Three essays on regulation and self-regulation in imperfectly competitive markets

Resumen

This Doctoral Dissertation is composed of three independent papers on regulation and self-regulation in the presence of imperfect competition on product markets. The common feature in all of them is that they all deal, in one way or another, with environmental regulation. Environmental regulation has traditionally taken the form of compulsory command and control (CAC) regulations stipulating the limits on the amount of pollution emissions that can be generated in a specific production process, or mandating the use of specific abatement or production technologies. While the CAC regulations have indeed achieved significant improvements in the environment, they also have received a significant amount of criticism for being inflexible and for obstructing technological innovations. As a consequence, economic instruments (pollution taxes and tradable permits), primarily developed and defended by environmental economists have emerged. The classical economic view sees pollution as a market failure that emerges when property rights for environmental resources are ill defined and agents do not bear the full social costs of their actions. The conventional wisdom holds that a corrective tax may be used in such circumstances to provide the necessary price incentives inducing optimal pollution control. Starting from a seminal work of Pigou (1920), who was the first to put forward the idea of corrective taxation, a great deal of literature have emerged discussing different types of incentive mechanisms that allow restoring the social optimum. One of the important branches of this literature deals with the design of the optimal mechanisms in imperfectly competitive industries, after Buchanan (1969) have demonstrated that the imposition of a Pigouvian tax on a monopolist can actually reduce social welfare. An additional twist has been introduced in the late 1970s, when the attention has shifted to the optimal environmental regulation of polluters under asymmetric information. The existence of private information on the side of polluting firms allows them to reap information rents, which in some cases may exceed the extra surplus generated by a more efficient policy. The incentive regulation literature suggests that the reduction of informational rents may often require some sacrifice in the productive efficiency. Our first chapter is closely related to this strand of literature. In the first chapter "Regulating an environmental externality-generating monopoly with unknown demand", we focus our analysis on the regulation of a polluting firm, which is privately informed about the demand it faces. We model a situation where the pollution can only be reduced by decreasing output, that is, there is no abatement technology available to the firm. We formulate the regulation as an agency problem, where the government designs an optimal incentive scheme consisting of a target output and a compensatory payment implemented in a form of a transfer from the regulator to the firm. In the asymmetric information setting, we demonstrate that the monopolist facing high demand has incentives to misrepresent her demand, which implies earning informational rents. In order to reduce the informational rents of the monopolist facing high demand, the production of the monopolist facing low demand must be distorted from the socially optimal level, while the production of the monopolist facing high demand remains intact. We show that the second-best output of the monopolist facing low demand may either be mandated below the socially optimal level, or above it, depending on the level of external damages and on the price-elasticity of demand. This result arises due to the fact that the standard single crossing property imposed in the adverse selection models of this sort, does not hold in our setting. Although the economic instruments ever since their emergence have been continuously gaining terrain, the last few decades have seen the surge of new non-mandatory approaches to environmental protection. These approaches encompass a diverse set of efforts aimed at environmental self-regulation by individual firms or industries, with or without direct government participation. Non-mandatory approaches (also called self-regulation) can be broadly classified into three categories, depending on the degree of government intervention: 1. Unilateral commitments, initiated by the firms or industries without any government intervention; 2. Public voluntary programs, primarily designed by the public regulators in which firms or industries can voluntarily participate; 3. Negotiated agreements between firms or industries and the public authorities. Non-mandatory approaches have gained popularity due to their presumed flexibility, sensitivity to market circumstances and diminished implementation time among other reasons (e.g. Brau and Carraro, 1999, Gunningham and Rees, 1997). Our second and third chapters of this Dissertation take a look at this phenomenon. In the second chapter, we consider the implementation of voluntary initiatives in oligopolistic markets. By voluntary initiatives we understand any voluntary action of the firm that goes beyond what is legally required. Therefore, both unilateral commitments and the participation in public voluntary programmes can be considered as voluntary initiatives. These actions can take on many forms, from reducing the harmful environmental impacts of oil exploration in developing countries, to eliminating child labour in the manufacture of sporting goods or to promoting equal opportunity employment in the workplace. In the second chapter, "Voluntary initiatives as a signalling device: the implications for market structure", which is a joint work with my supervisor Pau Olivella, we take the most cynical view of this phenomenon. Namely, we assume that voluntary initiatives do not have any impact either on consumer's demand, or on the firms' production costs. In the spirit of the pure signalling models of education, we take voluntary initiatives as a purely signalling device. We show how voluntary initiatives could be used to convey information to rivals about one's superior technology in production and we study which implications it has on market structure. We demonstrate that such type of signalling behaviour may explain the inconclusive empirical findings about the relationship between the implementation of voluntary initiatives and industry concentration. In the third chapter "Bargaining on environmental agreements in oligopoly", we continue our line of analysis of self-regulation forms, and we concentrate on the study of a specific type of environmental policy mix which consists of an exogenously set pollution tax and an environmental agreement negotiated between a public authority and an individual firm. The main idea is that a firm may benefit from a more lenient environmental regulation (in a form of a reduced pollution tax) if it agrees to undertake additional measures to reduce pollution. The level of pollution reduction is determined by cooperative bargaining between the firm and the public authority. This type of policy mix is applied in a setting of imperfect competition in the product market. Our focus on the oligopolistic structure of the final good market allows us to study the possibility of using these individual agreements by firms for strategic purposes to improve their competitive position vis-à-vis their rivals. In the setup with two firms with different marginal production costs, we analyse how the outcome of the bargaining process is influenced by which firms and in which order are selected for the bargaining. Our results demonstrate that when the negotiation is delegated to an environmental agency concerned with minimizing the damages from pollution, the existence of agreements may be welfare improving in comparison to the status quo policy both when the bargaining is done with a single firm and when the bargaining is done with two firms sequentially. In addition, we demonstrate that the choice of which firms are selected for the participation in environmental agreements is determined by the ultimate objective of the decision-makers and it may be different depending on whether the decision-maker is concerned with the reduction of the pollution damages or with the increasing social welfare.