Law versus Regulation: A Political Economy Model of Instrument Choice in Environmental Policy

We analyze the conditions under which a legal intervention can be compared to a regulatory framework in the context of a political economy model of environmental policy. The first part of the paper describes the characteristics of the different instruments we want to compare: first, an assignment of legal liability, focusing on the case of extended lender liability, and second, an incentive regulation framework. We briefly describe the application of those instruments in the United States and Europe. In the second part a formal economy model is presented where the possibility of capture of the regulatory agency is modeled in a reduced-form fashion through an overvaluation of the social value of the informational rent of the firms. We show that compared with an extended, strict, joint and several liability system, a regulatory system may perform better or worse from a welfare point of view. Three factors underlying this comparison are discussed in some depth, namely the differential cost between low and high levels of environmental protection activities, the social cost of public funds and the overvaluation factor.
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