The political economy of certificates for land use in Germany – experimental evidence

ABSTRACT

Certificate trading schemes have been discussed as a cost-efficient means of reducing urban land consumption in Germany by capping and reallocating permissions to conduct building projects. However, in contrast to the established cap & trade systems for emissions, reputation-seeking politicians would be in charge of buying and trading certificates – an aspect not considered to date. We thus present a laboratory experiment that captures politicians’ incentives connected to electoral cycles in a cap & trade scheme for land consumption, whereby tradable certificates are auctioned and grandfathered in equal shares. We find the cap & trade system to be efficient at large; yet, there are several politically relevant distortions that are aggravated by self-serving incentives. We thus identify potential problems to a cap & trade system for urban land consumption that could substantially reduce both its assumed superior efficiency and its political feasibility.

KEYWORDS:

• Economic experiment
• land consumption
• municipal politicians
• political business cycle
• tradable certificates

Disclosure statement

No potential conflict of interest was reported by the authors.

ORCID

Till Proeger http://orcid.org/0000-0001-9446-6829

Notes on contributors

Dr Lukas Meub is a research associate at the chair for economic policy and SME-research at the University of Goettingen.

Dr Till Proeger is a research associate at the chair for economic policy and SME-research at the University of Goettingen.

Dr Kilian Bizer is a professor of economic policy at the chair for economic policy and SME-research at the University of Goettingen.

Dr Ralph Henger is a senior economist at the Cologne Institute for Economic Research.

Notes

1. Coalition treaty between the conservatives (CDU/CSU) and socialists (SPD), see Coalition Treaty (2013), p. 83.

2. The discussion in Germany has been driven by numerous studies issued by governmental agencies following the federal government's 2002 commitment. Among the recent studies are Walz, Toussaint, Kuepfer, and Sanden (2005) for the Federal Ministry for the Environment, the Council of experts on environmental questions (2002), Heiland et al. (2006), Perner, Thoene, and Vormann (2007), Bizer et al. (2012) for the Federal Agency for the Environmental Protection, as well as Kaule and Siedentrop (2010). Evolving simultaneously, the scientific discourse has put forth a large number of publications from the perspective of institutional and environmental economics concerning its practical and theoretical questions, which can be accessed through the recent dissertations by Schroeter-Schlaack (2013) and Henger (2010).

3. While empirical studies on land consumption certificates remain limited, a large body of empirical literature has evolved dealing with various aspects of CO₂ emission certificates, particularly regarding the European emissions trading system in 2005, to which Convery (2009) provides an introduction. Furthermore, numerous experimental studies have investigated various aspects of certificate allocation trading schemes, including the efficiency of different allocation mechanisms (Grimm & Ilieva, 2013); the effect of market power of participants (Cason, Gangadharan, & Duke, 2003); price discovery in emissions certificate auctions (Burtraw et al., 2011); collusion and speculation in emission certificate markets (Mougeot, Naegelen, Pelloux, & Rullière, 2011) or different pricing strategies following an initial allocation of certificates (Wrake, Myers, Burtraw, Mandell, & Holt, 2010). While these studies enable a substantiated prediction of the behavior by profit-maximizing entities in a certificate-trading situation, they offer no outlook on potential distortions caused by reputation-seeking political actors.

4. To increase the comprehensibility of our experimental design, we provide a glossary of the experimental terms used in this section in Appendix C. We thank an anonymous referee for suggesting this improvement of our study.

5. For reasons of simplification, we only consider the case of simultaneous elections, which is also the appropriate setting when looking at German municipalities within a federal state.

6. The original instructions for the game were in German. They are available from the authors upon request; a translation is provided in Appendix A.

7. For example, player i realizes ten 100 ECU projects and five 80 ECU projects and is grandfathered 60 certificates. We then assume that she uses two-thirds of these grandfathered certificates for 100 ECU projects and one-third for 80 ECU projects. Accordingly, the 60 certificates she has to buy additionally raise costs of 40 certificates at 11.25 ECU and 20 certificates at 8.75 ECU.

8. Overall, 24 projects need to be realized until period 7, while the restriction to 24 certificates per period also restricts the maximal number of projects to [(24/8)*7=] 21.

9. Mean willingness to pay represents the average payoff a player can obtain with a certificate and depends on the available projects and the number of certificates needed to obtain the bonus. For example, for player i, we calculate the mean willingness to pay as:

[(# required Type A*(net value Type A) + bonus) / required certificates]=[(6*(100-10)+300)/48] =17.5 ECU.

10. The auctioneer can expect to sell 12 certificates at 23.75 ECU and 22.92 ECU. 20 certificates are sold to player iii; 12 at 20.65 ECU in period 4 and eight at a unit price of 20.42 ECU in period 4. Player vi buys four certificates in period 4 at 20.42 ECU and eight at 11.25 ECU in period 5. Given the residual Type A projects, 76 certificates are further sold at 11.25 ECU and 48 at 8.75 ECU from period 11 to 15. This gives a total income of 2418.8 ECU, which is about 30% higher than in BASELINE.

11. Applying a Wilcoxon-Signed-Rank test for matched-pairs on the society level gives significant differences in average prices for all treatments (p < .0117).

12. For the first half of the game, applying a Wilcoxon-Signed-Rank test for matched-pairs on the society level gives z = −2.240, p = .0251 for BASELINE; z = −2.51, p = .0117 for PRESTIGE and ACTIVITY. For the second half, we obtain z = −1.540, p = .1235 for BASELINE; again z = −2.51, p = .0117 for PRESTIGE and ACTIVITY.

13. The average standard deviation is calculated by summing the variances of auction prices of all societies within a treatment divided by the number of observation and subsequently taking the square root. For BASELINE/PRESTIGE/ACTIVITY, we get 10.68/8.25/12.0 for the first half of the game and 3.08/5.28/2.93 for the second half. Considering the average range of auction prices or the coefficient of variation gives the same tendency and ranking over treatments. We apply the same procedure for market prices, only adding the stage of standard deviations within periods, obtaining 9.15/8.77/13.03 for the first half and 2.21/7.20/1.84 for the second half.

14. Wilcoxon-Signed-Rank test for matched-pairs on the society level gives z = 1.823, p = .0684 for BASELINE; z = 1.96, p = .0499 for PRESTIGE and z = 2.38, p = .01173 for ACTIVITY.

15. Note that these results are in line with our prediction derived in the theoretical framework which shows that the smallest municipalities have the highest willingness to pay under ACTIVITY. Please find a comprehensive graphical illustration of cumulative realized projects by player type over periods in Appendix B.

Additional information

Funding

This work was supported by the German Environment Agency [Grant number 3714111032].