Transcript Slide 1

Policy for market failure
Nearly all environmental policies include two key
decisions (both components in practice are
typically linked):
A. Setting the goal or target
B. Selecting the means or instrument to achieve the
target
Stavins (1998)
A. Setting the goal:
Step 1: Characterize benefits
e.g. from reducing environmental degradation
Marginal damage function
Note:
• Emissions or
effluent (rate) vs.
ambient
concentration (level)
• Slope
• Relation to total
damages
Interpreting the marginal damage function
Field and Field, 2006
• Interpret area b, a,
& (a+b)
• Shift: interpret the
difference between
MD1 and MD2.
(more to come)
• What is the
efficient/optimal
level of emissions?
Is there enough
information?
A. Setting the goal:
Step 2: Characterize costs
e.g. of reducing environmental degradation
Marginal abatement cost function
Interpreting the MAC function
Field and Field, 2006
• Interpret area b, a,
& (a+b)
• Shift: interpret the
difference between
MD1 and MD2.
(more to come)
• What is the
preferred level of
emissions? Do we
have enough
information?
Uncontrolled emissions
$
$
MD
MAC
e
(emissions, tons/yr)
• MD curve does not pin down
the uncontrolled level of
emissions.
e’
e
• MAC curve does say something
about the uncontrolled level of e.
MAC becomes positive when
abatement begins, thus the
uncontrolled emission level is e’.
• <assume: no free lunch>
A. Setting the goal:
combining costs and benefits to identify an efficient target
Identify:
• Efficient level of emissions
– AT the efficient level, identify:
– MD of the last unit of
emissions
– Point of minimized total costs:
TC = TAC+TD
– TAC: Total abatement cost
– Apply equimarginal principle.
– TD: Total damage
B. Selecting the means:
Instrument taxonomy
“Myth of market solutions”
• Another myth about how economists see the
environment: “economists always recommend a market
solution to a market problem.” (Fullerton and Stavins,
1998)
– Economists do tend to “search for instruments of public policy
that can fix one market, essentially by introducing another
(market)” (e.g. marketable permits, tax) … “allowing each to
operate efficiently on its own”
– However, the market fix is only efficient if there are no market
failures associated with the market-based policy itself
• Sale of permits in a cap & trade market monopolized by a small
number of buyers/sellers
• Inadequate information or high transactions costs? (e.g. costly
to measure emissions?)
There is no policy panacea
• “(N)o individual policy instrument…is appropriate
for all environmental problems.”
• The best instrument depends on
– characteristics of the particular environmental
problem
– social, political, and economic context
• The policy challenge: selecting the best
instrument for the particular setting.
Stavins (1998)
Criteria for evaluation of
public policies
a. Cost-effectiveness
b. Incentives for technological innovation
c. Implementation and enforcement costs
d. Fairness/equity/distribution
e. Agreement with moral precepts
f. Political feasibility
a. Cost-effectiveness
• maximizing some objective (e.g. env. qual.) for a
given cost
• Informally: “most bang for the buck”
OR
• cost minimization for a given objective (e.g. a
particular level of environmental quality)
Existing environmental regulation:
not always cost-effective
• Direct cost of federally mandated environmental quality
regulations in 1997: ~ $147 billion (Hahn, 2000)
– Source: the “first comprehensive government report on the
benefits and cost of federal regulation produced by the Office of
Management and Budget” (OMB, 1997 via Hahn, 2000).
– Comparison: total outlays for domestic discretionary programs in
1997: $258B.
• “(M)any environmental regulations would not pass a
standard benefit-cost test” (Hahn, 2000)
– E.g.: reallocation of expenditures could save an estimated
60,000 additional lives/yr
Cost effective pollution control:
Minimizing costs
Abatement goal:
100
Question: costminimizing
allocation
between A & B
EP:
equimarginal
principle
K&O, figure 9.1
b. Technological change (a component of
cost eff.)
• Policies can provide incentives to
reduce the marginal abatement cost.
$
MAC
A
B
e1
e0
e
Innovation/R&D implications of policy
• Why care about innovation?
– Expected costs of environmental regulation (e.g. pollution
control) are a major barrier to action.
– Adoption of innovative technology can increase cost
effectiveness:
• (1) increase pollution control for the same cost, or
• (2) decrease cost for the same level of pollution control
– The optimal level of pollution control increases
• Example: regulatory history for nitrogen oxides (NOx)
pollutant emissions
– stationary sources (primarily coal-fired power plants)
– NO2: one of the six criteria pollutants regulated by the 1970
Clean Air Act (National Ambient Air Quality Standards set to
protect health and welfare)
NOx as a pollutant
The image reveals pollution hotspots above cities and even shipping lanes.
(From New Scientist. Image: University of Heidelberg)
•
Sources: internal combustion engines, fossil fuel power plants, pulp
mills.
•
Effects: long-term NO2 exposure may decrease lung function and
increase the risk of respiratory symptoms (World Health Organization).
Nitrogen oxides
(NOx): Policy,
innovation and
emissions
Source: Yeh et al. (2005)
1970: Clean Air Act
1977: CAA amendments
1990: CAA amendments
1994: Title I: OTC NOx Budget
Program
(more)…
c. Implementation and enforcement costs
• Implementation costs can be huge (e.g.
ESA Section 7 reviews)
• Often costly to monitor, assess
compliance and sanction violators
Claims don’t always
reflect reality
d. Fairness/equity/distribution
“Another trade-off society
faces is between efficiency
and equality.
• Efficiency means that
society is getting the
maximum benefits from
its scarce resources.
• Equality means that
those benefits are
distributed uniformly
among society's
members...
• These two goals often
conflict...
(Mankiw 2008)
Artist Hans Hemmert:
shoe-extenders for uniform height
…when the government tries to cut
the economic pie into more equal
slices, the pie gets smaller.”
• Policy burden…
– increases with income 
progressive
– decreases with income
regressive
“The inherent vice of
capitalism is the
unequal sharing of
the blessings.
The inherent blessing
of socialism is the
equal sharing of
misery.”
-Winston Churchill
(Drawing by Lyn Ott , 1942)
e. Agreement with moral precepts
• Whether a policy seems to violate accepted
moral standards
• E.g. subsidies may violate many people’s
feelings about who should bear the cost of
environmental improvement
• Concepts like the “polluter pays” principle
have moral foundations
• Though not necessarily clear cut (e.g.
Coasian counter-framing)
Counterpoint to interventionist perspective
• Government Failure: when a policy intervention
make matters worse rather than better
• “There is always an easy solution to every
human problem—neat, plausible, and wrong.”
– H. L. Mencken
• “The cause of most problems is solutions.”
– Eric Sevareid
Government Failure
• Minerals Management Service (M.M.S.) -- in charge of offshore
drilling)
• M.M.S behavior in last decade
– let oil companies shortchange government on oil-lease
payments,
– accepted gifts from industry reps
– literally slept with the people they were regulating.
• Industry protested against proposed regulations (including rules that
might have prevented the B.P. blowout) M.M.S. backed down.
• A few weeks after B.P.’s Deepwater Horizon oil rig blew up…Ken
Salazar, the Secretary of the Interior, ordered the breakup of the
M.M.S.”
Surowiecki, James. (2010). The Regulation Crisis. The New Yorker, June 14.
Government
failure