♪ Music ♪
In this lecture on topics and environmental economics,
Dr. Sheila Olmstead presents a summary of the
use of market-based approaches to dealing
with environmental externalities.
She first notes the difference between prescriptive
regulations, which generally take the form of
laws and policy standards and market-based
regulations, which can use price or quantity
instruments like taxes and allocation permits to create
new markets that capture the cost of externalities.
She presents an analytical example of cap-and-trade
approaches to highlight the difference between
market-based policies and prescriptive policies.
She notes the cost-effectiveness of market-based
policies in many scenarios and also identifies cases
in which prescriptive policies are more appropriate.
She ends with several examples of market-based
approaches to environmental policy and
the relative costs and benefits.
Just to kind of put this in context, so Jim at the end of
what he was talking about yesterday talked about what
are some solutions to externalities, these negative
externalities that are pretty common in the environmental
realm and, you know, there are other market failures,
public goods, commons problems, and so on, but
what are some solutions to the negative externalities.
Well he talked about the liability regime and that's
something that economists often just kind of forget
especially those of us who work on regulation
that is just floating there in the background
as an extraordinarily important part of the
apparatus for correcting externalities.
It may be even a greater incentive than, you know,
anything we might be doing in terms of
administrative regulation, but sometimes that's
not going to be sufficient for a variety of reasons.
The thing that I often put first at least when I'm teaching
and that we talk a little bit about yesterday as well
was kind of private solutions, right, the mere existence
of this external impact on a third party provides in some
ways an incentive to start thinking about correcting it
and that can either work through kind of social norms,
institution building à la Elinor Ostrom as Jim mentioned
yesterday or through this kind of Coasian bargaining,
private bargaining between the kind of externality causer
and the externality receiver and I won't talk too much
about that except to say that on the private bargaining
side, right, the kind of Coase's theory altogether
had some pretty restrictive assumptions about when
that would be likely to result in a sort of efficient
outcome given the negative externality and so in most
kind of real-life cases of pollution and other kinds
of negative externalities related to the environment
those conditions are not going to be met, so we don't
necessarily think that it, that in lots of cases this private
bargaining can arrive at efficient outcomes, although
sometimes it does and we can certainly talk about
some examples of that there are some good
fun ones to talk about maybe in the Q&A.
So in that sense, right, if private bargaining fails or
sort of social norm institutional approaches fail, if the
liability regime isn't sufficient either because the kind of
harmed parties are so diffused that they're sort of not
able to kind of come together in some reasonably
cost-effective way to deal with, right, whoever's causing
the externality, which is often the case when we think
about diffuse population problems like air pollution
problems or water pollution problems, then we're in
the world of thinking about some kind of government
intervention usually some kind of administrative or
legislative regulation and in economic terms, some
types of regulation are better than others and so
you've already kind of heard this from us, right.
Jim talking about thinking about costs when we
worry about where to put dollars for conservation
and Pete earlier mentioned individual tradable
quotas for fishing and some of you are already very
familiar with those kind of policy instruments and those
ways of thinking fit very much into this kind of broad
structure than I'm going to talked about today, but I
thought it would be useful to talk particularly about the
case of pollution control and why it is that economists
are so crazy about cap-and-trade and taxes,
right, these kind of market-based approaches to
environmental policy which have very strong
parallels, right, to the instruments that are applied
and resource policy and then we will kind of get to
thinking about how these things are more broadly
applied, right, outside of the world of pollution control.
Okay, so first I thought I would just mention
the way we typically as economists will
categorize pollution control policy approaches.
Okay, one we would create categories called either
prescriptive or command and control or traditional
regulations, right, so there's all different ways of
referring to the same thing and there we're usually
talking about two different classes of approach;
one would be a technology standard, right, so I say
I've got a problem with pollution, all of you municipal
sewage treatment facilities or all of you electric
generating utilities have to adopt the same technology
to deal with that pollution problem, right, and the electric
utility case it might be you have to install a scrubber,
right, a sort of flue gas desulfurization device to take
sulfur dioxide out of your emissions right before they
go up your stack or somewhere in the middle of your
stack and thereby reducing, right, damages to the public.
On the water quality side, it might be a particular
wastewater treatment piece of technology, but the key
thing about that when we call these technology
standards prescriptive or command and control
regulations, it is, is that it's the same across all firms,
right, or sort of constrained to a set of technologies
or even a single technology requiring all firms
to use a particular approach to compliance.
A second class of these command and control
regulations and it's listed second because it's
somewhat more flexible, rights, so it's moving
toward, you know, closer toward a market-based
approach is what we'd call a performance standard.
Okay, that would be something like I'm going to take
electric utilities and I'm going to say everybody you
can figure out how to do this however you want, but
everybody has to meet the same ceiling on their emissions
or their emissions rate, right, their kind of emissions
per unit of output like the unit of electricity generated or
something like that and again they're the key that makes it
kind of a command and control or prescriptive approach
is that it's uniform, right, I'm saying to every firm that,
you know, everybody's kinda sort of do the same thing
and there's some, a lot of good reasons why that's often
a starting point for discussion of regulations we,
you know, if I've got to reduce a hundred tons of
emissions while a kind of 50/50 split if I've got two firms
seems like a fair place to start, so it's not at all uncommon
to see these uniform performance standards out
there, so those two classes of regulations we'll call
prescriptive or command and control approaches.
And then we have the market-based instruments,
okay, and those are highly variable, so Pete had a
much longer list on his slides that can include
things like deposit refund systems and removal
of environmentally harmful subsidies, but the two
that we'll talk about mostly today are kind of price
instruments like a tax and quantity instruments
like a cap-and-trade system, right, where I'm
sort of setting some overall cap on pollution from
some set of firms and then I'm allowing firms to
decide amongst themselves who's going to do,
what kind, how much abatement.
Alright, so we'll talk about taxing negative externalities.
The flipside of that is subsidizing positive
externalities, so trying to subsidize good
behavior and we'll talk very much about that,
but I'm happy to talk about that in the Q&A.
There are some important differences in the dynamic
setting, for example, between taxes and subsidies,
although in theory in a static setting, they have a lot
in common and then again the quantity instruments
are, right, I'm going to set a cap, I'm going to allocate
some permits, and I'm going to let firms trade, alright.
There is also a class of approaches called
information-based approaches, these are also
market-based in nature in some ways, really
the idea there is through some kind of a labeling
program or an information disclosure program
providing information to consumers or about the
sort of environmental characteristics of the good
that they're paying for like I've gotta kind of green
power option for my electric utility or I can buy
shade grown coffee, right, or the coffee with the
little bird on it that says, right, that provides,
the way in which the coffee is grown, provides
bird habitat, so there's lots of these kinds of
labeling programs, they're very interesting, there's
plenty of interesting research on what those do.
At the end of the day, they're not going to change the
kind of, they're not going to change enough the kind of
fundamental incentives that consumers and producers
face in the market, right, so they can't, you know,
eliminate a negative externality, they can't fully provide
a public good at the level of, that we would think
efficiency would prescribe and so from an economic
perspective we're often still going to have to do
something else if we really want to get to the sort of
efficient level with these labeling programs, so I
won't talk much about them, but again I'm happy to
take questions in the Q&A about those practices too.
Okay, so first graph, so really what I'm doing here is
I'm taking Jim's graph from the end of the discussion
yesterday where what he started out talking about
was a cost curve for the production of candy bars,
that's my blue curve except now instead of candy bars
I'm going to talk about steel production okay, so it's
not the nougat this time, right, but something air
pollution I might be, if I'm burning coal to produce
steel, I'm generating some air pollution and that's
this kind of creates these third-party impacts,
right, these additional social costs that
I'm not taking into account when I think about
what the private cost of steel production are, so
the private cost of production are in the blue curve.
The demand curve for steel, right, that downward sloping
one is very similar to what Jim drew yesterday for candy
bars, right, so that's the demand curve, the green one
and then what I'm doing here, right, as Jim said well that,
right, that externality shifts the private curve, private cost
curve above the, social cost curve above the private cost
curve and I'm doing the same thing, but I'm just also
specifying that that comes from the fact that there are
some marginal called marginal damages from pollution
as I produce more and more steel I had these increasing
marginal damages from a unit of steel production,
right, and that could be because I'm producing more
units of pollution every time I produce a unit of
steel, but it also just could be that what I'm concerned
about is health damages and as I add more and more
pollution, those health damages per unit actually
gets steeper and steeper, right, as it gets, you know,
sort of dirtier and dirtier, the air gets dirtier and dirtier.
So I've got these increasing marginal damages and all
I'm doing when I make this purple curve of marginal
social costs is I'm adding this sort of brownish orange
one to the blue one, so the sum of this one and this
one is this one here, the purple one and so now I've got
this divergence and as Jim said yesterday, you know,
if you sort of look at this and I thought well the efficient
level of production of candy bars, this time steel
would've been, you know, not the intersection I'd
get from the market, the one that the private cost is
sort of determining, but the one that the social cost
is determining in conjunction with the social benefits
of the demand curve and so what I'd like to do is
kind of move back right along that horizontal axis
closer toward the zero point; I'd like to have less
production of steel than I do, for that matter I'd like to
have a higher price of steel than I do, right, than what the
market is going to give me and one way that we can think
about dealing with that is simply what we would call
kind of classic Pigouvian tax, right, so Arthur Pigouvian
is an economist, who in 1920 writes this very important
piece that sort of says, you know, these externalities may
be ubiquitous in society and pollution, you know, is a
good example and one of the things you might think
of doing is simply implementing attacks, make it more
costly for firms to produce steel and in doing so you
drive them back, right, along their own cost curve toward
a lower level of production and well what's the right tax?
Pigou said well, the right tax is the difference between
social costs and private costs was exactly the height here,
right, of this marginal damage function at whatever you
think the efficient level of production would be, right, at
this Q star and so I'm just showing T star would be the
Pigouvian or the efficient tax, the height of the damage
curve, which is equivalent to the distance between these
other two curves at this efficient level of production.
Alright, so you impose this price on pollution,
you internalize that externality, you get firms to
do the right thing, right, acting in their own
best interest in response to this price that
you're setting on the damaging good.
So this is a sort of an interesting heuristic, it's a nice
way of thinking about it, we do see pollution taxes out
there, but when I draw it in this way and in the way that
Pigou described back in 1920, one thing that you'll
notice is I'm sort of saying the way to reduce pollution,
right, the only way on this graph is to reduce production
of the polluting good, right, I'm just trying to back
everybody up and I'm trying to get less steel production
and that's certainly one way in which a firm might decide
to respond to a regulation that increases its costs of
production, might produce less steel, right, but a firm
might also decide if I did something, you know, that
very flexible like attacks or tradable permit system,
a firm might say, you know, if what you care about is
sulfur dioxide pollution, then I might switch from burning
high sulfur coal to burning low sulfur coal or from
burning coal altogether to burning gas, natural gas
to make my steel and in doing so I could, you know,
dramatically reduce emissions and maybe not have to
reduce my output, right, so I could switch my inputs.
Okay, I could also choose to install a pollution-control
device like a scrubber, right, I could make my steel using
my old dirty coal that I could scrub my emissions before
they go out the stack and in doing so maybe I'll have to
reduce my quantity produced, right, if that is very costly
for me, but maybe I won't, right, so this model where
we think about the right way of treating the pollution
externality as reducing production is not necessarily
comprehensive enough for us okay, so we're going to
switch to a different way of thinking about the problem
and that way of thinking about the problem is to think
about asking firms instead of to reduce their production;
we're asking them to produce now two products.
I want you to produce steel and I want you to produce
pollution abatement, right, I want you to invest some
money, right, whether it's switching your inputs,
installing pollution control technology, right, reducing
your output, whatever that happens to be, I want you
to invest, right, so sort of experience some
opportunity cost that sort of makes this the level of
pollution lower than what it is today and so the way
that we're going to think about that from the regulators
perspective is that we, what we really want is we want to
think about a sort of demand curve and a supply curve
or a cost curve for pollution abatement, okay, so now I've
got the quantity of abatement or pollution control that I'm
engaging in on the horizontal axis and the cost of that per
unit per ton was a good measure on the vertical axis
and if I'm the regulator, right, I might do things like
use some of the methods that Pete talked about yesterday
to think about what this demand curve looks like,
right, as abatement increases my kind of willingness
to pay for an additional unit should decrease.
A way to think about that heuristically is that as things
get cleaner and cleaner and cleaner, right, what's an
additional unit of control worth to you, it should be
worth less on the margin, right, and conversely as
things are getting dirtier and dirtier and dirtier,
right, then that first unit of control should be worth a
whole lot okay, in terms of health benefits or whatever,
right, the recreational, aesthetic benefits, visibility,
you know, whatever it happens to be, okay fish catch or
something like that if we're talking about water pollution.
Okay, so I could think about a regulator, thinking about,
right, either estimating a demand curve or coming up with
something qualitative that sort of looks like that and then
they have to think about the cost of abatement as well,
but the general idea would be, you know, I sort of don't
care how you firms get there, right, but what I'd like to
do is I'd like to get someplace kind of close to this
efficient level of pollution abatement, that's going to be
the Q star, right, this part of the equilibrium here and
there's going to be some associated price with that, that
would be that P star and, you know, not probably terribly
surprisingly that that efficient level of pollution control
is almost never going to be all of it, right, so the economic
prescription is almost never going to be we should
eliminate pollution, that's not to say that we don't have
statutes that suggest that that's what we should do,
right, the Clean Water Act in 1972 was written saying
we're going to eliminate, right, emissions to, you know,
effluent to water bodies in the United States by like
1986, okay, so we didn't get there, but that is sometimes
an important public goal, a public purpose, it's not
generally what will be prescribed by the economic analysis,
okay, so sometimes those two things would conflict.
Alright, so we're going to find some Q star and
then the idea there is how would I reach that?
Well I can have these two kind of market-based
alternatives in a very general way.
One would be I set that tax okay, the one we saw in
the prior diagram and it's the same thing that is what
I'm drawing here, but just with this different kind of
context in which firms can kind of do anything,
right, not just reduce output and that would be P star,
right, so I could set that efficient tax that would get me
to that efficient level of pollution abatement and
two I could set the quantity, I could just set the cap,
right, I'd say I don't want to have any more pollution
than Q star, it has to be, right, less than or equal to Q star,
so that would be the efficient cap, but the way in which
these two things are sort of the flipsides of the same
coin is that it turns out that if I set a cap on pollution
at Q star, then the permit price, the equilibrium permit
price that I get out of that process would be P star
and if I set P star as the efficient tax than what I would
expect to get out in terms of the amount of pollution
control if I really kind of estimated these things pretty
well would be Q star, so really this kind of, you know,
whether I choose the price versus the quantity doesn't
really make any difference for, right, for what's the
efficient level of control, right, and we have this sort of
nice parallel between the two, there are lots of other
differences between those two approaches and we'll
talk briefly about some of them today and I can
again, I'm happy to take questions about them, but
for the most part you want to think of them in a lot
of context as being fundamentally equivalent choices.
Okay, so why do we like those approaches?
We like those approaches because the question that
we ask ourselves is all else equal, right, you know, if
I'm, say that the standard, right, the sort of the command
and control approaches versus the market-based
approaches, imagine I can get the same level of
control, right, everything else is the same between
the two outcomes, but the only difference is that
one is less costly than the other, well then I
would prefer the less costly option and that's a
different criterion than the efficiency criterion.
Remember the efficiency we talked about
yesterday I'm comparing benefits and costs.
The cost-effectiveness criterion says given some level of
benefit, right, given that you tell me that we have to achieve
a pollution abatement goal of, right, subtracting a hundred
tons from current emissions, right, or a given that you tell
me the total allowable catch in a fishery, right, is going to
be whatever hundred, I don't have a good sense for what
that target might be, but imagine it's a hundred tons of fish
in a year, so given whatever the kind of politically decided,
right, negotiated pollution control or resource management
goal is, I can still use the tools of economics to try and
achieve that standard at least cost and there again this is
where this related pretty tightly to what Jim was talking
about this morning, right, how can we sort of preserve
the greatest amount of habitat for the least cost or, right,
these kind of cost-effectiveness questions are often where
we have relatively productive conversations as economists
with other folks engaged in resource management or
regulation because it, it's, right, where we sort of take the
benefits question in some ways off the table, right, you
tell me what benefits you want to achieve, I'll tell you how
to get there at the least cost, okay, alright, so why are
they cost-effective relative to the technology standards
and the uniform performance standards, there are two
reasons for this; one is a short run reason and I'll go
through the logic of that in a few minutes using some
graphs in the short run they take advantage of the fact
that some firms have different costs of abatement than
others okay, if there's no variation, no heterogeneity at
all and what firms would do to comply with the regulation,
then this doesn't matter at all, right, I can choose whatever
instrument I want, but as long as there are firms that would
like to do different things, some would like to switch inputs,
some would like to install a pollution-control technology,
some would like to reduce output, right, as long as
there is that heterogeneity out there and what they'd like
to do, what their least cost abatement choices are,
then in the short run we're going to take advantage of
that when we use a tax or a cap-and-trade system and
we're not going to take advantage of that when we use
the technology standard or a uniform performance standard
and that's going to make those traditional approaches
more costly relative to the market-based approaches.
And then the second reason they're more cost-effective
and this in some ways, if you think about a problem
like climate change is even more important, right,
because the, ultimately our ability to achieve big
cuts in emissions of something like carbon dioxide
over the long run is going to depend on how much
it costs to do that, right, how costly that is?
That's important politically, it's important economically,
and so what we'd really like is we'd like firms over
time to try and bring down the cost of pollution
control, like them to invest in either innovation or
diffusion, right, or adoption of technologies that
reduce those compliance costs that make it cheaper
to control pollution cause the more we do that over
time, the more pollution control we get for the same
amount of money we spend and it turns out that this
advantage, there's a strong advantage of market-based
approaches on that measure as well and again both
in theory and born out in empirical studies and we
like that because, right, that has this sort of long run
incentives for technological change, give us some
confidence that we're going to be able to meet
much more stringent goals in the future,
okay, without that it's awfully hard to, alright,
see how we move toward those more stringent goals.
Okay, so now I'm going to go through the theory side of
why the market-based approaches are more cost-effective
than these kind of uniform approaches like the technology
standards and the performance standards, so I'm going to
take a case of two firms and what I'll say here generalizes
very nicely to N firms, right, or large number of polluters.
This is a small number cause it's easy to show on a
graph and the key thing that I want you to keep your
eye on is this cost heterogeneity, right, it all comes down
to firms having different costs to comply with the
regulation, so what I'm going to draw here is abatement
again on the horizontal axis, the cost of abatement in
dollars per ton on the vertical axis and I'm going to have
two firms and firm A is going to be engaging in abatement
activities that increase as I move from left to right, okay,
so it starts out at zero on the left and goes all the way
to a hundred tons on the right and firm B is going to
move in the opposite direction and these guys are
going to have costs associated with that abatement and
firm A is going to look like this, okay, so her marginal
abatement cost is going to be upward sloping, it could be
linear, it could be all kinds of things, a lot of different
shapes, we can talk about that if people have questions,
but one reasonable assumption is that the cost of
abatement on the margin increases as I engage in more
and more abatement and they might even increase at
an increasing rate, okay, as I try and get after those last
units, right, out of my production process and that last
little bit of soot out of the stack it's going to be much more
costly than if I tried to get that first unit out of the stack,
okay so that's firm A's marginal cost curve, it's essentially
firm A supply curve for pollution abatement, okay,
that's what she'd like to do and firm B's going to move
the other way, okay, so from zero to a hundred moving
from right to left and B's going to have a marginal cost
curve too that looks the same, right, because they're
kind of mirror images of each other, they're going to cross
in the middle like that and what, the way I've drawn firm
B's cost function it's a lot steeper than firm A's, so when
I think about, right, kind of characterizing these firms,
firm A is the kind of low-cost firm meaning it's cheaper
kind of on the whole not for every unit, right, but sort of
on average it's cheaper for A to abate pollution than it
is for B to do so and A's, and B's rate of increase in
their cost is higher than A's rate of increase as well.
So a couple other things to notice about this graph before
we think about what's the right way to allocate pollution
across these two firms, the first is remember I said kind
of all else equal, you'd like to have the more cost-effective
approach, you'd like to have the cheaper approach and
so the kind of key all else equal is how effective is the
pollution control standard, right, so what I'm going to use
here is an example in which I want a hundred tons of
abatement and no matter what I choose no matter how
I choose to allocate abatement between these two firms,
right, I could say firm A doesn't have to do anything
and firm B has to abate a hundred tons, I could
say firm B, right, doesn't have to do anything and A
has to abate a hundred tons, or I could choose any
combination of those two spots in between and at
every point on the horizontal axis, I'm still going to
get a hundred tons of abatement, right, that's kind
of a key thing about the graph, I could choose any
point and I'm still going to meet my standard, okay.
So now let's start with the kind of intuitive place to
go, right, I, I'm a regulator, I gotta reduce a hundred
tons of abatement of pollution, I've got two firms,
one very kind of fair place to start would be to say
well let's just split it 50/50, right, let's say firm A
you have to abate 50 tons and firm B you have to
abate 50 tons and so I'm going to draw this line at
the 50/50 distribution of pollution control.
So how much did that last ton of
pollution control cost firm A?
Does anybody have, want to take a guess?
That 50th ton from this picture.
Half as much as firm B.
Yeah why're you saying half as much?
Well just the height of.
Good, right, so the height of this cost curve is just
telling me, right, for that last ton emitted how much
did it cost and if I had dollar values here on the
vertical axis, you could just kind of read the height
across here and you'd say well you know if this was
10 bucks, it kind of looks like this is, you know, 20 or
25 bucks, right, so you're just comparing the heights
of those curves between the two firms, so am I,
with this allocation, a 50/50 allocation, am I
achieving that hundred tons at the least cost?
No, but Pete doesn't count, so
Michelle's shaking her head no.
Why no?
It's correct to say no.
Why no? Simone.
Well because if A were doing the reducing
it would cost less than for B to do the reducing.
Yeah for that last, you know, if I'm at the 50th ton,
it costs me more, right, to have B do it
than it would've to have A do it.
Okay, so at 50/50 I could start at 50/50 and I
could start reallocating that pollution control
responsibility and I could say well, you know,
B it's pretty costly for B to reduce that 50th ton,
so I'm actually going to back up along B's curve,
right, I'm going to sort of move away from 50, go
down and what if I said, you know, B only has to
do 45 and A has to do 55, I still get my hundred,
but I do it cheaper, right, cause I saved, right,
all these distances between those two cost curves
and the same thing is true, we can just keep asking
ourself that question, well can I reallocate it, right,
if I go this way, I make things worse, right, so then,
right, if I for that last unit of pollution my cost to
B was a lot bigger than my cost to A, but every time
I move to the right and I reallocate some pollution
control from B, the high cost firm, to A, the low cost
firm, I save some money, right, if I'm sort of moving
and that's true until what point, well not surprisingly,
right, the point of intersection, right, where the two
marginal costs are exactly equal to each other, right,
for that last unit of pollution at that point of intersection,
now it costs me the same amount, right, A and B
are both paying the same thing on the margin,
it's not possible for me to reallocate control
from one firm to another and save money.
Any way I reallocate once I get to the intersection,
I make things worse, right, either B is more
costly than A in this direction or A is more
costly than B in that direction, so where I'd like to
be, right, if I'm doing this in the most cost-effective
manner possible is right at the intersection of the two
curves which is not in this graph a 50/50 split, but it's
a 60/40 split, right, so the low-cost firm, firm A is
going to do 60 tons of abatement and the high cost firm,
firm B is going to do 40 tons of abatement, so another
way of looking at that is to think about the total costs,
right, so these are marginal cost curves that means
I'm just saying for each ton of pollution how much
did it cost me to reduce that ton, to abate that ton?
So to get the total cost, right, at a 50/50 split,
I'm going to take the area under that curve.
Why?
Cause well, for the first ton, right, it costs A this much
and the second ton it costs that much and I just start
shading in, right, every time I control a ton of
pollution, I shade in that space and as I do that and
I think about pollution being this kind of continuous
process and not just, you know, not available just
in discrete chunks of one ton at a time, right,
then I can fill in the whole space and I can call this,
this is A's total abatement costs, right, if I give her
the 50/50 split, alright, and then similarly, right,
the area under B's curve represents B's total abatement
costs at the 50/50 split and you can again see visually,
but kind of in a different way, right, then just comparing
the curves that once I kind of passed this cross, right,
I have this excess cost, this shading between the two
cost curves, right, so this space in here, it's almost like
a triangle if they were lines, right, then it would be.
If the space between the two curves
that's that excess cost above the 60/40 split,
right, what we experience with the 60/40 split.
So the cost-effective abatement that we've already
identified is, would be here 60/40, okay, so that's
the cost-effective split and what you'll notice, right,
is it minimizes the total cost, the same thing you're
never going to get that sort of smaller area under
the curve than what you get at the intersection
of the two, so that it's the same thing as
comparing the marginals and then you can identify,
right, the kind of cost savings of the 60/40 split relative
to the 50/50 split on the curve as well as we said
earlier and so when I say a cost-effective allocation
of pollution control I mean something very specific.
I mean I'm allocating that responsibility for control across
firms in a way that equates the marginal cost of abatement
across every firm that's engaging in some pollution control.
Okay, so if I'm asking you to do something, then the cost
of that last ton that you control is exactly the same as
everybody else, right, who's controlling pollution under
the regulation and if that's not true then, right, we're
not doing this at the least cost, so now what we want
to know is how do these different policy instruments,
ways of attaining, right, the hundred tons of abatement
stack up against that criterion of cost-effectiveness.
Okay, so we'll start with the traditional approaches,
right, so the technology standard, right, so, you know,
1970 the Clean Air Act, there were exceptions to this and
we'll talk about it in a few minutes because it gave birth
to an important sort of, kind of pilot trading program.
The United States sulfur dioxide trading program in the
1970 Clean Air Act, one of the things that the EPA did
is it required the installation of scrubbers by certain
electric utilities, right, to eliminate sulfur dioxide or to
reduce sulfur dioxide pollution from power plants in the
U.S, so technology standards saying, right, everybody
should adopt the same technology is not going to meet our
cost-effectiveness criteria and it's not going to equalize
marginal costs across the regulated firms for two reasons,
one is that different firms have different adoption costs,
so if you think about the pollution control case and the
requirement to adopt a scrubber, an example of that
would be, right, I have a kind of rural electric utility,
I've got tons of land, I've got mad big coal piles sitting
around, I just clear out a little space and I install this
big piece of capital equipment called a scrubber, which
actually has a pretty big footprint, kind of pretty big
land footprint, but it's cheap for me to do that cause
I don't have to aquire new land or anything like that,
but maybe I'm a power plant in downtown Atlanta and
then I've got a problem, right, where am I going to fit the
scrubber, I'd really rather do anything than adopt the
scrubber, right, you know, give me some other options,
some other things to do because it's very expensive for
me to do that, so I'm not going to meet this criterion of,
right, of sort of equalizing marginal costs across firms
cause firms have different adoption costs for different
technologies and even within the same firm again,
right, the Atlanta power plant is going to say geez it'd be
cheaper for me to switch fuels or it'd be cheaper for me to,
you know, to, right, go from coal to gas and so on,
so I'm not even going to minimize cost for individual
polluters, so that's kind of a red flag, right, that I'm not
going to get to that cost-effective allocation and then
the performance standard, right, the one that I gave you
was uniform it just said everybody has to reduce by 50
tons, okay, and that was not cost-effective because it didn't
take advantage of this difference in cost across firms.
On the other hand, right, that's not because it was a
performance standard, which is pretty flexible, it says,
right, you can attain that however you want, install
your technology, right, or, you know, change your inputs.
It was only not cost-effective because I set it the same
for everybody, right, so as a regulator I could, if I had
information about firms marginal costs, I could set
a firm specific standard, I just say firm A you're going to
do 60, firm B you're going to do 40 and that would be
the cost-effective allocation of pollution control, but from
the regulator's perspective that's pretty information heavy,
right, I have to know a lot about, I'm taking a guess as
the regulator about what firms marginal costs are in a
market economy, I don't know and if I start asking them,
you know, are you a high cost or are you a low cost firm?
I'm setting some regulations.
You high cost or low cost?
You're high cost, you want to be high cost, right,
cause you want your allocation to be as low as possible,
so there's an incentive, right, there's this conflictual,
potential conflictual relationship between the regulated
communities and the regulator and everybody wants
to say I, it's extraordinarily costly for me to pollute.
Right, I, it's so costly you can't even imagine,
please give me the low allocation, right,
so everybody wants to be the high cost firm.
Okay, so regulators have to know the cost curves.
It's hard to know that, there's a lot of interesting
research on how good a job we do of guessing those
costs before and then looking at data afterward and
trying to learn from that, but in general the regulator's
in a difficult position trying to understand how firms
behave when they think about pollution abatement.
Okay, what about the market-based approaches?
Well let's think about this just with the sort of simplest
case which is the tax, alright, so I'm going to simplify the
diagram from what we saw before, I'm just going to take
firm A okay, so now I've just got firm A's cost curve on
here, it's the same thing you saw before, but everything
else is kind of erased and firm A is going to engage in
some pollution control, right, and if we imagine she
has some uncontrolled pollution that's Q max, that's
the most abatement she can do because it's the amount
of pollution that she's emitting without any regulations.
Okay, so she can engage in abatement activity,
she can control pollution anywhere from zero,
right, she can do nothing all the way up to
Q max, right, her uncontrolled emissions level.
So she's got some costs of doing that and if I want
to implement a tax and I'm the regulator, I'm going to
set the tax at some level, right, imagine I set it right
here, okay, so this is my new tax, so every time
you emit a unit of pollution a ton of sulfur dioxide
then you have to pay T, okay, so now the firm
has to decide how much to reduce pollution,
they gotta decide how much abatement to do.
How much are they going to do?
What's firm A going to do?
She's going to look at this calculus, I can either abate
a ton or I can pay the tax, so am I going to abate
this first unit of pollution, this first ton right here,
but I'd rather do that than pay the tax.
Yeah, why so?
It's lower exactly, right, so here's my cost of abatement,
right here, this is what it costs me to reduce that ton,
but if I choose to pay the tax I'm going to have to
pay this much, okay, so I'm going to keep asking
myself that question I'm going to keep, right, for every
ton I would emit in the uncontrolled setting until
I get to this point again it's a point of intersection,
not a big surprise, okay, but why?
Well, she's going to engage in as much abatement
as she can until it becomes more costly for her
to abate those units, right, this guy rises
above the tax right at this intersection point,
right, so it's cheaper to abate, right, and then
all of a sudden I get to this point and all
of a sudden, it's cheaper to pay the tax.
Okay, so for the pollution beyond that intersection
point, she's going to just go ahead and pay the tax
and so what's her total cost going to look like?
It just looks exactly like it did before when we think
about the abatement costs, it's the area under this
curve, right, this is the quantity that she'll abate given
the tax when she faces that and I can sort of fill in that
space and that's the same space we identified earlier.
There's something extra that happens under the
tax to the firm and it's why the firm does not like
the tax and that is the tax bill, okay, so now, right,
I have to pay for every unit that I control, I pay my
marginal cost and then I go to the right of Q tax,
the amount that I decide to abate and now for
every unit that I emit, I have to pay the tax.
Okay, so now I'm going to fill in this space too and
I'm going to say from, right, the amount that I abate
all the way to my uncontrolled level of pollution,
right, everything that's left over after I engage in my
pollution reduction activities I have to pay T, okay,
so then now I'm going to have this extra cost, which is
the area of the rectangle here and that's my tax bill.
Okay, so I've got some abatement costs and I've
got a tax bill and both of those are compliance
costs from the firm's perspective, okay.
Alright, so in thinking about whether the tax meets
our cost-effectiveness criteria, there's two things to
think about, one is does it equate those marginal costs
of abatement across firms, right, I define that as the
criterion that we have to meet to say something
is the least cost way of reducing the pollution to,
you know, by a hundred tons and for the tax it is.
Why?
Because I could have lots of firms with lots of
different marginal cost curves, one could look
like this and like that and like this and they're all
making that same choice that firm A is making.
They're trying to decide where should I stop controlling
pollution, oh I should stop as soon as it's more
expensive for me to control than it is to pay the tax.
So what are they all doing?
Well they're going right to the point where their
marginal cost is equal to the tax and if the tax is
the same across all the firms then so is the marginal
cost of control the same across all the firms, right,
they're all setting their costs set to the same constant,
right, to the same T and so that's cost-effective.
Now you could say, but there's this extra cost, right,
the firm has to pay the tax which is also true and
the firm does not like to pay the tax, but when they
pay that tax that money is not just sort of going
right away, it's going to the government, right,
and the government could presumably do things with
that and that's the difference between taxes and
permits and we can talk about that later in the Q&A,
but we're not going to call this a cost to the economy,
okay, so this is a cost to the economy, it's a social
cost, cost of abatement, this is a transfer, this is
money that I moved from one pot to another, okay
and it may take away from the real resources
that firm has in its pocket, but as far as sort of
the social costs go I'm not increasing social costs
by the amount of the tax, I'm only transferring money.
Okay, so the tax passes are tested being
cost-effective, it has some downsides,
we get this uncertainty over the quantity of
abatement that gets delivered and firms are
not going to be happy with their tax bill, okay.
Other than that though the tax can be a good thing.
Alright, what about cap-and-trade?
How does this work?
So we're going to go back to the diagram
that I drew earlier, but first let me just tell
you kind of intuitively how this works.
It's very similar to the uniform performance
standard with one important difference, right,
I might say I gotta reduce pollution by a hundred
tons, I'm going to give you, right, permits in the
amount that basically require you to reduce
pollution by 50 tons, I'm going to give you permits
in the amount that require you to reduce by 50 tons,
but instead of, right, just kind of keeping that at
50/50 the way I did with uniform performance
standard, I'm going to let you guys trade and you,
between the two of you, can sort of figure out, right,
how to allocate that responsibility for control,
so that we meet the hundred ton standard.
So firms are going to, under those conditions,
they'll buy and sell these allowances, these kind of
permits right until those marginal costs are equal
across firms and we'll just look at the graph briefly
again, so that we can see that that's the case and
so just like the tax, right, where everybody's setting
their marginal cost equal to the tax and thus the
marginal costs are equal across all firms because
firms are trading, right, and they've got theirs
we end up with this equilibrium permit price,
in the same way the marginal cost ends up equal across
all firms, right, they're all equal to the market price
of a permit, okay, it's that P star instead of a Q star.
So the equilibrium allocation, this is again something
I mentioned briefly earlier, one of the nice things is
it doesn't matter where I start, so let's go back to the
graph and we'll again we'll kind of think about this,
right, if I sort of, if I think of myself as starting at
50/50, my dashed line, the vertical line here,
well where are my incentives?
Well B is the high-cost firm, A is the low-cost firm,
so B would rather not abate that unit and he would
be willing to pay something to A to abate that unit
and A would be willing to accept something, some
compensation, right, for A as long as the compensation
was greater than her marginal cost she'd be happy and
for B as long as the payment was less than his
marginal cost he'd be happy, so we'd get these kind
of mutually beneficial gains from trade until we get
back to that point of intersection, right, and again if
I started out at, you know, 20/80, right, give firm A
20 tons of responsibility and B 80 tons, the same thing
would be true, I would just get more trading, right,
these costs are just even higher than A's at that level
and so the incentive would be even stronger to trade.
Again until we kind of move to the point of intersection,
right, or I could start out at, you know, a 100/0, right,
give firm A all the responsibility and firm B nothing,
right, then I could find, right, I'd find these gains from
trade and we'd end up back at 60/40, so this nicety,
right, was again it's nice and it's tough, right, cause
politically it matters very much to firms who gets what
in the beginning, right, so I would really rather be the
firm that gets a bunch of permits and gets to sell them
to other firms then be a firm that, right, gets a small
number and has to buy, right, in order to kind of
do my least cost thing and so it matters a lot to firms
distributionally, but it doesn't matter really at all
unless we have a story about market permit in the
permit market, right, and we haven't seen empirically
that kind of situation in very many actual applied
settings, so that would be an unusual thing to
happen and not only that, regulators are pretty wise
to that possibility and so, for example, in the actual
SO2 trading program the EPA set up in 1990 that
operated until 2008, the EPA was just sort of kept a certain
number of permits aside and would auction them each
year to prevent, right, any single firm from trying to kind
of corner the market, keep out new entrance and that
kind of thing, okay, so we might worry about market power,
but in general it hasn't been an issue and as long as we
don't have that, however we allocate these things in the
beginning, we're still going to get to 60/40, right, because
we're taking advantage of those incentives between
firms for those mutually beneficial gains from trade.
So I mean politically that can cause some nice situations
too, right, so in 1990 when the George H.W. Bush
administration was getting ready to implement what had
became the sulfur dioxide trading program, there were
some standouts, some states that, right, in the Senate,
in particular, were really resisting these changes in the
Clean Air Act that would make it more stringent and,
in particular, states that were resisting were states that
in sort of Appalachia where there either was coal mining
a lot of big coal industry or a lot of electric utilities
that were using high sulfur coal or both and one
particular stand out was the state of Ohio and then
senator Glenn ended up getting a very, very large sort of
chunk of the National permits for the program in order
to buy his support for the program in the senate, which
was essential to it passing and again that was sort of nice
for Ohio utilities cause they were in the position where
they started out from, you know, this sort of nice, big
permit allocation and they could sell some permits, right,
in the beginning and make some money, but it didn't
matter ultimately, right, for achieving the cost-effective
allocation across firms, right, so you can like or dislike
that story, but in general, it makes something, it's sort of
something that's appealing about cap-and-trade
programs from politicians perspectives cause they
have something to give out, right, not just, right,
it's not just the stick, but there's also some carrots.
Okay, so how does this work?
Right, again the equilibrium allocation's independent
of the initial allocation, that could be a nice thing unlike
the tax, the regular doesn't have to know firm's marginal
cost, right, this is something that's a little bit magical about
cap-and-trade programs, right, when I said you got us
through in order to get Q star I kinda had to know
something about the costs in order to get to Q star
with the tax, but if I just sort of know if I set Q, I know
I'm going to get Q that's my cap, right, I'm going to
enforce the cap and I don't have to know anything
about individual firms marginal cost curves in order
to know where, right, whether I'm going to achieve
Q or not, I just, I get it, right, because the firms are
trading with each other, so unlike the tax, I have this
certainty over the quantity, I don't have those certainty
over ultimately the price per ton, right, so the permit
equally, the permit price is going to end up wherever
it ends up, right, causing some uncertainty for firms,
in terms of their compliance costs, where as the tax,
right, I pinned down the price, but I don't know
the quantity, okay, it's pretty clear on that distinction.
Okay, so that's the story, the kind of short run
cost-effectiveness story, right, that's why we tend to
like these, again, all else equal for the same standard
achieve, we tend to like the taxes and the permits over
a uniform standard, a technology standard that doesn't
take advantage of these cost differences across firms.
Okay, so alright, what about the second question,
right, what's the incentive to kind of bring
down the cost of pollution control over time?
Again all else equal, we'd kind of like to
have a standard or some kind of pollution
control policy that would help us do this.
Okay that would provide incentives to bring, to do
this and I'm not going to go through the theory on
this, but I'll tell you what it says and that is, right,
when this, we're in this long run setting and my choice
of abatement technologies is not fixed and I can choose,
right, to change my whole factory or change my
pollution control process, I can lower my abatement
costs by developing or adopting new technologies, but
I'm going to have to usually make a pretty big upfront
capital cost to do that, so an example would be, right,
what if all of a sudden there's on the market now,
there's a new, more efficient scrubber, right, so that
its operating costs are lower, but if I want to do that,
if I want to get those sort of lower operating costs of
that scrubber, I have to buy the new thing, right,
I have to retire my old one and I have to buy a
new one and so firms are all in the position where
they're trying to weigh those kinds of decisions.
Should I invest in the costs reducing
technology or should I not?
Right, and it depends on the cost savings versus
the capital cost of the investment plus discounting,
right, I've gotta think about the, this
thing lasting over a long period of time.
Okay, so it turns out that the market-based policies
because they put a price on pollution, right,
cause every time that I abate I have to pay some
costs for, because of that, I'm going to provide
these greater incentives for technological change,
than what I see under either type of command
control policy, the technology standard or the
uniform performance standard, again we can go
through the theory on that, I'd rather kind of get
along to some examples of market-based approaches
and talk about how that's worked out in practice,
but I'm happy to answer questions about that too.
Some other things to worry about, okay, so
one thing, what are some potential downsides here?
Okay, one would be what I'm just going to call the
non-uniform mixing problems, so the way I've
talked about this and even the way I drew that
marginal damage function earlier and we talked
about negative externalities, I'm sort of saying, right,
that every firm has the same damages from pollution,
that it doesn't matter where the pollution is emitted,
right, I'm not causing sort of differential marginal
damages to society and that's true in some situations,
right, so for carbon emissions, it really doesn't matter
whether I emit a ton in Beijing or a ton in Boston,
right, a ton in Annapolis, it's causing the same
essential quantity of damages in the long run,
right, from sort of adding to the stock of carbon
in the upper atmosphere, but it's not true of a lot
of other pollutants, right, it's not true of most water
pollutants, it's not true of some air pollutants.
Sometimes where the pollution is emitted matters
very much, right, for how much damage it causes
and in that situation, we can get into these tricky
situations with market-based approaches, right,
again if I take a uniform standard and I say everybody
has to cut by 50 tons, okay, it's not necessarily true that
everybody has been exposed to the same amount of
pollution because there were some variation, right,
before I had the standard, there was some variation,
there's still going to be variation exposure to pollution,
but if I implement a market-based approach and I
move around, right, from 50/50 to 60/40 then the
place that had only 40 tons of emissions abatement
has less abatement relative to its baseline, then does
the place that has 60 tons and if it turns out that
those high-cost firms, right, the ones that would
do less abatement under the market-based
approach cause there it's more costly for them
to do so, are also high damage firms, right,
where pollution control gives us big benefits.
Then this can really kind of mess up the efficiency
criterion as well, then now we're talking about
changing the benefits of pollution control because
we've redistributed the pollution spatially, okay,
and so that can then cause some problems
and so what are some solutions to that?
Well the solutions are conceptually straightforward,
but have sort of turned out to be much harder to
implement in practice than anyone might have
imagined when people started writing about this
back in the 1960s and so the solutions are things
kind of like exchange rates, okay, and this is
something that Jim has written about really
interestingly especially thinking about taxes,
right, you could either directly tie attacks to the
marginal damage at your location, okay, that's one
thing you could do or if you, if it was reasonably
straightforward to set up sort of a zonal trading
system, you know, if I'm talking about, you know,
ozone generated by NOX and VOC Emissions in
Southern California and I know the prevailing winds
are off the coast from west to east then I sort of
wouldn't like to increase emissions, right, in the
kind of western areas, right, and decrease them in
eastern areas necessarily, right, because I'm just
sort of blowing that pollution over, so I might
have some rules of thumb, right, kind of regional
spatial rules of thumb that I can use to create a
tax system that taxes, you know, in some simple
straightforward way these sort of more damaging
emissions at a higher rate, okay, so that can either
be firm specific, location specific zones, there's
all different kinds of ways of working that out,
there could be an intertemporal aspect to this,
right, if it matters more this summer than it
does in the winter, if it matters more in the
middle of the day than it does in the night,
right, so you can think about these different
sort of types of taxes to accommodate that system.
Okay, so let me give you an example how this would
work with cap-and-trade, so this is a paper back,
from back in 2005 as a group of scholars at
Carnegie Mellon did this really neat thing and they were
looking at the problem of combined sewer overflows -
does everybody know what CSOs are?
- combined through overflows, right, so if you
live in a place that doesn't have separate storm
sewers from the sanitary sewage system, then
what happens when you have lots of rainfall all at
once, like what happens often in Austin, Texas
although we do have separate storm water systems.
The sanitary system receives all that storm runoff
and it overwhelms the capacity of the wastewater
treatment plant to treat that waste and so essentially
the plants in these areas have permits from the EPA
to just kind of open the gates, right, and then you
get a mix of sort of storm water and raw sewage
going into the receiving waters until, right, the flow
is sufficiently reduced, so that the plant can begin to
operate again and so these are called combined sewer
overflows or CSOs and they're common in, you know,
like some northeastern cities in parts of the Midwest,
where it's just, hasn't been sort of technically feasible
slash cost-effective to like dig up sort of, you know,
central Manhattan and install a new storm sewer
system and so on, okay, so it's not everywhere,
but there are parts of the country that have this more
than others, so what they did is they looked at the
Upper Ohio River Basin and the CSOs in the
Upper Ohio River Basin and in the Basin there are
70 municipal sewerage systems that receive runoff
during rainfall and have these CSO permits and
the damages that they were looking at were from
elevated levels of bacteria, biological oxygen demand,
total suspended solids during these CSO events, okay,
and in, into receding water bodies and so the marginal
damages from these depend on and they're sort of
simplified model, right, somebody asked earlier
what goes into that again, the sort of flow and
some other hydrological characteristics of the
receiving water as well as the exposed population.
Okay, so are we talking about
big cities or rural areas and so on.
And so what they do is they set up this system of
exchange rates, okay, so this is the, these are the 7
or sorry 8 of the 70 systems the kind of 8 biggest
ones and this matrix is just saying, okay, here's
regulated source I one through eight, Clairton
through Youngstown, okay, and then here's the,
so those are the rows and the columns are the same
thing, so 1 here corresponds to the city of Clairton,
right, a 2 corresponds to the city of Greensburg
and the 1's across the diagonal of the matrix is just
saying, right, this is sort of own trading, right,
if Clairton were to trade with Clairton,
if Greensburg were to trade with Greensberg,
if McKeesport were to trade with McKeesport,
so that's why those are 1's, but everything else in
the matrix is giving you this kind of exchange rate
that you would want to use taking into account the
marginal damages at the location of each of these
sources, alright that's the exchange rate you would
want to use in a trade, so, for example, I circled this,
right, Morgantown trading with Pittsburgh cause
Pittsburgh is number 5, so that's column 5 and it turns
out that the damages of emissions in Morgantown are
higher than the damages from emissions in Pittsburgh,
so if Morgantown wants to buy, right, it wants to offset
one of its ton, right, one ton of its kind of emissions
reduction responsibility by purchasing permits from
Pittsburgh, it has to buy sort of four and a half tons
for every ton that it wants to reduce of its own
responsibility, okay, and so you can read each of
these numbers like that, right, if they're smaller,
right, then it goes the other way, they can buy
less than one ton of emissions, right, from another
setting than, rather than reduce it themselves and
so they set up these exchange rates and you could
say well why don't they just prohibit trade between
Morgantown and Pittsburgh, right, if the damages
are higher in Morgantown and one could do that,
you know, you can set those kind of constraints in
the system, the problem in a system like this would
be well then, you know, Morgantown could trade with
McKeesport and then McKeesport could trade with
Pittsburgh, right, you'd have to really be very clever,
right, in sort of thinking about how to block,
right, the movement of pollution toward the
cheaper area and so right the system of exchange
rates kind of takes care of that and it says well
how much is it really worth, right, relative to the
damages, how much is it really worth?
And then it sort of sets those ratios just like,
you know, an exchange rate does, right, if you're
trading currency in another country and so this is
in theory how it would work and there are systems
that use these, so a couple to think about or look at
if you're interested in this would be the Minnesota River
phosphorus trading program has a very carefully, right,
again this is an area where, right, economists are
working closely with water quality modelers to
understand these impacts, what's important,
what are the characteristics that are important and
kind of coming up with these matrices of trading
ratios, so the Minnesota River phosphorus trading
program is one, the Chesapeake Bay TMDL, right,
that was issued back when I was at RFF around 2010
maybe I think, there are three states Virginia, Maryland,
and Pennsylvania that have set up trading programs
that also, right, there's this sort of systems of trading
ratios that I think they're being used in those programs
as well and there are others, okay, so that's how it
would work in theory, turns out to be, you know,
somewhat complicated to implement in practice.
Another thing to worry about when we think about
cap-and-trade programs or taxes is monitoring
enforcement, so a question came up earlier kind of
how do you, you know, how do you kind of monitor
and enforce regulations like this and it turns out that
while abatement costs tend to be the largest share of
social costs when we think about environmental
regulation, the kind of monitoring enforcement and
associated administrative costs to governments are
the second largest category, okay, so to give you a
sense of scale with the SO2 trading program, that
we'll talk about in a minute, that was running from
1990 to 2008, if a firm adopted a scrubber to comply
with that it would've cost on the order of tens to even
maybe hundreds of millions of dollars to purchase
that scrubber and install it and probably several million
dollars per year to operate it for an individual firm
and in order to enforce that regulation, EPA had to
install continuous emissions monitoring in all of the
regulated electric utilities stacks, right, so they could,
know in real time exactly how much pollution was
coming out, so they could check and see, right,
where firms complying with their permit allocations
and that cost you know several hundred thousand
dollars to install and about fifty thousand dollars per
year to operate, so it's not nothing, right, it's not
negligible, it can be a big cost, but on the scale,
so relative to abatement costs, it's relatively small,
okay, so they tend to be small relative to abatement
costs, but it's still and again if, you know, you can fit
twenty-five hundred electric, you know, generating
units in the United States on a spreadsheet, but if
we're talking about, you know, a hundred and forty
million cars or however, you know, hundreds of
millions of households are heating homes with
home heating oil, but if I wanted to try and do a
market-based approach with a much more diffuse,
you know, sort of, you know, very large sort of
numerous population of regulated entities, then
these monitoring enforcement costs of a cap-and-trade
or even a tax-based approach might be very high.
Okay, so if, you have to sort of think about the scale
of the regulation, if I want to compare these things, so,
you know, I guess the point I want to make is that
on the cost-effectiveness criterion, the market-based
approaches are just in most cases going to be better,
okay, and we'll talk about some exceptions to that
in a second, but on the monitoring enforcement
dimension there's sort of no clear winner, probably
the command and control approaches are cheaper on
average and so you'd want to weigh that against,
right, the savings and abatement costs, which are
often going to swamp those savings and monitoring
enforcement costs, but not always, okay.
So are the traditional approaches ever preferable,
that's sort of leading into this question,
so I would say under three different conditions.
One is when I really have these severe kind of
non-uniform mixing problems, so I remember
in at that, again there's this debate that we talked
briefly about yesterday, but over a new arsenic
standard under the Safe Drinking Water Act going
back to 1999/2000 and at the time an economist,
who I know well, but I can't imagine what he was
thinking when he wrote this, wrote an article
proposing oh we should have trading, right, and,
you know, some communities should have higher
arsenic levels and others could have low and we
could just sort of meet regional standards and
those in highly non-uniformly mixed problems,
right, where the damages are very, very specific,
right, to the location of emissions or exposure,
are really just not well suited, right, for a
market-based approach, right, you have, you really
run this risk of having this sort of high damage
firms doing less abatement or the high, right,
or vice versa and that's not at all going to be what
we want for efficiency, so another example, that
would be toxic waste, right, I would never say
well let's just trade toxic waste dumps, right,
cause of all that matters is what the total amount
of toxic waste produced by the United States,
well we know that that's not the case, right, the
spatial location of that thing matters very much,
so we want to be real careful in those situations.
A second situation in which we'd prefer the
traditional approaches is, you know, a single
control technology's just highly effective and
everybody would kind of do the same thing anyway,
right, abatement costs are very similar across firms.
Again if you think about those marginal cost curves,
the only reason we had that space between the curves
when we had some trading versus the 50/50 split was
because the cost curves were different, I drew one
steeper than the other, right, or one higher or one
lower and if that's not the case then everybody has
essentially the same costs, then I don't really get any
bang for the buck of using a market-based approach
and I might get, incur some extra costs to do that,
so and then, you know, in that case, it's not a great
idea, so a good example of that historically has
been double hold oil tankers, right, so what do we
do to kind of prevent another Exxon Valdez?
Well one thing that we did was under the Oil Pollution
Act of 1990 is that we required the sort of phasing in
of these double hold oil tankers, well if you've asked
firms to meet some standard, right, that was, had to
do with reducing the probability of another spill,
they would pretty much universally have chosen
double hold oil tankers, right, so why go through
the trouble of doing some kind of trading or some
kind of a tax system when that works just fine and
is cost-effective for most of the regulated entities.
And then finally, if the number of regulated entities
is really high, again that's the difference between
twenty-five hundred electric generating units
regulated by a cap-and-trade system versus, you know,
two hundred thirty million cars or a hundred forty
million households that kind of thing, right,
then we have this problem of monitoring and
enforcement becomes very expensive to think about
implementing and so as the problem gets more and
more diffuse like that, right, then we sort of start
to move away from market-based approaches in
our kind of mental toolkit of what's available to us.
The only thing I would say there is that, you know,
I often say well kind of for now, right, so we see I
mean especially in the aftermath of the Volkswagen,
right, this regulatory incident with the German firm
Volkswagen, people talk about well gee maybe we
should be testing auto emissions on the road and we just
combine license plate recognition technology with, right,
sort of field emissions testing, which some states already
do, right, to either compliment or substitute for some of
their kind of in-house emissions testing regulations.
Maybe, right, technology, that time, if those technologies
combine in a way in which is cost-effective to regulate
emissions in some sort of very diffuse way through a
tax or something like that, well then maybe it would
make sense, but in general the sort of more diffuse
the pollution problem, the greater the number of
regulated entities, the less it is likely that you
would want to go with the market-based.
Okay, so just to, I'll just kind of, this is
my list of some examples of market-based
environmental policies that have been tried.
British Columbia has a carbon tax, right,
I think it's, does anybody know?
Twenty-five dollars a ton something like that
it's, you know, set some, somewhere reasonably
close to what we would think would be at least
from U.S. estimates the social cost of carbon.
It's pretty new like it's, I don't know of any good
empirical analyses, yet, I know there are some
estimates B.C. has its own estimates of how its
reduced carbon emissions, but I, it's hard for me
to say how, how good those estimates are.
Lots of experiments with cap-and-trade program,
so again carbon dioxide, right, there's a market in
the European Union, there's one in California,
there's RGGI the Regional Greenhouse Gas Initiative
on the east coast, there's the SO2 trading program,
there's been some NOXtrading in the United States,
so a fair number now of examples in air pollution
control especially in industrialized countries.
As I mentioned earlier, a good example of
the tax-approach or that kind of Pigouvian
tax-approach or these unit charges for
municipal solid waste or pay as you throw
systems, a lot of communities have adopted them.
There's some good studies showing that they reduce
those sort of volume of the solid waste stream
interestingly, but not surprisingly, if you don't provide
curbside recycling when you do this, right, then
you may just not be doing yourself a favor, right,
you increase incentives for illegal disposal and so on.
So there are things to think about other
than just, right, what to tax and how much.
You gotta sort of think about the whole context.
Probably the most successful experiments with
these have been individual trading fishing quotas.
Pete I'm sure knows much more about those than I do,
but New Zealand manages something like 90 percent or 85
or 90 percent of its sort of the stocks within its Exclusive
Economic Zone using these tradable quota systems.
In the United States there are a lot of species that
are managed this way too, although it's been much
more controversial and its common, it's gone,
its been banned and its been unbanned, but gulf
snapper right now, Pacific halibut, those are two
very good examples and pretty well studied examples.
Water quality trading I mentioned the
Minnesota River Program and the Chesapeake Bay,
nitrogen phosphorus markets for a lot of
reasons that we can go into if anybody's interested.
These things have not taken off the way we thought they
might, perhaps due to some of this skepticism that
Jim expressed yesterday about how ready we are for
these things, but that's another set of examples and
there's a reason that I've sort of listed them in this order.
Wetlands banking that came up yesterday, tradable
development rights, I would put this as sort of maybe
with individual tradable fishing quotas at the top,
but then I would sort of put this list in this order,
sort of moving away from the easy cases toward the
much harder cases and the cases where it's not clear
that we have actually done sort of generated net
benefits within the environment in comparison to
what we would have done with more of a traditional
prescriptive approach and I think it's very hard to say.
I don't think we know nearly enough, right, about what
sort of what's happened, but if you think about the
essential problem here as we sort of move from the
easy cases to the hard cases, I'm just going to skip
through this and sort of just go to my summing up slide.
What we're doing is we're sort of moving away from
those clearly, you know, sort of uniformly mixed
problems, right, the problems where it really doesn't
matter where the control takes place or in the resource
case, so it doesn't really matter where the conservation
takes place or doesn't really matter right one kind of
piece of a wetland is tradable, fully tradable and
equivalent, right, to a piece someplace else or
different kind of wetland, so, right, we there's all
these things to like about market-based approaches.
We like that they're cost-effective, we like
that they have these long-run incentives for
technological change, we like that we see examples
and practice where empirically we've actually been
technological change, we like that we see examples
and practice where empirically we've actually been
able to estimate what have been the cost savings
relative to other approaches, right, what have been
the environmental impacts, we like all that, okay.
But there are these applications on the frontier, there's
this impulse, right, that when all I have a hammer
everything looks like a nail, right, to say well it
worked, right, for air pollution control and so now
we should have wetlands mitigation banking and we
should trade development rights and species habitat
and so on, but as we move to these newer kind of
and I don't mean new environmental problems
it's the sense that the problem is new, but, right,
that I've sort of taken the market-based approach
to a new set of problems that I haven't tried before.
Then we have these new challenges and it's
not that I, I think I may be somewhat more
optimistic, for example, in the water pollution
case then what Jim expressed yesterday.
I think there's been a ton of progress made in this
interdisciplinary work, right, trying to understand
how these things work, how they might work better
and really trying things on the ground, but I also
think, right, that the key problem is that for these
non-uniform damages, the markets have to have
constraints and they have to be designed really
carefully, right, in order to not make things worse,
right, not just to make things more costly, but actually
make things worse in terms of benefits and so the
design of those constraints requires these inputs from
the natural and physical sciences, it requires, right,
this kind of working together across disciplines
in ways that I don't think it happened either in
regulatory agencies or in academics or both
to the degree that they would really need to
in order to make these things fly pretty well.
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