Environmental Economics

Corbett Grainger (University of Wisconsin Madison)

  • Reverse-Grandfathering

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    Abstract: For any market to operate efficiently, property rights need to be clearly defined. Often rights to a resource need to be allocated prior to the establishment of a market. This is a critical step in the creation of markets to manage carbon, air, and water pollution; fisheries harvest, groundwater or surface water use; and a host of ecosystem services. In practice, these rights are almost always “grandfathered” to existing firms or users in proportion to historical emissions or extraction. We ask how grandfathering impacts incentives, environmental outcomes, and welfare before the market goes into place. We show theoretically that if currently-unregulated firms anticipate a future market where rights will be grandfathered, this distorts incentives and induces a race for allocation before the market goes into effect; this can exacerbate externalities such that welfare is lower than under an unregulated equilibrium. We then derive an alternative allocation rule called “Reverse-Grandfathering” that rewards prudence from the past; this significantly improves on unregulated outcomes and under certain conditions can replicate first-best, market-like firm behavior before the market is implemented. Reverse-Grandfathering provides a free lump-sum allocation but changes a firm’s marginal incentives prior to the market being established. We discuss three challenges to this mechanism: inducing entry, incentive compatibility, and political economy. We illustrate the role of anticipated allocation rules with a structural model of a hypothetical, but plausible, property rights system regulating fishing on the high seas.

  • Location:
    Online via Zoom
  • Address:
Organizers
LA
Lassi Ahlvik

University of Helsinki

lassi.ahlvik at helsinki.fi

AS
Anna Sahari

VATT

anna.sahari at vatt.fi