More Less
More Less
May 04, 2017

Environmental regulations and business decisions

Opinion image

President Trump campaigned on promises to slash regulation. His new EPA head said that some regulations need to be rolled back in a very aggressive way since they have cost jobs and prevented economic growth. On the other hand, environmental regulations have greatly improved air and water quality, providing substantial benefits to society over the years in terms of lives saved and ecosystems protected. While in most cases the direct costs of pollution abatement represent no more than 1% or 2% of a firm’s total production costs, regulations also affect business decisions when they result in delays and uncertainty. How costly are environmental regulations, and how do their costs compare with their benefits?

Many studies of costs focus on US air pollution, where regulations are more stringent in counties that fail to meet air quality standards. The annual list of these non-attainment counties provides researchers with easy-to-use variation in stringency across space and over time. Productivity is significantly lower when counties are in non-attainment, and new plants in polluting industries are significantly less likely to locate there.

These business decisions matter, and firms’ responses to regulation can lead to unintended consequences. Substantial pollution reductions in the dirtiest counties have sometimes been partially offset by pollution increases in cleaner counties facing less stringent regulation. Similarly, older power plants or automobiles exempted from new regulations have been kept in service, slowing the pace of pollution reductions over time.

Regulations are needed because pollution is an externality: air and water pollutants impose costs on downwind or downstream neighbors who have no influence over the firm’s decision to pollute. Society gains when regulations force pollution reductions where the damages from the pollution exceed the cost of abating it. There is convincing evidence that the overall benefits from pollution abatement have far exceeded the costs, driven largely by reductions in particulate air pollutants from industrial facilities: for example, the health benefits from the 1990 Clean Air Act Amendments in the US include many thousands of lives saved annually and are valued at nearly 30 times the legislation’s costs.

For some other pollutants it is less clear that the benefits of regulation have exceeded the costs, especially in developed countries where most people have access to high-quality drinking water and adequate sanitation—developing countries with higher pollution levels are likely to get greater benefits from regulation. In any case, regulations need to be evaluated on the margin: even for particulate pollution, the relevant question is not the great benefits from past regulations but how much additional reduction will come from the new regulation, and whether the additional benefits outweigh the costs.

Challenges lie ahead for environmental regulation. There seems little doubt that human-generated emissions of greenhouse gases are having substantial impacts on the earth’s climate, but the global nature of the problem requires difficult international cooperation and the long time lags involved make it risky to wait until all damages are observed before acting. Recent political change in the US has emphasized the cost of environmental regulations and signaled plans for substantial cutbacks, but optimal decision making in this area depends on considering both costs and benefits, based on the best available scientific evidence.

Please note:
We recognize that IZA World of Labor articles may prompt discussion and possibly controversy. Opinion pieces, such as the one above, capture ideas and debates concisely, and anchor them with real-world examples. Opinions stated here do not necessarily reflect those of the IZA.