Environmental policy in vertically related markets with cross-ownership: emission taxes, standards, and permits

The sustainable supply chain network competition with environmental tax policies

Global environmental problems such as transboundary pollution and global warming have been recognized as major issues around the world. In practice, governments of all countries are actively exploring various environmental policies to control pollution. The government needs to consider the impact of neighboring regions when formulating environmental policies, especially in the context of transboundary pollution. However, the above problems are less studied, to bridge this gap and aim at solving problems in existing practices, we consider a differential game model of transboundary pollution control to examine which policy is more effective in promoting environmental quality and social welfare in a dynamic and accumulative global pollution context. Three alternative policy instruments, namely emission standards, emission taxes, and emission permit trading, are considered and compared. The results show that the social welfare of each region is the lowest and the total pollution stock is the highest under the emission tax policy due to the “rent-shifting,” “policy-leakage,” and “free-riding” effects. Moreover, the realized level of the environmental policy in the Nash equilibrium of the policy game is distorted away from the socially optimal level. The emission standards policy is found to be better than the emission tax policy and characterized by initiating the rent-shifting effect without the policy-leakage effect. Moreover, the pollution stock of two regions is found to be the lowest and the social welfare is found to be the highest under the emission permit trading policy, which is not associated with any of the three effects. Finally, a numerical example is used to illustrate the results, and a sensitivity analysis is performed in the steady state.

Three essays on prices vs. quantities in environmental policy

n n nThis dissertation studies the interaction between environmental policy, market structure andfirmsr incentives to invest in emissions reduction technology or emissions abatement researchand development (RaD). It consists of three individual papers. The first paper examines howthe intensity of market competition may affect the environmental policy. The second paperstudies the conditions under which the design of an environmental policy can be beneficial forfirms and society. The third paper analyses the effect of environmental RaD organisationalstructures on firmsr innovation activities, profits, and social welfare when the RaD outcome isuncertain.n n nThe first paper investigates the optimal environmental policy (the mix of emissions tax andRaD subsidy) when two firms, producing differentiated products, compete in the output marketover time. Firms compete over supply schedules, which encompass a continuum of marketstructures from Bertrand to Cournot. While production generates environmentally damagingemissions, firms can undertake RaD, which has the sole purpose of reducing emissions. In additionto characterising the optimal policy, we examine how the optimal tax and subsidy, and theoptimal level of abatement change as competition intensifies, as the dynamic parameters changeand as the investment in abatement technology changes. In this setting, increased competitionno longer necessarily leads to an increase in welfare. Instead, there are two forces. Competitionincreases welfare through its impact on the final goods price. However, lower prices result inlarger quantities and more pollution. Our contribution is to show how this impact depends onthe extent of the market, the nature of preferences and the technology.n n nThe Porter Hypothesis, formulated by Michael Porter (1991), states that a well-designedenvironmental policy could encourage innovation and be beneficial for firms and society. In thesecond paper, we investigate the conditions under which the design of an environmental policycan align social and private interests. Results consistent with the Porter Hypothesis are derivedwithout any behavioural assumptions or bounded rationality arguments, as it is commonly thecase in the related literature. N symmetric firms compete in the output market by producing andselling homogeneous goods. Production entails the emission of a pollutant, which may be taxed.The general conditions for firmsr profits and social welfare to be higher under an emissions taxthan under no tax are determined. The key insight is that, for the representative firmrs profit toincrease with an increase in emissions tax, the emissions tax cost pass-through must be greaterthan the net emissions per unit of production, adjusted for the number of competing firms. Asthe intensity of competition increases, firms are more likely to benefit from an emissions tax, asthe tax facilitates the exercise of market power.n n nThe third paper analyses firmsr and social plannerrs choices of RaD cooperation when theinnovation outcome is uncertain. Two firms compete in the output market by producing andselling homogeneous goods. Production entails the emission of a pollutant, which is taxed andinduces firms to invest in emissions reduction RaD. It is assumed that the RaD outcome isuncertain and firms can either choose to fully protect or fully share their RaD results. UnderRaD uncertainty, the highest payoff for the firm is when it succeeds in its RaD efforts whilstits rival fails. Subsequent ex-post asymmetries can also lead to one firm exiting the market. Thisintroduces additional strategic elements for the firm, leading to new insights regarding firmsrand social plannerrs preferences. It is shown that for lower levels of marginal environmentaldamages, firms and the social planner always prefer cooperation in RaD and information sharingas this leads to the highest expected profit and social welfare. For higher levels of marginalenvironmental damages, firms always choose to cooperate but not to share information. Thesocial planner also prefers firms not to share information but only to cooperate when they areefficient in their abatement RaD; under inefficient abatement RaD conditions, no cooperationin RaD and no information sharing leads to the best social outcome. The private level ofinvestment in RaD is always smaller than the social optimum.

Foreword D. Siniscalco. Preface C. Carraro, et al. Part One: Environmental Taxation, Market Structure, International Trade. 1. Emission Taxes and Market Structure Y. Katsoulacos, A. Xepapadeas. 2. Environmental Taxation, Market Share, and Profits in Oligopoly C. Carraro, A. Soubeyan. 3. Naive Use of Environmental Instruments U. Ebert. 4. Optimal Environmental Policy for Oligopolistic Industries under Intra-Industry Trade K. Conrad. 5. Choosing Emission Taxes under International Competition K. Conrad. 6. Strategic Environmental Policy and International Trade - The Role of Market Conduct A. Ulph. Part Two: Environmental Policy, Innovation and Market Structure. 7. Innovation under the Threat of Stricter Environmental Standards O. Cadot, B. Sinclair Desgagne. 8. Environmental Innovation, Spillovers and Optimal Policy Rules Y. Katsoulacos, A. Xepapadeas. 9. Environmental Policy and the Choice of Production Technology C. Carraro, A. Soubeyan. 10. Trade, Strategic Innovation and Strategic Environmental Policy - A General Analysis A. Ulph, D. Ulph.

This paper examines the performance of two environmental regulation policies – emission taxes and absolute standards – in a vertical market where an upstream foreign monopolist sells a specific input to two downstream multiproduct firms that generate pollution in the domestic country. Specifically, we use a three-stage game to analyze and compare the two policies for regulating downstream pollution. In the first stage, the domestic government determines an optimal tariff and sets one of the two instruments (taxes or standards) by maximizing social welfare, in stage two, the upstream foreign monopoly sets its input price, and finally, the downstream domestic firms independently make their output and abatement decisions for profit maximization. We find that total emissions are lower under the absolute standard. Nevertheless, the tax dominates the standard in terms of domestic welfare, consumer surplus, and downstream multiproduct firms’ profits. Thus, the tax equilibrium leads to a win-win-win situation compared to the standard equilibrium. These results show the non-equivalence of emission taxes and absolute standards in regulating downstream pollution. The analyses suggest that a pollution tax is an economically and politically feasible policy.

“Green” innovation, privacy regulation and environmental policy

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 regulator's 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.

The present paper examines how improvements in consumers' environmental awareness influence the choice between output and emission taxes, within a framework of imperfect competition and endogenous choice of abatement level. We first show that in the absence of policy intervention, there exists a level of environmental awareness beyond which welfare is decreasing as market imperfections become more prominent relative to environmental concerns. We also confirm that both output and emission taxes are welfare superior to the free‐market case. What is surprising, however, is that the welfare performance of an optimally chosen emissions tax is monotonically decreasing in consumers' environmental sensitivity, while the opposite is true for an output tax up to a certain level. At low levels of consumers' environmental awareness an emissions tax is welfare superior, but eventually, there is a level of environmental awareness beyond which an output‐tax welfare dominates an emissions tax. Therefore, an emissions tax is better suited to societies that have not yet developed high levels of environmental awareness, while societies characterized by high levels of environmental awareness should prefer an output tax.

Even as the evidence of global warming mounts, the international response to this serious threat is coming unraveled. The United States has formally withdrawn from the 1997 Kyoto Protocol; other key nations are facing difficulty in meeting their Kyoto commitments; and developing countries face no limit on their emissions of the gases that cause global warming. In this clear and cogent book-reissued in paperback with an afterword that comments on recent events--David Victor explains why the Kyoto Protocol was never likely to become an effective legal instrument. He explores how its collapse offers opportunities to establish a more realistic alternative. Global warming continues to dominate environmental news as legislatures worldwide grapple with the process of ratification of the December 1997 Kyoto Protocol. The collapse of the November 2000 conference at the Hague showed clearly how difficult it will be to bring the Kyoto treaty into force. Yet most politicians, policymakers, and analysts hailed it as a vital first step in slowing greenhouse warming. David Victor was not among them. Kyoto's fatal flaw, Victor argues, is that it can work only if emissions trading works. The Protocol requires industrialized nations to reduce their emissions of greenhouse gases to specific targets. Crucially, the Protocol also provides for so-called "emissions trading," whereby nations could offset the need for rapid cuts in their own emissions by buying emissions credits from other countries. But starting this trading system would require creating emission permits worth two trillion dollars--the largest single invention of assets by voluntary international treaty in world history. Even if it were politically possible to distribute such astronomical sums, the Protocol does not provide for adequate monitoring and enforcement of these new property rights. Nor does it offer an achievable plan for allocating new permits, which would be essential if the system were expanded to include developing countries. The collapse of the Kyoto Protocol--which Victor views as inevitable--will provide the political space to rethink strategy. Better alternatives would focus on policies that control emissions, such as emission taxes. Though economically sensible, however, a pure tax approach is impossible to monitor in practice. Thus, the author proposes a hybrid in which governments set targets for both emission quantities and tax levels. This offers the important advantages of both emission trading and taxes without the debilitating drawbacks of each. Individuals at all levels of environmental science, economics, public policy, and politics-from students to professionals--and anyone else hoping to participate in the debate over how to slow global warming will want to read this book.

Comparing the effectiveness of market-based and choice-based environmental policy

This paper develops a duopoly model to investigate the impacts of emission tax and standards on the firms’ green R&D cooperation strategy in network industries, where firms have the strategic option to decide whether to produce compatible goods. The results indicate that except in the case of asymmetric spillovers, firms will always choose to engage in cooperative green R&D, regardless of the degree of product compatibility and the type of environmental policy. We also find that, under cooperative green R&D, emission tax leads to higher green R&D investment and social welfare compared with emission standards. We finally show that both full and no product compatibility can occur for firms that choose cooperative green R&D, depending on the efficiency of green R&D and the environmental policy. Under the emission tax, firms have an incentive to be product compatible only when the efficiency of green R&D is low; otherwise, no product compatibility is the optimal strategy. However, under the emission standard, there is no incentive for firms to be compatible.

Comparing the Effectiveness of Market-Based and Choice-Based Environmental Policy

This paper investigates how environmental policies—emission tax and emission standard—affect the optimal environmental R&D (ER&D) risk choices of firms in a mixed market. The results show that for the private firm, ER&D risk is lower (higher) under the emission tax than under the emission standard when consumer environmental awareness is low (high). For the public firm, ER&D risk is always higher under the emission tax than under the emission standard. We also show that a privatization policy always decreases the ER&D risk of the public firm but is likely to increase the ER&D risk of the private firm. Finally, we find that the private firm faces considerable welfare risk when consumer environmental awareness is high under the emission tax. However, the private firm's incentive for ER&D risk is always lower than the social incentive under the emission standard.

We set up a two-country model in which a foreign firm chooses FDI or exporting to enter the host market, and plays a Cournot competition game with 11 host firms. Facing the host country's emission tax policy, all firms located in the host country use the same abatement technology to abate emissions. The major findings are as follows. When the trade cost is high and the abatement technology is efficient, a higher emission tax rate may encourage FDI. Moreover, under plausible parameters, raising the emission tax to drive the foreign firm out of the host country will be detrimental to environmental quality but raise consumer surplus in the host country. The interaction of the abatement technological efficiency and trade cost with emission tax plays a key role in the entry mode of the foreign firm and the associate welfare of the host country.