Policy for Market failure Prescriptive/Command and Control Strategies: “Standards”

Instrument taxonomy Early environmental policies, such as the Clean Air Act of 1970 and the Clean Water Act of 1972, relied almost exclusively on the command and control (standards) approach. (Stavins, 1998)

Types of standards 1.Performance standard: a regulation prescribing a maximum allowable pollution level. Two common forms: a)Emissions rate: a never exceed level for a quantity of emissions from a polluter E.g. emissions/year; emissions/(unit of input); emissions/(unit of output) b)Ambient concentration: a never exceed level for a pollutant in the environment E.g. TMDLs (Total Maximum Daily Loads of contaminants in streams and rivers)

Types of standards 1977 Clean Air Act Amendments: new electric power plants required to install scrubbers to reduce SO 2 in flue gas (K&O p. 130) catalytic converter required on automobiles to reduce concentrations of emissions 2.Technology based standard: a regulation prescribing specifying the method (sometimes the actual equipment) that firms must use.

EPA Sets Thresholds for Greenhouse Gas Permitting July 2011: Clean Air Act permitting requirements for GHGs will kick in for large facilities all new facilities with GHG emissions of at least 100,000 tpy and modifications at existing facilities that would increase GHG emissions by at least 75,000 tpy permits must demonstrate the use of best available control technologies to minimize GHG emission increases

Summary of conclusions on standards in policy Initially appear simple and straightforward Potential weaknesses: –Lack of short- and long-run cost effectiveness Limited flexibility in achieving goals Weak incentive for innovation –may lock in particular technologies Potential advantages: –monitoring and enforcement costs –avoiding “hotspots”

Basic model of standards Initial emissions, e 1 Impose a standard of a maximum of e* tons/year emitted What area represents the total abatement cost at e*? Total damage? (standard pollution control model) b c

Example: Clean Air Act of 1970 Required that costly scrubbers be used by coal- fired electricity plants even though it would have been cheaper to achieve SO2 reductions by substituting to low sulfur coal. Imposed by senators from eastern states with high sulfur coal. Political feasibility: could not otherwise have passed congress. Hackett, S., Environmental and Natural Resources Economics: Theory, Policy, and the Sustainable Society, 3rd Edition (New York: M.E. Sharpe, 2006), p. 224.

Empirical evidence of standards inefficiency (Stavins, 1998) Survey of 8 empirical studies of air pollution control: –ratio of aggregate costs of the conventional, command-and-control (C&C) approach …OVER… the aggregate costs of least-cost (LC) benchmarks TAC C&C /TAC LC Ranged from: 1.07 for sulfate emissions in the Los Angeles area to 22.0 for hydrocarbon emissions at all domestic DuPont plants

Incentives generated by standards (long-run impacts) Technology innovation –Conceptual model: + demand for abatement tech.  + R&D  + technology innovation  MAC curve falls –Standards: tend to freeze development of technologies which would lead to greater levels of control. Especially technology standards –Little or no financial incentive to exceed control targets (Stavins, 1998) A business that adopts a new technology may be "rewarded" by being held to a higher standard of performance

Use the basic model to examine incentives for innovation Start: MAC 1 … innovation  MAC 2 Questions: Given a mandated standard of e 2 (assume compliance is perfect) –What level of abatement does the firm choose? (Under MAC 1 ? MAC 2 ?) –What is the firm’s TAC (total abatement cost) at this level? –What is the incentive (the benefit to the firm) to innovating? The new (post-innovation) socially efficient level of emissions is e 3, –What happens to R&D incentive if the firm believes the post-innovation standard will be set to e 3 ?

When might standards be preferable? Hotspots: simple market-based instruments may allow for areas of particularly high pollution levels to arise which is problematic for some emissions (e.g. mercury). A certain control technology may be so effective and widely available that mandating it is more effective than regulating “emissions” (e.g. double-hulled oil tankers – may also be a high cost of cleanup and difficulty in recovering damages). Too costly to effectively monitor emissions (e.g. catalytic converters on automobiles).

Standards are often uniform (identical across firms). The central issue in assessing the cost effectiveness of standards –Typically firms will have different MAC functions Uniform standard will not be cost-effective –Could achieve greater reduction at same total cost, or –Could achieve same reduction at reduced total cost Economics of standards: Should standards be uniform?

Cost effective pollution control: Minimizing costs K&O, figure 9.1 What does the area described by c represent?

Arguments… For uniform standards: Lower implementation costs (likely lower than for non- uniform standards) –to get non-uniform standards right, you need the MAC function for every source – a costly information requirement equity (treats everyone alike…which is not necessarily always a fair or equitable approach) –“leveling the economic playing field” Against uniformity: When marginal abatement costs differ among sources –Uniformity is not cost-effective (assuming MAC curves known or “easy” to assess) –Equity and leveling the economic playing field don’t necessarily imply equal standards.