ABSTRACT
What is the source of our environmental problems? Why is there in modern societies a persistent tendency to environmental damage? From within the neoclassical economic theory there is a straightforward answer to those questions: it is because environmental goods and harms are unpriced. They come free. Indeed, Arrow (1984) claims this to be a thesis peculiar to neoclassical economics: ‘The explanation of environmental problems as due to the nonexistence of markets is . . . an insight of purely neoclassical origin’ (Arrow, 1984, p. 155). Given that the source of environmental damage is that preferences for environmental goods are not revealed in market prices, then the solution is to ensure that they are. Hence the claim runs that we should either bring environmental goods into actual markets through an extension of tradable property rights to environmental goods, or alternatively we should construct shadow prices for environmental goods by ascertaining what individuals would pay for them were there a market. The construction of shadow prices is carried out either indirectly – by inferring from some proxy good in the market such as property values an estimated price for environmental goods or by using the costs incurred by individuals to use an environmental amenity to estimate values – or directly by the use of contingent valuation in which monetary values are estimated by asking individuals how much they would be willing to pay for a good or accept in compensation for its loss in a hypothetical market. Those economic values can then be entered into a cost-benefit analysis for any proposed projects such that their full benefits and costs can be ascertained. The standard Kaldor-Hicks test of efficiency employed in cost-benefit analysis can then be applied. A proposed project constitutes a welfare improvement if the gains are greater than the losses, so that the gainers could compensate the losers and still be better off. The optimal decision is that which produces the greatest benefits over costs. It is through extending prices to environmental goods so that their ‘true’ value can be discovered that the road to resolving environmental problems lies. Thus goes the neoclassical position.
