Regulating a Polluting Oligopoly: Emission Tax or Voluntary Agreement?

This paper compares, in a polluting oligopoly, an emission tax and a form of environmental policy called voluntary agreement (VA). Here there are two ways of reducing pollution: output contraction and end‐of‐pipe abatement. Given the imperfect competition, firms’ reaction to the tax is sub‐optimal. They reduce output excessively in order to raise the price and do not abate enough. The VA is a take‐it‐or‐leave‐it contract on abatement effort, offered to the firms with the threat of a tax. It has a limited effect on output and always allows higher abatement than the tax. We find that this kind of VA may be more efficient than the tax in a concentrated industry, when pollution is not too harmful and when the abatement technology is rather efficient and cheap.     

When do firms support environmental agreements?

Several firms have recently supported their countries’ participation in international environmental agreements where countries commit to stricter environmental regulation. This paper analyzes the rationale of this conduct by examining equilibrium emission standards with and without environmental treaties. We identify that more stringent environmental regulation produces two effects on firm profits: a negative effect due to larger abatement costs, and a positive effect that arises from the amelioration of duopoly overproduction. We describe under which conditions the positive effect dominates the negative effect, increasing firm profits, and inducing them to support their countries’ participation in environmental treaties.     

Market Effects of Voluntary Climate Action by Firms: Evidence from the Chicago Climate Exchange

Are private voluntary environmental actions by firms a sign of mismanagement, or a profitable “win-win” replacement for regulation? Empirical evidence is decidedly mixed. In this study, we use 19 years of monthly stock price returns, from 1991 to 2009, to examine the profitability of participation in CCX, a large voluntary greenhouse gas mitigation program. After controlling for systemic market risk as well as industry-specific shocks, we find statistically significant and positive excess returns for firms that announce their decision to join CCX. In addition, the progress of proposed greenhouse gas legislation (the Waxman–Markey bill) had a positive and large impact on excess returns for CCX member firms, suggesting that a major incentive for firms to join CCX may be to prepare for future regulation. Marginal abatement costs (proxied by the carbon price), on the other hand, were unrelated to excess returns. Our results imply that voluntary approaches should play a role in combating climate change, but that relying on them alone is not enough.     

On Environmental Regulation of Oligopoly Markets: Emission versus Performance Standards

By specializing Montero’s (J Environ Econ Manag 44:23–44, 2002) model of environmental regulation under Cournot competition to an oligopoly with linear demand and quadratic abatement costs, we extend his comparison of firms incentives to invest in R&D under emission and performance standards by solving for a closed form solution of the underlying two-stage game. This allows for a full comparison of the two instruments in terms of their resulting propensity for R&D and equilibrium industry output. In addition, we incorporate an equilibrium welfare analysis. Finally, we investigate a three-stage game wherein a welfare-maximizing regulator sets a socially optimal emission cap under each policy instrument. For the latter game, while closed-form solutions for the subgame-perfect equilibrium are not possible, we establish numerically that the resulting welfare is always larger under a performance standard.     

Comparing Environmental Policy Instruments in the Presence of Imperfect Compliance – A Case Study

In this paper, we aim to include rule making, implementation, monitoring and enforcement costs into the cost comparison of policy instruments. We use a simple partial equilibrium model and apply it to the textile industry. The model includes discrete abatement functions and costly monitoring and enforcement. The case study uses individual firm data to simulate the differences in abatement costs and compliance decisions between firms. We compare combinations of regulatory instruments (emission taxes, emission standards and technology standards) and enforcement instruments (criminal fines, civil fines and transaction offers). We show that the inclusion of information, monitoring and enforcement costs indeed alters the relative cost efficiency of the different instruments.     

Pollution Abatement Subsidies and the Eco-Industry

This paper considers the combination of pollution taxes and abatement subsidies when some polluting firms procure their abatement goods and services from an oligopolistic eco-industry. The regulator must here cope with two simultaneous price distortions: one that comes from pollution and the other which is caused by the eco-industry’s market power. In this context, we show that taxing emissions while subsidizing polluters’ abatement efforts cannot lead to first-best, but the opposite occurs provided it is the eco-industry’s output which is subsidized. When public transfers also create distortions, welfare can be higher if the regulator uses only an emission tax, but subsidizing abatement suppliers while taxing emissions remains optimal when the eco-industry is concentrated.     

Production and Abatement Distortions under Noisy Green Taxes

A pollution regulator seeking to maximize social surplus can be viewed as facing two efficiency problems. One is that, given abatement technology investment decisions, it should attempt to ensure that firms which should produce do produce and firms which should not produce do not produce. This ex-post efficiency problem is not trivial when there is noise concerning the extent of environmental damage a firm does. We use a Bayesian information framework to show that the regulator may find it efficient to tax a firm that reads as a high (low) damage polluter at less (more) than the damage reading. Unfortunately when an abatement decision has to be made, this ex-post efficient tax system also dampens the incentive to abate. In the absence of wrong-firm concerns, a regulator can solve the abatement problem by an ex ante declaration that taxes will not be adjusted for signal noise. However, the regulator has a commitment problem as such taxes may not be ex-post efficient. The most appropriate policy may involve a combination of instruments.     

Emission taxes for genuine altruistic firms

This article develops a theoretical model that explores firms' abatement choices. The main results are: First, in a market comprised of a not sufficiently large number of heterogeneous firms always there exists a subset of firms that are willing to undertake abatement activities, if their marginal altruistic cost of emissions is positive. Second, a low emission tax induces abatement when a firm is egoistic or if its altruistic cost of emissions has a concave structure. In contrast, if the firms’ altruistic cost of emissions has a convex structure, then intermediate emission taxes are required. Third, the effect of firms’ altruistic cost of emissions on the emission tax that induce the socially optimum abatement is also conditional on the genuine altruistic preferences and finally, the social planner has an incentive to impose a Pigouvian emission tax when firms are profit maximizers. Otherwise, a lower tax suffices.     

Collective voluntary agreements to eliminate polluting products

Recently some industries have collectively agreed not to produce models of a product that do not meet an environmental standard. We present a model to examine a voluntary agreement of this type. The conditions under which an agreement is profitable include the stringency of the agreement, the relative performance of the greener product, industry size and the number of participants. While an agreement can be profitable for all firms (both participants and non-participants), i.e., all firms can be better off with the agreement than without it, nonetheless, a free-rider incentive exists. Thus, despite the potential for a profitable agreement, absent an effective enforcement mechanism, the agreement is not part of a Nash equilibrium. We suggest that this provides a possible explanation for the initial success of the European washing machines agreement, as well as a recent move by the industry to abandon the voluntary approaches and call for mandatory standards.     

Frontrunners and Laggards: The Strategy of Environmental Regulation under Uncertainty

The extant literature on the political economy of environmental regulation does not provide a unified theoretical explanation for three salient stylized facts. First, companies voluntarily invest to reduce the environmental burden that they cause under threat of regulation. Second, ex ante estimates of the compliance cost tend to be systematically higher than ex post estimates. Finally, regulators use limited information provided by the industry. I construct a game-theoretic model of environmental regulation under uncertainty with a benevolent regulator. In equilibrium, companies undertake voluntary action to induce regulation that raises barriers to entry. This profit-driven behavior is not always socially detrimental, however, as the regulator obtains a credible commitment to production and a more accurate estimate of the compliance cost. Additionally, the results provide a selection explanation for the mismatch between ex ante and ex post cost estimates: if companies condition compliance on the installation cost, only low-cost companies install in equilibrium. The analysis combines “regulatory capture” with social welfare maximization to explain the curious combination of voluntary action and low ex post compliance cost without serious information collection by the regulator.     

Competitive Permit Markets and Vertical Structures: The Relevance of Imperfectly Competitive Eco‐Industries

Permit markets lead polluting firms to purchase abatement goods from an eco‐industry which is often concentrated. This paper studies the consequences of this sort of imperfectly competitive eco‐industry on the equilibrium choices of the competitive polluting firms. It then characterizes the second‐best pollution cap. By comparing this situation to one of perfect competition, we show that Cournot competition on the abatement good market contributes not only to a nonoptimal level of emission reduction but also to a higher permit price, which reduces the production level. These distortions increase with market power, measured by the margin taken by the noncompetitive firms, and suggest a second‐best larger pollution cap.     

Incentives to Diffuse Advanced Abatement Technology Under the Formation of International Environmental Agreements

We analyse the incentives for polluting firms to diffuse and adopt advanced abatement technology in a framework in which governments negotiate an international environmental agreement. These incentives crucially depend on whether the underlying environmental policy instrument is an emission tax or an emission quota. The results for the international setting fundamentally differ from those for the national setting that have been elaborated upon in the earlier literature. In particular, equilibrium diffusion and adoption of advanced abatement technology are not necessarily optimal under the tax regime and may be even lower than those under the quota regime.     

A Good Opening: The Key to Make the Most of Unilateral Climate Action

In this paper we argue that when a subgroup of countries cooperate on emission reduction, the optimal response of non-signatory countries reflects the interaction between three potentially opposing factors, the incentive to free-ride on the environmental benefits of cooperation, the incentive to expand energy consumption, and the incentive to adopt the cleaner technologies introduced by the coalition. Using an Integrated Assessment Model with a game-theoretic structure we find that the equilibrium abatement of the coalition composed by OECD countries would be moderate, in line with the Pledges subscribed in Copenhagen, but increasing. The mitigation strategy would consist of investments in energy R&D and deployment of cleaner technologies with high learning potentials. International knowledge and technology externalities would facilitate the diffusion of cleaner technologies in non-signatory countries, offsetting the free-riding incentive and reducing their emissions. If the OECD group curbs emissions beyond the optimal equilibrium level, reaching reduction rates between 40 and 45 % below 2005 levels in 2050, the benefits of technology externalities would no longer compensate the effect of lower fossil fuel prices. Our results suggest that a moderate unilateral climate policy could induce a virtuous behaviour in non-signatory countries and that policies promoting the international transfer of technologies and knowledge could represent an effective complement to mitigation targets.     

Rethinking the optimal level of environmental quality: justifications for strict environmental policy

Traditional environmental theory suggests that the optimal level of a pollution emission occurs when the marginal damage created by the emissions is equal to the marginal cost of reducing the emissions. We argue that the benefits from reducing pollution should be much more broadly defined to include at least three other sources of benefits. First, we develop a game-theoretic model in which firms may under-invest in cost-saving ‘green technologies’. Second, we demonstrate that consideration of future damages and abatement costs leads to a lower current optimal pollution level than that obtained in traditional models. Finally, we show that ecological complexity creates indirect pathways by which greater pollution increases the likelihood of generating irreversible environmental damage. This broader definition of the benefits of pollution abatement yields an optimal level of pollution that may actually be less than the level at which conventionally-measured marginal damages are equal to marginal abatement costs. Thus, environmental policy should be stricter.     

The Timing of Environmental Policy: A Note on the Role of Product Differentiation

We examine the role that product differentiation can play in the design of environmental policy under full commitment and no commitment on the part of the environmental regulator. We consider a setting with two firms selling a differentiated product which generates pollution through emissions. Firms can reduce their emissions by undertaking abatement activities while an environmental regulator taxes emissions. The main results are: (1) When products are highly differentiated, the optimal time-consistent (no commitment) tax is always lower than the optimal pre-commitment tax. As the degree of product differentiation decreases, for relatively efficient abatement technology and high damages, the time-consistent emission tax exceeds the optimal pre-commitment one. (2) Abatement when product differentiation is extensive is higher under the time-consistent regime unless the abatement technology is extremely efficient. The same ranking applies to social welfare. However, as products become more and more similar, these results are (partially) reversed and pre-commitment could lead to both higher levels of abatement and welfare.     

The appeal of voluntary environmental programs: which firms participate and why?

Why do firms participate in the EPA's voluntary environmental programs? Possible reasons include: (1) to appeal to consumers who demand ‘green’ products; (2) to preempt government regulation; (3) to seek regulatory relief from the agency; and (4) to gain a competitive advantage over competitors. This article examines the determinants of participation in voluntary environmental programs, focusing on testing hypotheses 1 and 3. To test 2, a different approach is used than in previous literature. The focus is on a specified universe of firms (manufacturing firms in the Standard & Poor 500), and their participation in each of three EPA voluntary programs (33/50, Green Lights, and WasteWi$) referring to differently regulated pollutants is analyzed. Our empirical analyses reveal that (1) publicity is an important component of participation; (2) the worse the environmental track record of the firm, the more likely the firm is to participate, but only in programs directly related to highly regulated pollutants; and (3) firms that scrutinize their environmental performance more carefully are wary of newer programs with uncertain reach of the public and uncertain benefits. Firms appear to value the information/technology transfer aspect of joining a program.     

Weitzman Revisited: Emission Standards Versus Taxes with Uncertain Abatement Costs and Market Power of Polluting Firms

Studies dealing with the optimal choice of pollution control instruments under uncertainty have invariably taken it for granted that regulated firms face perfectly competitive markets. By introducing the product market into the stochastic framework of Weitzman (Rev Econ Stud 41:477–491, 1974), this paper shows for the case of a polluting symmetric Cournot oligopoly that Weitzman’s policy rule for choosing emission standards versus taxes with uncertain abatement costs is biased in the presence of market power. Since the oligopolists take into account their influence on the market price, their total abatement effort, including the restriction of output, is less vulnerable to miscalculations of the tax rate compared to price-taking firms. Consequently, the comparative advantage of instruments is shifted in favour of taxes. In a further step, the provided policy recommendations are generalised by abolishing the assumption that firms are symmetric.     

Can ecolabels survive in the long run?: The role of initial conditions

This paper analyzes the interaction between three environmental strategies within a population of firms: brown, green, and certified green strategies. We first present a restricted version of an evolutionary game where only brown and green strategies are possible. Next, the model is extended to allow green firms to certify their environmental strategies by joining an ecolabel. Our analysis shows that when it survives, the ecolabel tends to fully replace other uncertified environmental initiatives and to increase the proportion of firms implementing voluntary abatement. Nevertheless, the long-run survival of the ecolabel is not a necessary outcome of the model, although it can be facilitated via policies that reduce abatement or certification costs, increase consumer's environmental concerns or improve the credibility of the certifier, whereas it may be reduced by green-wash news about the sector. An ecolabel's survival may also depend on how and when it is launched. In those common situations where the model has two stable equilibria, initial conditions play a key role in determining the ecolabel's survival. Specifically important determinants are the degree of adoption of voluntary abatement when the ecolabel is launched and the amount and composition of firms that participate in the creation of the ecolabel.     

A dynamic approach to voluntary environmental contributions in tourism

In an evolutionary game-theoretical model of tourism firms that use an endogenous natural Common Pool Resource (CPR) we show that stable equilibria with voluntary environmental initiatives may coexist with other equilibria where voluntary abatement is absent. The basins of attraction of the equilibria are identified and a bifurcation analysis is carried out producing two results with policy implications. First, there is a highly non-linear relationship between the cost of abatement required to be green and the share of green firms. Second, increases in the number of the CPR's users will ultimately dissipate the incentives to make abatement beyond regulation.     

Endogenous Minimum Participation in International Environmental Treaties

Many international treaties come into force only after a minimum number of countries have signed and ratified the treaty. Minimum participation constraints are particularly frequent in the case of environmental treaties dealing with global commons, where free-riding incentives are strong. Why do countries that know they have an incentive to free-ride accept to “tie their hands” through the introduction of a minimum participation constraint? This article addresses the above issues by modeling the formation of an international treaty as a three-stage non-cooperative coalition formation game. Both the equilibrium minimum participation constraint and the number of signatories—the coalition size—are determined. This article, by showing that a non-trivial partial coalition, sustained by a binding minimum participation constraint, forms at the equilibrium, explains the occurrence of minimum participation clauses in most international environmental agreements. It also analyses the endogenous equilibrium size of the minimum participation constraint.