Peter W. Kennedy

Environmental Policy and Time Consistency: Emissions Taxes and Emissions Trading

The authors examine policy problems related to the use of emissions taxes, and emissions trading, two market-based instruments for controlling pollution by getting regulated firms to adopt cleaner technologies. By attaching an explicit price to emissions, these instruments give firms an incentive to continually reduce their volume of emissions. Command, and-control emissions standards create incentives to adopt cleaner technologies only up to the point where the standards are no longer binding (at which point the shadow price on emissions falls to zero). But the ongoing incentives created by the market-based instruments are not necessarily right, either. Time-consistency constraints on the setting of these instruments limit the regulators ability to set policies that lead to efficiency in adopting technology options. After examining the time-consistency properties of a Pigouvian emissions tax, and of the emissions trading, the authors find that: 1) If damage is linear, efficiency in adopting technologies involves either universal adoption of the new technology, or universal retention of the old technology, depending on the cost of adoption. The first best tax policy, and the first-best permit-supply policy are both time-consistent under these conditions. 2) If damage is strictly convex, efficiency may require partial adoption of the new technology. In this case, the first-best tax policy is not time-consistent, and the tax rate must be adjusted after adoption has taken place (ratcheting). Ratcheting will induce an efficient equilibrium if there is a large number of firms. If there are relatively few firms, ratcheting creates too many incentives to adopt the new technology. 3) The first-best supply policy is time-consistent if there is a large number of firms. If there are relatively few firms, the first-best supply policy may not be time-consistent, and the regulator must ratchet the supply of permits. With this policy, there are not enough incentives for firms to adopt the new technology. The results do not strongly favor one policy instrument over the other, but if the point of an emissions trading program is to increase technological efficiency, it is necessary to continually adjust the supply of permits in response to technological change, even when the damage is linear. This continual adjustment is not needed for an emissions tax when damage is linear, which may give emissions taxes an advantage over emissions trading.

Learning about environmental damage: implications for emissions trading

In this paper the impact of adjusting the supply of tradeable emission permits on incentives for cleaner technology adoption is examined. Two policy rules for adjusting the supply of permits are considered: open market operations; and a proportional adjustment rule under which the regulator expropriates permits from individual firms in proportion to their existing permit holdings. Adjustment via open market operations is neutral with respect to cleaner technology investment decisions but may be politically difficult to implement. The proportional adjustment rule is also neutral with respect to investment decisions and at the same time allows more flexibility from a political perspective.

Information processing and organization design

Abstract This paper examines the optimal structure of an organization in which analysts are hired to process information on behalf of a principal decision-maker whose attention is limited. I focus on the case where information processing exhibits declining complexity . This means that information processing becomes less complex as it progresses. The optimal organization design is determined endogenously as an optimal response to the limitations of the principal decision-maker in her attention to communication and supervision and to the limited processing ability of the analysts. I examine serial and parallel processing structures. I show that the optimal serial structure is ordered by ability. This ordering reflects specialization according to comparative advantage in processing. The choice between a serial structure and a parallel structure involves a tradeoff between the benefits of specialization in the serial structure and lower communication costs in the parallel structure.

Equilibrium incentives for adopting cleaner technology under emissions pricing

Policymakers sometimes presume that adopting a less polluting technology necessarily improves welfare. This view is generally mistaken. Adopting a cleaner technology is costly, and this cost must be weighed against the technologys benefits in reduced pollution and reduced abatement costs. The literature to date has not satisfactorily examined whether emissions pricing properly internalizes this tradeoff between costs and benefits. And if the trend toward greater use of economic instruments in environmental policy continues, as is likely, the properties of those instruments must be understood, especially for dynamic efficiency. The authors examine incentives for adopting cleaner technologies in response to Pigouvian emissions pricing in equilibrium (unlike earlier analyses, which they contend, have been generally incomplete and at times misleading). Their results indicate that emissions pricing under the standard Pigouvian rule leads to efficient equilibrium adoption of technology under certain circumstances. They show that the equilibrium level of adopting a public innovation is efficient under Pigouvian pricing only if there are enough firms that each firm has a negligible effect on aggregate emissions. When those circumstances are not satisfied, Pigouvian pricing does not induce an efficient (social welfare-maximizing) level of innovation. The potential for inefficiency stems from two problems with the Pigouvian rule. First, the Pigouvian price does not discriminate against each unit of emissions according to its marginal damage. Second, full ratcheting of the emissions price in response to declining marginal damage as firms adopt the cleaner technology is correct expost but distorts incentives for adopting technology ex ante. The next natural step for research is to examine second-best pricing policies or multiple instrument policies. The challenge is to design regulatory policies that go some way toward resolving problems yet are geared to implementation in real regulatory settings. Clearly, such policies must use more instruments than emissions pricing alone. Direct taxes or subsidies for technological change, together with emissions pricing, should give regulators more scope for creating appropriate dynamic incentives. Such instruments are already widely used: investment tax credits (for environmental research and development), accelerated depreciation (for pollution control equipment), and environmental funds (to subsidize the adoption of pollution control equipment). Such direct incentives could be excessive, however, if emissions pricing is already in place. All incentives should be coordinated.

Industry structure and compliance with environmental standards

Abstract This paper analyses the relationship that exists between the expected level of non-compliance with environmental regulations and the number of firms in the industry. It shows that the larger the number of firms, the higher the equilibrium expected probability of compliance.

On Inferring the True Model's Direction

Using a recently-suggested definition of the direction of a model, it is shown that the direction of the true model relati ve to rejected non-nested alternatives can be inferred from the sign of an easily-calculated statistic. In some cases, this inference can be made by looking only at the signs of the relevant J or Cox statist ics.