Regulation of Non-Point Emissions – A Variance Based Mechanism

Non-point emission problems such as pesticide, nitrate, and phosphorus pollution of lakes and ground water are often characterised by a small number of polluters, convex damage functions, and stochastic emissions. Some regulatory mechanisms proposed in the literature for stochastic non-point emissions implement the optimal abatement vector in dominant strategies (ensuring that non-Nash conjectures cannot be rationalized). However, specification of these mechanisms requires firm level information and differentiated rates when the damage function is convex. Other mechanisms eliminate the need for firm level information and rate differentiation, but only implement optimum in Nash strategies (where non-Nash conjectures, that cause equilibrium to stray from optimum, can be rationalized). In this paper we propose a mechanism which eliminates the need for firm level information and rate differentiation, while retaining implementation in dominant strategies.     

Disutility of pollution and endogenous growth

Endogenous growth is generally built on a positive externality hypothesis which is the opposite of a negative externality caused by pollution. We study a linear technology with simple assumption: an aggregate capital stock which represents a learning by doing effect and a pollution flow proportional to production. In this framework, we analyse the precise effects on growth of the disutility of pollution and its interaction with the utility of consumption in an economy without abatement technology. The decentralized equilibrium always leads to unlimited growth, but optimal growth is often limited (the negative effect of pollution dominating the positive effect of learning by doing). In this case, the optimal policy which leads the decentralized economy to follow the optimal growth path is to tax capital; in contrast with the optimal subsidy policy in an economy without pollution. When an abatement technology is introduced, the optimal solution can lead the economy to unlimited growth, whatever the form of the utility function.     

Optimal pollution taxation in a Cournot duopoly

It is well known that the optimal pollution tax in a competitive industry is equal to the marginal damage inflicted by the pollution. It has also been shown that the optimal pollution tax on a monopoly is less than the marginal damage. In this paper, I derive the optimal pollution tax for a Cournot duopoly. If firms have different production costs, the optimal tax rate may exceed the marginal damage. This is so because the tax may be an effective instrument for allocating production from the less to the more efficient firm. It is also shown that, if one firm has a positive most preferred pollution tax, the sum of consumer and producer surpluses will be declining in the tax at this level.     

Government policy to reduce pollution emissions within the overlapping generations model

This article develops an overlapping generations model with multiple categories of capital. The importance of this article is in its ability to analyse changes in the distribution of various categories of capital along the growth path of the economy. Economic growth is accompanied by capital growth as well as increase in pollution emissions. Implementing a government policy to reduce pollution emission would change the equilibrium path of capital distribution. Within the model, the government builds a corporate tax function that defines the tax rate as a function of a ‘desired’ pollution level. The tax rate decreases as the ‘desired’ pollution level is higher. When the ‘desired’ pollution level is higher than the actual pollution level, production is subsidized and pollution levels rise. An example and a simulation are presented in order to confirm the theoretical results and demonstrate that the model can be used for empirical analysis.     

Habit formation in an endogenous growth model with pollution abatement activities

This paper studies how habit formation in consumption affects pollution abatement activities and the steady-state growth rate, in the context of an endogenous growth model in which agents derive disutility from the habit stock and pollution. The paper also examines how the effect of technological change in abatement on the optimal growth rate is enhanced or weakened by habit formation. We show that if agents persist in and care about their habits, sustained growth is only possible with rapid technological progress.      

Dynamic modelling of pollution abatement in a CGE framework

This paper deals with the specification of pollution abatement in dynamic computable general equilibrium (CGE) models and analyses the dynamic feedback mechanisms between economy and abatement in the context of environmental policy. A Ramsey-type economic model is presented, in which bottom-up technical and economic information on abatement techniques is integrated in a top-down dynamic CGE context. The practical suitability of the specification is illustrated by an empirical application for climate change and acidification in the Netherlands. The results show that a mixture of some slowdown of economic growth, a substantial restructuring of the economy and implementation of most technical abatement measures is optimal.     

Precaution under mixed uncertainty: Implications for environmental management

A model of pollution control subject to two types of uncertainty is presented. First, the natural decay of the pollution stock follows stochastic dynamics that drives a diffusion pollution process (“stochastic uncertainty”). Moreover, the damage coefficient which determines the amount of damage corresponding to each pollution stock can undergo an abrupt increase at some uncertain future time (“event uncertainty”). The model admits an explicit and simple dynamic characterization of the optimal emission rule and the ensuing pollution process. When only one type of uncertainty is permitted (by setting either the variance of the stochastic process or the hazard rate for the damage increase to zero) it acts to promote the intuitive response of precaution. However, allowing the two types to interact gives rise to a non-monotonic behavior, whereby increasing the stochastic variance first enhances, then diminishes the response to the hazard. The results confirm and expand recent findings based on discrete-time formulations.     

Environmental capital flight and pollution tax

This paper analyzes the impacts of a production pollution tax on environmental capital flight and national product in a two-country static general equilibrium model with two-way foreign investment. It is assumed that the capital input in both countries is a composite good of domestic and imported capital. And pollution is assumed to originate in the production process. The productivity of capital in each country is negatively (or positively) related to the worldwide aggregate emissions.The analysis shows that when a domestic pollution tax is levied, domestic capital outflows increase and foreign capital inflows decrease for sufficiently high elasticities of substitution between labor (immobile input) and capital (mobile input) in both countries. Moreover, with negative transnational externalities, increases of a domestic pollution tax reduce domestic production and increase foreign production. The difficulty of substitution between immobile and mobile inputs hinders the optimal allocation of worldwide capital and national product. In this paper, the optimal pollution tax is based on global welfare maximization, not on global income maximization, taking into consideration the impact of income change on individual welfare. Therefore, an optimal pollution tax in the developing country should be lower for a given rate of pollution.     

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.     

On the dynamics of renewable resource harvesting and pollution control

The paper presents a dynamic partial equilibrium model which combines optimal renewable resource harvesting and optimal pollution control. Pollution accumulates as a slowly decaying stock and is assumed to affect the growth and the quality of the renewable resource stock. The aim is to maximize a social welfare functional which gives the present value of the difference between natural resource benefits and pollution control costs. The existence, uniqueness and the dynamic properties of the steady states are investigated. The analysis also gives a general result concerning the steady state of any two state variable optimal control problems.     

On Cost Benefit Rules for Green Taxes

This paper concerns the welfare effects of a green tax reform in a dynamic general equilibrium model with preexisting taxes on labor income and capital income. In comparison with previous studies on green taxes in dynamic models, which have focused their main attention on long run effects of such reforms, I derive cost benefit rules for a change in the tax mix by using the properties of the value function in optimal control theory. This enables me to relate the welfare effect of a change in the tax mix to responses in employment, the capital stock, (flow) emissions and the stock of pollution along the whole general equilibrium path. Another contribution of the paper is to examine under what conditions an emission tax, which is set permanently below the marginal damage of pollution, is welfare superior to an emission tax path that fully internalizes the external effect.     

Constant-returns endogenous growth with pollution control

Pollution control with positive externality from the government is incorporated in an endogenous growth model with AK production function. The result indicate that if consumption and abatement expenditure grows at a constant rate, pollution stock will have smaller growth rate. The growth rate of consumption in a command economy will in general be greater than in a competitive economy. A greater intertemporal elasticity of substitution will result in a lower growth rate only if the household's preference parameter against pollution is sufficiently small. The development strategy of pursuing higher growth rate accompanied by more pollution in the early stage of economic development is economically justifiable. The utility in a wealthier economy is always higher in all stages of development than in a poorer economy, as is the pollution stock, although it may converge in the steady state.An earlier version of this paper was presented at the International Congress on Modelling and Simulation, December 6–10, 1993, Perth, Australia. Constructive comments and suggestions from two anonymous reviewers of this journal are greatly appreciated, and so is the financial support from the Bureau of Industrial Development in Taiwan.     

Location choice under trade and environmental policies

In this paper, we use a game theoretic model to analyze the trade-off between the attractiveness of FDI and the environmental damage caused by production under asymmetric information. In the first stage, the domestic developing country reveals the level of import tariff and pollution tax under information uncertainty about the environmental damage that the foreign firm can cause. The foreign firm from a developed country decides where to locate afterwards with complete information about its own damage. Results show that the developing country can be better off encouraging FDI if and only if the marginal damage of pollution is sufficiently low. The optimal level of pollution taxes attracting FDI is higher than the marginal damage of pollution. However, the optimal pollution tax without FDI can be lower than the marginal damage of pollution with sufficiently high demand in the developing country.     

Preparing for catastrophic climate change

We study optimal adaptation to climate change when the harmful consequences of global warming are associated with uncertain occurrence of abrupt changes. The adaptation policy entails the accumulation of a particular sort of capital that will eliminate or reduce the catastrophic damage of an abrupt climate change when (and if) it occurs. The occurrence date is uncertain. The policy problem involves balancing the tradeoffs between the (certain) investment cost prior to occurrence and the benefit (in reduced damage) that will be realized after the (uncertain) occurrence date. For stationary economies the optimal adaptation capital converges monotonically to a steady state. In most cases, investment begins immediately. However, if the initial adaptation capital exceeds a pre-specified threshold level, which lies above the optimal steady state, investment is delayed while the capital stock decreases (due to depreciation) and commences only when it reaches this threshold level. For growing economies the optimal adaptation capital stock approaches the maximal economic level above which further accumulation is ineffective.     

Optimal emission-extraction policy in a world of scarcity and irreversibility

This paper extends the classical exhaustible-resource/stock-pollution model with irreversibility of pollution decay, meaning that after reaching some threshold there is no decay of the pollution stock. Within this framework, we answer the question how the potential irreversibility of pollution affects the extraction path. We investigate the conditions under which the economy will optimally adopt a reversible policy, and when it is optimal to enter the irreversible region. In the case of irreversibility it may be optimal to leave a positive amount of resource in the ground forever. As far as the optimal extraction/emission policy is concerned, several types of solutions may arise, including solutions where the economy stays at the threshold for a while. Given that different programs may satisfy the first order conditions for optimality, we further investigate when each of these is optimal. We show that it is never optimal for the economy to stay at the threshold for a while before entering the irreversible region. The optimality analysis is then illustrated by means of a calibrated example. To sum up, for any pollution level, we can identify a critical resource stock such that there exist multiple optima i.e. a reversible and an irreversible policy that yield exactly the same present value. For any resource stock below this critical value, the optimal policy is reversible whereas with large enough resources, irreversible policies outperform reversible programs.     

Optimal emission-extraction policy in a world of scarcity and irreversibility

This paper extends the classical exhaustible-resource/stock-pollution model with irreversibility of pollution decay, meaning that after reaching some threshold there is no decay of the pollution stock. Within this framework, we answer the question how the potential irreversibility of pollution affects the extraction path. We investigate the conditions under which the economy will optimally adopt a reversible policy, and when it is optimal to enter the irreversible region. In the case of irreversibility it may be optimal to leave a positive amount of resource in the ground forever. As far as the optimal extraction/emission policy is concerned, several types of solutions may arise, including solutions where the economy stays at the threshold for a while. Given that different programs may satisfy the first order conditions for optimality, we further investigate when each of these is optimal. We show that it is never optimal for the economy to stay at the threshold for a while before entering the irreversible region. The optimality analysis is then illustrated by means of a calibrated example. To sum up, for any pollution level, we can identify a critical resource stock such that there exist multiple optima i.e. a reversible and an irreversible policy that yield exactly the same present value. For any resource stock below this critical value, the optimal policy is reversible whereas with large enough resources, irreversible policies outperform reversible programs.     

Consistency and optimality in a dynamic game of pollution control I: Competition

I model the interaction between a regulator and polluting firms as a Stackelberg differential game in which the regulator leads. The firms create pollution, which results in a stock extermality. I analyze the intertemporal effects of alternate pollution control measures in a competitive industry. The principal issue here concerns the dynamic inconsistency of the optimal solution. Inter alia, I compare the steady state levels of pollution under optimal and under time consistent policies.     

The optimal control of emissions and renewable resource harvesting under uncertainty

A model of a renewable resource is developed where the growth and quality of the resource are reduced by pollution. Ambient pollution concentrations and the renewable resource stock are modeled as stochastic processes. Conditions for the optimal harvest plan and the optimal emissions rate are derived. The effect of stochastic variations on the optimal management of the resource is analyzed. The steady-state joint probability distribution of the resource and pollution stocks is shown to exist under certain conditions.     

A state-contingent production approach to principal-agent problems with an application to point-source pollution control

Two basic representations of principal-agent relationships, the ‘state-space' and ‘parameterized distribution' formulations, have emerged. Although the state-space formulation appears more natural, analytical studies using this formulation have had limited success. This paper develops a state-space formulation of the moral-hazard problem using a general representation of production under uncertainty. A closed-form solution for the agency-cost problem is derived. Comparative-static results are deduced. Next we solve the principal's problem of selecting the optimal output given the agency-cost function. The analysis is applied to the problem of point-source pollution control.     

Consistency and optimality in a dynamic game of pollution control II: Monopoly

This paper continues a line of research begun in Batabyal (1995a). I model the interaction between a regulator and a monopolistic, polluting firm as a Stackelberg differential game in which the regulator leads. The firm creates pollution, which results in a stock externality. I analyze the intertemporal effects of alternate pollution control measures. The principal issue here concerns the dynamic inconsistency of the optimal solution. Inter alia, I compare the steady state levels of pollution under optimal and under dynamically consistent policies.