Rainbow Environmental students are often taught the precautionary principle, in which if a condition exists that there is clearly a potentially irreversible threat to the environment, cost-effective actions must be taken to protect the environment despite the lack of scientific proof. Although we can say that the air quality today has dramatically improved from that of sixty years ago, we can also say that there is always room for improvement.

The Need for Policy

Like any other externality, smog results in high costs and inefficiency to society in terms of welfare benefits to be gained. Left on its own, the market is unlikely to correct for this externality. Consequently, the need for policy arises.

Today, we have the Clean Air Act and several other governmental agencies, notably the EPA, trying to abate such problems as smog. Like most other environmental issues, control is usually done on a source-by-source basis (Davies 35). In other words, regulations are enforced against individual polluters based upon a polluter pay principle. Because the exact costs of the externalities is difficult to measure-simply because everyone has their own valuation methods and because of the uncertainty arising from identifying a scientific cause-and-effect relationship-policies are generally "second-best" and are based upon judgment on a defensible standard.

Smokestack Yet, policies are far from perfect in reaching the desired results. In a report released this month by the American Lung Association, it was found that 142 million Americans-75% of the nation's population living in counties with ozone monitors-were still living in unhealthy smog conditions ("The State of the Air 2002 Report"). In fact, more than 70% of those living in monitored counties and who were considered to be most susceptible or highly sensitive to smog lived in a county receiving an "F" rating in ozone pollution (ibid.). Additionally, problems have arisen in which policies have been delayed or put on hold due to legalities and other issues ("142 Million Americans"). In another case, the EPA is considering mitigating some restrictions or even withdrawing some of its recent proposals including the provision called New Source Review-which would require 17,000 of the nation's oldest and dirtiest power plants, refineries, and industries to meet emission standards through the adoption of newer facilities and control devices (ibid.). As it is turning out, policy decisions and implementation is becoming more difficult than otherwise predicted. Here we will take a closer examination on some of the policy implications and policy alternatives related to the correcting of the smog externality.

Back to top

The Need for Government Intervention

Washington DC It is difficult to imagine any policy on air pollutants not being implemented by the government itself or by some government agency like the EPA. There are several logical responses that explain this observation. For a first, clean air is a free resource or public good, subject to the problem of free riding. In such a case, government provision is perhaps the most efficient method in obtaining and distributing unrealized gains. For a second, as of today's technology, air cannot be collected and run through a giant filter. This implies that regulations must be implemented at the source of the output of pollution. Perhaps no single entity has as much power as government authorities. Given that industries are unlikely to regulate themselves, the role of the government becomes obvious. Lastly, the Coase theorem states that externalities can be corrected without government intervention only if property rights were clear and enforceable, there is perfect information, and there are no transaction costs. In the case of clean air, all three conditions seem to be violated one way or another. Property rights to clean air, for example, have not been explicitly assigned, and if it were to be, it could be a complicated issue. As for perfect information and no transaction costs, the simple fact that there are currently 286 million people in the United States and 6 billion people worldwide makes it obvious that these two conditions would not hold in reality. Even at a local level, we still deal with heterogeneous individuals who, in most cases, do not have perfect information. Moreover, transaction costs increase as the problems of smog, while having its greatest effects on immediate areas, become boundary-less and affect distant areas. It is thus no wonder why government intervention is so prevalent in the area of air quality.

Back to top

The Different Methods of Valuation of Externalities

The call for government intervention often assumes that an optimal quantity of emissions or a desired standard is known. Unfortunately, this is often an unrealistic case, and as a result, attempts must be made to measure the benefits and costs of clean air in order to determine optimal amounts of pollution regulation.

Sunny Sky As can be predicted, the process of placing a monetary value on clean air is difficult within itself. Like most environmental resources, market valuation of clean air seems awkward. After all, clean air is not traded in any observable market, unless the price of indoor air filters is considered to be a relevant measure for clean air. Moreover, market prices often fail to represent values of externalities and other non-use benefits (Zilberman 9.6). An alternative method that makes use of market prices is hedonic pricing. In such a case the value of property in smog prevalent cities can be compared with those in cleaner air neighborhoods as to determine a price for clean air (Hall and Brajer 350). This has the advantage of capturing the value placed on clean air by consumers without having to ask them directly-which could lead to inaccurate self-reporting ("Studies" 137). Likewise, as mentioned earlier, many people have spent thousands of dollars and hundreds of commuting hours just to live in less polluted areas (Nebel and Wright 534). This suggests the possibility of the use of travel cost methods as to infer some of the non-market values of clean air. Unfortunately, these methods assume that people do place a value on clean air and that such a relationship is reflected in their actions.

An even simpler method of valuing cleaner air can be derived using either the control cost valuation method or the mitigation cost valuation method. Under the control cost method, benefits of environmental regulation are determined by first calculating the costs of mandatory control technologies and their associated reductions in emissions, and then dividing the two figures to get a value in cost per unit of emissions ("Studies" 142). Similarly, the mitigation cost valuation method estimates the benefits of environmental regulation through the use of prospective mitigation costs-as opposed to current regulation costs-given that no action is taken now (ibid.). The biggest advantage of these two methods is the simplicity and availability of information necessary to calculate the environmental costs (ibid.). Unfortunately, these methods are under criticism for using circular reasoning; while analysts agree that it is important to compare the costs and benefits of regulation, they also argue that it is almost impossible to do so when estimates of environmental benefits are calculated based upon environmental costs avoided (ibid).

On the other hand, contingent valuation surveys people directly as to determine the maximum amount an individual is willingness to pay (WTP) for cleaner air. Alternatively, willingness to accept (WTA) aims to determine the minimal amount an individual will accept to forgo cleaner air. Eventually deriving a demand curve, this method has the advantage of estimating non-use values of environmental amenities. Moreover, proponents of this method point out that because people are not policymakers who must have the public interest in mind, they are not subject to being biased towards valuing cleaner air more or less than what they would actually place (ibid. 141). Of course, there is always the problem of other biases, and in some cases, hypothetical cases can lead to unreasonable answers conflicting with basic principles of economic theory (ibid.).

Woman A more recent attempt to measure the externalities of smog directly is the cost of illness method. The first economic valuation method developed in the context of health and safety, the cost of illness method places a monetary value on the effects of air pollution based upon real medical costs incurred and market determined wages lost due to illness (Hall and Brajer 349). Although it could cover some aspects of health not covered by other methods-such as mortality and morbidity-it does not account for losses associated with leisure time, lost school or unpaid work time, and misery (ibid. 351, 354). Thus, the estimate is, at best, a minimal estimate. Nevertheless, accompanied with WTP and WTA measures, the cost of illness method could be a relatively comprehensive measure of some of the externalities relating to smog.

An accurate depiction of the value of smog regulation can influence the determination of an optimal quantity of emission. This, in turn, can have significant policy implications in a cost-benefit analysis aimed in determining whether a certain policy proposal should be accepted or rejected. Consequently, several critiques are raised when valuation methods are used to measure environmental benefits. For a first, valuation methods are subject to problems with uncertainty. Critics have pointed out that a direct cause-and-effect relationship between smog and illness is difficult to establish. For a second, the issue of double counting has been problematic. Pollutants are likely to cause overlapping health symptoms, making it difficult to associate a specific health effect to any one source of pollutant (ibid. 360). For a third, critics argue that placing a monetary environmental effect fails to capture aspects in which a monetary value cannot be placed ("Studies" 150). For example, the environmental costs associated with the degree of irreversibility may be infinite. However, with growing amounts of experiments and studies, and with greater care as to be conscientious of the possibilities of double counting and other externalities, these problems should be somewhat appeased over time.

Despite the critiques, it should be noted that valuation methods aim at providing a numerical aspect as to assist the decision-making processes. Nothing beats a thorough understanding of all the scientific, technical, economical, political, and financial aspects of a proposal. Unfortunately, in a world where time waits for no one, and where information is not perfect, economic valuation provides a mean to quantify potential costs and benefits.

Back to top

The Policy Alternatives

Washington DC There are many alternative strategies the government can take to abate smog. Perhaps most familiar are the cases in which the government implements a direct control policy. This can mean anything from setting speed limits to requiring by law that firms use cleaner fuels, that industries install flue-gas scrubbers, that automobile manufacturers install catalytic converters into cars, and that car owners make frequent smog checks, to licensing or auctioning off of polluting rights. In the opposite extreme, voluntary actions by polluters themselves can be encouraged through the increase of public awareness and education on the benefits of car-pooling, cycling, or walking. In all these instances, however, these approaches alone are unlikely to have huge impacts on the reduction of emissions for one reason or another. Thus, in most cases, they complement other policies, in which we now turn to.

Perhaps most common are pollution standards or emission regulations, in which each firm is allowed to emit only a certain quantity of pollutants. A targeted level of permissible emissions can be allocated among firms based upon historical emission levels, or an equal allocation method, or some hybrid version of the two-such as a proportional allocation based upon market share. Firms that do not comply with these standards are subject to heavy fines, usually for each additional unit of pollution or emission generated. Essentially, this strategy was seen as a way to force heavy polluting industries into developing newer and better control technologies (Barbour 144). The results, however, have been mixed.

In the auto industry, the pressure to meet deadlines for exhaust emission standards on new automobiles led to short-term, high-cost solutions rather than practical long-term, cost-efficient procedures (ibid.). Moreover, penalties for each car not in compliance with the statutory standards were so high as to be capable of shutting down the automobile industry, thus making the threat implausible (ibid.). Yet even if the threats were credible, firms were only required to meet preset regulations and standards, as opposed to continuously adopting newer technologies to obtain emission levels below that of the permitted line (ibid.). The lack of incentives to self-improve, therefore, means that newer and stricter standards would have to be constantly set if continuous decline in emissions is to be achieved.

From an economic perspective, however, the main concern was on the loss in economic efficiency. As seen in a Hochman-Zilberman model, implementing a standard causes the shut down of high polluting but also high productivity firms while keeping low polluting and low productivity firms (Zilberman 5.9). This loss in output results in one efficiency. Another efficiency loss arises when heterogeneity causes marginal benefits between firms to differ. In such a case, overall welfare is not maximized, as some firms would benefit from polluting more while others would benefit from polluting less. In other words, there are gains from trade. This idea that there are gains from trade suggests an extension on the strategy of standards by making it market-based. That is to say, emission trading through tradable permits would be able to solve some of the efficiency losses seen with standards.

Smokestack The best example of tradable permits in the realm of air pollution perhaps arises from the sulfur dioxide markets established as a result of the United States Clean Air Act in 1990 (Elsom 170). The logic behind these tradable permits, as with any other tradable permits, was to allow firms who were unable to meet emission standards, either through the switching of low-sulfur fuel or purchasing scrubbers, to purchase emission credits from firms that had gone beyond meeting the standards and thus had excess emission credits in which they could sell (ibid.). Firms that could not meet their emission limits were liable to heavy fines. In cases where firms shut down, the emission credits that they carried would be non-transferable and retired (ibid.). Theoretically, national emissions would be reduced, and welfare would be maximized at the lowest cost to firms as marginal benefits across firms equalized.

The sulfur dioxide trading markets were indeed seen to be successful in several lights. Emissions were reduced. It was easy to implement, although it required close monitoring (ibid. 171). And it was estimated to have saved industries $2 billion per year in implementation costs relative to traditional command and control methods (ibid.). Nevertheless, several problems still remained unresolved. For a first, the problem with a lack of incentives to continuously reduce emissions beyond set standards still existed. For a second, tradable permits did not take into account the fact that different areas have different vulnerabilities to pollution. For example, one area may consist of many heavy polluting firms, while another area may consist of several less polluting firms. Tradable permits, then, would allow the area with highly polluting firms to purchase credits in order to continuously pollute at the same or even higher levels. Thus, while tradable permits reduced emissions nationally, the reduction will be distributed unequally among areas, with some areas experiencing a worsening of air quality (ibid.). Accordingly, economists have advocated an alternative strategy of taxes and subsidies in controlling air pollution.

Taxes, in their abilities to directly affect costs, offer the advantages of providing economic incentives and avoiding the regional biases in reducing emissions. In cases where emissions can be monitored, a tax proportional to the amount of pollutants emitted could be implemented. In cases where emissions are not as easily measurable, or where the costs of doing so are high, an alternative solution to tax outputs or inputs that are directly related to the generation of air pollutants can be made. Whichever the case, producers and consumers are given the freedom to seek their own best alternatives in continuously reducing costs through the continuous reduction in pollutant emissions. What is important is that a best-response scenario would mean that the tax rate is binding such that emissions are reduced to desired levels. This can be done either through the reduction of polluting generating activities, the adoption of newer and cleaner technologies, or the substitution towards cleaner fuels and material inputs. For producers like the heavily sulfur dioxide emitting plants, taxes translated into more installations of scrubbers, continuous private research and development activities, and the use of cleaner fuels (Barbour 145). For consumers, a higher "smog tax" or gasoline tax meant more car tune-ups, the purchases of cleaner and more gas-efficient cars, or less driving (ibid.). Yet, in the opposite extreme, higher pollution taxes in industries may simply mean a reduction in output production, leading to such unfavorable outcomes as higher prices and unemployment.

Because subsidies are viewed as negative taxes, their affects on pollution reduction are similar to those of taxes. In essence, a subsidy acts as a payment in exchange for the reduction of pollution or pollution-generating activities or an encouragement to adopt and develop pollution-reduction alternatives (Zilberman 5.14). This is done through several forms, of which investment tax credits, accelerated depreciation, and performance award payments are among the most common (Gerhardt 89). Unfortunately, subsidies are lacking in several perspectives. First, not all governments have the funds to support such a program. Second, to the extent that subsidies are used to encourage corrective actions or research and development activities, subsidies may fail in that they only reduce net costs of investments, not eliminate them (ibid.). Consequently, cheap "quick-fix" solutions may be chosen over the more expensive, long-term, economically efficient and effective alternatives (ibid.). Moreover, with the fact that not all research and development activities turn out fruitful, it could be the case that millions of dollars are wasted on unsuccessful attempts, in which little or no change in emissions results.

Traffic Jam Whatever the case, it should be noted that despite the numerous alternative policies the government can choose in reducing emissions, the ultimately decision and choice is often influenced by factors outside the economic realm. Because popularity and votes are often what counts in the political arena, government officials are often swayed to choose one policy over another. Generally speaking, taxes are undesirable, subsidies are favored, and standards lie somewhere in between with more weight towards being favorable than unfavorable. Of course, these generalizations are subject to change under different circumstances. For example, when the government is in need of funds to support various programs, a pollution tax may seem like the best solution in not only curbing the amount of pollutants released into the air, but also in raising the necessary tax revenues. However, turn the situation around and make it into an election year and it is most likely that subsidies or standards will be implemented instead of the tax. Taxes are, after all, highly visible, and as politicians know, the populace is generally more tolerant towards hidden costs than visible costs (Barbour 146). Likewise, standards can achieve the same reduction as a tax with smaller reductions in total outputs, and thus, smaller impacts on prices and employment (Zilberman 5.10). Because the burden of restrictions is often felt most by the poor who drive older cars and who are more vulnerable to price fluctuations, politicians must be conscientious of the various social impacts certain policies may hold. Ultimately, then, the political economy and the issue of the distribution of welfare can play a significant role in the determination of which policy is implemented.

Back to top
 © 2002 Felicia Su | All Rights Reserved
Works Cited
Pictures courtesy of Corbis, EyeWire, FPG International, Hulton|Archive, Illustration Works, The Image Bank, National Geographic, PhotoDisc, Stone, and Toyota