The Economic Roots of Environmental Decline: Property Rights or Path Dependence?

Goodstein, Eban, Journal of Economic Issues

Environmental economics has developed over the last 25 years by exploiting the theoretical apparatus of neoclassical microeconomics. In particular, environmental problems have been viewed through the lens of property rights: pollution arises because all resources (air, water, land) are not privately owned. This theoretical framework has led to a simple policy focus: simulate the outcome that would be achieved if all resources were privately owned (and markets were competitive). The two principal mechanisms that have been suggested for achieving this result, marketable permit systems and effluent taxes, are together known as Incentive-Based (IB) regulation.(1)

However, the conventional approach to environmental issues has recently been challenged on both the theoretical and policy fronts. From the theory perspective, dynamic issues are increasingly at the forefront of environmental analysis: "sustainable development" and "clean technologies" are terms that do not fit well into the property rights lexicon. While neoclassical theory does take a nod in the direction of long-term technology choice, the vast majority of research within the property-rights paradigm has been directed at more tractable issues of short-term cost-effectiveness and static efficiency.(2)

On the policy front, after 20 years of advocacy, environmental economists have won a major battle: incentive-based regulation is now widely accepted, even among many environmental organizations, as more cost-effective than so-called command-and-control regulation. But this victory has occurred at the same time that government and industry officials, environmental activists, and just plain folks have become frustrated by the explosion in rent-seeking activity inherent in information-intensive regulation of any sort - incentive-based or otherwise.(3) Given the conflict-ridden and costly regulatory apparatus, interest has turned toward preventing pollution in the first place, rather than regulating it after it has been produced.(4) With this increasing focus on the dynamic relationship between technology choice and sustainability, mining the property rights framework for further insights has reached the point of rapidly diminishing returns.

An alternative economic approach to understanding the roots of environmental decline can be found in the theory of path dependent technology choice. The basic idea here is that, at any given moment, technological progress can proceed along a variety of paths; once a path is chosen, however, positive feedback mechanisms (scale economies, R&D commitments, complementary investments, increasing consumer acceptance) lock society onto that path. The policy challenge is to nudge technology choice from a less to a more sustainable track, where sustainability is defined in terms of non-declining social welfare for future generations [e.g., Pezzey 1992].

This paper first explores how path dependence explains environmental decline and then considers the implications for policy. The conclusions are twofold. First, dynamic, rather than static, considerations should dominate regulatory design. In a dynamic framework, the choice between incentive-based and pejoratively labelled "command-and-control" regulation becomes less critical than is generally assumed. Second, environmental policy can and should move beyond regulation. Path dependence theory suggests a screen for successfully "picking winners" - technologies worthy of government promotion on sustainability grounds - while minimizing rent-seeking behavior.

Path Dependence and Environmental Decline

Path dependence theory begins by assuming the existence of positive feedback mechanisms in technological development. These can be driven by traditional economies of scale, learning by doing, the development of complementary industries and infrastructure, or a concentration of R&D resources on the chosen path.(5) As Arthur [1991] notes, in a real-world context, increasing returns to scale dominate "knowledge-based" technologies, requiring "large initial investments in research and development and tooling." Arthur cites "computers, pharmaceuticals, missiles, aircraft, automobiles, software, [and] telecommunications and fiber optics." To this list we could add environmentally attractive technologies like solar electric power (photovoltaics and solar thermal), alternative agriculture, waste reduction in manufacturing, or solid waste recycling.

A less obvious source of positive feedback can be found in the decreasing consumer resistance to new technologies as market penetration increases. Many environmentally superior technologies compete in mature markets, for example, solid waste recycling, energy efficient technologies, and alternative agriculture. These technologies do not "market themselves" in the sense of filling a new niche or providing a better service. Thus, a major marketing commitment is necessary to overcome consumer resistance. But low profit margins may not justify the large sunk costs associated with such a campaign. Goodstein [1994] argues that this presents a primary obstacle standing in the way of rapid diffusion of otherwise cost-effective and small-scale clean technologies.

The second assumption of path dependence theory is that at critical junctures in history, two or more technologies that generate comparable services compete for resources. Given the existence of positive feedback mechanisms, the triumph of one technology over the other becomes a matter of which first establishes a significant foothold. This in turn can depend on factors as diverse as "unexpected successes in the performance of prototypes, whims of early developers, [and] political circumstances" [Arthur 1989].

Examples of this type of history-specific triumph of one technology over the other that have been discussed include the QWERTY typewriter keyboard [David 1985], AC electricity [David and Bunn 1987], VHS videotape formats, Japanese automobiles, the FORTRAN computer language [Arthur 1991], and the selection of light-water nuclear reactors and the gasoline engine [Arthur 1989]. Path dependence theory has also been used to explain industry location patterns [Krugman 1991], the persistence of inefficient institutions [Setterfield 1993], as a criticism of laissez-faire policy [Hodgson 1991], and to make the case for investment in fossil fuel conservation [England, forthcoming].

Given positive feedbacks, path dependent technology choice means that once a path is chosen, it becomes very difficult to switch to an alternative path. As Arthur [1989] shows, even if the long-term marginal costs of the alternative …

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Publication information: Article title: The Economic Roots of Environmental Decline: Property Rights or Path Dependence?. Contributors: Goodstein, Eban - Author. Journal title: Journal of Economic Issues. Volume: 29. Issue: 4 Publication date: December 1995. Page number: 1029+. © 1999 Association for Evolutionary Economics. COPYRIGHT 1995 Gale Group.

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