PALMER, Tightening Environmental Standards - The Benefits-Cost or the No-Cot Paradigm.pdf

8/12/2019 PALMER, Tightening Environmental Standards - The Benefits-Cost or the No-Cot Paradigm.pdf

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Journal of Econom ic Perspectives Volume9, N umber 4 Fall1995 Pages 119132

Tightening Environmental Standards:The Benefit-Cost or the No-CostParadigm?Karen Palmer, Wallace E. Oates,and Paul R. Portney

M ichael Porter and Claas van der Linde have written a paper that is in-teresting and, to us at least, somewhat astonishing. It is a defense ofenvironmental regulation indeed, an invitation to more stringent reg-ulationthat makes essentially no reference to the socialbenefits of such regula-tion. This approach contrasts starkly with the methods that economists and otherpolicy analysts have traditionally used when assessing environmental or other reg-ulatory program s.The traditional approach consists of comparing the beneficial effects of regu-lation with the costs that must be borne to secure these benefits. For environmentalregulation, the social benefits include the reductions in morbidity or prematuremortality that can accompany cleaner air, the enhanc ed recreational o pportunitiesthat can result from water-quality improvements, the increased land values thatmight attend the cleanu p of a hazardous waste site, the e nha nce d vitality of aquaticecosystems that might follow reductions in agricultural pesticide use or any of theother potentially significant benefits associated with tighter standards. From thisbenefit-cost approach emerges the standard tradeoff discussed in virtually everyeconomics textbook.Porter and van der Linde deny the validity of this approach to the analysis ofenvironm ental regulation , claiming it to be an artifact of what they see as a "staticmindset." In their view, economists have failed to appreciate the capacity of

Karen Palmer is a Fellow at Resources for the Future, Washington, D.C. (e-mail:[email protected]). WallaceE. Oates isProfessorof Economics, University ofMaryland CollegePark, M aryland, and University Fellow, Resources for the Future, Washington, D.C.([email protected]). Paul R.Portney is VicePresident Resourcesfor the Future, Washing-ton,D.C. ([email protected]).


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120 Journal of Economic Perspectives

stringent environmental regulations to induce innovation, and this failure has ledthem to a fundamental misrepresentation of the problem of environmental regu-lation. There is no tradeoff Porter and van der Linde suggest; instead, environ-mental protection, properly pursued, often presents a free or even a paid lunch.As they put it, there are lots of $10 bills lying around waiting to be picked up.

We take strong issue with their view. If this were simply a m atter of intellectualsparring, it would be inconsequential outside academe. But their view has found aready audience in some parts of the policymaking community. For example, VicePresident Gore (1992, p. 342) writes that "3M, in its Pollution Prevention Paysprogram, has reported significant profit improvement as a direct result of its in-creased attention to shutting off all the causes of pollution it could find." If envi-ronmental regulations are essentially costless (or even carry a negative cost ), thenit is unnecessary to justify and measure with care the presu med social benefits ofenvironmental program s. Stringent environmental m easures (of the right kind) aregood for business as well as the environment; in the Washington parlance, we haveourselves a "win-win situation." Not surprisingly, this view has also been warmlyreceived by environmentalists and by regulators eager to avoid being seen as im-posing unwanted costs on businesses or lower levels of government. At a time ofburgeoning interest in Congress in the economic justification for federal regula-tions,Porter and van der Linde suggest the cost of environmental regulation maybe negligible or even nonexistent.

To clarify the points that are in dispute, we should state at the outset that weagree with Porter and van de r Linde on a num ber of matters. First, we share theirenthusiasm for a heavier reliance on incentive-based regulation in lieu of comman d-and-control. Early returns suggest, for example, that tradable permits for sulfurdioxide emissions will reduce the cost of the 1990 acid rain control program by atleast 50 percent when measured against the most likely command-and-control al-ternative (Burtraw, 1995; U.S. Gene ral Accounting Office, 1994; Rico, 1995). Sec-ond, we agree that early estimates of regulatory compliance costs are likely to bebiased upward because of unforeseen technological advances in pollution controlor prevention. Third, we accept that providing information, such as in EPA's"Green Lights" program (through which the agency provides technical assistancecon cern ing energy-efficient lighting ), may well help disseminate new technologies.Fourth, we acknowledge that regulations have sometimes led to the discovery ofcost-saving or quality-improving innovation; in other words, we do notbelieve thatfirms are ever-vigilantly perched on their efficiency frontiers.On this last point, however, we do not find Porter and van der Linde at allconvincing concerning the pervasiveness of inefficiencies. The major empirical ev-idence that they advance in sup port of their position is a series of case studies. Withliterally hund reds of thousands of firms subject to en vironmental regulation in theUnited States alone, it would be hard notto find instances where regulation hasseemingly worked to a polluting firm's advantage. But collecting cases where thishas hap pen ed in no way establishes a general presum ption in favor of this outcom e.It would be an easy m atter for us to assemble a matching list where firms have found


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Karen Palmer,WallaceE. O ates, and Paul R. Portney 121

their costs increased and profits reduced as a result of (even enlightened) environ-mental regulations, not to mention cases where regulation has pushed firms overthe brink into bankruptcy.What is neede d, we believe, is a mo re systematic approa ch to the issue. Follow-ing a general observation to put things in context, we begin with a model in whichincreasing the stringency of incentive-based environmental regulations mustresultin reduced profits for the firm. This model is incomplete in various ways, but itprovides a useful baseline for th e succeeding discussion. From this baseline, we canthen explore the sorts of changes in the model that could produce the result thatregulation leads to higher profitsthe outcome that Porter and van der Lindeseem to suggest is the no rm . We are then in a better position to assess the evidenceand the weight of their case.

Innovation and Environmental Regulation: An O bservationPorter and van der Linde accuse mainstream environmental economics, withits "static mindset," of having neglected innovation. This charge is puzzling. Forseveral decades now, environm ental economists have made their case for incentive-based policy instruments (such as effluent charges or tradable emission permits)

precisely by emphasizing the incentives tha t these m easures provide for innovationin abatem ent technology (Kneese and Bower, 1968, p. 139). Virtually every stand ardtextbook in environmental economics makes the point that incentive-based ap-proaches are perhaps more attractive for reasons of dynamic efficiency than fortheir ability to minimize the costs of attaining environmental standards at any par-ticular point in time. A substantial literature has developed in recent years thatexplores the effects of various policy instruments on research and developmentdecisions concerning abatement technology, a literature on which we shall draw inthis discussion.1What distinguishes the Porter and van der Linde perspective from neoclassicalenvironmental economics is no tthe "static m indse t" of the latter. It is two oth erpresumptions. First, they see a private sector that systematically overlooks profitableopportun ities for innovation.2Second, and equally important, they envision a reg-ulatory authority that is in a position to correc t this "ma rke t failure." 3With properlydesigned measures, regulators can set in m otion innovative activities through which1The reader interested in exploring this literature might begin with Magat (1978), Downing and White(1986), Malueg (1989), Milliman and Prince (1989), Parry (1992), Biglaiser and Horowitz (1995) andSimpson (1995).2 This, incidentally, seems a rather odd and sad commentary on the private sector to be coming fromone of the country's eminent business professors and consultants.3This "m arke t failure," incidentally, is quite different in chara cter from the usual public goods argum entthat private firms underinvest in research and development because they will have difficulty appropri-ating enough of the social benefits. What Porter and van der Linde have in mind is a failure of privatedecision makers to respond to private profit opportunities.


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firms can realize these overlooked opportunities. Their vision thus suggests a newrole for regulatory activity in bringing about dynamic efficiency: enlightened reg-ulators provide the needed incentives for cost-saving and quality-improving inno-vations that competition apparently fails to provide. Regulators can, as Porter andvan der Linde put it, help firms "to overcome organizational inertia and to fostercreative thinking," thereby increasing their profits.4We find this view hard to swal-low, and suspect that m ost regulated firms would share our difficulty.

Environmental Regulation and Com petitiveness: A Prop ositionDrawing on some of the early literature on innovation in abatement technol-ogy, we now present a model in which even incentive-based environmental regu-lation results in reduced profits for the regulated firm. The model essentially for-malizes the basic point that the addition (or tightening) of constraints on a firm'sset of choices cannot be expected to result in an increased level of profits. Readersuninterested in the analytics may wish to skip to the next section.We emphasize that this model is static in character and fails to address theinhe rent uncertainty in research and development (R&D) decisions. In this sense,it is subject to precisely the sort of criticism that Porter and van der Linde level intheir paper. However, for the same reason, it provides a useful point of entry into

the issue. Th e m odel is premised on the assumption that the polluting firm maxi-mizes profits and operates in a perfectly competitive market; the firm takes com-petitors' outputs and R&D expen ditures as given and also takes any regulations asexogenously determined. Given these assumptions, the model does not allow forany sort of strategic interaction. The possible effects of relaxing these assumptionsand allowing game-theoretic strategic interactions among firms, or between thepolluting firm and the regulator, will be discussed in the next section of this paper.Figure 1 depicts the polluting firm's options. The horizontal axis shows the"aba tem ent level," so that the re duction in pollution increases as one moves fromleft to right. The vertical axis is measured in dollars, which means that one cangraph both the firm's cost of various levels of pollution abatement and comparethose costs with market-oriented effluent charges imposed by environmental reg-ulators. Th e MAC curve (without a star) is the firm's prese nt "marg inal abatem entcost" function; it indicates the marginal cost incurred by the firm to reduce pol-lution by an additional unit. The upward slope of the curve implies that the mar-ginal cost of reducing pollution is rising.4 I t is unclea r wheth er Po rter an d van der L inde view this exp ande d role for regulation as a gen eralproposit ion, or wh ether i t is l imited to enviro nm ental regulation . They app ear to suggest the la t ter whenthey con tend that as waste emissions into the env ironm ent, " [Poll ution ] is a manifestat ion of eco nom icwaste and involves unnecessary, ineffic ient or inco mp lete uti l iza tion of resources. . . . " This we also f indpuzzling. W heth er i t is effic ient to recycle wastes, to discharge them into the envi ronm ent o r to ado ptan entire ly new technology that employs fewer polluting inputs dep end s on th e costs (mea ning, of course ,the full social costs) of th e various alternatives.


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Tightening Environmental Standards: The Benefit-Costor the No-CostParadigm? 123

Figure 1The Incentive to Innovate under an Emission Fee

Let us now assume that the firm could, if it chooses, reduce its marginal abate-m en t cost function from the curve MAC to MAC*. Notice th at with MAC*, a givenmarginal expenditure has a greater effect on pollution abatement than it wouldhave with MAC. However, to move from MAC to MAC*, the firm must spend moneyto research a nd develop new pollution abatem ent technology. To simplify the prob-lem, we will assume that the R&D expenditure necessary to move from MAC toMAC* is known completelythere is no risk or uncertainty.This m odel will presume market-oriented regulators who use effluent chargesto encourage pollution abatement. As long as a profit-maximizing firm can abatepollution itself for less than the effluent charge, it will choose to do so. However,after the point where the cost of abating pollution exceeds the effluent charge, thefirm will prefer to pay the cha rge. Let us assume tha t the firm is initially confron tedby an effluent charge ofP.It chooses its profit-maximizing level of abatem ent ac-tivity,A , corresponding to the point B , where marginal abatement cost equals theeffluent charge.If the firm has been operating at abateme nt levelA , an implication is that the(annua lized) cost of the R&D effort to reduc e MAC to MAC* must exceed the gainsto the firm. The R&D investment in additional pollution-abatement technologywon't pay off; thus outcome B must produce more profits for the firm than doesthe attainable pointC . Figure 1 also depicts the gains to the polluting firm fromundertaking the R&D effort, which can be divided into two parts. The source ofthe first part is that the earlier level of abatement activity becomes cheaper; theamount of gain here is given by the triangle OFB.The second part comes from thenew technology. The company will choose to abate a greater a m oun t of po llution


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124 Journal ofEconomic Perspectives

and thus avoid paying the pollution charge on that additional pollution; the gainhere is the triangle BCF.The total gains to the polluting firm from innovation would thus be the areabounded by OFCB. Since the firm has not chosen this option, it must be that thecost of the R&D program that would move the firm from MAC to MAC* exceedsthe area of the profit tha t would be gained, OFCB.Now, assume that the environmental authority introduces a new, more strin-gent market-oriented environmental standard, taking the form of an increase inthe effluent fee to P . Without further assumptions, one cannot say whether thefirm will respond to the higher effluent charge by sticking with the old technologyand ending up at H or by investing in the new one and ending up atD .5But wewill prove that both H and D generate lower profits than B.Therefore, it will beunambiguously true in this model that the h igher effluent standard red uces profitsfor the firm.It is straightforward to show tha t if the firm sticks with its old technology, thehigher effluent charge must reduce its profits. In this case, the firm moves from Bto H , and while this higher level of pollution abatement may be better for society,the firm is unambiguously worse off. It is paying the same am ount to aba te p ollutionup toB as it was before . BetweenB andH , it is paying more to abate pollution thanunder the previous, lower effluent charge. And above H , it is paying the highereffluent charge rather than the previously lower one. 6It is only a bit trickier to demonstrate that profits atD , where the firm faces ahigher effluent charge with the new technology, must be lower than profits at B ,where the firm chose to face the lower effluent charge w ith its existing technology.Notice first that along the MAC* frontier, profits at choice D (given the highereffluent charge) must be lower than profits at point C , given the lower previouseffluent charg e. As already explained, if technology is constan t, the hig her effluentcharge unambiguously reduces profits. But the basis of this model was that at the

5What are some of the factors determ ining wh ether th e f irm chooses to respon d to a higher eff luentcharg e by investing in new technolog y? Overall, of course , the ques tion is wh ethe r th e cost-savings fromthe new technology exceed the R&D expenditures. Recent work offers some fur ther insights. Ulph(1994) shows that an increase in an emission tax rate may increase a firm's incentive to engage inenvironmental R&D, but is likely to decrease its incentive to engage in R&D of a general unit-cost-reducing nature , leading to an ambiguous effect on overall R&D expenditures and on the f irm's costs.Simpson (1995) suggests that when R&D is both cost reducing and emission reducing, the incentiveeffects of an increase in the emissions tax for R&D are lower the more R&D reduces marginal cost andthe more competitive are rival firms.6 This is an application of a more general principle that for a given technology, profit is decreasing ininpu t pr ices. In th e enviro nm ental econom ics l i tera ture , waste emissions are typically treated as an inpu t(a long with labor , capita l and so on) in the pro ductio n function. This is reasonable , since a t tempts tocut back on waste emissions will involve the diversion of other inputs to abatement activities, therebyreducin g the availabil ity of these oth er in puts for the prod uction of goods. Reductions in em issions, inshort , result in reduc ed o utpu t. Moreover , given the reasonable assum ption of rising marginal abate me ntcosts, it makes sense to assume the usual curvature properties so that we can legitimately constructisoquants in emissions and ano ther inpu t and treat them in the usual way. In this framework, the em is-sions fee becomes simply the price of an input called "waste emissions."


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Karen Palmer, Wallace E. Oates, and Paul R. Portney 125

lower effluent charge, the firm didn't find it worthwhile to invest in the new tech-nology; th at is, profits were lower a t C than a tB.By transitivity, if profits atB exceedC , and profits at C exceed D , then i t must be true that the higher effluent chargereduces profits for the firm, even if it adopts a new technology.

T hus , in this model of innovation in abatement technology, an increase in thestringency of environmental regulat ions unambiguously makes the pollut ing firmworse off. Even if the firm can invest and adopt a new, more efficient abatementtechnology, i f that technology wasn' t worth invest ing in before, i ts benefi ts won'tbe enough to raise the company's profi ts after the environmental standards areraised, ei ther.

This leads us natural ly to ask how one might amend the simple model to al terthis basic result . We point out that simply making the model dynamic and/or in-troducing uncertainty will not overturn this result. It is straightforward to show thatou r basic propos i t ion l ikewise applies to a fi rm th at maximizes the expe cted pres entvalue of future profits. What elements, then, are missing from this simplified modelthat could give rise to an increasein profits following th e im pos ition of tighte rstandards?

We can identify two such elements of potential importance. One possibi l i ty isstrategic behavior, perhaps involving interact ions between pollut ing firms, or be-tween these firms and the regulat ing agency, or between regulatory agencies indifferent countries. The second possibi l i ty ( the one emphasized by Porter and vander Lind e) is the existence of opp ortun it ies for profi table inn ovation in the p ro-duction of the firm's output that for some reason have been overlooked and thatwould be real ized in the wake of new and tougher environmental regulat ions. Thenext two sect ions take up these extensions to the basic model and present some ofthe relevant empirical evidence.

Strategic Interaction Among Polluters and RegulatorsIn the basic model , the pollut ing firm was operat ing in a competi t ive environ-me nt, taking as given both the behavior of com petin g firms and the stand ards set

by the regulato r. O ne im po rtan t l ine of extension of the analysis is the introd uctio nof strategic interact ion among the various part icipants. There is some recent andongoing work along these l ines. For example, Barret t (1994) has explored a seriesof models in which regulators and polluting firms behave strategically. He findsthat , in the spiri t of the Portervan der Linde thesis, there are indeed cases inwhich the government can actual ly improve the internat ional competi t ive posi t ionof domest ic expor ters by imposing envi ronmen ta l s tandards upo n them. O ne suchcase occurs if each firm takes the price of its competitor as fixed and then competesby setting its own profit-maximizing price. If the government sets a strong emissionstandardby w hich Barre t t mean s a s tandard beyond the point where the margina lbenefi ts of pollut ion control equal marginal abatement coststhe domestic f i rm'smarginal cost, and therefore its price, will rise. Recognizing that the domestic firm


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must charge a higher price to comply with the new standard, foreign com petitorsraise their prices without fear of retaliation. However, an increase in the foreignprice raises demand for the output of the domestic firm with a resulting increasein its profits. This result holds when the domestic industry is an oligopoly as wellas when it is a monopoly com peting in an oligopolistic international mark et. Itmayalso hold under Cournot competitionwhere each firm takes the quantity pro-duced by its competitors as given and competes by altering the quantity it pro-ducesif the domestic industry is an oligopoly, although this need not be thecase.In gen eral, however, this result is not robu st to o ther changes in the natur e ofthe strategic behavior. For instance, if the domestic firm is a monopolist in its hom ecountry and the domestic and foreign firm are Cou rnot com petitors, then the h om egovernment can improve the domestic firm's competitive position by reducing itsenvironm ental s tandards below the efficient level. Kennedy (1994) obtains a similarfinding in a model with Cournot competition.In another treatment of the issue, Simpson and Bradford (1996) develop astrategic trade model that explicitly includes R&D expenditures by firms. In thismodel, firms behave strategically both in setting levels of spending on R&D and inselecting output levels. The government regulates pollution through an emissionfee. Simpson and Bradford find that for certain specifications of the cost and de-mand functions, increasing the emission fee can increase domestic R&D invest-m ent, reduce foreign R&D spending an d increase domestic welfare (composed ofdomestic profits plus pollution fee revenues). However, they note that slight vari-ations in the form of the cost function can reverse these results. Ulph (1994) surveysa number of recent papers that explicitly incorporate strategic R&D investmentbehavior by firms. This body of work indicates that the effect of environmentalregulation on R&D is ambiguous and that even in the cases where highe r emissionsstandards lead to higher domestic R&D spending, go vernments may still be betteroff selecting a lower-than-social-cost emission tax rate to shift profits from foreignfirms to domestic firms.

Overall, this literature suggests tha t while it is possible to get results like thosethat Porter and van der Linde suggest are the norm from models that incorporatestrategic behavior, such results are special cases. In many instances, these samestrategic trade models suggest that the domestic authority should employ weaken-vironmental regulations to promote international competitiveness. Moreover, asBarrett (1994) and Simpson and Bradford (1996) suggest, there are typically othersorts of measures tha t are mo re effective at improving in terna tiona l competitivenessthan strategic environm ental regulatory policy. This bottom line does no t deny thePortervan der Linde argum ent entirely; certain kinds of strategic models can pro-duce outcom es of the type they describe. But it does seem to us that strategic m odelsare unlikely to establish anything close to a general presumption that stringentenvironmental measures will enhance competitiveness. In addition, such strategicbehavior is not what Porter an d van der L inde have in mind. We turn to their basiccontention now.


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Tightening Environmental Standards: The Benefit-Cost or the No-Cost Paradigm? 127

Regulation and OffsetsTheir claim is that technologies exist of which the firm is unaware until prod-ded into discovering them by stringent environmental regulations. They go on tocontend that such regulation will spur firms to innovate and that the newly discov-ered technologies will generally offset, or more than offset, the costs of pollutionabatement or prevention. Our response takes two very different tacks.First, we spoke with the vice presidents or c orpo rate directors for environm en-tal protection at Dow, 3M, Ciba-Geigy and Monsantoall firms mentioned by Por-ter and van der Linde in their discussion of innovation or process offsets. Whileeach manager acknowledged that in certain instances a particular regulatory re-

quirement may have cost less than had been expected, or perhaps even paid foritself each also said quite emphatically that, on the whole, environmental regula-tion amounted to a significant net cost to his com pany.We have little doubt about the general applicability of this conclusion. Fortu-nately, we need not confine ourselves to speculation and anecdotes about the per-vasiveness or the significance of pollution or innovation offsets. There are dataavailable on this matter, and they indicate that such offsets pale in comparison toexpenditures for pollution abatement and control.Each year the Environmental Economics Division of the Commerce Depart-m en t's Bureau of Econom ic Analysis (BEA) makes estimates of pollution aba tem entand control exp enditures in the United States. One source for these estimates areBureau of the Census surveys of manufacturing establishments, state and local gov-ernments, electric utilities, petroleum refiners and mining operations. Other in-formation is gathered on federal government expenditures on pollution control,the cost of solid waste disposal, individual spending for motor vehicle pollutioncontrol equip me nt and operating costs and o ther environme ntal spending, as well.In 1992, according to BEA, pollution abatement and control expenditures in theUnited States came to $102 billion (Rutledge and Vogan, 1994, p. 47).In addition to estimates of environmental spending, BEA also estimates themagnitude of the "offsets" that Porter and van der Linde claim are so pervasive.In fact, the Census Bureau survey of manufacturers (upo n which BEA relies formost of its information about offsets) specifically asks respondents to report "costoffsets," which are defined in such a way as seemingly to encompass both the"product" and "process" offsets that Porter and van der Linde describe (U.S.Commerce Department, 1994).7 For 1992, BEA estimates that cost offsets for the

7It is worth includ ing on e of the examples from the Census Bureau survey to illustrate how closely thesurvey conforms to the Porter and van d er Linde vision of offsets. Th e survey (U.S. Com merce Depart-ment, 1994, p. A-11) contains the following wording: "A manufacturer installs a closed loop recoverysystem in the production process so as to prevent the dumping of the chemicals into the water system.Since the closed loop recovery system recap tures and reuses the chemicals in the p roduc tion process, itreduces expenses for chemicals. The pollution abatement p ortion of the capital expenditure pertainingto the closed loop recovery system is reported in Item 7 [the section of the survey where new capital


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Karen Palmer, Wallace E. Oates, and Paul R. Portney 129

the consequent reduction in the rate of economic growth. Porter and van der Lindedeny the validity of this work on the grounds that it fails to factor offsets intoaccount . Since these offsets appear to be quite smallbased on both the reportsof those who make environmental investments, as well as on hard datathis ishardly a l iabil ity of the genera l equil ibrium app roac h.

One more word about offsets. Suppose that every single dollar a firm spent onpollut ion control or prevention was matched by a dollar of savings in the form ofproduct or process offsets described by Porter and van der Linde. Would i t thenbe the case that enviro nm ental regulat ion is free? Of course no t . The sacrif ice w ouldbe measured by other opportunit ies foregone. Firms can and do invest in changingthe size and skill mix of their labor force, in their capital base, in the sources andterm structure of their f inancing, their research and development strategies andoth er thing s, as well. Each of these investments is expe cted to do m ore than retu rnone dollar for each dollar spenttypical ly f irms must project returns that exceeda "hu rd le ra te" of 20 perce nt or mo re before un der takin g an investment . Thu s,even if environmental compliance produced offsets on a dollar-for-dollar basisrath er tha n on e dollar for every 50 spent , as the data suggest the foregon e retu rnon invested capital would still be a significant cost of regulation.

The International SettingThe original quest ion prompting this debate concerned the impact of envi-

ronmental regulat ions on the competi t iveness of U.S. industry in the internat ionalaren a. In a mu ch shorte r essay that appe ared several years ago in ScientificAmerican ,Porter (1991) argued that the perverse command-and-control character of mostU.S. regulat ion has seriously handicapped American firms in competi t ion with for-eign rivals. Making the case (with which we enthusiastically agree) for incentive-based policy measures, Porte r argu ed that U.S. f irms were losing out to co mp eti t ionfrom Germ an an d Japan ese com panies , which benef i t f rom mo re enl ightened reg-ulatory regimes.9

However, we believe the truth of the matter is rather different. It is not thecase that oth er countries, including G erman y or Jap an , have ma de bet te r use ofincentive-based appro ache s than the Un ited States. While oth er countries app earto have put in place regulatory programs that are less adversarial (and thereforeless t ime consu ming ) than certain U.S. prog ram s, most environm ental regulat ionin Europe looks every bit as proscriptive as does the U.S. version. In fact, visitorsf rom OECD and developing count r ies pour throu gh W ashington on a regular basis,t rying to learn about the sulfur dioxide trading program put in place here fiveyears ago .9 For a more detailed treatment of these particular issues, see our response (Oates et al. , 1993) to thePorter (1991) paper .


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Moreover, it is not clear that environmental regulation is harming the com-petitiveness of U.S. firms. In fact, Porter and van d er Linde acknowledge as mu ch,citing Jaffe et al. (1995, p. 157), who co nclude in their survey paper that "overall,there is relatively little evidence to support the hypothesis that environmental reg-ulations have had a large adverse effect on competitiveness, however that elusiveterm is defined."This finding is important, but it has little to do with innovation offsets. AsJaffe et al. (1995) po int ou t, the re a re several reasons why the relative stringencyof U.S. environmental regulation to date has not been found to have adverseeffects on com petitiveness. First, for all but th e m ost heavily pollutin g ind ustries ,the cost of complying with federal environmental regulations is a small fractionof total costs, sufficiently small (in most instances) to be swamped by interna-tional differentials in labor and material costs, capital costs, swings in exchangerates and so on. Second, although U.S. environmental regulations are arguablythe mo st stringent in th e world, thedifferentialsbetween U .S. standards an d thoseof our major industrialized trading partners are not very great, especially for airand water pollution contro l. Third, U .S. firms (as well as other mu ltinationals)appear inclined to build modern, state-of-the-art facilities abroad, irrespectiveof the stringency of environmental statutes in the host country. Thus, even asignificant difference in environ m ental sta nda rds betwee n, say, the Un ited Statesand a developing country will mean little to firms not willing to take advantageof lax stand ards.10This is no t to say tha t cost differentials stemm ing from intern ational variationsin environm ental regulations are n one xiste nt But as Jaffe et al. (1995, p. 159)conclude, these differentials "pose insufficient threats to U.S. industrial competi-tiveness to justify substantial cutbacks in dom estic environm ental regulatio ns."More basically, the case for redesigning environmental programs to make moreeffective use of market incentives has little to do w ith inte rna tiona l competitiveness;it's a much more straightforward issue of getting environmental value for the ex-penditures of social resources.

ConclusionThe underlying message from Porter and van der Linde about environmentalregulation is not to worry, because it really won't be all that expensive. But it will.Annual U.S. expenditures for environmental protection, net of any offsets, cur-

10The rationale for this behavior appears to be two-fold. First, there is a widespread percep tion thattighte r environmen tal regu lations in th e developing coun tries are inevitable, and th at it is less expensiveto invest initially in state-of-the-art abatement technology than it will be to retrofit later. Second, theaftermath of certain disasters, notably the Union Carbide catastrophe in Bhopal, India, has made man-agement aware of the dangers inherent in the adoption of less than state-of-the-art control technologiesin developing countries.


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Tightening Environmental Standards: The Benefit-Cost or the No-CostParadigm? 131

rently are a t least $100 billion, and probably considerably more . From society sstand-point, with the benefits of a cleaner environment figured into the balance, everydime of this money may be well spent; the literature is replete with examples ofenvironmental programs that pass a benefit-cost test. But a comparison of the ben-efits and costs is exactly how one should determine the economic attractiveness ofspecific programsnot on the false premise of cost-free controls. We are grateful for helpful comm ents on earlier drafts to Albert McG artland, RichardSchmalensee and the editors of this journal. We wish to thank the Environmental ProtectionAgency, the Nationa l ScienceFoundation a nd the Sloan Foundation for support that madethis work possible.

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