[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

by 2 units and plant B by 4 units. The total cost is now only $3 + $5 or $8. We have
achieved the same overall reduction in pollution more efficiently by having the plant
that can cut emissions at a lower marginal cost (plant B) cut back the most.
If the two plants can participate in a market for permits, plant A would find it
advantageous to purchase a permit from plant B. By cutting back by only 2 units
instead of 3, plant A can reduce its costs by $3. Plant B, having sold a permit to plant
A, must cut its emissions back further, from a reduction of 3 to a reduction of 4. This
raises its costs by $2. As long as the price of a permit is between $2 and $3, both
firms gain. Society gains by achieving the desired reduction in emissions at the
least cost.
While the SO 2 tradable permit system has been in place only since the mid-1990s,
the evidence indicates that it has achieved emission goals in a cost-effective manner. 2
WEIGHING THE ALTERNATIVE APPROACHES
Incentive programs, such as taxes or marketable permits, have an important advantage
over direct controls, like regulations. The issue of pollution is not whether it
should be allowed—after all, it is virtually impossible to eliminate all pollution in an
industrial economy. Nor would such elimination be efficient; its costs would far
exceed its benefits. The real issue is how sharply pollution should be limited.
The marginal benefits have to be weighed against the marginal costs. This calculation
is not performed under regulation. If instead government ascertains the
marginal social cost of pollution and sets charges or marketable permits accordingly,
private firms will engage in pollution control up to the point at which the
marginal cost of pollution control equals the marginal social return of pollution
abatement (which is just the marginal cost of pollution). Each firm will have the
correct marginal incentives.
Governments often prefer direct regulations because they believe that they can
control the outcomes better. But such control can be illusory. If an unreachable standard
is set, it is likely to be repealed. For example, as automobile companies have
found the costs of various regulations to be prohibitive, they have repeatedly appealed
for a delay in the enforcement of those regulations, often with considerable success.
It must also be kept in mind that choosing the socially efficient method of pollution
abatement is the easy part of the policy problem. Figuring out the “right” level
of pollution to aim for is much harder. Uncertainty about the consequences of pollution
abounds, and how to value certain options is hotly debated. To what extent can
environmental degradation be reversed? How much value should be placed on the
extinction of a species like the spotted owl, or the preservation of the Arctic wilderness?
No matter what approach is chosen to externalities and the environment, such
questions will remain controversial.
2 See Richard Schmalensee et al., “An Interim Evaluation of Sulfur Dioxide Emissions,” and Robert N. Stavins,
“What Can We Learn from the Grand Policy Experiment? Lessons from SO 2 Allowance Trading,” in Journal
of Economic Perspectives 12, no. 3 (Summer 1998): 53–68, 69–88.
POLICY RESPONSES TO PROBLEMS IN THE ENVIRONMENT ∂ 415