The Costs of Creating Environmental Markets: A Commodification Primer

Authors

Michael Pappas
Victor B. Flatt

Abstract

Markets offer a potent tool for managing resources and values, even ones that have not traditionally been commodified. In the environmental context there is particular debate about market-based governance, in terms of both appropriateness and effectiveness. This Article offers a broadly applicable framework for considering the emergence, appropriateness, and design of market tools in environmental governance, and it demonstrates how the model is applicable well beyond that context. This framework offers a powerful diagnostic for programs to manage resources ranging from greenhouse gas emissions to Chesapeake Bay pollution, as well as from human organs to Uber regulation.

As a foundation for this framework, the Article identifies and examines two sets of underappreciated costs associated with establishing and utilizing market mechanisms. It terms these costs “severance costs” and “adjustment failure costs.”

Severance costs describe the costs associated with defining, enforcing, and transacting in marketable “goods.” For instance, to pluck an environmental good from its interconnected ecological and legal context and to attempt to define it as a severable, stand-alone commodity can be costly. Additionally, when such an environmental good is not necessarily associated with tangible, physical ownership or when it has not historically been commodified, further challenges arise in creating the complex institutions necessary for such markets to function. If severance costs are too high, property interests may never be defined or transactions may never occur.

In addition to severance costs, “adjustment failure costs” inherent in the pricing system represent another critical set of considerations that impact the emergence and success of market mechanisms. In all markets, pricing results from an iterative trial-and-error process, and it takes time and misallocations for supply and demand to align (assuming they ever do). The adjustment failure costs associated with such pricing delays and corrections may be trivial in some markets, but they can be particularly high and material in the context of non-fungible or irreparable goods. Since environmental goods in particular may display such non-fungible or irreparable characteristics, consideration of adjustment failure costs is crucial for environmental market mechanisms because high adjustment failure costs may exceed the potential gains of the market system. Thus, the adjustment failure costs that arise from the iterative function of markets represent another key factor in determining the appropriateness and success of market tools.

This Article posits that severance costs and adjustment failure costs represent the two most significant dimensions for assessing the appropriateness and design of market instruments, both in the environmental context and more broadly. If these costs are too high, either individually or in combination, they will exceed the potential gains of a market system.

Based on these sets of costs, the Article constructs a model for evaluating market emergence and success, and with this framework, the Article makes two major contributions. First, it offers a concrete and pragmatic method for gauging the desirability of market tools for certain resources in the environmental context and beyond. For instance, the model can identify specific situations where a cap-and-trade approach will be less effective than a Pigouvian-tax, or where a licensing system will be superior to a laissez-faire one. Consideration of severance costs and adjustment failure costs offers a generalizable model for describing the feasibility of commodifying environmental goods, prescribing interventions to marginally improve market instruments in general, and evaluating governance approaches for a variety of contexts.

Second, this Article contributes to the theoretical literature on commodification by offering a positive economic framework that can synthesize the leading scholarship and explain existing reservations regarding commodification. It provides a descriptive economic account that can help ground moral intuitions and objections about markets and commodification. As a result, it gives fresh insight into why existing laws and policies are as they are, and it bridges moral and economic arguments, providing a common point ofdeparture for future engagement in these debates.

Recommended Citation

Michael Pappas & Victor B. Flatt, The Costs of Creating Environmental Markets: A Commodification Primer, 9 U.C. Irvine L. Rev. 731 (2019).
Available at: https://scholarship.law.uci.edu/ucilr/vol9/iss3/7