Earth Day, Waste and Productive Complements

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It has been just over half a century since the first Earth Day in 1970. Over that time, April 22 has turned into a day with lots of waste cleanup activities, apocalyptic warnings, and proselytizing about how important it is that everyone gets on board with the green agenda. 

It is true that we must care for what is home to every one of us. However, Earth Day has also served as the springboard for jeremiads against private property rights and market arrangements (reflected in the term watermelon environmentalism: green on the outside but red on the inside), and in favor of various forms of coercion to ensure their recipe for environmental responsibility is followed.

Some people do not place much value on reducing negative environmental effects that they impose on others from their actions, though they do care about the effects they bear. Even so, however, the implication that government must therefore dictate “solutions” does not follow, because it ignores another truth — that private-property-based market systems provide incentives for owners to take care of the environment. 

A good example of that is the work of the Property and Environment Research Center (PERC), “the home of free market environmentalism…dedicated to harnessing the power of markets and property rights to improve environmental quality.” They recognize that “conservation is most effective and lasting when it is voluntary, cooperative, and makes economic sense — when there are incentives to make conservation an asset, not a liability,” so they “explore how aligning incentives for environmental stewardship produces sustainable outcomes for land, water, and wildlife.”

While PERC explores new and innovative ways to use voluntary arrangements to improve the environment (e.g., creating markets in stream flows and easements for species protection), private property rights have always generated incentives to reduce waste, a major focus of Earth Day. 

One of the most important such mechanisms involves what are called productive complements, or joint products that arise when production processes generate multiple outputs. Raising cattle, which produces both beef and hides as salable outputs (as well as many others, which we shall ignore here to make the analysis simpler), is perhaps the best-known common example (with other cases of animal husbandry, such as wool and mutton from sheep, analyzed similarly). A more modern example is petroleum refining, which produces multiple products in the process of “cracking” a barrel of oil.

At one level, the theoretical modification necessary to transition from the standard single-output case in economics texts, to the multiple-output productive complements case is straightforward. Since a steer will produce both beef and hides, suppliers must compare the opportunity cost of raising a steer to the sum of the values of the products produced, rather than to the value of a single product produced. 

But that modification introduces new issues into the analysis. How does an increase in the value of hides (the “other” product) affect the well-being of suppliers of beef? How does it change the output of beef? How does that change the price of beef and the wellbeing of demand for beef? Such questions are the key to understanding the market incentive to reduce waste. 

Essentially, when hides command a higher price, the added revenue generated from them can “absorb” a larger share of the costs of raising a steer. Consequently, the revenue from selling the beef must contribute a smaller amount to the cost than previously. That lower residual cost benefits producers. They then increase their supply of beef in the process of producing more hides (more beef and more hides are produced when a steer is slaughtered). That increase in supply lowers the price of beef, which, in turn, benefits all beef consumers. 

To summarize, when the value of one part of a set of productive complements increases, the producers gain and increase their output of each of the joint products involved. That increases supply of the other product(s) in the bundle as well, which benefits all those customers by way of greater output and lower prices.

A modified version of that joint-product analysis also shows the market incentive to reduce waste. 

Think of a production process that produces one salable product and waste of some kind. Since the removal of waste is a good, waste is essentially a part of the bundle of outputs with a negative value. If one is paying to dispose of waste, a reduction in waste would increase a producer’s profits, other things equal, just as an increase in the price of hides would raise the profits of a cattle rancher. 

There are many examples. Two are next to me as I write — an Amazon box that announces it contains less material than previously, and inside is packing material with more air and less material than previously. And I noticed them while drinking from a bottle of water whose cap had been made smaller to reduce the amount of plastic which would need to be recycled or would become waste. Another illustration is looking to use what would otherwise be thrown away in a firm’s own production processes.

Similarly, if one could lower the cost of disposing or treating a given amount of waste, profits would be raised. It would also increase the output of the other joint products, benefiting those consumers as well as the producers. In other words, discovering how to reduce waste, or the costs of waste disposal, generates increased profits to producers as well as benefiting the consumers of the saleable product(s), all without government coercion.

If one could turn what would otherwise be costly to dispose of into a saleable product, the profit incentive is even greater, as an output with a negative value is turned into something with a positive value. A good example was Standard Oil, long falsely pilloried for alleged predatory pricing. It was actually able to outcompete many competitors by offering lower kerosene prices, in part by its use of what would otherwise be waste products itself and by turning waste products of oil refining into saleable products. As Berton Folsom put it, the company not only “worked on getting more kerosene per barrel of crude,” but also “searched for uses for the byproducts: they used the gasoline for fuel, some of the tars for paving, and shipped the naphtha to gas plants. They also sold lubricating oil, vaseline, and paraffin for making candles.”

It seems surprising that the extension of the analysis of productive complements to incentives to reduce waste and its cost seem largely unrecognized. But one contributing factor is probably that the analysis is largely ignored in economics textbooks today. Only a few economics principles texts present the analysis of productive complements, and I have not seen an intermediate microeconomics text that does so, instead favoring the simpler modeling of the one-product case. 

Since even students who take economics are barely (or not at all) exposed to the analysis of productive complements, as if all production involved only a single output, their training does not lead them to “look” in the direction of productive complements for understanding. Consequently, they do not tend to see the extension to the parallel story for waste reduction. And not knowing the underlying analysis often means not recognizing the inherent market incentive to reduce waste. 

This also represents an important dumbing-down of what economics students learn (a market failure in the market for economics texts).

Over a century ago, in his 1920 Principles of Economics text, Alfred Marshall not only discussed “the case of joint products: i.e., of things which cannot easily produced separately; but are joined in a common origin, and may therefore be said to have a joint supply,” he provided several examples. Beyond beef and hides, he analyzed applications involving wheat and wheat straw (a particularly interesting example, as at one point, wheat straw was more valuable than wheat), wool and mutton, and cotton and cotton-seed oil. He even derived a rule for the supply price of a productive complement in competitive markets.

Even earlier, William Stanley Jevons argued in 1871 that “these cases of joint production, far from being ‘some peculiar cases,’ form the general rule, to which it is difficult to point out any clear of important exceptions.” And it is hard to disagree when we note that virtually no production process has only one potentially valuable output and generates nothing that imposes negative externalities or needs costly disposal. Even pollution from the generation of the energy necessary to power a production process means there are at least two relevant outputs.

Many people today have joined the bandwagon of those asserting “market failure” everywhere and prescribing more government impositions as the optimal or efficient solution. But those people seem unaware of how, when property rights are effectively defined and enforced, as long as producers care about their bottom lines, they have profit incentives to reduce environmental costs and damage. 

Further, such people are often utopian in thinking that what governments announce they intend to accomplish with their “solutions” in this area, they are actually able to effectively and efficiently do. But that ignores the many problems, conflicts and disincentives faced by government decision-making, as an alternative to owners making their own decisions. In fact, as Dwight Lee has stated, “No social institution does more to motivate current decision-makers to act as if they cared about the future than the institution of private property.” 

The analysis of productive complements opens the door to understanding the incentives that private property rights and markets provide to reduce waste and pollution, which is so at odds with one of the most common defamations made against them. In fact, the beneficial incentives apply beyond just the issues of waste and waste disposal. As Drew Bond and Anthony B. Kim recently wrote for the Heritage Foundation, “Economic freedom safeguards the environment by reinforcing environmental stewardship. Countries with greater economic freedom tend to fare better on protecting the environment than countries with more intrusive, government-directed environmental governance.” 

If people were serious about improving our environment, as well as the wellbeing of people as producers and consumers (the latter category being what all share most in common), rather than as an excuse to promote socialistic policies which undermine all of them, Mother Nature might be better protected than she is by her current “bodyguard” of coercive policies.

* This article was originally published here


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