1. 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

2. 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Superseded instrument remains but it is largely without effect

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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!