From Market Failure Paradigm to an Institutional Theory of Environmental Governance

Transcription

1 From Market Failure Paradigm to an Institutional Theory of Environmental Governance Dr Jouni Paavola Sustainability Research Institute, School of Earth and Environment University of Leeds Leeds LS2 9JT United Kingdom 22 May 2009 Word count 6920, all inclusive A paper presented at the 8th international conference of the European Society for Ecological Economics (ESEE) Transformation, Innovation and Adaptation for Sustainability: Integrating Natural and Social Sciences in Ljubljana, Slovenia, 29 June to 2 July 2009.

2 1 From Market Failure Paradigm to an Institutional Theory of Environmental Governance Abstract This manuscript examines how an institutional theory of environmental governance might be based on a re-interpretation and re-working of the arguments of the market failure paradigm and its main criticisms. The manuscript first examines in detail the arguments of the market failure paradigm regarding externalities and public goods, as well as their criticisms. The paper then suggests an institutional re-interpretation and revision of the key arguments of the market failure paradigm. The institutional theory of environmental governance acknowledges the interdependence of economic actors and the resulting fundamental role of conflicts as the rationale for environmental governance and its institutions. As environmental conflicts are primarily a matter of distribution rather than of efficiency, it becomes important to understand the likely consequences of institutional alternatives in the specific socioeconomic and physical setting of the environmental conflicts, and the degree to which these consequences match with the pertinent social or economic goals. Keywords: Environmental governance, market failure, externalities, public goods, welfare economics, institutional economics

3 2 1. Introduction Externalities and public goods together with monopolies, economies of scale and other deviations from the assumptions of the competitive model are cornerstones of the market failure paradigm. It holds that when markets cannot deliver efficient outcomes on their own such as when externalities or public goods are present the government has to establish and implement public policies calculated to achieve optimal allocation of resources and to maximise social welfare (Cowen, 1988; Zerbe and McCurdy, 1999). The beginnings of the market failure paradigm can be traced to Pigou s (1929) seminal work in welfare economics. He identified divergences between private and social net marginal products as obstacles for maximising social welfare and suggested that government intervention could avoid sub-optimal outcomes. Paul Samuelson (1954), Richard Musgrave (1959) and others consolidated the market failure paradigm in the 1950s. However, the market failure paradigm was contested since its inception by, for example, Knight (1924), Tiebout (1956), Coase (1960, 1974) and Buchanan (1965). The critics have shown that the market failure paradigm s arguments regarding market failures and institutional responses to them have often been inconsistent or unfounded. The market failure paradigm has a narrow, state-centred view of the range of institutional solutions that can be used as a response to market failures. This view deviates significantly from the contemporary political-economic reality. States are currently relinquishing some of their authority to emerging regional and international entities such as the European Union, NAFTA, WTO and the United Nations (see e.g. Rhodes, 1996; Jordan, 1999; Jordan et al., 2005). States have also delegated authority to sub-national and local governments and have

4 3 facilitated the participation of firms, non-governmental organisations and other stakeholders in collective decision-making. Furthermore, states have recognised the authority of some actors to self-governance. This transition to the use of a greater range of institutional solutions to socio-economic challenges is sometimes called as one from government to governance (see e.g. Rhodes, 1996). However, this is misleading as the government is still intimately involved in governance because the government is needed to back up the authority and legitimacy of new governance solutions. The government may have broadened the range of governance solutions as a response to the emergence of more complex and far-reaching governance problems. From this viewpoint, the new modes of governance may be efficient responses to the transaction costs of governing (see Williamson, 1991, 1999; see also Birner and Wittmer, 2004;). The other side of the coin is that governments pursue increasingly pluralist governance goals and in this setting inclusion of actors may become necessary for the legitimacy and effectiveness of governance solutions. While it is fair to say that there is no comprehensive economic theory of governance yet, it is obvious that it will be based in part on the scholarship on public goods and externalities that has underpinned the market failure paradigm. A reinterpretation of externalities, public goods and other market failures in the light of their criticisms can offer a nuanced understanding of governance problems and institutional responses to them. To put it differently, while it was enough for the market failure paradigm to call for government intervention when an instance of a market failure was observed, the emerging governance paradigm must be able to characterise governance problems in greater detail, to identify a range of applicable

5 4 governance solutions, and to assess their likely consequences and desirability in pluralist instead of only welfarist light. This manuscript critically reviews the seminal literature in the market failure paradigm in order to distil lessons from it for a broader and more institutionally oriented analytical approach to environmental governance. In what follows, the second section reviews the notions of externalities and their criticisms. The third section examines the notions of public goods and their criticisms in greater detail. The fourth section discusses how the market failure scholarship on public goods and externalities can contribute to an institutional economic theory of environmental governance. 2. Definitions and Analysis of Externalities Alfred Marshall discussed external economies already in the end of the 19th century in his Principles of Economics (1890). Marshall defined external economies as those which are dependent on the general development of industry, in contrast to internal economies which depended on the firm s own resources, organisation, and management practices (Marshall 1947, 266). That is, he considered that the expansion of markets, technological development and improved economic infrastructure conferred benefits to agents benefits which were created by decisions made by others. In essence, for Marshall, external economies lowered the marginal costs of firms over time. The contemporary understanding of externalities can be traced back to Arthur Pigou s seminal work in welfare economics. He (1929, 176) argued that divergences between

6 5 marginal private and social net products reduce the national dividend from its potential. These divergences could occur between agents and their tenants, agents and the general public, and agents and those who purchase goods or services from them. The first and third instances of Pigou s external economies are today usually referred to as principal-agent problems and imperfect information. The contemporary conception of externalities relates to Pigou s second type of divergences, which he defined as instances where person A, in the course of rendering some service, for which payment is made, to a second person B, incidentally also renders services or disservices to other persons C, D, and E, of such sort that technical considerations prevent payment being exacted from the benefited parties or compensation being enforced on behalf of the injured parties (1929, 185). Pigou has been branded the father of market failure paradigm. He indeed argued that in any industry, where there is reason to believe that the free play of self-interest will cause an amount of resources to be invested different from the amount that is required in the best interests of the national dividend, there is a prima facie case for public intervention (1929, 331). He suggested that taxes could be used when external diseconomies are present, and that the existence of external economies would warrant the use of subsidies. Yet he clearly recognised that divergences are only a prima facie case for intervention and that the government cannot necessarily improve the situation because it is plagued by perverse incentives, incompetence and rent-seeking (1929, ). Despite some early reactions to Pigou s work (see Papandreou, 1994), Baumol could still conclude in the early 1950s that the fact that categories like external economies and diseconomies remain largely empty economic boxes prevents any further application of welfare theory as it now stands (1952: 207). However, externalities received more attention

7 6 later in the 1950s (Baumol, 1952; Scitovsky, 1952; De V. Graaff, 1957). The core definition of externalities suggested by Pigou a side effect of the activity of one agent impacting others and which is not paid or compensated for was endorsed by a new generation of economists (Kapp, 1950; Baumol, 1952; Bator, 1958; Mishan, 1971). However, as was with public goods, references to externalities became more ambiguous. For example, Meade (1952) and Bator (1958) explicitly blurred the borderline between externalities and public goods. Meade (1952) distinguished between two types of externalities he called unpaid factors and atmosphere, which corresponded with ownership failures and public goods. Bator (1958) in turn defined externalities even more broadly, effectively equating them with market failures. He distinguished between ownership, technical, and public good externalities when trying to trace their origins to institutional failures, indivisibility of goods, and joint consumption. These ambiguities tell of the difficulties to define externalities consistently. Externalities can be defined consistently, however. The difficulty of excluding users from certain goods makes it impossible to establish effective rights to them and to charge prices or to exact compensation. If goods that are difficult to exclude from are jointly consumed, they are public goods as will be discussed in greater detail in the next section. Externalities prevail when goods that are difficult to exclude from are subject to rival consumption. That is, externalities are phenomena that characterise problems in the use and management of common pool resources (see below for details). However, it is not a trivial task to determine the nature of goods or sometimes even what are the pertinent goods (see Paavola, 2007). For example, it may appear obvious for some to consider degraded air quality either as an externality or a jointly consumed good. However, it would be more appropriate to consider air basins as the pertinent goods. Air basins are

8 7 complex resources which have multiple uses and a finite capacity to cater for users in most uses. Individual uses can be either rival or non-rival consider breathing the air and visibility, for example. When the use of air basins as waste sinks reduces the ability of others to use the air basin, the uses are rival. If exclusion is difficult, air basins should be considered common pool resources. The governance challenge here is that it is difficult to prevent unauthorised use of air basins as waste sinks. Today we face a similar problem with global atmospheric sinks for greenhouse gases which makes preventing climate change difficult (Paavola, 2008). A number of economists understood that externalities are created by the difficulty of exclusion and the resulting lack of effective rights of ownership. Perhaps most influentially, Ronald Coase (1960) argued that if one follows the Pigovian reasoning which ignores transaction costs (the costs of using the market system, which include the costs of seeking information, negotiating, making contracts and enforcing them) all that is needed is to establish private property rights and to allocate them to one of the involved parties. The parties would then be able to reach the efficient allocation of resources by bargaining without government intervention. The implication was that resource allocation is independent from distributive choices: different distributions would result in the same efficient outcome (see Samuels and Medema, 1998). This is the essence of what is usually called the Coase Theorem. However, it could also be renamed the Stigler Theorem because it is essentially George Stigler s (1966: ) interpretation of Coase s argument on externalities. However, Coase s own argument about externalities was broader than Stigler s influential interpretation of it. Coase (1960) criticised Pigou s recommendation of government intervention such as the imposition of fees and the paying of subsidies as a response to

9 8 externalities. Coase demonstrated how Pigou s own analytical approach did not warrant a recommendation for public intervention (Samuels and Medema, 1998). Cheung (1973) also provided later empirical evidence according to which markets and private bargaining have been established for what are often considered externalities the services that bee keepers render for orchard owners in the course of their activities. However, Coase (1960) also demonstrated how the conclusions would change when transaction costs are recognised in the analysis, arguing that there is no reason why governmental administrative regulation should not lead to an improvement in economic efficiency (Coase, 1960: 18). This is echoed in Oliver Williamson s work (e.g. 1991, 1999) on comparative economic organisation and in Coase s own earlier work that sought to explain the existence of the firm as a solution implying lower transaction costs than markets would generate (Coase, 1937). Coase (1960) also demonstrated that the specification and assignment of rights are important policy issues because alternative definitions of rights will result in different economic outcomes in the presence of transaction costs. However, Coase (1960) made the same kind of mistake he accused Pigou of when arguing that the allocation of rights should be chosen on the basis of cost-benefit considerations (see Samuels and Medema, 1998). That is, he in the end failed to respect the assumptions and limitations of his own analytical framework. His analysis considered the implications of alternative rights structures which create different distributions of wealth and income and different sets of prices, and which are not comparable in Paretian terms. Coase was more to the point when he suggested that the choice among different social arrangements must ultimately dissolve into a study of aesthetics and morals in the presence of transaction costs (Coase, 1960: 43; see also Calabresi, 1991).

10 9 Coase s arguments suggest that externalities prevail because transaction costs prevent the establishment of effective entitlements to all dimensions of all goods. They also suggest that transaction costs influence what governance solutions will be used, and that these may not always be private property rights and markets even when governance choices are informed by efficiency considerations. Coase highlighted that in principle attenuated systems of rights can perform governance functions well in the presence of transaction costs although they may not appear optimal in the analytical frameworks that ignore transaction costs (see also Birner and Wittmer, 2004; Paavola, 2007; Paavola, forthcoming). Omission of transaction costs from analysis can have troubling consequences. For example, Hardin (1968) argued that common ownership of natural resources such as forests, pastures and fisheries will lead to their destruction or to the tragedy of the commons. This prediction provided the rationale for nationalisation and privatisation of natural resources in the developing world in the 1970s. However, substantial amount of evidence exists now according to which common ownership can facilitate sustainable use of resources where open access would lead to their destruction and private ownership is not a feasible alternative (Bromley and Cernea, 1989; Ostrom, 1990). Ironically, misinformed nationalisation and privatisation have caused wide-spread environmental destruction in the developing world because they destroyed the security of customary entitlements and replaced them with uncertain and illegitimate entitlements which could not be enforced effectively. Others have taken Coase s arguments to the extreme, suggesting that externalities exist solely because of transaction costs or, more specifically, because of exclusion costs and that externalities may reflect what it is most efficient to do when exclusion costs are properly

11 10 considered (Buchanan and Stubblebine, 1962; Demsetz 1964). Dahlman (1979) demonstrated that, when taken to its logical conclusions, this line of reasoning leaves no conceptual ground for suggesting government intervention into externality situations. Yet this does not mean that we should not intervene into externality situations: it simply means that the conventional externality scholarship cannot provide consistent justifications for doing so. Dahlman (1979) himself suggested that we should look carefully at the consequences of institutional alternatives in an externality situation. Different institutional arrangements define entitlements differently and will result in different levels and distributions of transaction costs. Therefore, they will also influence what efficient outcomes will be produced (see also Calabresi, 1991; Paavola, 2002; Samuels and Medema, 1998). This view resonates with the above cited view of Coase according to which institutional choices are ultimately a matter of aesthetics and morals, and together the two sets of arguments can in their part help to underpin an institutional theory of environmental governance. Additional insights can be gained from debates on public goods, as will be discussed in greater detail in the next section. 3. Definitions and Analysis of Public Goods Central and local governments and various organisations have provided public goods such as religious rites, public safety and defence from the time immemorial. However, while John Stuart Mill and Henry Sidgwick did identify the challenge of supplying public goods already in the 19th century, they did not receive serious attention in economics before the mid-20th century. In his ground-breaking work, Paul Samuelson (1954: 387) defined public goods as

12 11 collective consumption goods which all enjoy in common in the sense that each individual s consumption of such a good leads to no subtraction from any other individual s consumption of that good. Others have later called this attribute of certain goods as joint consumption (Head, 1962). Samuelson (1954) concluded on the basis of his analysis that the market system does not make available an optimal amount of jointly consumed goods and that for this reason they should be publicly provided. Samuelson s views of public goods did not remain uncontested. Some, such as Margolis (1955), criticised Samuelson s definition of public goods as not matching with the attributes of many publicly provided goods. Others contested the idea that public goods are enjoyed by all by arguing that it is possible to exclude users from many publicly provided goods and that this is actually done with many of them. One reason for these somewhat confused criticisms was their misidentification of public goods with public provision and non-exclusive access. It has not been uncommon for governments to provide private goods to their citizens but their having done so does not transform these goods into public goods. For example, Richard Musgrave (1959) argued that there are merit goods that are considered so meritorious that their satisfaction is provided for through the public budget, over and above what is provided for through the market and paid for by private buyers (1959, p. 13). Musgrave identified education, free school lunches, low-cost housing, and health care as important and common examples of merit goods. Merit goods are essentially private goods but it is thought that people s preferences regarding them are not sufficiently well-informed because of imperfect information, irrationality and other reasons (Head, 1974). Conversely and as has been

13 12 discussed by Buchanan (1965) and Coase (1974) public goods can sometimes be provided privately without public involvement. This confusion indicates that the hallmark of public goods was not clear for economists at the time. Following Samuelson (1954), joint consumption should be considered the most important attribute of public goods. It has important implications for pricing and recovering the costs of public goods. Samuelson demonstrated that any positive price would render the consumption of public goods sub-optimal (1958: 335). Yet some, such as Goldin (1977), downplayed the possibility of joint consumption because they saw it as an undiminished consumption by an infinite number of users. As that is indeed hardly conceivable, for many the choice appeared to be simply between exclusive and open access to goods. Buchanan (1965) argued later that the scale of joint consumption can vary as the result of indivisibility or lumpiness of some goods. For instance, some goods and services such as live puppet shows can be jointly consumed by only a small number of agents, while others such as the rule of law can serve a great number of them. Crowding was also considered to characterise certain public goods. In fact, most public goods can become crowded when their capacity to provide for joint consumption is surpassed. The implications of the scale of joint consumption were first brought up by Charles Tiebout (1956). He argued that Samuelson s conclusions and treatment of public goods were based on a simplistic view according to which the central government provides all public goods which are then consumed jointly by all citizen. Tiebout (1956) argued that Samuelson had ignored the role of local governments in the provision of many public goods such as fire services, parks, recreational facilities and local amenities. He sought to refute Samuelson s conclusion

14 13 according to which no decentralised price system can generate an optimal level of public goods consumption by demonstrating how the provision of public goods by local governments would result in an optimal outcome when the consumers are perfectly mobile and there are an infinite number of local jurisdictions. The consumers would choose to reside in a jurisdiction which provides the bundle of public goods and the level of indirect prices (tax burden) best matching their preferences (see also Buchanan, 1972). The relationships between public goods, excludability, and de facto exclusion have been another subject of long-lasting ambiguity. As Goldin (1977) suggested, it is indeed often possible to choose between exclusive and open access to goods, whether they are public or private. However, this is not to say that exclusion is trivial with all goods. As Head (1962) pointed out, joint consumption and excludability are different attributes that may or may not characterise goods simultaneously. That is, it is easy to exclude users from some jointly consumed goods such as football matches, roads and bridges, while other such goods, for example public safety and defence, make exclusion more difficult. It is also noteworthy that excludability is not a dichotomous attribute: the costs of exclusion vary from low to high (Demsetz, 1964; Schmid, 1987). The level of exclusion costs depends on the size, divisibility, boundaries and other attributes of goods, technologies that are available for the exclusion of unauthorised users, and the attributes of involved agents. The level of exclusion costs influences the way in which public goods can be provided. When exclusion is costly, the only way to provide a public good may be, as Samuelson (1954) argued, for the government to tax the citizens and to use the tax revenue to provide the public good on a non-exclusive basis. When exclusion is easy, central and local governments can impose user fees such as those for national parks or communal swimming pools. They can

15 14 also limit access to public goods by some criterion such as merit or need. Many publicly provided goods whether they are private or public goods are provided on an exclusive basis because their supply is not sufficient to meet the potential demand at zero price. When exclusion is relatively easy, public goods can also be supplied privately. Coase s analysis of lighthouses the epitome of public goods for welfare economics is a case in point. Coase (1974: ) demonstrated how in England and Wales lighthouses were predominantly privately built and operated before the end of the 18th century, and how their public building and operation was an explicit public policy choice made in the 1830s. Private supply of lighthouses was possible because tolls for their services could be collected from vessels upon their arrival to harbours. The private provision of public goods hinges on the existence of low-cost exclusion technologies: they enable private providers to charge prices and recover the costs of supply. Examples of jointly consumed goods that have been often provided by private suppliers include roads, bridges and other transport facilities. When exclusion costs are low, clubs and other organisations can also provide public goods for their members (see Buchanan, 1965; Olson, 1965). Common examples of club goods include industry-wide marketing and quality assurance schemes such as marketing labels for organically grown produce or ecologically benign goods and services. Horizontal price cooperation between firms in the form of cartels is another, albeit illegal example. A neighbourhood watch is in turn an example of self-provisioning of public safety. To conclude, it is possible to provide jointly consumed good publicly and privately, as well as to self-provide in groups. Yet important questions remain. Efficient price for public goods is zero but this does not make cost recovery possible. Cost recovery makes provision sub-

16 15 optimal if it isn t based on perfectly discriminating set of prices. As this is not possible in the real contexts where substantial transaction costs prevail, the provision of jointly consumed goods remains sub-optimal. When mandatory cost recovery is used, some agents pay more than they would be willing whilst others will obtain the good at less than their willingness to pay. In short, there is ample scope for conflict of interest in the provision of public goods. 4. Towards an Institutional Theory of Environmental Governance Concepts of the market failure paradigm such as public goods and externalities have been widely used in policy analysis although they are ambiguous, do not facilitate detailed analysis of policy problems, and do not shed light on the whole range and implications of institutional arrangements that can be used as governance solutions. These shortcomings have become more problematic in the age of governance, because governance solutions are becoming more varied and complex, and have to balance between and realize multiple goals. Yet this does not render the literature on public goods and externalities useless. Quite the contrary, its reinterpretation can form a broader conceptual basis for analysing environmental governance. The market failure scholarship has made several important observations that can support a broader theory of governance. For example, it recognised that externalities and public goods are examples of instances where agents are interdependent (see Baumol, 1952: 24; Scitovsky 1954: 144), although it did not examine its full implications. Interdependence exists when agents choices or alternatives depend on choices made by others. In comparison, in the standard economic analysis agents are thought to make their choices independently of choices made by others. Yet independence is rather an exception while interdependence is

17 16 pervasive because one person s use or consumption of most goods influences the alternatives or choices of others (see Schmid, 1987; Paavola, 2001; Hagedorn, 2008). The significance of interdependence lies in its capacity to create conflicts, such as who gets to consume the goods subject to rival consumption. Conflicts like those over rival goods emerge because interdependent agents cannot simultaneously realise their incompatible interests in scarce environmental resources (see Paavola and Adger, 2005). Their conflict must be resolved one way or another, and this is done by defining (or re-defining) initial endowments. Resolution of conflicts is the substance governance and institutional arrangements are its instruments (Young 1994: 15). Several institutional solutions exist for resolving any particular conflict and they usually have different consequences. The second important observation of the market failure scholarship is that goods have attributes that create and shape interdependence. That is, interdependence does not come in one form only: the nature of interdependence varies according to the attributes of involved goods and resources (see Schmid, 1987; Hagedorn, 2008). This observation is the key to detailed analysis of governance problems and to the identification and assessment of governance solutions. Rival and joint consumption and the level of exclusion costs are among the central attributes that shape interdependence. However, there are also other attributes, such as economies of scale, transaction costs and fluctuations in the yields or levels of service that create and shape interdependence (see Schmid, 1987). Moreover, the source of interdependence can lie in the attributes of agents as Amartya Sen s argument on the impossibility of a Paretian liberal demonstrates (Sen 1970).

18 17 Consumption attributes and level of exclusion costs divide goods into four categories. Goods with rival consumption and low exclusion costs pizzas, shoes, and arm chairs are private goods. Goods of rival consumption and high exclusion costs are common-pool resources. Typical examples of them include pastures, fisheries, aquifers, and oil fields but they also include air basins, watercourses, and atmospheric sinks. Joint consumption and low-cost exclusion characterize toll goods and club goods which include roads, bridges and local amenities, for example. Finally, jointly consumed goods, which have high exclusion costs, such as public safety and defence, are pure public goods. However, goods may not fit neatly into these categories. For example, some resources such as bodies of water have multiple uses, some of which are joint while others are rival (see Paavola, 2007). Each good type creates different kind of interdependences and poses different kind of governance challenges. The governance problem with private goods is: whose claims to them are to be recognized and how? In market economies this governance problem is typically resolved by the establishment of private property rights and markets, which create incentives that are conducive to the satisfaction of preferences and economic growth. Yet they are by no means an exclusive governance solution for the provision of private goods. In many market economies private goods such as education, health care and child care services are publicly provided. One reason for this is that public provision can achieve more equal or fair distribution of goods than markets, which distribute goods according to ability and willingness to pay. Direct intervention into the distribution of merit goods is sometimes considered preferable to cash transfers, because people would not consume enough merit goods even if their ability to pay was improved. Yet while the access to merit goods may be broader under public provision than it would be under markets, it is still often exclusive.

19 18 Certain level of exclusivity can also often be justified by the scarcity of resources that are needed for the provision of goods and by its effect on individual incentives. The use of common-pool resources (CPRs) such as fisheries, pastures, aquifers and numerous environmental sinks is rival just like that of private goods, but it is more difficult to exclude unauthorised users from these CPRs. Rival use again creates an interdependence which calls for the establishment of entitlements just like is the case with ordinary private goods. However, it would be difficult to enforce private property rights to CPRs because the difficulty of exclusion creates opportunities and incentives for unauthorized use. For this reason, private property rights are often not established to CPRs in the first place. There are several ways to deal with the interdependence created by common-pool resources, however. One is to establish a private monopoly: the incentive for free riding disappears when only one user remains. The second alternative is for the state to establish regulations that specify the rights and duties of involved users with regard to the resource. This has been a common governance solution for the quality of environmental media such as water and air. The third alternative is for the involved parties to devise a system of self-governance that specifies the responsibilities and entitlements with regard to the resource. This is the solution used for the management of natural resources by many communities and organised user groups both in the developing and developed world (Ostrom, 1990). Nation states have adopted comparable solutions international environmental conventions for the governance of transboundary and global environmental resources (Young, 1994). All these institutional solutions replace market transactions with administrative ones (see e.g. Commons, 1932). In monopoly, transactions are internal to the firm while in the case of self-

20 19 provisioning they are internal to the involved organisation. In the case of regulation, administrative transactions take place within the state. Joint consumption makes users interdependent because goods such as biodiversity, landscapes and heritage are available for all when they are available to one agent. The agents thus have an incentive to ride free on the effort of others to provide the good. If nothing is done to constrain free-riding, nobody will make an effort to provide the good. Moreover, the same quantity and quality of good is available to all. Thus the conflict is: how much of the resource and of what quality should be provided when preferences differ, and how should the costs of provision be distributed (see Schmid, 1987)? Joint consumption creates an incentive to misrepresent one s preferences in these choices in anticipation that one can use the good for free when it becomes available. Governance institutions have to resolve these issues in one way or another with attendant distribution of burdens. When the costs of excluding users from jointly consumed goods are low, cost recovery is technically easy. Yet the methods of cost recovery distribute costs differently and cause conflicts among the involved agents. Recall that there is no single price that would result in the optimal level of joint consumption. Perfect price discrimination charging each user a different price, one which equals their personal willingness to pay for the use of good (including letting those not willing to pay to use the good for free) would result in optimal consumption. However, perfectly discriminating systems of prices are unattainable in the world of positive transaction costs, because users have incentives not to disclose their willingness to pay. Some cost recovery scheme must be used and it will enable some users to use the good at less than their willingness to pay. When involuntary payments such as taxes

21 20 are used for cost recovery, some unwilling riders will in turn pay more than they would be willing (see Brubaker, 1975; Schmid, 1987). 5. Conclusions The scholarship on public goods and externalities has fundamentally shaped public policy and finance in the 20th century. It has provided the rationale for the welfare and regulatory state and has guided public policies from primary education to nature conservation and military armament. However, its lack of precision requires reinterpretations that seek to guarantee the usefulness of notions of its insights in the era of governance. That said, scholarship on public goods and externalities can contribute to a more general approach to environmental governance. It offers several concepts that give a firm grip on the attributes of goods, the interdependences they create, and the necessity of adopting institutional arrangements to govern those interdependences. The research on public goods and externalities also gives tools to analyse the consequences of adopting particular institutional arrangements as governance solutions. From the viewpoint of an institutional theory of environmental governance, the interaction of agents in the context of specific good attributes and prevailing institutional arrangements will generate a particular set of outcomes. These governance outcomes can be predicted by conducting a comparative institutional analysis in the light of involved good attributes. While this approach generates observations that are useful for the design and choice of governance solutions, it is not necessarily easy. Pinpointing the relevant set of attributes that shape the governance problem is far from trivial, as the difficulty of past scholarship to get to the

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