Improving the environment with an initial government subsidy

Abstract

This paper attempts to study the approach of using government subsidies to mitigate negative externality, and aims to provide a system for the government to monitor the level of pollution and determine the optimal level of subsidy the level of pollution changes over time.First, literature on the effects of environmental changes is critically reviewed. It is found that the value of pollution mitigation measures was seldom investigated. The Pigovian and Coasian approaches in dealing with the externalities are investigated by a case of the provision of a balcony as a subsidy (negative tax) to the developers for mitigating air and noise pollution in Hong Kong. The results show that the “green” effects provided by a balcony are reflected in property prices. The value of a balcony reflects the privatized cost of pollution to the tenants. Given that transaction costs of negotiation and contracting between polluters and tenants are prohibitively high (irrespective of whether rights of pollution are assigned to either party), the market cannot resolve the problems of the external effects of pollution. This however, does not necessarily call for government intervention, as the information cost for the government to make the optimal decision is also very high. However, we believe that the government subsidy can be used to mitigate negative externalities by making indirect use of market information in Hong Kong. This is possible because the value of mitigating the housing market in Hong Kong is active enough for the estimation of the effects of pollution using a hedonic price model. We proposed an iterative process to solve the government’s problem of determining the optimal level of subsidy. A higher than optimal initial subsidy is necessary to ‘bootstrap’ the iteration process.