The Tragedy of Commons

The domain of social entrepreneurship is replete with possibilities and innovations to address and potentially solve some of society’s most intractable problems. In this essay, we highlight the role of the “Tragedy of the Commons” and examine how it represents both opportunities and obstacles for the social entrepreneur. We use the example of Verdant Power, a Green Energy provider, to illustrate our comments.

The Tragedy of the Commons refers to the depletion of a shared resource by individuals acting independently and rationally, according to one’s self-interest, despite knowing that an abuse of the common resource is contrary to those individuals’ long-term, best interests.  The first use of the term is attributed to the American ecologist Garrett Hardin’s 1968 Science article (first outlined in an 1833 pamphlet by W. F. Lloyd) describing European farmers practice of sharing common land on which they could graze their cattle. It is in each herder’s interest to put every cow he acquires on the land, even if the quality of the commons is damaged for all through overgrazing. The individual receives all of the benefits from any additional cow, but damage to the commons is shared by the group.

The Tragedy is often applied to a discussion of environmental issues and is a model for a great variety of society’s current resource-based problems, including over-irrigation, habitat destruction, over-fishing and traffic congestion. It is especially applicable to our purposes here, namely air pollution, where strong economic forces are encouraging the use of the atmosphere as a free-for-all dumping ground for greenhouse gases.  Any solution to this problem will clearly be a social good of mammoth proportions. But the fact is that any one of the six billion people on Earth has an incentive to avoid the cost of controlling polluting emissions, even though this in turn creates the ”Free Rider” problem, i.e., an individual who benefits from another’s work without paying for it.

MODERN APPROACHES AND SOLUTIONS
Generally speaking, there are two practical ways to try to overcome any Free Rider problem: compulsory participation (taxation) – a form of regulation, and secondly, linking the public good to a desirable private good (getting people to pay voluntarily).  In the case of air pollution, the most common solutions to date have been centered on compulsory participation through a carbon tax or emissions trading (cap-and-trade). In recent years, more attention has been spent on ways to ‘privatize’ the commons. That is, to convert the common good into private property, so giving the new owners an incentive to enforce its sustainability.  Clearly, this may be possible as a solution to traffic congestion through the use of toll roads for example. However, it is unlikely to succeed in the case of air pollution.

Introducing a carbon tax as a potential solution to the air pollution problem works this way. A tax is levied on the carbon content of fuels that are used, offering a potentially cost-effective means of reducing greenhouse gas emissions. This Pigouvian tax (i.e., a levy on activities that generate negative social costs) penalizes producers of greenhouse gases who do not pay the full social costs of their actions. Simply put, the tax on emitting pollution is based on the carbon content of the fuel used in the particular manufacturing process.

The other major approach is emissions trading (cap-and-trade), a market-based approach that provides economic incentives for reducing the emissions of pollutants. A central authority (governmental body) sets a limit (cap) on the amount of pollutant that may be emitted. The cap is then allocated or sold as permits, which represent the right to discharge a specified volume of the pollutant. Firms are required to hold the same number of permits as the quantity of their emissions (so, for example, one emissions permit may be considered equivalent to one metric ton of carbon dioxide emissions). Since the total number of permits cannot exceed the cap, total emissions are limited to that level.

After a cap has been set, individual companies are then free to choose how or if they will reduce their emissions. Failure to report emissions and/or surrender emission permits is generally punishable through a government oversight mechanism that imposes fines that in turn increase the cost of production. Ideally, firms will choose the least expensive means of complying with the pollution guidelines. In many cap-and-trade systems, organizations that do not pollute (and therefore have no obligations) can also participate in trading; environmental groups, for example, can purchase and retire emission permits, thereby driving up the price of the remaining permits.

Both of these methods are highly controversial and easily politicized, with opposition to environmental regulation centering on the increased costs of doing business through taxation, relocation of businesses, higher unemployment and outright denial of any linkage between carbon emissions and greenhouse gases.  In fact, such ‘top-down,’ bureaucratic approaches provide the social entrepreneur with the opportunity to address the problem with a more practical ‘bottom-up’ approach.  In particular, entrepreneurial innovation employing public-private partnerships are often successful.

ENTER THE SOCIAL ENTREPRENEUR
In essence, social entrepreneurs resolve the Free Rider problem by using innovative methods to bring the solution to the Tragedy (be it a product or service) to market and have the consumer pay for any social costs.  Thus, the Tragedy itself provides the opportunities for social entrepreneurs to perform a necessary and socially beneficial service at appropriate prices. (Almost every social enterprise begins with an idea for improving society in some way. They are the “commodities” of the entrepreneurial process. Just as is the case with physical commodities, ideas have a value as the raw materials from which opportunities are created and ventures are launched).

Verdant Power
Verdant Power (VP) was founded in 2000 in New York City and has since positioned itself as a developer specializing in the design and application of marine renewable energy using proprietary kinetic hydropower technologies. The firm’s mission is to provide renewable energy using underwater turbines, especially to developing world communities. Ron Smith, the firm’s Chairman and Chief Executive Officer, expresses the view shared by many, if not most, social entrepreneurs:

“My motivations are a combination of business and social aspirations. My career orientation has never really been focused on getting extremely wealthy but more in the work and the creation of something unique.”

VP’s technology has no carbon footprint from operations, and while management is steadfast in adhering to its mission, its main focus has to be on the business challenges involved in commercializing marine renewable technology and generating a revenue stream that will allow it to become sustainable.

The firm has recently finalized proof of concept tests for the Department of Energy in New York City’s East River. The objective was to demonstrate not only the viability of the system and optimize issues related to turbine spacing and power production, but also to assess its overall potential.  VP has shown that even with its limited array of turbines in place, it is capable of generating sufficient power to supply the Roosevelt Island community in the East River. Given the success of the tests, the absence of a carbon footprint and the ability to hook into the local electrical grid, one would think that VP represents a logical and viable solution to the Tragedy of air pollution.

However, bringing the solution to market was not so straightforward. In fact, the obstacles that confront Verdant Power are those same major obstacles that stymie most social entrepreneurs.

OBSTACLES TO PRIVATIZING THE COMMONS
VP currently does not have a revenue stream and thus is not making any profits. Because it has no revenue, it is at the mercy of private equity investors and/or the government. Further, most government funds require matching funds, which means that even with the government funding, VP has to find suitable private investors.  It is a formidable challenge. After all, how does one convince for-profit investors of the financial merits of providing a social good?

The cost of the substitute product – carbon-based fuels – does not fully reflect the cost of pollution. That is, everyone recognizes that there is a societal cost of air pollution. However, no one pays the full cost. To control these emissions, the true cost of pollution must be recognized (currently, either through a carbon tax or through cap-and-trade). Thus, carbon dioxide pollution must maintain a significant economic cost in the future, if the Free-Rider problem is to be avoided. Hence, the viability of Verdant Power relies on the willingness of the government to impose appropriately high emission taxes or to provide cost-reducing, public economic incentives such as production or investment tax credits and grants in support of sustainable technologies.

Fear of creating additional Tragedies includes conforming to existing regulatory oversight. The effect of the turbines on the river’s aquatic life, particularly fish, and the regulations associated with environmental protection, has been a major challenge for VP.  The company had initially budgeted about $750,000 for fish studies but that figure is now in the millions of dollars. In fact, the company has spent more money on environmental studies and assessments than it has on building products or developing technology.

A related issue is the difference in incentives for both regulators and social entrepreneurs.  Specifically, there is a severe problem in dealing with bureaucratic inertia. For example, to obtain a demonstration permit, VP had to examine the ecological, navigational, recreational, hydrodynamic, and historic preservation impacts of the East River Project. To do this, the company had to conduct numerous studies, including benthic habitat characterization; a water quality assessment; a hydrodynamic survey; a mobile hydro-acoustic survey; a fixed hydro-acoustic survey; an assessment of impacts on any rare, threatened, or endangered species; a biological survey of the East River; a recreational resources assessment; a navigational and security assessment, and an historical resources assessment.

Only after having completed the studies two years later, could VP apply for a license to build and operate a commercial scale project in the East River. Hence, the degree and associated costs of compliance necessary to satisfy regulators charged with overseeing overlapping portions of the commons is a major impediment to profitability.

While solutions to the Tragedy of the Commons quickly fall victim to bureaucratic inertia and/or red tape, the more insidious problem is the question of political will – namely that policy makers have to make change happen.  But, politicians also respond to incentives.   Each stakeholder in the air pollution drama prefers a solution that is paid for by someone else; the benefits of being a free rider on the global scale are huge.  Politicians know that they will be punished by well-funded interest groups, especially if the decision is made to allocate a larger share of the costs to specific sectors or industries rather than allow society as a whole to suffer from the free-rider problem.

In summary, the problems facing the social entrepreneur fall into two categories.  The first comprises the standard operational difficulties of developing a viable product, providing proof of concept and creating a sustainable operation.  The second problem, however, is much more difficult, namely trying to counter the existing bureaucratic and regulatory impediments designed to resolve Tragedy issues. Entrepreneurs often talk of Schumpeter’s (1911) concept of “creative destruction,” and as Baumol (Griffiths et al. 2012) recently pointed out “…the cost of obsolescence of old technology is borne by its proprietor, who is apt to be a very different person from the inventor. The old technology may still be usable but can be driven from the market prematurely by the newer item because the holder of the patent thereby gains profits but the damage from premature obsolescence falls on others.”  We contend that a similar argument can be used to criticize bureaucrats and regulators.

MAJOR DECISIONS ON THE HORIZON
When dealing with opportunities involving the Tragedy of the Commons, social entrepreneurs are faced with two major decisions.  One is the question of whether or not to continue operating in rigidly regulated markets.  That is, do social entrepreneurs have an ethical duty to prioritize the firm’s operating goals? Are the social objectives really more important and immediate than their fiduciary responsibility?

These sustainability issues can only be answered in terms of the second question, which involves the existing regulatory environment and the likelihood of change therein. That is, should social entrepreneurs recognize the regulatory and bureaucratic obstacles and rely on market forces to put pressure on governments to amend their “top-down” approaches to resolving Free Rider problems?  Should social entrepreneurs attempt to work within the system, incur the costs associated with that decision and risk the erosion of competitive advantage through administrative delay? Or, will investors be better served by moving operations to friendlier, less-restrictive operating environments, which allow for the more immediate exploitation of the entrepreneur’s competitive advantage and the related benefits of profitability and market power?

THE GOOD NEWS: THE BURGEONING SOCIAL ENTREPRENEURSHIP SUPPORT ECOSYSTEM
In recent years, the amount and variety of assistance and institutional support for social entrepreneurs have grown enormously to include academics, practitioners, government agencies, non-governmental organizations (NGOs), public and private organizations, and other social enterprises.  These support organizations are now part of the ecosystem that enables social entrepreneurs to better prepare ventures to be financially sustainable and achieve the desired impact on individuals, families, and society.

For example, an increasingly large and vibrant pipeline of training, support, and awareness now supports the rapid growth in social entrepreneurship education in terms of classes, activities, and research (Ashoka & Brock, 2011).  The Aspen Institute surveys business schools biennially to better understand how universities can integrate social and environmental issues into curricula and research.  The percentage of schools requiring students to take a course dedicated to business and societal issues increased from 34 percent in 2001 to 79 percent in 2011 (Aspen Institute, 2011). They also find that 20 percent of the courses offered at universities contain social, environmental or ethical content. Many of the programs, courses and especially community engagement initiatives at the university provide new insights into how social entrepreneurs can create and develop their ventures as they encounter many of the challenges and obstacles in attaining economic and social impact.  

Finally, more organizations are evolving to provide aspiring social entrepreneurs with the resources needed to effect social change by supporting new entrants to the market. Partnering with NGOs provides social entrepreneurs with the opportunity to work on projects that deal directly with challenges in advocacy, fund raising, becoming a change agent, opportunity recognition and scale. Established social enterprises can benefit from groups such as the Social Enterprise Alliance (SEA) (www.se-alliance.org/member-spotlight), which coordinates regular educational and networking events for non-profit business practitioners including social enterprises, corporations, lenders, educators, and service providers. SEA proactively advertises its members’ businesses to cultivate partnerships, attract clients, and identify sources of capital. Other organizations with similar goals and objectives include Ashoka, ANDE, Echoing Green and the Skoll Foundation.

Social entrepreneurs are innovators. Wherever societal problems are found, it is the social entrepreneur who rises to the challenge and uses his/her ability to recognize, motivate, and mobilize others to take action.  In this field, the issue may not be opportunity recognition as much as obstacle recognition and finding collective solutions within the burgeoning social entrepreneurship support ecosystem.  Nowhere is this so compellingly true than when dealing with issues involving the Tragedy of the Commons.

Reprint from Ivey Business Journal

Reprint from Ivey Business Journal
[© Reprinted and used by permission of the Ivey Business School]