Conflicts, Power and Environmental Institutions: The Case of Social Unrest on Palawan (Philippines) due Mining External Effects

Contents

Figures

Tables

Abbreviations

1 Introduction
1.1 The Background and the Research Subject
1.2 The Analytical Focus
1.3 Methodology and Study Plan

2 Theories, Definitions and Models
2.1 On the Theory of External Effects
2.1.1 An Attempt to Define External Effects
2.1.2 Classification of External Effects
2.1.3 External Effects Regarding Conflicts
2.2 Institutions and Conflicts
2.2.1 Behavioral Assumptions
2.2.1.1 Bounded Rationality
2.2.1.2 Opportunism
2.2.2 Institutions
2.2.3 Conflicts
2.2.3.1 The Inherent Conflictive Nature of Distributions Applied to Externalities
2.2.3.2 Institutions Shaping Behavior of Actors and Actors Shaping Institutions
2.2.4 A Bargaining Model of Institutional Emergence and Factors Featuring Individual Interaction
2.3 The Property Rights Approach
2.3.1 Property Rights
2.3.2 Types of Property Rights Regimes
2.3.3 Elements of Property Rights Regimes
2.3.4 Some Implications
2.3.4.1 When Property Rights do not Exist
2.3.4.2 When Property Rights do Exist
2.4 The Theory of Contracts: A Transaction Costs Economic Approach
2.5 Understanding Public Servants in Representative Democracies
2.5.1 The Behavior of Politicians in Representative Democracies
2.5.2 The Behavior of Bureaucrats in Representative Democracies
2.6 Extending the Theory of Conflicts
2.6.1 The Case of Perceived Institutional or Implementation Failure
2.6.2 Factors Influencing the Attitudes toward Institutional or Implementing Failure

3 Methodological Framework
3.1 The Analytic Narratives Approach
3.1.1 Building Analytic Narratives
3.1.2 Testing Analytic Narratives
3.2 The Field Work
3.2.1 Gathering Information
3.2.1.1 Semi-Structured Interviews
3.2.1.2 The Exercise of Discriminating and Processing Information
3.2.2 Location: Palawan, the Last Frontier

4 Case Study
4.1 The Background: The Mining Project and the Protests
4.1.1 The Rio Tuba Nickel Mining Corporation
4.1.2 The Hydrometallurgical Processing Plant
4.2 Narratives and Models
4.2.1 Narrative: The Onset of an Ongoing Relationship
4.2.2 Models and Explanation: Initial expectations, a Coordination Problem and a Contract of Promise
4.2.3 Narrative: The Complex Net of Environmental Institutions and the Presence of Externalities
4.2.4 Models and Explanations: Not just a Problem of Coordination
4.2.5 Narrative: The Grant of the Environmental Compliance Certificate
4.2.6 Models and Explanations: On Environmental Bureaucracies and Behavioral Assumptions
4.2.6.1 Strategies of the Philippine Environmental Bureaucracies
4.2.6.2 Strategies of the Rio Tuba Nickel Mining Corporation
4.2.7 Narrative: The NGOs and the Evaluation of a Toxicologist
4.2.8 Models and Explanations: The Limited Cognition
4.2.9 Narrative: The Interests of the Philippine Government
4.2.10 Models and Explanations: The Interests of the State and Conflicts over Formal Institutions
4.2.11 Narrative: Coming Back to the Protest
4.2.12 Models and Explanations: The Choice between Exit, Voice, Silence and Dirty Hands

5. Conclusions

6. Summary

References Cited

Figures

Figure 2-1: Negative External Effects of a Nickel Refinery

Figure 2-2: Preferences of Two Individuals among Three Efficient Institutional Outcomes

Figure 2-3: A Political Economic Scheme

Figure 3-1: Study Region Map

Figure 4-1: Hydrometallurgical Processing Plant Operation

Figure 4-2: Decision Tree of RTNMC

Tables

Table 2-1: A Classification of External Effects by Producing and Consuming activities

Table 2-2: A Mixed-motive Game

Table 2-3: A Basic bargaining Model

Table 2-4: Attributes of the Contracting Process

Table 2-5: Possible Strategies of the Environmental Bureau and the Emitting Firm

Table 2-6: Choice Among Different Behavioral Options

Table 3-1: Schedule of Interviews

Table 4-1: A Simple Coordination Model of the Start Situation

Table 4-2: A Problem of Coordination and Distribution: The presence
of Externalities

Table 4-3: Bargaining Model between RTNMC and the State-South-Palawenos

Table 4-4: Possible Strategies of Philippine Environmental Bureaucracies and the Rio Tuba Nickel Mining Corporation (RTNMC)

Table 4-5: Bargaining Model between RTNMC and the Government of Philippines

Table 4-6: Behavioral Options toward Institutional or Implementation Failure

Table 4-7: South-Palawenos Options Responding to Perceived Implementation Failure

Abbreviations

illustration not visible in this excerpt

1 Introduction

1.1 The Background and the Research Subject

In October 2003, the executive director of the Philippine non-governmental-organization (NGO) Palawan Conservation Corp, Mrs. Sheila Chan, held a Lecture at the Brandenburg University of Technology Cottbus. The presentation topic was on the events that currently endanger the biodiversity of Palawan. Palawan is an island located at the south-west side of the Philippines, which due its rich environmental resources was declared a biosphere reserve by the United Nations in 1991. As a result of this, tourism is a major source of income. Among the seven menaces pointed out by Mrs. Chan, one particularly attracted my attention: The increasing mining activities on the biosphere reserve, and a specific case of protests against a mining project.

The Rio Tuba Nickel Mining Corporation, a firm that have been operating on the island since almost thirty years, became the centre of major controversy. After a contentious past regarding its poor performance with environmental resources, resulting from the presence of negative external effects, as well as legal concerns regarding property rights claims, the company was granted in July 2002 an Environmental Compliance Certificate to expand its mining activities. The legal battle among representatives of the firm and NGOs, which were actively advocating the interests of the native population, was added to the volatility of the south-palawenos that finally resulted in a rally, attracting around 1000 demonstrators of the municipality Bataraza.

This social dissatisfaction is not only as a result of the expectations of the native population being let down in the past by the company, especially those of the south-palawenos and some well-informed urban residents, but is also directed towards the environmental bureaucracies, even to the level of the central government. Formal arrangements concerning the management of the assets involved have been apparently violated, thus generating the need for new institutional arrangements.

1.2 The Analytical Focus

The afore-mentioned events constitute the subject of this document. Social unrest due to (re)distributions is certainly not a new issue; nonetheless distributional conflicts with reference to external effects and its political economic approach are a relatively recent issue of discussion. Furthermore, conflicts may lead to change or emergence of institutions. The transaction cost theory suggests that the genesis of institutions underlines an efficiency purpose, where actors are held to have an equal bargaining power. Knight (1992) contrary to this view, holds that power asymmetries matter. However, Knight (1992) integrates distinctive elements of the transaction costs theory, and more generally, of the new public choice theory, where the relationship among actors is approached using typical tables of the game theory. Knight’s (1992) judgment toward conflicts will be applied in this paper, where institutions, the decision-making according to the actors’ bargaining power, and transaction costs play the key role.

As stated implicitly, I move in my research interest in the grey zone between economic and political theory, where simple economic postulates of human behavior act as guideposts to understand decision-making. The rational choice and the public choice are mainly the assumptions that I pursue when explaining the conflict on Palawan.

With these varied perspectives, without pretending to elaborate an all purpose construction, I aim to answer the following questions:

1. What are the determinants of the conflict on Palawan?
2. What determines the decisions of the involved actors?
3. To what extent are formal and informal institutions shaping the behavior of the involved actors?

These three main research questions concern however other minor questions that are needed to be addressed in order to understand the dimension of the conflict:

1. What are the external effects arising from Rio Tuba Nickel Mining Corporation activities?
2. Why is the new mining project so controversial?
3. What is the role of environmental organizations (governmental and non-governmental) on Palawan and the Philippines?

With this analysis, I propose to combine different theoretical perspectives that will be empirically tested, and that will contribute, so I hope, to the understanding of the conflict on Palawan.

1.3 Methodology and Study Plan

As previously mentioned, I have set out different theoretical frameworks that I shall attempt to integrate together. As such, some definitions will be provided; Chapter 2 is reserved for this purpose. Section 2.1 provides a definition and classification of external effects, called externalities, as well. In Section 2.2 I explore the definition of institutions and conflicts, where some human behavioral patters are assumed. Within the institutional framework, the property rights approach and the theory of contracts is dealt with in Sections 2.3 and 2.4 respectively. In Section 2.5 I render particular attention to the public choice perspective regarding the behavior of public servants; specifically the environmental bureaucrats and politicians. Concluding this theoretical chapter, I extend the theory of the conflicts in Section 2.6.

In Chapter 3, I describe the analytical framework that I have selected. I employ narratives that are analysed using the framework of Bates et al (1998), based on the use of qualitative fieldwork.

The case study detailed in Chapter 4 consists of narrations of events arranged in sequence. Each narrative is analysed with the theoretical tools provided in Chapter 2. In total, six narratives are written with their six correspondent models and explanations. I start with the background of the problem and a description of the company, the Rio Tuba Nickel Mining Corporation and its latter project, the Hydrometallurgical Processing Plant. The first narrative concerns the initial contact between the company and the south-palawenos and it is modelled with a game-table and contractual arguments provided by Williamson (1985). The second narrative refers to the emergence of environmental laws and the first complains of the south-palawenos due to external effects. As in the former narrative, the explanation is based on the contractual model and a game-matrix. The third and central narrative handles the Environmental Compliance Certificate (ECC), which was granted to the company. I explain the ECC-issuance since the bureaucratic behavior assumed by the economic theory of bureaucracy, which is a branch of the public choice theory. The action of the NGOs is the topic of the fourth narrative, and is modelled using contractual assumptions. I refer to the interests of the State in the fifth narrative regarding the conflict at the south of Palawan, of which modelling and explaining is undertaken using some elements of the economical theory of democracy. Finally, and going back to the starting point offered in the background, the protest as a vivid manifestation of the conflict is set out and explained, including the strategic choices of exit, voice, silence and dirty hands.

I terminate the paper in Chapter 5 with some conclusions, and a summary of the paper is provided in Chapter 6.

2 Theories, Definitions and Models

Wenn Sie wirklichen Realismus möchten,

dann schauen Sie sich die Welt um sich herum an;

wenn Sie Verständnis erreichen möchten,

dann schauen Sie auf Theorien^[1].

- R. Dorfman (1964)

In the following sections, I provide the theoretical framework on which this paper is based. I address a bundle of theories and models, where most of them are interlinked, especially in the field of environmental issues. The idea behind this selection of theories, is that they can contribute to understand the conflict on Palawan.

2.1 On the Theory of External Effects

The acknowledgment of the existence of external effects (also called externalities) and their study are virtually the foundation of the economic branch known as environmental economics. Although there has been some contribution in the related area of resource economics by classical economists like Smith, Malthus, Ricardo and Mill, neoclassical economists have largely neglected this field. The first systematic analysis of pollution as an externality is to be found in The Economics of Welfare by Pigou (1920). This work was followed in terms of prominence, by the paper of Ronald Coase (1960) The Problem of Social Cost, which discusses the solutions to external effects proposed by Pigou. However, environmental economics did not really “take off” until the 1970s (Pearman et al, 2003: 8), when economists like Bator (1958) in his The Anatomy of Market Failure and Buchanan and Stubblebine (1962) with Externality appeared. Hence, Baumol and Oates (1988: 1) state: “when the ‘environmental revolution’ arrived in the 1960s, economists were ready and waiting”.

2.1.1 An Attempt to Define External Effects

Given certain rather stringent conditions, an economy organised as a competitive market economy will attain a state of economy efficiency also known as allocative efficiency. Under these circumstances the benevolent influence of the Smith invisible hand will be take place. Where the conditions do not hold, markets do not attain efficiency in allocation, and a state of market failure is said to exist^[2]. One manifestation of a market failure is the phenomenon of externalities or external effects^[3]. Although in the next section a categorization of external effects will be pointed out, it is worth noting at this point that external effects may be positive or negative, according to the consequences that are related to their presence. Considering the topic of this paper, I will focus my enquiry predominantly upon the negative externalities^[4] generated by production processes.

A negative externality in production results in costs, which are not borne by producers. This situation is depicted graphically in figure 2-2. A nickel refinery firm is selling in a competitive market, in the absence of government market intervention, that is, before pollution-control laws were imposed and enforced. The nickel supply curve (NS) reflects merely the private marginal cost of producers (Mprivate) while ND is the nickel demand curve. The marginal private cost is less than the marginal social cost (MCsocial) by the amount of the external cost, e.g. the cost of river pollution, imposed to the society by the firm. Hence, the social marginal curve is the private marginal cost curve added to the marginal cost of environmental damages. Pd,s is the equilibrium price in absence of government market intervention, and Q d,s is the amount of nickel produced and demanded. When the government imposes a tax, which accounts for the damage to the environment, the nickel supply curve shifts to NS´. By the new equilibrium price (Pd,s´), the nickel supply and demand quantity declines to Qd,s´. Even though producers and consumers experience a lost in their rents; there is a social welfare gain, since the environmental damage declines.

Figure 2-1: Negative External Effects of a Nickel Refinery

illustration not visible in this excerpt

Source: Own figure.

The question that arises is: Why do external effects emerge? Buchanan and Stubblebine (1962) cited by Baumol and Oates (1998: 17) assert that an external effect is present “when in competitive equilibrium, the marginal conditions of optimal resource allocation are violated”. Moreover, the authors called the concept itself “Pareto-relevant-externality”, which corresponds to what is meant in the literature when the term externality or external effect is used without modifiers. This violation of the marginal conditions of optimal resource allocation are pointed out by Baumol and Oates (1988: 17-18):

Condition 1: An externality is present whenever some individual’s (A’s) utility or production relationships include real variables, whose values are chosen by others like persons, corporations or governments (B) without particular attention to the effects on A’s welfare. This definition rules out cases in which someone deliberately does something to affect A’s welfare.

Condition 2: The decision maker, whose activity affects others’ utility levels or enters their production functions, does not receive (pay) for this activity an amount equal in value to the resulting benefits (or costs) to others.

One may define an externality to be present whenever condition 1 holds whether or not condition 2 is present. However, the condition 2 seems to be required if the externality has all of the unpleasant consequences that are associated with the concept. In this case, proper pricing or tax-subsidy arrangements will eliminate these misallocations.

With these thoughts, one can define an externality as follows: An external effect or externality, is said to occur when the production or consumption decisions of one agent have an impact on the utility or profit of another agent in an unintended way, and when no compensation/payment is made by the generator of the impact to the affected party (Pearman et al., 2003: 134).

2.1.2 Classification of External Effects

Apart from the fact that an external effect may be classified according its harmful or beneficial consequences, another dimension by which external effects can be classified is in terms of whether they have the public goods characteristics of non-rivalry and non-excludability. While external effects can have the characteristics of private goods, these that are more relevant for policy analysis exhibit non-rivalry and non-excludability. These external effects that present the above-mentioned public goods characteristics are defined by Baumol and Oates (1988: 19-21) as undepletable external effects. An undepletable external effect is like an undepletable good, whose consumption by one individual does not reduce the consumption of anyone else. For example, my breathing of polluted city air does not alter the quality of air inhaled by others. An external effect that possesses the characteristics of private goods is called a depletable external effect, where the consumption of a depletable external effect reduces the availability to others. If my neighbour for example decides to dump his trash on my garden, the amount of trash that I consume will be not available to other trash consumers.

Pearman et al (2003: 135) categorize external effects according to what sort of economy activity they originate from and what sort of economic activity they impact upon. In order to make clear what is involved by Pearman et al’s classification, it is worthwhile to illustrate firstly some assumptions that are common in microeconomics, stripping them down to their barest essentials. Imagine an economy consisting of two persons (A and B) and two goods (K and Y) that are available for consumption. The production of each good uses K (for capital) and L (for labour) that are available in fixed quantities. U represents an individual total utility, which depends solely on the quantities of the two goods that he^[5] consumes. In doing so, the utility functions for A and B can be written in the form shown in the following equations:

U^A = U^A (X^A, Y^A) and U^B = U^B (X^B, Y^B) (2-1)

The total utility enjoyed by individual A (UA), depends on the quantities, XA and YA, he consumes of the two goods. An equivalent statement can be made about B’s utility.

Additionally, it is assumed that the quantity required in producing the good X depends only on the quantities of the inputs K and L. The same consideration can be made for the good Y. Thus, the two production functions can be written in the form showed in the following equations:

X = X (K^X, L^X) and Y = Y(K^Y, L^Y)(2-2)

It is noteworthy that in the equations 2-1 and 2-2, the only things that affect the individual’s utility are his own consumption levels, and that the only thing that affects firm output are the levels of inputs that it uses. Thus, external effects are absent. Nevertheless, in the real world economic behavior involves, in fact, external effects.

Once these assumptions are made, the external effects classification of Perman et al (2003) becomes clearer. Given two sorts of economic activity, consumption and production, expressed in the equations 2-1 and 2-2, a six-fold classification can be made. This is shown in the table 2-1.

Table 2-1: A Classification of External Effects by Producing and Consuming activities

Abbildung in dieser Leseprobe nicht enthalten

Source: Pearman et al (2003: 135)

The first row of Table 2-1 provides an example of a consumption externality, where agent B’s consumption of commodity X is an argument in A’s utility functions. In the second row, A’s consumption of Y is shown as affecting the production of X, for given levels of capital and labour input. The third row illustrates B’s consumption of X affecting both A’s utility and the production of Y. In row four, the B consumption of X affects A’s utility and the production of Y. Row five shows the production of Y, determining, for given capital and labour inputs, the amount of X produced. Finally, in row six one can observe a situation where the level of Y affects both A’s utility and the production of X.

2.1.3 External Effects Regarding Conflicts

In the literature of external effects, two main economical approaches deal with the internalisation^[6] of such effects: Pigou’s taxation/subsidy, which implicates State regulation and market mechanisms. However, distributional issues and their political significance have been neglected for some time, especially with regard to conflicts, since unequal distribution of assets is inherently conflictive^[7]. Thus, the presence of external effects, and the way in which they are approached, may lead to social unrest as a manifestation of the inherent conflictive nature that characterizes environmental resources distribution. It means that such conflicts’ consequences, such riots and the like, could be removed by internalising external effects, but are not. However, institutional arrangements, like environmental laws, in the case of the Pigou viewpoint are demanded, and conflict consequences may disappear or be neutralized, assuming that actors do not violate these institutional arrangements.

Going back to the efficiency argument, Ronald Coase (1960) in his The Problem of the Social Cost, prefers the bargaining solution to achieve efficient outcomes instead of State intervention. However, at least three requirements must be met: 1. Property rights are well defined, 2. The number of people involved is small, and 3. Bargaining costs are small. The role of the State is reduced to become a facilitator between bargaining parties, and as enforcer of rules, (for example, contracts) that arise from bargaining processes. For this purpose, a definition of property rights is a major requirement where the State intervenes directly; where pollution taxes are a common instrument when dealing with externalities or the State owns the resources. Property rights, bargaining issues, conflicts, and the State are issues that I address in the following sections.

2.2 Institutions and Conflicts

Before going through the definitions of institutions and their role, it is worth highlighting at this point some human behavioral assumptions, which stem from the economic understanding of individual action.

2.2.1 Behavioral Assumptions

The transaction costs economics’ standpoint characterizes human nature by reference to bounded rationality and opportunism. Neo-classical theories assume that individuals are primarily interested in utility maximization, and are therefore rational. However, the fact that agents are subject to bounded rationality, where behavior is “intendedly rational, but only limitedly so” (Simon, 1961 quoted by Williamson, 1985: 30) and given to opportunism, has previously been ignored by the neoclassical economics approach.

2.2.1.1 Bounded Rationality

Bounded rationality is, according to Williamson (1985: 44), together with maximizing and organic rationality, an element of the rational assumption. The maximizing orientation, which is a basic assumption in neoclassical economics, is held by transaction costs economics as unobjectionable, if all the relevant costs are recognized. However, the reason that not all costs can be recognized is the reason for the existence of bounded rationality. In this sense, transaction costs economics recognizes that rationality is restricted, that is, that cognitive competence is limited. Therefore, contracts are an organizational alternative when dealing with bounded rationality.

2.2.1.2 Opportunism

Opportunism is a facet of the self-interest orientation assumption. In fact, opportunism is the strongest one followed by seeking simple-self interest, and obedience. Williamson (1985: 47) defines opportunism as:

“…self-interest seeking with guile. This includes but is scarcely limited to more blatant forms, such as lying, stealing, and cheating. Opportunism more often involves subtle forms of deceit. Both active and passive forms and both ex ante and ex post types are included…”

Ex ante and ex post opportunism are related in the agency theory under the terms of moral hazard and adverse selection. Adverse selection is the result of the inability of one of the bargaining individuals or both to distinguish between risks, and an unwillingness of poor risks to disclose a potential true risk condition. Moral hazard relates the potential irresponsible behavior of one or both of the bargaining individuals, who violates the rules contained in for example, a contract. In both cases ex ante mitigating measures should be take into account in order to reduce ex post execution problems. Both conditions of adverse selection and moral hazard are included under the heading of opportunism.

Furthermore, opportunism relates a problem of information. It refers to the possible behavior of actors that gives incomplete or distorted disclosure of information, especially calculated efforts to “mislead, distort, disguise, obfuscate, or otherwise confuse” (Williamson, 1985: 47). It relates therefore to problems of asymmetric information, where those who have some kind of relevant information for the coordination activities, have a comparative advantage and additionally an incentive to behave opportunistically. In fact, transaction costs economics, or more generally, the new institutionalism, assumes that humans have a propensity to behave opportunistically. If this holds true, then an exchange in property rights through contracts that are subjected to an ex ante and ex post opportunism should be properly safeguarded ex ante. Incentives may be realigned and/or superior governance structures within which to organize transactions may be devised.

2.2.2 Institutions

Among the different definitions of institutions, it seems that the term used to define them most commonly is rules. North (1990: 3-4) defines institutions as the humanly devised rules of behavior that shape human interaction: A set of rules created by humans to facilitate cooperation and competition and thereby to adjust conflicting claims of different individuals and groups for scarce resources. Institutions include formal rules as well as informal conventions and codes of behavior. Formal rules that are presented in the State in the form of constitutions, and informal rules are these that, for example, govern the family. Many of these rules are buttressed by the force of law, itself an institution. Law and legal institutions rely on the State’s enforcement power to guarantee that social actors will abide by these rules. Institutions serve to reduce uncertainty, and therefore to forecast to some extent the behavior of actors. Furthermore, Institutions can be seen as social capital (Coleman, 1990). Institutions, like property rights, state who the owner of benefits streams are. Knight (1992: 67) in reference to Marshall (1983: 188) affirms that institutions “may in fact ‘penalize, prohibit, require, obligate, prescribe, inform, guide, empower, permit, license, enable, facilitate, entitle, command, define, designate, constitute, distribute, describe, exempt, and identify’ future courses of action”.

How institutions do emerge? This question has been answered in many ways: Institutions are held to appear in order to minimize transaction costs (Coase, 1960; Williamson, 1985), which is an efficiency viewpoint. Other authors maintain that they are created by principal agents in order to extend their dominance upon others (North, 1990; Libecap, 1989), or appear spontaneously as a by-product of strategic conflict over substantive social outcomes (Knight, 1992), where power elements are held to play a key role. Using some elements of the transaction cost theory, I employ in this paper mainly Knight’s approach.

Knight (1992: 13) affirms that the emphasis that other scholars place on collective benefits when dealing with social institutions fails to capture major features of institutional development and change. These major features are the distributional effects of such institutions, the conflict inherent in such distributions, and how such conflicts are resolved, introducing power asymmetries between bargaining actors.

2.2.3 Conflicts

Institutions play a preponderant role when dealing with conflicts. The main difference of Knight’s approach in dealing with the development and change of institutions, and other scholar’s approaches, is that the latter assume equal distributed power between actors involved in bargaining processes. Knight (1992) affirms that power asymmetries matter, when dealing with distributions.

2.2.3.1 The Inherent Conflictive Nature of Distributions Applied to Externalities

Knight (1992) holds that social outcomes like institutions are the product of social conflict, and social conflict arises due the interaction between actors who have competing interests in those outcomes. Thus, the final product, for example a contract, reflects the interests of actors, and their bargaining power in shaping the institution. In the rational choice approach, the interests of actors are mainly based on their self-interest; thus, strategic^[8] actors give priority to their individual goals under collective goals. In absence of transaction costs, the interaction of actors would result in a social institutional efficient outcome. An institutional efficient outcome can be understood, using analogically the allocative efficiency notion^[9].

Consider the figure 2-2. The curve between UAmax and UBmax represents the maximal possible utility frontier the individuals A and B can attain by some institutional outcome. The three institutional outcomes, A, B and C, are on the efficiency frontier. Inasmuch as individuals want to maximize solely their utility or welfare, they compare these possible outcomes. The individual A prefers the outcome B, since this maximizes its utility. However, the interests of individual B by the outcome of B are not satisfied, thus it will prefer the outcome C. The outcome A appears to be a fair outcome for both, however rational self-interested actors will not be initiators of such outcomes if they diminish their utility. In this case, Individual B prefers just these outcomes that brings him more utility, that is, converging on the ordinate x to its maximal utility and the same behavior will follow individual A, that is, these outcomes that converge on the ordinate Y to its maximal utility.

Figure 2-2: Preferences of Two Individuals among Three Efficient Institutional Outcomes.

Abbildung in dieser Leseprobe nicht enthalten

Source: Knight (1992: 34), modified and restructured by the author.

The figure 2-2 shows the essence of conflict underlying distributions. Assume for example, that the efficient outcome C takes place due unknown reasons. This outcome clearly favors the individual B. How would the behavior of actor A be? Although I shall approach this question in the following sections, it should be at this point emphasised that conflicts are inherent to distributional issues. Self-interested individuals want institutional arrangements that favour them, for this reason, they will prefer institutional rules that constrain the actions of others with whom they interact. Furthermore, this same logic can be employed when dealing with external effects. I want to illustrate this consideration through the next example using coasian elements:

Suppose the cattle of individual A are straying onto the cornfield of individual B, creating $ 200 worth of damage. B earns $ 300 for corn sales. Since an economic viewpoint, the activity of A is destructive, doing more harm than good, it should stop.

Assume further that some institutional arrangement, like a property rights arrangement declares that the cattle of A is the problem of B, and for this reason, A’s action is not wrong by letting its cattle stray onto the field of B.

Under these circumstances it would make sense for B to pay A $ 250 to reduce its herd, so that it will not destroy the corn of B. Individual A then pays $ 250 to save its cornfield, worth $ 300. A would lose $ 200 in cattle earnings but receives from A $ 250, making a surplus of $ 50. In this case, through bargain, the natural resources are efficiently allocated.

But now assume another institutional environment, where the current property rights state that the cattle of A is the problem of A, or in other words, the corn of B is the problem of A. If A wants to develop its herd, so that it would graze on the land of B, A must solicit permission to B. If B is acting rationally, it will require from B at least $ 200 for the permission, as this is the cost of the crop damage. Assuming that the opportunity of A to develop its herd would raise its income in $ 100, it would not pay. The herd of A will not graze in the cornfield of B. And again, through bargain, the natural resources are efficiently allocated.

Although in both of the aforementioned variants, resources are efficiently allocated, the distribution of wealth is quite different. In the first variant, individual A ended with a decreased wealth of $ 250, whilst in the second variant, its wealth does not decrease. In the first variant B’s wealth increased by $ 50, while in the second variant B must abandon a potential increase of wealth of $ 100.

From this example, many questions arise. What would be the reaction of individual A whose amount of wealth is diminished through the first institutional arrangement? Does he accept pacifically and suffer in silence ? How did this institutional arrangement arise? If it stemmed from the State, will A resist? What will be the reaction of B in the second variant? Does he respect the institutional arrangement and renounce the potential profit? These are questions that I approach in the following sections. The purpose of this example was to highlight that the conflicts underlying distributional issues can be applied to the problematic of external effects.

2.2.3.2 Institutions Shaping Behavior of Actors and Actors Shaping Institutions

Self-interested individuals are affected by their interactions, that is, by interdependencies between themselves, as well by institutions and third actors. In this section, I aim primarily to explore the effect of institutions on actors. I stated supported by North (1990), that institutions shape the human behavior. Strategic individuals base their choices not only on their self-interested intentions, but also on the self-interested intentions of others, and on the institutional environment. In doing so, individuals “must formulate expectations about what other actors are going to do” (Knight, 1992: 48). Thus, institutions contribute to form social expectations, and by so doing, diminish uncertainties. Institutions accomplish this by providing information. The sort of information provided by institutions is a. Sanctions for non-compliance and b. The probable future action of others. By formal institutions, the sanction for non-compliance is expected to be enforced by the State, where sanctions against prohibited actions is a common element of laws and legal systems. Such information must be thereby acknowledged and accepted by those who are the members of the relevant group.

The potential sanctions in cases of non-compliance affect the decision making of individuals in two ways: The costs imposed by those, who violate the rule, making the non-compliance a less attractive strategy, and the probability of being penalized. If the costs exceed the benefits of non-compliance and the enforcement is sufficiently probable, an individual will revise its strategy. Conversely, where the benefits of non-compliance are larger than the costs, and the probability of a penalty is small, a violation of the rule is a rational strategy.

These rules that require the external enforcement by third actors open up the possibility of additional sources of conflict, as the utility function of those enforcers influence outcomes (North, 1990: 73), that may conflict with those who originally develop the institution.

Knight (1992: 113) considers that institutional researchers have neglected power asymmetries affecting the emergence, maintenance and development of institutions. He states that institutions are conceived as a product of the efforts of some to constrain the actions of others with whom they interact. Williamson (1997: 12) criticizes the employment of power asymmetries in explanations of the emergence and change of institutions, as one is inclined to attribute the power advantage to the party, which after the fact, appears to enjoy the advantage. Therefore, if power is held to have some influence on the interaction among actors and on social outcomes, it must be identified ex-ante rather than ex-post. Power asymmetries are together with the costs of collective action and uncertainties, the basic elements to understand social outcomes derived of conflicts.

2.2.4 A Bargaining Model of Institutional Emergence and Factors Featuring Individual Interaction

Two Individuals are coordinating their actions in order to attain benefits. As shown in the figure 2-2, the coordination is conflictive because different outcomes benefit one actor more than the other. The same scenario can be symbolized with a table distinctive by game theorists. The difference between the following table and the figure 2-2 is that the table 2-2^[10] contemplates the possibility of non-coordination, which corresponds to the outcomes 1,1.

Table 2-2: A Mixed-motive Game

Abbildung in dieser Leseprobe nicht enthalten

Source: Knight (1992: 53)

Due to distributional differences the players A and B differ in their preference ranking of the available equilibrium. The equilibrium^[11] outcomes are 2,4 and 4,2. The player A prefers outcome 4,2 to 2,4, whereas player B prefers exactly the opposite. However, both favour coordination on one of the two available equilibriums, as opposed to the non-equilibrium alternatives.

If institutions shape human behavior, and affect the distributions of benefits in social life, then it should be expected that rational actors, by making strategic decisions, prefer these rules that provide them the greatest share of benefits. Hence, conflicts over benefits extend to the emergence, development and change of institutional arrangements.

Knight (1992: 123) affirms that to understand the appearance or development of institutions, one must centre one’s attention primarily upon the strategic conflict itself and on the mechanisms by which this conflict is resolved.

The framework of Knight (1992) integrates the element of bargaining power, where the fact that actors might be more powerful than others leads to different conclusions as from when actors are held to be equally powerful.

“Those actors with a relative bargaining advantage can force others to comply with institutional rules because compliance is the best reply to the actions of the members of a group. In the end, if strong actors can constrain other to choose a particular equilibrium strategy, the weak will comply whether or not they want to do so”. (Knight, 1992: 127)

Based on the Table 2-2, Knight proposes a model of the bargaining problem, which includes power elements (see Table 2-3). The model assumes a coordination problem between two actors, without the presence of formal institutions.

Table 2-3: A Basic bargaining Model

Abbildung in dieser Leseprobe nicht enthalten

Source: Knight (1992: 129)

If ΔA,B< X, there will be two equilibrium outcomes that can solve the bargaining problem, namely, the R,L and L,R strategy combinations. The Δ values represent the payoffs that the actors will receive if they fail to achieve one of the equilibrium outcomes, that is, breakdown values^[12]. In other words, Δ values measure the opportunity costs of non-coordination on an equilibrium outcome. Setting ЄA,B > 1, the Є values represent the distributional advantage accruing to one of the actors, if a particular equilibrium outcome is chosen. Thus the main goal of actors is to achieve Є.

The mechanisms by which distributive effects form social institutions rest on two elements: The factors that resolve individual social interactions and the correlation between the resources that produce asymmetries in power. In Knight’s framework, five factors are addressed regarding individual social interaction; specifically in the case of bargain between actors that shape the emergence of institutions: The credibility of strategic commitments, the attitude of bargainers toward risk, transaction costs, time preferences, and the threat of retaliatory action, where all of them are related with the way in which power^[13] is distributed among the actors.

Looking at the basic bargaining model (table 2-3), the task of player A is to constrain the actions of player B so that he will choose to play L. By so doing, A must maintain credibly to B, that he will play R. If A can make his commitment credible, the rational action of player B will be to follow the rule and play L. Although player B may prefer another alternative, (e.g., to play R) the knowledge that A will play R in any case, constrains B’s choice to playing L. The question that arises is, what mechanisms make the commitment of player A credible? There are two manners by which actors make their strategy commitments credibly, and in doing so, affecting the expectations of others: a. They must be capable of manipulating the benefits derived from their own strategies and b. They hold relative bargaining power.

To be capable of manipulating their benefits resulting from their own strategies means player A can alter the benefits that he would receive if he chose strategy L, where the choice of R becomes the dominant strategy for player A, and in doing so, choosing L becomes the rational strategy for player B.

The other source of credibility, which is grounded on the relative bargaining power of the actors^[14] can be explained as follows, by examining again the basic bargaining model: Assume that player A has power over player B, that is, ΔA > Δ B. The breakdown values are unequal, meaning that there are asymmetries of power in the game. If A can affect in some way the alternative actions available to B, the costs of breakdown for B are greater than for A. If player A states he played R regardless of what B did, what will player B do?

To answer this question, I refer to the starting point of this section. The factors that shape the emergence of institutions are, aside from credibility; the attitude of bargainers toward risk, transaction costs and time preferences, and these factors influence the action that player B will do. On the one hand, player B must believe A will in fact choose R. This point was discussed previously. On the order hand, maintaining the condition that ΔA > Δ B, player B will rationally choose L. The reason is that resource ownership influences one’s attitude toward risk. In the case of bargain break down, A will suffer fewer costs, and B, being aware that he is weaker than A, will suffer greater costs of breakdown. On this point, Knight (1922: 133) address that there is a positive relationship between ownership of resources and risk acceptance, so that a player who has less to lose in case of breakdown, is more likely to risk one. This implies that the greater the differences in resource ownership between actors are, the stronger the relationship will be between break down values and risk attitudes. Therefore, the certainty of the resource asymmetry leads player B to accept the credibility of A’s commitment and will play L.

Additionally, power asymmetries have an effect on how actors act facing transaction costs and time preferences. The first relates the costs of for example, extended bargaining. If B does not believe that A will play R regardless of what B does, the rational choice for B remains playing L. The reason is that due ΔA > Δ B, in an extended bargaining process that is costly, A has still less to lose than B. Thereby, if A player holds more resources than B, he will be less dependent on the bargaining outcome, and therefore he will be more patient in the bargaining process. The latter relates to the parameters by which the future is discounted, where the player with the higher discount parameter receives a greater share of the benefits. If A and B have different time preferences, the value of future bargains will be greater for A than for B. Since bargaining is not costless, B will be more willing to accept a smaller share now than a possibly larger share later, if that share will be diminished by a serious discount factor.

Finally, power asymmetries involve possible threats of retaliatory action. Here, threats are understood as “the actors’ capacity to affect the benefits derived by others from their own choice of action” (Knight, 1992: 135). For example, A may threaten B with retaliation if he does not choose L. The effect of the threat can be to increase the pressure on B to adopt his less-preferred alternative, namely L. In the bargaining model, A could inflict a punishment, c, on B that will alter the benefits of the L, R equilibrium outcome, so that Δ B > X + ЄB – c, making for B the choice of L to be the rational strategy^[15].

[...]

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^[1] If you want reality, then look at the world around, if you want to achieve understanding, then look at theories. Translated by the Author

^[2] This concept alleged by Bator (1958) is however disputed by Arrow (1969). Arrow associates externalities with the absence of some markets for the trading of items affecting the welfare of economic agents. In other words, the prime cause of externalities is not a market failure, but the absence of markets.

^[3] Externality or external effect, both terms refer the same subject of study, for this reason they will be used in this document interchangeably.

^[4] These externalities that present the characteristics of public goods and are insidious to both environment and human health, like sulphur dioxide, particulates, and other contaminants of the atmosphere have attracted more frequently the attention of the public than beneficial external effects. However, the same theoretical considerations have been made by OECD (2001) that employs the concept of multifunctional agriculture by the internalisation of positive external effects emerging of the agriculture, and Von Braun J. and Virchow, D. (1998), that relate to the topic of beneficial external effects by conserving rain forests in tropical countries.

^[5] Concerning how to handle English third-person singular pronouns, when referring to an individual of unspecified sex, I will use the neutral pronoun he, bearing in mind that it refers to both men and women. I purposively remark upon this issue, since I am aware that he is not necessarily perceived to encompass both females and males, what it is not my intention. Nevertheless, I consider that continuous he/she reminders are stylistically not appropriate, especially in the coming sections where a frequent use of the third-person singular is needed.

^[6] Internalising external effects addresses a process that enables these effects to bear on all interacting persons. The process is usually a change in property rights (Demsetz, 1967: 348)

^[7] In this context, the more prominent example is certainly the domestic distributional consequences that the government of the United States had in mind, when it does not ratified the Kyoto agreement on global climate change in 2001.

^[8] The term ‘strategic’ refers the fact that actors, when coordinating their activities, take into account the knowledge, interests and expectation of the others.

^[9] An allocation of resources is said to be efficient if it is not possible to make one or more persons better off without making at least one other person worse off (Pearman et al, 107).

^[10] This table represents the classical strategic game of battle of the sexes.

^[11] An equilibrium outcome can be defined as follow: No single player would have obtained a larger payoff had he used an alternative strategy, given the strategies of the other players (Knight, 1992: 53)

^[12] The definition “breakdown value” goes back to Osborne and Rubinstein (1990).

^[13] The term ‘power’ is related to the ability of an individual or group to influence the behavior of others, so that they do, what the ‘powerful’ individual or group desires. For an extensive discussion of the definition of power see Hanisch (2003: 54-56)

^[14] Knight (1992: 132) addresses the fact that several factors can determine relative bargaining power: On the one hand, intangible resources available to the actors, like skills, intelligence, and experience, which are called bargaining savvy, and on the other hand, the possession of material relevant assets that he calls supported on other researchers resource-holding power. The possession of these resources determines the breakdown values ΔA,B, which as stated before, is a measure of the costs of non-coordination on an equilibrium outcome. In bargaining interactions, the most important resources are these, which are available to the actors in the event that bargaining is either lengthy and costly or ultimately unsuccessful; for example, these resources that an actor might retain after a broken down game.

^[15] Knight (1992: 135) affirms that in an isolated interaction, B could ignore the threat of A. However, in an ongoing relationship, threat can be a rational strategy.