Voluntary Agreements

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ENVIRONMENTALECONOMICS &POLICY


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VOLUNTARY AGREEMENTS

A policymaker faces two basic options when coming to a policy for a cleanerenvironment:

to use mandatory regulations (command and control, taxes, TPPs ), or induce firms to

participate in V

oluntary Agreements.

There are three broad types of voluntary agreement that occur:

U nilateral commitments (where firms take action without prompting by regulators ).

Ex ample: 1984-89 , Chemistry Industry Associations in the US ,UK, Canada establishedR esponsible Care programmes after a chemical leak in India .

Negotiated agreements (where a firm and regulator negotiate the terms of avoluntary agreement ).

Ex ample: F rench Government and car manufacturers agreed that , by 2002 , 9 0% of car parts could be reused , recycled and recovered

Public Voluntary agreements (where a regulator creates the conditions of anagreement and attempts to recruit firms ).

Ex ample: US Environmental protection Agency (EPA) lead the 33/50 programme

where listed chemicals were to be reduced by 33% in199

2 and 50% in199

5.


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Wh at are t he benefits of V. As above mandatory regulation?

The most common benefit is that V .As are far more flexible (especiallyunder Unilateral and Negotiated agreements ), which allow the firm totake the least cost method of abatement .

This argument is most persuasive when the alternative (regulation) ishighly inefficient and rigid ; for example , regulation rather than TPP s -the more flexible the regulatory instrument , the lower the cost savings .

Indeed , TPP s/ P igouvian taxes satisfy the equimarginal principle (wherethe marginal abatement cost is minimised across all firms ), voluntaryagreements , due to their non -mandatory nature , may not satisfy it .

Also, there are gains from reduced confrontation .

V. As may have lower transaction costs than regulation , and there isless spending on lobby groups .

Also, information flows are richer reducing asymmetricalinformation about abatement technologies and therefore reducingimplementation lags .


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S egerson & Li (1999) provided atheoretical framework under which allthree forms of voluntary agreementcould be modelled , see next slide .

It can be seen as a game between threeactors ; the regulator , the firm and thelegislator .

A Unilateral agreement occurs if theregulator doesn t provide avoluntary agreement plan or offer tostart negotiations , but the firm stillimplemented a voluntaryagreement .

A Negotiated agreement or a P ublicVoluntary agreement occurs if theregulator does offer a plan/start negotiations and the firm acceptsthe offer/plan .

Problems: N o interaction between the

parties , no strategic behaviour of thefirm , does not model information

asymmetries on abatement cost , theLegislative response (p ,q) should beendogenous .

Let the key be as follows:

Cv the cost of abatement under aV.A, Cm the cost under legislation , (Cv Cm) are cost savings due to aV. A.

1 is the profit under environmentalregulation , 0 is the profit without . ( 1 0 ) is t h e premium formarketing a green good .

B is the indirect benefit from a V .A. (good publicity ). S is the subsidyunder an incentive -based V .A.

P is the probability of legislation if offer is made and rejected , q is theprobability of legislation if offer is

not made .


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VOLUNTARY AGREEMENTS S EGERSON &LI (1999) U NIFYING FRAMEWORK

Regulator

Firm

Firm

Legislator

Legislator

1-Cv+S +B

1-C v+B

0 :(1-q)

0 :(1-p)

1-Cm : (q)

1-Cm : (p)

D o not make

offer/set upvoluntary programme

Make offer/set up voluntary programme

D o not adopt voluntary controls

Adopt voluntary controls

R eject

Accept

ImposeLegislation

Do not ImposeLegislation

Do not ImposeLegislation

ImposeLegislation


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The firm faces a choice between a CERT AIN outcome (if they take a V .A) and anEX PECTED outcome (if they reject/do not start a V .A).

Therefore , a V.A will occur if the CERTA IN payoff from either of thecontingencies is greater than or equal to they EXPECTE D payoff :

It is possible to see that even if no offer is made , and there is no threat (q=0 ), aV.A may still arise due to the premium associated with marketing green goodsand the indirect benefits ; a V.A is more likely to arise , under no threat (p=0 ), if an offer is made

, however , as a subsidy increases the payoff for the firm .

However , the threat of regulation increases the probability of a V. A

, untilp=q=1 , where a V .A will ALWAYS be taken:

011 1 T T T qC q BC mv u 011 1 T T T pC pS BC mv u

vC B u01 T T vC S B u01 T T

0 BC C v 0uS BC C vm


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Wh en do firms participate in V. As?

If there are either ENVI RONMENTAL STEWARDSHIP or MARKET INCENTIVES:

Environmental Stewardship:

Individuals or firms utility is directly dependent on their local environmental quality . More likely when concerned with individuals rather than large firms .

Market Incentives:

Green consumers may pay a premium for environmentally -friendly produce , asshown in the previous model . Linked to the Environmental Kuznets Curve , wherehigher income consumers become more environmentally aware . But , greenconsumer argument may not extend to intermediate/primary industries .

Capital markets react to a firm s environmental track record , which reduces their access to capital and reduces their stock price .

Porter h ypot h esis ; a firm may be in a win-win situation where it can reduce pollutionthrough innovation , and also improve efficiency (reducing costs and thereforeincreasing profits) . However , if such technology was available then it suggests thatthe firm systematically overlooks it prior to the threat of regulation .


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If there are no strong market incentives , then use Government Incentives :

The Government can use sticks (negative incentives ) or carrots (positive incentives ):

Carrots take the form of subsidies (S in the model ), which increase the likelihood of participating if B=0 and/or there is no premium from green consumers .

The problem with carrots is that they create perverse incentives ; firms may enter the industry inorder to receive the subsidies . Also, subsidies increase t h e e x cess burden of ot h er distortionaryta x es used to fund t h em . The regulator may therefore find it too socially costly to generate thefunds .

Sticks are the threat of regulation (p and q in the model ).

In order to be effective , th e t h reat must be credible . Sticks and carrots can be used to complementone another , as also shown in the model .

Incentives should also take into account the possibility of free riding, if the target is industry-wide, as opposed to firm-specific . An incentive would work better if it was exempting a firmfrom already existing regulation .

Incentives should also consider information asymmetries wit h h eterogeneous firms . Underimperfect information regarding abatement costs:

Carraro and Siniscalo (1996 ) create an adverse selection model where the regulator offers amenu of contracts to firms aimed at inducing firms to reveal their costs . However , this givesrise to information rents and a distorted level of emissions for some firms , which impact onthe welfare effects of a V .A.


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Any of the V .A types could appear dueto Corporate Environmentalism(attempting to shape regulatorydecisions ):

Pre-empting toug h er regulations :

If the organizing costs of environmental groups lobbying fortoug h er regulations is h igh, nounilateral action will take place . If itis low, then the firm will act to

head-off the regulator .

The Segerson + Li model shows thisalso ; a Public V. A/ N egotiated agreement arises to reduce the

firm s cost of abatement .

Welfare reductions could occur if:Corporate Lobbying expendituresreduce the efficacy of environmental lobbying

expenditures , regulators have non-welfare maximising objectives

(raising revenue) so that weak V. Asare instituted , or that Legislatorsdelegate too much power toregulators .

Weakening fort h coming regulations :

If legislators announce regulation , but delay outlining specifics (such asthe C lean Air Act of 199 0 ), the firmmay undertake a level of abatementto prevent harsh standards beingimposed .

R educing regulatory monitoring :

By investing , the firm may convincethe regulator that it is less likely torenege on commitments . However , the firm may over-invest, reducingwelfare .

Inducing regulation to keep small firms

out of t h e market (no real evidence ).


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Wh en is a V. A effective regarding abatement?

One of the main criticisms of V .As is that they are unlikely to reduce pollution to anoptimal level .

The probability of regulation , or the magnitude of subsidies determine the baseline levelof profit for t h e firm (in which it does not voluntarily abate ). This baseline profit level inturn determines the maximum level of abatement an individual firm will undertake .

Therefore , abatement levels are likely to be h igh er under greater subsidies (opportunitycost ) or a more stringent t h reat of regulation V. As are useful as a complement , not asubstitute , for an underlying regulatory framework .

Under a negotiated agreement , the abatement level reflects two factors:

The baseline payoffs for both the firm and regulator .

The relative bargaining power of the two parties If the background threat is high (forexample , already in place ), then the regulator has high bargaining power and abatementis likely to be high ; the flipside for low background threat .

A V.A scheme also works better if it acts as a complement for individual abatementactions .


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A CEC(1996 ) study shows that V. As are relatively rare in t h eEU , with most states having under 20 examples . However , th eNet h erlands and Germany bot h h ave ~1 00 ex amples of V. As.

The Netherlands use N egotiated Agreements as the keyenvironmental policy , since the 199 0 National EnvironmentalP olicy P lan (NEEP ).

Most negotiated agreements have been concentrated in t h emost polluting industries (chemical , energy , metals ).

Therefore , there is still potential for increasing the use of voluntary agreements in the EU , following a Netherlands - style

model .

The next slides document some empirical findings regarding theefficacy and implementation of V .As.


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Lyon and Ma x well (2 00 2) make a number of stylised facts about V .As:

Larger firms are more likely to undertake a V. A.

Firms wit h h igh er R +D intensities are more likely to undertake V .As.

Firms wit h poor environmental records are more likely to undertake V .As.

Firms do not free-ride on past clean up efforts in V. As (which is surprising , as it issomething (B) for no marginal cost ).

Likelih ood and e x tent of V. As are increasing in t h e strengt h of environmental pressuregroups and t h reat of regulation .

Investors act negatively to above-e x pected emissions and firms are rewarded for goodenvironmental results . Firms respond to this investor pressure SEEBP O IL SP ILL.

Alberni and Segerson (2002 ) note that the evidence is largely mixed however , due todifferences in methodologies and definitions .

They note the success of 3M sPollution Prevention Pays (1975 ) scheme aimed at reducingwaste and improving efficiency . It has reduced total emissions by around 50% between197 5-199 0 and to date it has saved nearly $ 1 .4 billion .

Also, the prevalence of D

olp h in friendly tuna and the use of paper wraps instead of S tyrofoam s h ells for fast -food burgers as evidence for green consumerism .


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Kh anna and D amon (1999) study the E PA s33/ 50 programme :

They find that listed chemical emissions fell by 4 2%, under the target , but a significantimprovement on the reductions of non - listed chemicals (22%).

Therefore , consumer awareness and pressure is a key factor in t h e efficacy of V. As . P argaland Wheeler (1996 ) show that Indonesian plants pollute less in residential areas, without the need for Government intervention .

Alberni and S egerson (2 00 2) study the 1995 declaration of German Industry Associations :

The agreement was to reduce CO 2 emissions by 2 0% relative to 1987 levels by 2005 .

The agreement included 8 0% of industrial energy production and 99% of public energy

production , however EE A (1997) found t h at t h e agreement h as not lead to substantialabatement beyond w h at would occur anyway .

Although the target would be met , it would ve been met anyway , due to the restructuring of industry post -reunification . As this abatement was baseline , the cost was likely to be lowa mi x ed result for V. A.

Therefore , regulations could ve elicited greater reductions (carbon tax) . However , it didplay a longer - term role in establishing a dialogue between industry and Government .

Voluntary Agreements

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