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Environmental Regulation



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Environmental Regulation in Vertically Coordinated Industries by Rimjhim Aggarwal and Erik Lichtenberg WP 01 13 Department of Agricultural and Resource Economics The University of Maryland College Park ENVIRONMENTAL REGULATION IN VERTICALLY COORDINATED INDUSTRIES by Rimjhim Aggarwal aggarwal14 home com and Erik Lichtenberg erikl arec umd edu Department of Agricultural and Resource Economics University of Maryland College Park Maryland 20742 5535 Abstract Many notable pollution problems occur in industries where production is carried out under vertical coordination arrangements that are characterized by conditions of double moral hazard In contrast to situations characterized by full informatio n we show that standard prescriptions of environmental economics do not apply Imposing a Pigouvian tax equal to the marginal cost of pollution does not lead to the first best level of pollution The equilibrium levels of production and pollution are not independent of which agent is taxed Making either agent or the industry as a whole financially liable for full environmental damage at the margin similarly does not lead to a first best level of pollution On the contrary under conditions of double moral hazard the industry should pay for less than the full cost of environmental damage At present only one agent if any is typically liable for environmental damage We derive conditions under which imposing new regulations that make only one agent financially responsible for the full cost of environmental damage as conventional wisdom in environmental policy suggests is excessively stringent in that it results in pollution and production that are less than the first best levels We also show that such new regulations could result in negatively correlated deviations of pollution and production from their first best levels a situation that cannot arise under conditions of complete information JEL Classification Q2 L51 L22 K32 Keywords Environmental regulation pollution vertical



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