If the last two years of American economic life have demonstrated anything, it is that property rights are not static. Sometimes things that were once private property become public property (see, e.g., Motors, General). Sometimes things that were once public property become private property, then become public property again, before they presumably become private property again (see, e.g., Mae, Fannie). And sometimes things that were once considered inherently communal and thus inamenable to private property rights at all, become divided and privatized (see,e.g., the air).
Tradeable carbon emissions allowances are an example of the latter. There’s a lot to like in the cap-and-trade programs proposed under the Waxman-Markey and Kerry-Boxer bills. I hope some robust version of them passes and becomes law. But one sticky issue that needs to be resolved is how initial allowances to fill airspace with carbon gases should be allocated. Options include auctioning off all of the allowances, giving the allowances to existing carbon producers, and, most politically palatable, something in between – some mixed proportion of free allocations and auctions.
Economist Robert Stavins, in the Coasean tradtion, has insightfully argued that (with some caveats, including that transaction costs in this cap-and-trade program are similar to the transaction costs in others) the initial allocation of allowances doesn’t matter in most significant ways: it will have no effect on the distribution of allowances after trading, and will have no effect on the total magnitude of emissions and their attendant social costs.
But there is another factor economists have not addressed, that could effect the total magnitude of emissions and their attendant social costs, and that may well depend in part on the method of initial allocations: compliance.
Law Professor Christine Parker and political scientist Peter May, among others, have demonstrated that compliance with business regulation is highest when the regulated businesses believe that the regulatory regime is fair. Lower levels of compliance reduce the effectiveness of the regulation in producing the desired outcome, and increase the costs of achieving it. In the world of carbon emissions, this would mean a higher total magnitude of emissions and a reduced benefit to the public through the higher costs required to achieve them.
My research into Icelandic fisheries suggests that in moving natural resources from communal to private property through cap and trade programs, initial allocations of rights do have an important effect on the perceived fairness of the regulatory regime, and thus on the willingness of the regulated to comply with it.
In Iceland, the government decided to protect fish stocks by freely allocating tradeable fishing rights and implementing catch quotas. Permits were issued to fishing vessel owners based on their average catches during a three-year test period. New entrants to the industry must now buy their way in by purchasing or leasing rights from others through the Icelandic Quota Exchange. Although the system has been successful in reducing the overall catch, the perception that it is unfair has led to open defiance. In an extraordinary case before the Icelandic Supreme Court, one fishing company did openly what many apparently do quietly — defied the system on the grounds that it was unfair.
Transactions costs, of course, are inevitable, but it is not transaction costs that have produced resistance to the Icelandic system. Rather, resistance is itself is a type of transaction cost, broadly construed, produced by the perceived unfairness of the initial allocation of rights. In other words, the initial allocation of rights does indeed effect the overall effectiveness of a private property system.
There has been considerable uproar over the potential free allocation rights to current carbon emissions producers. Whether or not, as a matter of classical economic theory, the initial allocation of rights should effect the overall effectiveness of the program, the perception of fairness or unfairness will probably effect compliance with the system, and that in turn will effect its overall effectiveness. It is important, therefore, for policy makers to bear in mind that the perceived fairness of initial allocations of property rights does indeed matter.