Enforcement and Environmental Quality in a Decentralized Emission Trading System

This paper addresses the issue of whether the powers of monitoring compliance and allocating tradeable emissions allowances within a federation of countries should be appointed to a unique federal regulator or decentralized to several local regulators. To this end, we develop a two stage game played by environmental regulator(s) and the polluting industries of two countries. Regulator(s) choose the amount of emission allowances to be issued and set the level of monitoring effort to achieve full compliance, while regulated firms choose actual emissions and the number of permits to be held. We identify various, possibly conflicting, spillovers among states in a decentralized setting. We show that cost advantage in favor of local regulators is not sufficient to justify decentralization. Nevertheless, cost differential in monitoring violations can imply lower emissions and greater welfare under a decentralized institutional setting than under a centralized one. However, while a better environmental quality under decentralization is a sufficient condition for higher welfare under the same regime, it is not also a necessary condition.Emissions Trading, Environmental Federalism, Enforcement, Monitoring Cost

Regulating unverifiable quality by fixed-price contracts

We apply the idea of relation contracting to a very simple problem of regulating a single-product monopolistic firm when the regulatory instrument is a fixed-price contract, and quality is endogenous and observable, but not verifiable. We model the interaction between the regulator and the firm as a dynamic game, and we show that, provided both players are sufficiently patient, there exist self-enforcing regula- tory contracts in which the firm prefers to produce the quality man- dated by the regulator, while the regulator chooses to leave the firm a positive rent as a reward to its quality choice. We also show that the socially optimal self-enforcing contract implies a distortion from the second best, which is greater the more impatient is the firm and the larger is the (marginal) effect of the contractual price on the profits the firm would make by deviating from the offered contract. Whenever the punishment profits are strictly positive, even if the firm were infinitely patient, the optimal contract would ensure a Ramsey condition but with positive profits to the firm. Our result also illustrates that, whenever the firm's output has some unverifiable component, optimal regulatory lag in fixed-price contract should be reduced to limit the reward of the firm's opportunistic behaviour.Quality regulation, relational contracts

Digging into the Technological Dimension of Environmental Productivity

We propose a mixture model approach to identify locally optimal technologies and to dissect environmental productivity (output produced per unit of emission) into a technological and a managerial component. For a large sample of plants covered by the EU ETS, we find that the share of plants adopting the frontier technology is about 21%. We also find that the average output gains that plants could reach by adopting optimal technologies and managerial practices are 75% and 80% respectively. These results remain qualitatively similar after addressing endogeneity of emissions. Finally, we match EU ETS data with balance-sheet data on parent companies and find that better environmental technologies tend to be adopted by larger, listed, multi-plant and international companies, while older firms and firms with higher intangibles assets intensity more commonly show improved environmental management. Our results suggest that existing technologies have large unexploited potentials and deliver important insights for policy

Indirect Taxation, Public Pricing and Price Cap Regulation: a Synthesis

It is well known that many standard results on optimal taxation and tax reforms have a straightforward counterpart in the monopoly pricing context and the Ramsey-Boiteux pricing rule represents the most obvious and well known example of this connection. What is less acknowledged, maybe even by many regulatory economists, is that this parallelism exists also with respect to a number of properties that characterize some types of price cap regulation. This paper reviews the economic literature that explored such properties, showing that there is a strong parallelism between the price cap results that are surveyed in this paper and those originating from the well-established theories on optimal indirect taxation and tax reforms, as well as public pricing

Estimating Environmental Compliance Costs at the Installation Level

We develop a new measure of installation-level environmental compliance costs under an Emissions Trading System (ETS) by estimating normalized demand curves of permits sector-by-sector. Our measure reflects installation-level compliance costs deviations within-sector and it is scaled by both the installation’s baseline output and the sector-specific abatement efficiency. An application to four sectors in Phase 3 of the EU ETS unveils a non-negligible within-sector variance and reveals that the installation-level dimension explains the largest part of it, while the country effect accounts for 7.7% to 11.4% of the total within-sector variance. This points to the installation-level dimension as mostly important when the impact of environmental regulations has to be assessed in practice

Regulating Unverifiable Quality by Fixed-Price Contracts

We apply the idea of relational contracting to a simple problem of regulating a single-product monopoly with unverifiable (then ex ante not contractible) quality. We model the interaction between the regulator and the firm as an infinitely repeated game; we observe that there exist self-enforcing contracts in which the regulator, using her discretionary power on the price (the contractible variable) can induce the firm to produce the required quality level by leaving it a positive rent. When players use grim trigger strategies, the optimal self-enforcing contract implies a distortion from the second best which is greater the more impatient is the firm and the larger is the effect of the price on the deviation profits. Whenever the equilibrium profits of the static game are strictly positive, even if the firm were infinitely patient, the optimal contract would not reach the second-best: it would ensure a quality-adjusted Ramsey condition and, at the same time, leave positive profits to the firm. We extend the model in a few ways: we find that when players use stick-and-carrot strategies, with an infinitely patient firm the second-best outcome is reached even if this implies to punish the deviating firm with negative profits. When instead the regulator is unable to perfectly monitor the firm’s quality choice, the price/quality pair giving the highest payoff to the regulator does not directly depend on the firm’s discount factor, which instead affects the probability of punishment. Our results suggest that, in fixed price regulatory contracts, the regulatory lag should be shorter the more relevant is the issue of unverifiability, in order to reduce the reward for opportunistic behavior by the firm

Enforcement and Environmental Quality in a Decentralized Emission Trading System

This paper addresses the issue of whether the powers of monitoring compliance and allocating tradeable emissions allowances within a federation of countries should be appointed to a unique federal regulator or decentralized to several local regulators. To this end, we develop a two stage game played by environmental regulator(s) and the polluting industries of two countries. Regulator(s) choose the amount of emission allowances to be issued and set the level of monitoring effort to achieve full compliance, while regulated firms choose actual emissions and the number of permits to be held. We identify various, possibly conflicting, spillovers among states in a decentralized setting. We show that cost advantage in favor of local regulators is not sufficient to justify decentralization. Nevertheless, cost differential in monitoring violations can imply lower emissions and greater welfare under a decentralized institutional setting than under a centralized one. However, while a better environmental quality under decentralization is a sufficient condition for higher welfare under the same regime, it is not also a necessary condition