6
The Tradable Permits Approach to Protecting the Commons: What Have We Learned?

Tom Tietenberg

One of the new institutional approaches for coping with the problem of rationing access to the commons involves the use of tradable permits. Applications of this approach have spread to many different types of resources and many different countries. A recent survey found 9 applications in air pollution control, 75 applications in fisheries, 3 applications in managing water resources, 5 applications in controlling water pollution, and 5 applications in land use control (Organization for Economic Co-operation and Development, 1999:Appendix 1:18-19). And that survey failed to include many current applications.1

Tradable permits address the commons problem by rationing access to the resource and privatizing the resulting access rights. The first step involves setting a limit on user access to the resource. For fisheries this would involve the total allowable catch. For water supply it would involve the amount of water that could be extracted. For pollution control it typically specifies the aggregate amount of emissions allowed in the relevant control region. This limit defines the aggregate amount of access to the resource that is authorized. These access rights are then allocated on some basis (to be described) to potential individual users. Depending on the specific system, these rights may be transferable to other users and/or bankable for future use. Users who exceed limits imposed by the rights they hold face penalties up to and including the loss of the right to participate.

These approaches have been controversial.2 The controversy arises from several sources, but the most important concerns the allocation of the wealth associated with these resources. Although these approaches typically do not privatize the resources, as conventional wisdom might suggest, they do privatize at least to some degree access to and use of those resources. Because the access rights can



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The Drama of the Commons 6 The Tradable Permits Approach to Protecting the Commons: What Have We Learned? Tom Tietenberg One of the new institutional approaches for coping with the problem of rationing access to the commons involves the use of tradable permits. Applications of this approach have spread to many different types of resources and many different countries. A recent survey found 9 applications in air pollution control, 75 applications in fisheries, 3 applications in managing water resources, 5 applications in controlling water pollution, and 5 applications in land use control (Organization for Economic Co-operation and Development, 1999:Appendix 1:18-19). And that survey failed to include many current applications.1 Tradable permits address the commons problem by rationing access to the resource and privatizing the resulting access rights. The first step involves setting a limit on user access to the resource. For fisheries this would involve the total allowable catch. For water supply it would involve the amount of water that could be extracted. For pollution control it typically specifies the aggregate amount of emissions allowed in the relevant control region. This limit defines the aggregate amount of access to the resource that is authorized. These access rights are then allocated on some basis (to be described) to potential individual users. Depending on the specific system, these rights may be transferable to other users and/or bankable for future use. Users who exceed limits imposed by the rights they hold face penalties up to and including the loss of the right to participate. These approaches have been controversial.2 The controversy arises from several sources, but the most important concerns the allocation of the wealth associated with these resources. Although these approaches typically do not privatize the resources, as conventional wisdom might suggest, they do privatize at least to some degree access to and use of those resources. Because the access rights can

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The Drama of the Commons be very valuable when the resource is managed efficiently, the owners of these rights may acquire a substantial amount of wealth. Although the ability to reclaim the previously dissipated wealth for motivating sustainable behavior is an important strength of the system, the ethical issues raised by its distribution among competing claimants are a significant and continuing source of controversy (McCay, 1999). Another source of controversy involves a broad class of externalities. In general, externalities are effects on the ecosystem or on other parties that are not reflected adequately in the decisions by those holding the access rights. This incomplete internalization of externalities could involve diverse concerns such as adverse effects on species of fish other than those regulated by tradable permits, on the spatial concentration of emissions, or on the consequences of particular upstream water uses on downstream users. A final source of controversy is ideological. It suggests that because capitalist property rights are the major source of the problem, it is inconceivable that these same rights could be part of the solution.3 OVERVIEW In this essay I review the experience with three main applications of tradable permit systems: air pollution control, water supply, and fisheries management.4 The next section provides a brief summary of the theory behind these programs and both the economic and environmental consequences anticipated by this theory. Some brief points of comparison are made with other competing and/ or complementary formal public policy strategies such as environmental taxes and legal regulation. The essay proceeds with a description of the common elements these programs share and the design questions posed by the approach. These include the setting of the limit on access, the initial allocation of rights, transferability rules (both among participants and across time) as well as procedures for monitoring and enforcement. It continues by examining how these design questions have been answered by the air pollution, fishery, and water supply applications and how the answers have evolved over time. This evolution has been influenced by changing technology, increased familiarity with the system, and a desire to respond to some of the controversies surrounding the use of these approaches. The penultimate section examines the hard evidence on the economic and environmental consequences of adopting these approaches. This evidence is juxtaposed with the expectations created by both the economic theory of tradable permits and the theory of choice between co-management and tradable permits by Rose (this volume:Chapter 7). The final section brings together some tentative lessons that can be drawn from this experience.

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The Drama of the Commons THE BASIC ECONOMIC THEORY Our inquiry begins by defining what is meant by an optimal allocation of a resource and by extracting the principles that can be used to design economic incentive policies that fulfill the optimality conditions. Optimality theory can help us understand the characteristics of these economic approaches in the most favorable circumstances for their use and assist in the process of designing the instruments for maximum effectiveness. The Economic Approach to Optimal Resource Management What is meant by the optimal allocation of a resource depends on how the “policy target” is defined. Several possible targets have been considered in the literature.5 Chronologically the first forays into instrument design were based on traditional concepts of economic efficiency. The economically efficient allocation of a resource, defined in partial equilibrium terms, maximizes the net benefits to society, where net benefits are defined as the excess of benefits over costs.6 Ignoring corner solutions (i.e., when the optimum involves either no use or total use), efficiency is achieved when the marginal benefit of that last unit used is equal to the marginal cost of its provision. Because the resulting allocation of responsibility is quite sensitive to both spatial and temporal considerations, defining optimality in terms of efficiency imposes a heavy information burden both on modelers and on those charged with the responsibility for implementing the policies. Not only does an efficiency target make it necessary to track the physical relationships underlying the use of the resource, but it also requires monetizing the consequences (both human and nonhuman). Each of these steps is subject to data limitations and uncertainties. Even when the information burdens associated with the efficiency criterion can be surmounted, it is not universally accepted as an appropriate criterion outside the discipline of economics. Applying this criterion has several somewhat subtle implications, some of which are quite controversial. Take as just one example the class of pollutants having a major impact on human health. The efficiency criterion implies, all other things being equal, targeting more resources toward controlling those emissions that affect larger numbers of people (because the marginal damage caused by a unit of emissions is higher in that setting). This particular allocation of control resources can result in lower individual risks for those in high-exposure settings. This contradicts a popular policy premise that suggests that citizens should face equal individual risks regardless of where they work or reside.7 To respond to both the information and moral concerns with an efficiency approach, the tradable permit approach starts from a sustainability perspective.8 Whereas efficiency may or may not be consistent with a sustainable allocation,

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The Drama of the Commons the tradable permits program starts by defining a sustainable target. The sustainable target may or may not be efficient,9 but it does provide a good opportunity to achieve sustainable outcomes even in cases where efficient allocations may not be compatible with sustainability.10 Value-Maximizing, Sustainable Policy Instruments One of the insights derived from the empirical literature is that traditional command-and-control regulatory measures, which depended on government agencies to both define the goals and the means of meeting them, were, in many cases, insufficiently protective of the value of the resources.11 One of the principal theorems of environmental economics demonstrates that under specific conditions, an appropriately defined tradable permit system can maximize the value received from the resource, given the sustainability constraint (Baumol and Oates, 1971,1988). The logic behind this result is rather simple. In a perfectly competitive market, permits will flow toward their highest valued use. Those that would receive lower value from using the permits (due to higher costs, for example) have an incentive to trade them to someone who would value them more. The trade benefits both parties. The seller reaps more from the sale than she could from using the permit, and the buyer gets more value from the permit than he pays for it. A rather remarkable corollary (Montgomery, 1972) holds that this theorem is true regardless of how the permits are allocated initially among competing claimants. It is true regardless of whether permits are auctioned off or allocated free of charge. Furthermore, when permits are allocated free of charge, any particular initial allocation rule can still support a cost-effective allocation. Again the logic behind this result is rather straightforward. Whatever the initial allocation, the transferability of the permits allows them ultimately to flow to their highest valued uses. Because those uses do not depend on the initial allocation, all initial allocations result in the same outcome and that outcome is cost-effective. The potential significance of this corollary is huge. It implies that with tradable permits, the resource manager can use the initial allocation to solve other goals (such as political feasibility or ethical concerns) without sacrificing cost-effectiveness. In Alaskan fisheries, for example, some of the quota has been allocated to communities (rather than individuals) to attempt to protect community interests (Ginter, 1995).12 Preconditions Tradable permits systems may not maximize the value of the resource if the market conditions are not right. Circumstances when the conditions may not be right include the possibility for market power (Hahn, 1984), the presence of high

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The Drama of the Commons transaction costs (Stavins, 1995), and insufficient monitoring and enforcement.13 Because tradable permits involve an aggregate limit on access, however, the consequences of market power and/or high transaction costs typically affect costs more than environmental quality. Furthermore, even in the presence of these imperfections, tradable permit programs can be designed to mitigate their adverse consequences.14 Without effective enforcement, permit holders who don’t get caught may gain more by cheating than by living within the constraints imposed by their allocated permits. In contrast to the two previously mentioned imperfections, this one could lead to the degradation of the resource because the aggregate limit could be breached. Another important precondition involves the absence of large uninternalized externalities.15 The presence of uninternalized externalities would imply that maximizing the net benefits of permit holders would not necessarily maximize net benefits for society as a whole, even with a fixed environmental target. For example, fishermen might catch the specified amount of the covered species, but they might use gear that destroys other components of the marine ecosystem. Polluters that reduce a covered pollutant by switching inputs could well increase emissions of another unregulated pollutant. The regulation could serve to protect one environmental resource at the expense of another. Comparing Tradable Permits with Environmental Taxes The mathematics underlying the theorems mentioned also can be used to demonstrate similar theoretical properties for environmental taxes. For every tradable permit system that maximizes the value of the resource, there exists an environmental tax that could achieve the same outcome. In principle, therefore, taxes and tradable permits exhibit a striking symmetry. In practice, however, this symmetry disappears and striking differences can arise. Once a quantity limit is specified, the government has no responsibility for finding the right price in a tradable permit system; the market defines the price. With a tax system, the government must find the appropriate tax rate—no small task. And with a tax system, the resource rents normally are channeled to the government. With tradable permits, resource users typically retain them. Recent work examining how the presence of preexisting distortions in the tax system affects the efficiency of the chosen instrument suggests that the ability to recycle the revenue (rather than give it to permit holders) can enhance the cost-effectiveness of the system by a large amount. That work, of course, creates a bias toward taxes or auctioned permits and away from “grandfathered” permits (Goulder et al., 1999). How revenues are distributed, however, also affects the attractiveness of alternative approaches to environmental protection from the point of view of the various stakeholders. To the extent that stakeholders can influence policy

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The Drama of the Commons choice, “grandfathering” may increase the feasibility of implementation (Svendsen, 1999). Over time the two systems may act quite differently as well if the government decides not to intervene in the market. In a tradable permits system, inflation will merely result in higher permit prices; the limit will remain intact. With taxes the amount of environmental protection will decline over time (as the real value of the tax declines) in the absence of some kind of indexing scheme. Conversely, technical progress that lowers compliance cost will result in more environmental protection under taxes than tradable permits. Finally, the presence of uncertainty about the benefits and costs can lead to a preference of one instrument or the other depending on the nature of the uncertainty (Weitzman, 1974). DESIGN CONSIDERATIONS Governance Structures The academic community has emphasized the importance of co-management of environmental resources, with users having a substantial role. This is presumed to increase compliance.16 Although tradable permit systems in principle allow a variety of governance systems, the current predominant form in all three applications seems to be a system of shared management, with users playing a smaller role than envisioned by most co-management proposals. For those resource regimes in the United States, it is common for the goals to be set by the government (either at the national or state level) and considerable “top-down” management to be in evidence. In the case of air pollution, specific quantitative ambient standards are set at the national level, and all programs must live within those limits. In the sulfur allowance program, a national program, the emissions cap also is set at the national level. In the RECLAIM system, the emissions cap was established by the local air quality management district, but the district is subject to the oversight of the national Environmental Protection Agency (EPA) and must show how its choice will enable it to meet the nationally set ambient standards. Fisheries have a somewhat similar governance arrangement. The Secretary of Commerce and his implementing agency, the National Marine Fisheries Service, use their oversight and approval powers to attempt to assure that locally created approaches meet the various requirements of the Magnuson-Stevens Act, as amended.17 Unlike the ambient standards, which are quantitatively precise, these objectives are more vaguely specified. That allows the Secretary more discretion, which can be used either to exercise stronger control or to allow more community discretion.18 Subject to this oversight, regional fisheries councils de-

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The Drama of the Commons fine both the caps and the rules. Although representatives of access right holders usually are represented on these councils, other groups are represented as well. Although the use of true co-management in air pollution control is rather rare, some limited forms are beginning to appear in both fisheries and water. Water user associations, for example, play a considerable role in allocating water resources in Chile. Although the Dirección General de Aguas has broad authority in water resource management, much of the actual control over river flows is exercised by the Juntas de vigilancia, associations made up of all users and users associations on a common section of a river (Hearne, 1998). The absence of centralized control by California over its groundwater has resulted in the growth of a number of basin authorities controlled by water producers. The transfers of rights that take place among producers of groundwater can be seen as “informal” tradable rights markets.19 These informal markets appear to be much more likely to involve user-defined rules. In fisheries, particularly those involving highly sedentary species such as lobsters, substantial local control by users typically is exercised.20 For example, Maine controls its lobster fishery by means of a zonal system. Fishers within these zones play a considerable role in defining the rules that govern fishing activity within their zone. Though none of the zones currently involve the use of tradable permits, that option is being discussed. Following the U.S. Congress-imposed moratorium on individual transferable quotas (ITQs), some alternative self-regulation alternatives arose in fisheries. In the Pacific whiting fishery in the Bering Sea, the annual total allowable catch (TAC) of whiting is divided among various sectors, including the catcher-processor vessels, which hold 34 percent of the 1997-2001 TAC (National Research Council, 1999:130). In April 1997, the four companies holding limited entry permits in the catcher-processor sector agreed to allocate the quota among themselves, forming a cooperative for the purpose. To avoid possible antitrust prosecution, a potential barrier to user-based management agreements in the United States, members submitted their proposal to the Department of Justice, which approved it. Though this is not a formal tradable permit, the negotiations over allocations among participants have begun to take on some of the attributes of an informal market. It should not be surprising that although tradable permit systems potentially allow for a considerable co-management role, only in fisheries and water is there any evidence of an evolution in this direction. The pollution and natural resource cases exhibit an important asymmetry. For air pollution control, the benefits from resource protection fall on the victims of air pollution, not on the polluters who use the resource; from a purely self-interest point of view, resource users (polluters) would be quite happy to degrade the resource if they could get away with it. On the other hand, water users and fishers both can benefit from protection of the resource. Their collective self-interest is compatible with resource protection. This

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The Drama of the Commons suggests that the incentives for collective action should be, and apparently are, quite different in these two cases. The Baseline Issue In general, tradable permit programs fit into one of two categories: a credit program or a cap-and-trade program. The credit program involves a relative baseline. With a credit program, an individual access baseline is established for each resource user. The user who exceeds legal requirements (say by harvesting fewer fish than allowed or emitting less pollution than allowed) can have the difference certified as a tradable credit. The cap-and-trade program involves an absolute baseline and trades allowances rather than credits. In this case a total resource access limit is defined and then allocated among users. Air pollution control systems and water have examples of both types. Fisheries tradable permit programs are all of the cap-and-trade variety. Credit trading, the approach taken in the Emissions Trading Program (the earliest program) in the United States, allows emission reductions above and beyond legal requirements to be certified as tradable credits. The baseline for credits is provided by traditional technology-based standards. Credit trading presumes the preexistence of these standards and it provides a more flexible means of achieving the aggregate goals that the source-based standards were designed to achieve. Allowance trading, used in the U.S. Acid Rain Program, assigns a prespecified number of allowances to polluters. Typically the number of issued allowances declines over time and the initial allocations are not necessarily based on traditional technology-based standards; in most cases the aggregate reductions implied by the allowance allocations exceed those achievable by standards based on currently known technologies. Despite their apparent similarity, the difference between credit- and allowance-based trading systems should not be overlooked. Credit trading depends on the existence of a previously determined set of regulatory standards. Allowance trading does not. Once the aggregate number of allowances is defined, they can, in principle, be allocated among sources in an infinite number of ways. The practical implication is that allowances can be used even in circumstances (1) where a technology-based baseline either has not been, or cannot be, established, or (2) where the reduction is short lived (such as when a standard is met early) rather than permanent. The other major difference is that cap-and-trade programs generally establish an upper aggregate limit on the resource use, while the credit programs establish only an upper limit for each user. In the absence of some other form of control over additional users, an increase in the number of users can lead to an increase in aggregate use and the eventual degradation of the resource.

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The Drama of the Commons The Legal Nature of the Entitlement Although the popular literature frequently refers to the tradable permit approach as “privatizing the resource” (Spulber and Sabbaghi, 1993; Anderson, 1995), in most cases it doesn’t actually do that. One compelling reason in the United States why tradable permits do not privatize these resources is because that could be found to violate the well-established “public trust doctrine.” This common law doctrine suggests that certain resources belong to the public and that the government holds them in trust for the public; they can’t be given away.21 Economists have argued consistently that tradable permits should be treated as secure property rights to protect the incentive to invest in the resource. Confiscation of rights could undermine the entire process. The environmental community, on the other hand, has argued just as consistently that the air, water, and fish belong to the people and, as a matter of ethics, they should not become private property (Kelman, 1981). In this view, no end could justify the transfer of a community right into a private one (McCay, 1998). The practical resolution of this conflict has been to attempt to give “adequate” (as opposed to complete) security to the permit holders, while making it clear that permits are not property rights.22 For example, according to the title of the U.S. Clean Air Act dealing with the sulfur allowance program: “An allowance under this title is a limited authorization to emit sulfur dioxide. … Such allowance does not constitute a property right” (104 Stat. 2591). In practice this means that administrators are expected to recognize the security needed to protect investments by not arbitrarily confiscating rights. They do not, however, give up their ability to change control requirements as the need arises. In particular, they will not be inhibited by the need to pay compensation for withdrawing a portion of the authorization to emit as they would if allowances were accorded full property right status. It is a somewhat uneasy compromise, but it seems to have worked. Adaptive Management One of the initial fears about tradable permit systems is that they would be excessively rigid, particularly in the light of the need to provide adequate security to permit holders. Policy rigidity was seen as possibly preventing the system from responding either to changes in the resource base or to better information. This rigidity could seriously undermine the resilience of biological systems (Holling, 1978). Existing tradable permit systems have responded to this challenge in different ways depending on the type of resource being covered. In air pollution control, the need for adaptive management typically is less immediate and the allowance typically is defined in terms of tons of emissions. In biological systems, such as fisheries, the rights typically are defined as a share of the TAC. In this

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The Drama of the Commons way the resource managers can change the TAC in response to changing biological conditions without triggering legal recourse by the right holder.23 Some fisheries actually have defined two related rights (Young,1999). The first conveys the share of the TAC, while the second conveys the right to catch a specific number of tons of harvest in a particular year. Separating the two rights allows a harvester to sell the right to catch fish in a particular year (perhaps due to an illness or malfunctioning equipment) without giving up the right of future access.24 Water has a different kind of adaptive management need. Considerable uncertainty among users is created by the fact that the amount of water can vary significantly from year to year.25 Because different users have quite different capacities for responding to shortfalls, the system for allocating this water needs to be flexible enough to respond to this variability or the water could be seriously misallocated. These needs have been met by a combination of technological solutions (principally water storage) and building some flexibility into the rights system. In the American West, the appropriation doctrine that originated in the mining camps created a system of priorities based on the date of first use. The more senior rights then have a higher priority of claim on the available water in any particular year and consequently could be expected to claim the highest price (Howe and Lee, 1983; Livingston, 1998).26 Other systems, most notably in Australia, use a system of proportionality that resembles the share system in fisheries (Livingston, 1998). An alternative approach to flexibility with security, the “drop-through mechanism,” involves a cascade of fixed-term entitlements, a variation of an approach currently used in the New South Wales fishery (Young, 1999) and proposed for use in controlling climate change (Tietenberg, 1998b). Under this scheme, initial entitlements (call them Series A Entitlements) would be defined for a finite period, but one long enough to encourage investments (say, for the sake of illustra tion, 30 years; see Figure 6-1). The rights and obligations covered by the Series A entitlements would be known in advance.27 Periodically (say, for illustration, every 10 years) a comprehensive review would be undertaken that would result in a new set of entitlements (Series B, Series C, and so forth) that also would have a 30-year duration. Emitters holding Series A Entitlements could have the option to switch to the new set of entitlements at any time earlier than the expiration of their Series A Entitlements. Once they switched they would be able to hold Series B Entitlements for their remaining life. This process would continue until it appeared no more reviews were necessary. Defining the Aggregate Limits In all three applications, the limits are defined on the basis of some notion of sustainable use. In air pollution control, the limits are defined to assure that the resulting concentrations fall below the Ambient Air Quality Standards (AAQS).

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The Drama of the Commons FIGURE 6-1 Building resilience into tradable permit systems. SOURCE: Based on Figure 7-1 in Young and McCay (1995). Reprinted with permission. The primary AAQS are defined at levels that protect human health.28 In water the aggregate limit typically is based on expected water flow (Easter et al., 1998). In formal tradable permit fisheries, the governing body routinely estimates the size of the fish stocks to determine the amount of fish that can be harvested in a given year so that fisheries can be sustained; this amount is termed the “allowable biological catch” (ABC). The catch level that fishermen are allowed to take, the total allowable catch, normally would be equal to or less than the ABC (National Research Council, 1999:3). Initial Allocation Method The initial allocation of entitlements is perhaps the most controversial aspect of a tradable permits system. Four possible methods for allocating initial entitlements are:

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The Drama of the Commons multispecies fisheries. Water control authorities must cope with the consequences of trades on downstream users. These small-scale, complex resources with multiple externalities may be better managed by cooperative arrangements. The academic community has emphasized the importance of co-management of environmental resources, with users having a substantial role. Although tradable permit systems in principle allow a variety of governance systems, only in fisheries and water is there any evidence of an evolution in this direction. The current predominant form in both air pollution control and fisheries seems to be a system of shared management, with users playing a smaller role than envisioned by most co-management proposals. For those resource regimes located in the United States, it is common for the goals to be set at the national level and considerable “top-down” management to be in evidence. The management of water resources seems closest to user-controlled co-management schemes. In those systems, the rights markets are at the “informal” end of the spectrum. Although tradable permit systems in principle allow a variety of governance systems, the only evidence of an evolution toward true co-management has occurred in fisheries and water. The pollution and natural resource cases exhibit an important asymmetry. For air pollution control, the benefits from resource protection fall on the victims of air pollution, not on the polluters who use the resource. From a purely self-interest point of view, resource users (polluters) would be quite happy to pollute the air if they could get away with it. On the other hand, water users and fishers can both benefit from protection of the resource. Their collective self-interest is compatible with resource protection. This suggests that the incentives for collective action should be quite different in these two cases, and this difference could well explain the lower propensity for collective self-governance in the air pollution case. A main element of controversy in tradable permits systems involves both the processes for deciding the initial allocation and the initial allocation itself. These problems seem least intense for air pollution and most intense for fisheries. Though a rich set of management and initial allocation options exists, current experience seems not to have been very creative in their use. Tradable permit programs are sometimes held to be a relatively rigid approach to resource management. This expectation is created by the belief that once instituted, property rights cannot be changed. In fact, implemented tradable permit programs have exhibited a considerable amount of flexibility. A variety of new design features (such as zero-revenue auctions, bycatch quotas, and drop-through mechanisms) have emerged that are tailored to the characteristics of particular resources. These offer greater flexibility in meeting the needs of particular resource systems. For example, especially flexible adaptive management systems have evolved in programs designed to protect resources that exhibit higher degrees of supply variability (fisheries and water). In their most successful applications, tradable permits have been able to simultaneously protect the resources and provide sustainable incomes for users.

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The Drama of the Commons Technology advances, such as computerized exchanges, are helping to lower transaction costs, thereby facilitating the capture of more of the rent. The two elements that most jeopardize the success of a tradable permits program are inadequate enforcement and uninternalized externalities. Unfulfilled Theoretical Expectations Two important expectations flowing from the economic theory have proved to be an inaccurate characterization of reality: The first is the theoretical expectation that transferable permit programs do not effect conservation of the resource because that is handled by the cap. In the theory, setting the cap is considered to be outside the system. Hence, it is believed, the main purpose of the system is to protect the economic value of the resource, not the resource itself. That is an oversimplification for several reasons. First, whether it is politically possible to set an aggregate limit may be a function of the policy used to achieve it. The use of grandfathered permits in the acid rain program, for example, made it possible to establish the limit on sulfur emissions. Second, in both fisheries and air pollution control, the evidence suggests that both the magnitude of the implemented limit and its evolution over time may be related to the policy. The flexibility and lower cost of meeting the limit offered by tradable permits systems can, and has, resulted in the acceptance of more stringent limits. Third, the choice of policy regime may affect the level of monitoring and enforcement, and noncompliance can undermine the achievements of the limit. Experience suggests that depending on the context, transferable permits can either improve or degrade the monitoring and enforcement situation. Fourth, the policy may trigger environmental effects that are not covered by the limit. Activity may be diverted from covered to uncovered resources. The second theoretical expectation that falls in the light of implementation experience involves the tradeoff between efficiency and equity in a tradable permits system. Traditional theory suggests that tradable permits offer a costless trade-off between efficiency and equity because, regardless of the initial allocation, the ability to trade assures that permits flow to their highest valued uses. This implies that the initial allocation can be used to pursue equity goals without lowering the value of the resource. In practice, implementation considerations nearly always allocate permits to historic uses, whether or not that is the most equitable allocation. This failure to use the initial allocation to protect equity concerns has caused other means to be introduced to protect equity considerations (such as restrictions of transfers). The additional restrictions generally do lower the value of the resource. In practice, therefore, tradable permits systems have not avoided the trade-off between efficiency and equity so common elsewhere in policy circles.

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The Drama of the Commons This evidence seems to suggest that tradable permits are no panacea, but they do have their niche. NOTES 1   Two examples of existing programs that did not make the list include the NOx Budget air pollution control program in the northeastern United States (Farrell et al., 1999) and programs to control conventional air pollutants in several states (Solomon and Gorman, 1998). For a large online bibliography covering these systems, see http://www.colby.edu/personal/t/thtieten/. 2   Consider just three examples. In air pollution control, a legal challenge was brought in Los Angeles during June 1997 by the Los Angeles-based Communities for a Better Environment (Tietenberg, 1995a). In fisheries a challenge was brought against the halibut/sablefish tradable permits system in Alaska (Black, 1997) and Congress imposed a moratorium on the further use of a tradable permits approach in U.S. fisheries (National Research Council, 1999). Though both legal cases ultimately were thrown out, as of this writing the moratorium is still in effect, despite a recommendation by the National Research Council to lift it. 3   One author, for example, compares a tradable permits system to the sale of indulgences in the Middle Ages (Goodin, 1994). 4   For a previous survey that also examines tradable permit systems across resource settings, see Colby (2000). 5   Another characteristic that affects the allocation of control responsibility is the degree to which the pollutant accumulates over time. In the interest of brevity I have not included that case. For an analysis of that case, see Griffin (1987). 6   For a general equilibrium treatment that derives the efficient allocation using a utility framework, see Tietenberg (1973). 7   As an interesting aside, the efficiency approach would tend to minimize health damage for a given level of expenditure, but it would do so by subjecting some individuals to a higher level of individual risk. 8   In this essay, “sustainability perspective” is used to refer to an outcome in which the resource itself is preserved. Sometimes called “environmental sustainability” (Tietenberg, 2000:97), this approach is more restrictive than the conventional notions of weak sustainability and strong sustainability, which maintain the value of the total capital stock and natural capital stock respectively. 9   In U.S. air pollution control, for example, an “acceptable” pollutant concentration level in the ambient air has been established on the basis of human health considerations. For fisheries the total allowable catch is usually defined in terms of the “allowable biological catch.” Because neither of these processes involves an explicit calculation of net benefits, they would be efficient only by coincidence. 10   For an excellent formal treatment of the relationship between efficiency and sustainability in both renewable and nonrenewable resource contexts, see Heal (1998). 11   For a detailed explanation of the circumstances leading to the increasing evolution of market-based approaches to pollution control, see Tietenberg et al. (1999). 12   Unfortunately the usefulness of this corollary is limited whenever more than one goal needs to be satisfied by the initial allocation. This is commonly the case, for example, when the resource managers want to use the initial allocation both to build enough support to implement the program and to treat all claimants fairly. The allocations that satisfy each of those two goals may be quite different. 13   Inadequate monitoring and enforcement, of course, plagues all policy instruments, not just tradable permit systems. 14   In the case of market power in fisheries, the maximum number of permits that can be held by any individual or defined group routinely is limited by regulation.(National Research Council, 1999). In the case of transaction costs, it is possible to design administrative systems so as to minimize these costs (Tietenberg, 1998c).

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The Drama of the Commons 15   Uninternalized externalities plague most other policy instruments as well. This precondition is not meant to differentiate tradable permit systems from other approaches, but rather to point out the conditions under which such systems work more smoothly. 16   Some empirical support for this proposition in implemented programs is beginning to appear. For example, one study of compliance behavior in the United Kingdom fishery (which was not an individual transferable quota, or ITQ, fishery) found that individuals who felt more involved in the management system had a statistically significantly lower probability of a violation (Hatcher et al., 2000). 17   Requirements of the act include the duty to end overfishing, to rebuild overfished stocks, to protect essential fish habitat, to reduce bycatch, and to consider fishing communities (National Research Council, 1999). 18   At least one major analysis of this relationship makes it clear that the Secretary of Commerce and the National Marine Fisheries Service have erred on the side of micromanagement rather than delegating too much authority to the regional councils (National Research Council, 1999:8). 19   Consider the following example from the Raymond Basin in California: “Under the Water Exchange Agreement, each party must offer to the ‘exchange pool’ its rights to water in excess of its needs for the coming year, at a price no greater than the party’s average water production cost. Parties anticipating that their access to water wil1 be inadequate to meet their needs for the coming year submit requests to the exchange pool. The watermaster matches the offers to the requests, with the lowest priced water allocated first, then the next lowest, and so on. The actual allocation does not involve the transfer of water, but rather the right to pump specific quantities of water” (Blomquist, 1992:87-88). 20   McCay (2001) provides examples of other forms of co-management in fisheries. Most of her examples do not involve ITQs, and those that do have limited participation by users. 21   For example, Article XIV of the California Constitution of 1879 denied the ownership of water to individuals and granted them a usufructuary right—the right to the use of the water (Blomquist, 1992). The 1981 Water Code in Chile stipulates that water is a national resource for public use, but rights to use water can be granted to individuals (Hearne, 1998). 22   One prominent exception is the New Zealand ITQ system. It grants rights in perpetuity (National Research Council, 1999:97). 23   Compare this case with a case where the rights were defined in tons. If biological conditions indicated the need to lower the TAC significantly, the need to confiscate existing rights might trigger suits seeking compensation against the resource manager. 24   Other systems achieve this result by allowing rights holders to lease the rights to others for a specific period of time. 25   Livingston (1998) reports on an unpublished World Bank survey that found that out of 35 developing countries examined, more than half had rainfall variability of 40 percent. 26   In the western United States, the number of rights expected to be fulfilled in any given year is determined by snowpack measurements and satellite monitoring of streamflows (Livingston, 1998). 27   The scheme is sufficiently flexible that entitlements could rise over time, fall over time, or be constant. The main condition is that the time path be specified for the duration of that particular series. 28   Some programs have additional requirements. In the lead phaseout program, the annual limits declined over time until, in the final year, they went to zero (Nussbaum, 1992). In the RECLAIM program in Los Angeles, the limits decline 8 percent per year (Fromm and Hansjurgens, 1996; Zerlauth and Schubert, 1999). 29   An interesting third possibility emerges from an examination of the air pollution control experience in Chile (Montero, 2000a). Apparently the use of a grandfathered system of allocation, coupled with the high rents from holding those permits, induced a number of previously undiscovered sources to admit their emissions in order to gain entry to the program. 30   For example, assigning rights in this way is considered one factor in how the United States was able to implement a system to control acid rain after many years of failed attempts (Kete, 1992).

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The Drama of the Commons 31   From the point of view of the user, two components of financial burden are significant: (1) extraction or control costs, and (2) expenditures on permits. Although only the former represent real resource costs to society as a whole (the latter are merely transfers from one group in society to another), to the user both represent a financial burden. The empirical evidence suggests that when a traditional auction market is used to distribute permits (or, equivalently, when all uncontrolled emissions are subject to an emissions tax), the permit expenditures (tax revenue) frequently would be larger in magnitude than the control costs; the sources would spend more on permits (or pay more in taxes) than they would on the control equipment (Tietenberg, 1985). 32   The downside occurs when the investments being rewarded were initiated purely for the purpose of increasing the initial allocation of tradable permits. Not only are these investments inefficient, but rewarding them undermines the ethical basis for an initial allocation based on historic use. 33   The “new source bias” is, of course, not unique to tradable permit systems. It applies to any system of regulation that imposes more stringent requirements on new sources than existing ones. 34   Tradable permits systems are perfectly compatible with the principles of co-management. In this case the community would play a large role in defining the goals and procedures in the system; see National Research Council (1999:135-138). 35   This setaside has not been used because sufficient allowances have been available through normal channels. That doesn’t necessarily mean the setaside was not useful, however, because it may have alleviated concerns that otherwise could have blocked the implementation of the program. 36   The revenue is returned to the original permit holders rather than retained by the government, hence the name “zero-revenue auction” (Svendsen and Christensen, 1999). 37   This concern does not arise in all communities because in several fisheries and in air pollution control, the effect of any particular transfer or set of transfers is negligible. 38   These effects may be less pronounced in short river systems. This may be one of the reasons why tradable permit markets in water are so active in Chile (Hearne, 1998). 39   In an unprecedented complaint filed in California during June 1997, the Los Angeles-based Communities for a Better Environment contends that RECLAIM is allowing the continued existence of toxic “hot spots” in low-income communities. Under RECLAIM rules, Los Angeles-area manufacturers can buy and scrap old, high-polluting cars to create emissions-reduction credits. These credits can be used to reduce the required reductions from their own operations. Under RECLAIM most California refineries have installed equipment that eliminates 95 percent of the fumes, but the terminals in question reduced less because the companies scrapped more than 7,400 old cars and received mobile source emission reduction credits, which they credited toward their reduction requirements. The complaint notes that whereas motor vehicle emission reductions are dispersed throughout the region, the offsetting increases at the refineries are concentrated in low-income neighborhoods (Marla Cone, Los Angeles Times, as cited in GREENWIRE, 7/23/97:http:/www.eenews.net/greenwire.htm). Though this particular complaint was eventually dismissed by the court, the forces of discontent that gave rise to the suit are far from silenced. 40   In fisheries, for example, stock assessments sometimes depend on the size and composition of the catch. If the composition of the landed harvest is unrepresentative of the actual harvest due to illegal discards, this can bias the stock assessment and the total allowable catch that depends on it. Not only would true mortality rates be much higher than apparent mortality rates, but the age and size distribution of landed catch would be different from the size distribution of the initial harvest (prior to discards). In fisheries this is known as “data fouling.” 41   Prior to 1988, the expected positive effects of ITQs did not materialize in the Dutch cutter fisheries due to inadequate enforcement. Fleet capacity increased further, the race for fish continued, and the quotas had to be supplemented by input controls such as a limit on days at sea (National Research Council, 1999:176). 42   Not only has the recovery of monitoring and enforcement costs become standard practice in some fisheries (New Zealand, for example), but funding at least some monitoring and enforcement activity out of rents generated by the fishery already has been included as a provision in the most

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The Drama of the Commons     recent amendments to the U.S. Magnuson-Stevens Act. The sulfur allowance program mandates continuous emissions monitoring financed by the emitting sources. 43   An IFQ is the right under a limited access system to harvest a specific quantity of fish. ITQs are a form of IFQs in which the rights are transferable. 44   It is frequently suggested that new programs should be of the “cap-and-trade” type because they reduce transaction costs. Although I agree that they reduce transaction costs, it is less clear to me that cap-and-trade programs can always achieve the political will to be implemented without gaining familiarity through the more heavily controlled credit programs. My own reading of the U.S. case suggests that we would not currently have cap-and-trade programs if we had not proceeded first to implement credit programs. These served as a training ground for the various stakeholders before moving to the more flexible programs. 45   One exception is the ITQ program used in Chilean fisheries. Here the permits are allocated by auction (Bernal and Aliaga, 1999). 46   New users have to buy into the system, while existing users retain their traditional entitlement. 46   In an interesting analysis of the cost and emissions savings from implementing an emissions trading system for light-duty vehicles in California, Kling (1994) finds that although the cost savings from implementing an emission trading program (holding emissions constant) would be modest (on the order of 1 percent to 10 percent), the emissions savings possibilities (holding costs constant) would be much larger (ranging from 7 percent to 65 percent). 48   In derby fishing the harvest is landed in a relatively short period of time, creating the need for more peak capacity. 49   In many fisheries, for example, the relevant markets are global, with many different sources of supply. In air pollution the number of participants is typically quite high. 50   An Organization For Economic Co-operation and Development review concludes, “There was very little evidence to support the hypothesis that small scale fishers would be eliminated” (National Research Council, 1999:84). REFERENCES Adelaja, A., J. Menzo, and B. McCay 1998 Market power, industrial organization and tradeable quotas. Review of Industrial Organization 13(5):589-601. Anderson, L.G. 1991 A note on market power in ITQ fisheries. Journal of Environmental Economics and Management 21(2):291-296. 1994 An economic analysis of highgrading in ITQ fisheries regulation programs. Marine Resource Economics 9:189-207. 1995 Privatizing open access fisheries: Individual transferable quotas. Pp. 453-474 in The Handbook of Environmental Economics, D.W. Bromley, ed. Oxford, Eng.: Blackwell. Annala, J.H. 1996 New Zealand’s ITQ system: Have the first eight years been a success or a failure? Reviews in Fish Biology and Fisheries 6:43-62. Baumol, W.J., and W.E. Oates 1971 The use of standards and prices for protection of the environment. Swedish Journal of Economics 73:42-54. 1988 The Theory of Environmental Policy. Cambridge, Eng.: Cambridge University Press. Bernal, P., and B. Aliaga 1999 ITQ’s in Chilean fisheries. In The Definition and Allocation of Use Rights in European Fisheries: Proceedings of the Second Workshop held in Brest, France, 5-7 May 1999, A. Hatcher and K. Robinson, eds. Portsmouth, Eng.: Centre for the Economics and Management of Aquatic Resources.

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