LIMITATIONS OF BARGAINING SOLUTIONS TO EXTERNALITIES AND IMPLICATIONS FOR PUBLIC POLICY

Bargaining solutions to externality problems are unlikely to take place when the number of affected parties is large. Where many people are involved, the costs of bargaining may be so large as to prevent it taking place. Bargaining also requires that the affected parties can be identified. It is easy to think of circumstances where this is either difficult or impossible.

These conditions suggest that bargaining is not likely to be a an effective means of dealing with external effects where the natural environment is concerned. Typically environmental pollution affects a large number of people, and it is often difficult to identify all the affected parties. An additional difficulty arises from the fact that the adverse impacts on the natural environment of many types of economic activity persist over long periods of time. Economic activity today does not only affect those living today, but also imposes external costs on future generations. If people living in the future “matter”, then bargaining solutions require that the interests of future generations be included in the bargaining process. It is difficult to see how this can take.

Bargaining is also unlikely to lead to efficient outcomes where the externalities have the characteristics of public goods. A public goods has a very important property: consumption of the good by one person does not prevent another person also consuming it. Examples include national defence, the services of lighthouses, radio and television transmissions, and public health programmes. In each of these cases, consumption is non-rivalrous in the sense just described.

Public goods often have a second property, that of non-excludability. Once the good is made available to one person, others cannot be excluded from using it. This is true for national defence, lighthouse services and public health schemes. Non-excludability poses severe difficulties for bargaining solutions. The reason for this is the “free-rider” problem. If someone cannot be prevented from consuming a public good and believes that others will pay for its provision there is an incentive to “free-ride” on its provision by others. In a bargaining process, the individual has an incentive to understate his or her willingness to pay. So the true social valuation of a public good will not be revealed in a bargaining process, and as a consequence it is likely to be underprovided.

Many environmental goods and services (such as clean air, ground and water, wilderness areas and ecosystems with extensive biodiversity) are public goods. Environmental protection measures also often fall within the class of public goods. Bargaining is unlikely to lead to optimal amounts of environmental resources or environmental protection.