The Problem of Shared Social Cost

Transcription

1 The Problem of Shared Social Cost Alan C. Marco, Adon S. Van Woerden, Robert M. Woodward Review of Law & Economics, 2009 Heather Sagar & Jason Rhinelander

2 Introduction Background Regulation of Pollution Total Liability for Excessive Harm Shared Social Cost Discussion of the Model Information Participation Heterogeneous firms Innovation Remediation

3 The Pollution Problem Traditional approaches: Pigouvian taxes on emissions Command & control (emissions standards) Tradable emission permits (Coase) Information problem Optimality depends on regulator information, not private incentives Cleanup cost-sharing Firms only partially internalize harm Marginal incentives are too small

4 Total Liability for Excessive Harm (TLEH) Cooter and Porat (2007): Total Liability For Excessive Harm H: observed pollution H*: legal standard Each firm is liable for: max (0, H - H*)

5 TLEH: Example Harm caused with no abatement: h(0) = 120 Harm caused with abatement: h(1) = 100 Cost of abating: c = 10 Regulator sets H* = 100 Damages payable (no abatement): d = 20 Expansion to multiple firms.

6 TLEH: Discussion Efficiency in the model: If the cost of measuring total and optimal harm is low, TLEH will lead to efficient abatement levels. If firms are only responsible for a portion of their marginal harm then in equilibrium there would be excessive entry. Determining optimal harm: lower H* until firms decide to pay damages rather than reduce liability. Must monitor technology changes.

7 Shared Social Cost Regulators observe: total harm individual firm abatement expenditures Abatement level: Pollution harm: Abatement cost: Social planner problem: Social optimum:

8 Shared Social Cost Each firm pays, in total: Average harm Average abatement cost of all firms E.g. N firms Total harm and abatement costs: Each firm assessed:

9 Shared Social Cost Thus each firm has total pollution-related costs of: Firm i s problem is then: (where H -i and C -i are total harm and abatement costs of other firms) Firm s first-order condition same as social planner s:

10 Shared Social Cost: An Example Without abatement With abatement Social harm: Abatement cost: 0 30 Total social cost: Firms: Firm A abates Firm A does not B & C abate Only one abates Neither firm abates

11 Discussion: Information Regulator information requirements: TLEH SSC Aggregate harm Abatement technologies and costs Optimal harm level, H* Aggregate harm Abatement expenditures by firms When abatement costs inexpensive to verify, SSC achieves first-best in decentralized way

12 Discussion: Participation SSC induces optimal participation in cases where TLEH may not. Example: Firm c(a) h(a) Private costs (TLEH) (H* = 120) A B C Private costs (SSC) If profits of C under TLEH are less than 40, C should exit, but does not. Under SSC, C exits.

13 Discussion: Participation TLEH requires H*, optimal total harm, to be determined, but H* depends both on optimal harm and on the optimal number of firms When optimal number of firms is unknown, SSC is more likely to lead to optimal participation.

14 Discussion: Heterogeneous Firms A Without abatement With abatement h A c A 0 20 h B c B 0 10 B a B =0 a B =1 a A =0 75,75 65,65 a A =1 55,55 45,45 Therefore firms will choose to abate since that is the option with the lowest cost.

15 Discussion: Heterogeneous Firms Strategic advantages for large firms under SSC Predatory pollution : less likely in SSC than in TLEH because in order to raise the costs for the vulnerable firms by x they will have to raise pollution by Nx. Therefore after exit the dominant firm will have to pay: N N 1 (because Nx is distributed across N 1 firms) Predatory abatement : actual abatement expenditures are artificially increased. x

16 Discussion: Heterogeneous Firms Predatory Abatement: an example Without abatement With abatement h A c A 0 20 h B c B 0 10 B a B =0 a B =1 Exit a A = 0 π A -75, π B -75 π A -65, π B -65 π A -100, 0 A a A = 1 π A -55, π B -55 π A -45, π B -45 π A -60, 0 x 2 x 2 a A = 1+x π A -55-, π B -55- π A -45 -, π B π A -75 -x,0 x 2 x 2

17 Discussion: Heterogeneous Firms Two conditions delineate the bounds on x: it must be large enough to induce exit, and small enough that the gain in profit makes it worthwhile. In the situation of significant heterogeneity, regulators can mitigate the problem of predatory abatement by scaling liability to market share. So instead of: firms would pay: 1 N ( C H ) i ( C H )

18 Discussion: Innovation Traditional approaches offer incentive to innovate, but not to disseminate abatement innovations Under TLEH, insufficient incentive to adopt innovation No incentive for innovation that reduces harm without reducing cost Incentives for cost-reducing innovations Regulator may needs to lower H* over time in order to achieve proper incentives Under SSC, firms pursue both types of innovation as both reduce the firm s costs

19 Discussion: Innovation An example: 2 firms, A and B. New technology, a 2, is invented that replaces the old technology, a 1 c(a 1 ) = 30 h(a 1 ) = 40 c(a 2 ) = 50 h(a 2 ) = 15 Technology TLEH Cost, H* = 80 TLEH Cost, H* = 30 A: a 1, B: a [(40+40) 30] = 80 SSC Cost A: a 2, B: a [(40+15) 30] = 75 SSC provides incentive to adopt new innovation TLEH provides incentive only if H* updated

20 Discussion: Innovation Under SSC, firms have incentive to adopt abatement innovations, while under TLEH the incentive only exists with the correct regulatory updates SSC also provides an incentive for dissemination of innovations Since a firm s liabilities are based on total industry harm and costs, firm has incentive for other firms to adopt as well

21 Discussion: Remediation Remediation refers to the clean-up of pollution as opposed to the prevention of pollution by abatement. Any firm can clean up the industry s pollution. Efficient for firm with the lowest cost to clean up more pollution Firms with lower marginal costs of remediation will have an incentive to spend more Example: 2 firms: Each create harm of 50. Out of 100, it is possible to clean up 50 units. One firm can clean up at a cost of 0.6 per unit, the other at 0.4. It is efficient for the firm with the lower cost to do all of the clean up.

22 Conclusion SSC is an alternative to Cooter and Porat s TLEH that still achieves optimal abatement incentives, while requiring less regulator information and intervention. SSC offers advantages as a mechanism for pollution control: Firms internalize social costs of actions Requires less regulator knowledge Better incentives for entry and exit, and innovation Avoids transaction costs for remediation Thus, when verification of abatement expenditures is inexpensive, SSC provides an efficient policy option.