Tietenberg Tom, Lewis Lynne. Environmental & Natural Resource Economics

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501Efficiency and Cost-Effectiveness

$/Unit

Amount of Precaution

Marginal Cost

of Precaution

Limited

Expected

Penalty

Normal Expected

Penalty

Q Q*

FIGURE 18.4 Oil Spill Liability

One problem with legal remedies is their high administrative cost; assigning the

appropriate penalties is no trivial matter. Even if the court were able to act expeditiously,

the doctrines it imposes are not necessarily efficient since the financial liability for

cleaning up spills is limited by statute. This point is demonstrated in Figure 18.4, which

depicts the incentives of a vessel owner to take precautions. The owner will minimize

costs by choosing the level of precaution that equates the marginal cost of additional

precaution, with the resulting reduction in the marginal expected penalty. The marginal

reduction in expected penalty is a function of two factors: the likelihood of a spill and the

magnitude of financial obligation it would trigger. This function slopes downward

because larger amounts of precaution are presumed to yield smaller marginal reductions

in both the likelihood and magnitude of resulting accidents.

The vessel owner’s cost-minimizing choice with unlimited liability is shown as

Q*. As long as the imposed penalty equaled the actual damage and the probability

of having to pay the damage once an accident occurred was 1.0, this outcome would

normally be efficient. The external costs would be internalized. The owner’s

private costs would be minimized by taking all possible cost-justified precaution

measures to reduce both the likelihood and the seriousness of any resulting spill;

taking precautions would simply be cheaper than paying for the cleanup.

Limited liability, however, produces a different outcome. With limited liability,

the expected penalty function rotates inward for levels of precaution lower than that

level that would produce an accident resulting in damages exactly equal to the limit.

To avoid confusion, note that the marginal expected penalty for additional precaution when the damage

would exceed the liability limit is not zero. While further precaution does not lower the ultimate penalty

in this range, it does lower the likelihood of an accident and, hence, the expected penalty.

502 Chapter 18 Water Pollution

Lower levels of precaution imply damages that exceed the limit, but the vessel owner

would not have to pay anything above the limit. (The only benefit to the vessel owner

faced with limited liability of increasing precaution at lower levels of precaution is the

reduction in the likelihood of a spill; in this range, increasing precaution does not

reduce the magnitude of the financial payment should a spill occur.) The deviation

in the magnitude of the limited expected penalty function from the normal expected

penalty function is greatest at lower levels of precaution; it declines to zero at

that precaution level where the expected magnitude of an accident is equal to the

liability limit.

What is the effect of limited liability on the vessel owner’s choice of precaution

levels? As long as the liability limit is binding (which appears to routinely be the

case with recent spills), the owner will choose too little precaution. (The owner’s

choice is shown as Q in Figure 18.3.) Both the number and magnitude of resulting

spills would be inefficiently large.

Garza-Gil et al. (2006) estimate the economic losses from the Prestige oil spill off

the Spanish city of Galicia. Ultimately 63,000 tons were spilled (Table 18.1) and the

tanker sank. This spill was considered one of the worst tanker spills due not only to

the size of the spill, but also to the “black tides” caused by the spill in valuable

tourist regions of Northern Spain and Southern France. Garza-Gil et al. consider

short-term (immediately following the spill) damages to the fishing industry and

the tourism sector and find losses of almost 200 million Euros. Including cleanup

and restoration costs brings the total to 762 million Euros. They were not able to

include lost recreation opportunities or passive use-value losses. The current inter-

national liability framework does not allow for the inclusion of these values. (Recall

the importance of these for the Exxon Valdez damage estimates discussed in

Chapter 4). What effect would omitting these values be expected to have on the

incentives for risk-aversion by tanker owners?

Citizen Suits

Initiated during the 1970s, citizen suits add a private enforcement alternative to

public enforcement in correcting environmental market failures. Public and

private enforcement are partial substitutes. If government enforcement were

complete, all polluters would be in compliance and citizen suits would have no

role to play. Noncompliance is a necessary condition for a successful suit. In the

early 1980s, when public enforcement decreased, private enforcement—citizen

suits—increased to take up the slack. Lax public enforcement appears to have

played a significant role in the rise of citizen suits.

All attorney’s fees incurred by the citizen group in any successful action under

the Clean Water Act must be reimbursed by the defendants. Reimbursement

of attorney’s fees has affected both the level and focus of litigation activity.

Suppose, at the efficient level of precaution, the magnitude of a resulting spill was less than the liabil-

ity limit. How would this be depicted graphically? Would you expect the vessel owner’s choice to be

efficient?

This section is based on Naysnerski and Tietenberg (1992).

503Efficiency and Cost-Effectiveness

By lowering the costs of bringing citizen suits, attorney-fee reimbursement has

allowed citizen groups to participate far more often in the enforcement process

than otherwise would have been possible. Since courts only reimburse for

appropriate claims (noncompliance claims that are upheld by the court), citizen

groups are encouraged to litigate only appropriate cases.

The existence of citizen suits should affect the decision-making process of the

polluting firm. Adding citizen suits to the enforcement arena increases the expected

penalty to the noncomplying firm by increasing the likelihood that the firm will face

an enforcement action. While this can be expected to increase the amount of precau-

tion taken by the firm, the unavailability of compliance data makes it impossible

to confirm this expectation, though participants believe compliance has increased.

While citizen suits probably do lead to greater compliance, greater compliance

is not necessarily efficient, especially if the defendant polluters face inefficiently

harsh standards. If the standards are excessively high, citizen suits have the poten-

tial to promote inefficiency by forcing firms to meet standards where the marginal

benefits are significantly lower than the marginal costs. However, if the effluent

standards are either inefficiently low or efficient, the existence of citizen suits will

necessarily create a more efficient outcome. In these cases, increasing compliance is

perfectly compatible with efficiency.

An Overall Assessment

Although the benefit estimates from water pollution control are subject to much

uncertainty, they do exist. While being careful not to place too much reliance on

them, we can see what information can be gleaned from the studies in existence.

One early study concluded that the net benefits from water pollution control

policy were positive but were likely to become negative as costs escalate in the

future. Relying on benefits estimates derived from contingent valuation, Carson

and Mitchell (1993) estimate that aggregate benefits from water pollution control

in 1990 exceeded aggregate costs by $6.4 billion. They also found, however, that

projected aggregate costs would exceed projected aggregate benefits because of the

high marginal costs and the low marginal benefits associated with bringing the

remaining bodies of water up to swimmable quality.

Griffiths and Wheeler (2005) summarize the costs and benefits of the most

economically significant

water quality rules that are subject to benefit–cost

analysis. For the five rules that relate to surface water, they find that two of them do

not pass a benefit–cost analysis and for the other three, the range of benefits

estimates bounds the costs. They point out that policies do not necessarily have to

pass a benefit–cost test to be adopted; benefit–cost calculations are simply one

source of information for the decision-making process.

Using cost-effective policies rather than the current approach, it would be possible

to reduce costs substantially, without affecting the benefits. Cost-effectiveness would

require the development of better strategies for point source control and for

achieving a better balance between point and nonpoint source control. The resulting

Defined as rules with an economic impact of more than $100 million.

504 Chapter 18 Water Pollution

reduction in costs probably would allow net benefits to remain positive even with the

more stringent control levels envisioned for the future. Even positive net benefits

would not necessarily make the policy efficient, however, because the level of control

might still be too high or too low (meaning the present value of net benefits would

not have been maximized). Unfortunately, the evidence is not rich enough to prove

whether the overall level of control maximizes the net benefit.

In addition to promoting current cost-effectiveness, economic incentive

approaches would stimulate and facilitate change better than a system of rigid, tech-

nology-based standards. Russell (1981) assessed the importance of the facilitating

role by simulating the effects on the allocation of pollution-control responsibility in

response to regional economic growth, changing technology, and changing product

mix. Focusing on the steel, paper, and petroleum-refining industries in the

11-county Delaware Estuary Region, his study estimated the change in permit use

for three water pollutants (BOD, total suspended solids, and ammonia) that would

have resulted if a marketable permit system were in place over the 1940–1978

period. The calculations assume that the plants existing in 1940 would have been

allocated permits to legitimize their emissions at that time, that new sources would

have had to purchase permits, and that plant shutdowns or contractions would free

up permits for others to purchase.

This study found that for almost every decade and pollutant, a substantial

number of permits would have been made available by plant closing, capacity

contractions, product-mix changes, and/or by the availability of new technologies.

In the absence of a marketable permit program, a control authority would not

only have to keep abreast of all technological developments so emissions standards

could be adjusted accordingly, but it would also have to ensure an overall balance

between effluent increases and decreases so as to preserve water quality. This

tough assignment is handled completely by the market in a tradable permit

system, thereby facilitating the evolution of the economy by responding flexibly

and predictably to change.

Tradable effluent permits encourage, as well as facilitate, this evolution. Since

permits have value, in order to minimize costs, firms must continually be

looking for new opportunities to control emissions at lower cost. This search

eventually results in the adoption of new technologies and in the initiation of

changes in the product mix that result in lower amounts of emissions. The pres-

sure on sources to continually search for better ways to control pollution is a

distinct advantage that economic incentive systems have over bureaucratically

defined standards.

Summary

Historically, policies for controlling water pollution have been concerned with

conventional pollutants discharged into surface waters. More recently, concerns

have shifted toward toxic pollutants, which apparently are more prevalent than

505Discussion Questions

previously believed; toward groundwater, which traditionally was thought to be an

invulnerable pristine resource; and toward the oceans, which were mistakenly

considered immune from most pollution problems because of their vast size.

Early attempts at controlling water pollution followed a path similar to that of

air pollution control. Legislation prior to the 1970s had little impact on the

problem. Frustration then led to the enactment of a tough federal law that was so

ambitious and unrealistic that little progress resulted.

There the similarity ends. Whereas in air pollution a wave of recent reforms

have improved the process by making it more cost-effective, little parallel exists for

control of water pollution. Policy toward cleaning up rivers and lakes was based

upon the subsidization of municipal waste-treatment facilities and national effluent

standards imposed on industrial sources.

The former approach has been hampered by delays, by problems in allocating

funds, and by the fact that about half of the constructed plants are not performing

satisfactorily. The latter approach has given rise to delays and to the need to define

the standards in a series of court suits. In addition, effluent standards have

assigned the control responsibility among point sources in a way that excessively

raises cost. Nonpoint pollution sources have, until recently, been virtually

ignored. Technological progress is inhibited, rather than stimulated, by the

current approach.

This lack of progress could have been avoided. It did not result from a lack of

toughness. Rather, it has resulted from a reliance on direct regulation, rather than

on emissions charges or tradable effluent permits, which are more flexible and

cost-effective in both the dynamic and static sense. Recognizing this deficiency,

watershed-based now trading programs are now gaining attention.

The court system has assumed most of the responsibility for controlling oil

spills. Those responsible for the spills are assessed the financial liability for

cleaning up the site and compensating for any resulting damages to natural

resources. While in principle this approach can be efficient, in practice it has

been hampered by liability limitations and the huge administrative burden an oil

spill trial entails.

Enforcement is always a key to successful environmental and natural resource

policy. One recent innovation in enforcement involves giving private citizen groups

the power to bring noncomplying firms into court. By raising the likelihood that

noncomplying firms would be brought before the court and assessed penalties for

noncompliance, this new system can increase compliance.

Discussion Questions

1. “The only permanent solution to water pollution control will occur when

all production by-products are routinely recycled. The zero-discharge goal

recognizes this reality and forces all dischargers to work steadily toward

this solution. Less stringent policies are at best temporary palliatives.”

Discuss.

506 Chapter 18 Water Pollution

2. “In exercising its responsibility to protect the nation’s drinking water, the

government needs to intervene only in the case of public-water supplies.

Private-water supplies will be adequately protected without any government

intervention.” Discuss.

Self-Test Exercises

1. Consider the situation posed in Problem 1(a) in Chapter 14.

a. Compute the allocation that would result if 10 tradable effluent permits

were given to the second source and 9 were given to the first source. What

would be the market permit price? How many permits would each source

end up with after trading? What would the net permit expenditure be for

each source after trading?

b. Suppose a new source entered the area with a constant marginal cost of

control equal to $1,600 per unit of emission reduced. Assume further

that it would add 10 units in the absence of any control. What

would be the resulting allocation of control responsibility if the cap of only

19 total units of effluent allowed were retained? How much would

each firm clean up? What would happen to the permit price? What

trades would take place?

2. Suppose you have three production facilities that are polluting a river. Each

emits 10 units of pollution. Their marginal cost functions for reducing

emissions are, respectively, MC

= $3, MC

= $4, and MC

= $5.

a. If the objective is to cut emissions in half (to 15) cost-effectively, how

much reduction should be assigned to each firm?

b. What would be the total variable cost of controlling these emissions?

c. What would be the total variable cost that would result from forcing

each facility to control one-half of its emissions? Is this different from

the cost associated with the cost-effective allocation? Why or why not?

Further Reading

Brouwer, Roy, and David Pearce, ed. Cost Benefit Analysis and Water Resources Management

(Cheltenham, UK: Edward Elgar, 2005). A collection of benefit/cost analyses case studies

for water pollution control projects, flood control, and water allocation. Most of the cases

occurred in Europe.

Letson, David. “Point/Nonpoint Source Pollution Reduction Trading: An Interpretive

Survey,” Natural Resources Journal Vol. 32 (1992): 219–232. Considers a host of

implementation details that must be resolved if point/nonpoint source trading is to live

up to its potential.

507Further Reading

Ohlmstead, Sheila M. “The Economics of Water Quality Trading,” Review of Environmental

Economics and Policy Vol. 4, No. 1 (winter 2010): 44–62. A thorough review of the

literature on the economics of water quality.

Russell, Clifford, and Jason Shogren, ed. Theory, Modeling and Experience in the Management

of Nonpoint Source Pollution (Hingham, MA: Kluwer Academic Publishers, 1993).

A collection of 12 essays, providing a state-of-the-art review of the economic perspective

on nonpoint source pollution.

Additional References and Historically Significant References are available on this book’s

Companion Website: http://www.pearsonhighered.com/tietenberg/

508

Toxic Substances and

Environmental Justice

The fact that a problem will certainly take a long time to solve, and

that it will demand the attention of many minds for several

generations, is no justification for postponing the study....Our

difficulties of the moment must always be dealt with somehow, but

our permanent difficulties are difficulties of every moment.

—T. S. Eliot, Christianity and Culture (1949)

Introduction

It is one of the ironies of history that the place that focused public attention in the

United States on toxic substances is called the Love Canal. Love is not a word any

impartial observer would choose to describe the relationships among the parties to

that incident.

The Love Canal typifies in many ways the dilemma posed by toxic substances.

Until 1953, Hooker Electrochemical (subsequently Hooker Chemical, a subsidiary

of Occidental Petroleum Corporation) dumped waste chemicals into an old

abandoned waterway known as the Love Canal, near Niagara Falls, New York.

(Hooker was acquired by Occidental Petroleum in 1968.) At the time it seemed a

reasonable solution, since the chemicals were buried in what was then considered

to be impermeable clay.

In 1953 Hooker deeded the Love Canal property for $1 to the Niagara Falls

Board of Education, which then built an elementary school on the site. The

deed specifically excused Hooker from any damages that might be caused by the

chemicals. Residential development of the area around the school soon followed.

The site became the center of controversy when, in 1978, residents complained

of chemicals leaking to the surface. News reports emanating from the area included

stories of spontaneous fires and vapors in basements. Medical reports suggested

that the residents had experienced abnormally high rates of miscarriage, birth

defects, and liver disease.

Similar contamination experiences befell Europe and Asia. In 1976 an accident

at an F. Hoffmann-La Roche & Co. plant in Sevesco spewed dioxin over the

Italian countryside. Subsequently, explosions in a Union Carbide plant in Bhopal,

509Introduction

India, spread deadly gases over nearby residential neighborhoods with significant

loss of life, and water used to quell a warehouse fire at a Sandoz warehouse near

Basel, Switzerland, carried an estimated 30 tons of toxic chemicals into the Rhine

River, a source of drinking water for several towns in Germany. In 2010 an

explosion and fire at the BP/Deepwater Horizon drilling rig off Louisiana’s coast in

the Gulf of Mexico killed 11 people and ruptured an underwater pipe that caused

a massive oil spill.

In previous chapters we touched on a few of the policy instruments used to

combat toxic substance problems. Emissions standards govern the types and

amounts of substances that can be injected into the air. Effluent standards regulate

what can be discharged directly into water sources, and pretreatment standards

control the flow of toxics into wastewater treatment plants. Maximum concentration

levels have been established for many substances in drinking water.

This impressive array of policies is not sufficient to resolve the Love Canal

problem or others having similar characteristics. When violations of the standards

for drinking water are detected, for example, the water is already contaminated.

Specifying maximum contaminant levels helps to identify when a problem exists,

but it does nothing to prevent or contain the problem. The various standards for

air and water emissions that do protect against point sources do little to prevent

contamination by nonpoint sources. Furthermore, most waterborne toxic pollutants

are stock pollutants, not fund pollutants; they cannot be absorbed by the receiving

waters. Therefore, temporally constant controls on emissions (a traditional method

used for fund pollutants) are inappropriate for these toxic substances since they

would allow a steady rise in the concentration over time. Finally controlling

accidental discharges may require a rather different set of policies. Some additional

form of control is necessary.

In this chapter we describe and evaluate the main policies that deal specifically

with the creation, use, transportation, and disposal of toxic substances and how

those policies affect environmental justice. Many dimensions will be considered:

What are appropriate ways to dispose of toxic substances? How can the

government ensure that all waste is appropriately disposed of in a way that does not

disproportionately disadvantage some socioeconomic groups? How do we prevent

surreptitious dumping? Who should clean up old sites and how should the cleanup

be financed? Should victims be compensated for damages caused by toxic

substances under the control of someone else? If so, by whom? What are the

appropriate roles for the legislature and the judiciary in creating the proper set of

incentives?

Nature of Toxic Substance Pollution

A main objective of the current legal system for controlling toxic substances is to

protect human health, although protecting other forms of life is a secondary

objective. The potential health danger depends upon the toxicity of a substance to

humans and their exposure to the substance. Toxicity occurs when a living organism

experiences detrimental effects following exposure to a substance. In normal

concentrations, most chemicals are not toxic. Others, such as pesticides, are toxic

510 Chapter 19 Toxic Substances and Environmental Justice

by design. Yet, in excess concentrations, even a benign substance such as table salt

can be toxic.

While a degree of risk is involved when using any chemical substance, there are

benefits as well. The task for public policy is to define an acceptable risk by balancing

the costs and benefits of controlling the use of chemical substances.

Health Effects

Two main health concerns associated with toxic substances are risk of cancer and

effects on reproduction.

Cancer. While many suspect the mortality rate for cancer may be related to

increased exposure to carcinogens, proving or disproving this link is very difficult

due to the latency of the disease. Latency refers to the state of being concealed

during the period between exposure to the carcinogen and the detection of cancer.

Latency periods for cancer run from 15 to 40 years, and have been known to run as

long as 75 years.

In the United States, part of the increase in cancer has been convincingly linked

to smoking, particularly among women. The proportion of women who smoke has

increased, and the incidence of lung cancer has increased as well. Smoking does not

account for all of the increase in cancer, however.

Although it is not entirely clear what other agents may be responsible, one

suggested cause is the rise in the manufacture and use of synthetic chemicals since

World War II. A number of these chemicals have been shown in the laboratory to

be carcinogenic. That does not necessarily implicate them in the rise of cancer,

however, because it does not take exposure into account. The laboratory can reveal,

through animal tests, the relationship between dosage and resulting effects. To

track down the significance of any chemical in causing cancer in the general

population would require an estimate of how large a segment of the population was

exposed to various doses. Currently, our data are not extensive enough to allow

these kinds of calculations to be done with any confidence.

Reproductive Effects. Tracing the influence of environmental effects on human

reproduction is still a new science. A growing body of scientific evidence, however,

suggests that exposure to smoking, alcohol, and chemicals known as endocrine

disruptors may contribute to infertility, may affect the viability of the fetus and the

health of the infant after birth, and may cause genetic defects that can be passed on

for generations.

Problems exist for both men and women. In men, exposure to toxic substances

has resulted in lower sperm counts, malformed sperm, and genetic damage. In

women, exposure can also result in sterility or birth defects in their children.

Policy Issues

Many aspects of the toxic substance problem make it difficult to resolve. Three

important aspects are the number of substances involved, latency, and uncertainty.

Tietenberg Tom, Lewis Lynne. Environmental &amp; Natural Resource Economics

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Tietenberg Tom, Lewis Lynne. Environmental & Natural Resource Economics