Political economy, cost and efficiency aspects of market-based regulation: The case of tradeable permits under the Clean Air Act amendments of 1990.
Creators: name: Jayasinghe, Milan John Chrysustom.
Publisher: name: Université d'Ottawa / University of Ottawa
Year: 2000
Subjects: subject: Economics, Commerce-Business.

description: Market-based economic instruments have become increasingly important as alternatives to conventional methods of environmental regulation, as public policy makers are increasingly aware of the ineffectiveness of command and control regulation. A remarkable breakthrough in the search for lasting solutions to pressing environmental problems is the emergence of the tradeable permits. They recognize the need for establishing property rights prior to addressing the issues of environmental degradation, and offer solutions that are cost-effective, without requiring complex technical information about industry structures to monitor compliance. However, the current literature provides little guidance for evaluating the overall effectiveness of this new economic instrument. The lack of simultaneous emphasis on all of the important dimensions of market-based regulation led to conflicting views among economists as to the significance of tradeable permits, and the circumstances under which they perform effectively. In an attempt to resolve these different viewpoints, this dissertation undertakes an in-depth inquiry into three fundamental facets of tradeable permits, namely political economy aspects, cost aspects and efficiency aspects. The primary emphasis is on the U.S. SO2 emissions trading program which was accompanied by the Amendments to the U.S. Clean Air Act in 1990 (CAAA). Using a political economy framework, the dissertation examines the institutional dimensions of tradeable permits, and explores how they influence the instrument choice at different stages of the policy making process. The investigation uncovers a number of important linkages of political, social, legal and market conditions, whose interactions determine the desirability of market-based economic instruments over other alternatives. Using examples mainly from the United States, it demonstrates how the performance of tradeable permits depends on situation-specific characteristics of the above factors. The dissertation then considers the cost aspects of the tradeable permits in order to elucidate the behaviour of the affected firms, and to resolve conflicting views of the potential effects of the tradeable permits on the production costs of regulated industries. The investigation is based on an econometric framework and a large-scale data set representing coal-fuelled electric utilities operating in the United States. It reveals that there has been an upward pressure on the production costs of electric utilities in the aftermath of the CAAA, and that as a result, the utilities have adjusted their optimal mix of inputs by shifting away from pollution-intensive inputs. The empirical analysis of market-based regulation then explores efficiency aspects of tradeable permits, based on Data Envelopment Analysis (DEA) and a Tobit model. This reveals that tradeable permits created an incentive to search for "greener" production technologies as part of the compliance with the new market-based regulation. In particular, the resulting improvements to the existing power generation technologies surpass the increases in production costs. Therefore, the CAAA resulted in a net improvement in production efficiency of the U.S. electric utilities. This evidence is consistent with the latest findings of the literature, and supports the Porter hypothesis, that environmental regulation confers to firms a dynamic incentive to innovate.