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Environmental Policies

Environmental Policies. Econ 373 Feb 27, 2012. Topics to be covered during the class. Decentralized Policies Command-and-Control Policies Market Based Policies Emission Charges and Subsidies Cap-and-Trade Criteria for Evaluating Environmental Policies. Decentralized Policies.

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Environmental Policies

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  1. Environmental Policies Econ 373 Feb 27, 2012

  2. Topics to be covered during the class • Decentralized Policies • Command-and-Control Policies • Market Based Policies • Emission Charges and Subsidies • Cap-and-Trade • Criteria for Evaluating Environmental Policies

  3. Decentralized Policies • Advantages: • Stakeholders has strong incentives to seek out solutions • People involved have better knowledge of damage and abatement costs. • Liability Laws • Property Rights • Voluntary Action

  4. Decentralized PoliciesLiability Laws • Liability: To be liable for some behavior is to be held responsible for whatever untoward consequences result from that behavior • Compensation: requires that those causing the damage compensate those damaged in amounts appropriate to the extent of the injury. • Incentivize firms to internalize the external effects.

  5. Decentralized PoliciesLiability Laws Compensation payments: b+c+d Marginal Abatement cost Marginal Damage $ a d b c e1 e* Emissions (tons/year)

  6. Decentralized PoliciesLiability Laws • Common law: court proceedings in which plaintiffs and defendants meet to make claims and counterclaims. • Statutory law • U.S.: Oil Pollution Act of 1990 • Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) • Japan: The Law for the Compensation of Pollution-Related Health Injury

  7. Decentralized PoliciesLiability Laws • Theoretically work well but depends on the actual legal processes • Specified time frame: 2-3 years • Establish a direct causal link between the pollution and the damage • Transaction costs – the costs reaching and enforcing agreements • Restricted to the case where relatively few people are involved, causal linkages are clear and damages are easy to measure

  8. Recent Oil Spills Litigations-Exxon Valdez • 1989 11 million gallons of oil leaked into Prince William Sound, Alaska • Exxon spent 2 billion on cleanup • 1994 ruling: $287 millions in actual damage; $5 billion as punitive damage. • 2002 appeal reduced the punitive damage to $4 billion • 2004 appeal: 4.5 billion • 2006 appeal: 2.5 billion • 2008 appeal: 500 million

  9. Recent Oil Spills Litigations-CoscoBusan Oil Spill • 2007: half a million gallons of oil spilled in California • Settlement worth $44M + $10M fine

  10. Recent Oil Spills Litigations-Deepwater Horizon Explosion • 2010: 200 million gallons of oil leak in the Gulf of Mexico • Trial starts at 8am, Feb 27 • 116,000 plaintiffs • 300 witness • 72m pages • 90 law firms and 340 lawyers spent 230,000 hours so far for the private sector plantiffs • Defendants’ legal fees has reached $1.73bn

  11. Decentralized PoliciesProperty Rights • Conditions for property rights to work: • Well defined, enforceable and transferable rights • Reasonable efficient and competitive system that allows stakeholders to come together and negotiate the usage of the rights • Complete set of markets such that private owners may capture all social values associated with the use of an environmental asset

  12. Decentralized PoliciesVoluntary Action • Moral Suasion • Informal Pressure • Corporate Social Responsibility • Downside and upside of the voluntary action • Indirect, unenforceable and cause free-rider situation • Possible larger spillover effect

  13. Command and Control Strategies: The Case of Standards • Types of Standards • Economics of Standards • Standards and Incentives • Economics of Enforcement

  14. Command and Control Strategies: The Case of Standards- Types of Standards • Standards: a mandated level of performance that is enforced in law • Types of environmental standards: • Ambient • Never-exceed level for some pollutant in an neighborhood. Example • Emission • Emission rate, concentration, % removal of pollutant • Technology • Scrubber to reduce SO2 emission

  15. Economics of Standards • Equimarginal Principle: When there are multiple polluting sources, the efficient abatement level is when MC1=MC2=…MCi • Deficient in providing incentive to abate in a efficient way and technological innovation.

  16. In-class activity- Setting Standards The table shows the marginal abatement cost relationship for two different sources, each emitting the same waste material. Currently the emissions are uncontrolled at 20 tons/month at each firm. Assume now that authorities wish to reduce total emissions to 20 tons/month by setting emission standards. How should the standards be set and what is the associated cost?

  17. Market Based Strategies: Emission Charges • Emission charges: polluting firm pays for each unit of pollutant discharge

  18. Market Based Strategies: Emission Charges 300 Marginal Abatement cost 200 $ 100 a b 10 2 4 8 6 Emissions (tons/month)

  19. Market Based Strategies: Emission Charges • Questions: Under the effluence charge of $33/ton on each source, how much emission reduction will each source engage and what is the abatement costs? • A: • B: Reduce by 15 ton/month Cost of $204.4 Reduce by 5 ton/month Cost of $67.9

  20. Market-Based Strategies: Cap-and-Trade • Basic features of cap-and-trade: • Government decides on the quantity of emissions to be allowed under the program for a stated time period => CAP • Government creates allowances (or “permits”), denominated in quantities of the pollutant in question. The total number of allowances issued is equal to the cap. (Grandfathering vs. Auction) • A regulated entity must hold and surrender to the government at the end of each compliance period allowances equivalent to that entity’s actual emissions during the period.

  21. Market-Based Strategies: Cap-and-Trade (Gains from trade) A B $ MAC 4000 MAC $ 1500 1500 1200 40 60 120 65 90 45 Emissions (tons/year) Emissions (tons/year)

  22. The Least Cost Theorem • Baumol and Oates 1971 and Montgomery 1972 • Under condition of perfect competition, absence of transaction costs, a market for tradable emissions permits can implement any aggregate emission reduction target at the least total abatement cost. This cost efficiency property is, moreover, independent of the initial allocation of the permits among the participants in the market.

  23. The Comparison between Emission Tax and Tradable Permits Iterative process with changing tax rates is needed to reach the standard Standard is automatically satisfied In growing economy, the tax rate has to be increased over time to maintain the standard An increase in demand for permits is automatically reflected in the price While from the point of view of society, the tax revenue is just a transfer, from the point of view of firms, it is a substantial financial burden. If permits are distributed for free (grandfathering), then there is no additional financial cost. However, the financial burden reappear if the permits are being auctioned away. The revenue may be used to reduce other taxes and thereby reduce the overall cost of the tax system (a double dividend) Grandfathering generates no revenue and so, no double dividend. Auctioning does.

  24. The Comparison between Emission Tax and Tradable Permits No search costs but there may be substantial adjustment costs associated with the fact that the tax rate has to be changes regularly. Since trading has to take place unless the permits are being auctioned away, there may be substantial search costs involved. Difficult to deal with environmental problems that have a spatial dimension. i.e. where the location of the source and the final place of deposition are important. Tradable permit system can easier be adopted to environmental problems that have a spatial dimension.

  25. Nonpoint Source Pollution • Point-source pollution problem: • Nonpoint source emission problem: Regulator can observe emission from individual sources It’s either impossible or prohibitively expensive for the regulator to observe emission from each source and trace it to the receptor.

  26. Nonpoint Source Pollution-What to do? • Ambient taxes • Green taxes • The principle of targeting (Bhagwati, 1970s) • Tax collected based on the total ambient pollution • Tax levied on inputs and outputs for environmental • reasons. Works well if there is high correlation between • input/output and pollution. • Optimal (first-best policy) policy should address the • source of the distorting factor.

  27. Criteria for Evaluating Environmental Policies • Efficiency • Static Cost-effectiveness • Dynamic Cost-effectiveness • Fairness • Political Acceptability • Incentives for technological innovations • Enforceability • Agreement with moral precepts

  28. Ambient Air Standard Example • National Ambient Air Quality Standards (NAAQS) required by Clean Air Act 1990 Amendment • EPA sets standards for 6 principle pollutants • Carbon Monoxide • Lead • Nitrogen Dioxide • Ozone • Particle Pollution () • Sulfur Dioxide Measured in ppm (parts per million), ppb or

  29. Air Quality Example

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