Does Technological Innovation Really Reduce Marginal Abatement Costs? Some Theory,Algebraic Evidence,and Policy Implications

The existing literature models innovation in pollution control as a reduction in marginal abatement costs. We show that this assumption is inappropriate for production process innovations such as fuel switching. Algebraically, we examine the effects of different innovation types on marginal abatement cost curves, showing that some desirable innovations increase marginal abatement costs. Empirically, we estimate marginal abatement costs for sulfur dioxide by measuring the output distance function for electric power in Korea. Regression results confirm that production process innovations did raise marginal abatement costs in this case. One policy implication: economic instruments do not always provide stronger innovation incentives than command-and-control policies.      

A Note on Emissions Taxes and Incomplete Information

In contrast with what we perceive is the conventional wisdom about setting a second-best emissions tax to control a uniformly mixed pollutant under uncertainty, we demonstrate that setting a uniform tax equal to expected marginal damage is not generally efficient under incomplete information about firms’ abatement costs and damages from pollution. We show that efficient taxes will deviate from expected marginal damage if marginal damage is increasing and there is uncertainty about the slopes of the marginal abatement costs of regulated firms. Moreover, tax rates will vary across firms if a regulator can use observable firm-level characteristics to gain some information about how the firms’ marginal abatement costs vary.     

Capturing the least costly way of reducing pollution: A shadow price approach

The production analysis literature is increasingly concerned with estimating marginal abatement costs. Yet, most studies do not emphasize the ways in which pollutants may be reduced and their costs, which makes them unable to identify the least costly compliance strategy. This paper utilizes the materials balance principle to relate pollution to the employment of material inputs. A production model which allows input and output substitution, downscaling of operations, pollution control, and emission permits purchases as compliance strategies is proposed, and the implications of joint and non-joint pollution controls for the trade-off between pollutants and desirable outputs are considered. Marginal abatement costs, reflecting the least costly way of compliance, are derived by exploiting the duality between the directional distance function and the profit function.     

Endogenous market power in an emissions trading scheme with auctioning

This paper contributes to the literature on market power in emissions permits markets, modeling an emissions trading scheme in which polluters differ with respect to their marginal abatement costs at the business-as-usual emissions. The polluters play a two-stage static complete information game in which their market power arises endogenously from their characteristics. In the first stage all polluters bid in an auction for the distribution of the fixed supply of permits issued by the regulator, and in the second stage they trade these permits in a secondary market. For compliance, they can also engage in abatement activity at a quadratic cost. Under the assumptions of the model, in equilibrium all polluters are successful in the auction. In the secondary market the low-cost emitters are net sellers and the high-cost emitters are net buyers. Moreover, the high-cost emitters are worse off as a result of the strategic behavior. In addition, the secondary market price is unambiguously above the auction clearing price. I find that the aggregate compliance cost when polluters act strategically increases in the heterogeneity of their marginal abatement costs at the business-as-usual emissions, but there exists a threshold of the fixed supply of permits above which strategic behavior is compliance cost-saving for the polluters. Finally, for a low enough variance of the marginal abatement cost at the business-as-usual emissions, strategic behavior is compliance cost-saving for the polluters, regardless of the level of the available supply of permits.     

Taxes versus quotas for a stock pollutant

We compare the effects of taxes and quotas for an environmental problem where the regulator and polluter have asymmetric information about abatement costs, and environmental damage depends on pollution stock. An increase in the slope of the marginal abatement cost curve, or a decrease in the slope of the marginal damage curve, favors taxes. An increase in the discount rate or the stock decay rate favors tax usage. Taxes dominate quotas if the length of a period during which decisions are constant is sufficiently small. An empirical illustration suggests that taxes dominate quotas for the control of greenhouse gasses.     

Environmental innovation and the cost of pollution abatement revisited

It is widely assumed in the literature that environmental innovation reduces the marginal cost of pollution abatement. In this paper we show that this is not necessarily the case and we provide some unexpected outcomes.     

From command-and-control to market-based environmental policies: Optimal transition timing and China’s heterogeneous environmental effectiveness

Despite the rich literature on command-and-control and market-based environmental policies, the transition between them has received relatively less attention. This paper identifies that there exists an optimal transition timing from command-and-control policies to market-based policies by analyzing the trade-off between the abatement cost and innovation compensation effects of environmental regulations, and the optimal transition timing occurs when the marginal opportunity cost of pollution abatement equals the marginal output of capital input. Using province-level data of 30 regions in China from 2007 to 2015, we measure environmental efficiency by the slack-based model with desirable and undesirable output, and adopt the spatially adaptive semi-parametric model to carry out our empirical research, which shows that command-and-control policies, rather than market-based policies, promote China’s environmental efficiency. Enhancing investment in technological innovation contributes to improving environmental efficiency for both types of policies. Finally, the effect of such policies on environmental efficiency remains heterogeneous across regions.     

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.     

A Cournot Mechanism for Pollution Control under Asymmetric Information

The contribution of this paper is to show that a simple nonlinear tax can achieve a long-run socially optimal level of pollution without the regulator knowing marginal abatement costs. Firms are charged their differential contribution to total damages, evaluated at the upper margin of current emissions. This induces a Cournot game in pollution levels. We show that the Nash equilibrium exists, corresponds to the socially optimal long-run output and emission levels and number of firms, is stable, and can be reached by iterative computations where conjectures are formed using a linear estimator based on past emission levels.     

To Comply or Not To Comply? Pollution Standard Setting Under Costly Monitoring and Sanctioning

In this paper, we characterize optimal regulatory policies composed of a pollution standard, a probability of inspection and a fine for non-compliance, in a context where both monitoring and sanctioning are socially costly, and the penalty may include gravity and non-gravity components at the regulator’s discretion. Under given penalties, the optimal policy entails compliance with the standard as long as a quite intuitive condition is met. Non-compliant policies may include standards even below the pollution levels that minimize the sum of abatement costs and external damages. Interestingly, the appropriate structure of the penalty under non-compliance is highly progressive, while the best possible shape of the fine under compliance is linear. If the regulator is entitled to choose the structure of the fine, linear penalties are socially preferred and the optimal policy induces compliance.      

The Cost-Effective Choice of Policy Instruments to Cap Aggregate Emissions with Costly Enforcement

We study the cost-effectiveness of inducing compliance in a program that caps aggregate emissions of a given pollutant from a set of heterogeneous firms based on emissions standards and the relative cost-effectiveness of such a program with respect to an optimally designed program based on tradable discharge permits. Our analysis considers abatement, monitoring and sanctioning costs, as well as perfect and imperfect information on the part of the regulator with regard to the polluters’ abatement costs. Under perfect information we find that (a) the total-cost-effective design of a program based on standards is one in which the standards are firm specific and perfectly enforced, and (b) the total cost of an optimally designed program based on standards is lower than the total cost of an optimally designed transferable emission permits system, except under special conditions. This is true when it is optimum to induce perfect compliance and when it is not. Under imperfect information, nevertheless, it is only by implementing a system of tradable permits and perfectly enforcing it with a constant marginal penalty tied to the price of the permits, that the regulator can surmount the informational problem and at the same time minimize the total cost of the program with certainty.     

Using Non Market Valuation to Inform the Choice Between Permits and Fees in Environmental Regulation

The purpose of this short note is to open an exploration regarding the use of non market valuation to help guide the selection of economically efficient pollution control instruments. As long as non market valuation techniques can correctly estimate the slope of the marginal benefit of abatement curve, this information along with engineering cost estimates of the unit costs or slope of the marginal abatement cost will provide useful information to policy makers in choosing between fees and permits. An illustrative review of the literature suggests that both stated and revealed preference methods have estimated slopes of marginal benefit functions for reducing several pollutants. To investigate the efficiency of permits versus fees, an illustrative review of corresponding marginal abatement costs is also made. For air pollutants affecting visibility, the slope of the marginal benefit curve is far greater than the slope of the marginal abatement costs, suggesting permits as the efficient instrument. For nitrates in groundwater used for drinking, the marginal benefit curve is flatter than the rather steep marginal abatement cost, suggesting fees/taxes would be a more efficient economic instrument. We hope this note stimulates more emphasis in non market valuation on estimating the slope of the marginal benefit function to enhance environmental economists ability to make policy recommendations regarding the choice of pollution instruments for specific pollutants.      

The ‘advancedness’ of knowledge in pollution-saving technological change with a qualitative application to SO2 cap and trade

This paper investigates the extent to which ‘advanced’ knowledge and technology played a role in the SO2 compliance process in electric power plants under the US SO2 cap and trade program. It investigates the hypothesis that advanced knowledge and technology dedicated to pollution abatement played a minor role in that process while relatively unadvanced forms of knowledge and technology played the main role. New qualitative evidence in this somewhat well-known case is considered: interviews with electric power plant R&D managers, plant-level compliance data, and the changes undergone by boiler manufacturer, coal mining and railroad companies in the supply chain. Advanced knowledge dedicated to pollution abatement like the type now being emphasised for carbon capture and storage (CCS) played a minor role, while unadvanced knowledge and technology played the main role. While there are clearly limits to how far this unadvanced knowledge and technology finding can be generalised to GHG emission control, the specific aspects of the SO2 case that might be broadly informative of the response to GHG emissions are elaborated. In any case, the paper shows how ‘innovation’ in pollution control can be inexpensive and effective without involving very much advanced knowledge and technology for pollution control.     

Investment and emission control under technology and pollution externalities

This paper studies incentives to develop advanced pollution abatement technology when technology may spillover across agents and pollution abatement is a public good. We are motivated by a variety of pollution control issues where solutions require the development and implementation of new pollution abatement technologies. We show that at the Nash equilibrium of a simultaneous-move game with R&D investment and emission abatement, whether the free rider effect prevails and under-investment and excess emissions occur depends on the degree of technology spillovers and the effect of R&D on the marginal abatement costs. There are cases in which, contrary to conventional wisdom, Nash equilibrium investments in emissions reductions exceed the first-best case.     

The regulatory choice of noncompliance in emissions trading programs

This paper addresses the following question: To achieve a fixed aggregate emissions target cost-effectively, should emissions trading programs be designed and implemented to achieve full compliance, or does allowing a certain amount of noncompliance reduce the costs of reaching the emissions target? The total costs of achieving the target consist of aggregate abatement costs, monitoring costs, and the expected costs of collecting penalties from noncompliant firms. Under common assumptions, I show that allowing noncompliance is cost-effective only if violations are enforced with an increasing marginal penalty. However, one can design a policy that induces full compliance with a constant marginal penalty that meets the aggregate emissions target with lower expected costs. This last result does not depend on setting an arbitrarily high constant marginal penalty. In fact, the marginal penalty need not be higher than the equilibrium marginal penalty under the policy with the increasing marginal penalty, and can actually be lower. Finally, tying the marginal penalty directly to the permit price allows the policy objective to be achieved without any knowledge of firms’ abatement costs.     

ABATEMENT COST HETEROGENEITY IN PHASE I ELECTRIC UTILITIES

The market-based instruments embodied in the Acid Rain Program have been instrumental in the reduction of SO₂ and NO _x emissions from electric utilities. Economic theory suggests that tradable pollution permit systems encourage polluters to reallocate pollution burdens to take advantage of any differences in marginal abatement costs. Such reallocations improve the efficiency of pollution reduction. This article evaluates the effectiveness of the first phase of the Acid Rain Program in achieving increased homogeneity of marginal abatement costs using an output distance function approach. The results indicate that plants have been successful in adapting to this more flexible regulatory framework.     

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.     

Environmental Policy Instruments: Technology Adoption Incentives with Imperfect Compliance

We study the incentives to adopt advanced abatement technologies in the presence of imperfect compliance. Interestingly, incentives under emission taxes and pollution abatement subsidies are the same that in the perfect compliance scenario. However, under emission standards imperfect compliance can increase firms’ incentives to invest, whereas under an emission permit mechanism investment incentives decrease only if widespread non-compliance induces a reduction in the permit price. Our results are valid for fairly general characteristics of the monitoring and enforcement strategies commonly found in both, theoretical and empirical applications.     

How Large are the Welfare Gains from Technological Innovation Induced by Environmental Policies?

This paper examines whether the welfare gains from technological innovation that reduces future abatement costs are larger or smaller than the Pigouvian welfare gains from optimal pollution control. The relative welfare gains from innovation depend on three key factors—the initially optimal level of abatement, the speed at which innovation reduces future abatement costs, and the discount rate. We calculate the welfare gains from innovation under a variety of different scenarios. Mostly they are less than the Pigouvian welfare gains. To be greater, innovation must reduce abatement costs substantially and quickly and the initially optimal abatement level must be fairly modest.     

Joint Management of Emission Abatement and Technological Innovation for Stock Externalities

We investigate how emission abatement and technological innovation provide different solutions to reduce pollutant emissions. In the case of a stock externality emission abatement leads to a smooth and continuous adjustment of emissions. Conversely, technological innovation has to be interpreted as an option on a less polluted environment and can justify the use of a pollution threshold above which it is optimal to start a research and development programme for a less polluting technology. It is shown that technological innovation interferes with the traditional emission abatement approach. The optimal abatement level is logically lowered once the less polluting technology is available; nevertheless a temporary increase in emissions is optimal during the research and development period. The usual Pigouvian tax system proves to remain an efficient corrective instrument. A numerical application to the Greenhouse effect is provided.