The theory of environmental policy SECOND EDITION

Transcription

1 The theory of environmental policy SECOND EDITION WILLIAM J. BAUMOLand WALLACE E. OATES

2 The theory of environmental policy Second edition William J. Baumol Princeton and N ew York Universities Wallace E. Oates University o f M aryland with contributions by V. S. Bawa and David F. Bradford C a m b r i d g e U N IV E R S IT Y P R E S S

3 Published by the Press Syndicate of the University of Cambridge The Pitt Building. Trumpington Street. Cambridge CB2 1RP 40 West 20th Street. New York. NY USA 10 Stamford Road. Oakleigh, Victoria 3166, Australia First edition Prentice-Hall, Inc Second edition Cambridge University Press 1988 First edition published by Prentice-Hall. Inc Second edition first published by Cambridge University Press 1988 Reprinted Printed in the United States of America Library o f Congress Cataloging-in-Publication Data Baumol, William J. The theory of environmental policy. Includes index. 1. Environmental policy. 2. Externalities (Economics) 3. Expenditures. Public. 4. Quality of life. I. Oates. Wallace E. II. Title. HC79.E5B British Library Cataloguing in Publication Data Baumol. William J. The theory of environmental policy. - 2nd ed. 1. Environmental policy I. Title II. Oates. Wallace E HC79.E5 ISBN hardback ISBN paperback

4 Contents Preface to the second edition Preface to the first edition page vii ix 1. Introduction: economics and environm ental policy 1 PART I. On the theory of externalities 2. Relevance and the theory o f externalities 7 3. Externalities: definition, significant types, and optim al-pricing conditions Externalities: form al analysis U ncertainty and the choice of policy instrum ents: price or quantity controls? M arket im perfections and the num ber o f participants Are com petitive outputs with detrim ental externalities necessarily excessive? D etrim ental externalities and nonconvexities in the production set On optim al pricing o f exhaustible resources 138 PART II. On the design of environmental policy 10. Introduction to Part II Efficiency without optimality: the charges and standards approach M arketable emission perm its for protection o f the environm ent Stochastic influences, direct controls, and taxes 190

5 vi Contents 14. Taxes versus subsidies: a partial analysis Environm ental protection and the distribution o f incom e International environm ental issues National or local standards for environm ental quality? 284 Index 297

6 Preface to the second edition Since the publication o f the first edition of this book in 1975, there have been several im portant contributions both to the theory o f externalities and to the design o f policy instrum ents making use of economic incentives for environm ental m anagem ent. Perhaps most im portant has been the emergence o f instrum ents that control quantity directly rather than through price adjustm ents; these measures represent an alternative to the standard Pigouvian prescription for a unit tax on activities with detrim ental external effects. Since publication o f the seminal paper by M artin W eitzm an, econom ists have explored the properties o f a system under which the regulatory authority issues a limited num ber o f transferable permits. This work has shown that in a setting o f uncertainty, the expected gain in welfare may be higher or lower under such a permit system than under a tax regime, depending on the shapes of the control cost and dam age functions. The choice o f one system over the other thus depends on the way damages and control costs change with the level of pollution. At the sam e tim e, there has been growing interest at the policy level in the use of transferable permit systems for the attainm ent of our environm ental standards. In the United States, the Environm ental Protection Agency has introduced the Emissions T rading Program for the regulation o f air quality; this program allows polluters (subject to certain restrictions) to trade emissions entitlem ents. Environm ental econom ists have studied emissions trading and have, more generally, investigated the properties o f a num ber o f variants o f transferable permit systems. From these efforts is emerging the exciting prospect o f an effective system o f m arket incentives for protection of the environm ent. Economists have long argued that economic incentives have an im portant role to play in environm ental policy; there are now cases where such incentives are being embodied in actual environm ental legislation. In the revision o f this book, we have devoted considerable attention to the use o f quantity instrum ents for environm ental m anagem ent. Two o f the three wholly new chapters address this topic. The first half o f the book, which deals with the theory of externalities, has been augm ented

7 Preface tu Ihe second edition by a chapter based on the work o f W eitzman and others describing the relative welfare gains prom ised by quantity and price instrum ents where the environmental authority is uncertain about the true damage and abatement cost functions. In the second half o f the book, where we address more directly the design and im plem entation of policy measures, we present a new chapter on systems o f transferable discharge perm its and their potential for attaining a predeterm ined level o f environm ental quality at the least cost. We investigate a num ber o f alternative permit systems and contend that one, the pollution offset system, is the most prom ising of such systems for the achievement of our environm ental targets. The second edition has also allowed us to explore some further topics in environm ental policy, to update various results, and to correct mistakes from the first edition. The third new chapter in the book considers the setting o f standards for environm ental quality and asks whether such standards should be set by national or local authorities. There is a real conflict between the desire to tailor environm ental measures to particular local conditions and the fear that economic com petition for jobs and incomes will lead local governm ents to compete in environm ental degradation as a means to attract new industry. We explore this conflict in the context o f a model o f interjurisdictional com petition; although the issue is adm ittedly a com plicated one, we believe that the analysis provides a persuasive case for the introduction of some local variation in environm ental measures. We should also note that in response to a series o f articles by A. Myrick Freem an and others, we have rew orked C hapters 3 and 4 to correct our treatm ent o f depletable and undepletable externalities. As Freem an show ed, our claims concerning the different policy im plications o f these two types of externalities were incorrect. We think that (thanks to this assistance) we have it straight now. We have also corrected and extended our treatm ent o f the taxation o f m onopolists and o f the use o f subsidies for pollution abatem ent. Finally, we have introduced some new m aterial on the redistributive properties of environm ental m easures and on environm ental policy in an international economy. In order to keep the book to a reasonable size, we have deleted the three concluding chapters from the first edition, which exam ined the provision o f public services and the tax system. W hile the public sector obviously m akes a crucial contribution to the quality o f life, these chapters turned out to be som ewhat peripheral to the interests of most readers. We are grateful to several econom ists for their assistance in this revision. In particular, we w ish to thank P eter C oughlin, Robert Schw ab, and Eyton Sheshinski for their invaluable help with the new m aterial.

8 Preface to the first edition This book is one o f a pair o f com panion volumes devoted to the study of economic policies to enhance the quality of life.* Our willingness to embark on so considerable a subject only reflects our conviction that economists as a body have already m ade sufficient headway on these problems to m ake such an undertaking w orthwhile. We believe, in short, that this is a subject on which econom ists have a great deal to say that is useful; these books are intended both to bring that m aterial together and to carry the investigation some stages further. This volume is prim arily theoretical and is consequently addressed to our fellow econom ists. However, it is not m eant to be theory for theory s sake. Here our prim e concern is policy; we are interested in the theory as a means of understanding the complexities o f environm ental program s. The orientation o f the other book is prim arily em pirical; there we will present and evaluate pertinent data and experience for guidance in the choice o f policies for environm ental protection and for the im provement o f other aspects o f the quality o f life. Though it will be less technical than the theoretical volum e and will consequently address itself to a broader audience, we intend it to provide the empirical counterpart to the theoretical structure developed in this book. O ur most direct debt is that to the N ational Science F oundation, whose support has m ade our work on the two volumes possible. In particular, the collection and analysis o f the em pirical m aterials in the com panion volume has, predictably, proved to be a long and difficult undertaking which would have been impossible without the Foundation s generosity. Happily, intellectual debt does not carry with it the threat of bankruptcy, for in w riting this volum e the debts we have accum ulated have been num erous and heavy. O ur deepest obligations for help above and beyond what m ight reasonably be asked o f anyone, are those to our colleagues, David Bradford and Elizabeth Bailey. Their painstaking reading of the *The companion volume is \V. Baumol and W. Oates, Economics, Environmental Policy, and the Quality o f Life (Englewood Cliffs, N.J.: Prentice-Hall, 1979). ix

9 x Preface to the first edition entire m anuscript and their extensive and valuable suggestions and comm ents have resulted in enorm ous im provem ents both in substance and in exposition (and, incidentally, have added considerably to the labor of revision). Professor Bradford also contributed more directly by his co-authorship o f an article which served as the basis for C hapter 8 and by his authorship of Appendix B to Chapter 8. A second such contribution was provided by Dr. V. S. Bawa of Bell Laboratories, who in his very illuminating appendix to C hapter 11 solved some basic problem s underlying our discussion in that chapter. We also owe special thanks to Lionel Robbins for urging us to undertake this project (though there have been m om ents when we doubted whether this was cause for gratitude) and to Robert D orfm an and a num ber of advanced students at the Stockholm School of Economics for detecting some critical errors in our argum ents. For their very useful com m ents on particular parts o f the analysis, we are also m ost grateful to Polly Allen, H ourm ouzis Georgiades, Peter Kenen, H arold Kuhn, Edwin Mills, H erbert M ohring, Richard Musgrave, Fred Peterson, Robert Plotnick, Michael Rothschild, Ralph Turvey, and Edw ard Zajac. The opportunity to work through these m aterials in two separate lectures delivered by one o f us at the Stockholm School served as a stim ulus for our ideas and the com pletion o f this book, and for this too we are most grateful. Finally, for patience, good hum or, skill at deciphering our hieroglyphics, and for ability to produce order out o f chaos, we want to thank Sue Anne Batey, who has acted as research assistant, secretary, and a repository o f sanity, and who, we trust, will not be excessively em barrassed as she types these words.

10 C H A P T E R 1 Introduction: econom ics and environm ental policy W hen the environm ental revolution arrived in the 1960s, econom ists were ready and waiting. The econom ic literature contained an apparently coherent view of the nature of the pollution problem together with a compelling set o f im plications for public policy. In short, econom ists saw the problem o f environm ental degradation as one in which econom ic agents im posed external costs upon society at large in the form o f pollution. With no prices to provide the proper incentives for reduction of polluting activities, the inevitable result was excessive dem ands on the assimilative capacity o f the environm ent. The obvious solution to the problem was to place an appropriate price, in this case a tax, on polluting activities so as to internalize the social costs. M arshall and Pigou had suggested such m easures m any decades earlier. M oreover, pollution and its control through so-called Pigouvian taxes had become a standard textbook case o f the application o f the principles o f m icroeconom ic theory. Econom ists were thus ready to provide counsel to policy m akers on the design of environm ental policy. However, things have proved not quite so simple as this. First, at the policy level, environm ental economists have been dismayed at their m odest impact on the design of environmental measures. Rather than introducing the econom ist s taxes or effluent fees on polluting activities, policy m akers have generally opted for the m ore traditional com m and-andcontro l instrum ents involving explicit lim itations on allowable levels of emissions and the use of specified abatem ent techniques. Pricing m easures for the regulation o f pollution have been rare. Second, the profusion o f literature on the theory o f externalities and its applications to environm ental m anagem ent suggests that there were m ore than just a few loose ends to the available analysis. This literature over the past three decades runs into hundreds of papers. These papers explore the properties of the Pigouvian solution, its lim itations, and the potential o f a num ber o f alternative policy instrum ents, including subsidies for pollution abatem ent, deposits for dam aging m aterials, and systems o f m arketable emission perm its. There is much more to the economic 1