Policy Instruments at the Extreme: Decentralized Policies and Command & Control

1. Policy Instruments at the Extreme: Decentralized Policies and Command & Control Session 6: Field and Field Chapters 10 & 11

2. Course Reminders Midterm Exam on Wednesday, June 20. • Topics from Sessions 1-6. • Calculator that does exponents but with no advanced features for solving equations or financial formulas. • Expect to draw properly labeled graphs as part of your answers. • Expect to be required to complete a cost-benefit maths problem. Also on Wednesday, June 20. Visit to Metsä-Sairila Waste Center. Please spend 15 minutes looking at their website to learn about the company. Departure at 12:30.

3. Learning Objectives After this session, you should be able to • Discuss the effectiveness of the different types of decentralised policy options available to governments to combat environmental damage • Specify the appropriateness of liability law in reducing and preventing environmental damage • Assess the usefulness of ‘moral suasion’ in limiting and reducing environmental damage • Discuss the usefulness of decentralised policies over other types of strategies in cases of environmental damage to biodiversity, air & water quality and climate change • Appreciate the complexity of applying standards as a tool in improving environmental quality • Understand the differences among the three major types of standards • Evaluate the issues underlying the application of standards in relation to the levels at which they should be set, whether they should be uniform or not and their incentive effects • Discuss the issues in relation to enforcement of standards

4. Criteria for evaluating environmental policies • Efficiency: MDC=MAC • Cost effectiveness: Given the emissions reduction target, is this the least cost method, or, given a budget for emission reduction, is this maximum reduction possible? • Fairness: Geographic, demographic, income, etc. • Incentives for technological innovation: A more effective policy will also result in reduced costs in the future. • Enforceability: can regulators enforce policy in a practical and cost effective manner? • Agreement with moral precepts: Is our approach consistent with social justice? These are key points from Chapter 9 that we skipped.

5. major public policy instruments available? Three major policy types • Decentralised Policies (Session 6, Chapter 10) • Command and Control Strategies (Session 6, Chapter 11) • Incentive Based strategies (Session 7, Chapters 12 & 13.) The effectiveness of each depends on a unique set of characteristics What are main categories of environment policies operating in the EU? http://www.youtube.com/watch?v=uTEMFKKuKxE&feature=PlayList&p=8A7578AB6100828C&playnext=1&playnext_from=PL&index=1

6. Ch 10: Decentralized policies Allow private resolution of environmental dispute. Two approaches • Liability & compensation • Moral suasion & voluntary action Why decentralization makes sense. • Parties involved probably have a better understanding of damages. • Parties involved are causing and suffering externality, and have incentive to work it out.

7. Coase Theorem helps understand when decentralized policy works Coase Theorem: The private sector is likely to be able to resolve externalities iff: • Competitive market • Symmetrical information • Well-defined property rights

8. Liability & Compensation € MD Fig 1: Effect of Liability Laws Liability laws work by making polluters liable for the damages they cause Suppose actual emission rate is e1 and a liability law is introduced requiring polluters to compensate those damaged At e1, total damages = b+c+d=total compensation If polluter reduces emissions to e* damages reduced to b Effect of the law is to internalise the environmental damage that were external before the law r a d b c MAC 0 e* e1 Emissions (tons/year)

9. How is Liability Assessed? There are two primary ways • Common Law approach • Statutory Law Key Question. How effective are these in identifying the efficient level of pollution, e*?

10. Common Law • This is the law as interpreted by court decisions • Difference between ‘strict liability’ and ‘negligence’ • Strict Liability- polluters responsible for damages regardless of circumstances • Negligence holds the polluter responsible only if they did not take appropriate steps to avoid the damage

11. Effectiveness of Common Law Difficulties with common law • Standards of proof • Causal chain of events • High transaction costs • Balance of power between plaintiff and defendant • Time frame This approach is generally effective only when there are relatively few people involved, casual linkages are clear and damages are easy to measure (Coase Theorem)

12. 1.2 Statutory Law Legislature enacts a law requiring the payment of compensation when a polluter causes damage Difficulty: legislators must be able to predict and legislate for any circumstance. • Example: Deepwater Horizon Oil Spill • Deepwater television news summary story 4 min • Deepwater Horizon BBC documentary 45 min • Encyclopedia of Earth Deepwater Horizon page • Guardian article on Deepwater safety device failure

13. Deepwater Horizon 2010 Oil Spill • April 22 2010 a massive explosion on the oil rig operated by BP killed 11 people and resulted in 172mn gallons of oil into the Gulf of Mexico • A formal investigation found that the cause of the explosion was due to bad management and negligence • Very significant economic and environmental consequences • Economic impacts included fishing and tourism, damage to shipping channels, oil pipelines and port facilities and industrial facilities • US Oil spills are governed by the Oil Pollution Act 1990 which sets an upper limit of $75mn in liability for the responsible party

14. Effectiveness of Statutory Laws In the case of the Deepwater Oil Spill statutory law failed • Very small upper limit for damages • OPA outdated and damages not indexed to inflation • Limiting Liability offers an implicit subsidy to the oil sector- once damages go over a certain level it is tax payers and the public that ultimately end up paying the vast difference (actual cost $60bn) • Limiting Liability offers little incentive to improve safety technology

15. 2. Voluntary Action Individual and firms engage in pollution control behaviour in the absence of any formal, legal requirement to do so • Proponents participate for long-term improvement. • Firms often participate to forestall legislation and regulation. Moral suasion: it is the right things to do! • Youtube Environmental PSA search 10,100 hits • Beach Artists against plastic Informal community pressure: social consequences if you don’t! • Youtube Europe Environmental Protest search 15,100 hits • Youtube Dakota Access Pipeline Protest search 79,400 hits

17. Moral Suasion/ Informal Community Pressure Compliance tends to rely on moral suasion Relies on moral argument and restraint Problem of free riders Examples: voluntary recycling; litterbug campaigns etc… Communities may put informal pressure on polluters to reduce their emissions • Loss of reputation • Loss of markets • Declines in stock values For more on this, check out

18. CH 11: Command & Control Policy Mandated level of performance that is enforced by law • Types of Standards • Ambient Standards (level of pollutant) • Emission Standards (output of pollutant) • Technology Standards (equipment requirement)

19. Theoretical Impact of Standards • Fig 1 • Assume pre-regulatory emissions = e1 • Assume one firm • Regulator sets e* as maximum standard • Compliance cost for firm = area a • Information problem: • Can regulator know MD function? • Is MAC function known? • Is e* efficient? € MD MAC a e* e1 Emissions

20. The EU National Emissions Directive 2008 • Sets a maximum limit on sulphur dioxide concentrations • Ambient standards are normally expressed in terms of average concentration levels • Limits on sulphur dioxide are set at 125µg/m3 (micrograms per cubic meter) on a 24 hour basis and not to be exceeded more than 3 times a yr and a 350 µg/m3 on an hourly basis and not to be exceeded more than 24 times a year.

21. The Economics of Standards • What is the efficient level for the standard? • Does scientific level equal economically efficient level? • Should the standard be applied uniformly? • What are the incentive effects of standards?

22. What is the appropriate level to set the standard? Should you take into account marginal damages and marginal abatement costs? • Zero-Risk level • ‘Reasonable level’ • Efficient Emission level • Strict Standards ----’Technology Forcing’

23. At what level do you set standards? • Fig 2 • e2= threshold level • e* = efficient level • e3= reasonable level € MD MAC a e2 e* e3 e1 Emissions

24. Should Standards be applied uniformly? • The efficient level of pollution can vary for many reasons • Geographic areas • Meteorological conditions • Seasonality • Population density • Setting a single standard may not be efficient • See fig 3

25. Should Standards be applied uniformly? • Fig 3 • eu= efficient level of emissions for urban area • er = efficient level of emissions for rural area • Setting one standard not efficient MDu € MDr MAC a e2 eu er e1 Emissions

26. Equiproportionate vs. equimarginal reductions

27. Standards often fail to arrive at Equi-Marginal Principle • Authorities set standards according to equi-proportionate method rather than the equi- marginal principle • Equal standards approach will produce less reduction in total emissions than would be achieved under equi-marginal principle • Govs do not have knowledge of MAC curves of polluters

28. incentive effects of standards? Do standards incentivize firms to cost-effectively reduce emissions through choice of method and innovation? • Short-Run • Standards are an all or nothing approach • No incentives for firms to do better • Take away decision flexibility from producers (ie technology standards) • Long-Run • With respect to technology standards: NO (Why not?) • With respect to emission standards: Yes (Why?) • See fig 4

29. Emission Standards: Short Run and Long Run Incentives € MAC1 MD • Fig 4 • Firm in 2 situations • MAC1 – represents abatement costs in SR • MAC 2- represents abatement costs in LR • If emission standard is set at e2, compliance =a +b for MAC1 • If emission standard set at e2, compliance = b for MAC2 • a = r& d incentive MAC2 a b e1 e2 Emissions

30. Enforcement • Enforcement of standards takes resources • Penalties are not often sufficient • Trade-off between resources used in enforcement and benefits of greater compliance • Should standards be set with enforcement costs in mind? • Size of sanction for non-compliance • See fig 5

31. The Economics of Enforcement MD € • Fig 5 • C1 & C2 are curves that combine MAC and marginal enforcement costs • Correspond to different technologies of enforcement • Origin at e0 (why?) • At C1: Total costs equal to enforcement costs (a +b) and abatement costs (c +d) • What are the total costs at C2? C1 C2 MAC a e b f c d eo e2 e1 Emissions

32. Summary • Decentralised public policy approaches to environmental issues: liability law; property rights and voluntary action • The threat of liability action can lead polluters to internalise external costs and hence produce efficient levels of emissions • Only works in simple cases and where causal effects are clear • Moral suasion to influence voluntary actions useful to encourage ethical behaviour • Standards are the most popular method of pollution control • There are three primary types of standards (ambient, emissions and technology) • Important questions are 1) what level to set the standards at ?2) Should standards be uniform? and 3) what are the incentive effects of standards? • Enforcement including available sanctions are an important issue • Standards are very complex tools when applied to environmental policy

33. Required Reading • Field & Field ch 10 & 11 • Directed websites and videos