working the system: market enforcement of emission standards

Resource Economics
Stockbridge 217, UMass
Amherst

Dr Linus Nyiwul’s dissertation defense was conducted almost exclusively in the language of math, with very little generic English explanation for the non-resource management layperson. So I cannot write very much about it, except that it was obvious that his faculty members are excited about the potential of this framework Dr Nyiwul has created for government regulators to exploit market mechanisms by leveraging emissions standards against the needs of firms to attract investors.
There are a couple of premises that Dr Nyiwul builds upon, including a perception that investors would prefer to put their money into “green” companies, and evidence that companies who improve their own environmental management systems experience increases in stock value (e.g., Feldman 1996). Dr Nyiwul described a whole lot of complicated stuff that needs to be properly balanced:

  • setting a standard,
  • needing to monitor to ensure companies are meeting the standard,
  • keeping the cost of monitoring low enough to be reasonable (for government) while
  • making the threat of monitoring real enough that companies prefer to comply rather than risk being caught and having to pay the penalty.

LinusGRAPH.jpgSomehow all those things get crunched through some equations that calculate

  1. “marginal damage” (whatever this means! it apparently refers wholistically to “society”) and
  2. monitoring costs (to the government) and
  3. costs of compliance (for the firms)

…. now, where it gets real interesting is when the government establishes two emissions standards: a regular standard (the minimum to be deemed “in compliance” and avoid penalties) and an overcompliance standard – which would earn a special certification proving uber-greenness (or something en route to such glorified status). There is pilot project currently underway, the National Environmental Performance Track (NEPT), which has weaknesses but whose results – plugged into Dr Nyiwul’s equations – demonstrates that TWO STANDARDS IS GOOD POLICY! Not to mention that firms which earn the overcompliance certification have a special marketing asset to appeal to investors. (They have to meet the minimum “regular” standard first, then apply and demonstrate accomplishment of the overcompliance standard.)

There was some fancy problem-framing, as Linus described one finding, saying that it came about in one way if you set the problem up this way, and comes about in another way if you set the problem up that way. (I love the fact that subjectivity can be found in math!) There are some issues with firms getting to self-report emissions (apparently without verification, unless the regulator goes to conduct the actual monitoring?) And there was quite a discussion about looking at the problem endogamously: with free entry into and out of the market. And output and size effects really matter (but cannot be reversed) in terms of the direct and indirect effects of enforcement costs. Yea, I don’t really know what those sentences mean in “real” economic terms, but there may be other things in play at times which can lead to inconclusive results.
but…. drumroll please! Dr Linus Nyiwul concludes, and his faculty agree:

“An optimal tax rate is smaller than the social marginal damage for a fixed n and no market imperfections.”

The challenges that issue forth from Dr Nyiwul’s work include (in no particular order):

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  1. identifying which are the important uncertainties (given that anything could be uncertain except for whatever is under direct regulatory monitoring)
  2. defining clearly what “overcompliance” means (if “compliance” means paying the right tax, i.e., reducing emissions in order to minimize tax…. does overcompliance move a firm into a “credit” situation?)
  3. how to extend the framework from a single firm to an industry
  4. identifying how the framework as it is fits within known policy issues and concerns, and
  5. extending the frame beyond emissions to look at a lot of other policy issues.

5 thoughts on “working the system: market enforcement of emission standards”

  1. Steph,
    Thanks for such a great overview of Dr. Nyiwul’s (it’s very cool to type “Dr.”) work! You’ve been doing a fantastic job of “translating/interpreting” (I’m not sure which word is appropriate) people’s dissertation defenses.
    And Linus, if you are reading this, congratulations!
    –pete

  2. I think you did a good job after all the math and little or no words
    to accompany them. You are quite terrific in how you can absorb
    complicated stuff.
    Anyway, I may just add that there are two completely separate and
    different essays but there are clearly a mix of issues in both (did
    you notice that I used -some of the same- symbols in both essays?
    haha…). The 1st essay exploits market enforcement of emissions
    standards to design effective environmental policy. I thought your
    comments on the 1st essay were hilarious.
    I will elaborate on the second essay. The second is asking the
    question “what would the nature of an emissions tax be if the tax has
    to be enforced?” As of now, the idea of imposing emissions taxes is
    based on the fact that the government will rely on the firms to
    self-report their emissions. Well, you know how well that can go! What
    stops a firm from under-reporting its emissions and hence paying a
    smaller tax? There is every incentive for the firm to behave this way.
    You can take this incentive away by enforcing the tax. Enforcing the
    tax means that you monitor and punish the firm (through penalties) if
    it is found to be cheating. But monitoring is costly; you have got to
    hire and send inspectors to the facilities! Is that tax the same with
    and without costly enforcement. In my dissertation the answer is NO.
    Other distortions in the tax, addressed in my dissertation (and also
    addressed by others), include the potential for market power. So
    enforcement costs and the potential for market power are issues to be
    addressed when setting emissions taxes.
    (Note the idea of enforcement may sound sort of obscured. But we
    hardly have answers to the question of why this or that law is not
    being applied. Often, it is because it is simply not enforceable. The
    law was drafted and enforcement was an after-thought.)

  3. Hiya Linus, you gotta tell me what is so “hilarious” about what I wrote?!!! I’m sure glad it is amusing but is it because I got it so totally wrong or it’s just funny to see a layperson’s feeble attempt to understand?!!
    Whatever distinction between the two essays, they both refer to the same object, so I was more interested in making a larger inference based on the combined than in shaking out which ideas belonged with which essay.
    I also chose to emphasize the finding that there is a market power to be exploited for good environmental purposes. We need this! I understand that it is important to tease out the tax implications of whether or not one pays for monitoring (a high cost or a reasonable cost), but – rhetorically – the public and business need to be convinced that there is an incentive for compliance with climate change initiatives. Don’t weaken that effort by getting bogged down in a morass of details that have no firm conclusions!
    😀

  4. “It’s just funny to see a layperson’s feeble attempt to understand?!!” I guess that’s all it was. Your summaries are just fun to read. That’s all I meant.
    My comments were meant to provide more details (which I like a lot) and not subtract anything you wrote. I have no qualms with your summary, it’s a must read! You are good at it. You can tell I don’t have that skill just yet 🙂
    So I guess my hope was that by providing those details it makes it easier for someone wanting to make a good critique of my work. The issues raised by my research (some of which you listed) are what I’m looking for. It helps provide me with more research questions! The conclusions are there. They are important but they are only a part of the story. As they say “the devil is in the detail”. That’s only my $0.01 🙂
    I see where you are. You are already looking far and beyond the results/conclusions. Remember they are those who pick up and those who pick apart the results/conclusions of every piece of research. If I may dare say we all have each foot in both camps but I’m a little more entrenched in the latter, and for obvious reasons. Get what I’m sayin’? 🙂

  5. Pete! Thank you. 🙂 Especially since Linus is mostly laughing at me. Grin.
    I wish I could get to more of these . . . you’ll have to be sure and invite me to yours (soon enough, soon enough!)

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