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Regulating through institutions: the implications of institutional economics for the conduct of more effective environmental policies. - BR0112

The project will consider what a shift in the focus of economic analysis toward the structure and behaviour of institutions can contribute to the development of environmental regulation (where by an institution we mean any complex system of social arrangements or interactions that endures beyond the lifetimes of its constituent elements). Governments, markets, business organizations, stable networks, etc. are all institutions on this

The aim is to help fill a gap in the understanding of economic regulation that has arisen in consequence of the dominance of rational choice theory perspectives in underlying theories – a gap that is unlikely to be filled by behavioural economics, which, like rational choice theory, is concerned principally with individual decisions, not the behavior of systems.

The gap has been well explained by Professor Ronald Coase. “Economic policy involves a choice among alternative social institutions … The majority of economists do not see the problem in this way. They paint a picture of an ideal economic system, and then, by comparing it with what they observe (or think they observe), they prescribe what is necessary to reach this ideal state, without much consideration for how this could be done. The analysis is carried out with great ingenuity but it floats in the air.”

Environmental regulation is characterized by reliance on a diverse range of institutions, and the project will centre on questions why this is the case, and how understanding of why it is the case can help facilitate better policy making. Following a general discussion of the application of principles and concepts developed in institutional economics to environmental regulation (eg. the significance of transactions costs) the project work will focus on four specific issues:

1. The implications of factors such as transactions costs for the creation or modification of property rights in environmental goods and services (property rights structures being particular types of institution).
2. The problem of ‘missing institutions’ (in practice often to linked to inappropriately defined property rights, and therefore closely linked to (1) above).
3. The interface between public regulation and self-regulation, including voluntary action and voluntary
4. The potential contribution of ‘hybrid organisations’, intermediate between public regulators and businesses (system or network operators in utility sectors being examples).

All four of these areas involve questions of institutional design, which is the common thread.
Thus, rather than exploring a framework that asks questions about the effectiveness of individual regulations, the project will develop a framework built around questions such as: What are the effects of this type of institutional arrangement? What are the alternatives? What might be the effects of these alternatives?

These issues are of considerable importance because major environmental policy challenges frequently raise questions about existing structures of property rights and existing economic institutions more generally (i.e. policy is not just a matter of determining prices and/or quantities in a stable institutional structure). Examples include the redefinition of water abstraction rights, the development of CHG emission rights, and the development of CHG rights markets.
To produce a report setting out how institutional economics – the use of economics to analyse the social institutions that play key roles in economic activity – can inform the conduct of public policy in the environmental arena, and thereby help to promote better, more effective regulation.

The objective is based on a belief that there is a gap in the economic knowledge that is typically applied to policy issues across all types of regulatory activity. The gap is particularly significant in the environmental policy area, however, because the challenges faced call for institutional innovation and adaptation, which can only be impaired by any failures to apply what knowledge we have of relevant institutional trade-offs. Put simply, the
stakes are higher in environmental policy that in areas where institutional arrangements can be expected to be more stable.

The general problem is illustrated by the policy aim of promoting market approaches to environmental problems where such approaches are feasible. This implies Defra contributions to the development of markets, which are social/economic institutions. However, conventional, taught economics has no substantive “theory of markets” – the market is simply regarded as a theoretical abstraction. This is not helpful for practical policymaking
Project Documents
• FRP - Final Report : RPI paper on Institutional Economics June 2012   (534k)
Time-Scale and Cost
From: 2011

To: 2012

Cost: £12,000
Contractor / Funded Organisations
Regulatory Policy Institute (RPI)
Better Regulation              
Regulatory policy