This article synthesizes the growing empirical literature on transaction costs to identify pragmatic design recommendations for environmental and natural resource policies. The New Institutional Economics literature recognizes that appropriate policy choice and design will be a function of the specific characteristics of the problem. The physical and institutional determinants of both transaction costs and abatement costs should be considered in the policy design process due to potential interactions between them. Analysts also need to incorporate the extent to which the technologies, institutional environment, governance structures, or policy designs can be changed; some factors can only be adjusted to or “designed around” while others can be designed differently. This framework highlights the importance of property rights since transaction costs will be incurred to obtain or retain property rights and since the rights assignment may affect both the magnitudes and distribution of costs. Another implication is that education and extension programs or use of behavioral economics concepts to affect choices can be cost-effective in some circumstances. Policy design should take advantage of economies of scale and foster technical change. Appropriate sequencing of policy instruments may decrease transaction costs, particularly if there is potential for technical change.
For some environmental and natural resource issues, it is difficult to model cause and effect, the problem definition may change over time, and there may not be consensus about the policy goal. Examples of these so-called “wicked” problems include climate change, nonpoint source pollution, water resource scarcity, and biodiversity conservation. Batie (2008) contrasts these with tame problems that are well-defined, do not require stakeholder input, and can be solved by using the normal scientific methods of a discipline, e.g., creating a new vaccine. For wicked problems, improving the situation rather than coming up with an optimal solution, is what is realistic (Batie, 2008).
Design of policies and economic instruments is a relatively neglected area in applied economics according to King, 2012a and King, 2012b, and he has therefore encouraged applied economists to devote more attention to this task. While environmental economists have examined design issues regarding the incentives for, and costs and benefits of abatement (e.g., Aldy et al., 2010 and Zilberman and Segerson, 2012), there is relatively little literature on transaction costs1 and design of environmental policies. However, transaction costs should be a key consideration in policy design, especially for wicked environmental and natural resource issues, which are likely to entail high transaction costs. For example, examining several studies of the transaction costs of agri-environmental policies, McCann et al. (2005) found that transaction costs borne by public agencies were about 30% of the total costs of the programs. Ofei-Mensa and Bennett (2013--this issue) found that transaction costs per tonne of reduced CO2 equivalent varied from $2.5 to $7.2, almost a three-fold difference. Reducing these costs by improving policy design is especially important given government budget deficits.
One of the benefits of incorporating transaction costs, as well as abatement costs, into the design of institutions and policy instruments is that it enables the analyst to bring in practical issues that are normally ignored. For example, incorporating transaction costs implies that basing policy instruments on practices or some other easily observable factor, rather than emissions should be considered. It also allows one to examine factors such as conflict and lobbying that are often seen as beyond the scope of environmental economics but which are crucial to making progress on wicked problems. In addition, it helps us to think about unintended consequences of policies. Previous decisions affect not only environmental quality and natural resource use, but also norms and the institutional environment, e.g., the issue of path dependence or lock-in that is raised by Challen (2000), Crase et al. (2013--this issue); Garrick et al. (2013--this issue), and Marshall (2013--this issue) in the context of water. Path dependence, and the interaction between abatement costs and transaction costs imply that an examination of the sequencing of policies, rather than just choice of policies may be useful.
