Mitigation Banking: A Cosian Solution?

For two summers, I interned at a startup mitigation banking firm.  This fall, I've been asked about mitigation banking in a few interviews, and I have found that it is a relatively unknown industry that is difficult to explain in a one minute response.  Luckily, this class has provided framework to make explaining mitigation banking easier.  Mitigation banking is a semi-Coasian solution to a negative production externality.  Consider the planned expansion of a rock quarry near the Atlanta airport.  In “producing” the new rock quarry, the quarry owner will irrevocably damage a wetland area.  Because wetlands act as natural water "filters," the destruction of the wetlands deteriorates water quality in the surrounding area, negatively effecting the fish population and thus the fishermen in the community. Other community members who derive utility from good water quality in the area also experience the negative externality.  The Clean Water Act makes the quarry owner liable for these negative externalities.

The exchange of mitigation credits makes mitigation banking is a semi-Cosian solution to this externality. A mitigation banker can restore a previously destroyed wetland in the same county as the expanding rock quarry, creating mitigation credits. The quarry owner can then purchase these credits to compensate for the negative externality.  The result is a zero-net loss of wetlands.  If the marginal benefit of the expansion to quarry owner exceeds the marginal cost, which includes the cost of the mitigation credits, then he will expand the quarry.  If not, the quarry owner will not pursue the expansion.

This is not a totally Cosian solution because the transactions costs are high.  Furthermore, government regulation is necessary for the creation and exchange of mitigation credits, but it could be argued that the regulation just acts to clearly define property rights.  Regardless, I think mitigation banking is an interesting industry that has been created to deal with with negative environmental externalities.