Analysing different forms of regulation

Generally the implementation of any form of environmental regulation re­quires that the quantity of polluting emissions and the monetary costs of the damage caused by an eventual accident should be determined.

In each case, informational problems can derive from closely monitoring the firm’s conduct, for example, its emission levels, and these problems can lead to an inefficient level of enforcement and to overdeterrence. But these issues need to be analysed in connection with each regulatory instrument.

There are different forms of regulation: public-oriented command-and- control instruments that require the use of a particular technology or the observation of a performance standard, prescribing the maximum amount of pollution that a source can emit; and market-oriented instruments that are essentially pollution taxes or a system of tradable permits. Supporters of command-and-control technology requirements have clashed with devotees of incentive-based approaches advocating taxes and tradable allowances (Wiener, 1999).

Under highly restrictive conditions, it can be shown that both environmen­tal policy instruments share the desirable feature that any gains in environmental quality are obtained at the lowest possible cost (Baumol and Oates, 1975). Hahn and Stavins (1991, p. 6) commented:

Theoretically, the government could achieve such a cost-effective allocation of the pollution control burden among sources if it could ensure by some means that all sources controlled at the same marginal cost. However, such an approach would require the government to have detailed information about the cost functions of individual firms and sources - information that the government clearly lacks and could obtain only at great cost, if at all.

With regard to command-and-control instruments, regulatory measures are generally defined and imposed by agencies that prescribe what measures a firm should take to prevent harm. Therefore, the existence of an agency charged with meeting these objectives is assumed. The essence of the agency activity is to control the actions of many individuals and independent actors (firms, households, other government units), and to induce them to take constraining actions contrary to their narrow self-interests (Bohm and Russell, 1985). These measures can be imposed by general rules or individual licences, taking the form of emissions standards based on a particular quality or quantity of emissions in the environment. Non-compliance with such stand­ards is usually enforced by administrative or criminal sanctions.

Command-and-control instruments set uniform standards for firms: on one hand, such instruments force all firms to shoulder an equal share of the mitigation burden, regardless of the relative costs of this burden to them even if the same firms can adopt preventive measure at much less cost than others; and on the other, the command-and-control instruments directly and effec­tively limit dangerous emissions.

In its application, this regulation system has proved to be well suited to setting policies regarding the definition and implementation of standards. The centralized search facilities, the continual oversight of problems and a broad array of regulatory tools can make the regulation system capable of system­atically assessing environmental risks and of implementing a comprehensive set of policies. But, regulatory agencies may not be very flexible in adapting to changing conditions, and a centralized command structure relying on expert advice may be subject to political pressure as well as to collusion and capture by the regulated firms.

We can distinguish between different kinds of standards: technology or performance. In the former, the firm is not free to choose the measures by which it will achieve a certain environmental quality; this is literally a com- mand-and-control instrument which imposes a certain technology that has to be used by the firm.

The performance-based standard does not stipulate any particular equipment to be used to comply with a regulation to achieve a specific ecological goal, thus giving private parties a certain amount of flexibility. This feature can be an advantage in relation to the informational problems connected in general with the use of command-and-control instruments: the agency activities are not costless - checking the behaviour of the actors against applicable regulatory orders, or determining what is owed by way of emission charges implies some expense; the activity of monitoring is another cost for the agencies; there is also the so-called ‘capture’ problem - public agencies can be motivated by financial rewards and promises of promotion or there can be a connection between their own and their firm’s interests given that they are vulnerable to bribery from third parties or from the offenders they are supposed to monitor.

We can now analyse other kinds of regulatory instruments, which, in contrast to command and control, do not directly prescribe what the behav­iour of potentially polluting firms should be. A Pigouvian tax, for example, is a way to attribute a price to pollution that will be incorporated by the firm in the price of its products, but the incentive for the adoption of abatement techniques relies on the market mechanism because if a firm does not apply the optimal techniques, it will produce more pollution, pay more taxes and sell its products at a higher price than its competitors. Market-based instru­ments as regulatory devices that shape behaviour through price signals rather than explicit instructions on pollution-control levels or methods, are often described as ‘harnessing market forces’ because they can encourage firms and individuals to undertake actions that serve both their own financial inter­est and public policy goals (Stavins, 1998).

Using these instruments, rather than traditional command-and-control ones, provides a dynamic incentive for technology innovation. This is accom­plished by allowing firms to share the burden of pollution control more efficiently through encouraging them to achieve reductions in pollution more cheaply. So market-based instruments such as taxes and tradable permits should generally be preferred to technology requirements and fixed emissions standards because the incentive-based instruments are typically far more cost-effective and innovation generating than their alternatives (Keohane et al., 1997). In particular, these instruments could provide continuous dynamic incentives for the adoption of superior technology, since it is always in the interest of firms to clean up more if sufficiently inexpensive clean-up tech­nologies can be identified (Jaffe and Stavins, 1995).