An Introduction to the Law and Economics of Environmental Policy: Issues in Institutional Design: Volume 20

In 1998, UNECE Member States completed negotiation of the Aarhus Convention to enhance public participation in environmental decision-making. Three years later, only two western democracies have ratified the agreement. This paper suggests why parliamentary democracies in Western Europe have been slow to ratify the Convention. We argue that their political structure discourages strong public participation in bureaucratic policy making, in contrast to separation of powers regimes, such as the United States. To illustrate our point, we discuss examples from the U.S., selected European countries, and the European Community, which has separation-of-powers features similar to the U.S.

Strong versions of the Precautionary Principle (PP) require regulators to prohibit or impose technology controls on activities that pose uncertain risks of possibly significant environmental harm. This decision rule is conceptually unsound and would diminish social welfare. Uncertainty as such does not justify regulatory precaution. While they should reject PP, regulators should take appropriate account of societal aversion to risks of large harm and the value of obtaining additional information before allowing environmentally risky activities to proceed.

In recent years there has been a debate over whether or not moral sentiments should be included in normative economic analysis. This paper compares the standard normative criteria for benefit cost analysis, Kaldor-Hicks, that does not include moral sentiments with a modification that does called KHZ. The choice between these criteria should rest on which is the most acceptable and useful. The conclusion is that KHZ dominates KH even by the standards of KH itself and that its use illuminates certain problems in environmental law and economics such as comparing projects with compensation and those without and whether discount rates should be used in evaluating the far future.

The paper focuses on the question of the extent to which individual preference-based values are suitable in guiding environmental policy and damage assessment decisions. Three criteria for “suitableness” are reviewed: conceptual, moral and legal. Their discussion suggests that: (i) the concept of economic value as applied to environmental resources is a meaningful concept based on the notion of trade-off; (ii) the limitations of the moral foundations of cost-benefit analysis do not invalidate its use as a procedure for guiding environmental decision making; (iii) the input of individual preferences into damage assessment is compatible with the basic foundations of tort law; (iv) using individual preference-based methods provides incentives for efficient levels of due care; (v) determining standing is still very contentious for various categories of users as well as for aggregating non-use values. Overall, the discussion suggests that the use of preference-based approaches in both the policy and legal arenas is warranted provided that they are accurately applied, their limitations are openly acknowledged and they assume an information-providing rather than a determinative role.

Most theories of environmental instrument choice focus exclusively on differential compliance costs. But compliance costs comprise only part of the total costs of environmental protection. Administrative costs - particularly the costs of measuring emissions and monitoring compliance - can differ significantly between environmental instruments. Those administrative cost differentials may offset the compliance cost advantages commonly associated with economic instruments, such as tradeable permits and effluent taxes. Moreover, measurement and monitoring constraints may increase ex ante uncertainty over the differential costs and benefits of alternative regulatory policies. That uncertainty may militate against selecting regulatory instruments that appear superior from the perspective of models focusing exclusively on compliance-cost differentials.

We address in this paper the problem of comparing and choosing among different policy instruments to implement the incentive objective of an efficient deterrence of environmental degradation and the remedy objective of an efficient clean-up of damages and a proper compensation of victims. Two main instruments are considered, namely the assignment of legal liability for environmental damage, such as in the American CERCLA and in the European White Paper, including extended liability provisions, and the design of an incentive regulation framework. Our results derive from a formal and structured analytical approach to modeling the economic interactions between different decision makers such as governments, firms, regulators and financiers.

In this paper, some particularities of environmental insurance are addressed. First, the paper summarizes the general conditions of insurability. Then, it is explained why insuring environmental liability may be difficult. Specifically, the necessity of an adequate risk differentiation may be difficult to obtain in cases of environmental liability. Then, it is explained how, at the theoretical level, a move towards different insurance schemes (notably first party or direct insurance schemes) provides a solution to problems of insurance of environmental liability. Although the move towards first party or direct environmental insurance may seem attractive at a theoretical level, nevertheless a variety of practical questions may arise. The alternative utilized in practice is not first party insurance (whereby victims would take out insurance coverage), but a form of direct insurance, whereby environmental damage is insured directly, that is to say as soon as damage occurs and irrespective of liability. The paper then discusses a recent example of such a direct environmental insurance, as it was applied in the Netherlands. Although this system seems to have considerable benefits, the major disadvantage lies in the fact that apparently all insurers in the Netherlands moved to this new environmental damage insurance. This raises important questions as to the competitiveness of the particular market.

In recent years, there has been a steady rise in the use of marketable permits in environmental regulation. They have been employed as tools to control both air and water pollution, and have been implemented on local, regional, and national scales. These trading regimes - based upon a single market in emission permits - do not control the distribution of emissions throughout the trading region or prevent the formation of “hot spots” of pollution. In this chapter, we propose a marketable permit scheme that is consistent with the attainment of ambient standards and that does not significantly interfere with the benefits of trading.

The problem of intentional environmental harms is discussed as the combined consequence of limited liability laws and specific capital structures. When the conditions are “right”, then the option of planned liquidation is optimal for certain types of firms. These firms are typified by capital structures that make it easy for them to engage in “hit and run” strategies on their industries, i.e. they operate with the intention of early exit. When this is the case it can be demonstrated that mandatory insurance forms of institutions are inadequate to the regulation of this particular problem. It is necessary to engage some manner of continuous monitoring institution, capable of observing and identifying when the capital structure of the firm begins to resemble those that would choose to engage in strategic liquidation. The paper concludes by stating that it might be possible to introduce private sector (bonding) institutions that perform this function, but it is more likely that a combination of public and private sector institutions will be able to best undertake the combined monitoring/insurance role that this requires. In short, the paper recommends that the public sector should have the obligation to monitor/audit all limited liability institutions for the existence of the pre-conditions for “looting” behaviour, and then to charge these firms for limited liability in order to cover the costs of the monitoring. In this way the costs of incorporation would be raised sufficiently to render the worst forms of looting unlikely from the outset.

Financial assurance rules, also known as financial responsibility or bonding requirements, foster cost internalization by requiring potential polluters to demonstrate the financial resources necessary to compensate for environmental damage that may arise in the future. Accordingly, assurance is an important complement to liability rules, restoration obligations, and other regulatory compliance requirements. The paper reviews the need for assurance, given the prevalence of abandoned environmental obligations, and assesses the implementation of assurance rules in the United States. From the standpoint of both legal effectiveness and economic efficiency, assurance rules can be improved. On the whole, however, cost recovery, deterrence, and enforcement are significantly improved by the presence of existing assurance regulations.

This paper investigates the economic implications of applying different sanctions, notably criminal penalties, the suspension or revocation of licences and administrative fines to environmental regulatory contraventions. Using familiar economics of law enforcement models, we predict that the almost exclusive reliance by British environment agencies on criminal justice sanctions leads to under-deterrence. We argue that the agencies should be given powers to levy administrative financial charges from offenders without the procedures and onus of proof with which the criminal process protects defendants, but which also inhibits prosecution. The German system of Ordnungswidrigkeit provides an excellent model for this purpose.

Enforcement of any rule or regulation is where ‘the rubber hits the road’. Many economists and policy analysts have been guilty of proposing and promoting legal and regulatory instruments having given scant or no regard to the problems that might surround their implementation. Having said this, a significant and rapidly growing economics literature (both theoretical and empirical) has sought to think through some of the practical issues of implementation. Many of its conclusions for policy are not always obvious, and sometimes downright surprising.