Tradable development rights under uncertainty: an experimental approach

ABSTRACT

Tradable development rights (TDR) are discussed as a mechanism to reduce land consumption while ensuring an efficient implementation of profitable building projects. We present a novel laboratory experiment on the feasibility of TDR and simulate the acquisition and trading of development rights. In particular, we investigate the effects of uncertainty in the revenues of land consumption projects. Overall, we find that TDR are reallocated as suggested by theory, although higher uncertainty has substantial detrimental effects on the distribution of land consumption projects and thus aggregate welfare. This enables us to formulate distinct policy implications for the design of TDR systems.

KEYWORDS:

• Auction
• economic experiment
• land consumption
• tradable planning permits
• urban sprawl

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Examples are, e.g. a strong demand for additional development zones or receiving areas customized to the demands of the respective communities (Pruetz and Standridge 2009).

2. The debate on the merits and potential disadvantages of applying behavioral economics to the design of public policies has been conducted for more than a decade by now. Among the central contributions are Falk and Fehr (2003), Falk and Heckman (2009), Madrian (2014) and Chetty (2015), who present the core arguments.

3. We precluded agents from borrowing in our design for two distinct reasons. First, the general experience from scholarly and policy discussions is that funding for administrative units such as municipalities to buy certificates is quite limited. Therefore, strong budgetary restrictions in terms of credit availability is a common phenomenon. Second, there are limits to the complexity of an economic experiment in terms of subjects’ understanding. Since our experimental design is already challenging compared to standard economic experiments, we had to ensure subjects’ full understanding and therefore had to abstain from certain elements of a real-world TDR scheme, such as borrowing.

4. Strictly delaying all payoffs from realized projects until the end of the game might seem as strong limitation to a subject's choice set. However, delayed profits represent the most likely scenario of large scale building projects. Further, it keeps the game simple as subjects are not required to calculate their future budget dynamically conditional on profits from realized projects.

5. Testing for differences between unit auction and market prices in the first half of the game by applying a Wilcoxon-Sign-Rank test gives z =–3.240 and p =.0251 for BASELINE, z = –2.666 and p = .0077 for LOW RISK and z = –2.521 and p = .0117 for HIGH RISK. For the second half, the test gives z = –1.540 and p = .1235 for BASELINE, z = –2.192 and p = .0284 for LOW RISK and z = –2.521 and p = .0117 for HIGH RISK.

Additional information

Funding

We gratefully acknowledge financial support from the German Environment Agency (Umweltbundesamt) for the laboratory experiments in the project “Planspiel Flächenhandel” [grant number 3714111032].