Policy Persistance in Environmental Regulation

We study the optimal emission standards under uncertain pollution damages and transaction costs associated with policy changes. We show that in many situations, the authority should avoid or reduce the scale of a policy change in the presence of future transaction costs. Then policy persistence is a rational response of forward-looking policy makers to future transaction costs, rather than a passive outcome of the current political process. Economists have long taught that the eÆcient level of e uent (or more generally any externality) occurs when the marginal bene ts and costs of pollution are equated. Despite this clear policy advice, there is considerable agreement that economists' in uence on environmental policy making has been modest (Hahn (2000)). Rather, there is a strong sense that many times it is the political process, in particular the interaction of interest groups, that shapes the nal design of environmental policy and any changes in that policy over time (Maloney and McCormick (1982), Keohane, Revesz and Stavins (forthcoming) and Yandle (1989)). An important reason for this belief is the predominant presence of policy persistence; the fact that policies such as pollution standards tend to change slowly if at all. Signi cant agreement is emerging in the literature concerning the diÆculty of reversing a policy once it has been established. For example, Coate and Morris (1999) shows that the introduction of a policy invites agents to undertake actions that allow them to bene t from the policy. These bene ts, in turn, create incentives for these agents to protect their interests in the form of political pressure and lobbying. Likewise, Dixit (1996) argues that \policy acts shape the future environment by creating constituencies that gain from the policy, who will then ercely resist any changes that take away these gains." Di erent voting rules (Fernandez and Rodrik (1991) and Alesina and Drazen (1991)) and aggregation methods (Sen (1977)) can also lead to di erent forms of policy inertia. In these papers, policy persistence is seen to be an outcome of the political process, replacing economic eÆciency as the determinant of a policy such as an emission standard. But, suppose the environmental authority is uncertain of the damages of the e uent and is cognizant of the transaction costs engendered by the political process associated with a future change in policy. How should the environmental authority set a standard that may need to be changed when additional information becomes available, when it knows those changes are costly? This is the question addressed by this paper. Speci cally, we study the optimal pollution standard