Policy Mix or Evolution? A. Denny Ellerman Center for Energy and Environmental Policy Research Massachusetts Institute of Technology Joint CAFE/NEBEI Conference Brussels, Belgium November 12, 2004 Massachusetts Institute of Technology Center for Energy and Environmental Policy Research

A Question ? Are co-existing instruments the result of policy mixes, or The supplanting of one instrument by another? Superseded instrument remains but it is largely without effect

The SO2 Case in the US The Policy Mix Argument (circa 1990) Pre-existing prescriptive regulation protects health and remains to do so SO2 cap deals with a regional problem: acid rain The Supplanting Argument (CAIR, 2004) Clean Air Interstate Rule (CAIR) will force a 2/3 reduction in acid rain cap for health reasons Why not more usual prescriptive approach? Follows the SIP Call precedent

The SIP Call & Other Precedents The NOx SIP Call Revision of the Ozone National Ambient Air Quality Standard (NAAQS) requires a revision of State Implementation Plans (SIPs) EPA invites states to adopt NOx trading program Same choice of cap-and-trade over conventional regulation for: The Northeastern NOx Budget Program The RECLAIM (Los Angeles) Programs

Why This Trend? No lack of legal authority to impose command-and-control regulation to achieve health-based standards The Clean Air Act and the Federal EPA are not viewed as ineffective A change of regulatory role that violates public choice arguments Regulators will expand role, not diminish it

Reason #1: Tougher Problems Early environmental problems were obvious, the sources big, and appropriate regulation relatively easy to devise and to enforce Later environmental problems are more subtle Problem and effects are often not visible Sources are not obvious, smaller, more mobile Costs of abatement are usually higher Appropriate regulation not obvious & even impractical

Reason #2: Informational Asymmetry More subtle nature of problem makes good information far more important Complex sourcing and high cost of abatement actions make regulators reluctant to act Regulators lack information on what can be done and the regulated won’t/don’t provide it Brute force mandates become politically infeasible

Reason #3: Enabling Technology Trading systems are very data intensive Monitoring and Allowance Tracking New information technology has lowered cost of, and made feasible, monitoring and data handling that could not have been done before At the same time, higher incomes and better opportunities have made labor-intensive inspection and enforcement more costly

Reason #4: Easier & More Effective Implementation Allowances make initial agreement easier A compensating asset is created to go along with the new liability With allowances allocated, regulatory implementation becomes technical and less prone to political interference & “capture” Experience has shown programs to be effective in lowering emissions and reducing costs

Reason #5: More Faith in Markets Part of a broader trend to greater reliance on markets to provide quasi-public goods Not so much a matter of ideology as practical experience and economic literacy Allows refocusing of government effort on identifying problems and designing incentives instead of prescribing individual solutions

The Fate of Conventional Prescriptive Regulation Conventional, prescriptive regulation doesn’t disappear Too much invested in it emotionally and politically Perhaps it serves as a “safety net” But increasingly it just withers away and remains only as a relic of an earlier age

Why Cap-and-trade? It manages to impose a price on emissions Thereby providing incentive for a decentralized solution that will be effective and least-cost Prescriptive regulation does not It imposes conditions but allow free emissions once the condition is met And often relaxed for equity (or worse) reasons Emission taxes could do the same But only with compensation as in Swedish NOx tax

A Quiet Supplanting of Conventional Regulation The basic deal Regulators recognize informational and political limits of their legally absolute authority Firms accept regulation and prefer permits A disappointment to public choice theorists and the double dividend But better environmental regulation!