Designing an Environmental Responsibility Institution – The Environmental Mitigation Banking System

While institutions are a key determinant of economic behavior and new institutions are often formed as a part of an economic policy, a systematic way to design these institutions and test their potential performance before they are created does not exist. I have attempted in this paper to create and test such a design for an environmental mitigation banking system using system dynamics modeling and computer simulation. Viewed as an environmental responsibility institution for transmitting the cost of restoration to the agent responsible for damage and assuring at the same time that net damage to the environment remains zero, environmental mitigation banking has been introduced in limited niches like forests and wetlands and operated mostly in the private sector, but at a scale that its impact on human activity and environment cannot be ascertained. Many opinions exist about how this industry should be instituted and regulated, but without a clear understanding of how proposed institutional arrangements and regulatory policies would affect its performance in terms of supporting human activity, preserving environment and minimizing organizational costs and social conflicts. Environmental restoration costs in a mitigation banking system are transmitted to users through mitigation credits, which are earned by a mitigation bank and bought by a user prior to inflicting damage to the environment. Pricing of these credits is an important aspect of the banking system and complex engineering methods connecting cost to price have been proposed as pricing criteria. Also, environmental groups often advocate subsidization of the environmental mitigation activity by the government. Experimentation with my model suggests that the market is able to yield an optimal price without inputs from engineering methods connecting price to cost, while the delays associated with engineering calculations , when they are used to determine price, would reduce growth of human activity by stifling its multiplier effects. Subsidies would indirectly support human activity by reducing the price of credits, but for the same budget, direct subsidies support human activities more than the market-based subsidies. Connecting credit requirements to environmental condition introduces instability in all cases due to the delays involved in this process. The experimental method used to test the efficacy of the mitigation banking system is seen in general to be important to the design of new institutions and improving performance of existing ones.