1. Regulatory Innovations What are some of the new and innovative ways to regulate environmental protection?

2. Motivation Group Project: The Clean Air Act is up for renewal and your group project has been tasked with coming up with new and innovative ways of achieving the same objectives of the act but in a more flexible and less burdensome way.

3. Today’s Menu Command-and-Control: Improving on it Marketable permits Voluntary Approaches Information disclosure regulations Banking of credits

4. Command-and-Control Problems Failure of Equimarginal Principle Reduced incentives to find better ways to control problem Regulator needs private info from polluter – tough Advantages Flexibility in defining standard Verification can be easy (is equipment in place?) Greater certainty regarding extent of pollution Intuitively attractive to engineers

5. Command-and-Control: Innovations Technology standards vs. Performance Standards Most inflexible is standards specifying type of control technology Somewhat more flexible are standards stipulating overall emission level Bubbles Firm may have multiple plants, each subject to regulation Bubble allows firm to put all plants under a bubble and only count what leaves bubble Offsets New firm wants to enter polluted urban area Must “induce” another firm to reduce emissions, offsetting new emissions How is this similar/dissimilar to a marketable permit system? Technology forcing Stipulate regulation that is not currently technologically feasible If credible, can reduce costs in long run Subject to manipulation through the ratchet effect

6. Marketable Permits – a.k.a. “cap and trade” How to set up a marketable permit system: 1. Determine the unit of analysis 2. Set the “cap” 3. Set the trading rules 4. Determine method of initial allocation

7. Marketable Permits-- Examples Acid Rain Allowance System (SO2) RECLAIM in LA (NOx and SO2) EU Carbon Trading (CO2) Wetlands banking Habitat Plans Lead in gasoline phasedown Fishing Quotas Conservation banking

8. Marketable Permits: +/- Advantages Informational requirements can be smaller Provides incentives for polluters to reduce costs Equimarginal principle automatically satisfied Disadvantages Can be difficult in complex world of spatial and temporal variation Political problems associated with making firms pay more or from setting up property rights to pollute

9. Marketable Permits: Innovations Auction or free? Auction generates revenue for gov Free distribution solves major political problem Safety Valve Big issue for climate is cost uncertainty Allow trading of permits but make available extra permits from gov at price perhaps double expected market price For example, for greenhouse gases, expect permits to trade for $25; make extra permits available at $50 What advantage does this have? Feebates Above average performers get subsidies for good performance Below average performers pay penalites (fees) for poor performance Net payments approximately zero Provides upward pressure on performance.

10. Voluntary Actions: Examples Unilateralism BP’s program to reduce GHG emissions ISO 14000 [management plan] Bilateral Agreements Project XL [allows firms to violate statutes if they can show they will achieve greater environmental performance] Voluntary Opt-in Programs 33/50 Program at EPA [33% redux of certain toxics by 1992; 50% redux by 1995, relative to 1988; firms voluntarily opt-in and agree to make the reductions] Conservation Reserve Program [pay subsidies to participate]

11. Why do firms participate in voluntary programs? Seems like no firm would voluntarily incur extra costs Reasons for undertaking Way of fending off non-voluntary regs Way of establishing a “green” image and enhancing product marketing Reduce perceived environmental risk to investors, thus reducing the cost of capital Social responsibility (?) Bottom line: firms are generally assumed to still be acting in their own self interest, broadly defined.

12. Information disclosure Toxic Release Inventory (TRI) started in 1986 to provide public information about release of toxic substances 640 chemicals Also voluntary agreements (e.g. 33/50) Local environmental groups use TRI to pressure & report on industry More info yields better economic performance. Good starting point for new regulations.

13. Incentives for innovation PolicyGains to innovating firm Command & Controllittle to none Best available technology- Performance Standards++ Emissions tax+++ Auctioned permits+++++ Grandfathered permits++ Tradable performance standards ++ Voluntary Measuresnone

14. Conclusions Innovations in regulation is where the action is Marketable permits have achieved great success and will probably continue to expand Voluntary approaches have had questionable success in terms of improving environmental performance at reduced costs