What is Political Economy?

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

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What is Political Economy?

• 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.

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What is Political Economy?

• 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.

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What is Political Economy?

• 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.

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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.
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Economic Models of Political Economy and the
Regulatory Process

• 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.

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Economic Models of Political Economy and the
Regulatory 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.
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Economic Models of Political Economy and the
Regulatory Process

• 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.

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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.
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The Political Market for Regulation

• 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.

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The Political Market for Regulation

• 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.
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The Political Market for Regulation

• 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.
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The Political Market for Regulation

• 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.
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The Political Market for Regulation

• 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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The Political Market for Regulation

• 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).
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The Political Market for Regulation

• 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.
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The Political Market for Regulation

• 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.
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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.

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Applications The Political Economy of
Environmental Regulation

• 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.

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Applications The Political Economy of
Environmental Regulation

• Milliman and Prince political economy model of a
  polluting firms incentives for research and
  development (RD) 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).

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Applications The Political Economy of
Environmental Regulation

• 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.

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Applications The Political Economy of
Environmental Regulation

• 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 (CFCs). DuPonts
  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.

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Applications The Political Economy of
Environmental Regulation

• Maxwell, Lyon, and Hackett political economy
  model of voluntary self-regulation by polluting
  firms
• Firms 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.

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Applications The Political Economy of
Environmental Regulation

• 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.

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Applications The Political Economy of
Environmental Regulation

• 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 Hacketts 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.

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Applications The Political Economy of
Environmental Regulation

• 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.

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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)
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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
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Median Voter Theorem More Assumptions

• Voters have single-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.

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Median Voter Theorem More Assumptions

• There are two candidates seeking election to a
  single 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
  rule (candidate with the most votes wins).

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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.
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Median Voter Theorem
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.
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Median Voter Theorem

• Most elections in the U.S. feature single member
  district (winner-takes-all) plurality (or simple
  majority) voting rules SMDP 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.
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Duvergers Law
Duvergers Law asserts that winner-takes-all-plura
lity 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.
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Duvergers 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.
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Duvergers Law
A frequent consequence of Duverger's law is the
spoiler effect, where a third-party candidate
takes votes away from one of the two leading
candidates.
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Illustration Duvergers Law
Party Platform Locations
of Voters
Example Left splinters, right maintains party
discipline and wins
Vote D
Vote R
Vote G
R
D
G
Right-Wing Values
Left-Wing Values
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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.

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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.

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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.
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Proportionate Voting Systems
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.
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Proportionate Voting Systems
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.
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Proportionate Voting Systems

• 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 to have
disproportionate power in coalition governments
because they can threaten to leave the coalition
and throw government control to the other
coalition.
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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.
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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 Duvergers Law) is intrinsic in
  winner-takes-all plurality systems.
• To learn more, visit the Center for Voting and
  Democracys website http//www.fairvote.org/irv/

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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.

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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.

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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.

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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.

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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.

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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.

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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).

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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).

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• 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).

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Application of Social Choice Theory to
Self-Governance of Local CPRs

• Field research generally indicates that rules
  linking CPR harvest shares to an appropriators
  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.

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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.
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Political Economy of the Montreal Protocol

• 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.
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Political Economy of the Montreal Protocol

• 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.

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Political Economy of the Montreal Protocol

• 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.
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Political Economy of the Montreal Protocol

• 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.

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Political Economy of the Montreal Protocol

• 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. 19394).