Profits, politics, and pollution: Efficiency and equity aspects of market-based externality allocation

In this dissertation I examine two situations in which society relies on market mechanisms to allocate externalities among communities. After first providing a general discussion and overview of the regulation of externalities within a market context, I move on to take a detailed look at the electric utility tradable sulfur dioxide permit system set up under the 1990 Clean Air Act Amendments. Chapters 2 and 3 present a market equilibrium model that demonstrates the importance of considering wholesale electric power trading as a strategic compliance option in any analysis of alternative environmental regulations. The central theoretical results demonstrate that the main arguments supporting the adoption of a tradable pollution permit system rather than a command and control regulation--that compliance costs will be greatly reduced--and the main arguments opposing such a policy--that regions with high abatement cost firms will attract an inequitable amount of pollution--can lose much of their strength when power trading is a realistic strategic option. In Chapter 4 I discuss one of the major impediments to the smooth functioning of the tradable permit system: public utility profit regulation. Since the success of a tradable permit system depends on cost minimizing behavior by firms, any deviation from such behavior threatens the policy's success. I first consider whether utility profit regulation can cause utilities to deviate from cost minimization. Then, I analyze several policy proposals that aim to restore utility incentives to behave efficiently in the permit market. Finally, in Chapter 5 I shift to a second policy issue: environmental equity. Using primary data from the cement industry, I demonstrate that when domestic cement manufacturers had the option to apply for EPA hazardous waste incineration permits and diversify their operations into this business, those plants in low income, high-minority areas were far more likely to seek permits than those plants in high income, white communities. I explore the implications of these findings for EPA policies toward enhancing environmental equity.