Costs of Environmental Regulation

[Econ 2277](
[Prof. Richard L. Sweeney](

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Overview of next two lectures


What comes to mind when you think of environmental policy costs?

Economic Concept of Costs

Opportunity Cost: value of whatever must be sacrificed in order to obtain something (i.e. foregone net benefits)

Types of costs

Private compliance costs

Government regulatory costs

Social Welfare Costs

Definition: Losses in consumer and producer surplus due to rise in price or decrease in output of good and services (caused by regulation)

Basic Story: if regulation leads to increase in price of good, leads consumers to buy less of good and/or switch to substitutes, leading to a decrease in surplus.

Indirect costs:

General equilibrium costs:

Example: Fracking

title_img_2row Fracking = Multistage hydraulic fracturing + horizontal drilling

Incredible Increase in US Oil Production


Problem: Wastewater


Hydraulic Fracturing Background

Policy Proposal

Consider a regulation which would require firms to either pre-treat or recycle water

How can we estimate the total cost of this proposal?


First imagine the regulation applies to a single well


Initial quantity:

Initial profits:

Regulation shifts MC up by $10


New quantity:

Policy profits:

So full opportunity cost larger than actual expenditure, but smaller than an “engineering” approach that ignores behavioral response.

Now imagine it applies to all 10K wells in the US


Assume aggregate demand curve:

To get aggregate supply, note that quantity is now 10,000 times bigger at every MC:

$Q = 1,000,000$

If entire industry faces regulation, both consumers and firms respond


To find the new Q’: Q’ = 90 P’ = 55

Change in surplus:

What about general equilibrium effects?

Do you think they might be large?

What are some spillovers in this setting?


Who bears the cost of regulation?

• In the previous example, both consumer and producer surplus declined even though the statutory burden was imposed solely on producers

• This is a key point: Incidence of a tax (or regulation) is independent of the side the tax is imposed on

Example: Gasoline Excise Taxes


What is the economic incidence of these taxes?

Statutory burden does not equal economic incidence


Statutory burden does not equal economic incidence


What does determine incidence?

The true burden of regulation depends on the relative responsiveness of demand and supply

Elasticity of demand:

Elasticity of supply:

Inelastic factors bear taxes


Elastic factors avoid them


Inelastic factors bear taxes; Elastic factors avoid


Formula for tax incidence

Fraction paid by consumers:

Fraction paid by producers:

Consumers bear full burden if:

Producers bear full burden if:

What determines these elasticities?



What about the long run?

Are things more or less elastic?

What about incidence among subgroups?

Ultimately, costs are borne by individuals

Either consumers, taxpayers, or shareholders


Employment Effects


(Photo by Win McNamee/Getty Images)

Group discussion

Do you think the employment effects of environmental regulation are likely large or small?

  1. Yes or no (justify your answer)

  2. What factors determine whether the effects are large or small?

Some Context on Employment

Here are some highlight from the most recent BLS monthly labor report.

Over past 12 months: hires totaled 66.7 million and separations totaled 64.2 million, yielding a net employment gain of 2.5 million

Some Context on Employment


Source: Politifact

Extent of employment effects depends on regulatory asymmetry

Gross Job Losses Can Be Large

Greenstone (2002) found that the counties unaffected by the Clean Air Act gained 590,000 jobs relative to those affected as a result.

However, we actually care about net jobs.

When might we actually care about gross numbers too?

Why all the fuss then?

One snarky WaPo article noted that the entire coal industry employs fewer people than Arby’s.

However, as a reply noted:

The average coal salary is $$$15 - 30 per hour, while the average fast food worker makes $$$8.

So what really matters is how long you’re out of work, and the difference in salaries.

Empirical evidence suggests these transition costs can be large

Walker (2016) looked at workers in plants regulated under the 1990 Clean Air Act, and found that

Should we explicitly be counting jobs in BCA?

Summary on jobs

Next week: Jobs are a cost not a benefit!


Policy costs my a be offset by innovation

Hypothesized in a very influential article by Michael Porter

“Weak” version of the Porter Hypothesis

“stringent policies should trigger greater investment in developing new pollution-saving technologies. If these technologies induce input (e.g., energy) savings that would not have occurred without the policy, they may offset part of the compliance costs”

Group discussion:

Do you believe the weak Porter hypothesis?

Induced innovation has long history in economics

Sir John Hicks (1932): “a change in the relative prices of the factors of production is itself a spur to invention, and to invention of a particular kind-directed to economizing the use of a factor which has become relatively expensive”

Newell, Jaffe, Stavins (1999)

Study spike in energy prices in 1970’s


NJS (1999)

Find firms responded by making more efficient appliances


What about the “strong” version of the PH?

“Porter and van der Linde (1995b) go further, arguing that environmental regulations can actually “trigger innovation that may more than fully offset the costs of complying with them,” i.e., lowering overall production costs and boosting competitiveness”

Group discussion:

Do you believe the strong Porter hypothesis?

What about the strong Porter hypothesis?

Porter and van der Linde (1995), gave several examples:

At Ciba-Geigy’s dyestuff plant in NewJersey, the need to meet new environmental standards caused the firm to reexamine its wastewater streams. Two changes in its production process-replacing iron with a different chemical conversion agent that did not result in the formation of solid iron sludge and process changes that eliminated the release of potentially toxic product into the wastewater stream-not only boosted yield by 40 percent but also eliminated wastes, resulting in annual cost savings of $740,000 (Dorfman, Muir and Miller, 1992).

Similarly, 3M discovered that in producing adhesives in batches that were transferred to storage tanks, one bad batch could spoil the entire contents of a tank. The result was wasted raw materials and high costs of hazardous waste disposal. 3M developed a new technique to run quality tests more rapidly on new batches. The new technique allowed 3M to reduce hazardous wastes by 10 tons per year at almost no cost, yielding an annual savings of more than $200,000 (Sheridan, 1992).

What do we think of these examples?

In order for Porter to shape how we think about regulation, such examples must be quite common

Would imply:

1) that firms are making large mistakes - possible

2) government intervention triggers attention in a way that corrects these - hardly obvious

Takeaway on Porter


Required Readings

KO pages 35-44
Porter (1991) [link]
RFF Blog [link]
Dechezleprêtre and Sato (2017) [link]