Oscar Wilde, in Lady Windermere's Fan (1892)
Sometimes, an ideological conflict engulfs me. Being a strong believer of the market mechanism, I have always been attempting to propagate that the market is the most important institution that has ever existed, and has the capacity of being the panacea of various ills. However, a recent debate placed me in some kind of a doubt. The critical question is related to markets for environments, and my concern is: can markets really help in combating pollution and climate change?
It is a fact that there has been a worldwide call for the development of markets for environmental services. This call, at the initial face value, is based on the faith that markets will help solve the problems of environmental pollution at various forms. The recent expansions of markets for environmental services suggest that they may rapidly become a central point of sustainable development financing that could be tens of billions of dollars annually within the next 10 to 15 years. The enthusiasm has been picking up to the extent that even commodity exchange promoters have been thinking of trading natural capital on derivative exchange platforms.
All these moves toward markets have been triggered by two major drivers that include conscious national environmental policy movements toward market-based instruments, and rising demand for environmental goods and services from public authorities, private entities, and consumers. On the one hand, there are new public regulations along with the establishment of market-based instruments, and on the other, it has become quite lucrative and fashionable for private players to show initiatives toward efforts of biodiversity protection. Consumer demand for derivatives of healthy ecosystems, such as organic foods, fair trade products, and eco-tourism, has also increased over time. Interestingly, most of these changes have primarily been noted in the developed nations. Developing nations have also been gearing up to institutionalise some of the changes, as they find that there exists a demand for certain environment-related products and services in the developed world. One such example is eco-tourism initiatives in Africa and Asia, where a large number of tourists visit the tourism spot from EU and USA.
There are several proposals that have been put forward in favour of environmental markets, entailing the overarching objective of controlling pollution. First, it has been stated that markets will help in raising funds for sustainable development financing. As a result, CDM markets have emerged through “cap and trade” mechanisms, where carbon credits are transacted. Payments for Ecosystem Services (PES) mechanisms have emerged to look after local level sustainable development issues, where beneficiaries from ecosystem services are made to pay to the local communities for the service rendered. Second, market institutions are supposed to make the common man understand the value of the services that the ecosystem provides to the economy as a whole, the incidence of economic activity on the ecosystem, and finally, its possible repercussions on the quality of life. This dictates the supply-side phenomenon of an economy, including human health, welfare, and eventually, labour markets. Third, it is felt that the price realised in the market mechanism will result in efficient allocation of resources, as market equilibrium leads to efficiency.
My concern, however, has arisen primarily from the third point. Ideally, the price of a commodity in the market should have reflected the scarcity value of the commodity. This logic emerges from the marginal utility theory and its corollary, the demand theory. It is known that marginal utility (which is the “utility” or satisfaction derived from consuming the last unit of a “good”—a “good” being anything that offers positive “utility” through consumption) is a diminishing function of availability of a commodity: more the availability, less the marginal utility, though the total utility might increase. Any consumer will consume a commodity till the point where the price of the commodity is equivalent to the marginal utility of the commodity – this is the result that emerges from the utility maximisation exercise subject to the budget constraint of the consumer. As a result, effectively, it is the one-to-one correspondence of the marginal utility “tuple” with the price “tuple” for each level of quantity, which gives rise to the demand function. On the other hand, there is a well-specified supply function, which is the marginal cost function for the firm. Finally, the market interaction between the demand and the supply forces leads to the equilibrium prices.
There is an important assumption that is taken into consideration here. This is related to the fact that the consumer is aware of the “utility” of the commodity. When I go and buy a watch from a retail store, I might pay few “extras” from my pocket if there is an underlying “big brand” producing it. This “big brand” phenomenon enhances my marginal utility by leaps and bounds. By all means, I am aware of almost every type of service that the watch will render me with. I pay extra amount as the “scarcity value” of the brand, which yields me the utility. This is true for all the commodities covered in the market framework.
The situation is, however, a bit difficult for environment as a commodity. As stated earlier, the efficient market price should ideally reflect the scarcity value of the resource. However, while value of the resource precisely emanates from its use value, scarcity value emanates from the value loss due to the existing scarcity. Under perfect market conditions, prices become equal to the scarcity value. Incidentally, the assumption out here is that the consumer is aware of what he is losing out by not consuming the resource. In the context of the environmental market, the information or knowledge is the missing element. So far, even ecological scientists have failed to decipher the range of the ecosystem services provided by nature. There is clear lack of knowledge among the general public about what will be the entire range of impacts from transboundary air or water pollution. Under these circumstances, it is difficult for the market prices to reflect the true scarcity value.
It has been argued in some quarters that during the recent financial meltdown, the CER prices came down, and that is precisely because the demand for CER, as a commodity in the consumer’s utility bundle, diminished. My concern is: does that mean that the value of environmental damage has diminished? Of course not! Pollution keeps on doing the same damage during recession, as it does during the times of prosperity. This means that there is a clear divorce between prices and value when it comes to environment. This is because buyers of environmental services are only aware of a minuscule portion of the entire range of services that the ecosystem can offer. It is only this minuscule portion that enters their utility bundle, and gets realised in the market prices.
Let us now look at the supply side of the environmental market. Ecosystem services of nature, more often than not, are independent of the environmental market phenomenon. Their supply is not contingent upon rising market prices. Nature will continue with its provision of ecosystem goods and services of gas regulation, waste treatment, climate regulation, biological control, water control and regulation, pollination, food production, soil formation, nutrient cycling, and other functions, unless disturbed by extreme anthropogenic forces or other external stimuli. Hence, supply might seem perfectly inelastic under such circumstances.
Hence, the prices are demand-determined. Unfortunately, due to arguments stated above, the entire problem is with the demand function of the environmental services. This demand schedule is formed with minuscule information. Here, I differentiate between the economic services and the ecosystem services of nature. I define the economic services as those goods and services that are directly realised by the economy, and hence finds a price in the market framework. Ecosystem services of nature also affect our economy as realised by critical ecosystem-livelihoods linkages (e.g. mangrove forests help in fishery production, storm controls, etc.), but, often these services are not taken into the fold of the market framework. The criticism against existing market frameworks also arises from the perspective that by putting a monetary value to the ecosystem we are not only putting a use-value to it, but by putting an exchange-value we are also ignoring the irreversibility of ecosystem losses. This element emerges from sheer ignorance about ecosystem, and nothing else! As a result, the entire element of scarcity value gets lost from the price realized in the market.
Concluding Remarks
Readers should not get me wrong! I am a proponent and a strong believer of the market forces. I still believe that markets can solve several problems. It is amazingly recalcitrant yet buoyant, unbridled yet resilient, ruthless yet rewarding! This essay of mine is solely based on my concerns about the present day working of the environmental markets. Markets are meant to solve problems, and therefore, there is a need to identify where its problem lies. In this case, the problem lies with information and knowledge. Market participants participate in environmental markets not merely for the sake of saving the environment. Neither is it expected that only environmentalists should participate in such markets! Without adequate speculators and investors in such markets, the market mechanism will stop functioning. The problem is that there has not been adequate information placed in public place by governments and market makers.
Let me urge yet again… there is nothing wrong with the institution of market. The wrongness lies in what we make markets to be.
All these moves toward markets have been triggered by two major drivers that include conscious national environmental policy movements toward market-based instruments, and rising demand for environmental goods and services from public authorities, private entities, and consumers. On the one hand, there are new public regulations along with the establishment of market-based instruments, and on the other, it has become quite lucrative and fashionable for private players to show initiatives toward efforts of biodiversity protection. Consumer demand for derivatives of healthy ecosystems, such as organic foods, fair trade products, and eco-tourism, has also increased over time. Interestingly, most of these changes have primarily been noted in the developed nations. Developing nations have also been gearing up to institutionalise some of the changes, as they find that there exists a demand for certain environment-related products and services in the developed world. One such example is eco-tourism initiatives in Africa and Asia, where a large number of tourists visit the tourism spot from EU and USA.
There are several proposals that have been put forward in favour of environmental markets, entailing the overarching objective of controlling pollution. First, it has been stated that markets will help in raising funds for sustainable development financing. As a result, CDM markets have emerged through “cap and trade” mechanisms, where carbon credits are transacted. Payments for Ecosystem Services (PES) mechanisms have emerged to look after local level sustainable development issues, where beneficiaries from ecosystem services are made to pay to the local communities for the service rendered. Second, market institutions are supposed to make the common man understand the value of the services that the ecosystem provides to the economy as a whole, the incidence of economic activity on the ecosystem, and finally, its possible repercussions on the quality of life. This dictates the supply-side phenomenon of an economy, including human health, welfare, and eventually, labour markets. Third, it is felt that the price realised in the market mechanism will result in efficient allocation of resources, as market equilibrium leads to efficiency.
My concern, however, has arisen primarily from the third point. Ideally, the price of a commodity in the market should have reflected the scarcity value of the commodity. This logic emerges from the marginal utility theory and its corollary, the demand theory. It is known that marginal utility (which is the “utility” or satisfaction derived from consuming the last unit of a “good”—a “good” being anything that offers positive “utility” through consumption) is a diminishing function of availability of a commodity: more the availability, less the marginal utility, though the total utility might increase. Any consumer will consume a commodity till the point where the price of the commodity is equivalent to the marginal utility of the commodity – this is the result that emerges from the utility maximisation exercise subject to the budget constraint of the consumer. As a result, effectively, it is the one-to-one correspondence of the marginal utility “tuple” with the price “tuple” for each level of quantity, which gives rise to the demand function. On the other hand, there is a well-specified supply function, which is the marginal cost function for the firm. Finally, the market interaction between the demand and the supply forces leads to the equilibrium prices.
There is an important assumption that is taken into consideration here. This is related to the fact that the consumer is aware of the “utility” of the commodity. When I go and buy a watch from a retail store, I might pay few “extras” from my pocket if there is an underlying “big brand” producing it. This “big brand” phenomenon enhances my marginal utility by leaps and bounds. By all means, I am aware of almost every type of service that the watch will render me with. I pay extra amount as the “scarcity value” of the brand, which yields me the utility. This is true for all the commodities covered in the market framework.
The situation is, however, a bit difficult for environment as a commodity. As stated earlier, the efficient market price should ideally reflect the scarcity value of the resource. However, while value of the resource precisely emanates from its use value, scarcity value emanates from the value loss due to the existing scarcity. Under perfect market conditions, prices become equal to the scarcity value. Incidentally, the assumption out here is that the consumer is aware of what he is losing out by not consuming the resource. In the context of the environmental market, the information or knowledge is the missing element. So far, even ecological scientists have failed to decipher the range of the ecosystem services provided by nature. There is clear lack of knowledge among the general public about what will be the entire range of impacts from transboundary air or water pollution. Under these circumstances, it is difficult for the market prices to reflect the true scarcity value.
It has been argued in some quarters that during the recent financial meltdown, the CER prices came down, and that is precisely because the demand for CER, as a commodity in the consumer’s utility bundle, diminished. My concern is: does that mean that the value of environmental damage has diminished? Of course not! Pollution keeps on doing the same damage during recession, as it does during the times of prosperity. This means that there is a clear divorce between prices and value when it comes to environment. This is because buyers of environmental services are only aware of a minuscule portion of the entire range of services that the ecosystem can offer. It is only this minuscule portion that enters their utility bundle, and gets realised in the market prices.
Let us now look at the supply side of the environmental market. Ecosystem services of nature, more often than not, are independent of the environmental market phenomenon. Their supply is not contingent upon rising market prices. Nature will continue with its provision of ecosystem goods and services of gas regulation, waste treatment, climate regulation, biological control, water control and regulation, pollination, food production, soil formation, nutrient cycling, and other functions, unless disturbed by extreme anthropogenic forces or other external stimuli. Hence, supply might seem perfectly inelastic under such circumstances.
Hence, the prices are demand-determined. Unfortunately, due to arguments stated above, the entire problem is with the demand function of the environmental services. This demand schedule is formed with minuscule information. Here, I differentiate between the economic services and the ecosystem services of nature. I define the economic services as those goods and services that are directly realised by the economy, and hence finds a price in the market framework. Ecosystem services of nature also affect our economy as realised by critical ecosystem-livelihoods linkages (e.g. mangrove forests help in fishery production, storm controls, etc.), but, often these services are not taken into the fold of the market framework. The criticism against existing market frameworks also arises from the perspective that by putting a monetary value to the ecosystem we are not only putting a use-value to it, but by putting an exchange-value we are also ignoring the irreversibility of ecosystem losses. This element emerges from sheer ignorance about ecosystem, and nothing else! As a result, the entire element of scarcity value gets lost from the price realized in the market.
Concluding Remarks
Readers should not get me wrong! I am a proponent and a strong believer of the market forces. I still believe that markets can solve several problems. It is amazingly recalcitrant yet buoyant, unbridled yet resilient, ruthless yet rewarding! This essay of mine is solely based on my concerns about the present day working of the environmental markets. Markets are meant to solve problems, and therefore, there is a need to identify where its problem lies. In this case, the problem lies with information and knowledge. Market participants participate in environmental markets not merely for the sake of saving the environment. Neither is it expected that only environmentalists should participate in such markets! Without adequate speculators and investors in such markets, the market mechanism will stop functioning. The problem is that there has not been adequate information placed in public place by governments and market makers.
Let me urge yet again… there is nothing wrong with the institution of market. The wrongness lies in what we make markets to be.
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