A note on permits, standards, and technological innovation

Montero (J. Environ. Econom. Manage. 44 (2002) 23) contrasts the incentives to invest in new abatement technologies under different regulatory instruments and argues that one needs to consider the induced output effects that derive from lower abatement costs. Montero shows that, once one takes into account these effects on output, command-and-control instruments can generate stronger incentives to innovate than market-based instruments. This result rests on strategic output effects under command-and-control. However, he maintains that, under perfectly competitive conditions, market-based instruments will continue to weakly dominate command-and-control regulation. This note clarifies two issues raised by Montero. First, I use Montero's approach to show that in fact performance (concentration) standards will generate greater incentives to innovate than market-based instruments in perfectly competitive markets. One does not require strategic effects to get this result. Second, Montero abstracts from production costs and concentrates solely on abatement costs. He implicitly assumes that marginal production costs are constant. I show that some of Montero's results change once increasing marginal production costs are considered. When marginal costs are increasing, the benefit of additional output is tempered and market-based instruments again look more favorable.     

Environmental federalism and environmental liability

Environmental federalism considers what level of government should optimally regulate pollution. This paper addresses this question for accidental pollution, which government regulates through the ex post liability regimes of either negligence or strict liability. We find that decentralizing the choice between these regimes does not, in general, induce the socially optimal outcome. When firms can pay all damages, all regions may choose negligence and impose an overly strict standard of due care. When firms may be bankrupted by damages, all regions may choose strict liability, which induces too little care. In addition, asymmetric equilibria are possible in which some regions choose negligence, others strict liability. Combining negligence with a Pigovian tax, or strict liability with a bonding requirement can align regional authorities' incentives with those of a central government.     

Incentives and prices in an emissions trading scheme with updating

Emissions trading schemes where allocations are based on updated baseline emissions give firms less incentive to reduce emissions for a given quota (or allowance) price. Nevertheless, according to Böhringer and Lange [On the design of optimal grandfathering schemes for emission allowances, Europ. Econ. Rev. 49 (2005) 2041–2055], such allocation schemes are cost-effective if the system is closed and allocation rules are identical across firms. In this paper, we show that the cost-effective solution may be infeasible if marginal abatement costs grow too fast. Moreover, if a price cap or banking/borrowing is introduced, the abatement profile is no longer the same as in the case with an auction (or lump-sum allocation). In addition, we show that with allocation based on updated emissions, the quota price will always exceed marginal abatement costs, possibly misguiding policy makers and investors about abatement costs. Numerical simulations indicate that the quota price most likely will be several times higher than marginal abatement costs, unless a significant share of allowances is auctioned.     

Prevention and cleanup of dynamic harm under environmental liability

This paper explores incentives for accident prevention and cleanup when firms are subject to environmental liability. In our two-period setup, the level of environmental harm in the second period depends on first-period harm when cleanup was incomplete. Under strict liability, in the first period, firms with a positive probability of going out of business before the second period have inadequate prevention and cleanup incentives. The fundamental disconnect between private incentives and social optimality cannot be remedied by using a multiple of harm as the level of compensation. Under negligence with a causation requirement, incentive problems remain; however, under negligence without such a requirement, first-best incentives may emerge, and using a multiple of harm as the level of compensation can ensure the efficient solution.     

Dynamic incentive regulation of diffuse pollution

Diffuse pollution from agriculture and extractive industries reduces air and water quality and contributes to climate change. We consider a setting in which a regulator must incentivize unobserved abatement given that firms have limited liability, and when they can enter and exit. We demonstrate that a simple dynamic incentive scheme can solve this difficult regulatory problem: firms pay a constant tax and receive rebates following periods of low pollution. We apply the model to water pollution from a fracking operation and simulate the contract to explore the volatility of the firm's payments and the costs of limited liability.     

Firm incentives to promote technological change in pollution control: Reply

Our paper (Firm incentives to promote technological change in pollution control, J. Environ. Econom. Management 17, 247–265 (1989)) concluded that firms will most actively search for new abatement technology under taxes and auctioned permits. However, Marin (Firm incentives to promote technological change in pollution control: Comment, J. Environ. Econom. Management, 21, 297–300 (1991)) argues that we overstated the efficacy of auctioned permits: that we used an unrealistic assumption which might affect our findings; that auctions may misallocate permits and are administratively burdensome; and that innovation detection is difficult under this regime. Here we show that our results are largely unchanged when the assumption questioned by Marin is relaxed. We also argue that he overstates the other concerns.     

Pollution Taxes and Pollution Abatement in an Oligopoly Supergame

This paper investigates the effects of an emissions tax on the incentives for oligopolists to acquire alternative pollution abatement technologies. The analysis is conducted in terms of a repeated game and it is demonstrated that there are circumstances in which the firms may reject the option of acquiring the pollution abatement equipment, even when this lowers their production costs.     

Environmental policy with upstream pollution abatement technology firms

This paper examines how the existence of an upstream abatement technology sector affects optimal environmental policy. We explore whether the policy should be especially stringent in order to spur a successful export industry based on abatement technology. Furthermore, we investigate if a stringent policy can be used to increase competition in the upstream sector. Our point of departure is a three-stage game between a government in a country with a polluting downstream industry, and a limited number of upstream firms supplying abatement technologies. The government moves first, and may use its environmental policy strategically to influence the behavior of the upstream technology firms. We find that an especially stringent environmental policy towards the polluting downstream sector may be well founded, as it increases competition between the technology suppliers, leading to lower abatement costs. However, to our surprise, an especially stringent environmental policy is not a particularly good industrial policy with respect to developing successful new export sectors based on abatement technology.     

The effects on electricity prices in england and wales of notional sulphur dioxide emission standards for power stations

Reducing emissions of sulphur dioxide from the electricity industry in England and Wales would require application of abatement technology and raise electricity prices through increases in marginal supply costs. Capital and operating costs of alternative abatement techniques and their application under possible long-term investment and retirement plans for the industry are discussed. An approximate halving of projected emissions is found to have an effect of the order of 5% on prices under the existing tariff structure. Reductions of up to one-fifth are found to have an effect of under 1% on electricity prices.     

Achieving air pollutant emission reduction targets with minimum abatement costs: An enterprise-level allocation method with constraints of fairness and feasibility

• Quantification of efficiency and fairness of abatement allocation are optimized. • Allocation results are refined to the different abatement measures of enterprises. • Optimized allocation results reduce abatement costs and tap the abatement space. • Abatement suggestions are given to enterprises with different abatement quotas. For achieving air pollutant emission reduction targets, total pollutant amount control is being continuously promoted in China. However, the traditional pattern of pollutant emission reduction allocation regardless of economic cost often results in unreasonable emission reduction pathways, and industrial enterprises as the main implementers have to pay excessively high costs. Therefore, this study adopted economic efficiency as its main consideration, used specific emission reduction measures (ERMs) of industrial enterprises as minimum allocation units, and constructed an enterprise-level pollutant emission reduction allocation (EPERA) model with minimization of the total abatement cost (TAC) as the objective function, and fairness and feasibility as constraints for emission reduction allocation. Taking City M in China as an example, the EPERA model was used to construct a Pareto optimal frontier and obtain the optimal trade-off result. Results showed that under basic and strict emission reduction regulations, the TAC of the optimal trade-off point was reduced by 46.40% and 45.77%, respectively, in comparison with that achieved when only considering fairness, and the Gini coefficient was 0.26 and 0.31, respectively. The abatement target was attained with controllable cost and relatively fair and reasonable allocation. In addition, enterprises allocated different emission reduction quotas under different ERMs had specific characteristics that required targeted optimization of technology and equipment to enable them to achieve optimal emission reduction effects for the same abatement cost.     

Tell the truth or not? The montero mechanism for emissions control at work

We experimentally test the truth-telling mechanism proposed by Montero (2008) for eliciting firms' abatement costs. We compare this mechanism with two well-known alternative allocation mechanisms, free and costly allocation of permits at the Pigouvian price. Controlling for the number of firms and the firms' maximal emissions, we find that, in line with the theoretical predictions, firms over-report their maximal emissions under free allocation of permits and under-report these under costly allocation of permits. Under Montero's mechanism, by contrast, firms almost always report their maximal emissions truthfully. However, in terms of efficiency, the difference between Montero's mechanism and costly allocation disappears with industries including more than one firm.     

Optimal quasi-market choice in the presence of pollution externalities

When the relationship between emissions and ambient pollution is known, it is possible to implement a program to achieve economically efficient pollution levels, even when the control agency knows nothing about the victim's valuation of pollution damages or about emission abatement costs. Unlike a Pigouvian tax, the program provides the correct incentives for entry and exit whether or not marginal damages from a firm's emissions vary over the range of these emissions. Through the provision of “missing” markets, sizable revenues are raised while allocative distortions are corrected.     

Stochastic pollution, costly sanctions, and optimality of emission permit banking

This paper identifies a new economic motive for pollution regulations that allow polluting firms to bank and borrow emission permits over time. When aggregate pollution is stochastic, an intertemporal permit trading regime can provide firms with efficient incentives for pollution abatement without the need for costly government enforcement actions that would otherwise be required.     

Modeling the impact of uncertainty in emissions trading markets with bankable permits

The various forms of uncertainty that firms may face in bankable emission permit trading markets will affect firms’ decision making as well as their market performance. This research explores the effect of increased uncertainty over future input costs and output prices on the temporal distribution of emission. In a dynamic programming setting, the permit price is a convex function of stochastic prices of coal and electricity. Increased uncertainty about future market conditions increases the expected permit price and causes a risk neutral firm to reduce ex ante emissions in order to smooth out marginal abatement costs over time. Finally, safety valves, both low-side and high-side, are suggested to reduce the impact of uncertainty in bankable emission trading markets.     

Market design in cap and trade programs: Permit validity and compliance timing

Cap and trade programs have considerable heterogeneity in permit validity and compliance timing. For example, permits have different validities across time (e.g., banking, borrowing, and seasons) and space (e.g., zonal restrictions), and compliance timing can be annual, in overlapping cycles, or in multi-year periods. We discuss nine prominent cap and trade programs along these dimensions and construct a general model of permit validity and compliance timing. We derive sufficient conditions under which abatement is invariant to compliance timing, i.e., compliance timing cannot smooth abatement cost shocks. Under these conditions, (i) expected compliance costs are invariant, (ii) the variance of compliance costs increases with the delayed compliance, (iii) equilibrium prices may not be unique, and (iv) the delayed compliance equilibrium may rely on “degenerate” prices not determined by marginal abatement costs. We demonstrate the model's broad applicability by illustrating different types of temporal permit validity.     

Pollution control and technological advance: A dynamic model of the firm

The paper extends the static comparison of effluent taxes and effluent standards to a dynamic world in which firms invest resources in improving their abatement technology as well as their production technology. The analysis shows that the two pollution control policies lead to a distinctly different allocation of research and development (R & D) funds between improvement in abatement technology and improvement in production technology. The model also shows that a temporally constant effluent tax leads to an increasing effluent discharge rate for “typical” firms. Other results concern the pattern of output growth and the rate of technological advance.     

Spatial economic theory of pollution control

In February 1972 the Nixon Administration proposed a tax on sulfur oxide emissions, beyond the Federal standards, of electric power plants. It was hoped that such a tax would discourage power plant locations in heavily polluted areas like urban areas. Assuming that such a tax varies over space because pollution is not invariant over space, the spatial theory of the firm is presented in this paper cast doubt on the efficacy of such a polltuion tax to achieve the desired goal of the administration. In particular it is shown that the cost-minimizing spatial firm would abate its pollution in response to a tax by either changing its location or by reducing waste through process change or by using a transportable abatement good if the tax savings due to the change in marginal abatement through location change per unit change in abatement is greater than or equal to transport rate on the abatement good. If the goal of the firm is to maximize profits, the desired outcome would follow if in addition to the fulfillment of the above condition the percentage change in the delivered price of raw material (situated at one end of the linear location space) per unit distance is greater than or equal to the percentage change in net marginal revenue, i.e., marginal revenue net of transport cost per unit of output. In simple terms, the conclusions of this paper raise doubts regarding the effectiveness of a pollution tax in curtailing pollution of a firm which is operating in a space economy. This outcome is peculiar to a spatial firm. Sufficient conditions also have been obtained when land input is included in the production function of the firm.     

The strategic use of innovation to influence regulatory standards

This paper investigates the welfare consequences of strategic behavior by firms to affect the amount of environmental regulation they face. Environmental regulation often attempts to force an industry to develop cleaner technology, but the regulator may have no means to commit to a specific standard. This lack of regulatory commitment induces firms to choose innovation strategically. It is well-known that firms have incentives to suppress innovation to induce the regulator to ratchet down the standard, and this strategic behavior lowers welfare. This paper explores a countervailing incentive. In oligopoly settings, firms have heightened incentives to innovate so as to increase regulation and raise rivals costs. In equilibrium, the incentive to raise rivals cost can mitigate the welfare loss arising from no regulatory commitment. Also, a regulator who is unable to commit ex ante to the stringency of a regulatory standard can induce more clean technology than a regulator with a commitment mechanism.     

Plant vintage, technology, and environmental regulation

We use data on productivity and pollution abatement costs at individual pulp and paper mills to test whether the impact of environmental regulation on productivity differs by plant vintage and technology. Plants with higher pollution abatement costs have significantly lower productivity levels. This relationship differs greatly based on a plant's technology, with productivity at integrated mills being greatly affected by abatement costs, while the impact at non-integrated mills is negligible. Plant vintage does not seem to matter, with older and newer plants showing similar impacts. Reported abatement costs appear to substantially understate the true costs of abatement. Accounting for the impact of technology differences makes some difference in the estimated overall impact of environmental regulation.