Download Environmental and Resource Economics, lecture 1

ERE10: Instruments of
Environmental Policy
• Criteria, incl. cost-effectiveness
• Instruments
– Institutional
– Command and control
– Market based
• A comparison
Last week
• Optimal targets
– Flow pollution
– Stock pollution
• When location matters
• Steady state
– Stock-flow pollutant
• Steady state
• Dynamics
• Alternative targets
Criteria
•
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•
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•
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Cost-effectiveness
Dependability, environmental effectiveness
Information requirements
Enforceability
Long-run effects
Dynamic efficiency
Flexibility
Equity
Uncertainty
Cost-effectiveness
The firm‘s abatement cost
The least cost formulation
Cn  n  n Mn   n Mn2
N
min  Cn  Mn  s.t.
n 1
The Lagrangian
N
M
n 1
N
M
N


L   Cn    M   Mn 
n 1
n 1


The necessary condition
L
  n  2 n Mn    0
Mn
n
 CM  
Marginal costs are equal for all producers
The firm’s abatement
cost function
Ci
i •
Ci  αi  βi M*i  δi M*i2
M*i
0
•
M*i
M*i
 M̂i
Emissions
Marginal abatement cost functions for two firms
MC
200
MCB = 5ZB

CB = 100+2.5Z2B
MCA = 3ZA
100

75

CA = 100+1.5Z2A










5
10
15
20
25
30
35
40
Z
Pollution abatement
Pollution abatement:
Zi  Mˆ i  M i*
Current emissions:
Mˆ A  40 and Mˆ B  50
Abatement target:
40  Z A  ZB
Cost-effectiveness (2)
• Least-cost implies that the marginal cost
of abatement is equalised over all polluters
• This will in general not involve equal
abatement effort by all polluters
• Where abatement costs differ, relatively
low-cost abaters will undertake most of
the total abatement effort
Instruments: Overview
• Institutional
– Bargaining
– Legal redress
– Information, awareness, responsibility
– Property rights
– Voluntary agreements
• Command and control
– Inputs, technology
– Output (product, pollutant)
– Location (source, individual)
– Timing
– Prohibition
• Market-based
– Taxes (inputs, outputs)
– Subsidies
– Tradeable permits
Institutional Instruments
• Coase (1960) Theorem: The social optimum
can be established through bargaining
between polluter and victim
• Alternatively, the court may step in
• Or, the government may appeal to the
polluter‘s conscience
• Or, the government may establish property
rights
Command and Control
• Command and control = direct regulation
• It is the most common form of environmental
regulation, reflecting a natural science frame of
mind, and highly successful in past management of
point sources of toxics
• Essentially, command and control prescribes
aspects of the production process, be it inputs,
production or outputs
• Requires substantial knowledge on the part of the
regulator (e.g. abatement cost function of each
firm)
• Requires homogenous producers
Types of Direct Regulation
• Inputs, e.g., fuel efficiency
• Technology, e.g., catalytic converters
– Best practicable means
– Best available technology (not exceeding
excessive costs)
• Outputs
– Products, e.g., carcinogenic toys
– Waste, e.g., sulphur emissions
• Timing, e.g., air traffic
• Location, e.g., nature reserves
• Prohibition, e.g., CFCs
Taxes and Subsidies
• Taxes: Pay a charge or levy or penalty for
every unit consumed, produced or emitted
– It is levied on emissions, not output
– Encourages substitution effects
• Subsidies: Receive a premium for every
unit not consumed, produced or emitted
• Uniform taxes and subsidies have a
uniform effect on marginal production
costs, thus ensuring efficiency
• Taxes and subsidies have an equivalent
effect on emissions in the short run, but
have different budgetary distributional,
and long-term effects
An economically efficient emissions tax
Marginal benefit (before tax)
Marginal damage
*
Marginal benefit
(after tax)
0
M
M*
M̂
Marginal cost of
abatement
*
Marginal benefit of
abatement
0
Z* =
M̂  M*
Z
The economically efficient level of emissions abatement
Z
Tradeable Permits
• The government sets an overall target on
consumption, production or, most common,
emission
• Each producer obtains a certain amount of
emission permits, can sell these, or buy more at
the market place
• Creates property rights
• If the permit market is perfect, all producers pay
the same price, and marginal costs of production
increase uniformly
• Taxes and tradeable permits are equivalent
provided that the regulator knows the marginal
abatement costs
Permits: Initial Allocation
• Auctioning
– Sell permits to highest bidder
– Generates revenue, perhaps a lot
• Grandfathering
– Give permits to current polluters
– Politically easy, as confirms status quo
• To victim
– Perhaps fair, definitely complicated
– May generate large transfers
• Per capita
– Perhaps fair, relatively easy
– May generate large transfers
Marketable permits and efficient abatement
MC
200

MCB
125

MCA
75

40









5
10
15
20
25
30
35
40
uncontrolled emissions
abatement
initial allocation
initial abatement
final allocation
efficient abatement
A
40
?
25
15
15
25
B
50
?
25
25
35
15
A+B
90
40
50
40
50
40
Z
Pollution abatement
Voluntary Agreements
• Environmental regulation requires a lot of
knowledge, perhaps more so than at the
disposal of the regulator
• Increasingly, governments and industry
negotiate over emission targets, the results of
which are laid down in a voluntary agreement
• This is a euphemism, as the government
typically threatens to intervene if no voluntary
agreement is used
• Voluntary agreements make optimal use of the
information within industry but have a problem
with public acceptability
Cost-Effectiveness
• Market-based instruments are costeffective
• Command and control is unlike to be costeffective, unless the regulator knows a lot
and the industry is homogenous
• Institutional instruments may be costeffective (voluntary agreements), and even
efficient (bargaining, property rights)
• Tradeable permits may also be efficient, if
people buy (hold) but not use (sell) permits
Cost-effectiveness (2)
Cn  n  n Mn   n Mn2
Cost function:
N
min  Cn  Mn  s.t.
Least cost formulation:
Necessary condition:
n 1
N
M
n 1
n
M
L
  n  2 n Mn    0  C M  
Mn
Taxes, subsidies and permits:
CTn  n  n Mn   n Mn2  tMn
min Cn  Mn 
CT
  n  2 n Mn  t  0  CTM  t
Mn
CSn  s (Mˆn  Mn )  (n  n Mn   n Mn2 )
CLn  n  n Mn   n Mn2  p (Ln  Ln0 )
Environmental Effectiveness
• The environmental effect of taxes and
subsidies is uncertain (but its marginal costs
are certain)
• The environmental effect of tradeable
permits is certain (but its costs are uncertain)
• The environmental effects of emission
standards are certain (bar illegal dumping), of
input and production standards less certain
• The environmental effects of institutional
instruments are uncertain, and unpredictable
as enforcement is not in the hands of the
government
Environmental Effectiveness (2)
taxes
A*
permits
A*
*=(t*)
*=)t*
M*
A2
A*
L*(=M*)
Mˆ
A1
A*
1
Mˆ
A1
A2
*
t*
2
M2 M* M1
Mˆ
L*=(M*)
Mˆ
Dynamic Effects
• Taxes and tradeable permits provide a
continuous incentive to emit less
• Subsidies have the same effect, but may
attract new entrants
• Direct regulation is static; once the standard
is met, there is no need to further reduce
emissions
• Unless, standards get stricter over time
• Institutional instruments are mixed
Flexibility
• Flexibility is important, as new
information may arise
• It is easy to lower taxes, make
standards less strict; it is hard to do
the opposite
• The exception is tradeable permits,
where the government can release new
permits but also buy existing ones
Equity
• Different instruments have different
distributional consequences
• In general, environmental policy makes things
more expensive; with cost-effective
instruments, this effect and hence the
distributional effects are less pronounced
• If necessary (luxury) goods are regulated, the
environmental policy is regressive
(progressive)
• Tradeable permits have as advantage that
cost-effectiveness is secured by the market,
and equity perhaps by the initial allocation
Uncertainty
• Welfare losses can occur as a result of
the (unknowingly) selection of incorrect
targets
• Overregulation is more (less) costly with
taxes than with standards if the
marginal damage cost curve is steeper
(flatter) than the marginal abatement
cost curve
Uncertainty about abatement cost – cost
overestimated
MD
Loss when
licenses used
tH
t*
MC
(assumed)
Loss when
taxes used
MC (true)
Mt
M* LH
Emissions, M
Uncertainty about abatement cost –
cost overestimated (2)
MD
tH
t*
MC
(assumed)
MC (true)
Mt
M*
LH
Emissions, M
Uncertainty about abatement cost – cost
underestimated
MD
t*
tL
MC (true)
MC
(assumed)
LL M*
Mt
Emissions, M
Uncertainty about abatement cost –
cost underestimated (2)
MD
t*
tL
MC (true)
MC
(assumed)
LL
M*
Mt
Emissions, M