Dynamic optimal control of pollution abatement under emissions permit banking

In a recent work, Dragone et al. (2010) modeled an optimal control model of pollution abatement, and investigated the adoption of a tax levied on the firm's instantaneous contribution to the accumulation of pollution. In this paper, we extend the work of Dragone et al. (2010) by providing a dynamic optimal control model of pollution abatement with emissions permits banking, where the firm is allowed to purchase, sell and bank emissions permits given a finite planning horizon of length. Our objective is to find the optimal levels of the production, the pollution abatement investment and the quantity of emissions permits bought or sold in continuous time through the use of optimal control theory. We illustrate the results with a numerical example.     

Bilateral Oligopoly,Private Information,and Pollution Permit Markets

We analyze the effects of strategic behavior and private information in pollution permit markets in which all firms have market power. The market is characterized by supply-function equilibria. Firms submit net supplies for permits and a market maker determines the market-clearing price. Net supplies depend on abatement cost functions, which in turn depend on private information parameters. We calculate the increase in aggregate abatement costs due to strategic behavior and private information and show that private information attenuates the effects of strategic behavior.      

Technology Diffusion with Market Power in the Upstream Industry

This paper compares taxes and tradable permits when used to regulate a competitive and polluting downstream industry that can purchase an abatement technology from a monopolistic upstream industry. Second-best policies are derived for the full range of the abatement technology’s emission intensities and marginal abatement costs. The second-best permit quantity can be both above or below the socially optimal emission level. Explicit consideration of the output market provides further insights on how market power distorts the allocation in the downstream industry. The ranking between permits and taxes is ambiguous in general, but taxes weakly dominate permits if full diffusion is socially optimal. In addition, it is analysed how a cap on the permit price affects the diffusion of an abatement technology.     

A dynamic general equilibrium model of pollution abatement under learning by doing

In 2013, Beladi et al. constructed a dynamic general equilibrium model of pollution, and characterized a steady-state equilibrium. In this paper, we extend Beladi et al.’s model to an even more general model in which the pollution abatement costs under learning by doing are taken into account. In our model, the instantaneous abatement costs depend on both the rate of abatement and the experience of using a technology. Our objective is to apply optimal control theory to investigate the dynamic general equilibrium model of pollution abatement, and derive the steady-state equilibrium properties and optimal levels of emission permits and pollution treatment.     

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.     

Green Technology and Optimal Emissions Taxation

Unless an active environmental policy exists, firms have no incentive to engage in abatement or environmental R&D so policy design is of paramount importance. This design heavily depends on the way R&D spillovers operate. There are two distinct types of R&D spillover: output spillover and input spillover. An input spillover operates on the expenditure toward pollution reduction, whereas an output spillover manifests as the achieved abatement. Under optimal emissions taxation, significant differences arise due to this distinction, in particular, when the spillover operates on R&D inputs. In an oligopolistic setting, the result is higher R&D expenditure, but also higher aggregate emissions and, consequently, higher emissions taxes. By contrast, when spillovers occur in R&D output, there is a U‐shaped relationship between the optimal tax and the spillover, showing a trade‐off between the optimal tax rate and spillovers when these are low. In terms of the relative effectiveness of different R&D organization setups, combining emissions taxes with R&D cooperation, this paper shows that under low levels of R&D spillover R&D cooperation gives higher emissions reductions, whereas when spillovers are high this is not the case.     

Abatement and Permits when Pollution is Uncertain and Violations are Fined

This paper considers a firm’s choice of abatement and of the number of permits if actual pollution is stochastic such that full compliance cannot be ensured. This straightforward extension induces non-trivial and unexpected comparative static properties, such as: permits and abatement can be either substitutes or complements, higher fines can lower the number of acquired permits (or abatement), and higher permit prices can reduce abatement. Yet integrating these reactions into a (competitive) permit market eliminates puzzling features. This is an additional justification of tradable permits over standards, where regulators must cope with potentially counterproductive firm reactions. A first version of the paper was written at the School of Finance and Economics, University of Technology, Sydney and I am grateful for the enjoyed hospitality. I am also grateful for the valuable comments from an anonymous referee.     

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.      

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.     

On a Fundamental Advantage of Permits Over Taxes for the Control of Pollution

We extend the tax versus permits literature by considering permit supply functions and pollution tax functions that are generalizations of the usual constant permit supply and constant pollution tax rate. In our model, pollution is not uniformly mixed and the regulator is uncertain about the polluting firms’ abatement costs. We determine the optimal permit supply functions and the optimal pollution tax functions. Using these functions, we show that permits lead unambiguously to lower total expected costs than taxes. We analyze the magnitude of this difference for a simple model of climate change. By relating the optimal permit supply functions to Weitzman (Am Econ Rev 68:683–691, 1978) we provide a new interpretation of his results.     

Market power,private information,and the optimal scale of pollution permit markets with application to North Carolina's Neuse River

We extend the analysis of optimal scale in pollution permit markets by allowing for both market power and private information. We characterize the total costs (abatement costs and damages) under market power and private information and compare them to total costs under competition. It is possible for both market power and private information to lead to lower total costs than competition, but generally the differences between the three market structures will be small. We also conduct an optimal scale analysis of nitrogen pollution from waste water treatment plants (WWTP) into North Carolina's Neuse River System. An economic model of damages and abatement costs is integrated with a hydro-ecological model of nitrogen flow through the Neuse. We determine the optimal number of trading zones and allocate the WWTP into these zones. Under the most likely regulatory scenario, we find cost savings of 1.55 million dollars per year under the optimal market design relative to the typical 303(d) regulation in which the WWTP are not allowed to trade.     

Environmental Policy with Endogenous Technology from a Game Theoretic Perspective: The Case of the US Pulp and Paper Industry

The merits of different types of regulatory tools in eliminating pollution and at the same time inducing innovation have long been an interest of researchers in both environmental economics and industrial organization. Although there is a substantial theoretical literature investigating the potential for various environmental policies to attain these dual goals, this is a challenging empirical problem because every industry has its own inherent characteristics that play an important role in determining the performance of different regulatory tools. The majority of the work to date focuses on pollution abatement while leaving pollution prevention understudied. In most of the literature firms are also assumed to be symmetric. Asymmetries among firms add another degree and level of complexity to their strategic interactions, and affect the performance of different regulatory tools. This paper investigates the performance of two alternative regulatory tools, an emissions performance standard and an emissions tax, in reducing pollution and inducing pollution prevention and abatement R&D in the US pulp and paper industry. We construct a model representing the industry in an asymmetric Cournot duopoly framework, calibrate the model to disaggregated industry data, and run scenarios to replicate the behavior of the firms in an imperfectly competitive output market. Our results suggest that pollution prevention R&D can respond quite differently than abatement R&D to different policy instruments. The results indicate that R&D spillovers among firms play crucial role in technology development and strategies of the firms. Our results also suggest that strategic interactions between firms in an imperfectly competitive industry can have significant impacts of the levels of both types of R&D.      

Random wastes,imperfect monitoring and environmental quality standards

This paper considers a firm's choice of optimal pollution abatement strategy in an environment where pollution licences are purchased through a market and a fine is levied for pollution in excess of the licences held. The pollution associated with any level of abatement is stochastic and the authority monitors pollution via a random sample of observations. Firms choose cost-minimising values for the mean and variance of emissions and the authority selects its sample size and the number of licences issued to achieve an exogenous level of environmental quality with abatement costs and monitoring costs at a minimum level.     

Decentralization in Pollution Permit Markets

A pollution permit market is decentralized when firms are allowed to trade permits across time, regions or pollutants. Using a model in which firms have better information about their abatement costs than a regulator, we develop a comparative advantage formula that delineates whether or not pollution permit markets should be decentralized. When the damage from pollution is described by a separable function, the formula implies a simple sufficient condition for not allowing decentralization.     

The efficiency of decentralized environmental policies under global pollution and tradable emission permits

We build a two asymmetric regions model with cross‐border pollution related to production. Each region issues emission permits and revenues from their sales finance public pollution abatement. The decentralized level of emission permits is efficient when permits are interregionally tradable and cross‐border pollution is perfect. This result is robust in a variety of cases—for example, when (i) capital is immobile or internationally mobile or only mobile between the two regions, and (ii) revenue from permits sales is transferred to a federal authority.     

Allowing for Household Preferences in Emission Trading – A Contribution to the Climate Policy Debate

In the context of emission trading it seems to be taken as given that people's preferences can be ignored with respect to the whole process of fixing emission targets and allocating emission permits to polluters. With this paper we want to reopen the debate on how citizens can be involved in this process. We try to show how citizen preferences can be included in the process of pollution control through emission trading. We propose an emission trading system where all emission permits are initially allocated to households who are then allowed to sell them in the permit market or to withhold (at least some of) them in order to reduce total pollution. This proposal tries to overcome the fundamental disadvantage of traditional permit systems which neglect consumer preferences by solely distributing emission permits to producers / polluters. In our system the property right to nature is re-allocated to the households who obtain the opportunity of reducing actual emissions according to their personal preferences by withholding a part or all of the emission permits allotted to them. Such a change in environmental policy would mark a return to the traditional principles of consumer sovereignty by involving households (at least partially) in the social abatement decision process instead of excluding them. Another advantage of admitting households to the TEP market as sellers or buyers of permits is that this increases the number of agents in the permit market and thus significantly reduces the possibilities of strategic market manipulations.     

Carbon Abatement and International Spillovers

Carbon abatement policies in large open economies affect both the allocation of domestic resources and international market prices. A change in international prices implies an indirect secondary burden or benefit for all trading countries. Based on simulations with a large-scale computable general equilibrium model of global trade and energy use, we show that international spillovers have important welfare implications for carbon abatement policies designed to meet exogenous emission reduction targets. We present a decomposition of the total welfare effect of carbon abatement policies into a primary domestic market effect (at constant international prices) and a secondary international spillover impact as a result of changes in international prices. This decomposition reveals the extent to which domestic abatement costs are increased or decreased as a result of the impact of carbon abatement on international prices.     

Emission Taxes and Product Differentiation in the Presence of Foreign Firms

Industries characterized by differentiated products are important contributors of greenhouse gases and currently subject to market‐based policies such as emission taxes. In the context of developing countries, fears about foreign investment leaving the country are often used as an argument not to address industry emissions through emission taxes. This paper develops a Cournot model with product differentiation in the presence of abatement efforts where host and foreign firms are subject to an emission tax. The analysis indicates that abatement efforts and differences in pollution intensity coefficients across firms may play a significant role in the characterization of optimal policy. The analysis also suggests that the government may opt to encourage foreign, less pollution‐intensive firms via higher taxation. Additionally, this paper examines how an optimal emission tax may be adjusted as products become more differentiated; industry emissions may fall/rise as a result of more differentiated products. One important contribution of this paper is that it emphasizes the role of abatement efforts, product differentiation, and differences in pollution intensity coefficients across firms in the characterization of the optimal emission tax.     

Environmental Regulation and the Eco-Industry

This paper re-examines environmental regulation, under the assumption that pollution abatement technologies and services are provided by an imperfectly competitive environment industry. It is shown that each regulatory instrument (emission taxes and quotas; design standards; and voluntary agreements) has a specific impact on the price-elasticity of the polluters’ demand for abatement services, hence on the market power of the eco-industry and the resulting cost of abatement. This implies that the optimal pollution tax will be higher than the marginal social cost of pollution, while a voluntary approach to pollution abatement may fail unless the eco-industry itself is willing to participate.We thank Dominique Bureau, Olivier Godard, Émeric Henry, Nicolas Marchetti, Alain-Désiré Nimubona, Anne Perrot, Gilles Rotillon, Katheline Schubert, the editors Michael Crew and Anthony Heyes, and two anonymous referees for helpful discussions and suggestions. We also acknowledge valuable comments from seminar audiences at HEC Montréal, the University of Paris I, the University of Toulouse, and the DG-Entreprise of the European Commission in Brussels.     

Static and dynamic efficiency of pollution control strategies

A great deal of the economic literature on pollution control strategies concentrates on the efficiency of environmental policy instruments. Most analytical studies in this field show that market instruments are more efficient with respect to the cost of pollution abatement of a given number of polluters than non-market instruments. According to several analytical studies, market instruments should also be more efficient with respect to innovation in pollution abatement equipment than non-market instruments. In the empirical literature a great number of case studies exist with estimations of the savings of abatement costs of market instruments in a situation without technological progress. Empirical studies about the impact of environmental policy market instruments on the abatement costs in situations with technological progress are lacking.The purpose of this paper is to fill this gap. The paper deals with an empirical estimation of abatement costs for the emission of SO₂ of coal-fired electricity units in the Netherlands from 1985 to 2000. First, the working of market instruments and non-market instruments (the existing environmental policy of the Dutch government) is simulated in a static situation. Second, we analyse the learning effects of flue gas desulphurization. The efficiency advantage of market instruments turns out to be larger in a situation of technological progress than in a static situation.