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19 The Policy Context for Flexible, Negotiated, and Voluntary Measures Alan Randall _ ' n recent times, the rhetoric of environmental regulation has shifted quite dramatically toward the use of flexible incentives, voluntary approaches, _ _ and the devolution of authority. These approaches cover a broad range of possibilities, which vary along several dimensions: the assignment of responsi- bility among different levels of government and between the public and private sectors, the choice of policy instruments, and the degree of rigor with which accountability is assigned and policies are enforced. It is important at this stage to ask which aspects of regulatory control should be flexible, voluntary, or de- volved to other authorities, and what implications they pose for environmental quality. REDEFINING THE ROLE OF GOVERNMENT In the standard model of environmental regulation, a central government agency adopted environmental quality standards to protect a wide range of pub- lic interests, including the health and safety of its citizenry. The standard tools for achieving environmental policy targets included strict regulation of point sources of pollution and rigorous monitoring and enforcement. "Polluter pays" was a core principle. In practice, typically, particular control technologies were prescribed. Although nonpoint sources were, in aggregate, major contributors of effluents, they got something of a free pass. Addressing them within the "command-and-control" framework seemed too difficult technically difficult because their diffuse nature impeded monitoring nonpoint effluents from partic- ular sources and enforcing controls, and politically difficult because the long- standing public propensity to subsidize rather than regulate farming militates 311

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312 POLICY CONTEXT FOR FLEXIBLE, NEGOTIATED, AND VOLUNTARY MEASURES against regulatory controls and "polluter pays" for agriculture, a major source of nonpoint pollution. After roughly two decades of this approach to pollution control, the seeds of change were evident. Command-and-control regulation of point sources had accomplished significant reductions in water pollutant loadings nationwide, but increasingly had come to be regarded as inflexible, inefficient, and stifling to innovation, all of which tend to increase pollution control costs. In addition, changes in the economy the service sector grew faster than manufacturing, and more dispersed modes of manufacturing gained at the expense of traditional, concentrated forms necessitated changes in the standard command-and-control modus operandi (Rejeski and Salzman, this volume, Chapter 2~. The successes in reducing loads from point sources left the nonpoint sources increasingly con- spicuous, as their proportional contribution to the remaining total loads grew. Although implementation even in the point source case seldom matched the rigor of the rhetoric, the language of "command and control" and "polluter pays" started to give way to a new and more gentle language emphasizing flexible incentives, voluntary approaches, negotiated solutions, and Revolution of author- ity. Policy approaches within this very broad and ill-defined set that serve to soften the sharp edges of regulatory control also tend to Reemphasize the distinc- tion between point and nonpoint sources. With these newer approaches in the mix, the policy tool kit offers a broad range of possibilities, and a consensus typology has yet to emerge (Andrews, 1998~. The choice of policy tools is linked to the Revolution question not just the question of federal, state, or local jurisdiction, but also the division of author- ity and responsibility among governments, industry groups, and individual firms. The following incomplete list serves to illustrate the breadth of considerations that are relevant for thinking about the effectiveness of flexible and voluntary approaches. Regulatory status. Possibilities include regulations already in place, self- policing at the individual or group level with threat of regulation if the problem persists, and neither of the above. Control objective. The objective may be to control environmental per- formance, or to impose prescribed control technology. The details (the required level of performance, or the control technologies designated as acceptable) may be set by the regulator or negotiated among industry groups, firms, and government. Incentives/penalties. Possibilities include flexible incentives (taxes, mar- kets in pollution reduction credits) aimed at inducing desired environ- mental performance, prescribed penalties for failure either to achieve the required level of performance or to implement the acceptable control technologies, negotiated penalties (such as warnings, time extensions), shaming, and none.

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ALAN RANDALL Monitoring. Options 313 include i, inspection by the regulator (with greater or lesser frequency and effectiveness), self-inspection with self-reports to the regulator, self-inspection with audit confidentiality and immunity, and self-monitoring at the individual or group level. Enforcement. Possibilities include enforcement by the regulator, self- enforcement at the individual or group level (and enforcement may vary from strict to lax), public pressure, and no enforcement. Given the considerable diversity of arrangements that are placed in the cate- gory of flexible, negotiated, and voluntary measures, we cannot begin to discuss their effectiveness without paying close attention to particulars: The devil truly is in the details. SOME THINGS WE HAVE LEARNED FROM ECONOMICS AND EXPERIENCE Traditional economic theory has emphasized that rational individuals be- have cooperatively only when the expected penalties for noncooperative behav- ior exceed the private benefits. This line of reasoning supports a generally skeptical attitude to self-monitoring, voluntary agreements, and the like. It is, however, supportive of flexible incentives and "smart" monitoring and enforce- ment strategies. Flexible Incentives Flexibility in the assignment of responsibility for pollution control and choice of control technology may be introduced via pollution taxes, trading in pollution reduction credits, and similar market-oriented policy instruments. This approach seeks to enforce a given level of environmental performance, while freeing managers to choose the means of compliance. By permitting firms to choose optimal technologies and factor combinations, this approach has been shown to reduce compliance costs and increase effectiveness in a broad range of situations. Perhaps more importantly in the long run, human creativity is un- leashed in the search for even more cost-effective pollution control technologies. Economic theory predicts as much, and experience with pollution permit mar- kets tends to confirm their powerful incentives for cost reducing innovations in control technology (Burtraw, 1996~. "Smart" Monitoring and Enforcement Strategies Often the regulator is chronically underfunded for monitoring and enforce- ment, which threatens regulatory effectiveness. Nevertheless, "smart" monitor- ing and enforcement strategies have been developed that are promising in such

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314 POLICY CONTEXT FOR FLEXIBLE, NEGOTIATED, AND VOLUNTARY MEASURES situations. Here I summarize three results that support this conjecture. First, focusing monitoring pressure on prior offenders would reduce regulatory costs of compliance. Hentschel and Randall (2000a) support this conjecture with theoretical results and simulations based on real data on pollution control costs in the paper industry. Second, self-monitoring and self-reporting requirements would reduce regulatory costs of compliance. Note that this approach is a kind of Revolution as firms self-monitor and self-report, but Revolution is limited to the extent that the authorities require reports and maintain monitoring capacity sufficient to sustain a credible threat of inspection. Hentschel and Randall (2000a) provide theoretical results and simulations. Third, audit confidentiality and immunity laws tend to encourage firms to self-audit and clean up environ- mental problems discovered. But there is a caveat: Legislation typically permits firms to earn confidentiality or immunity by making a diligent effort at cleanup and, if relatively ineffective cleanup efforts count as "diligent effort," such pro- visions may undermine the advantages of these laws. Hentschel and Randall (2000b) provide theoretical results. Richer People Demand More Environmental Quality People function both as workers and consumers, and they value consumer goods and environmental quality. From these modest premises, we can draw several interesting conclusions. First, the relatively high income elasticity of demand for environmental quality (as incomes rise, demand for environmental quality rises even faster) limits the "race to the bottom" in a particular society. A state or local jurisdiction seeking economic advantage by weakening its environ- mental controls will find that, other things being equal, skilled workers demand higher wages to compensate for the poorer environment, thus undermining any gains from such a strategy (Blomquist et al., 1988~. Empirical cross-state com- parisons in the United States have demonstrated that lax environmental policies are not associated with any consistent advantage in terms of growth and prosper- ity (Levinson, 1996~. Second, richer societies may nevertheless engage in a race to export pollu- tion to poorer, less sensitive places. It is not clear that this is reprehensible. Although pollution can be life threatening, so can abject poverty with its associ- ated poor health care, malnutrition, and abysmal workplace safety. Postwar history in East Asia reveals several success stories (Japan, Taiwan, South Ko- rea), in which societies jump started economic development by serving as pollu- tion sinks, but quickly became more environmentally sensitive as incomes rose. The key point is that citizen demand for environmental quality serves as a pow- erful restraint on environmentally lax policy (Andreoni and Levinson, 2001~. Third, the same citizen demand for environmental quality will motivate the behavior of private firms, which will rationally seek good environmental reputa- tions and if the best way to gain a good environmental reputation is to earn it-

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ALAN RANDALL 315 will do some environmental good in the process (Th0gerson, this volume, Chap- ter 5; Teisl et al., in press). Industry codes, such as ISO 14000 and Energy Star, apply the same principle at the industry level. Compliance provides a means of signaling "greenness" to consumers, and such codes have achieved some envi- ronmental successes (Nash, this volume, Chapter 14~. The Sustainability and Effectiveness of Collective Action Economists now realize that their traditional "tragedy of the commons" skep- ticism about the sustainability and effectiveness of collective action was over- done. Empirical evidence tends to reject the hypothesis of pervasive collapse of the public goods and common property sectors. These sectors tend to be ineffi- cient yet to avoid total collapse (Ostrom, 1990), and game theory provides some powerful reasons why (Axelrod, 1984~. This line of research shows the poten- tial for creating stable market incentives that encourage group cooperation, as opposed to individual competition, and provides optimism for overcoming many kinds of "market failures." As we better understand the role of repetition in games, reputation effects, etc., we become more optimistic about the prospects for voluntary agreements, industry codes, and performance regulation in cases where individual performance is not readily observable. For example, Randall and Taylor (2000) suggest the feasibility of performance-based instruments, with monitoring of collective performance at the subcatchment level, for nonpoint- source pollution control. If such a scheme proved workable, farmers would gain the considerable savings in control costs that come with the switch to policy instruments that reward pollution-control performance rather than subsidize spec- ified technologies. Negotiated Solutions and Voluntary Agreements Most people discussing flexible environmental policy have in mind something much more flexible than the flexible incentives described earlier, which while introducing flexibility by assigning the lion's share of the abatement task to low- cost abaters and allowing flexibility in choice of control technology adhere rigidly to the specified environmental performance standard. Negotiated and voluntary agreements, which are very much a part of the European scene and figured promi- nently in the 2000 U.S. presidential election campaign, focus on flexibility in setting and enforcing performance expectations as well as in choosing methods to achieve improved performance. What does it mean to have environmental regula- tion where standards are flexible, negotiated, or voluntary? Although there is some U.S. experience with voluntary approaches (Ma- zurek, this volume, Chapter 13), some European countries have made consider- ably greater commitments to voluntary agreements. The European experience with these more flexible policies is instructive. For example, Bruyninckx (2001)

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316 POLICY CONTEXT FOR FLEXIBLE, NEGOTIATED, AND VOLUNTARY MEASURES has evaluated the voluntary agreements that are widely used by the Flemish government to specify what is expected of Flemish municipalities in the way of environmental performance. At the outset, it is important to recognize that these agreements are perhaps better characterized as negotiated agreements: The pro- vincial government, which had long neglected environmental policies aimed at municipalities, made it clear in 1992 that municipalities henceforth would be expected to commit to environmental improvement objectives. After about 8 years of operating experience with this policy, Bruyninckx concluded, 38 per- cent of municipalities had met all of their commitments. He considers this a significant accomplishment given that the policy is relatively new, the baseline level of environmental performance was low, and many of the municipalities in the noncompliant 62 percent had met at least some of their commitments. He observes that these kinds of agreements are more likely to be effective if: policy objectives can be accomplished even if there remains significant nonparticipation of potential actors (to put it another way, approaches stronger than "voluntary" agreements are necessary if success requires that everyone comply); the goals are clearly defined in terms of performance indicators; the agreements have a motivational or norm-setting aspect that can move other actors in the same direction; the obligations of all parties are clearly defined; and a serious enforcement mechanism is in place. Conclusion Traditional economic theory supports flexible incentives, and "smart" mon- itoring and enforcement strategies, but is skeptical toward many of the policy innovations discussed earlier. However, recent conceptual advances and a grow- ing body of empirical experience support cautious optimism about voluntary or negotiated agreements, industry codes, green marketing, and performance-based rather than technology-based instruments for nonpoint pollution control. Never- theless, all of these rather optimistic results depend on the presence of an effec- tive regulator, at least in the background. The only firm economic-theoretic result I know of, concerning voluntary agreements, has a similar flavor: Volun- tary agreements can work if there is a credible threat of regulation should self- policing fail (Segerson and Miceli, 1998~. WHAT SHOULD GOVERNMENT DO? These economic-theoretic results and empirical observations allow us to draw some fairly strong tentative conclusions about the appropriate stance of government toward environmental control instruments.

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ALAN RANDALL 317 1. Some essentialfunctions of government. Maintain a capacity for meaningful monitoring (even effective self- monitoring requires a credible threat of regulatory inspection). Maintain a credible threat of regulation should self-policing fail. . Maintain a regulatory and/or legal liability system ready to throw the book at blatant polluters and repeat offenders. These minimal functions of government in the environmental sphere remain essen- tial because it would be naively incautious to rely entirely on good intentions, green consumerism, and social pressures to achieve consistent environmental per- formance that is costly to polluting firms, consumers, and public agencies. 2. Some good things government can do. . Regulate ambient performance standards for those environmental at- tributes that really matter for protection of human and ecosystem health. Provide broad freedom for firms and individuals to find cost-effective methods of compliance. Policy is responsive to costs, benefits, and economic impacts, so innovations that lower the costs of compliance enhance the political viability of strong environmental policies. Fur- thermore, a strong economy encourages consumers to demand higher environmental quality and motivates firms and industry groups to seek "green" reputations. Encourage experiments with a broad range of flexible policy instru- ments, while reserving the right to terminate experiments and reject policy instruments that fail. Cultivate a legal and political environment that encourages polluting industries, firms, and public agencies to accept the obligations of envi- ronmental good citizenship, and an active, informed citizenry to re- ward and punish firms and industries on the basis of environmental performance. . The approach recommended here is hierarchical: Serious environmental regula- tion to protect human and ecosystem health is the foundation, and flexible incen- tives are the favored instruments where feasible. That much is standard econom- ics. Yet, because we economists are no longer quite so sure we have all the answers, the policy framework should be open to experiments with a variety of flexible policy instruments, and good environmental citizenship should be en- couraged for industries, firms, public agencies, and individuals. 3. Might voluntary agreements, industry codes, green marketing, and so on, be sufficient by themselves? Innovations such as voluntary (or negotiated) agreements, industry

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318 POLICY CONTEXT FOR FLEXIBLE, NEGOTIATED, AND VOLUNTARY MEASURES codes, and green marketing should be viewed as promising additions to the environmental tool kit, but they should supplement, not supplant, the regulatory framework. They make a nice frosting on the regulatory cake. But the cake itself must be there. REFERENCES Andreoni, J., and A. Levinson 2001 The simple analytics of the environmental Kuznets curve. Journal of Public Economics 80(2):269-286. Andrews, R.N.L. 1998 Environmental regulation and business "self-regulation." Policy Sciences 31: 177-197. Axelrod, R. 1984 The Evolution of Cooperation. New York: Basic Books. Blomquist, G.C., M.C. Berger, and J.P. Hoehn 1988 New estimates of quality of life in urban areas. American Economic Review 78(1):89- 107. Bruyninckx, H. 2001 Voluntary Environmental Agreements between the Flemish Community and Munici- palities. Unpublished paper presented at the Environmental Policy Conference, Ohio State University Environmental Policy Initiative, Columbus, OH, April 16-18. Burtraw, D. Levinson, A. Ostrom, E 1996 The SO2 emissions trading program: Cost savings without allowance trades. Contem- porary Economic Policy 14:79-94. Hentschel, E., and A. Randall 2000a An integrated strategy to reduce monitoring and enforcement costs. Environmental and Resource Economics 15:57-74. 2000b Audit Confidentiality and Immunity Laws: The Problem of Diligent Effort. Presented at annual conference, European Association of Environmental and Resource Economists, Rethymnon, Greece, June 28-30. 1996 Environmental regulations and manufacturers' location choices: Evidence from the cen- sus of manufacturers. Journal of Public Economics 62(1-2):5-29. lsso Governing the Commons: The Evolution of Institutions for Collective Action. Cam- bridge, Eng.: Cambridge University Press. Randall, A., and M.A. Taylor 2000 Incentive-based solutions to agricultural environmental problems: Recent developments in theory and practice. Journal of Agricultural and Applied Economics 32:221-234. Segerson, K., and T.J. Miceli 1998 Voluntary environmental agreements: Good or bad news for environmental protection? Journal of Environmental Economics and Management 36(2):109-130. Teisl, M., B.E. Roe, and R. Hicks in Can eco-labels tune a market? Evidence from dolphin-safe labeling of press canned tuna. Journal of Environmental Economics and Management.