Balancing economic growth and environmental protection is not easy. Consider wetlands, which provide flood protection, aid water quality, and are linchpins of larger ecosystems. How can we best preserve wetlands while enhancing economic activity?
According to a new study, one solution involves supplanting traditional conservation mandates, which require replacing affected wetlands locally, with tradeable offsets. Through this system, a developer can build on a wetland by purchasing credits representing an equivalent environmental value created by improving a wetland somewhere else in the same watershed, away from concentrated development.
While this has largely been the approach of U.S. federal and state regulators since the mid-1990s, current regulations do not account for the flood protection benefits of wetlands. The new study finds a workable solution in an offset policy that also includes a locally varying tax on development, precisely to compensate for the increased flood risk it causes.
In the lower 48 states of the U.S., wetlands are heavily concentrated in California and Florida, two high-population states. Through a highly granular look at Florida's wetlands from 1995 to 2020, with a new scholarly methodology that carefully weighs local factors, the scholars estimate that development of wetlands led to $2.4 billion in net economic gains. Their alternate policy would have preserved most of these gains while also preventing about $1.6 billion in flood damage.
"You're retaining two-thirds of the private gains from trade," says Daniel Aronoff PhD '22, a research affiliate in MIT's Department of Economics and co-author of a newly published paper summarizing the study's findings. "And the flood damages shrink by an order of magnitude, so only you're incurring a small fraction of the flood damage while collecting that amount in increased tax revenue, which can subsidize the cost of restoration after flood damage has occurred."
This system is neither a simple conservation mandate nor a free ride for developers. The scholars say it would provide a better way of balancing wetlands preservation and economic gains, while lowering flood risk.
"You could do this," Aronoff says. "It's an implementable thing. You could build a policy out of this."
The paper, " Conservation Priorities and Environmental Offsets: Markets for Florida Wetlands ," appears in the May issue of the American Economic Review. The authors are Aronoff, who is also a research associate at the Laboratory for Economic Analysis and Design at MIT and a research collaborator at the Digital Currency Initiative; and Will Rafey PhD '20, an assistant professor of economics at the University of California at Los Angeles.
No net loss - but more risk
Federal wetlands policy in the U.S. has been governed since the 1970s by a "no net loss" objective, meaning that development must be accompanied by approved actions to offset any loss of wetlands functionality. State laws have often mirrored this federal approach. The current rules work on a watershed level, enabling public and private developers to offset the impact of developing a wetland by purchasing offset credits from a "wetland mitigation bank" in the same watershed.
The researchers developed their study as an ambitious, data-rich project. They obtained comprehensive data on environmental offset credits issued, and transfers to developers from state and regional regulators; a record of offset prices from a private broker as well as state and county purchase records; maps detailing wetlands development and private property ownership; and Federal Emergency Management Agency (FEMA) data on flood risk policies and claims.
The scholars then built a detailed database of development from every wetland bank permit issued in Florida that included enhancements, land acquisition, estimated costs, and offset credit release schedules, as well as records of actual releases and sales over time. They used these data to build a dynamic model of the wetland offset market, from which they obtained their estimates of economic gains and flood risk costs.
Whereas other work has applied national data to wetlands analysis, this more granular approach allowed the scholars to conduct a locally focused examination of economic activity, floods, and policy specifically applying to Florida.
"The functional form that has been used to estimate the relationship between wetlands and flood risk across all America is not compatible with data on wetlands and flooding in Florida," Aronoff says.
The study also underscores an important distinction in the kinds of offset policies that have previously been deployed. The first iteration of offset policy required a developer to restore wetlands adjacent to any wetlands area that is newly developed. A second iteration, the one still in use, allows developers to purchase offset credits - which might apply to wetlands that are not adjacent to the development in question. The latter carries with it greater risk of flood damage to developed property, as an equivalent amount of restored wetlands in a rural area will not serve as a flood buffer for as many structures.
The proposed policy solution would levy a tax - either on offset sellers or buyers - that would equal the estimated increase in flood risk created by the development.
"Going from the first policy iteration to the second iteration could have created a lot of value, because you have development taking place with wetlands created in the lowest-cost way," Aronoff says. "But that gave rise to an externality: the flood risk. Because you're creating flood risk by developing in urban areas with lots of buildings, while creating wetlands in rural areas without buildings around."
Tuning the policy
Ultimately, that is why the empirical analysis developed by the economists shows a more optimal path using so-called Pigouvian taxes, named after 20th-century economist Arthur Pigou. These taxes add a levy when people create negative circumstances for society at large. Taxes to inhibit pollution, for instance, are Pigouvian. The modeling in the current study indicates the same concept would work effectively for wetlands policy.
"Economics is about tradeoffs," Aronoff says. "And this is a tradeoff. Flood risk is expensive - that's a cost. But development creates value because it is only profitable to the extent that the end user desires it."
Ultimately, the scholars think, implementing systems that balance factors will work better in the long run than many kinds of prohibitions on economic activity - or than allowing unrestricted activity without weighing the public good.
"If you choose an absolute, you're choosing one over the other in all instances," Aronoff says. "And what is at the core of the outlook of an economist is to assume there's a tradeoff, and the question is how do you negotiate that tradeoff in an optimal way. That's what we are trying to get at here."
The research was supported by the National Science Foundation and the George and Obie Schultz Fund.
