How we treat these externalities or social costs will make a big difference in human incentives. Let us examine ownership and rights, and then impacts on these Tier 2 assets by human activities.
2) Tier 2 Ownerships and Rights
Another key concept is that air, water, land, natural resources, wild life, public health, historical and archaeological assets, etc., are assets that belong to the residents, and by the power of agency, to the states. In other words, they form a Tier 2 class of assets. This concept is not new. Thomas Paine wrote in Agrarian Justice, “It is a position not to be controverted that the earth, in its natural, cultivated state was, and ever would have continued to be, the common property of the humanrace.” Giving ownership to the abstract entity, the human race, makes it very difficult to exercise control. It is more meaningful and practical to assign ownership to the residents and then work out the interrelationships between these groups of residents in the form of transactions, when the effects of a particular human activity cross geographical boundaries. When enterprises use these assets or have adverse or beneficiary impacts on them, they are making use of these Tier 2 assets, and mixing them with their private properties. If this principle is accepted, the issue of ownership of enterprises or their plants and investments should be re-examined. Along with the ownerships of Tier 2 assets are certain rights to be asserted by the owners. These rights relate to the impacts of use or misuse of the Tier 2 properties and the disposition of the monetary gains or losses from their uses.
3) Tier 2 Capital and Tier 2 Ongoing Impacts
It would be helpful to think about the difference between one-time but permanent impacts and ongoing impacts. Is the use of the Tier 2 asset a continuous process or is it a one-time consumption (within a reasonable duration, like during a construction period) that permanently or semi-permanently changes the characteristics of that asset? Take land, for example. Land used by a factory is a permanent or semi-permanent (requiring additional costs to restore to the original conditions) removal of land from other uses. It is equivalent to a capital investment or a fixed asset invested in the factory. The degradation to the air due to the operation of the factory is an ongoing impact to the Tier 2 air asset separate from the already impacted Tier 2 land asset. Ongoing impacts to Tier 2 assets should be treated as operating costs, whereas one-time but permanent impacts should be treated as capital investment.
4) Corporate Governance with Tier 2 Ownerships
As a consequence of Tier 2 ownership, the governance and the decision making process of the enterprises should also be re-examined in light of the Tier 2 assets being used or impacted.
In short, the residents deserve certain amount of control of the enterprises and perhaps deserve to share in the costs and profits of the enterprises.
If Tier 2 costs are monetized and included in product prices, then there will be a Tier 2 class of revenues and costs to be accounted for. The decision criteria of an enterprise would be to maximize the total profit, which would equal (revenue – Tier 1 costs – Tier 2 costs). With this new objective function, externalities that are included in Tier 2 costs are explicitly considered in the decisions of the enterprises. The result would be solutions that are optimal from the total cost standpoint.
5) How Tier 2 Prices Are Determined
Ideally, Tier 2 prices should be based on a market-like system. At the bottom is the cost, just like the production of an orange has a cost, consisting of the allocated costs of the grower, and the direct material and labor costs of producing and harvesting the orange, etc. A tree in the forest has a cost even though little or no money was spent by anyone on it. It is only free because it had used free Tier 2 assets to become what it is. A tree planted by the city on the street is not free. There are direct expenses incurred by the city to buy the sapling, plant it, irrigate it, prune it and maintain its health. Air is not free. Polluted air creates adverse health impacts on the residents (and vegetation and wild life also), which result in medical costs and the shortening of human lives, which in turn has economic effects. Water is not free. Its availability is often limited. Limited resources carry economic values, quantifiable by shadow prices or opportunity costs. Contaminated water, like polluted air, also creates adverse health impacts and therefore also has other cost effects.
a) Scientific Studies
Objective scientific studies can be conducted to quantify these cost effects. It will obviously take time for such quantification methodologies to be developed and analysis to be done. In time, these data will become more available.
b) Polling
Polling is another approach for determining Tier 2 prices. By conducting regular polls of the residents about the monetary value of different degrees of clean air or clean water, for example, without a controversial project approval currently at stake, unbiased values of Tier 2 assets could be obtained through scientific polls. Research is needed to develop methodologies for inferring Tier 2 values by making relative comparisons between two Tier 2 assets and looking for an indifference curve.
c) Trading
In cases where trading for Tier 2 assets or rights is done through some market mechanism, e.g., air emissions, these prices may be used, with care. Prices due to the supply and demand for emission rights reflect the economic value of using those limited rights. They do not necessarily reflect the true economic value of clean air to the public.
d) Negotiation
Until the methods listed above are viable, a practical approach to determine Tier 2 prices is by negotiation among the parties involved. Subjective factors are involved but the result will reflect a balancing of the willingness of the involved parties.
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