The Tragedy of the Commons in a Supply Chain

In an influential article, Hardin (1968) described the tragedy of the commons as a dilemma aris­ing when the common good does not align perfectly with the good of individual entities. It is useful to study his example in somewhat greater detail. Consider a pasture that is open to all herders with cattle. Each herder attempts to maximize his gain from this public asset. When one herder’s cattle feed in the pasture, that herder gains from their growth and all the gains accrue only to him. Any cost of overgrazing, however, is spread over all herders whose cattle feed at the pasture. Thus, overgrazing by the cattle of any herder provides a positive utility of +1 for that herder but a negative utility of only a fraction of -1 for the herder because the negative utility of -1 is spread over all herders. Thus, each rational herder continues to increase his herd because the positive utility to that herder of adding another animal exceeds the negative utility that he experiences from overgrazing. As Hardin writes, “Therein is the tragedy. Each man is locked into a system that compels him to increase his herd without limit—in a world that is limited. Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the commons. Freedom in a commons brings ruin to all.”

Hardin then describes how the issue of environmental pollution is essentially the tragedy of the commons. Every individual and every company releases waste and pollution into the envi­ronment in the form of sewage, chemicals, and carbon dioxide. The individual or the company would incur the entire cost of reducing the amount of waste it discards, whereas the cost of throwing waste into the environment is shared by the entire world. The common environment available to all at no cost makes it difficult to get every company to invest in waste reduction efforts, even though this waste hurts everybody.

This issue also appears at the country level. The Intergovernmental Panel on Climate Change, a United Nations body that has been assessing global warming since 1990, has written that even though most of the buildup of carbon dioxide in the atmosphere has come from the United States and Western Europe, poorer countries closer to the equator are likely to pay the biggest price. The risk of drought, disrupted water supplies, and the swelling of oceans from melting ice sheets as a result of global warming will be experienced mostly in Africa and the “crowded river deltas in southern Asia and Egypt, along with small island nations.”^[1] In such an environment, getting any agreement on action is difficult because the optimal joint action is not individually optimal, whether at the company or country level. No wonder that it has been almost impossible to negotiate a climate change agreement that every country is willing to adhere to! Other examples of the tragedy of the commons come from the overuse of natural resources such as fish, water, and forests. Overfishing of sturgeon in Russia and the destruction of salmon runs in rivers that have been dammed are well documented.

Every company and supply chain faces the challenge of the tragedy of the commons as it operates in a global environment. They must compete against others that may be extracting bene­fits from the environmental or resource commons without spending to maintain these commons. They must compete in a market in which customers often value low cost and are not willing to pay the price of a more sustainable solution, in the form of either a higher price or reduced consump­tion. Unless all consumers suddenly change their mindsets, it is difficult to imagine a sustainable solution emerging without some intervention. Whereas everyone agrees about the need for inter­vention, there is considerable disagreement on the required form of intervention.

What Are Some Solutions to This “Tragedy”?

In his article, Hardin focused on the problem arising from the fact that the commons are “free” to all. As he put it, no solution could be found without taking away some of the freedom that participants enjoyed in the commons. Regarding the national parks in the United States, he wrote, “We might sell them off as private property. We might keep them as public property, but allocate the right to enter them. The allocation might be on the basis of wealth, by the use of an auction system. It might be on the basis of merit, as defined by some agreed upon standards. It might be by lottery. Or it might be on a first-come, first-served basis, administered to long queues. These, I think, are all objectionable. But we must choose—or acquiesce in the destruction of the commons that we call our National Parks.” Rather than focus on Hardin’s many ideas, it is important to understand his point—the need for us to choose from options that are unlikely to be supported by all of their own free will.

In the article, Hardin introduces the idea of “mutual coercion,” whereby social arrange­ments or mechanisms coerce all participants to behave in a way that helps the common good. Given that participants will not tend to the commons of their own free will, mutual coercion mechanisms that apply to all participants can encourage the appropriate behavior. Mutual coer­cion can be attempted through a command-and-control approach or market mechanisms. We introduce these approaches in this section but discuss them in greater detail in Section 17.6. As with Hardin’s suggestions for the national parks, both command-and-control and market mecha­nisms have some aspects that are “objectionable.” Despite the absence of a perfect solution, it is important to make a choice. Otherwise the environmental commons will continue to degrade.

In a command-and-control approach, the government or regulators set standards that everybody must adhere to. An example is carbon monoxide emission standards set by the United States for new automobiles. Another example is the Waste Electrical and Electronic Equipment (WEEE) Directive from the European Union that is geared at proper recycling and landfill avoid­ance in the electrical and electronics industry. A third example is the use of higher fuel efficiency standards for the automobile industry. These standards increase the required fuel efficiency from about 29 miles per gallon in 2012 to 54.5 miles per gallon in 2025. The challenge with com- mand-and-control approaches is that they tend to be inflexible and are not always cost effective. An example is the Environmental Protection Agency proposal to require carbon capture tech­nologies at new coal-fired power plants. Besides increasing overall electricity costs, there is fear that this proposal is unlikely to be effective because of the high cost of carbon capture technol­ogy. The high cost of the mandate may push power plant operators away from coal-fired plants, which may slow down research in carbon capture and hurt future improvements in the area. Rather than improve performance in carbon capture, such a mandate may slow down future inno­vation in this space.

We give a couple of examples of market mechanisms that have been debated (but not yet implemented nationally in the United States as of October 2014) in the context of greenhouse gases, a problem that is only getting worse as supply chains become more global. Currently, there is no “charge” for emitting greenhouse gases and no explicit limits that are strictly enforced. The commons here is the environment, and the lack of any “mutual coercion” leads to excessive emission of greenhouse gases into the atmosphere. The hope is to set mechanisms in place that can sustainably address the problem.

One mechanism, referred to as cap-and-trade, constrains the aggregate emissions by creat­ing a limited number of tradable emission allowances that emission sources must secure and surrender in proportion to their emissions. Any failure to surrender the appropriate number of allowances leads to a significant fine. The mechanism starts with the government creating a lim­ited number of total allowances that are distributed among all players in the economy. If players generate fewer emissions than the allowances they own, they can sell their surplus allowances to others that may be polluting above their limit and need additional allowances. The “price” of allowances in this mechanism is created by the supply and demand for allowances. Such a mech­anism offers companies an incentive to reduce their emissions because they get a financial reward for this improvement by selling their additional allowances to those that cannot (or are unable to) reduce their emissions. The hope with this mechanism is that firms will choose the least expen­sive way to comply with the emissions limit by either implementing emissions reduction plans or buying allowances on the open market. This mechanism has been implemented by several regions, including the European Union (EU) and the state of California. The experience of the EU points to one of the challenges of implementing cap-and-trade. The Emissions Trading Scheme (ETS) was launched by the EU in 2005 with a distribution of free permits or allowances. Once trading started, the price of these allowances peaked around 30 euro a ton in April 2006 before collapsing to below 5 euro a ton by 2013. The drop in price took away any incentive for firms to make further improvements in emissions. This failure of the market was linked to the distribution of too many free allowances and the setting of caps that were easily reached using the improvements made by firms. California, which started its cap-and-trade program in 2013, distributed a fraction of the permits free and has auctioned off the rest. California has also estab­lished a floor on the price of these permits during the auctions. The use of auctions with a floor price to release permits has allowed for a better equilibrium that is less likely to collapse. The EU has also changed its plans and moved from free allocations to auctions as the method for allocat­ing allowances. The Acid Rain Program is another market-based initiative by the U.S. Environ­mental Protection Agency that has had success in reducing overall levels of sulfur dioxide and nitrogen oxides in the atmosphere.

A second mechanism to control emissions is an emission tax. Each entity generating greenhouse gases is charged a tax proportional to the size of the emissions. This is similar in principle to the congestion-based toll we discussed to manage traffic congestion (see Chapter 14). A charge for emissions encourages companies to reduce their emissions using all ideas whose marginal cost is less than the charge. As a result of an emission tax, the total amount of green­house gases produced will decrease. These taxes are often implemented on fossil fuels related to carbon content. For example, India introduced a nationwide carbon tax of 50 rupees per metric ton of coal both produced and imported into India.^[2] Similarly, Japan has introduced a tax on oil, natural gas, and coal that is expected to cost utilities about 80 billion yen annually from 2016.^[3] One problem with a carbon tax, though, is that it tends to be regressive and hurt low-income groups to a greater extent.

We discuss the pros and cons of cap-and-trade versus a carbon tax in greater detail in Sec­tion 17.6. There is still considerable debate among experts about the relative merits of the two approaches. Unfortunately, this debate has slowed the implementation of either approach across the globe. The challenge of tending the environmental commons is magnified because the state of the environment is affected by every region of the world. To be effective, mutual coercion must have the same global reach as the environment. Solutions are unlikely to be effective unless there is global coordination in the implementation of any mutual coercion mechanisms. The need for coordination is evident even in the experience of the EU with cap-and-trade. After starting with national caps that created problems, the EU had to shift to EU-wide caps. There is concern that the introduction of cap-and-trade in California may result in some firms moving out of the state. In the absence of global coordination, it will be difficult to get market mechanisms to be very effective in controlling emissions. The need for global coordination is particularly impor­tant given that although most of the existing emissions have come from the developed world, an increasing share of future emissions is likely to come from economies that are still developing. It will not be enough to have solutions that are limited to the developed world.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.