Market Failures Multiple market failures at issue “No single instrument is superior along all dimensions relevant to a policy choice.” Typical Market Failures.

Market Failures

Multiple market failures at issue “No single instrument is superior along all

dimensions relevant to a policy choice.”

Typical Market FailuresEnvironmental Externalities Information deficitsCapital limitationsNetwork effects Inadequate internalization of the benefits

associated with new technologies

Inducing Technological Change

Policy Instruments – CO2 Emissions

Emissions taxesTradable emissions permits/allowancesSubsidies for R&DSubsidies for emissions reductionsPerformances Standards (emissions levels)Technology Mandates (e.g., renewable

portfolio standards) IP: Patents, Trade Secrets

Inducing Technological Change

Instrument Selection Criteria

Economic efficiency (cost-benefit analysis)

Cost-effectiveness (band for the buck)

Fairness/Distributional benefits and costs

Ease of administration (i.e., implementing, monitoring, enforcement)

Minimizing/mitigating uncertainties

Political feasibility

Clean Air Act: Mobile Sources

1970 Amendments mandated a 90% reduction in tailpipe emissions of VOCs and CO w/in 5 years; NOx w/in 6 yearsCongress extended deadline several timesBut between 1970 and 2000, NOx and

VOC emissions dropped >95%

Foundation: back-of-the-envelope estimation of reductions needed to protect human health

Clean Air Act: Mobile Sources202(a)(1): The Administrator shall by regulation prescribe . . . standards applicable to the emission of any air pollutant from any class or classes of new motor vehicles or new motor vehicle engines, which in his judgment cause, or contribute to, air pollution which may reasonably be anticipated to endanger public health or welfare.

202(a)(2): Any regulation prescribed under paragraph (1) . . . shall take effect after such period as the Administrator finds necessary to permit the development and application of the requisite technology, giving appropriate consideration to the cost of compliance within such period

Standards v. Taxes/Cap & Trade

Technology Standards:May be easier to administerMore predictable resultsLower information demands

Taxes/Cap & tradeEconomic studies find costs 40-95% lower

Dependent on heterogeneity among firmsDifferential declines with level of reductions

Taxes dependent on price sensitivityDo not limit technology choice

Hybrid Approaches

Mobile Sources – CO2 emissionsEnhance engine efficiency; technologies

that reduce CO2 emissionsReduce vehicle miles travelled

Duplicate efficiency of emissions pricing while avoiding high administrative costsMandate emissions-control technologyTax on gasoline

Hybrid Approaches – Virtues

Threat to energy-intensive industries from relying on emissions pricing alone

Distributional consequences (energy intensive industries, consumers)

Credibility: high CO2 taxes not viable

Innovation market failures (spillovers)

Potential synergies/enhanced efficiency Reduce emissions intensity of energy production Energy conservation (products, behavior)

Hybrid ApproachesEuropean Energy Taxes Denmark & Finland only country with a net

reduction in CO2 emissions

Denmark’s Success “Danish policy makers made huge investments in

renewable energy and subsidized environmental innovation.”

Overcame: risk aversion of firms, countervailing sunk costs, and network effects

Policies: direct subsidies, differential taxes, and tax benefits for voluntarily emissions reductions

Monica Prasad, Taxation as a Regulatory Tool: Lessons from Environmental Taxes in Europe (2008).

European Energy Taxes

European Energy Taxes